Download Primary Concepts of Economics for Economics Learner

To My Colleagues, To Our Youth Forum
185 Essential Concepts of
Economics for Primary Learners
Edited by Li Keqin
Preface
• Economics is the study of how the economy works: how
the society manages its scarce resources and how
people make their decisions. It is an important task for
us to study and use its theories and tools.The essential
concepts are the languages and tools of Economics.
They can help us to develop the economic way of
thinking. During my study of Economics, I had paid
more attention to those concepts and it made me
understand the theories of Economics easily. For the
purporse of helping my colleagues study Economics
well, I have edited this book. I hope that this book can
give you some convenience when you study Economics.
Li Keqin
2
December 30, 2006
1.Scarcity
• Scarcity means that society has limited resources
and therefore cannot produce all the goods and
services people wish to have.Just as a household
cannot give every member everything he or she
wants, a society cannot give every individual the
highest standard of living to which he or she might
aspire.Because of scarcity,a society must decide
how to allocate its scarce resources.
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2.Economics
• Economics is the study of how society manages its scarce
resources.It studies how people make decisions:how much
they work,what they buy,how much they save,and how
they invest their savings.It also studies how people interact
with one another.For instance,it examines how the
multitude of buyers and sellers of a good together
determine the price at which the good is sold and the
quantity that is sold,Finally, it analyzes forces and trends
that affect the economy as a whole,including the growth in
average income,the fraction of the population that cannot
find work, and the rate at which prices are rising.In fact,
Economics is one science on tradeoffs.
4
3.Efficiency
• Efficiency means that society is getting the most it can
from its scarce resources. The question of efficiency is
whether the economic pie is as big as possible. An
outcome is said to be efficient if the economy is getting all
it can from the scarce resources it has available. From the
standpoint of welfare economy, efficiency is the property
of a resource allocation of maximizing the total surplus
received by all members of society. If an allocation of
resources maximizes total surplus,we say that the
allocation exhibits efficiency. If an allocation of resources
is inefficient, then some of the gains from trade among
buyers and sellers are not being realized.
5
4.Equity
• Equity means that the benefits of scarce resources
are distributed fairly among society’s members.
The question of equity is whether the economic
pie is divided fairly. Efficiency and equity is one
of the most important tradeoffs that society faces.
Often,when government policies are being
designed,these two goals conflict. Evaluating the
equity of a market outcome is more difficult than
evaluating the efficiency, because equity involves
normative judgments that go beyond economics
and enter into the realm of political philosophy.
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5.Opportunity Cost
• Opportunity cost means whatever must be
given up to obtain some item.For instance,
when you spend a day playing computer
games,you cannot spend that time reading a
book or writing papers.When making any
decision, decisionmakers should be aware
of the opportunity costs that accompany
each possible action.They should decide
whether the benefit is worth the cost.
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6.Marginal Changes
• Marginal changes mean small incremental
adjustments to a plan of action. “Margin”
means “edge”, so marginal changes are
adjustments around the edges of what you
are doing. Usually, rational people think at
the margin. A rational decisionmaker takes
an action if and only if the marginal benefit
of the action exceeds the marginal cost.
8
7.Market Economy
• Market economy is an economy that allocates
resources through the decentralized decisions of
many firms and households as they interact in
markets for goods and services.Firms decide
whom to hire and what to make.Households
decide which firms to work for and what to with
their income. These firms and households interact
in the marketplace,where prices and self-interest
guide their decisions.Usually, markets are a good
way to organize economic activity with an
invisible hand.
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8.Market Failure
• Market failure is a situation in which a market left
on its own fails to allocate resources efficiently.
Market power and externalities are examples of
market failure.Because of market failure, we
sometimes need government to improve market
outcomes:to promote efficiency and to promote
equity.That is,most policies aim either to enlarge
the economic pie or to change how the pie is
divided.
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9.Externality
• Externality is the impact of one person’s actions on the well-being of a
bystander.If the impact on the bystander is adverse, it is called a
negative externality; if it is beneficial, it is called a positive externality.
The exhaust from automobiles is a negative externality because it
creates smog that other people have to breath. Research into new
technologies provides a positive externality because it creates
knowledge that other people can use. Externality is one cause of
market failure. The classic example of an external cost is pollution that
affects people not in the market. Externality causes welfare in a market
to depend on more than just the value to the buyers and the cost to the
sellers. Because buyers and sellers do not take these side effects into
account when deciding how much to consume and produce, the
equilibrium in a market can be inefficient from the standpoint of
society as a whole.
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10.Market Power
• Market power is the ability of a single economic
actor(or small group of actors)to have a substantial
influence on market prices.It is one cause of
market failure. For example,if everyone in town
needs water but there is only one well, the owner
of the well is not subject to the rigorous
competition with which the invisible hand
normally keeps self-interest in check.If a firm can
influence the market price of the good it sells, it is
said to have market power.
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11.Productivity
• Productivity is the quantity of goods and services
produced from each hour of a worker’s time. A
country’s standard of living depends on its
productivity.In nations where workers can produce
a large quantity of goods and services per unit of
time, most people enjoy a high standard of living;
in nations where workers are less productive, most
people must endure a more meager existence.
Productivity depends on the amounts of physical
capital, human capital, natural resources, and
technological knowledge available to workers.
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12.Inflation
• Inflation means an increase in the overall
level of prices in the economy.In general,
growth in the quantity of money causes
inflation. When a government creates large
quantities of the nation’s money, the prices
rise and the value of the money falls.
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13.Phillips Curve
• Phillips curve is a curve
that shows that society
faces a short-run tradeoff
between inflation an
unemployment. It tells us
that many economic
policies push inflation and
unemployment in opposite
direction in short-run. The
Phillips Curve is crucial
for understanding many
development such as
business cycle in the
economy.
15
14.Business Cycle
• Business cycle means fluctuations in economic
activity, such as employment and production. It
tells us that economic fluctuations correspond to
changes in business. When real GDP grows
rapidly,business is good. During such periods of
economic expansion, firms find that customers are
plentiful and that profits are growing. When real
GDP falls during recessions, businesses have
trouble. During such periods of economic
contraction, most firms experience declining sales
and dwindling profits. The term business cycle is
somewhat misleading, because it seems to suggest16
15.Circular-flow Diagram
• Circular-flow diagram is a visual model of
the economy that shows how dollars flow
through markets among households and
firms.
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16.Production Possibilities
Frontier
• Production possibilities frontier is a graph
that shows the various combinations of
output that the economy can possibly
produce given the available factors of
production and the available production
technology. The economy can produce any
combination on or inside the frontier.Points
outside the frontier are not feasible given
the economy’s resources.
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17.Microeconomics
• Microeconomics is the study of how
households and firms make decisions and
how they interact in markets including the
effects of rent control on housing in a city,
the impact of foreign competition on the
U.S auto industry, and the effects of
compulsory school attendance on workers’
earnings.
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18.Macroeconomics
• Macroeconomics is the study of economywide phenomena, including inflation,
unemployment, and economic growth.
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19.Positive Statements
• Positive Statements are one type of
statement about world. Positive statements
are descriptive. They make a claim about
how the world is.In principle, positive
statements can be confirmed or refuted by
examining evidence.When an economist
makes a positive statements, he works just
like a scientist to explain how the economy
runs.
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20.Normative statements
• Normative statements are another type of
statements about world.They are
prescriptive. They make a claim about how
the world ought to be. Usually, evaluating
normative statements involves values as
well as facts. When an economist makes
normative statements, he works just like a
policy adviser to judge what is good or bad
policy.
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21.Absolute Advantage
• Absolute advantage is the comparison
among producers of a good according to
their productivity.The producer that requires
a smaller quantity of inputs to produce a
good is said to have an absolute advantage
in producing that good.
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22.Comparative Advantage
• Comparative advantage is the comparison among
producers of a good according to their opportunity
cost. The producer who has the smaller
opportunity cost of producing the good is said to
have a comparative advantage in producing it. The
principle of comparative advantage shows the
gains from trade are based on comparative
advantage, not absolute advantage.Trade can
benefit everyone in society because it allows
people to specialize in activities in which they
have a comparative advantage.
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23.Imports
• Goods produced abroad and sold domestically are
called imports. When a country allows trade and
becomes an importer of a good, domestic
consumers of the good are better off, and domestic
producers of the good are worse off. Trade raises
the economic well-being of a nation in the sense
that the gains of the winners(consumers) exceeds
the losses of the losers(producers).
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24.Exports
• Goods produced domestically and sold abroad are
called exports. When a country allows trade and
becomes an exporter of a good, domestic
producers of the good are better off, and domestic
consumers of the good are worse off. Trade raises
the economic well-being of a nation in the sense
that the gains of the winners(producers) exceeds
the losses of the losers(consumers).
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25.Market
• A market is a group of buyers and sellers of
a particular good or service. The buyers as a
group determine the demand for the product,
and the sellers as a group determine the
supply of the product. Market forces
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26.Competitive Market
• A competitive market is a market in which there
are many buyers and many sellers so that each has
a negligible impact on the market price. For
instance, the market for ice cream is a highly
competitive market, because no single buyer or
seller of ice cream can influence the price of ice
cream. Each buyer of ice cream and seller of ice
cream takes the market price as given. They are all
price takers.
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27.Perfectly Competitive Market
• Perfectly competitive markets are defined
by two primary characteristics: (1)the goods
being offered for sale all the same,and (2)
the buyers and sellers are so numerous that
no single buyer or seller can influence the
market price. In perfectly competitive
markets buyers and sellers are price takers.
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28.Quantity demand
• Quantity demand is the amount of a good
that buyers are willing and able to
purchase.Usually, many things determine
the quantity demanded of any good, but the
price of the good plays a central role
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29.Law of Demand
• Law of demand shows the relationship
between price and quantity demanded.It
claims that the quantity demanded of a good
falls when the price of the good rises with
other things equal
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30.Demand Schedule
• Demand schedule is a table that shows the
relationship between the price of a good and
the quantity demanded, holding constant
everything else that influences how much
consumers of the good want to buy.
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31.Demand Curve
• Demand curve is a graph
of the relationship
between the price of a
good and the quantity
demanded. It can come
from the demand schedule
The price of a good is on
the vertical axis, and the
quantity demanded is on
the horizontal axis.
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32.Normal Good
• Normal good is a good for which, other
things equal, an increase in income leads to
an increase in demand. Cars, for instance
are normal goods.
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33.Inferior Good
• Inferior good means a good for which,other
things equal, an increase in income leads to
a decrease in demand. Bus ride ,for
instance,might be an inferior good.
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34.Substitutes
• Substitutes are two goods for which an
increase in the price of one leads to an
increase in the demand for the other.
Substitutes are often pairs of goods that are
used in place of each other, such as hot dogs
and hamburgers, movie tickets and video
rentals. They show the prices of related
goods influence the demand of the goods.
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35.Complements
• Complements are two goods for which an
increase in the price of one leads to a
decrease in the demand for the other.
Complements are often pairs of goods that
used together, such as gasoline and
automobiles, computers and software. They
show that the prices of related goods
influence the demand of the goods.
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36.Supply Schedule
• Supply schedule is a table that shows the
relationship between the price of a good and
the quantity supplied, holding constant
everything else that influences how much
producers of the good want to sell.
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37.Supply Curve
• Supply curve is a graph of
the relationship between
the price of a good and the
quantity supplied. It can
come from the supply
schedule The price of a
good is on the vertical axis,
and the quantity supplied
is on the horizontal axis.
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38.Equilibrium
• Equilibrium is a situation
in which the price has
reached the level where
the quantity supplied
equals quantity
demanded.The
equilibrium is found
where the supply and
demand curves intersect.
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39.Equilibrium Price
• Equilibrium price is the price that balances
quantity supplied and quantity
demanded.The equilibrium price is
sometimes called the market-clearing price
because, at this price,everyone in the market
has been satisfied: Buyers have bought all
they want to buy, and sellers have sold all
they want to sell.
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40.Equilibrium Quantity
• Equilibrium quantity is the quantity
supplied or the quantity demanded at the
equilibrium price.
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41.Surplus
• Surplus is a situation
in which quantity
supplied is greater
than quantity
demanded. A surplus
is sometimes called a
situation of excess
supply. Suppliers are
unable to sell all they
want at the going price.
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42.Shortage
• Shortage is a situation in
which quantity demanded
is greater than quantity
supplied. A shortage is
sometimes called a
situation of excess demand.
Demanders are unable to
buy all they want at the
going price.
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43. Law of Supply and Demand
• Law of supply and demand is the claim that
the price of any good adjusts to bring the
quantity supplied and the quantity
demanded for that good into balance. In
most free markets, surplus and shortage are
only temporary because prices eventually
move toward their equilibrium levels.
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44.Elasticity
• Elasticity is a measure of the responsiveness
of quantity demanded or quantity supplied
to one of its determinants.(see price
elasticity of demand)
46
45.Price Elasticity of Demand
• Price elasticity of demand is a measure of how
much the quantity demanded of a good responds
to a change in the price of that good, computed as
the percentage change in quantity demanded
divided by the percentage change in price.
• Price elasticity of demand = Percentage change in
quantity demanded / Percentage change in price
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46.Income Elasticity of demand
• Income elasticity of demand is a measure of
how much the quantity demanded of a good
responds to a change in consumers’ income,
computed as the percentage change in
quantity demanded divided by the
percentage change in income. Normal good
have positive income elasticity. Inferior
good have negative income elasticity.
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47.Cross-price Elasticity of
Demand
• Cross-price elasticity of demand is a
measure of how much the quantity
demanded of one good responds to a
change in the price of another good,
computed as the percentage change in
quantity demanded of the first good divided
by the percentage change in the price of the
second good.
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48.Price Elasticity of Supply
• Price elasticity of supply is a measure of how
much the quantity supplied of a good responds to
a change in the price of that good, computed as the
percentage change in quantity supplied divided by
the percentage change in price.
• Price elasticity of supply = Percentage change in
quantity supplied / Percentage change in price
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49.Price Ceiling
• Price ceiling is a legal maximum on the price at
which a good can be sold. If the price ceiling is
above the equilibrium price, the price ceiling is
not binding, and the market can reach the
equilibrium of supply and demand. If the price
ceiling is below the equilibrium price, the price
ceiling is binding.When the government imposes a
binding price on a competitive market, a shortage
of the good arise, and sellers must ration the
scarce goods among the large numbers of potential
buyers.
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50.Price Floor
• Price floor is a legal minimum on the price at
which a good can be sold. If the price floor is
below the equilibrium price, Market forces
naturally move the economy to the equilibrium,
and the price floor is not binding. If the price floor
is above the equilibrium price, the price floor is
binding, and the binding price floor causes a
surplus. Buyers must ration their demand among
seller.
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51.Tax Incidence
• Tax incidence is the manner in which the burden
of a tax is shared among participants in a market.
Taxes on buyers and taxes on sellers are
equivalent. Buyers and sellers share the tax burden.
The only difference between taxes on buyers and
taxes on sellers is who sends the money to the
government. In fact , a tax on a good places a
wedge between the price paid by buyers and the
price received by sellers.
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52.Welfare Economics
• Welfare economics is the study of how the
allocation of resources affects economic wellbeing. It examines the benefits that buyers and
sellers receive from taking part in a market and
how society can make these benefits as large as
possible. These researches lead to a profound
conclusion: The equilibrium of supply and
demand in a market maximizes the total benefits
received by buyers and sellers. The study of
welfare economics explains why markets are
usually a good way to organize economic activity.
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53.Willingness to Pay
• Willingness to pay means the maximum amount
that a buyer will pay for a good. Each buyer’s
maximum is called his willingness to pay, and it
measures how much that buyer values the good.
Each buyer would be eager to buy the good at the
price less than his willingness to pay, would refuse
to buy the good at a price more than his
willingness to pay, and would be indifferent about
buying the good at a price exactly equal to his
willingness to pay.
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54.Consumer Surplus
• Consumer surplus is the amount a buyer is willing
to pay for a good minus the amount the buyer
actually pays for it. For instance, if John is willing
to pay $100 for a book but pays only $80 for it, we
say that John receives consumer surplus of
$20.Consumer surplus measures the benefit to
buyers of participating in a market. In the
graph(right), the area below the demand curve and
above the price measures the consumer surplus in
a market. In most markets, consumer surplus
reflects economic well-being because buyers are
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rational when they make decisions.
55.Cost
• Cost is the value of everything a seller must give
up to produce a good. Here the term cost should
interpreted as the seller’s opportunity cost. Cost is
a measure of a seller’s willingness to sell his good
or services. Each seller would be eager to sell his
goods at a price greater than his cost, would refuse
to sell his goods at a price less than his cost, and
would be indifferent about selling his goods at a
price exactly equal to his cost.
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56.Producer Surplus
• Producer surplus is the amount a seller is paid for
a good minus the seller’s cost. For instance, if
Mary is willing to sell a book for $80 but sells it
for $100 , we say that Mary receives producer
surplus of $20. Producer surplus measures the
benefit to sellers of participating in a market. In
the graph(right), the area below the price and
above the supply curve measures the producer
surplus in a market.
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57.Deadweight Loss
• Deadweight loss is the fall in total surplus that
results from a market distortion, such a tax. People
respond to incentives. When a tax raises the price
to buyers and lowers the price to sellers, it gives
buyers an incentive to consume less and sellers an
incentive to produce less than they otherwise
would. Taxes cause deadweight losses because
they prevent buyers and sellers from realizing
some of the gains from trade.
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58.World Price
• World price is the price of a good that
prevails in the world market for that good.
If the world price of a good is higher than
the domestic price of the good, the country
price lower would become an exporter of
that good. Conversely, if the world price of
a good is lower than the domestic price of
the good, the country price higher would
become an importer of that good.
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59.Tariff
• Tariff is a tax on goods produced abroad
and sold domestically. The tariff reduces the
quantity of imports and moves the domestic
market closer to its equilibrium without
trade. Tariff raises the domestic price of the
good, reduces the welfare of domestic
consumers, increases the welfare of
domestic producers, and cause deadweight
loss.
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60.Import Quota
• Import quota is limit on the quantity of a
good that can be produced abroad and sold
domestically. Import quota raises the
domestic price of the good, reduces the
welfare of domestic consumers, increases
the welfare of domestic producers, and
cause deadweight loss.
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61.Internalizing an Externality
• Internalizing an externality means altering incentives so that people
take account of the external effects of their actions. For instance,if the
government taxes aluminum for each ton of aluminum sold, the tax
would makes the aluminum producers take the costs of pollution into
account when deciding how aluminum to supply because people
respond to incentives. Negative externalities lead markets to produce a
larger quantity than is socially desirable. Positive externalities lead
markets to produce a smaller quantity than is socially desirable. To
remedy the problem, the government can internalize the externality by
taxing goods that have negative externalities and subsidizing goods
that have positive externalities.
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62.Coase Theorem
• The Coase theorem is the proposition that if
private parties can bargain without cost over the
allocation of resources, they can solve the problem
of externalities on the own. The Coase theorem
says that private economic actors can solve the
problem of externalities among themselves.
Whatever the initial distribution of rights, the
interested parties can always reach a bargain in
which everyone is better off and the outcome is
efficient.
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63.Transaction Cost
• Transaction cost is the costs that parties incur in
the process of agreeing and following through on a
bargain. It tells us why private solutions do not
always work. The Coase theorem applies only
when the interested parties have no trouble
reaching and enforcing an agreement. In other
word, however, bargaining does not always work,
even when a mutually beneficial agreement is
possible. If the benefit of solving a problem is less
than the cost of transaction cost, the parties might
choose to leave the problem unsolved. When
private bargaining does not work, the government65
64.Pigovian Tax
Taxes enacted to correct the effects of negative
externalities are called Pigovian taxes, after
economist Arthur Pigou(1877-1959), an early
advocate of their use. Pigovian taxes are unlike
most other taxes. Most taxes distort incentives and
move the allocation of resources away from the
social optimum. By contrast, when externalities
are present, society also cares about the well-being
of the bystanders who are affected. Pigovian taxes
correct incentives for the presence of externalities
and thereby move the allocation of resources
closer to the social optimum. Thus,while Pigovian66
65.Excludability
• Excludability is the property of a good
whereby a person can be prevented from
using it.
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66.Rivalry
• Rivalry is the property of a good whereby
one person’s use diminishes other people’s
use.
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67.Private Goods
• Private goods are goods such as ice-cream cones
cars and clothing, that are both excludable and
rival. An ice-cream cone is excludable because it
is possible to prevent someone from eating an icecream cone-you just don’t give it to him. An icecream cone is rival because if one person eats an
ice-cream cone, another person cannot eat the
same cone. Most goods in the economy are private
goods.
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68.Public Goods
• Public goods are goods such as national
defense, basic research and fighting
poverty,that are neither excludable nor rival.
That is , people cannot be prevented from
using a public good, and one person’s use of
a public good does not reduce another
person’s ability to use it.
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69.Free Rider
• Free rider is a person who receives the benefit of a
good but avoids paying for it. Because public
goods are not excludable, people have an incentive
to be free riders. The problem of the free rider
prevents the private market from supplying them.
The government can potentially remedy the
problem. If the government decides that the total
benefits exceed the costs, it can provides the
public good and pay for it with tax revenue,
making everyone better off.
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70.Common Resources
• Common resources are goods such as fish in the
ocean, clean air and water, and congested nontoll
roads, that are rival but not excludable. There are
many examples of common resources. In almost
all cases, the same problem arises: Private
decisionmakers use the common resource too
much. Governments often regulate behavior or
impose fees to mitigate the problem of overuse.
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71.Cost-benefit Analysis
• Cost-benefit analysis is a study that compares the
costs and benefits to society of providing a public
good. The government should provide public
goods because the private market on its own will
not produce an efficient quantity. the government
must then determines what kinds of public goods
to provide and in what quantities. When
evaluating whether the government should provide
a public good, the government might hire a team
of economists and engineers to conduct a costbenefit analysis.
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72.Tragedy of the Commons
• Tragedy of the commons is a parable that
illustrates why common resources get used more
that is desirable from the standpoint of society as a
whole. When one person uses a common resource,
he diminishes other people’s enjoyment of it.
Because of this negative externality, common
resources tend to e used excessively. The tragedy
of the commons then arises. The government can
solve the problem by reducing use of the common
resource through regulation or taxes. Alternatively
the government can sometimes turn the common
resources into a private good through establishing74
73.Total Revenue
• Total revenue is the amount a firm receives
for the sale of its output. It equals the
quantity of output the firm produces times
the price at which it sells its output. That is,
•
Total revenue = Quantity × Price.
75
74.Total Cost
• Total cost is the market value of the inputs a
firm uses in production. When economists
speak of a firm’s cost of production, they
include all the opportunity costs of making
its output of goods and services.
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75.Explicit Costs
• Explicit costs are input costs that require an outlay
of money by the firm. For instance, when a firm
hires workers to produce goods, the wages it pays
are part of the firm’s explicit costs. Accountants
have the job of keeping track of the money that
flows into and out of firms. They are usually
interested in studying the flow of the money . As a
result, they measure the explicit costs but often
ignore the implicit costs.
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76.Implicit Costs
• Implicit costs are input costs that do not require an
outlay of money by the firm. An important
implicit cost of almost every business is the
opportunity cost of the financial capital that has
been invested in the business. Because economists
are interested in studying how firms make
production and pricing decisions that are based on
both explicit costs and implicit costs, they include
not only explicit costs but also implicit cost. This
is an important difference between how
economists and accountants analyze a business.
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77.Profit
• Profit is a firm’s total revenue minus its total cost. That is,
Profit = Total revenue – Total cost.
Economists normally assume that the goal of a firm is to
maximize profit.
Because economists and accountants measure costs
differently, they also measure profit differently. An
economist measures a firm’s economic profit as the firm’s
total revenue minus all the opportunity costs(explicit and
implicit) of producing the goods and services sold. An
accountant measures the firm’s accounting profit as the
firm’s total revenue minus only the firm’s explicit costs. As
a result, accountant profit is usually larger than economic
profit.
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78.Production Function
• Production function is the relationship
between quantity of inputs used to make a
good and the quantity of output of that good.
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79.Marginal Product
• Marginal product is the increase in output
that arises from an additional unit of input.
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80.Diminishing Marginal Product
• Diminishing marginal product is the
property whereby the marginal product of
an input declines as the quantity of the input
increases.
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81.Fixed Costs
• Fixed costs are costs that do not vary with
the quantity of output produced.they are
incurred even if the firm produces nothing
at all.
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82.Variable Costs
• Variable costs are costs that do vary with
the quantity of output produced.
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83.Average Total Cost
• Average total cost is total cost divided by the quantity of
output. That is,
Average total cost = Total cost / Quantity
ATC = TC / Q
Because total cost id just the sum of fixed and variable costs,
average total cost can be expressed as the sum of average
fixed cost and average variable cost. Average fixed cost is
the fixed cost divided by the quantity of output, and
average variable cost is the variable cost divided by the
quantity of output. Average cost tells us the cost of a
typical unit of output if total cost is divided evenly over all
the units produced.
85
84.Marginal Cost
• Marginal cost is the increase in total cost
that arises from an extra unit of production.
Marginal cost = Change in total cost /
Change in quantity
MC = △TC / △Q
Marginal cost tells us the increase in total cost
that arises from producing an additional unit
of output.
86
85.Efficient Scale
• Efficient scale is the quantity of output that
minimizes average total cost.
87
86.Economies of Scale
• Economies of scale is the property whereby
long-run average total cost falls as the
quantity of output increases. Economies of
scale often arise because higher production
levels allow specialization among workers,
which permits each worker to become better
at his or her assigned tasks.
88
87.Diseconomies of scale
• Diseconomies of scale is the property
whereby long-run average total cost rises as
the quantity of output increases.
Diseconomies of scale can arise because of
coordination problems that are inherent in
any large organization.
89
88.Constant Returns to Scale
• Constant returns to scale is the property
whereby long-run average cost stays the
same as the quantity of output changes.
90
89.Average Revenue
• Average revenue is total revenue divided by the
quantity sold. It tells us how much revenue a firm
receives for the typical unit sold.
• Average revenue = Total revenue / Quantity.
•
AR = TR / Q
• Because total revenue is the price times the
quantity (P×Q) and average revenue is total
revenue (P×Q) divided by the quantity, average
revenue equals the price of the good.
• AR = TR / Q = (P×Q) / Q = P.
91
90.Marginal Revenue
• Marginal revenue is the change in total
revenue from an additional unit sold.
MR = △TR / △Q.
For competitive firms, marginal revenue
equals the price of the good.
92
91.Sunk Cost
• Sunk cost is a cost that has already been
committed and cannot be recovered. In a sense, a
sunk cost is the opposite of an opportunity cost:
An opportunity cost is what you have to give up if
you choose to do one thing instead of another,
whereas a sunk cost cannot be avoided, regardless
of the choices you made. Because nothing can be
done about sunk costs, you can ignore them when
making decisions about various aspects of life,
including business strategy.
93
92.Monopoly
• Monopoly is a firm that is the sole seller of
a product without close substitutes. A
monopoly arises when a single firm owns a
key resource, when the government gives a
firm the exclusive right to produce a good,
or when a single firm can supply the entire
market at a smaller cost than many firms
could(natural monopoly).
94
93.Price Discrimination
• Price discrimination is the business practice of selling the
same good at different prices to different customers. For
instance, many movie theaters charge a lower price for
children and senior citizens that for This practice of price
discrimination can raise economic welfare by getting the
good to some consumers who otherwise would not buy it.
In the extreme case of perfect price discrimination, the
deadweight losses of monopoly are completely
eliminated.more generally, when price discrimination is
imperfect, it can either raise or lower welfare compared to
the outcome with a single monopoly price. There is no
easy answer as to whether price discrimination, in general,
is a good thing or a bad thing.
95
94.Gross Domestic Product(GDP)
• Gross domestic product(GDP) is the market value of all
final goods and services produced within a country in a
given period of time. GDP measures an economy’s total
expenditure on newly produced goods and services and the
total income earned from the production of these goods
and services. GDP is divided among four components of
expenditure: consumption, investment, government
purchases, and net exports.
Y= C + I + G + NX
GDP is a good measure of economic well-being because
people prefer higher to lower incomes. But it is not a
perfect measure of well-being.
96
95.Nominal GDP
• Nominal GDP is the production of goods
and services valued at current prices. It
reflects both the prices of goods and
services and the quantities of goods and
services the economy is producing.
97
96. Real GDP
• Real GDP is the production of goods and services
valued at constant prices. It uses constant baseyear prices to place a value on the economy’s
production of goods and services.Because real
GDP is not affected by changes in prices, changes
in real GDP reflect only changes in the amounts
being produced. Thus, real GDP is a measure of
the economy’s production of goods and services.
98
97. GDP Deflator
• GDP deflator is a measure of the price level
calculated as the ratio of nominal GDP to
real GDP times 100. It reflects the prices of
goods and services but not the quantities
produced. The GDP deflator is calculated as
follows:
GDP deflator = Nominal GDP ÷ Real
GDP ×100
99
98.Consumption
• Consumption is spending by households on
goods and and services, with the exception
of purchases of new housing. “Goods”
include household spending on durable
goods, such as automobiles and appliances,
and non-durable goods, such as food and
clothing. “Services” include such intangible
items as haircuts and medical care.
100
99. Investment
• Investment is the purchase of goods that
will be used in the future to produce more
goods and services. It is the sum of
purchases of capital equipment, inventories,
and structures. Investment in structures
includes expenditure on new housing.
101
100. Government Purchases
• Government purchases are spending on
goods and services by local, state, and
federal governments. It includes the salaries
of government workers and spending on
public works. Government transfer
payments can alter household income, and
do not reflect the economy’s production,
they are not counted as part of government
purchases.
102
101. Net Exports
• Net exports equal the value of goods and
services produced domestically and sold
abroad (exports) minus the value of goods
and services produced abroad and sold
domestically (imports)
103
102. Consumer Price Index (CPI)
The consumer price index (CPI) is a measure of
the overall cost of the goods and services bought
by a typical consumer. The consumer price index
shows the cost of a basket of goods and services
relative to the cost of the same basket in the base
year. The index is used to measure the overall
level of prices in the economy. The percentage
change in the consumer price index measures the
inflation rate. The consumer price index is an
imperfect measure of the cost of living. It usually
overstates true inflation.
104
103. Inflation Rate
Inflation rate is the percentage change in the
price index from the preceding period. That
is, the inflation rate between two
consecutive years is computed as follows:
Inflation rate in year 2 = (CPI in year 2 －
CPI in year 1) ÷ CPI in year 1 × 100
105
104. Producer Price Index
• Producer price index is a measure of the
cost of a basket of goods and services
bought by firms. Because firms eventually
pass on their costs to consumers in the form
of higher consumer prices, changes in the
producer price index are often thought to be
useful in predicting changes in the
consumer price index.
106
105. Indexation
• Indexation is the automatic correction of a dollar
amount for the effects of inflation by law or
contract. For example, many long-term contracts
between firms and unions include partial or
complete indexation of the wage to the consumer
price index. Such a provision is called a cost-ofliving allowance, or COLA. A COLA
automatically raises the wage when the consumer
price index rises.
107
106. Nominal Interest Rate
• Nominal interest rate is the interest rate as
usually reported without a correction for the
effects of inflation. It is the rate at which the
number of dollars in a savings account
increases over time. It tells you how fast the
number of dollars in your bank account
rises over time.
108
107. Real Interest rate
• Real interest rate is the interest rate corrected for
the effects of inflation. The real interest rate equals
the nominal interest rate minus the rate of inflation:
Real interest rate = Nominal interest rate －
Inflation.
The real interest rate tells you how fast the
purchasing power of your bank account rises over
time.
109
108. Physical Capital
• Physical capital is the stock of equipment
and structures that are used to produce
goods and services. An important feature of
physical capital is that is a produced factor
of production. Physical capital is a factor of
production used to produce all kinds of
goods and services.
110
109. Human Capital
human capital refers to the knowledge and
skills that workers acquire through
education, training, and experience. It is a
produced factor of production.
111
110. Natural Resources
• Natural resources are the inputs into the
production of goods and services that are
provided by nature, such ad land, rivers ,
and mineral deposits. Natural resources take
two forms: renewable and nonrenewable. A
forest is an example of a renewable
resources. Oil is an example of a
nonrenewable resources.
112
111. Technological Knowledge
• Technological knowledge refers to the
understanding of the best ways to produce
goods and services. It is society’s
understanding about how the world works.
113
112. Diminishing Returns
• Diminishing returns refer to the property whereby
the benefit from an extra unit of an input declines
as the quantity of the input increases. In other
words, the more capital an economy has , the less
additional output the economy gets from an extra
unit of capital. Because of diminishing returns,
higher saving leads to higher growth for a period
of time, but growth eventually slows down as the
economy approaches a higher level of capital,
productivity, and income.
114
113. Catch-up Effect
• Catch-up effect refers to the property
whereby countries that start off poor tend to
grow more rapidly than countries that start
off rich. Because of the catch-up effect,
poor countries can grow faster with other
things equal.
115
114. Financial System
• Financial system refers to the group of
institutions in the economy that help to
match one person’s saving with another
person’s investment. Financial institutions
can be grouped into two categories-financial
markets and financial intermediaries. In
essence, financial system moves an
economy’s scarce resources from savers to
borrowers.
116
115.Financial Markets
• Financial markets are the institutions
through which a person who wants to save
can directly supply funds to a person who
wants to borrow. The two most important
financial markets in our economy are the
bond market and the stock market.
117
116.Bond
• Bond refers to a certificate of indebtedness that specifies
the obligations of the borrower to the holder of the bond. It
identifies the time at which the loan will be repaid, called
the date of maturity, and the rate of interest that will be
repaid periodically untill the loan matures. Usually, bonds
have three important characteristics: term, credit risk and
tax treatment. The term is the length of time untill the bond
matures. The credit risk is the probability that the borrower
will fail to pay some of the interest or principal. The tax
treatment is the way in which the tax laws treat the interest
earned on the bond.
118
117.Stock
• Stock represents ownership in a firm and is a claim to the
profits that the firm makes. For example, if Intel sells a
total of 1,000,000 shares of stock, then each share
represents ownership of 1/1,000,000 of the business. The
sale of stock to raise money is called equity finance,
whereas the sale of bonds is called debt finance.stocks and
bonds are very different. The owner of shares of a firm’s
stock is a part owner of that firm; the owner of a firm’s
bond is a creditor of that firm. Compared to bonds, stocks
offer the holder both higher risk and potentially higher
return.
119
118.Financial Intermediaries
• Financial intermediaries are financial
institutions through which savers can
indirectly provide funds to borrowers. The
term intermediary reflects the role of these
institutions in standing between savers and
borrowers. Banks and mutual funds are two
of the most important financial
intermediaries.
120
119.Mutual Fund
• Mutual fund is an institution that sells shares to
the public and uses the proceeds to buy a portfolio
of stocks and bonds. The shareholder of the
mutual fund accepts all the risk and return
associated with the portfolio. The primary
advantage of mutual fund is that they allow people
with small amounts of money to diversify. A
second advantage claimed by mutual fund
companies is that mutual funds give ordinary
people access to the skills of professional money
managers.
121
120.National Saving
• National saving is the total income in the
economy that remains after paying for
consumption and government purchases.
We write
S=(Y–T–C)+(T–G)
National saving can be separated into two
pieces: private saving and public saving.
122
121.Private Saving
• Private saving is the amount of income that
households have left after paying their taxes
and paying for their consumption. Private
saving is Y – T – C .
123
122.Public Saving
• Public saving is the amount of tax revenue
that the government has left after paying for
its spending. Because the government
receives T in tax revenue and spends G on
goods and services, public saving is T – G .
124
123.Budget Surplus
• Budget surplus is an excess of tax revenue
over government spending. It means that the
government receives more money than it
spends. This surplus of T – G represents
public saving. A budget surplus increases
the supply of loanable funds, reduces the
interest rate, and stimulates investment.
125
124.Budget Deficit
• Budget deficit is a shortfall of tax revenue
from government spending. It means that
the government spends more than it
receives in tax revenue. In this case, public
saving T – G is a negative number. When
the government reduces national saving by
running a budget deficit, the interest rate
rises, and investment falls.
126
125.Market for loanable funds
• Market for loanable funds is the market in
which those who want to save supply funds
and those who want to borrow to invest
demand funds. It is governed by supply and
demand in the market. Saving is the source
of the supply of loanable funds. Investment
is the source of the demand for loanable
funds.
127
126.Crowding Out
• Crowding out is a decrease in investment
that results from government borrowing.
When the government borrows to finance
its budget deficit, it crowds out private
borrowers who are trying to finance
investment. Because investment is
important for long-run economic growth,
crowding out reduces the economy’s growth
rate.
128
127.Finance
• Finance refers to the field that studies how
people make decisions regarding the
allocation of resources over time and the
handling of risk. The tools of finance can
help us understand the decisions that people
make as they participate in financial
markets and in turn, understand how the
economy works.
129
128.Present Value
• Present value refers to the mount of money today
that would be needed to produce, using prevailing
interest rates, a given future amount of money.
Suppose you are going to be paid $200 in 10 years.
If the interest rate is 5 percent, the future $200 has
a present value of $123. The concept of present
value is useful in many applications. For example,
when a company evaluates investment projects
and makes its decision, it will depends on the
interest rate.
130
129.Future Value
• Future value refers to the amount of money
in the future that an amount of money today
will yield, given prevailing interest rates.
Suppose you put $123 in a bank account
today . If the interest rate is 5 percent, the
present $123 has a future value of $200 in
10 years.
131
130.Compounding
• Compounding refers to the accumulation of
a sum of money in , say , a bank account,
where the interest earned remains in the
account to earn additional interest in future.
132
131.Risk Averse
• Risk averse refers to exhibiting a dislike of
uncertainty. It means that people dislike bad
things more than they like comparable good
things. Economists have developed models
of risk aversion using the concept of utility,
which is a person’s subjective measure of
well-being or satisfaction. There are at least
three ways to deal with risk: insurance,
diversification, and the risk-return tradeoff.
133
132.Diversification
• Diversification refers to the reduction of
risk achieved by replacing a single risk with
a large number of smaller unrelated risks.
Simply, it means that don’t put all your eggs
in one basket.
134
133.Idiosyncratic Risk
• Idiosyncratic risk refers to risk that affects
only a single economic actor. It is the
uncertainty associated with the specific
companies. Diversification can eliminate
idiosyncratic risk.
135
134.Aggregate Risk
• Aggregate risk refers to risk that affects all
economic actors at once. It is the
uncertainty associated with the entire
economy, which affects all companies.
Diversification reduces the risk of holding
stocks, but it does not eliminate it.
136
135.Fundamental Analysis
• Fundamental analysis refers to the study of
a company’s accounting statements and
future prospects to determine its value. It
may include the demand for its product,
how much competition it faces, how much
capital it has in place, whether its workers
are unionized, how loyal its customers are,
what kinds of government regulations and
taxes it faces, and so on.
137
136.Informationally Efficient
• Informationally efficient reflects all
available information about the value of the
asset in a rational way, according to
efficient markets hypothesis theory. It
claims that the market price is the best
guess of the company’s value based on
available information at any moment in
time.
138
137.Random Walk
• Random walk refers to the path of a
variable whose changes are impossible to
predict. This means that the changes in
stock prices are impossible to predict from
available information. It is one implication
of the efficient markets hypothesis.
139
138.Labor Force
• Labor force refers to the total number of
workers, including both the employed and
the unemployed, if we places each adult
into one of three categories(employed,
unemployed and not in the labor force)
Labor force = Number of employed +
Number of unemployed.
140
139.Unemployment Rate
• Unemployment rate is the percentage of the
labor force that is unemployed.
Unemployment rate = Number of
unemployed ÷ Labor force ×100.
141
140.Labor-force Participation Rate
• Labor- force participation rate is the
percentage of the adult population that is in
the labor force.
Labor-force participation rate = Labor force
÷ Adult population × 100.
142
141.Natural Rate of Unemployment
• Natural rate of unemployment is the normal
rate of unemployment around which the
unemployment rate fluctuates.
143
142.Cyclical Unemployment
• Cyclical unemployment is the deviation of
unemployment from its natural rate.
144
143.Discouraged Workers
• Discouraged workers are individuals who
would like to work but have given up
looking for a job. These individuals may
have tried to find a job but have given up
after an unsuccessful search.
145
144.Frictional unemployment
• Frictional unemployment refers to
unemployment that results because it takes
time for workers to search for the jobs that
best suit their tastes and skills. It is often
thought to explain relatively short spells of
unemployment..it also shows that there are
always some workers without jobs and the
unemployment rate never falls to zero.
146
145.Structural Unemployment
• Structural unemployment refers to
unemployment that results because the
number of jobs available in some labor
markets is insufficient to provide a job for
everyone who wants one. It is often thought
to explain longer spells of unemployment.
147
146.Job Search
• Job search is the process by which workers find
appropriate jobs given their tastes and skills.
Because Workers differ in their tastes and skills,
and jobs differ in their attributes, and information
about job candidates and job vacancies is
disseminated slowly among the many firms and
households, the process of matching workers and
jobs is necessary. Some unemployment in
economy is inevitable.
148
147.Unemployment Insurance
• Unemployment insurance is a government
program that partially protects workers’
incomes when they become unemployed.
This program is designed to offer workers
partial protection against job loss. While
unemployment insurance reduces the
hardship of unemployment, it also increases
the amount of unemployment because it can
reduces workers’ search effort for new jobs.
149
148.Union
• Union refers to a worker association that
bargains with employers over wages and
working conditions. Economists who study
the effects of unions typically find that
union workers earn much than similar
workers who do not belong to unions. The
role of unions in the economy depends in
part on the laws that govern union
organization and collective bargaining.
150
149.Collective Bargaining
• Collective bargaining is the process by
unions and firms agree on the terms of
employment. When a union bargains with a
firm, it asks for higher wages, better
benefits, and better working conditions than
the firm would offer in the absence of a
union.
151
150.Strike
• Strike refers to the organized withdrawal of
labor from a firm by a union. Sometimes the
union and the firm can not reach a
agreement. In this case, the union can
organize a withdrawal of labor from the fim.
Because a strike reduces production, sales,
and profit, a firm facing a strike threat is
likely to agree to pay higher wages than it
otherwise would.
152
151.Efficiency wages
• Efficiency wages refer to above-equilibrium
wages paid by firms in order to increase worker
productivity. The theory of efficient wages uses it
to explain why economies always experience
some unemployment. According to this theory,
firms operate more efficiently if wages are above
the equilibrium level because high wages can
improve worker health, lower worker turnover,
increase worker effort, and raise worker quality.
153
152.Money
• Money is the set of assets in an economy
that people regularly use to buy goods and
services from other people. Money has three
functions in the economy: It is a medium of
exchange, a unit of account, and a store of
value.
154
153.Medium of Exchange
• Medium of exchange is an item that buyers
give to seller when they want to purchase
goods and services. When you walk into a
store, you are confident that the store will
accept your money for the items it is selling
because money is the commonly accepted
medium of exchange.
155
154.Unit of Account
• A unit of account is the yardstick people use
to post prices and record debts. When we
want to measure and record economic value,
we use money as the unit of account.
156
155.Store of Value
• A store of value is an item that people can
use to transfer purchasing power from the
present to the future. When a seller accepts
money today in exchange for a good or
service, that seller can hold the money and
become a buyer of another good or service
at another time.
157
156.Liquidity
• Liquidity is used to describe the ease with
which an asset can be converted into the
economy’s medium of exchange. Money is
the most liquid asset available. Most stocks
and bonds are relatively liquid assets. Assets
like houses are less liquid.
158
157.Commodity Money
• Commodity money is money that takes the form
of a commodity with intrinsic value. The term
intrinsic value means that item would have value
even if it were not used ad money. One example of
commodity money is gold. Another example of
commodity money is cigarettes. In prisoner-of-war
camps during World war II, prisoners traded goods
and services with one another using cigarettes as
the store of value, unit of account, and medium of
exchange.
159
158.Fiat Money
• Fiat money is money without intrinsic value that is
used as money because of government decree. A
fiat is simply an order or decree, and fiat money is
established as money by government decree. For
example, the paper RMB in your wallet is fiat
money printed by the China government. To a
large extent, the acceptance of fiat money depends
as much on expectations and social convention as
on government decree.
160
159.Currency
• Currency refers to the paper bills and coins
In the hands of the public. Currency is
clearly the most widely accepted medium of
exchange in our economy. It is part of the
money stock.
161
160.Demand Deposits
• Demand deposits refer to balances in bank
accounts that depositors can access on
demand by writing a check.
162
161.Central Bank
• Central bank refers to an institution designed to
oversee the banking system and regulate the
quantity of money in the economy. The major
central banks around the world include the Federal
Reserve, the Bank of England, the Bank of Japan,
the European Central Bank, and the Central Bank
of Chinese People. The central bank usually has
two related jobs. One is to regulate banks and
ensure the health of the banking system. Another
is to control the quantity of money supply.
163
162.Money Supply
• Money supply refers to the quantity of
money available in the economy. It is the
more important job for the central bank to
control the quantity of money that is made
available in the economy. To some extent,
money supply is the core of monetary policy.
164
163.Monetary Policy
• Monetary policy refers to the setting of the
money supply by policymakers in the
central bank. In China, the Central Bank of
Chinese people decides monetary policy. It
discusses the condition of the economy and
considers change in monetary policy.
165
164.Fractional-reserve Banking
• Fractional-reserve banking is a banking
system in which banks hold only a fraction
of deposits as reserves. Reserves are
deposits that banks have received but have
not loaned out.The fraction of total deposits
that a bank holds as reserves is called
reserve ratio. This reserve ratio is
determined by a combination of government
regulation and bank policy.
166
165.Money Multiplier
• Money multiplier refers to the amount of
money the banking system generates with
each dollar of reserves. The money
multiplier is the reciprocal of the reserve
ratio. Thus ,the higher the reserve ratio, the
less of each of deposit banks loan out, and
the smaller the money multiplier.
167
166.Open-Market Operations
• Open-market operations are the purchase
and sale of the government bonds by the
central bank. It is one of tools of monetary
control. To increase the money supply, the
central bank buy government bonds from
the public in the bond markets. To reduce
the money supply, the central bank does just
the opposite: it sells government bonds to
the public in the bond markets.
168
167.Reserve Requirements
• Reserve requirements refer to regulations on the
minimum amount of reserves that banks must hold
against deposits. It is one of tools of monetary
control. An increase in reserve requirements
means that banks must hold more reserves and,
therefore, can loan out less of each dollar that is
deposited; as a result, it raises the reserve ratio,
lowers the money multiplier, and decreases the
money supply. Conversely, a decrease in reserve
requirements lowers the reserve ratio, raise the
money multiplier, and increases the money supply.
169
168.Discount Rate
• Discount rate is the interest rate on the loans that
the central bank makes to banks. A higher discount
rate discourages banks from borrowing reserves
from the central bank. Thus, an increase in the
discount rate reduces the quantity of reserves in
the banking system, which in turn reduces the
money supply.conversely, a lower discount rate
encourages banks to borrow from the central bank,
increases the quantity of reserves, and increases
the money supply.
170
169.Quantity Theory of Money
• Quantity theory of money is a theory asserting that
the quantity of money available determines the
price level and that the growth rate in the quantity
of money available determines the inflation rate. It
explains the effects of a monetary injection. An
increase in the money supply decreases the the
value of money, and increases the price level.
Thus, the price level is determined by money
supply.
171
170.The Classical Dichotomy
• The classical dichotomy is the theoretical
separation of nominal and real variables. Nominal
variables are variables measured in monetary units.
Real variables are variables measured in physical
units. According to the theory, changes in the
supply of money affect nominal variables but not
real variables. This irrelevance of monetary
changes for real variables is called monetary
neutrality.
172
171.Velocity of Money
• Velocity of money refers to the rate at
which money changes hands. If P is the
price level (the GDP deflator), Y the
quantity of output(real GDP), and M the
quantity of money, then velocity of money
is
V = (P*Y)/M.
173
172.Quantity Equation
• Quantity equation is the equation M*V = P*Y,
which relates the quantity of money, the velocity
of money, and the dollar value of the economy’s
output of goods and services. It shows that an
increase in the quantity of money in an economy
must be reflected in one of the other three
variables:the price level must rise, the quantity of
output must rise, or the velocity of money must
fall.
174
173.Inflation Tax
• Inflation tax refers to the revenue the government
raises creating money. The inflation tax is not
exactly like other taxes because on one receives a
bill from the government for this tax. The inflation
tax is more subtle. When the government prints
money, the price level rises, and the dollars in
your wallet are less valuable. Thus, the inflation
tax is like a tax on everyone who holds money.
175
174.Fisher Effect
• Fisher effect refers to the one-for-one adjustment
of the nominal interest rate to the inflation rate. It
shows that the result is both a higher inflation rate
and a higher nominal interest rate when the central
bank increases the rate of money growth. Fisher
effect is based on the principle of monetary
neutrality. It is crucial for understanding changes
over time in the nominal interest rate.
176
175.Shoeleather Costs
• Shoeleather costs belong to the costs of inflation.
The cost of reducing your money holdings is
called the shoeleather cost of inflation because
making more frequent trips to the bank causes
your shoes to wear out more quickly.The actual
cost of reducing your money holdings is not the
wear and tear on your shoes but the time and
convenience you must sacrifice to keep less
money on hand than you would if there were no
inflation.
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176.Menu Costs
• Menu costs belong to the costs of inflation. Menu
costs are the costs of changing prices. When
inflation increases rapidly, firms must change their
prices. Menu costs include the cost of deciding on
new prices, the cost of printing new price lists and
catalogs, the cost of sending these new price lists
and catalogs to dealers and customers, the cost of
advertising the new prices, and even the cost of
dealing with customer annoyance over price
changes.
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177.Recession and Depression
• Recession refers to a period of declining real
incomes and rising unemployment. A severe
recession is called a depression. During the
periods of recessions, especially of depressions,
firms find themselves unable to sell all of the
goods and services they have to offer, so they cut
back on production, and workers are laid off,
unemployment rises, real GDP and other measures
of incomes fall.
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178.Model of Aggregate Demand
and Aggregate Supply
• Model of aggregate demand and aggregate supply
refers to the model that most economists use to
explain short-run fluctuations in economic activity
around its long-run trend. Most economists
believe that classical theory describes the world in
the long run but not in the short run. In the short
run, we need the model of aggregate demand and
aggregate supply to study the changes in economy.
According to this model, the price level and the
quantity of output adjust to bring aggregate
demand and aggregate supply into balance.
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179.Aggregate-Demand Curve
• The aggregate-demand curve is a curve that shows
the quantity of goods and services that households,
firms, and the government want to buy at each
price level. Because of the wealth effect, the
interest-rate effect and the exchange-rate effect,
The aggregate-demand curve slopes downward
with other things equal. Changes in consumption,
investment, government purchase, or net exports
at a given price level shift the aggregate-demand
curve to the left or the right.
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180.Aggregate-Supply Curve
• Aggregate-supply curve is a curve that shows the
quantity of goods and services that firms choose to
produce and sell at each price level. In the long
run, the aggregate-supply curve is vertical,
whereas, in the short run, the aggregate-supply
curve is upward sloping. Changes in labor, capital,
natural resources, or technology shift the short-run
supply curve and may shift the long-run supply
curve.
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181.Stagflation
• Stagflation refers to a period of falling
output (stagnation) and rising
prices(inflation). When a economy faces a
stagflation, Policymakers can influence
aggregate demand, but can not offset both
of these adverse effects simultaneously.
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182.Theory of Liquidity
Preference
• The theory of liquidity preference is Keynes’s
theory that the interest rate adjusts to bring money
supply and money demand into balance. Keynes
proposed the theory of liquidity preference to
explain what factors determine the economy’s
interest rate. The theory of liquidity preference
illustrates an important principle: monetary policy
can be described either in terms of the money
supply or in terms of the interest rate.
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183.multiplier Effect
• The multiplier effect refers to the additional shifts
in aggregate demand that result when
expansionary fiscal policy increases income and
thereby increases consumer spending. It shows
how the economy can amplify the impact of
changes in spending: A small initial change in
consumption, investment, government purchases,
or net exports can end up having a large effect on
aggregate demand and, therefore, the economy’s
production of goods and services.
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184.Crowding-out Effect
• Crowding-out effect refers to the offset in
aggregate demand that results when
expansionary fiscal policy raises the interest
rate and thereby reduces investment
spending. The crowding out of investment
partially offsets the impact of the multiplier
effect.
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185.Automatic Stabilizers
• Automatic stabilizers refer to changes in
fiscal policy that stimulate aggregate
demand when the economy goes into a
recession without policymakers having to
take any deliberate action. The most
important automatic stabilizer is the tax
system. Government spending also acts as
an automatic stabilizer.
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