BARRONS AP MacroEconomics study book vocab

absolute advantage

the ability to produce something more efficiently

capital

productive equipment or machinery

comparative advantage

the ability to produce something with a lower opportunity cost

economics

a social science that studies how resources are used and is often concerned with how resources can be used to their fullest potential

efficiency

using resources to their maximum potential

labor

all human activity that is productive

land

all natural resources

law of increasing costs

law that states that when more of a product is initially being produced, the higher the opportunity cost will be to produce still more

macroeconomics

economic problems encountered by the nation as a whole

microeconomics

economic problems faced by individual units within the overall economy

normative economics

economics involving value judgements

opportunity cost

the amount of one good that must be sacrificed to obtain an alternative good

positive economics

economic analysis that draws conclusions based on logical deduction or induction; value judgements are avoided

production possibilities frontier (PPC)

the combinations of two goods that can be produced if the economy uses all of its resources fully and efficiently

resource

anything that can be used to produce a good or service

terms of trade

the amount of one good a country is willing and able to trade for another

terms of trade must be BETWEEN both countries opportunity costs for the good, otherwise none will benefit

allocative efficiency

when resources are deployed to produce just the right amount of each product to satisfy society’s wants

happens when supply and demand are allowed to determined prices in competitive markets

capitalism

an economic system where supply and demand determine prices

circular flow diagram

diagram that shows how households and firms are related by the exchange of resources and products

3 fundamental economic questions

1. what should be produced?
2. how much of each good should be produced?
3. who gets what?

command economy

economy in which the central government dictates what will or will not be produced and who gets what

law of demand

law that states that when the price of a product increases, the quantity demanded decreases (all other things equal)

law of supply

law that states that when the price of a product increases, the quantity supplied increases (all other things equal)

market

a mechanism that allows buyers and sellers to exchange a good or service

a place where buyers and sellers meet to exchange goods and services

mixed economy

a blend of government commands and capitalism

ceterus paribus

holding all other factors or conditions constant

demand

the quantity of a product consumers are willing and able to purchase at each and every price

quantity demanded

• increases when price of a good decreases
• decreases when price of a good increases

law of demand

law that states that the price and demand for a product are inversely related:

• when the price of a product increases, demand for it decreases
• when the price of a product decreases, demand for it increases

reasons for the law of demand

INCOME EFFECT

• the purchasing power of income is inversely related to the price of a product

  if the price of a particular good decreases, a consumer may buy more of this good as his income has more buying power

SUBSTITUTION EFFECT

• when the price of a good increases consumers will replace their consumption of the good with other goods that are now relatively cheaper (decreasing demand for the good).

DIMINISHING MARGINAL UTILITY

• as consumers buy more of the same product (demand increase), the use/satisfaction they get out of it decreases - along with the price they are willing to pay.

determinants of demand (+ acronym)

the factors that cause consumers to buy more or less of a good or service at the SAME price

acronym: S(Px2)ICE

S: prices of substitutes

• if the price of a substitute goes up, demand for the good goes up
• if the price of a substitute goes down, demand for the good goes down

P1: preferences

P2: population / market size

• bigger market = more overall demand
• smaller market = less overall demand

I: income

• as income increases, demand for normal goods increases while demand for inferior goods decreases
• as income decreases, demand for normal goods decreases while demand for inferior goods increases

C: complementary goods

• if the price of a complementary good goes up, demand for the good goes down
• if the price of a complementary good goes down, demand for the good goes up

E: expectations

• expectations of lower prices in the future = decrease in current demand
• expectations of higher prices in the future = increase in current demand

normal goods

goods where an increase in income INCREASES demand for them

• ex. vacation homes, nice cars, new technology

inferior goods

goods where an increase in income DECREASES demand for them

• ex. used cars, thrift store clothes

supply

the quantity of a product producers are willing and able to offer for sale at various prices

quantity supplied

• increases when price of a good increases
• decreases when price of a good decreases

law of supply

law that states the price and supply of a product are directly related:

• when the price of a product increases, its supply increases
• when the price of a product decreases, its supply decreases

reasons for the law of supply

each additional unit of a good produced costs more and more (increasing marginal utility), so it takes higher prices to incentivise producers to make more.

• higher prices = easier to cover costs of production, greater opportunity to increase profits
• lower prices = harder to cover costs of production, less profit

determinants of supply (+ acronym)

the factors that cause producers to offer more or less of a product for sale at the same prices

acronym: ROTTEN

R: resource costs and availability

• increase in price of inputs = less profit = less supply
• decrease in price of inputs = more profit = more supply

O: other good’s prices

• profit-maximizing firms choose to produce what gives them the most profit
• increase in price of good B relative to A = firms choose to produce B for more profit = less supply A
• decrease in price of good B relative to A = firms choose to produce more of A for more profit = more supply of A

T: technology

• better technology = better productivity = less production costs = more supply

T: taxes and subsidies

• more taxes on goods = more production costs = less profit = less supply
• less taxes on goods = less production costs = more profit = more supply
• more subsidies on goods = less production costs = more profit = more supply
• less subsidies on goods = more production costs = less profit = less supply

E: expectations

• expectation for higher prices in the future = less produced now to maximize profit later
• expectation for lower prices in the future = more produced now to maximize profit now

N: number of sellers

• more sellers = more supply (and competition)
• less sellers = less supply (and competition)

substitute goods

two goods are substitutes when the following is true

• increase in price of one good increases demand for the other
• decrease in price of one good decreases demand for the other

complementary goods

two goods are complementary when the following is true

• increase in price of one good decreases demand for the other
• decrease in price of one good decreases demand for the other

subsidy

a payment from the government to produce a product - creates greater incentive to produce more of a product, INCREASES SUPPLY

equilibrium price

price at which quantity supplied equals quantity demanded

price at which demand curve and supply curve intersect

also called the “market clearing price”

equilibrium quantity

the quantity of a good produced at equilibrium price

income effect

the purchasing power of income is inversely related to the price of a product

if the price of a particular good decreases, a consumer may buy more of this good as his income has more buying power

• reason for law of demand

shortage

when the quantity demanded is greater than the quantity supplied - price is BELOW equilibrium price

in a competitive market with a shortage, buyers will bid prices back up until they reach equilibrium

surplus

when the quantity supplied is greater than the quantity demanded - price is ABOVE equilibrium price

in a competitive market with a surplus, producers will respond by decreasing prices until they are back at equilibrium

substititution effect

• when the price of a good increases consumers will replace their consumption of the good with other goods that are now relatively cheaper (decreasing demand for the good).

reason for the law of demand

consumption expenditures

dollar value of all the goods and services sold to households

disposable personal income (DPI)

the income of households after taxes have been paid

government expenditures

the dollar value of goods and services sold to governments

gross domestic product (GDP) + 3 ways to calculate

dollar value of all the production within a nation’s borders in one year

1. expenditure approach

   1. GDP = C + I + G + (X-M)

2. income approach

3. value-added approach

gross NATIONAL product (GNP)

value of all products and services produced by the citizens of a country both DOMESTICALLY (living in the country) and INTERNATIONALLY (living outside national borders)

GNP = GDP + income made by firms/citizens abroad - income earned by foreign firms/nationals

intermediate sales

sales to firms that will incorporate the item into their final product

investment expenditures

• expenditures by businesses on plant and equipment
• residential construction
  • change in business inventories

national economic accounts (NEA)

a comprehensive group of statistics that measures various aspects of the economy’s performance

national income (NI)

the income earned by households and profits earned by firms AFTER subtracting depreciation and indirect business taxes

depreciation

the gradual decrease in the economic value of the capital stock of a firm, nation or other entity

• through physical depreciation,
• obsolescence, or
• changes in the demand for the services of the capital in question

net exports

exports - imports

real GDP

GDP adjusted for price changes

underground economy

all the legal production of goods and services + legal production that does not pass through markets

things not counted in GDP

• secondhand sales (sales of products NOT produced that year or were already sold once) (double-counting)
• transactions that are purely financial (stock, bonds, etc. - do not represent actual production of a good)
• intermediate sales - sales to firms that will be incorporated into the new product

cash drain

money held by households and firms as currency rather than in bank deposit accounts - diminishes the money supply

central bank

an institution that oversees the banking system and conducts monetary policy (the “Fed” in the US)

currency

coins and paper money

demand deposit

a checking account at a bank

discount rate

the rate of interest the Fed charges when it makes loans to depository institutions

excess reserves

the amount of any deposit that does not have to be held aside and may be used to make loans and buy investments

federal reserve

the central bank of the United States

fiat money

money that is not backed by any precious commodity (like gold)

government securities

IOUs that the government issues when it borrows money

• also called Treasury bills

liquidity

the ability to turn an asset into cash rapidly and without loss

M1

currency + demand deposits + other checkable deposits + savings accounts

M2

M1 plus small time deposits and retail money market funds

monetary base

currency plus bank reserves

money

anything that society generally accepts in payment for a good or service

money multiplier

equal to 1/ reserve requirement

• the multiple by which the money supply will change because of a change in bank reserves

open market operations

activities in which the Fed buys and sells government securities in the secondary market

• used to conduct monetary policy

other checkable deposits

an account at a savings and loan, credit union, or other depository institution that functions like a checking account at a bank

other liquid assets

other checkable deposits plus savings accounts

precautionary reserves

bank reserves over and above what are needed for loans, investments, and withdrawals

• basically excess reserves that are kept excess reserves and not loaned out

required reserves

the amount of any deposit that must be held aside and not used to make loans or buy investments

reserve requirement

the percentage of any deposit that must be held aside and not used to make loans or buy investments

retail money market fund

similar to an interest-earning checking account except there are limits on how many withdrawals can be made in a month

savings account

an account at a depository institution that earns interest while the funds are readily available but cannot be withdrawn with checks

secondary market

place where government securities that have already been issued may be bought or sold

small-time deposit

an interest-earning bank account under $100,000 that cannot be withdrawn without penalty until a specified date

classical dichotomy

theory that states a change in the money supply will affect nominal variables in the economy but not real variables

• same as monetary neutrality

demand for money

the amount of money households, firms, government, and foreign entities want to hold in currency and in their transaction accounts (and savings accounts)

financial intermediary

any firm or institution that participates in financial intermediation

financial intermediation

the process of moving money from savers (lenders) to spenders (borrowers)

hyperinflation

very severe inflation

loanable funds

money available for borrowing and lending

monetary neutrality

theory that states a change in the money supply will affect nominal variables in the economy but not real variables

• same as classical dichotomy

nominal interest rate

the interest rate as stated and not adjusted for inflation

nominal variables

things that are expressed in dollar amounts and are not adjusted for inflation

real interest rate

the interest rate adjusted for inflation

= nominal interest rate - inflation rate

real variables

things that are expressed in non-monetary units or adjusted for inflation

velocity of money

the number of times a typical unit of money is used for purchases in a year

aggregate demand

the demand for all goods and services by all households, businesses, governments, and foreigners

aggregate supply

the supply of all goods and services by all producers in the economy