Introduction to Economics Final Exam, Key Concepts

Rational Choice Assumption

The rational choice assumption is the idea that individuals choose actions that maximize their own utility based on stable preferences and full information.

Inflation and Deflation

Inflation is the rise in overall prices reducing money's purchasing power, while deflation is the opposite—a general decrease in prices increasing money's value.

Classical Political Economy

Classical political economy emerged in the late 18th and 19th centuries and focused on understanding the laws of production, distribution, and value in capitalist economies. Key figures include Adam Smith, David Ricardo, and John Stuart Mill, who emphasized free markets and the role of labor in value creation.

Determination Of Income And Interest Rate

In the IS-LM framework, income (or output) and interest rate are determined together through the interaction of the goods market and money market. The IS curve shows income levels where goods market is in balance and the LM curve shows interest rates where money market is balanced. Their intersection sets the overall equilibrium income and interest rate.

Countercyclical Fiscal Policy

Countercyclical fiscal policy involves government actions, such as increasing spending or cutting taxes, designed to reduce the fluctuations in economic activity by stimulating the economy during a recession and cooling it down during booms.

Money Market Equilibrium

Money market equilibrium occurs when the quantity of money demanded by the public equals the quantity of money supplied. At this point, the interest rate remains stable, balancing liquidity preference and money availability.

Marshall's Synthesis and Partial Equilibrium

Alfred Marshall combined ideas from classical economics and the new marginalist approach, creating what is known as Marshall's Synthesis. He introduced the concept of partial equilibrium, which studies the equilibrium of a single market while holding other markets constant. This method simplified analysis and helped economists understand supply and demand, price formation, and consumer behavior within individual markets.

Demand Curve

A demand curve shows the relationship between the price of a good and the quantity consumers are willing and able to buy at different prices. It typically slopes downward, indicating that lower prices increase demand.

Supply Curve

A supply curve displays the relationship between the price of a good and the quantity producers are willing to sell. It usually slopes upward, meaning higher prices encourage greater supply.

Pareto Efficiency

Pareto Efficiency is a concept named after economist Vilfredo Pareto. It describes a situation where resources are allocated in such a way that no one can be made better off without making someone else worse off. This idea is important in welfare economics and helps analyze economic efficiency, equity, and optimal resource distribution in markets.

Monetarism, New Classical & Rational Expectations

Monetarism, New Classical & Rational Expectations combine theories that emphasize the role of money supply, market efficiencies, and individuals’ forward-looking behavior in explaining and forecasting economic outcomes.

Economic Growth

Economic Growth refers to the sustained increase in a country's output of goods and services over time, reflecting improvements in productivity, capital stock, and technology.

Exogenous Technological Change

Technological improvements that occur outside the model and grow at a constant rate, helping to increase productivity and economic growth without being explained by the model itself.

Technological Innovation

Technological innovation refers to the development and application of new technologies or techniques that improve productivity and efficiency in the economy. It often drives economic growth by enabling better production methods and products.

Solow-Swan Model: Convergence, Golden Rule, Conditional β-convergence

The Solow–Swan Model is a foundational economic model explaining long-term economic growth by focusing on capital accumulation, labor, and technology. 'Convergence' means poorer economies tend to grow faster than richer ones, catching up over time. The 'Golden Rule' refers to the ideal savings rate that maximizes steady-state consumption per worker. 'Conditional β-convergence' suggests that countries converge to their own balanced growth paths, given similar structural conditions like savings rates and technology, not necessarily to the same income level.

Investment Equals Depreciation

This condition means that the total new investment in capital exactly replaces the capital lost due to depreciation, ensuring no net change in capital stock per worker at steady state.

IS-LM Model

The IS-LM model is a framework that shows the interaction between the goods market (Investment-Saving or IS curve) and the money market (Liquidity preference-Money supply or LM curve) to determine the equilibrium level of income and interest rate.

Fiscal vs. Monetary Policy Mix & Crowding-out

Fiscal policy means changing government spending or taxes, while monetary policy involves adjusting the money supply or interest rates. Together, they influence output and interest rates in the IS-LM model. Crowding-out refers to how expansionary fiscal policy can raise interest rates, reducing private investment partially offsetting fiscal effects.

Interest Rate Policy

Interest rate policy refers to the central bank's use of setting or adjusting short-term interest rates to influence economic activity and control inflation. By raising or lowering interest rates, the central bank can affect borrowing, spending, and investment in the economy.

Marginal Propensity to Consume

The marginal propensity to consume (MPC) is the proportion of an additional unit of disposable income that a household spends on consumption. It shows how consumption changes as income changes.

IS-LM Equilibrium

IS-LM equilibrium occurs where the IS and LM curves intersect, indicating simultaneous equilibrium in both the goods market and the money market. At this point, planned saving equals planned investment and money demand equals money supply.

Simultaneous Equilibrium

Simultaneous Equilibrium occurs when both the goods market and the money market are in balance at the same time. This means that the output level and interest rate simultaneously satisfy both the IS curve (goods market equilibrium) and the LM curve (money market equilibrium).

LM curve: Money Demand, Liquidity Preference & Central-bank Balance Sheet

The LM curve represents points where the demand for real money balances equals the supply, reflecting liquidity preference. It shows how income and interest rates interact to balance money demand with the fixed money supply managed by the central bank. When income rises, money demand increases, pushing interest rates up along the LM curve.

Change in Money Supply

Change in money supply refers to the central bank increasing or decreasing the total amount of money available in the economy. An increase in money supply generally lowers interest rates and shifts the LM curve downward or to the right.

Money Market Equilibrium

Money Market Equilibrium happens when the quantity of money demanded by the public equals the quantity of money supplied by the central bank. At this point, the interest rate balances the desire to hold money and the available money supply.

Inflation, Expectations & the Phillips Curve

This topic explores the relationship between inflation and unemployment, including how inflation expectations shape wage-setting and price-setting behavior, illustrated by the Phillips curve.

Discretionary Policy

Discretionary policy refers to economic policies that are actively designed and implemented by policymakers to influence the economy, such as changes in government spending or interest rates, based on current economic conditions rather than following preset rules.

Investment & Capital Accumulation

Investment and Capital Accumulation involve the flow of resources into capital goods, which increases the productive capacity of an economy and contributes to economic growth over time.

Capital Accumulation

Capital accumulation is the process of growing physical, human, or natural capital through investment, leading to increased productive capacity over time.

Output per Worker

Output per Worker measures the total production of goods and services divided by the number of workers, reflecting labor productivity in the economy.

Optimal Capital Stock

Optimal Capital Stock is the amount of capital that maximizes a firm's value. It is the level where the company's marginal product of capital equals the user cost of capital, meaning investing more or less would reduce profits.

Macroeconomic Measurement & Accounting

Macroeconomic Measurement and Accounting refers to the methods used to quantify overall economic activity, including calculating GDP, national income, and various price indices to evaluate a country's economic performance.

Nominal Gross Domestic Product

Nominal Gross Domestic Product is the total market value of all final goods and services produced within a country in a specific time period, measured using current prices without adjusting for inflation.

Implicit Price Deflator

Implicit price deflator is a price index that measures the overall level of prices of all new, domestically produced, final goods and services in an economy. It is calculated by dividing nominal aggregate output by real aggregate output and is used to remove the effects of inflation when measuring economic growth.

Exports Of Goods And Services

Exports of goods and services are the value of products and services produced domestically but sold to other countries. They bring income into the domestic economy from foreign buyers.

Net Exports Component

The net exports component equals the value of exports minus imports. It shows the impact of trade on the country’s GDP, where positive net exports add to GDP and negative net exports subtract from it.

Wages And Salaries

Payments made to employees for their labor, including pay for regular hours worked, overtime, bonuses, and any other compensation related to employment.

Circular Flow Of Income

The Circular Flow of Income is a model showing the continuous movement of income and spending between households and firms through markets for goods, services, and factors of production.

Product Approach

The Product Approach, also known as the output approach, measures GDP by summing the market value of all final goods and services produced within an economy over a specific period. It focuses on the value added at each stage of production to avoid double counting.

National Income Accounting

National Income Accounting is a system used to measure the economic activity of a country by recording aggregate income and expenditure totals like GDP, savings, and investment.

Gross Domestic Product By Expenditure

Gross Domestic Product By Expenditure measures the total value of all goods and services produced in a country by summing consumption, investment, government spending, and net exports (exports minus imports).

Social Optimum

The Social Optimum is the level of production or consumption where total social welfare is maximized. It balances marginal social costs and benefits, achieving an efficient outcome for society as a whole.

Welfare Loss

Welfare Loss is the reduction in total surplus caused by inefficiencies in the market, such as externalities, resulting in an allocation of resources that is not optimal for society.

Factor Markets & Mechanisms

This topic looks at markets for factors of production such as labor, capital, and land. It examines how prices and quantities are determined and how factors are allocated efficiently among various uses.

Graphical Optimization Analysis

Graphical Optimization Analysis is a visual method used to solve optimization problems. It involves drawing curves or lines, such as budget constraints and indifference curves, to find the point where the objective function is optimized while satisfying any constraints.

Budget Line

The budget line represents all combinations of two goods that a consumer can purchase with a given income and fixed prices. It shows the trade-off in consumption between the two goods within the budget constraints.

Comparative Statics & Envelope Theorem

Comparative statics is the study of how changes in parameters affect the optimal outcome of an economic model. The envelope theorem simplifies calculation of these effects by focusing only on direct changes in the objective function while holding optimal choices fixed, making comparative statics more manageable.

Cost-Benefit Analysis in Microeconomics

Cost-benefit analysis in microeconomics is a systematic approach to compare the benefits and costs of different economic choices or projects. It helps decision-makers evaluate whether the advantages of an action outweigh the disadvantages, including consideration of opportunity costs, to determine the most beneficial option.

Pareto Efficiency and Market Failure

Pareto efficiency occurs when resources are allocated in a way that no one can be made better off without making someone else worse off. Market failure happens when markets do not allocate resources efficiently, leading to outcomes that are not Pareto efficient. This can result from externalities, public goods, or information problems, causing a need for intervention or analysis in microeconomics.

First & Second Welfare Theorems

The First Welfare Theorem states that any competitive equilibrium allocation is Pareto efficient. The Second Welfare Theorem says that under certain conditions, any Pareto efficient allocation can be achieved as a competitive equilibrium after appropriate redistribution of initial endowments.

General Equilibrium with Production

General equilibrium with production extends the model of exchange economies by including firms that produce goods using inputs like labor and capital. In this setting, prices and production plans adjust simultaneously so that all markets for goods and factors are in equilibrium, ensuring that supply equals demand everywhere and resources are used efficiently.

Intermediate Consumer Theory

This field examines how individual consumers make choices to maximize their satisfaction given budget constraints, analyzing concepts like utility functions, budget lines, preference ordering, and demand functions.

Market Demand Shifts

Changes in total market demand at every price level caused by factors other than the good's own price, such as changes in income, tastes, or prices of related goods.

Optimal Choice and Interior / Corner Solutions

Optimal choice is the consumer's best decision that maximizes utility given budget constraints. An interior solution occurs when the consumer spends on positive amounts of all goods. A corner solution happens when consumption of some goods is zero, indicating the optimum lies at the boundary of the consumption choices.

Utility Maximization Concept

Utility maximization is the idea that consumers choose the combination of goods and services that gives them the highest satisfaction or happiness, given their limited income and prices of goods.

Intertemporal Choice & Capital Markets

This area analyzes how people decide to distribute consumption and saving over time. It includes the role of interest rates, borrowing and lending, and choices related to investment and consumption across different periods.

Two-Period and Multi-Period Models

Two-Period and Multi-Period Models are frameworks used to analyze decisions that involve choosing consumption or savings over two or more time periods. These models help to understand how people allocate resources over time, considering income, interest rates, and preferences for present versus future consumption.

Present Discounted Value

Present discounted value is the current worth of future income or consumption, calculated by applying a discount factor to account for the preference of present consumption over future consumption.

Market Price

The actual price at which a good or service is bought and sold in the market, determined by supply and demand.

No Deadweight Loss At Equilibrium

No Deadweight Loss At Equilibrium signifies that at the market equilibrium, there is no loss of economic efficiency. The production and consumption levels are optimal, and no resources are wasted or unutilized, ensuring the maximum total surplus.

Total Surplus After Tax

Total surplus after tax is the sum of consumer surplus, producer surplus, and tax revenue, reflecting the overall economic welfare after a tax is imposed.

Tax Incidence and Burden

Tax incidence refers to how the burden of a tax is shared between buyers and sellers in a market. It shows who actually pays the tax after it is imposed, which may differ from who is legally required to pay it. The tax burden depends on the relative price elasticities of demand and supply.

Short-Run vs Long-Run Production; Returns to Scale Concept

Short-run production refers to a time period when at least one input is fixed, limiting the firm's ability to adjust all inputs. Long-run production is a period when all inputs can be varied. Returns to scale describe how output changes when all inputs are increased proportionally: increasing returns to scale means output grows more than inputs; constant returns to scale means output grows proportionally; decreasing returns to scale means output grows less.

Returns to Scale in the Long Run

Returns to scale in the long run describe how output changes when all inputs are increased proportionally. If output increases more than inputs, there are increasing returns to scale; if output increases less, decreasing returns to scale; and if output increases proportionally, constant returns to scale.

Short-Run and Long-Run Competitive Supply

Short-run competitive supply is the total quantity of a good that firms are willing to produce at different prices when some inputs are fixed, limiting their ability to adjust fully. In contrast, long-run competitive supply considers all inputs as variable and firms can enter or exit the market freely, leading to an equilibrium where firms earn zero economic profits.

Marginal Utility of Consumption

Marginal utility of consumption is the additional satisfaction or benefit gained from consuming one more unit of a good or service, often decreasing as consumption increases.

European Central Bank (ECB)

The European Central Bank (ECB) is the institution responsible for managing the euro and setting monetary policy for Eurozone countries. Its main goals are to maintain price stability and support economic growth within the euro area.

Comparative Advantage: Ricardian Model

The Ricardian model explains international trade based on comparative advantage, which occurs when a country can produce a good at a lower opportunity cost than another country. This model uses labor as the only production factor and shows how trade benefits countries by allowing each to specialize in goods they produce relatively more efficiently.

Autarky Price Ratio

The autarky price ratio is the ratio of the prices of two goods in a country when it is closed off to trade. It shows how much of one good must be given up to get a unit of the other based on domestic production technologies.

Comparative Advantage Concept

Comparative advantage means that a country has the ability to produce a good at a lower opportunity cost than another country. It allows countries to benefit from trade by specializing in producing goods in which they have comparative advantage and then exchanging them. This principle explains why countries can gain from trade even if one country is less efficient in producing all goods.

Efficiency Gains From Trade

Efficiency gains from trade occur when countries specialize according to their comparative advantage, allowing for higher total production and consumption than without trade.

Production Possibility Frontier

The production possibility frontier (PPF) is a curve that shows the maximum possible production of two goods given limited resources and technology. It illustrates trade-offs and opportunity costs in production.

Relative Productivity

Relative productivity compares how efficiently different countries can produce various goods. It measures output per unit of input and helps determine which country should specialize in which products for trade.

Quantity of Labor to Produce One Unit

This term refers to the specific amount of labor input needed to create one unit of a product. It is another way to describe the unit labor requirement.

Real Income Redistribution

Real income redistribution involves changes in the purchasing power and income distribution among households and factors of production caused by openness to international trade.

Gross Domestic Product

Gross Domestic Product (GDP) is the total market value of all goods and services produced within a country over a certain time frame.

Political Economy of Trade Policy

The Political Economy of Trade Policy studies how economic interests, political institutions, and power influence government decisions on trade regulations like tariffs and quotas. It examines how different groups affected unevenly by trade, such as industries with specific factors, lobby for policies that protect or promote their interests.

International Monetary System & Crises

The global framework of rules and institutions governing international currency exchange and finance, including episodes of financial instability and how they are managed.

Trade Policy Instruments & Analysis

These are the tools governments use to influence international trade, such as tariffs, quotas, and subsidies. Analysis of these tools helps understand their effects on trade flows, prices, and economic welfare.

Efficiency Loss (Deadweight Loss)

Efficiency Loss refers to the loss of total welfare in the market because tariffs cause consumers to buy less and producers to produce more less efficiently. This loss includes lost consumer and producer surplus not compensated by government revenue.

Welfare Costs of Protection & Deadweight Loss

Welfare costs of protection are reductions in overall economic efficiency caused by trade policies like tariffs or quotas, which distort prices and market behavior. Deadweight loss refers to the net loss of total welfare (consumer and producer surplus) that occurs because protection makes goods more expensive and reduces the volume of mutually beneficial trade.

Trade, Growth & Development

This area studies the relationship between international trade and the economic growth and development of countries. It explores how trade can help countries improve incomes, reduce poverty, and promote industrial development.

Trade, Trade Imbalance, Inequality & Poverty

Trade imbalance occurs when the value of a country's imports differs from its exports, which can affect national economic health. Unequal distribution of trade benefits can exacerbate income inequality and poverty, as some groups gain more from trade while others may face job losses or lower wages in impacting sectors.

Foundations of Labor Economics

Foundations of Labor Economics refer to the basic principles and theories that explain how workers and employers interact in the labor market. It studies the behavior of workers in supplying labor and firms in demanding labor to understand employment, wages, and work conditions.

Natural Rate of Unemployment

The natural rate of unemployment is the level of unemployment that exists when the labor market is in equilibrium, including frictional and structural unemployment but excluding cyclical unemployment. It reflects normal labor market turnover.

Equilibrium Wage Rate

The wage at which the quantity of labor supplied equals the quantity of labor demanded in the labor market, resulting in no tendency for wage changes.

Elasticity of Substitution and Factor Demand

Elasticity of substitution measures how easily a firm can replace one input, like labor, with another input, like machinery. If substitution is easy, when wages rise, firms will use less labor and more capital. This impacts how much labor a firm demands.

Value Of Marginal Product

The Value of Marginal Product (VMP) is the worth of the additional output produced by one more unit of labor, calculated as the marginal product of labor multiplied by the output price.

Labor Market Equilibrium & Compensating Differentials

Labor Market Equilibrium occurs when labor supply equals labor demand, determining the market wage and employment levels; Compensating Differentials are wage differences that compensate workers for non-monetary job characteristics like risk or location.

Minimum Wage Laws

Minimum wage laws set the lowest legal hourly pay rate that employers must offer workers. These laws aim to ensure a basic standard of living for employees and can affect labor market supply and demand.

Minimum Wage Laws and Living Wage Ordinances

Minimum wage laws are government rules that set the lowest hourly pay that employers can legally give to workers.

Living wage ordinances go a step further by requiring higher wages that meet the basic cost of living in a specific area, ensuring workers can afford essential expenses like housing and food.

Labor Market Equilibrium

Labor Market Equilibrium occurs when the quantity of labor supplied equals the quantity of labor demanded. At this point, the wage rate balances the desires of workers to work and employers to hire, leaving no force pushing wages or employment up or down.

Marginal Utility of Consumption

The Marginal Utility of Consumption is the additional satisfaction or benefit a worker gains from consuming one more unit of goods or services, holding leisure constant.

Unemployment

The situation where individuals who are willing and able to work cannot find jobs despite searching, measured as a percentage of the labor force.

Interest Rates & Term Structure

Interest rates are the cost of borrowing money or the return on savings, usually expressed as a percentage. The term structure of interest rates shows the relationship between interest rates and different maturities of debt, often depicted by the yield curve.

Government Borrowing

Government borrowing is when the government borrows funds from the capital markets or the public to finance its spending when tax revenues fall short. It influences the demand for loanable funds and the equilibrium interest rate.

Monetary Policy Frameworks

Monetary policy frameworks are systems designed by central banks that outline their objectives, tools, and strategies to influence inflation, employment, and economic growth.

Independent Monetary Policy

Independent Monetary Policy refers to a country's ability to set its own interest rates and control the money supply without being constrained by exchange rate targets or capital flow restrictions. It allows policymakers to focus on domestic economic goals like inflation and growth.

Policy Transmission Mechanism

Policy Transmission Mechanism describes the process through which monetary policy decisions affect the economy and influence variables like inflation, output, and employment. It explains how changes in policy interest rates work their way through financial markets to the broader economy.

Expectation-Augmented Phillips Curve

The expectation-augmented Phillips Curve is a version of the Phillips Curve that includes inflation expectations. It shows how both actual inflation and expected inflation affect unemployment and wage-setting behavior.