question

Externality

answer

A cost or benefit imposed or bestowed on an individual or a group that is outside, or external, the transaction.

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Marginal Social Cost (MSC)

answer

The total cost to society of producing an additional unit of a good or service. MSC is equal to the sum of the marginal costs of producing the product and the correctly measured damage costs involved in the process of production.

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Marginal Private Cost (MPC)

answer

The amount that a consumer pays to consume an additional unit of a particular good.

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Marginal Damage Cost (MDC)

answer

The additional harm done by increasing the level of an externality-producing activity by one unit. If producing product X pollutes the water in a river, MDC is the additional cost imposed by the added pollution that results from increasing output by one unit of X per period.

question

Five Solutions to Externalities

answer

1. Private bargaining and negotiation 2. Legal rules and procedures 3. Government-imposed taxes and subsidies 4. Sale or auctioning rights to impose externalities 5. Direct government regulation

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Coase Theorem

answer

Under certain conditions, when externalities are present, private parties can arrive at the efficient solution without government involvement (good with smaller number of people involved).

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Injunction

answer

A court order forbidding the continuation of behavior that leads to damages.

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Liability rules

answer

Laws that require A to compensate B for damages imposed.

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Public Goods (Social or Collective Goods)

answer

Goods that are (1) nonrival in consumption and/or their benefits are (2) nonexcludable.

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Nonrival in Consumption

answer

A characteristic of public goods: One person's enjoyment of the benefits of a public good does not interfere with another's consumption of it.

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Nonexcludable

answer

A characteristic of most public goods: Once a good is produced, no one can be excluded from enjoying its benefits.

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Free-Rider Problem

answer

A problem intrinsic to public goods: Because people can enjoy the benefits of public goods whether or not they pay for them, they are usually unwilling to pay for them.

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Drop-in-the-bucket Problem

answer

A problem intrinsic to public goods: The good or service is usually so costly that its provision generally does not depend on whether any single person pays.

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Optimal Level of Provision for Public Goods

answer

The level at which society's total willingness to pay per unit is equal to the marginal cost of producing the good.

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Imperfect (asymmetric) Information

answer

One of the parties to a transaction has information relevant to the transaction that the other party does not have.

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Adverse Selection

answer

A situation in which imperfect information results in high-quality goods or high-quality consumers being squeezed out of transactions because they cannot demonstrate their quality.

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Moral Hazard

answer

Arises when one party to a contract changes behavior in response to that contract and thus passes on the costs of that behavior change to the other party.

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Oligopoly

answer

A form of industry (market) structure characterized by a few dominant firms. Products may be homogenous or differentiated. (Oligopolies are interdependent)

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Contestable Markets

answer

Markets in which entry and exit are easy.

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Cartel

answer

A group of firms that gets together and makes joint price and output decisions to maximize joint profits.

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Tacit Collusion

answer

Collusion occurs when price-fixing and quantity-fixing agreements among producers are explicit. Tacit collusion occurs when such agreements are implicit.

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Price Leadership

answer

A form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy.

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Game Theory

answer

Analyzes the choices made by rival firms, people, and even governments when they are trying to maximize their own well-being while anticipating and reacting to the actions of others in their environment.

question

Dominant Strategy

answer

In game theory, a strategy that is best no matter what the opposition does.

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Nash Equilibrium

answer

In game theory, the result of all players' playing their best strategy given what their competitors are doing.

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Monopolistic Differentiation

answer

A common form of industry (market) structure in the United States, characterized by a large number of firms, no (or few) barriers to entry, and product differentiation.

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Product Differentiation

answer

A strategy that firms use to achieve market power. Accomplished by producing products that have distinct positive identities in consumers' minds.

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Imperfectly Competitive Industry

answer

An industry in which individual firms have some control over the price of their output.

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Barriers to Entry

answer

Factors that prevent new firms from entering and competing in imperfectly competitive industries.

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Natural Monopoly

answer

An industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

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Patent

answer

A barrier to entry that grants exclusive use of the patented product or process to the inventor (usually for a period of 20 years).

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Net Social Gain

answer

The consumer surplus that is regained when government intervenes to regulate or break up a monopoly.

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Price Discrimination

answer

Charging different prices to different buyers.

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Perfect Price Discrimination

answer

Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit.

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Sherman Act

answer

Made forming a monopoly or trust, or restraining free trade and commerce in any way, illegal.

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Rule of Reason

answer

The criterion introduced by the Supreme Court in 1911 to determine whether a particular action was illegal ("unreasonable") or legal ("reasonable") withing the terms of the Sherman Act.

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Clayton Act

answer

Passed by Congress in 1914 to strengthen the Sherman Act and clarify the rule of reason, the act outlawed specific monopolistic behaviors such as tying contracts, price discrimination, and unlimited mergers.

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General Equilibrium

answer

The condition that exists when all markets in an economy are in simultaneous equilibrium.

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Efficiency

answer

The condition in which the economy is producing what people want at the least possible cost.

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Pareto Efficiency

answer

A condition in which no change is possible that will make some members of society better off without making some members of society worse off.

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Three Basic Questions of Economics Systems

answer

1. What gets produced? 2. How is it produced? 3. Who gets what is produced?

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Market Failure

answer

Occurs when resources are misallocated, or allocated inefficiently. The result is waste or lost value.

question

Imperfectly Competitive Industry

answer

An industry in which individual firms have some control over the price of their output.

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Public Goods or Social Goods

answer

Goods or services that bestow collective benefits on members of society. Generally, no one can be excluded from their benefits. The classic example is national defense.

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Externality

answer

A cost or benefit imposed or bestowed on an individual or a group that is outside, or external to, the transaction.

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Imperfect Information

answer

The absence of full knowledge concerning product characteristics, available prices, and so on.

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Derived Demand

answer

The demand for resources (inputs) that is dependent on the demand for the outputs those resources can be used to produce.

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Productivity of an Input

answer

The amount of output produced per unit of that output.

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Marginal Product of Labor (MP subscript L)

answer

The additional output produced by one additional unit of labor.

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Marginal Revenue Product (MRP subscript L)

answer

The additional revenue a firm earns by employing one additional unit of input, ceteris paribus.

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Factor Substitution Effect

answer

The tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen.

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Pure Rent

answer

The return to any factor of production that is in fixed supply.

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Technological Change

answer

The introduction of new methods of production or new products intended to increase the productivity of existing inputs or to raise marginal products.

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Physical or Tangible Change

answer

Material things used as inputs in the production of future goods and services. The major categories of physical capital are nonresidential structures, durable equipment, residential structures, and inventories.

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Social Capital or Infrastructure

answer

Capital that provides services to the public. Most social capital takes the form of public works (roads and bridges) and public services (police and fire protection).

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Intangible Capital

answer

Nonmaterial things that contribute to the output of future goods and services.

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Human Capital

answer

A form of intangible capital that includes the skills and other knowledge that workers have or acquire through education and training that yields valuable services to a firm over time.

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Capital Stock

answer

For a single firm, the current market value of the firm's plant, equipment, inventories, and intangible assets.

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Depreciation

answer

The decline in an asset's economic value over time.

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Capital (financial) market

answer

The market in which households supply their savings to firms that demand funds to buy capital.

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Bond

answer

A contract between a borrower and lender, in which the borrower agrees to pay the loan at some time in the future, along with interest payments along the way.

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Financial Capital Markets

answer

The part of the capital market in which savers and investors interact through intermediaries.

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Capital Income

answer

Income earned on savings that have been put to use through financial capital markets.

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Interest

answer

The payments made for the use of money.

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Interest Rate

answer

Interest payments expressed as a percentage of the loan.

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Stock

answer

A share of stock in an ownership claim on a firm, entitling its owner to a profit share.

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Expected Rate of Return

answer

The annual rate of return that a firm expects to obtain through a capital investment.

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Breaking Even

answer

The situation in which a firm is earning exactly a normal rate of return.

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Shutdown Point

answer

The lowest point on the average variable cost curve. When price falls below the minimum point of AVC, total revenue is insufficient to cover variable costs and the firm will shut down and bear losses equal to fixed costs.

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Increasing Returns to Scale or Economies of Scale

answer

An increase in a firm's scale of production leads to lower average costs per unit produced.

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Decreasing Returns to Scale or Diseconomies of Scale

answer

An increase in a firm's scale of production leads to higher costs per unit produced.

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Long Run Average Costs Curve (LRAC)

answer

The "envelope" of a series of short-run cost curves.

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Optimal Scale of Plant

answer

The scale of plant that minimizes average cost.

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Long-Run Competitive Equilibrium

answer

When P=SRMC=SRAC=LRAC and profits are zero.

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Fixed Cost (Overhead, Sunk Cost)

answer

Any cost that does not depend on the firms' level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run.

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Variable Cost

answer

A cost that depends on the level of production chosen.

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Total Cost

answer

Total fixed costs plus total variable costs

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Spreading Overhead

answer

The process of dividing total fixed costs by more units of output. Average fixed cost declines as quantity rises.

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Marginal Cost

answer

The increase in total cost that results from producing 1 more unit of output. Marginal costs reflect changes in variable costs.

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Average Total Cost

answer

Total cost divided by the number of units of output.

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Perfect Competition

answer

An industry structure in which there are many firms, each small relative to the industry, producing identical products and in which no firm is large enough to have any control over prices. In perfectly competitive industries, new competitors can freely enter and exit the market.

question

Homogenous Products

answer

Undifferentiated products; products that are identical to, or indistinguishable from, one another.

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Total Revenue

answer

The total amount that a firm takes in from the sale of its product: the price per unit times the quantity of output the firm decides to produce (P x q).

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Marginal Revenue

answer

The additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, P=MR.

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Profit-Maximizing Output Level

answer

For all firms it is the output level where MR=MC. In perfect competition, however, MR=P. Hence, for perfectly competitive firms, we can rewrite our profit-maximizing condition as P=MC.

question

Supply Curve

answer

Marginal cost is the supply curve of a perfectly competitive firm.

question

Perfect Knowledge

answer

The assumption that households possess a knowledge of the qualities and prices of everything available in the market and that firms have all available information concerning wage rates, capital costs, and output prices.

question

Perfect Competition

answer

An industry structure in which there are many firms, each being small relative to the industry and producing virtually identical products, and in which no firm is large enough to have any control over prices.

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Homogenous Products

answer

Undifferentiated outputs; products that are identical to or indistinguishable from one another.

question

Three Basic Decisions of a Household

answer

1. How much of each product, or output, to demand. 2. How much labor to supply. 3. How much to spend today and how much to save for the future.

question

Determinants of Household Demand

answer

1. The price of a product. 2. The income available to the household. 3. The household's amount of accumulated wealth. 4. The prices of other products available to the household. 5. The household's tastes and preferences. 6. The household's expectations about future income, wealth, and prices.

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Budget Constraint

answer

The limits imposed on household choices by income, wealth, and product prices.

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Utility

answer

The satisfaction a product yields.

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Marginal Utility (MU)

answer

The additional satisfaction gained by the consumption or use of one more unit of a good or service.

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Total Utility

answer

The total amount of satisfaction obtained from consumption of a good or service.

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Law of Diminishing Marginal Utility

answer

The more of any one good consumed in a given period, the less satisfaction (utility) generated by consuming each additional (marginal) unit of the same good.

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Utility per Dollar Spent

answer

To spend money on the combination of activities lying within your budget constraint that gives you the most total utility.

question

Diamond/Water Paradox

answer

A paradox stating that (1) the things with the greatest value in use frequently have little or no value in exchange and (2) the things with the greatest value in exchange frequently have little or no value in use.

question

Income Effect

answer

The change in consumption of a product due to an improvement in well-being (increased income).

question

Substitution Effect

answer

A fall in the price of a product causes a household to shift its purchasing pattern away from substitutes toward that product.

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Labor Supply Decision

answer

1. Whether to work. 2. How much to work. 3. What kind of a job to work at.

question

Determinants of the Labor Supply Decision

answer

1. Availability of jobs. 2. Market wage rates. 3. Skills they possess.

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Labor Supply Curve

answer

A curve that shows the quantity of labor supplied at different wage rates. Its shape depends on how households react to changes in the wage rate. It is determined by the substitution effect.

question

Financial Capital Market

answer

The complex set of institutions in which suppliers of funds (households) and the demand for funds to buy capital (firms) interact.

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Production

answer

The process by which inputs are combined, transformed, and turned into outputs.

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Firm

answer

An organization that comes into being when a person or a group of people decides to produce a good or service to meet a perceived demand.

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Profit (Economic Profit)

answer

The difference between total revenue and total cost (total economic cost).

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Total Revenue

answer

The amount received from the sale of the product (quantity x Price).

question

Total Cost (Total Economic Cost)

answer

The total of (1) out-of-pocket costs and (2) opportunity cost of all factors of production.

question

Normal Rate of Return

answer

A rate of return on capital that is just sufficient to keep owners and investors satisfied. For relatively risk-free firms, it should be nearly the same as the interest rate on risk-free government bonds.

question

Short Run

answer

The period of time for which two conditions hold: The firm is operating under a (1) fixed scale (fixed factor) of production, and (2) firms can neither enter nor exit an industry.

question

Long Run

answer

That period of time for which there are no fixed factors of production: Firms can increase or decrease the scale of operation, and new firms can enter and existing firms can exit the industry.

question

Optimal Method of Production

answer

The production method that minimizes cost per unit produced.

question

Production Technology

answer

The quantitative relationship between inputs and outputs.

question

Production Function or Total Production Function

answer

A numerical or mathematical expression of a relationship between inputs and outputs. It shows units of total product as a function of units of inputs.

question

Marginal Product

answer

The additional output that can be produced by adding one more unit of a specific input, ceteris paribus.

question

Law of Diminishing Returns

answer

When additional units of a variable input are added to fixed inputs, after a certain point, the marginal product of the variable input declines.

question

Average Product and Marginal Product Graph

answer

Average product is at its maximum at the point of intersection with marginal product.

question

Complementary Inputs

answer

Additional capital that increases the productivity of existing capital.

question

Substitute Input

answer

Additional capital that renders existing capital obsolete.

question

Economics

answer

The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.

question

Opportunity Cost

answer

The best alternative that we forgo, or give up, when we make a choice or decision. Trade off.

question

Scarce

answer

Limited.

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Marginal Cost

answer

Cost of doing the next increment after the sunk cost. Different than average cost.

question

Sunk Cost

answer

Costs that cannot be avoided because they have already been incurred.

question

Efficient Market

answer

A market in which profit opportunities are eliminated almost instantaneously. Opportunities are small and quick.

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Why Study Economics?

answer

To learn a way of thinking, to understand society, to understand global affairs, and to be an informed citizen.

question

Microeconomics

answer

The branch of economics that examines the functioning of individual industries and the behavior of individual decision-making units- that is, firms and households. Focuses on the unit, "the trees."

question

Macroeconomics

answer

The branch of economics that deals with aggregates-income, inflation, jobs and unemployment, GDP and output growth, and so on-on a national scale. Focuses on the whole, "the forest."

question

Positive Economics

answer

An approach to economics that seeks to understand behavior and operation of systems without making judgments. It describes what exists and how it works.

question

Normative Economics

answer

An approach to economics that analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action.

question

Ockham's Razor

answer

The principle that irrelevant detail should be cut away.

question

Ceteris Paribus

answer

All else equal. A device used to analyze the relationship between two variables while the values of other variables are held unchanged.

question

Post Hoc, Ergo Propter Hoc

answer

After this in time, therefore because of this. A common error made in thinking about causation: If Event A happens before Event B, it is not necessarily true that A caused B.

question

Fallacy of Composition

answer

The erroneous belief that what is true for a part is necessarily true for the whole.

question

Four Criteria for Judging Economic Outcomes

answer

1. Efficiency 2. Equity 3. Growth 4. Stability

question

Efficiency

answer

In economics, allocative efficiency. An efficient economy is one that produces what people want at the least possible cost.

question

Equity

answer

Fairness

question

Economic Growth

answer

An increase in the total output of an economy.

question

Stability

answer

A condition in which national output is growing steadily, with low inflation and full employment of resources.

question

Globalization

answer

The trend toward increased cultural and economic connectedness between people, businesses, and organizations throughout the world.

question

Cost-Benefit Analysis

answer

A way of thinking provided by economics that bases decisions on rational logic.

question

Three Basic Questions to Understand the Functioning of the Economic System

answer

1. What gets produced? 2. How is it produced 3. Who gets what is produced?

question

Starting Presumption of Economics

answer

Human wants are unlimited but resources are not.

question

Capital

answer

Things that are produced and then used in the production of other goods and services.

question

Factors of Production

answer

Also known as factors, inputs, or resources. The inputs into the process of production.

question

Production

answer

The process that transforms scarce resources into useful goods and services.

question

Three Key Factors of Production

answer

1. Land 2. Labor 3. Capital

question

Inputs or Resources

answer

Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants.

question

Outputs

answer

Goods and services of value to households.

question

Theory of Comparative Advantage

answer

Ricardo's theory that specialization and free trade will benefit all trading parties, even those that may be "absolutely" more efficient producers.

question

Absolute Advantage

answer

A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources.

question

Comparative Advantage

answer

A producer has a comparative advantage over another in the production of a good or service if he can produce that product at a lower opportunity cost.

question

Consumer Goods

answer

Goods produced for present consumption.

question

Investment

answer

The process of using resources to produce new capital.

question

Production Possibility Frontier (PPF)

answer

A graph that shows all the combinations of goods and services that can be produced if all of society's resources are used efficiently (productive efficiency).

question

Production Efficiency

answer

A state in which a given mix of outputs are produced at the least cost.

question

Allocative Efficiency

answer

A state in which an economy is producing what people want.

question

Economic Growth

answer

An increase in the total output of an economy. It occurs when a society acquires new resources or when it learns to produce more using existing resources (develops new technology).

question

Command Economy

answer

An economy in which a central government either directly or indirectly sets output targets, incomes, and prices.

question

Laisse-Faire Economy

answer

Literally from the French: "allow [them] to do." An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.

question

Market

answer

The institution through which buyers and sellers interact and engage in exchange.

question

Free Enterprise

answer

The freedom of individuals to start and operate private businesses in search of profits.

question

Markets

answer

The institutions through which exchange takes place.

question

Firm

answer

An organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy.

question

Households

answer

The consuming units in an economy.

question

Entrepreneur

answer

A person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.

question

Product or Output Markets

answer

The markets in which goods and services are exchanged

question

Input or Factor Markets

answer

The markets in which the resources used to produce goods and services are exchanged.

question

Labor Market

answer

The input/factor market in which households supply supply work for wages to firms that demand labor.

question

Capital Market

answer

The input/factor market in which households supply their savings, for interest (bonds) or for claims to future profits (stocks), to firms that demand funds to buy capital goods.

question

Land Market

answer

The input/factor market in which households supply land or other real property in exchange for rent.

question

Factors of a household's decision about what quantity of a particular output, or product to demand.

answer

1. The price of the product in question. 2. The income available to the household. 3. The household's amount of accumulated wealth. 4. The prices of other products available to the household. 5. The household's tastes and preferences. 6. The household's expectations about future income, wealth, and prices.

question

Quantity Demanded

answer

The amount (number of units) of a product that a household would buy in a given period if it could buy all it wanted at the current market price.

question

Demand Curve

answer

A graph illustrating how much of a given product a household would be willing to buy at different prices.

question

Utility

answer

We consume goods and services because they give us utility or satisfaction.

question

Law of Diminishing Marginal Utility

answer

As we consume more of a product within a given period of time, it is likely that each additional unit consumed will yield successively less satisfaction.

question

Income

answer

The some of all a household's wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time.

question

Wealth or Net Worth

answer

The total value of what a household owns minus what it owes.

question

Normal Goods

answer

Goods for which demand goes up when income is higher and for which demand goes down when income is lower.

question

Inferior Goods

answer

Goods for which demand tends to fall when income rises.

question

Substitutes

answer

Goods that can serve as replacements for one another; when the price of one increases, demand for the other increases.

question

Complements, Complementary Goods

answer

Goods that "go together"; a decrease in the price of one results in an increase in demand for the other and vice versa.

question

Change in Price of a Good or Service Leads to:

answer

Change in quantity demanded (movement along a demand curve).

question

Change in Income, Wealth, Preferences, or Prices of Other Goods Leads to:

answer

Change in demand (shift of a demand curve).

question

Market Demand

answer

The sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

question

Profit

answer

The difference between revenues and costs.

question

Quantity Supplied

answer

The amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period.

question

Supply Curve

answer

A graph illustrating how much of a product a firm will sell at different prices.

question

Firm's Decisions about what Quantity of Output to Supply Depends on:

answer

1. The price of the good or service. 2. The cost of producing the product (The price of required inputs (land, labor, and capital); The technologies used to produce the product). 3. The prices of related products.

question

Changes in Price of a Good or Service Leads to:

answer

Change in quantity supplied (movement along a supply curve).

question

Changes in Cost, Input Prices, Technology, or Prices of Related Goods and Services Leads to:

answer

Change in supply (shift of a supply curve).

question

Market Supply

answer

The sum of all that is supplied each period by all producers of a single product.

question

Equilibrium

answer

The condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for price to change.

question

Excess Demand or Shortage

answer

The condition that exists when quantity demanded exceeds quantity supplied at the current price.

question

Excess Supply or Surplus

answer

The condition that exists when quantity supplied exceeds quantity demanded at the current price.

question

Price Rationing

answer

The process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied. Rationing will continue until the market clears (adjusts to equilibrium).

question

Price Ceiling

answer

A maximum price that sellers may charge for a good, usually set by the government.

question

Queuing

answer

Waiting in line as a means of distributing goods and services: a nonprice rationing mechanism.

question

Favored Customers

answer

Those who receive special treatment from dealers during situations of excess demand.

question

Ration Coupons

answer

Tickets or coupons that entitle individuals to purchase a certain amount of a given product per month.

question

Black Market

answer

A market in which illegal trading takes place at market-determined prices. Not a legal secondary market such as Stub Hub.

question

Price Floor

answer

A minimum price below which exchange is not permitted.

question

Minimum Wage

answer

A price floor set for the price of labor.

question

Consumer Surplus

answer

The difference between the maximum amount a person is willing to pay for a good and its current market price.

question

Producer Surplus

answer

The difference between the curent market price and the full cost of production for the firm.

question

Deadweight Loss

answer

The total loss of producer and consumer suplus for underproduction or overproduction.

question

Short Side Rule

answer

When demand and supply differ, the short side of the market (whichever is less) determines the quantity that is actually sold.

question

Law of Diminishing Returns

answer

As more labor is added to fixed capital, returns decrease. This is the reason the supply curve has a positive slope.

question

Trade Surplus

answer

The situation when a country exports more than it imports.

question

Trade Deficit

answer

The situation when a country imports more than it exports.

question

Corn Laws

answer

The tariffs, subsidies, and restrictions enacted by the British Parliament in the early nineteenth century to discourage imports and encourage exports of grain.

question

Theory of Comparative Advantage

answer

Ricardo's theory that specialization and free trade will benefit all trading partners (real wages will rise), even those that may be absolutely less efficient producers.

question

Absolute Advantage

answer

The advantage in the production of a good enjoyed by one country over another when it uses fewer resources to produce that good than the other country does.

question

Comparative Advantage

answer

The advantage in the production of a good enjoyed by one country over another when that good can be produced at lower cost in terms of other goods (opportunity cost) than it could be in the country.

question

Terms of Trade

answer

The ratio at which a country can trade domestic products from imported products.

question

Exchange Rate

answer

The ratio at which two currencies are traded. The price of one currency in terms of another.

question

Factor Endowments

answer

The quantity and quality of labor, land, and natural resources of a country.

question

Heckscher-Ohlin Theorem

answer

A theory that explains the existence of a country's comparative advantage by its factor endowments: A country has a comparative advantage in the production of a product if that country is relatively well endowed with inputs used intensively in the production of that product.

question

Protection

answer

The practice of shielding a sector of the economy from foreign competition.

question

Tariff

answer

A tax on imports.

question

Export Subsidies

answer

Government payments made to domestic firms to encourage exports.

question

Dumping

answer

A firm's or an industry's sale of products on the world market at prices below its own cost of production.

question

Quota

answer

A limit on the quantity of imports.

question

Smoot-Hawley Tariff

answer

The US tariff law of the 1930s, which set the highest tariffs in US History (60%). It set off an international trade war and caused the decline in trade that is often considered one of the causes of the worldwide depression of the 1930s. An example of extreme protectionism.

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General Agreement on Tariffs and Trade (GATT)

answer

An international agreement signed by the United States and 22 other countries in 1947 to promote the liberalization of foreign trade.

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World Trade Organization (WTO)

answer

A negotiating forum dealing with rules of trade across nations.

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Economic Integration

answer

Occurs when two or more nations join to form a free-trade zone.

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European Union (EU)

answer

The European trading bloc composed of 27 countries (of the 27 countries in the EU, 16 have the same currency- the euro).

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North American Free Trade Agreement (NAFTA)

answer

An agreement signed by the United States, Mexico, and Canada in which the three countries establish all North America as a free-trade zone.

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Infant Industry

answer

A young industry that may need temporary protection from competition from the established industries of other countries to develop an acquired comparative advantage.

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Exchange Rate

answer

The price of one country's currency in terms of another country's currency; the ratio at which two currencies are traded for each other.

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Foreign Exchange

answer

All currencies other than the given domestic currency of a given country.

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Balance of Payments

answer

The record of a country's transactions in goods, services, and assets with the rest of the world; also the record of a country's sources (supply) and uses (demand) of foreign exchange.

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Balance of Trade

answer

A country's exports of goods and services minus its imports of goods and services.

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Trade Deficit

answer

Occurs when a country's exports of goods and services are less than its imports of goods and services.

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Balance on Current Account

answer

Net exports of goods plus net exports of services plus net investment plus transfer payments.

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Marginal Propensity to Import (m)

answer

The change in imports caused by a $1 change in income.

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Trade Feedback Effect

answer

The tendency for an increase in the economic activity of one country to lead to a worldwide increase in economic activity, which then feeds back to that country.

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Open-Economy Multiplier

answer

1/(1-(MPC-m))

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Price Feedback Effect

answer

The process by which a domestic price increase in one country can "feed back" on itself through export and import prices. An increase in the price level in one country can drive up prices in other countries. This in turn further increases the price level in the first country.

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Floating (Flexible), or Market-Determined, Exchange Rates

answer

Exchange rates that are determined by the unregulated forces of supply and demand.

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Appreciation of a Currency

answer

The rise in value of one currency relative to another.

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Depreciation of a Currency

answer

The fall in value of one currency relative to another.

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Law of One Price

answer

If the costs of transportation are small, the price of the same good in different countries should be roughly the same.

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Purchasing-Power-Parity Theory

answer

A theory of international exchange holding that exchange will adjust so that the price of similar goods in different countries is the same.

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Stock

answer

A certificate that certifies ownership of a certain portion of a firm.

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Capital Gain

answer

An increase in the value of an asset.

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Realized Capital Gain

answer

The gain that occurs when the owner of an asset actually sells it for more than he or she paid for it.

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Determining the Price of a Stock

answer

1. Expected future dividends 2. Time the dividends are expected to be payed. 3. Discount for risk.

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Dow Jones Industrial Average

answer

An index based on the stock prices of 30 actively traded large companies. The oldest and most widely followed index of the stock market.

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NASDAQ Composite

answer

An index based on the stock prices of over 5,000 companies traded on the NASDAQ Stock Market. The NASDAQ market takes its name from the Nation Association of Securities Dealers Automated Quotation System.

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Standard and Poor's 500 (S&P 500)

answer

An index based on the stock prices of 500 of the largest firms by market value.

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Time Lags

answer

Delays in the economy's response to stabilization policies.

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"Fool in the Shower" - Milton Friedman

answer

Turns knob to extremely hot to heat up shower, then to far cold to cool it down, but continually over corrects (metaphor for government in the economy).

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Recognition Lag

answer

The time it takes for policy makers to recognize the existence of a boom or slump.

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Implementation Lag

answer

The time it takes to put the desired policy into effect once economists and policy makers recognize that the economy is in a boom or slump.

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Response Lag

answer

The time that it takes for the economy to adjust to new conditions after a new policy is implemented; the lag that occurs because of the operations of the economy itself.

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Effectiveness of Fiscal vs. Monetary Policy

answer

The economy's response to monetary changes is probably slower that its response to changes in the fiscal policy so tax and spending changes may play a useful role in macroeconomic management.

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Automatic Stabilizers

answer

Revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to stabilize GDP.

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Automatic Destabilizers

answer

Revenue and expenditure items in the federal budget that automatically change with the economy in such a was as to destabilize GDP.

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Velocity of Money

answer

The number of times a dollar bill changes hands, on average, during a year; the ratio of nomial GDP to the stock of money.

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Quantity Theory of Money

answer

The theory based on the identity M x V = P x Y

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Sustained Inflation

answer

Inflation that continues over many periods- is a purely monetary phenomenon.

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Laffer Curve

answer

With the tax rate measured on the vertical axis and tax revenue measured on the horizontal axis, the Laffer curve shows that there is some tax rate beyond which the supply response in large enough to lead to a decrease in tax revenue for further increases in the tax rate.

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Unemployment Rate

answer

The number of unemployed people as a percentage of the labor force.

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Sticky Wages

answer

The downward rigidity of wages as an explanation from the existence of unemployment.

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Social or Implicit Contracts

answer

Unspoken agreements between workers and firms that firms will not cut wages.

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Cost-of-Living Adjustments (COLAs)

answer

Contract provisions that tie wages to changes in the cost of living. The greater the inflation rate, the more wages are raised.

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Natural Rate of Unemployment

answer

The unemployment that occurs as a normal part of the functioning of an economy. Sometimes taken as the sum of frictional unemployment and structural unemployment.

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Aggregate Supply

answer

The total supply of all goods and services in an economy.

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Cost Shock or Supply Shock

answer

A change in costs that shifts the short-run aggregate supply (AS) curve.

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Equilibrium Price Level

answer

The price level at which the aggregate demand and aggregate supply curves intersect.

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Potential Output or Potential GDP

answer

The level of aggregate output that can be sustained in the long run without inflation.

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Demand-Pull Inflation

answer

Inflation that is initiated by an increase in aggregate demand.

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Cost-Push or Supply-Side Inflation

answer

Inflation caused by an increase in costs.

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Aggregate Demand Curve

answer

At all points on the AD curve, the goods market and the money market are in equilibrium. The AD is downward sloping because Y and P are inversely proportionate.

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Three Shifts of Short Run Supply Curve

answer

1. Input Costs (Wage Rates and Energy Prices) 2. Destruction from Weather or War 3. Technology

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Interest

answer

The fee that borrowers pay to lenders for the use of their funds.

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Transaction Motive

answer

The main reason that people hold money- to buy things.

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Nonsynchronization of Income and Spending

answer

The mismatch between the timing of money inflow to the household and the timing of money outflow for household expenses.

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Optimal Balance

answer

The level of average money balances that earns a person the most profit, taking into account both the interest earned on bonds and the costs paid for switching from bonds to money.

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Speculation Motive

answer

One reason for holding bonds instead of money: Because the market price of interest-bearing bonds is inversely related to the interest rate, investors may want to hold bonds when fixed interest rates are high with the hope of selling them when interest rates fall.

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Tight Monetary Policy (Contractionary)

answer

Fed policies that contract the money supply and thus raise interest rates in an effort to restrain the economy.

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East Monetary Policy (Expansionary)

answer

Fed policies that expand the money supply and thus lower interest rates in an effort to stimulate the economy.

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Animal Spirits

answer

The feelings of entrepreneurs that affect investment decisions.

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Expansionary Fiscal Policy

answer

An increase in government spending or a reduction in net taxes aimed at increasing aggregate output (income) (Y).

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Expansionary Monetary Policy

answer

An increase in the money supply aimed at increasing aggregate output (income) (Y).

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Crowding-Out Effect

answer

The tendency for increases in government spending to cause reductions in private investment spending.

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Policy Mix

answer

The combination of monetary and fiscal policies in use at a given time.

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Aggregate Demand (AD) Curve

answer

A curve that shows the negative relationship between aggregate output (income) and the price level. Each point on the AD curve is a point at which both the goods market and the money market are in equilibrium.

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Real Wealth, or Real Balance Effect

answer

The change in consumption brought about by a change in real wealth that results from a change in the price level.

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Money

answer

A means of payment, a store of value, and a unit of account.

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Barter

answer

The direct exchange of goods and services for other goods and services (requires a double coincidence of wants).

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Medium of Exchange or Means of Payment

answer

What sellers generally accept and buyers generally use to pay for goods and services.

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Store of Value

answer

An asset that can be used to transport purchasing power from one time period to another.

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Liquidity Property of Money

answer

The property of money that makes it a good medium of exchange as well as a store of value: It is portable and readily accepted and thus easily exchanged for goods.

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Unit of Account

answer

A standard unit that provides a consistent way of quoting prices.

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Commodity Monies

answer

Items used as money that also have intrinsic value in some other use.

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Fiat or Token Money

answer

Items designated as money that are intrinsically worthless.

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Legal Tender

answer

Money that a government has required to be accepted in settlement of debts.

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Currency Debasement

answer

The decrease in the value of money that occurs when its supply is increased rapidly.

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M1 or Transactions Money

answer

Money that can be directly used for transactions.

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Near Monies

answer

Close substitutes for transactions money, such as savings accounts and money market accounts.

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M2 or Broad Money

answer

M1 plus savings accounts, money market accounts, and other near monies.

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Financial intermediaries

answer

Banks and other institutions that act as a link between those who have money to lend and those who want to borrow money.

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Run on a Bank

answer

Occurs when many of those who have claims on a bank (deposits) present them at the same time.

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Federal Reserve Bank (the Fed)

answer

The central bank of the United States (The Banker's Bank).

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Reserves

answer

The deposits that a bank has at the Federal Reserve plus its cash on hand.

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Required Reserve Ratio

answer

The percentage of its total deposits from customers that a bank must keep as reserves at the Federal Reserve or in its own vaults.

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Excess Reserves

answer

The difference between a bank's actual reserves and its required reserves.

question

Loaned Up

answer

When a bank has no excess reserves and thus can make no more loans.

question

Money Multiplier

answer

The multiple by which final deposits can increase for every dollar increase in reserves; equal to 1 divided by the required reserve ratio.

question

Open Market Desk

answer

The office in the New York Federal Reserve Bank from which government securities are bought and sold by the Fed.

question

Lender of Last Resort

answer

One of the functions of the Fed: It provides funds to troubled banks that cannot find any other sources of funds.

question

Three Tools Available to the Fed for Changing the Money Supply

answer

1. Changing the required reserve ratio. 2. Changed the discount rate. 3. Engaging in open market operations.

question

Open Market Operations

answer

The purchase and sale by the Fed of government securities in the open market; a tool used to expand or contract the amount of reserves in the system and thus the money supply.

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Fiscal Policy

answer

The government's spending and taxing policies.

question

Monetary Policy

answer

The behavior of the Federal Reserve concerning the nation's money supply.

question

Discretionary Fiscal Policy

answer

Changes in taxes or spending that are the result of deliberate changes in government policy.

question

Net Taxes (T)

answer

Taxes paid by firms and households to the government minus transfer payments made to households by the government.

question

Disposable or After-Tax Income (Yd)

answer

Total income minus net taxes: Y-T.

question

Budget Deficit

answer

The difference between what a government spends and what it collects in taxes in a given period: G-T.

question

Government Spending Multiplier

answer

The ratio of the change in the equilibrium level of output to a change in government spending (purchases not transfer payments).

question

Federal Surplus of Deficit

answer

Federal government receipts minus expenditures.

question

Federal Debt

answer

The total amount owed by the federal government.

question

Automatic Stabilizers

answer

Revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP.

question

Automatic Destabilizer

answer

Revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to destabilize GDP.

question

Fiscal Drag

answer

The negative effect on the economy that occurs when average tax rates increase because taxpayers have moved into higher income brackets during an expansion.

question

Full-Employment Budget

answer

What the federal budget would be if the economy were producing at the full-employment level of output.

question

Structural Deficit

answer

The deficit that remains at full employment (a result of bad fiscal policy).

question

Cyclical Deficit

answer

The deficit that occurs because of a downturn in the business cycle.

question

Aggregate Output

answer

The total quantity of goods and services produced (or supplied) in an economy in a given period.

question

Aggregate Income

answer

The total income received by all factors of production in a given period.

question

Aggregate Output (Income) (Y)

answer

A combined term used to remind you of the exact equality between aggregate output and aggregate income.

question

Consumption Function

answer

The relationship between consumption and income.

question

Marginal Propensity to Consume (MPC)

answer

That fraction of a change in income that is consumed, or spent.

question

Marginal Propensity to Save (MPS)

answer

That fraction of a change in income that is saved.

question

Planned Investment (I)

answer

Those additions to capital stock and inventory that are planned by firms.

question

Actual Investment

answer

The actual amount of investment that takes place; it includes items such as unplanned changes in inventories.

question

Planned Aggregate Expenditure

answer

The total amount the economy plans to spend in a given period. Equal to consumption plus planned investment: AE = C + I.

question

Multiplier

answer

The ratio of the change in the equilibrium level of output to a change in some exogenous variable (planned investment).

question

Employed

answer

Any person 16 years of age or older (1) who works for pay, either for someone else or in his or her own business for more that one week, (2) who works without pay for 15 or more hours per week in a family enterprise, or (3) who has a job but has been temporarily absent with or without pay.

question

Unemployed

answer

A person 16 years of age or older who is not working, and has made specific efforts to find work during the previous four weeks.

question

Labor Force Participation Rate

answer

The ratio of the labor force to the total population 16 years old or older.

question

Discouraged-Worder Effect

answer

The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force.

question

Three Types of Unemployment

answer

1. Frictional Unemployment 2. Structural Unemployment 3. Cyclical Unemployment

question

Frictional Unemployment

answer

The portion of unemployment that is due to the normal turnover in the labor market; used to denote short-run job/skill-matching problems.

question

Structural Unemployment

answer

The portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries.

question

Natural Rate of Unemployment

answer

The unemployment rate that occurs as a normal part of the functioning of the economy. Sometimes taken as the sum of frictional unemployment rate and structural unemployment rate. Normally 4-5%

question

Cyclical Unemployment

answer

Unemployment that is above frictional plus structural unemployment.

question

Consumer Price Index (CPI)

answer

A price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the "market basket" purchased monthly by the typical urban consumer. Represents the cost of living for consumers.

question

Producer Price Indexes (PPIs)

answer

Measures of prices that producers receive for products at all stages in the production process. An indicator for CPI.

question

Real Interest Rate

answer

The difference between the interest rate on a loan and the inflation rate.

question

Indexed

answer

A price, wage, or interest rate that is adjusted automatically for inflation.

question

Output Growth

answer

The growth rate of the output of the entire economy.

question

Productivity Growth

answer

The growth rate of output per worker.

question

Ways to Increase Output

answer

1. Hire more workers 2. More skills per worker 3. More machines (capital) 4. Better machines (capital) 5. Longer workweek

question

Three Major Concerns of Macroeconomics

answer

1. Output Growth 2. Unemployment 3. Inflation and Deflation

question

Business Cycle

answer

The cycle of short-term ups and downs in the economy.

question

Aggregate Output

answer

The total quantity of goods and services produced in an economy in a given period.

question

Recession

answer

A period during which aggregate output declines for two consecutive quarters.

question

Depression

answer

A prolonged and deep recession

question

Expansion or Boom

answer

The period in the business cycle from a trough up to a peak during which output and employment grow.

question

Inflation

answer

An increase in the overall price level (over 3% is bad).

question

Hyperinflation

answer

A period of very rapid increases in the overall price level.

question

Deflation

answer

A decrease in the overall price level (usually accompanies a recession).

question

Transfer Payments

answer

Cash payments made by the government to people who do not supply goods, services, or labor in exchange for these payments. They include Social Security benefits, veterans' benefits, and welfare payments.

question

The Three Market Arenas

answer

1. The goods-and-services market 2. The labor market 3. The financial market

question

The Components of the Macroeconomy

answer

1. Households 2. Firms 3. The Government 4. The Rest of the World

question

Treasury Bonds, Notes, and Bills (Government Bonds)

answer

Promissory notes issued by the federal government when it borrows money.

question

Corporate Bonds

answer

Promissory notes issued by firms when they borrow money.

question

Shares of Stock

answer

Financial instruments that give to the holder a share in the firm's and therefore the right to share in the firm's profits.

question

Dividends

answer

The proportion of a firm's profits that the firm pays out each period to its shareholders.

question

Fiscal Policy

answer

Government policy concerning taxes and spending.

question

Monetary Policy

answer

The tools used by the Federal Reserve to control the quantity of money, which in turn affects interest rates.

question

Fine-Tuning

answer

The phrase used by Walter Heller to refer to the government's role in regulating inflation and unemployment.

question

Stagflation

answer

A situation of both high inflation and high unemployment.

question

Gross Domestic Product (GDP)

answer

The total market value of all final goods and services produced within a given period by factors of production located within a country.

question

Final Goods and Services

answer

Goods and services produced for final use.

question

Intermediate Goods

answer

Goods that are produced by one firm for use in further processing by another firm.

question

Value Added

answer

The difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.

question

Gross National Product (GNP)

answer

The total market value of all final goods and services produced within a given period by factors of production owned by a country's citizens, regardless of where the output is produced.

question

Expenditure Approach

answer

A method of computing GDP that measures the total amount spent on all final goods and services during a given period.

question

Income Approach

answer

A method of computing GDP that measures the income-wages, rents, interest, and profits-received by all factors of production in producing final goods and services.

question

Why are Expenditure and Income Approach Equal?

answer

Every payment (expenditure) by a buyer is at the same time a receipt (income) for the seller.

question

Personal Consumption Expenditures (C)

answer

Expenditures by consumers on goods and services.

question

Durable Goods

answer

Goods that last a relatively long time, such as cars and household appliances.

question

Nondurable Goods

answer

Goods that are used up fairly quickly, such as food and clothing.

question

Services

answer

The things we buy that do not involve the production of physical things, such as legal and medical services and education.

question

Gross Private Domestic Investment (I)

answer

Total investment in capital-that is, the purchase of new housing, plants, equipment, and inventory by the private (or nongovernment) sector.

question

Nonresidential Investment

answer

Expenditures by firms for machines, tools, plants, and so on.

question

Residential Investment

answer

Expenditures by households and firms on new houses and apartment buildings.

question

Change in Business Inventories

answer

The amount by which firms' inventories change during a period. Inventories are the goods that firms produce now but intend to sell later (unsold goods).

question

Depreciation

answer

The amount by which an asset's value falls in a given period.

question

Government Consumption and Gross Investment (G)

answer

Expenditures by federal, state, and local governments for final goods and services (government purchases not government transfers).

question

Net Exports (Ex-Im)

answer

The difference between exports (sales to foreigners of US-produced goods and services) and imports (US purchases of goods and services from abroad). The figure can be negative.

question

National Income

answer

The total income earned by the factors of production owned by a country's citizens.

question

Personal Income (Y)

answer

The total income of households.

question

Disposable Personal Income or After-Tax Income

answer

Personal income minus personal income taxes (Y-T). The amount that households have to spend or save.

question

Current Dollars

answer

The current prices that we pay for goods and services.

question

Nominal GDP

answer

Gross domestic product measured in current dollars.

question

Underground Economy

answer

The part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.

question

Keynesian Economics

answer

Governments can intervene in the economy and affect the level of output and employment.

question

Unemployment Rate

answer

The percentage of the labor force that is unemployed.

question

Costs of Inflation

answer

1. Decrease in purchasing power 2. Hurts people on fixed income 3. Hurts Creditors 4. Administrative Costs

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