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Introduction to Economics Key terms and Definitions Economic problem: Scarcity: Land: Labour: Capital: Enterprise: Profit: Rent: Wages: Interest: Capital intensive: Labour intensive: Opportunity Cost: PPC/PPF: Consumption: Investment: Positive (economic) statements: Normative (economic) statements: Key Diagrams: PPF/PPC curves to show: a) trade off between consumption and investment b) actual growth versus potential growth c) economic growth versus economic development Use a PPC to show the impact of greater capital investment in S.Korea Use a PPC to show the impact on the Spanish economy due to a rise in unemployment Use a PPC to show economic growth but not development In assessment, make sure you……… Know that the three basic economic questions that must be answered by any economic system are: “What to produce?”, “How to produce?” and “For whom to produce?”. In a mixed and market economic system the price/market mechanism is fundamental in providing an answer to these questions (see later). Section 1: Microeconomics review: Key terms and definitions (HL only = bold) Demand Quantity demanded Ceteris Paribus Substitute effect Income effect Utility Marginal Utility Complementary goods/joint demand Substitute goods/competitive demand Normal goods Inferior goods Superior goods Supply Quantity supplied Complementary producer good Substitute producer good Market equilibrium Surplus Shortage Price mechanism- Price as a signalling device, rationing device & profit incentive Maximum price Minimum price Parallel market Price elasticity of demand Inelastic demand Elastic demand XED YED PES Tax Subsidy Specific tax Ad valorem tax Tax incidence/burden Market failure Social costs (Marginal) Social benefits (Marginal) Externalities Positive externalities/external benefits Negative externalities/external costs Public goods/Private goods Rivalry/Non rivalry Excludability/non excludability Merit goods Demerit goods Welfare loss Consumer surplus Producer surplus Short run and long run cost periods Total cost Fixed cost Variable cost Marginal cost Average cost Marginal product Total product Average product Economics of scale Total revenue Average revenue Marginal revenue Economic Profit Normal profit Abnormal profit Economic loss/Sub normal profit Profit maximisation Revenue maximisation Perfect competition Monopolistic competition Oligopoly Monopoly Natural monopoly Barriers to entry/exit Sunk costs Price makers/takers Productive efficiency Allocative efficiency Social efficiency Price competition and non-price competition Price discrimination Contestable markets Key Diagrams: Market demand and supply to show: Equilibrium market price and quantity Changes in the conditions of demand and supply and subsequent effects on above Effects of tax and subsidy on market price and quantity The incidence/burden of taxation/subsidy Max price scheme Min price scheme Buffer stock scheme Surplus and shortage Elasticities of demand and supply Diagram to show relationship between income and quantity demanded for normal and inferior goods Show impact of falling oil & coal prices on market for renewable energy Show government intervention when price falls below min price in market for rice Show burden of an ad valorem tax on airfares on the market for airline travel Show price acting as a signalling and rationing device In assessment, make sure you………. Always try to apply a relevant example in supply/demand diagrams Use terminology correctly e.g. know when to use quantity demanded rather than demand Apply the concept of elasticity when relevant. Inelastic demand is relevant to a variety of productsnecessities, those with few substitutes, general product categories (e.g. cars as opposed to a particular brand of car). Inelastic supply is particularly relevant to agricultural produce and goods that take time to produce. Know the reasons why the demand curve slopes downward and supply slopes upwards Use terminology associated with elasticities appropriately- refer to a change in price that leads to a proportionality larger/smaller change in quantity demanded/supplied Know the significance of PED on revenue when price changes (due to supply changing). This is an important concept for microeconomics (significance of PED for business decisions, impact of tax on producers, kinked demand curve for a firm in oligopoly (HL)), International trade (impact of a depreciation/appreciation of currency on export revenue/import expenditure, relationship between terms of trade and BOT (HL) & Development economics (impact of variable supply on the producers of primary commodities with inelastic demand) Market failure diagrams MSC/MSB diagram to show: Market failure associated with: Positive externalities of consumption (merit goods, public goods) Negative externalities of consumption (demerit goods) Positive externalities of production Negative externalities of production Profit maximising output versus socially efficient output Welfare loss Show potential welfare gain associated with tertiary education Show welfare loss associated with coal fired power stations In assessment, make sure you………. Always try to apply a relevant example. Use the good/service that you may have used for your IA commentary and the relevant government policy If referring to a tax on a demerit good/polluter or a subsidy to a producer of a merit good, use the term ‘internalising the externality’- I love it. If the question asks’ ‘To what extent should governments…….’ the examiner is looking for you to recognise that government intervention may lead to government failure and that often markets left alone are simply the best way to allocate resources (when market failure is relatively insignificant) HL Diagrams Diagram to show relationship between fixed costs, variable costs and total costs Diagram showing economies and diseconomies of scale on LRAC curve Diagram to show relationship between marginal product and average product Output positions for a firm in perfect competition- used to show: Short run and long run output positions (must use in conjunction with market supply and demand) Productive and allocative efficiency Shut down output position Output positions for a firm in monopoly- used to show: Possible profit situations in monopoly Revenue maximisation position Productive and allocative efficiency (or lack of) Output positions for a firm in monopolistic competition- used to show: Short run and long run output positions Productive and allocative efficiency (or lack of) Possible profit situations in monopolistic competition Output positions for a firm in oligopoly- used to show: Possible profit situations in oligopoly Price fixing agreement – firms act as monopoly The Kinked Demand Curve- used to show: Price rigidity in oligopolies Output and pricing positions for a firm practising (third degree) price discrimination Use both diagrams to show the long run adjustment process in perfect comp. on the market for oranges (left) and a firm (right) if the firm is earning abnormal profits Show the shutdown price & output for a firm in per. competition Show how a monopolist can produce at a higher output level and lower price than a firm in per comp. Show the welfare loss that exists when a monopolist maximises profit rather than being allocatively efficient Show price rigidity for a non-collusive firm in oligopoly In assessment, make sure you………. Know the difference between the long run adjustment process in perfect comp. and mono. comp. When comparing market structures compare characteristics, behaviour and performance and ALWAYS compare levels of efficiency If you are asked to evaluate the desirability of a market structure, ask yourself, desirable for whom? Firms in the market structure? Consumers? The government? Society? Remember the golden rule of drawing output/price diagrams for firms in any market structure: 1. AR 2. MR 3. MC 4. PMO 5. AC 6. Profit/loss Macroeconomics review: (HL only – bold) Key terms/definitions: National income GDP National Output v. Domestic Output Gross National Income v. Net National Income Real GDP versus Nominal GDP per capita Green GDP Economic growth Economic development Aggregate demand Consumption Investment Net exports Fiscal policy (expansionary/deflationary) Monetary policy (expansionary/deflationary) Interest rates APC APS Durable goods v. non durable goods Disposable income Real income/Purchasing power Aggregate supply LRAS Macroeconomic equilibrium Output gap Recessionary gap Inflationary gap Recession The multiplier Inflation Deflation Disinflation Demand pull inflation Cost push inflation RPI/CPI Producer Price Index Unemployment Unemployment rate Derived demand Labour force Structural unemployment Seasonal unemployment Frictional unemployment Real wage rate unemployment Demand deficient unemployment Equilibrium unemployment Disequilibrium unemployment Taxation Direct taxes Indirect taxes Regressive taxes Progressive taxes Proportional taxes Budget deficit v. surplus National debt Current expenditures Capital expenditures Transfer payments Gini coefficient/index Automatic stabilisers Key diagrams: Circular flow of income used to show: National income Leakages and injections The effects of the multiplier (perhaps) Investment schedule: used to show: Relationship between level of investment and interest rates Macroeconomic equilibrium: used to show: Changes in AD caused by changes in components of AD Changes in SRAS caused by supply side shocks & changes to costs of production Changes in LRAS caused by supply side policies Effects of policies: demand side and supply side, fiscal, monetary, x-rate etc All show impact on price level and output level Output gaps- recessionary and inflationary Inflation (cost push and demand pull) Keynesian versus Neo-classical LRAS: used to show: Differences in opinion between two schools of thought on Long Run equilibrium in economy Use Keynesian LRAS to illustrate the effects of demand deficient unemployment The differing impacts of demand side policies on a Keynesian and Neo-classical long run equilibrium The business/trade cycle: used to show: Fluctuations in economic output and long run trends The Labour market: used to show Equilibrium unemployment (search/seasonal/structural) – include ADL, ASL and LF Disequilibrium unemployment (real wage rate & demand deficient) show ASL>ADL at equilibrium wage rate Lorenz curve: used to show: income distribution/income inequality Gini coefficient The Phillips curve: used to show: Trade off between unemployment and inflation HL: The LR Phillips curve: used to show: Natural rate of unemployment Macroeconomic diagrams Show the existence of equilibrium unemployment Using an AD/AS diagram, show the impact of supply side policies on an economy Without using an AD/AS diagram, show the impact of supply side policies on an economy Show good deflation HL- show the impact of the multiplier on national output due to an increase in exports Show the impact of progressive taxes on income distribution Show how expansionary fiscal policy can close a recessionary gap Show how, in the neo-classical model , the economy will always return to fully employment level of output despite an increase in AD Show how an increase in AD might not result in inflation on the Keynesian LRAS model Show a reduction in disequilibrium unemployment HL- Using a LR Phillips curve, show the impact of a rise in AD on the natural rate of unemployment and on inflation Show the impact of rising interest rates on Investment In assessment, make sure you………. Use the SRAS curve when showing cost-push inflation Use the correct labelling for AD/AS diagrams- Price Level, Output (Real GDP), Y, P. Know why the AD curve slopes downward (wealth effect, interest rate effect, net export effect) Use YFE when labelling full employment output on the x-axis Draw a Keynesian LRAS curve with a clear horizontal section, upward sloping section and vertical section Know why the Keynesian LRAS curve has horizontal, upward sloping and vertical sections Recognise that supply side policies are designed to increase level of potential output (shift of LRAS/shift out of PPC). They can also lead to lower business costs therefore shifting out SRAS. Recognise that demand side policies generally influence AD, but some also act of supply side policies and therefore influence SRAS/LRAS. For example, lower income tax, lower corporate tax, lower indirect taxes, investment in training, education, new technology and infrastructure Know the difference between interventionist supply side policies and market based supply side policies Know supply side polices aimed specifically at improving labour market flexibility Use correct labelling for labour market diagrams- ADL, ASL, LF, wage rate and quantity of labour Recognise that different causes of unemployment have different degrees of severity & therefore require different levels (and types) of government intervention Recognise that low unemployment can result in inflationary pressures (AD/AS diagram). This is a classic macroeconomic trade off (Phillips Curve) Know that there are a wide variety of government revenue sources – taxation, national insurance/social insurance contributions, profits from nationalised industries, privatisation, sale of government land or lease of land. Know a variety of areas of government expenditure (defence, education, pensions etc). Know the impact of progressive, regressive and proportional taxes on income distribution. Know how governments support lower income groups through transfer payments and the providing of direct benefits (Benefits in kind) Apply real world examples!!! — Demand deficient unemployment in US during Great Depression and Roosevelt’s expansionary fiscal policy (as advocated by Keynes) to create jobs. — Demand deficient unemployment in US after 2008 financial crash and Obama’s expansionary fiscal policy to create jobs. — Interest rates currently at all time lows (0.5% in many countries & even negative interest rates in Japan!!). — Austerity policies (contractionary fiscal policy) currently in UK, Ireland, Spain and Greece to reduce national debt and budget deficits. — Current expansionary monetary policy & devaluation of RMB in China to stimulate economic growth — Demand pull inflation caused by high consumer & business confidence and Government spending on Vietnam war in USA in 1960’s — Bad deflation in Japan during 1990’s & 2000’s as a result of falling consumer spending & low business confidence Key terms and diagrams: International trade (HL only = bold) International trade Factor endowments HL: Absolute advantage HL: Comparative advantage Free trade Protectionism Infant industries Declining industries Dumping Tariffs Quotas Export subsidy Embargo Globalisation MNE FDI Trading blocs Free Trade Areas Customs Unions Common Market Monetary Union HL Trade Creation HL Trade Diversion Exchange rate Fixed x-rate Floating x-rate Managed x-rate Appreciation and depreciation Revaluation and devaluation Balance of Payments Current Account Trade balance Current account surplus/deficit Capital account Financial account Expenditure switching policies Expenditure reducing polices Terms of trade Deteriorating terms of trade Improvement in terms of trade Key diagrams: HL- PPF/PPC curves to show: Gains from specialisation and trade Comparative and absolute advantage Tariff diagram to show: Impact onEquilibrium market price and quantity, world producers, domestic producers, domestic consumers, government revenue, loss of consumer surplus, welfare loss. Quota diagram to show: Impact onEquilibrium market price and quantity, world producers, domestic producers, domestic consumers, loss of consumer surplus, welfare loss Protectionist subsidy diagram to show: Impact onEquilibrium market price and quantity, world producers, domestic producers, domestic consumers, government spending & welfare loss Foreign Exchange market diagram to show: Changes in demand and supply of currency and subsequent impact on equilibrium value of currency in terms of another currency. Differences between fixed and floating x-rate systems HL- The J curve to show Correction of current account deficit over time due to Marshall Lerner condition International trade diagrams Show the impact of reduced interest rates in Japan on the value of Japanese Yen Show the impact of a domestic subsidy to protect domestic farmers of olive oil in the EU Show the impact of increased tariffs on Chinese solar panels in the US market Show the impact of inflation in Argentina on the Argentinian peso HL- show trade creation that might occur if Turkey joins the EU Show the impact of interventionist buying of the RMB by the Peoples Bank of China In assessment, make sure you………. For two mark definitions, try to have two points for each definition. In four mark ‘explain using a diagram……..’ questions, make sure you respond to what exactly the question asks in your explanation. Be prepared to use micro and macroeconomic definitions, diagrams and concepts in both data response questions (international trade and development economics) Label quota, tariff, and domestic subsidy diagrams correctly (Price, quantity, domestic supply, domestic demand, world supply) Don’t get confused between and export subsidy and domestic subsidy used for protectionism Label exchange rate diagrams correctly (price of $ in terms of Euro, quantity of $, supply of $, demand for $) Know the main factors that cause an increase the demand for a currency (increase in demand for exports, speculation buying, higher interest rates, Central Bank intervention buying, deflation) Know the main factors that cause an increase in the supply of a currency (increase in demand for imports, speculation selling, lower interest rates, inflation, Central Bank intervention selling) Don’t confuse depreciation with deflation!!!!! Don’t confuse appreciation with inflation!!!!! Know that a currency appreciation makes imports cheaper and exports more expensive Know that a currency depreciation makes imports more expensive (particularly raw materials) and exports cheaper Recognise that PED for imports and exports plays a MASSIVE/HUGE/SIGNIFICANT impact on export revenue and import expenditure as a result of exchange rate fluctuations and therefore affects Bal. of Trade/Current Account Bal./Net Exports accordingly. Recognise that the Balance of Trade and Current Account Balance are often used synonymously but they are not exactly the same Know that FDI flows into a country are credited in the Financial account (of the country where investment is made) but any profits sent back abroad are debited in the Current account. Development Economics – Key terms ELDC (characteristics) EMDC (characteristics) Underemployment Infrastructure Property rights Informal markets Indebtedness Capital flight Poverty trap/cycle (all key diagram) Export promotion/outward orientation strategies Import substitution/inward-orientated strategies Micro-finance Aid Tied aid Multilateral aid Bilateral aid Grants Indebtedness Sustainable development Key diagrams: Poverty cycle In assessment, make sure you………. Be prepared to use micro and macroeconomic definitions, diagrams and concepts in both data response questions (international trade and development economics) Know the difference between GDP per capita/GNY per capita/GDP per capita at PPP Evaluate the use of GDP per capita and/or HDI as a measure of economic growth and development Be prepared to evaluate the role of MNEs/FDI on economic growth & development Be prepared to evaluate the role of different types of foreign aid on economic growth & development Be prepared to argue for and against debt relief for Highly Indebted Poor Countries Recognise the barriers to economic growth and development that exist in some LDCs (notably lack of infrastructure-road, rail and electricity networks, poor governance and associated corruption, brain drain, indebtedness, aid dependence, low tax revenue due to huge informal economies and underemployment/unemployment) Recognise the strengths & limitations of export promotion strategies Recognise the strengths & limitations of import substitution strategies Evaluate the role the government should play in economic development (interventionist strategies) Evaluate the role the market should play in economic development (market orientated policies)