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allocative efficiency
A state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it
productive efficiency
a situation in which a good or service is produced at the lowest possible cost
equity
the fair distribution of economic benefits
factors of production
labor, capital, natural resources, and other INPUTS used to make goods and services
scarcity
A situation in which unlimited wants exceed the limited resources available to fulfill those wants
normal good
a good for which the demand increases as income rises and decreases as income falls
complements
goods and services that are used together
inferior good
a good for which the demand increases as income falls and decreases as income rises
economics
the study of the choices people make to attain their goals, given their scarce resources
Where does optimal decision making occur?
at the MARGIN (where marginal benefit equals marginal cost)
market
a group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade
rational decision making occurs when
people have used all available information and have weighed all known benefits and costs
centrally planned economy
an economy in which the government decides how economic resources will be allocated
market economy
an economy in which the decisions of households and firms interacting in markets allocate economic resources
mixed economy
An economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources.
opportunity cost
The highest-valued alternative that must be given up in order to engage in an activity.
three economic questions that every society must answer
1.) What goods and services will be produced?
2.) How will the goods and services be produced?
3.) Who will receive the goods and services produced?
Who could possibly make decisions about what goods and services will be produced?
consumers, firms and government
In the US, what determines who will receive goods and services?
income distribution
hypothesis
a statement, usually about casual relationships, that may either be correct or incorrect and has to be tested before it can be accepted (or not rejected)
positive analysis
analysis concerned with what is
normative analysis
analysis concerned with what ought to be
macroeconomics
the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth
microeconomics
the study of how households and firms make decisions and how they interact in markets and how the government attempts to influence their choices
three assumptions of economics
1.) People are rational
2.) People respond to economic incentives
3.) Optimal decisions are made at the margin
demand schedule
a table that shows the relationship between the price of a good and the quantity of the product demanded
demand curve
a curve that shows the relationship between the price of a product and the quantity of the product demanded
ceteris paribus
"all else equal" condition; the requirement that when analyzing the relationship between two variables, such as price and quantity demanded- all other variables must be held constant
law of demand
A rule that states that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease; price and quantity demanded have an inverse relationship
Shifters of Demand
1.) Income
2.) Prices of related goods
3.) Tastes
4.) Population and demographics
5.) Expected future prices
Shifters of Supply
1.) Prices of inputs
2.) Technological change
3.) Prices of related goods in production
4.) Number of firms in the market
5.) Expected future prices
Three conditions of a perfectly competitive market
1.) Many buyers and sellers
2.) All firms selling identical products
3.) No barriers to new firms entering the market
What does not shift the supply or demand curve?
PRICE/The price of the product itself
What does a change in price cause?
Movements along the supply or demand curve
substitutes
Goods and services that can be used for the same purpose and serve as replacements for one another
complements
goods and services that are used together (when you use one, you use the other)
law of supply
a law that states that, holding everything else constant, increases in price cause increases in quantity supplied and decreases in price cause decreases in the quantity supplied (price and quantity supplied have a direct relationship)
market equilibrium
a situation in which quantity demanded equals quantity supplied
surplus
A situation in which quantity supplied is greater than quantity demanded
shortage
A situation in which quantity demanded is greater than quantity supplied
When is the PPF a straight line?
When opportunity cost is constant
comparitive advantage
the ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors
absolute advantage
the ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources
marginal benefit
the additional benefit from consuming one more unit.
marginal cost
the additional cost of producing one more unit
consumer surplus
the difference between the highest price a consumer is willing to pay for a good or service and the actual price the consumer pays
producer surplus
the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives
Consumer surplus is equal to the area
under the demand curve and above the price line for the units consumed
Producer surplus is equal to the area
above the supply curve and below the price line for units produced and sold
price ceiling
a legally determined maximum price that sellers may charge
price floor
a legally determined minimum price that sellers may receive
deadweight loss
the reduction in economic surplus resulting from a market not being in competitive equilibrium
Economic surplus is maximized when
the marginal benefit of consumption is equal to the marginal costs of production
economic surplus
the sum of consumer surplus and producer surplus
black market
a market in which buying and selling take place at prices that violate government price regulations
tax incidence
the actual division of the burden of a tax between buyers and sellers in a market
What is the leading exporting country in the world?
China
autarky
a situation in which a country does not trade with other countries
Reasons why countries do not completely specialize
1.) Production of most goods includes increasing opportunity costs
2.) Not all goods are traded internationally
3.) Tastes for products differ
dumping
selling a product for a price below its cost of production
protectionism
The use of trade barriers to shield domestic firms from foreign competition
GDP equation
Y = C + I + G + NX
4 components of expenditures in GDP
consumption, investment, government purchases and net exports
value added
the market value a firm adds to a product
final good or service
a good or service purchased by a final user
Intermediate good or service
a good or service that is an input into another good or service, such as a tire on a truck
GDP
the market value of all final goods and services produced within a country in a given period of time
The value of GDP in a given year can also mean
Value of output
Total income
Total spending
3 Categories of Investment
1) Business fixed investment (spending by firms on . new factories, office buildings and machinery)
2) Residential investment (spending on NEW houses)
3) Changes in inventories (changes in the stocks of goods that have been produced, but not yet sold)
What levels of government spending are included in government purchases?
Federal, state and local (all levels)
shortcomings of GDP
-does not measure household production
-does not account for the underground economy
-cannot account for the environmental effects of production
-other measures of well being are unaccounted for
GDP deflator equation
(Nominal GDP/Real GDP) x 100
nominal GDP
the value of final goods and services evaluated at current year prices
real GDP
the value of final goods and services evaluated at base year prices
disposable personal income
personal income minus tax payments, such as the federal income tax
gross national product
Production performed by citizens of a nation, including overseas production
national income
GDP minus depreciation (value of worn out production investments, like equipment, machinery and buildings, that have to be replaced)
personal income
national income minus retained corporate earnings plus government transfer payments and interest on government bonds.
reasons that the unemployment rate understates the true value of unemployment
-discouraged workers are not included in the labor force
-part time workers are considered employed
-lack of verification of people's responses in the household survey
-underemployed people are considered employed
-it fails to account for illegal activities
labor force participation rate equation
(labor force/working age population) x 100
What is the general trend in the labor force participation rate since 1948?
decreasing for men and increasing for women
unemployment rate equation
(number unemployed/labor force) x 100
Three types of unemployment
frictional, structural, cyclical
frictional unemployment
short-term unemployment that arises from the process of matching workers with jobs
structural unemployment
unemployment that arises from a persistent mismatch between the skills or attributes of workers and the requirements of jobs
cyclical unemployment
unemployment caused by a business cycle recession
natural rate of unemployment
the normal rate of unemployment, consisting of frictional and structural unemployment
When is the economy at FULL EMPLOYMENT?
When the unemployment rate equals the natural rate of employment
How does government unemployment insurance affect the unemployment rate?
It tends to increase the unemployment rate by lowering the opportunity cost of job search
efficiency wage
an above-market wage that a firm pays to increase workers' productivity
Consumer Price Index (CPI)
A measure of the average of the prices a typical urban family of four pays for the goods and services they purchase
CPI equation
(expenditures in the current year/expenditures in the base year) x 100
inflation rate equation
((CPI Year 2 - CPI Year 1)/ CPI Year 1) x 100
Reasons that CPI overstates the inflation rate
-substitution bias
-new product bias
-increase in quality bias
-outlet bias
Producer Price Index (PPI)
an average of the prices received by producers of goods and services at all stages of the production process
What measurement can give an early warning of future increases in the price level?
PPI (Producer Price Index)
nominal interest rate
the stated interest rate on a loan
real interest rate
the nominal interest rate minus the inflation rate
What happens when the nominal interest rate is lower than the real interest rate?
deflation
menu costs
the cost to firms of changing prices
