Core Principles of Economics and Key Concepts

Cost-Benefit Principle

A principle that evaluates the costs and benefits of a decision.

Opportunity Cost Principle

The cost of forgoing the next best alternative when making a decision.

Marginal Principle

A principle that focuses on the additional benefits and costs of a decision.

Interdependence Principle

The principle that economic agents are affected by the actions of others.

Scarcity

Scarcity refers to the limited nature of society's resources, given society's unlimited wants.

Marginal Benefit

The additional benefit received from consuming one more unit of a good or service.

Marginal Cost

The additional cost of producing one more unit of a good or service.

PPF graph

A Production Possibilities Frontier graph shows the maximum possible output combinations of two goods or services that an economy can produce given its resources and technology.

Comparative Advantage

Allows countries or individuals to specialize in producing goods they are more efficient at, and trade to gain access to goods they are less efficient at producing, increasing overall value.

Law of Demand

The Law of Demand states that, all else being equal, as the price of a good increases, the quantity demanded decreases.

Factors that shift the demand curve

1. Income (Normal vs Inferior Goods) 2. Tastes and preferences 3. Prices of related goods (Substitutes and Complements) 4. Expectations of future prices 5. Number of buyers

Goal of a business/supplier

To maximize profit by minimizing costs and maximizing revenue.

Law of Supply

The Law of Supply states that, all else being equal, as the price of a good increases, the quantity supplied increases.

Market Equilibrium

Market equilibrium is where the quantity supplied equals the quantity demanded, resulting in no shortage or surplus.

Causes of market equilibrium

Market forces such as shortages and surpluses drive the market towards equilibrium, where supply equals demand.

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of the quantity demanded of a good to changes in its price.

Factors determining price elasticity of demand

1. Availability of substitutes 2. Necessity vs luxury 3. Time horizon 4. Definition of the market 5. Proportion of income spent on the good 6. Habit formation

Economic Efficiency

Economic efficiency occurs when resources are allocated in a way that maximizes total economic surplus (consumer surplus + producer surplus).

Deadweight Loss

Deadweight loss is the loss of economic efficiency that occurs when the equilibrium quantity is not achieved, often due to taxes, price controls, or other market failures.

Effect of Taxes on Sellers

Taxes on sellers shift the supply curve upward, leading to a higher price and lower quantity in the market.

Effect of Price Ceilings

A price ceiling, if binding, leads to shortages in the market because the price is kept lower than the equilibrium price.

Externality

An externality occurs when the actions of individuals or firms affect the well-being of others who are not involved in the transaction, leading to market inefficiency.

Externalities

Externalities can be addressed through corrective taxes, subsidies, the Coase theorem, or government regulation to internalize the externality.

GDP

GDP measures the total value of all final goods and services produced within a country in a given period.

Nominal GDP

Nominal GDP is measured using current prices.

Real GDP

Real GDP is adjusted for inflation.

Solow Model

Factors contributing to economic growth in the Solow Model include capital accumulation, technological progress, and labor force growth.

Natural Unemployment Rate

The natural unemployment rate is the rate of unemployment that exists when the economy is at full employment, excluding cyclical unemployment.

Structural Unemployment

Structural unemployment occurs when there is a mismatch between the skills of the workers and the demands of the job market.

CPI

The Consumer Price Index (CPI) measures the average change in prices paid by consumers for goods and services.

Money Illusion

The money illusion occurs when people mistake nominal gains (such as a raise in salary) for real gains, ignoring inflation.

Bond

A bond is a debt security where the issuer borrows funds from the bondholder and agrees to pay back the principal along with interest over time.

Efficient Markets Hypothesis

The efficient markets hypothesis asserts that asset prices fully reflect all available information, making it impossible to consistently achieve returns higher than the average market return.

Business Cycle

A business cycle refers to the fluctuations in economic activity characterized by periods of expansion (growth) and contraction (recession) in an economy.

Potential Output

Potential output is the level of output the economy can produce when all resources are fully employed, without causing inflation.

Federal Reserve's Dual Mandate

The Federal Reserve's dual mandate is to promote maximum employment and stable prices (control inflation).

Federal Reserve Influence

The Fed influences the economy through changes in the federal funds rate, which affects interest rates and aggregate demand.

Fiscal Multiplier

The fiscal multiplier measures the impact of a change in government spending or taxation on the overall economy. A higher multiplier means that the effect of government spending or tax cuts on GDP is larger.

Comparative Advantage

Comparative advantage occurs when a country can produce a good at a lower opportunity cost than another country, leading to trade that benefits both countries.

Tariff

A tariff raises the price of imports, reducing the quantity of imports, which leads to reduced economic surplus for consumers but benefits domestic producers.

Economic Profit

Economic profit takes both explicit and implicit costs into account.

Accounting Profit

Accounting profit only considers explicit costs.

Shutdown Point

The shutdown point occurs when a firm cannot cover its variable costs in the short run, meaning it will minimize losses by ceasing production.