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economics economic problem economic theory The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided Given scarce resources, how exactly do large, complex societies go about answering the three basic economic questions? A statement or set of related statements about cause and effect, action and reaction microeconomi The branch of economics that examines the cs functioning of individual industries and the behavior of individual decision-making units-that is, business firms and households macroThe branch of economics that examines the economics economic behavior of aggregates-income, employment, output, and so on-on a national scale Great The period of severe economic contraction and Depression high unemployment that began in 1929 and continued throughout the 1930s fine-tuning The phrase used by Walter Heller to refer to the government's role in regulating inflation and unemployment stagflation Occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation). laissez-faire Literally from the French: "allow [them] to do." economy An economy in which individual people and firms pursue their own self-interests without any central direction or regulation command An economy in which a central government economy either directly or indirectly sets output targets, incomes, and prices consumer The idea that consumers ultimately dictate what sovereignty will be produced (or not produced) by choosing what to purchase (and what not to purchase) price The amount that a product sells for per unit. It reflects what society is willing to pay theory of Ricardo's theory that specialization and free trade comparative will benefit all trading partners (real wages will advantage rise), even those that may be absolutely more (or less) efficient producers model A formal statement of a theory, usually a mathematical statement of a presumed relationship between two or more variables variable A measure that can change from time to time or from observation to observation Ockham's The principle that irrelevant detail should be cut razor away positive An approach to economics that seeks to economics understand behavior and the operation of systems without making judgments. It describes what exists and how it works. normative An approach to economics that analyzes economics outcomes of economic behavior, evaluates them as good or bad, and may prescribe course of action. Also called policy economics. descriptive The compilation of data that describe phenomena 1 economics empirical economics equity efficiency stability economic growth opportunity cost sunk costs ceteris paribus, or all else equal efficient market Industrial Revolution capital outputs resources or inputs input or factor markets labor market capital market land market three basic questions producers production factors of production and facts The collection and use of data to test economic theories Fairness The condition in which the economy is producing what people want at least possible cost A condition in which output is steady or growing, with low inflation and full employment of resources 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 The best alternative that we forgo, or give up, when we make a choice or a decision Costs that cannot be avoided, regardless of what is done in the future, because they have already been incurred A device used to analyze the relationship between two variables while the values of other variables are held unchanged A market in which profit opportunities are eliminated almost instantaneously. The period in England during the late eighteenth and early nineteenth centuries in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities Those goods produced by the economic system that are used as inputs to produce other goods and services Usable products Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants The markets in which the resources used to produce products are exchanged The input factor market in which households supply work for wages to firms that demand labor The market in which households supply their savings to firms that demand funds to buy capital goods The input/factor market in which households supply land or other real property in exchange for rent The three basic questions that all societies must answer: What will be produced? How will it be produced? Who will get what is produced? Those people or groups of people, whether private or public, who transform resources into usable products The process by which resources are transformed into useful forms The inputs into the production process. Land, Labor, and capital are the three key factors of production 2 product or output markets quantity demanded The markets in which goods and services are exchanged 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 demand curve A graph illustrating how much of a given product a household would be willing to buy at different prices law of demand The negative relationship between price and quantity demanded: As price rises, quantity demanded decreases. As price falls, quantity demanded increases shift of a The change that takes place in a demand curve demand curve corresponding to a new relationship between quantity demanded of a good and price of that good. The shift is brought about by a change in the original conditions movement The change in quantity demanded brought about along a by a change in price. demand curve market The sum of all the quantities of a good or service demand demanded per period by all the households buying in the market for that good or service. aggregate The total demand for goods and services in an demand economy consumer Goods produced for present consumption goods normal goods Goods for which demand goes up when income is higher and for which demand goes down when income is lower inferior goods Goods for which demand tends to fall when income rises substitutes Goods that can serve as replacements for one another; when the price of one increase, demand for the other goes up perfect Identical products substitutes complements, Goods that "go together"; a decrease in the price complementar of one results in an increase in demand for the y goods other, and vice versa investment The process of using resources to produce new capital. New capital additions to a firms capital stock. Although capital is measured at a given point in time (a stock), investment is measured over a period of time (a flow). The flow of investment increases the capital stock production A graph that shows all the combinations of goods possibility and services that can be produced if all of frontier (ppf) society's resources are used efficiently marginal rate The slope of the production possibility frontier of (ppf). transformation (MRT) firm 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. Most firms exist to make a profit 3 entrepreneur households income wealth or net worth wealth or net worth profit quantity supplied supply schedule law of supply supply curve market supply aggregate supply equilibrium excess demand or shortage excess demand or shortage excess supply or surplus price rationing price ceiling queuing favored customers ration coupons black market inflation hyperinflation A person who organizes, manages, and assumes the risk of a firm, taking a new idea or a new product and turning it into successful business The consuming units in an economy The sum of all a household's wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure The total value of what a household owns minus what it owes. It is a stock measure The total value of what a household owns minus what it owes. It is a stock measure The excess of revenues over cost in a given period 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 A table showing how much of a product firms will supply at different prices The positive relationship between price and quantity of a good supplied: An increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied A graph illustrating how much of a product a firm will supply a different price The sum of all that is supplied each period by all producers of a single product The total supply of goods and services in an economy The condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for price to change The condition that exists when quantity demanded exceeds quantity supplied at the current price The condition that exists when quantity demanded exceeds quantity supplied at the current price The condition that exists when quantity supplied exceeds quantity demanded at the current price The process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied A maximum price that sellers may charge for a good, usually set by government Waiting in line as a means of distributing goods and services; a nonprice rationing mechanism Those who receive special treatment from dealers during situations of excess demand Tickets or coupons that entitle individuals to purchase a certain amount of a given product per month A market in which illegal trading takes place at market-determined prices An increase in the overall price level A period of very rapid increases in the overall 4 price level The cycle of short-term ups and downs in the economy aggregate The total quantity of goods and services output produced (or supplied) in an economy in a given period recession Period during which aggregate output declines. Conventionally, a period in which aggregate output declines for two consecutive quarters depression A prolonged and deep recession expansion or The period in the business cycle from a trough boom up to a peak, during which output and employment rise contraction, The period in the business cycle from a peak recession, or down to a trough, during which output and slump employment fall unemployment The percentage of the labor force that is rate unemployed fiscal policy Government policies concerning taxes and expenditures monetary The tools used by the Federal Reserve to control policy the money supply supply-side Government policies that focus on stimulating policies aggregate supply instead of aggregate demand. circular flow A diagram showing the income received and payments made by each sector of the economy transfer Cash payments made by the government to payments people who do not supply goods, services, or labor in exchange for these payments. They include social security benefits, veterans' benefits, and welfare payments Treasury Promissory notes issued by the federal bonds, notes, government when it borrows money and bills corporate Promissory notes issued by corporations when bonds they borrow money shares of stock Financial instruments that give to the holder a share in the firm's ownership and therefore the right to share in the firm's profits dividends The portion of a corporation's profits that the firm pays out each period to its shareholders national Data collected and published by the government income and describing the various components of national product income and output in the economy accounts gross domestic The total market value of all final goods and product (GDP) services produced within a given period by factors of production located within a country final goods Goods and services produced for final use and services intermediate Goods that are produced by one firm for use in goods further processing by another firm value added 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 gross national The total market value of all final goods and product (GNP) services produced within a given period by factors of production owned by a country's business cycle 5 expenditure approach income approach personal consumption expenditures (C) durable goods citizens, regardless of where the output is produced A method of computing GDP that measures the amount spent on all final goods during a given period A method of computing GDP that measures the income—wages, rents, interest, and profits— received by all factors of production in producing final goods A major component of GDP: expenditures by consumers on goods and services Goods that last a relatively long time, such as cars and household appliances nondurable Goods that are used up fairly quickly, such as goods food and clothing services The things we buy that do not involve the production of physical things, such as legal and medical services and education gross private Total investment in capital—that is, the purchase domestic of new housing, plants, equipment, and inventory investment (I) by the private (or nongovernment) sector nonresidential Expenditures by firms for machines, tools, investment plants, and so on residential Expenditures by households and firms on new investment houses and apartment buildings change in The amount by which firms' inventories change business during a period. Inventories are the goods that inventories firms produce now but intend to sell later depreciation The amount by which an asset's value falls in a given period gross The total value of all newly produced capital investment goods (plant, equipment, housing, and inventory) produced in a given period net investment Gross investment minus depreciation government Expenditures by federal, state, and local consumption governments for final goods and services and gross investment (G) net exports The difference between exports (sales to (EX - IM) foreigners of U.S.-produced goods and services) and imports (U.S. purchases of goods and services from abroad). The figure can be positive or negative national The total income earned by the factors of income production owned by a country's citizens compensation Includes wages, salaries, and various of employees supplements—employer contributions to social insurance and pension funds, for example—paid to households by firms and by the government proprietors' The income of unincorporated businesses income corporate The income of corporate businesses profits rental income The income received by property owners in the form of rent indirect taxes Taxes like sales taxes, customs duties, and 6 subsidies license fees Payments made by the government for which it receives no goods or services in return Payments of factor income to the rest of the world minus the receipt of factor income from the rest of the world net factor payments to the rest of the world net national Gross national product minus depreciation; a product (NNP) nation's total product minus what is required to maintain the value of its capital stock personal The total income of households. Equals (national income income) minus (corporate profits minus dividends) minus (social insurance payments) plus (interest income received from the government and households) plus (transfer payments to households). The income received by households after paying social insurance taxes but before paying personal income taxes disposable Personal income minus personal income taxes. personal The amount that households have to spend or income or save after-tax income personal The amount of disposable income that is left saving after total personal spending in a given period personal The percentage of disposable personal income saving rate that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously current dollars The current prices that one pays for goods and services nominal GDP Gross domestic product measured in current dollars weight The importance attached to an item within a group of items base-year The year chosen for the weights in a fixedweight procedure fixed-weight A procedure that uses weights from a given base procedure year underground The part of the economy in which transactions economy take place and in which income is generated that is unreported and therefore not counted in GDP per capita A country's GDP or GNP divided by its GDP or GNP population employed Any person 16 years old or older (1) who works for pay, either for someone else or in his or her own business for 1 or more hours per 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 unemployed A person 16 years old or older who is not working, is available for work, and has made specific efforts to find work during the previous 4 weeks not in the A person who is not looking for work, either labor force because he or she does not want a job or has 7 given up looking The number of people employed plus the number of unemployed unemployment The percentage of the labor force that is rate unemployed labor-force The ratio of the labor force to the total population participation 16 years old or older rate discouragedThe decline in the measured unemployment rate worker effect 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 frictional The portion of unemployment that is due to the unemployment normal working of the labor market; used to denote short-run job/skill matching problems structural The portion of unemployment that is due to unemployment changes in the structure of the economy that result in a significant loss of jobs in certain industries natural rate of The unemployment that occurs as a normal part unemployment of the functioning of the economy. Sometimes taken as the sum of frictional unemployment and structural unemployment cyclical The increase in unemployment that occurs during unemployment recessions and depressions labor supply A graph that illustrates the amount of labor that curve households want to supply at the particular wage rate labor demand A graph that illustrates the amount of labor that curve firms want to employ at the particular wage rate sticky wages The downward rigidity of wages as an explanation for the existence of unemployment social, or Unspoken agreements between workers and implicit, firms that firms will not cut wages contracts relative-wage An explanation for sticky wages (and therefore explanation of unemployment): If workers are concerned about unemployment their wages relative to other workers in other firms and industries, they may be unwilling to accept a wage cut unless they know that all other workers are receiving similar cuts explicit Employment contracts that stipulate workers’ contracts wages, usually for a period of 1 to 3 years cost-of-living Contract provisions that tie wages to changes in adjustments the cost of living. The greater the inflation rate, (COLAs) efficiency wage theory An explanation for unemployment that holds that the productivity of workers increases with the wage rate. If this is so, firms may have an incentive to pay wages above the market-clearing rate efficiency An explanation for unemployment that holds that wage theory the productivity of workers increases with the wage rate. If this is so, firms may have an incentive to pay wages above the market-clearing rate minimum Laws that set a floor for wage rates—that is, a wage laws minimum hourly rate for any kind of labor labor force 8 inflation deflation sustained inflation NAIRU An increase in the overall price level A decrease in the overall price level An increase in the overall price level that continues over a significant period The nonaccelerating inflation rate of unemployment inflation rate The percentage change in the price level consumer A price index computed each month by the price index Bureau of Labor Statistics using a bundle that is (CPI) meant to represent the "market basket" purchased monthly by the typical urban consumer producer price Measures of prices that producers receive for indexes (PPIs) products at all stages in the production process real interest The difference between the interest rate on a loan rate and the inflation rate Phillips Curve A graph showing the relationship between the inflation rate and the unemployment rate velocity of money quantity theory of money rationalexpectations hypothesis Lucas supply function price surprise real business cycle theory Laffer curve trade surplus trade deficit Corn Laws absolute advantage comparative The number of times a dollar bill changes hands, on average, during a year; the ratio of nominal GDP to the stock of money The theory based on the identity M × The theory based on the identity M × V = P × Y and the assumption that the velocity of money (V) is constant (or virtually constant). The hypothesis that people know the "true model" of the economy and that they use this model to form their expectations of the future The supply function embodies the idea that output (Y) depends on the difference between the actual price level and the expected price level Actual price level minus expected price level An attempt to explain business cycle fluctuations under the assumptions of complete price and wage flexibility and rational expectations. It emphasizes shocks to technology and other shocks With the tax rate measured on the vertical axis and tax revenue measured on the horizontal axis, the Laffer curve shows there is some tax rate beyond which the supply response is large enough to lead to a decrease in tax revenue for further increases in the tax rate The situation when a country exports more than it imports The situation when a country imports more than it exports The tariffs, subsidies, and restrictions enacted by the British Parliament in the early nineteenth century to discourage imports and encourage exports of grain The advantage in the production of a product enjoyed by one country over another when it uses fewer resources to produce that product than the other country does The advantage in the production of a product 9 advantage enjoyed by one country over another when that product can be produced at lower cost in terms of other goods than it could be in the other country terms of trade The ratio at which a country can trade domestic products for imported products exchange rate The ratio at which two currencies are traded. The price of one currency in terms of another factor The quantity and quality of labor, land, and endowments natural resources of a country HeckscherA theory that explains the existence of a Ohlin theorem 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 protection The practice of shielding a sector of the economy from foreign competition tariff A tax on imports export Government payments made to domestic firms to subsidies encourage exports dumping A firm or industry sells products on the world market at prices below the cost of production quota A limit on the quantity of imports SmootThe U.S. tariff law of the 1930s, which set the Hawley tariff highest tariffs in U.S. history (60 percent). It set off an international trade war and caused the decline in trade that is often considered a cause of the worldwide depression of the 1930s General An international agreement signed by the United Agreement on States and 22 other countries in 1947 to promote Tariffs and the liberalization of foreign trade Trade (GATT) economic Occurs when two or more nations join to form a integration free-trade zone European The European trading bloc composed of Austria, Union (EU) Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom U.S.-Canadian An agreement in which the United States and Free-Trade Canada agreed to eliminate all barriers to trade Agreement between the two countries by 1998 North An agreement signed by the United States, American Mexico, and Canada in which the three countries Free-Trade agreed to establish all North America as a freeAgreement trade zone (NAFTA) foreign All currencies other than the domestic currency exchange of a given country balance of The record of a country's transactions in goods, payments services, and assets with the rest of the world; also the record of a country's sources (supply) and uses (demand) of foreign exchange balance of A country's exports of goods and services minus trade its imports of goods and services trade deficit Occurs when a country's exports of goods and services are less than its imports of goods and services in a given period 10 balance on current account balance on capital account Net exports of goods, plus net exports of services, plus net investment income, plus net transfer payments In the United States, the sum of the following (measured in a given period): the change in private U.S. assets abroad, the change in foreign private assets in the United States, the change in U.S. government assets abroad, and the change in foreign government assets in the United States The change in imports caused by a $1 change in income marginal propensity to import (MPM) trade feedback The tendency for an increase in the economic effect activity of one country to lead to a worldwide increase in economic activity, which then feeds back to that country price feedback The process by which a domestic price increase effect 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 floating, or Exchange rates that are determined by the marketunregulated forces of supply and demand determined, exchange rates appreciation of The rise in value of one currency relative to a currency another depreciation of The fall in value of one currency relative to a currency another law of one If the costs of transportation are small, the price price of the same good in different countries should be roughly the same purchasingA theory of international exchange holding that power-parity exchange rates are set so that the price of similar theory goods in different countries is the same J-curve effect Following a currency depreciation, a country's balance of trade may get worse before it gets better. The graph showing this effect is shaped like the letter J, hence the name "J-curve effect." vicious-circle- Suggests that poverty is self-perpetuating of-poverty because poor nations are unable to save and hypothesis invest enough to accumulate the capital stock that would help them grow capital flight The tendency for both human capital and financial capital to leave developing countries in search of higher rates of return elsewhere brain drain The tendency for talented people from developing countries to become educated in a developed country and remain there after graduation social Basic infrastructure projects such as roads, power overhead generation, and irrigation systems capital import An industrial trade strategy that favors substitution developing local industries that can manufacture goods to replace imports export A trade policy designed to encourage exports promotion 11 International Monetary Fund World Bank structural adjustment fertility rate mortality rate natural rate of population increase debt rescheduling stabilization program socialist economy capitalist economy communism market– socialist economy tragedy of commons shock therapy economic growth modern economic growth aggregate production function An international agency whose primary goals are to stabilize international exchange rates and to lend money to countries that have problems financing their international transactions An international agency that lends money to individual countries for projects that promote economic development A series of programs in developing nations designed to (1) reduce the size of their public sectors through privatization and/or expenditure reductions, (2) decrease their budget deficits, (3) control inflation, and (4) encourage private saving and investment through tax reform The birth rate. Equal to (the number of births per year divided by the population) × 100 The death rate. Equal to (the number of deaths per year divided by the population) × 100 The difference between the birth rate and the death rate. It does not take migration into account An agreement between banks and borrowers through which a new schedule of repayments of the debt is negotiated; often some of the debt is written off and the repayment period is extended An agreement between a borrower country and the International Monetary Fund in which the country agrees to revamp its economic policies to provide incentives for higher export earnings and lower imports An economy in which most capital is owned by the government instead of private citizens. Also called social ownership An economy in which most capital is privately owned An economic system in which the people control the means of production (capital and land) directly, without the intervention of a government or state An economy that combines government ownership with market allocation The idea that collective ownership may not provide the proper private incentives for efficiency because individuals do not bear the full costs of their own decisions but do enjoy the full benefits The approach to transition from socialism to market capitalism that advocates rapid deregulation of prices, liberalization of trade, and privatization An increase in the total output of an economy. Defined by some economists as an increase of real GDP per capita The period of rapid and sustained increase in real output per capita that began in the Western World with the Industrial Revolution The mathematical representation of the relationship between inputs and national output, or gross domestic product 12 labor productivity productivity of an input invention innovation consumer sovereignty fiscal policy monetary policy discretionary fiscal policy net taxes (T) disposable, or after-tax, income (Yd) budget deficit government spending multiplier tax multiplier Output per worker hour; the amount of output produced by an average worker in 1 hour The amount of output produced per unit of an input An advance in knowledge The use of new knowledge to produce a new product or to produce an existing product more efficiently The notion that people are free to choose, and that things that people do not want will not sell. "The customer rules." The government's spending and taxing policies The behavior of the Federal Reserve concerning the nation's money supply Changes in taxes or spending that are the result of deliberate changes in government policy Taxes paid by firms and households to the government minus transfer payments made to households by the government Total income minus net taxes: Y - T The difference between what a government spends and what it collects in taxes in a given period: G - T The ratio of the change in the equilibrium level of output to a change in government spending The ratio of change in the equilibrium level of output to a change in taxes federal surplus Federal government receipts minus expenditures (+) or deficit (-) federal debt The total amount owed by the federal government automatic Revenue and expenditure items in the federal stabilizers budget that automatically change with the state of the economy in such a way as to stabilize GDP fiscal drag The negative effect on the economy that occurs when average tax rates increase because taxpayers have moved into higher income brackets during an expansion fullWhat the federal budget would be if the economy employment were producing at a full-employment level of budget output structural The deficit that remains at full employment deficit cyclical deficit The deficit that occurs because of a downturn in the business cycle transaction The main reason that people hold money—to motive buy things nonsynchroniz The mismatch between the timing of money ation of inflow to the household and the timing of money income and outflow for household expenses spending speculation One reason for holding bonds instead of money: motive Because the market value of interest-bearing 13 bonds is inversely related to the interest rate, investors may wish to hold bonds when interest rates are high with the hope of selling them when interest rates fall tight monetary Fed policies that contract the money supply in an policy effort to restrain the economy easy monetary Fed policies that expand the money supply in an policy effort to stimulate the economy average The proportion of income households spend on propensity to consumption. Determined by dividing consume consumption (C) by income (Y). (APC) life-cycle A theory of household consumption: Households theory of make lifetime consumption decisions based on consumption their expectations of lifetime income permanent The average level of one's expected future income income stream nominal wage The wage rate in current dollars rate real wage rate The amount that the nominal wage rate can buy in terms of goods and services nonlabor, or Any income received from sources other than nonwage, working—inheritances, interest, dividends, income transfer payments, and so on unconstrained The amount a household would like to work supply of within a given period at the current wage rate if it labor could find the work constrained The amount a household actually works in a supply of given period at the current wage rate labor inputs The goods and services that firms purchase and turn into output plant-andPurchases by firms of additional machines, equipment factories, or buildings within a given period investment inventory Occurs when a firm produces more output than it investment sells within a given period labor-intensive A production technique that uses a large amount technology of labor relative to capital capitalA production technique that uses a large amount intensive of capital relative to labor technology animal spirits A phrase coined by Keynes to describe investors' of feelings entrepreneurs accelerator The tendency for investment to increase when effect aggregate output increases and decrease when aggregate output decreases, accelerating the growth or decline of output excess labor, Labor and capital that are not needed to produce excess capital the firm's current level of output adjustment The costs that a firm incurs when it changes its costs production level—for example, the administration costs of laying off employees or the training costs of hiring new workers desired, or The level of inventory at which the extra cost (in optimal, level lost sales) from lowering inventories by a small of inventories amount is just equal to the extra gain (in interest 14 productivity, or labor productivity Okun's Law revenue and decreased storage costs). Output per worker hour; the amount of output produced by an average worker in 1 hour The theory, put forth by Arthur Okun, that the unemployment rate decreases about 1 percentage point for every 3 percent increase in real GDP. Later research and data have shown that the relationship between output and unemployment is not as stable as Okun's "Law" predicts 15