The Economy 1-5

Positive Correlation: Two phenomena tend to occur at the same time or among the same individuals

Causation: One phenomena results from the other

Natural experiment: situation in which, for a reason independent of any Z, X changes for one group (treatment group) while staying fixed for another comparable group (control group)

GDP (Gross Domestic Product): total spending on all final goods + services produced in the economy over a time period

Nominal GDP: express GDP in current prices

Real GDP: expresses GDP in prices of a reference year i.e. adjusted for inflation

GNP (Gross National Product): the total value of all finished goods and services produced by a country's citizens in a given financial year, irrespective of their location

HDI (Human Development Index): mean years of schooling, expected years of schooling, life expectancy at birth, and gross national income (GNI) per capita.

Stock variable: sum of previous flows that have accumulated e.g wealth or debt

Flow variable: value depends on time period rather than an instant e.g. income, GDP

Opportunity Cost: value of next best alternative foregone = MRT

Marginal Rate of Substitution: how much of a good I am willing to sacrifice to get another good while maintaining the same level of satisfaction

Marginal Rate of Transformation: slope of budget constraint, what you have to give up to get another unit = opportunity cost

Indifference Curve: describes all the consumption bundles between which the agent is indifferent

Budget Constraint: describes all the combinations of the goods that an agent can consume given the price of each of them + his total income

Ordinary Good: price of C decreases + consumption of C increases, budget constraint curve shifts outwards

Giffen Good: price of C decreases + consumption of C decreases, budget constraint curve shifts inwards

Substitution Effect: change in relative price → change in opportunity cost

Income Effect: change in income → change in purchasing power → shift in demand

Substitutes: an increase in the price of one good leads to an increase in the demand of the other good

Complements: an increase in the price of one good leads to a decrease in the demand of the other good

Normal Good:  an increase in income → an increase in demand of the good

Inferior Good: an increase in income → a fall in demand of the good

Game Theory: study of social interactions between economic agents under the standard economic assumptions

Strategic Interactions: making individually optimising decisions understanding that other agents also make individually optimising decisions

Best response: best behaviour taking as given the other player’s strategy

Dominant strategy: best behaviour of an agent regardless of other players’ actions

Nash Equilibrium: if qA is optimally chosen when A believes that qb is chosen by B + vice versa - no player has an incentive to deviate from the outcome they have chosen

Repeated Games: players play several rounds of the game; at each round, they have a perfect memory of the history of the game.

Pareto Efficient: nobody can be better off without making someone worse off

Social Norms: an understanding that is common to most members of a society about what people should do in a given situation when their actions affect others

Ultimatum Game: a paradigmatic two-player game.

  • A proposer can offer a certain fraction of some valuable good. A responder can accept the offer or reject it, implying that the two players receive nothing

Public Goods

  • Non-rival: consumers cannot be prevented from consuming the good
  • Non-excludable: one individual’s consumption of the good does not diminish other consumers’ enjoyment of the same good

Divorce of Ownership of Control: when the owners of a business do not control the day-to:,-day decisions made in the business

Price-making: has power to dictate price to customers, Pareto inefficient

Price-taking: cannot change price to attract customers, Pareto efficient

Economic Profit: Total Revenue - (Explicit Costs + Opportunity Costs)

Contestability: how easy it is for a firm to enter/exit a market

Natural Oligopolies: when a single firm can serve that market at lower cost than any combination of two or more firms

Pigouvian Tax: tax applied to a market activity that generates negative externalities to modify market quantity e.g. London Congestion Charge

Information Symmetry: no agent has access to a piece of information that the other agents do not have

Moral Hazard: one party in an econ. transaction cannot observe the other party’s actions

Adverse Selection: one party in an econ. transaction cannot observe the characteristics of the other party

Shareholder value: social responsibility of business is to increase its profits

Stakeholder value: wider responsibility to society, not just shareholders

Externality: a cost or benefit that affects a third party not directly involved in a transaction

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Assumptions made in Models

Malthusian Trap:

Agricultural economy with farmers producing crop

  • Production function with decreasing returns to labour
  • Endogenous population size
  • Consumption must be above a certain subsistence level for farmers to survive
  • If consumption of farmer is above subsistence level, population grows

Solow Growth Model:

  • Output per worker is increasing in input factors
  • Output increases less and less with increasing input factors (decreasing returns)