AP Macroeconomics

absolute advantage

the ability of a country to produce a good or service using fewer resources than another country

allocative efficiency

using resources to produce output in the combination and quantity of goods and services most desired by the consumers in a country

capital

machinery, tools, and equipment used in the production of goods and services

command economy

an economic system in which the government or central planning authority answer the three basic economic questions

comparative advantage

the ability of a country to produce a good or service at a lower opportunity cost than another country

constant opportunity costs

Using a PPC, when an economy produces two goods and as it increases the production of one good, it gives up the same amount of the other good as it allocates its resources towards more of one good.

economics

a social science concerned with the study of scarcity and resource allocation

entrepreneurship

the method by which risk-takers organize the other factors of production into goods and services

factors of production

the resources, or inputs, used in the production of goods and services; includes land, labor, capital, and entrepreneurship

free market economy

an economic system where the three basic economic questions are answered by the free market forces of supply and demand

law of increasing opportunity costs

Using a PPC, when an economy produces two goods and as it increases the production of one good, it gives up more and more of the other good as it allocates its resources towards more of one good

labor

human capital, workers; one of the factors of production

land

natural resources; one of the factors of production

marginal benefit

the added gain of consuming one more unit of a good or service

marginal cost

the added cost of creating one more unit of a good or service

mixed economy

an economic system that combines elements from both free market economies and command economies; some choices are determined by supply and demand and others are established by the government (Most countries are mixed economies.)

opportunity cost

the next best alternative forgone

production possibilities curve (PPC)

shows the combinations of goods or services a country can produce with its resources (The assumption in this model is that a nation can only create two products.)

productive efficiency

Producing output using the least possible resources or at the lowest possible cost (i.e., The resources in a country are all being used efficiently. This is shown as a point on the PPC.)

scarcity

the condition created when limited resources are available to satisfy the unlimited wants and needs of people

three basic economic questions

Every economy must answer these three fundamental questions: What to produce? How to produce? For whom to produce?

traditional economy

an economic system where the three basic economic questions are answered by what has always been (i.e., by the traditions of a society)

demand

the quantity of goods and services that consumers are willing and able to buy at different prices and quantities, in a given period of time

excess

when the quantity supplied (Qs) is greater than the quantity demanded (Qd); This happens when price is above market equilibrium.

income effect

one of the reasons for the downward sloping demand curve; When prices are lower, consumers feel as though they have more money, so more quantity is demanded, and vice versa.

law of demand

states that as prices increase, quantity demanded decreases, and as prices decrease, quantity demanded increases

law of supply

states that price and quantity are directly related

law of diminishing marginal utility

As consumers use more of a good, their utility of that good decreases, so a lower price is needed as an incentive to buy more of this good.

market

any place where buyers and sellers come together to make an exchange

market equilibrium

quantity demanded is equal to quantity supplied

market failure

an over-allocation or under-allocation of resources towards the production of a good or service

price ceiling

a maximum legal price

price control

prices set by law

price floor

a minimum legal price

productivity

when output per hour is increased

regulations

rules and laws that must be followed; for example, regulations regarding safety of a product

shortage

when quantity demanded (Qd) is greater than quantity supplied (Qs); This happens when the price is below market equilibrium.

subsidies

payment by the government for the production of a good or service

substitute effect

When prices for a good or service increase, consumers will buy a lower priced substitute, and vice versa. This is one of the reasons for the downward sloping demand curve.

supply

the willingness and ability of producers to offer goods and services for sale at different prices and quantities, in a given time period

supply shock

a sudden increase or decrease in the supply of a good or service

tax

a payment made to the government; Direct tax is on a good or service. Indirect tax is on income or profit.

aggregate demand (AD)

total value of the output that all buyers in an economy are willing and able to buy at different price levels, in a given period of time

aggregate supply (AS)

total value of goods and services produced in an economy at different price levels, in a given period of time

bonds

debt issued by the government or a corporation; In exchange for cash, the government or corporation will issue the debt holder a paper specifying the amount of the principal borrowed, the maturity date, and the interest rate.

budget deficit

when a government spends more than it collects in revenue

business cycle model

shows that over time, while economies experience an increase in real GDP in the long run, there are short term fluctuations of periods of expansion and contraction

circular flow model

shows the flow of income between households and firms in the resource and product markets; In the resource market, firms demand resources from households in exchange for payment for those resources. In the product market, households demand goods and services from firms, in exchange for payment for those goods and services. Leakages out of the flow include savings, taxes, and spending on imports. Injections into the flow include interest, government spending, and payment for exports

classical economics view (monetarist)

Classical economists view the economy as self-correcting in the long run. While an economy will experience recessionary and inflationary gaps, the economy will return to long-run potential output, as workers wages and resource prices adjust.

consumer spending

household spending on goods and services; one of the components of AD

contractionary phase

when the economy experiences a downturn; Spending in the economy slows down as less demand for goods and services leads to less output by firms who lay off workers and need less resources

exchange rates

the price of once currency in terms of another

expansionary phase

when the economy experiences economic growth; Spending increases as more demand for goods and services leads to more output by firms who hire more workers and resources.

expenditure approach to measuring GDP

expenditure means spending; This is one of the ways to measure GDP, measuring the total spending by consumers, firms, government and net exports in an economy

fiscal policy

a tool the government uses to correct inflationary and recessionary gaps; changes in government spending and/or changes in taxation

foreign trade effect

one of the explanations for the downward sloping AD curve; As PL increases in a nation, that nation's goods become more expensive so foreigners will decrease their demand for that nation's exports, causing Xn to decrease. This leads to a decrease in AD. AS PL decreases in a nation, that nation's goods become less expensive so foreigners will increase their demand for exports, causing Xn to increase. This leads to an increase in AD

gross domestic product (GDP)

the final value of all goods and services produced in an economy, in a given time period; It is measured by the income approach, the output approach or the expenditure approach. This course focuses on the expenditure approach.

government spending

spending by the government; one of the components of AD

inflation

an increase in the average price levels in a nation

inflationary gap

caused by an increase in AD beyond the full employment level of output; results in increases in PL and real GDP

injections

income into the Circular Flow Model in the form of interest, government spending, and payments for exports

interest rate

the price of money

interest rate effect

one of the explanations for the downward sloping AD curve; At higher PL, consumers and firms will need more money, so the demand for money will increase. This causes interest rates to increase. Consumers and firms will borrow and spend less. At lower PL, the demand for money decreases, so interest rates decrease. Consumers and firms will borrow and spend more.

intermediate goods and services

used in the production of final goods and services; It is important not to count them in GDP, as double counting will cause the value of GDP to be greater than it really is.

investment spending

spending by firms on capital goods, such as machinery and equipment used in the production process; one of the components of AD

Keynesian view

named after famed economist, John Maynard Keynes; Keynesian economists differ from classical/monetarists in that Keynesians do not see the economy as self-correcting in the long run. Instead, they argue that wages are upward sticky, and workers will not accept lower wages during a recession. Therefore, it is the job of the government to enact policy to correct the economy during recessionary and inflationary gaps

leakages

income flowing out the Circular Flow Model in the form of savings, taxes, and spending on imports

long run

the period of time when wages and resource prices are flexible

long-run aggregate supply (LRAS)

shows the full employment level of output in an economy. There is no relationship between output and PL.

macroeconomics

the study of how decisions by consumers, producers, the government, and foreigners affect an entire economy

marginal propensity of consume (MPC)

when an extra dollar of income is earned, how much of that dollar is spent by consumers

marginal propensity to save (MPS)

when an extra dollar of income is earned, how much of that dollar is saved

national debt

all of the yearly budget deficits of a nation added together

net exports

exports minus imports; component of AD

nominal GDP

the value of all final goods and services produced in a nation, in current prices

non-produced, financial transactions

stocks and bonds; Nothing is being produced, and these are not counted in GDP measures.

product market

shows the flow of income in the Circular Flow Model when households demand goods and services from firms in exchange for payment

progressive income tax system

income tax rates increase as income increases. It is an automatic stabilizer.

real GDP

the value of all final goods and services produced in a nation, adjusted for inflation

recession

two consecutive quarters, or 6 months, of economic downturn

recessionary gap

when AD decreases below the full employment level of output; This results in a decrease in PL and real GDP. Unemployment increases.

resource market

shows the flow of income in the Circular Flow Model when firms demand resources from households in exchange for income payments

short run

the period of time when resource prices and wages are fixed

spending multiplier

Me \= 11- MPC or 1MPS; It is used in the calculation to determine how much a change in spending will change the AD.

short-run aggregate supply (SRAS)

the value of all goods and services produced in an economy

stagflation

As a result of a decrease in SRAS, the economy experiences an increase in PL and a decrease in real GDP.

tax multiplier

Mt \= Me - 1; used in the calculation to determine how much changes in taxes will affect AD

trade protection

tariffs, subsidies, quotas, and embargoes put in place to protect a domestic economy

transfer payments

payments from the government such as welfare or social security payments; Nothing is being produced. It is a transfer of wealth from richer households to poorer households.

wealth effect

one of the explanations for the downward sloping AD curve; At a lower PL, households feel wealthier, so they will spend more. At a higher PL, households feel less wealthy, so they will spend less.

capital stock

Capital is machinery and equipment used in the production process, so an increase in capital stock is an increase in resources. This will lead to economic growth, with a shift of LRAS to the right and an outward shift of the PPC.

consumer price index (CPI)

an index created to measure inflation; It is based off the value of a market basket of goods and services that a typical household buys in a year.

core rate of inflation

inflation measured without the prices of energy and food, as these have high fluctuations in price

cost-push inflation

inflation caused by a decrease in the SRAS

cyclical unemployment

unemployment caused by a downturn in the economy

deflation

a decrease in the average PL in a nation

demand-pull inflation

inflation caused by an increase in AD

discouraged workers

workers who have given up looking for work, so they are no longer considered unemployed

disinflation

a decrease in the inflation rate

economic growth

an increase in real GDP of a nation