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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
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
law of demand
law that states that the price and demand for a product are inversely related:
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
DIMINISHING MARGINAL UTILITY
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
P1: preferences
P2: population / market size
I: income
C: complementary goods
E: expectations
normal goods
goods where an increase in income INCREASES demand for them
inferior goods
goods where an increase in income DECREASES demand for them
supply
the quantity of a product producers are willing and able to offer for sale at various prices
quantity supplied
law of supply
law that states the price and supply of a product are directly related:
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.
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
O: other good’s prices
T: technology
T: taxes and subsidies
E: expectations
N: number of sellers
substitute goods
two goods are substitutes when the following is true
complementary goods
two goods are complementary when the following is true
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
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
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
expenditure approach
income approach
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
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
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
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
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
open market operations
activities in which the Fed buys and sells government securities in the secondary market
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
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
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
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