Chapter 1

Welcome to Economics!

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Summary

Microeconomics and macroeconomics are two different perspectives on the economy. Economics seeks to solve the problem of scarcity, which is when human wants for goods and services exceed the available supply. Division and specialization of labor only work when individuals can purchase what they do not produce in markets. A modern economy displays a division of labor, in which people earn income by specializing in what they produce and then use that income to purchase the products they need or want.

Key terms

economics

the study of how humans make choices under conditions of scarcity

specialization

when workers or firms focus on particular tasks for which they are well-suited within the overall production process

microeconomics

the branch of economics that focuses on actions of particular agents within the economy, like households, workers, and business firms

macroeconomics

the branch of economics that focuses on broad issues such as growth, unemployment, inflation, and trade balance

division of labor

the way in which different workers divide required tasks to produce a good or service

market

interaction between potential buyers and sellers; a combination of demand and supply

scarcity

when human wants for goods and services exceed the available supply

command economy

an economy where economic decisions are passed down from government authority and where the government owns the resources

Chapter 2

Choice in a World of Scarcity

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Summary

The budget constraint, which is the frontier of the opportunity set, illustrates the range of available choices. The relative price of the choices determines the slope of the budget constraint. Choices beyond the budget constraint are not affordable Opportunity cost measures cost by what we forgo in exchange.

Key terms

budget constraint

all possible consumption combinations of goods that someone can afford, given the prices of goods, when all income is spent; the boundary of the opportunity set

opportunity set

all possible combinations of consumption that someone can afford given the prices of goods and the individual’s income

opportunity cost

measures cost by what we give up/forfeit in exchange; opportunity cost measures the value of the forgone alternative

productive efficiency

when it is impossible to produce more of one good (or service) without decreasing the quantity produced of another good (or service)

positive statement

statement which describes the world as it is

comparative advantage

when a country can produce a good at a lower cost in terms of other goods; or, when a country has a lower opportunity cost of production

law of diminishing marginal utility

as we consume more of a good or service, the utility we get from additional units of the good or service tends to become smaller than what we received from earlier units

law of diminishing returns

as we add additional increments of resources to producing a good or service, the marginal benefit from those additional increments will decline

Chapter 3

Demand and Supply

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Summary

The equilibrium price and equilibrium quantity occur where the supply and demand curves cross. The equilibrium occurs where the quantity demanded is equal to the quantity supplied. The law of demand states that a higher price typically leads to a lower quantity demanded The law of supply says that a higher price typically leads to a higher quantity supplied

Key terms

demand

the relationship between price and the quantity demanded of a certain good or service

supply

the relationship between price and the quantity supplied of a certain good or service

equilibrium

the situation where quantity demanded is equal to the quantity supplied; the combination of price and quantity where there is no economic pressure from surpluses or shortages…

law of demand

the common relationship that a higher price leads to a lower quantity demanded of a certain good or service and a lower price leads to a higher quantity demanded, while all other…

law of supply

the common relationship that a higher price leads to a greater quantity supplied and a lower price leads to a lower quantity supplied, while all other variables are held constant

equilibrium quantity

the quantity at which quantity demanded and quantity supplied are equal for a certain price level

quantity demanded

the total number of units of a good or service consumers are willing to purchase at a given price

quantity supplied

the total number of units of a good or service producers are willing to sell at a given price

Chapter 4

Labor and Financial Markets

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Summary

In the demand and supply analysis of financial markets, the “price” is the rate of return or the interest rate received. In the labor market, households are on the supply side of the market and firms are on the demand side. In the market for financial capital, households and firms can be on either side of the market: they are suppliers of financial capital when they save or make financial investments, and demanders of financial capital… In the demand and supply analysis of labor markets, we can measure the price by the annual salary or hourly wage received.

Key terms

interest rate

the “price” of borrowing in the financial market; a rate of return on an investment

minimum wage

a price floor that makes it illegal for an employer to pay employees less than a certain hourly rate

usury laws

laws that impose an upper limit on the interest rate that lenders can charge

Chapter 5

Elasticity

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Summary

An inelastic demand or supply curve is one where a given percentage change in price will cause a smaller percentage change in quantity demanded or supplied. Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. A unitary elasticity means that a given percentage change in price leads to an equal percentage change in quantity demanded or supplied Infinite or perfect elasticity refers to the extreme case where either the quantity demanded or supplied changes by an infinite amount in response to any change in price at all.

Key terms

elasticity

an economics concept that measures responsiveness of one variable to changes in another variable

elastic demand

when the elasticity of demand is greater than one, indicating a high responsiveness of quantity demanded or supplied to changes in price

inelastic demand

when the elasticity of demand is less than one, indicating that a 1 percent increase in price paid by the consumer leads to less than a 1 percent change in purchases (and vice…

unitary elasticity

when the calculated elasticity is equal to one indicating that a change in the price of the good or service results in a proportional change in the quantity demanded or supplied

price elasticity

the relationship between the percent change in price resulting in a corresponding percentage change in the quantity demanded or supplied

inelastic demand or supply curve

one where a given percentage change in price will cause a smaller percentage change in quantity demanded or supplied

cross-price elasticity of demand

the percentage change in the quantity of good A that is demanded as a result of a percentage change in the price of good B

Chapter 6

Consumer Choices

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Summary

However, the additional utility people receive from each unit of greater consumption tends to decline in a pattern of diminishing marginal utility In general, greater consumption of a good brings higher total utility. You can add up total utility of each choice on the budget line and choose the highest total. You can select a starting point at random and compare the marginal utility gains and losses of moving to neighboring points—and thus eventually seek out the preferred choice.

Key terms

diminishing marginal utility

the common pattern that each marginal unit of a good consumed provides less of an addition to utility than the previous unit

marginal utility

the additional utility provided by one additional unit of consumption

total utility

satisfaction derived from consumer choices

consumer equilibrium

point on the budget line where the consumer gets the most satisfaction; this occurs when the ratio of the prices of goods is equal to the ratio of the marginal utilities

fungible

the idea that units of a good, such as dollars, ounces of gold, or barrels of oil are capable of mutual substitution with each other and carry equal value to the individual

income effect

a higher price means that, in effect, the buying power of income has been reduced, even though actual income has not changed; always happens simultaneously with a substitution…

budget constraint (or budget line)

shows the possible combinations of two goods that are affordable given a consumer’s limited income

behavioral economics

a branch of economics that seeks to enrich the understanding of decision-making by integrating the insights of psychology and by investigating how given dollar amounts can mean…

Chapter 7

Production, Costs, and Industry Structure

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Summary

While accounting profit considers only explicit costs, economic profit considers both explicit and implicit costs Production is the process a firm uses to transform inputs (e.g., labor, capital, raw materials, etc.) into outputs. Thus, in the short run the only way to change output is to change the variable inputs (e.g., labor). Marginal product is the additional output a firm obtains by employing more labor in production.

Key terms

production

the process of combining inputs to produce outputs, ideally of a value greater than the value of the inputs

short run

period of time during which at least one or more of the firm’s inputs is fixed

firm

an organization that combines inputs of labor, capital, land, and raw or finished component materials to produce outputs

implicit costs

opportunity cost of resources already owned by the firm and used in business, for example, expanding a factory onto land already owned

diminishing marginal productivity

general rule that as a firm employs more labor, eventually the amount of additional output produced declines

explicit costs

out-of-pocket costs for a firm, for example, payments for wages and salaries, rent, or materials

fixed inputs

factors of production that can’t be easily increased or decreased in a short period of time

variable inputs

factors of production that a firm can easily increase or decrease in a short period of time

Chapter 8

Perfect Competition

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Summary

Perfect competition means that there are many sellers, there is easy entry and exiting of firms, products are identical from one seller to another, and sellers are price takers A perfectly competitive firm is a price taker, which means that it must accept the equilibrium price at which it sells goods. In a perfectly competitive market there are thousands of sellers, easy entry, and identical products. Long-run equilibrium in a perfectly competitive industry occurs after all firms have entered and exited the industry and seller profits are driven to zero

Key terms

perfect competition

each firm faces many competitors that sell identical products

perfectly competitive firm

a price taker, which means that it must accept the equilibrium price at which it sells goods

short-run production period

when firms are producing with some fixed inputs

exit

the long-run process of firms reducing production and shutting down in response to industry losses

long-run equilibrium

where all firms earn zero economic profits producing the output level where P = MR = MC and P = AC

price taker

a firm in a perfectly competitive market that must take the prevailing market price as given

entry

the long-run process of firms entering an industry in response to industry profits

perfectly competitive market there

thousands of sellers, easy entry, and identical products

Chapter 9

Monopoly

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Summary

These barriers include: economies of scale that lead to natural monopoly; control of a physical resource; legal restrictions on competition; patent, trademark and copyright protection; and practices to intimidate the… The laws that protect intellectual property include patents, copyrights, trademarks, and trade secrets. A natural monopoly arises when economies of scale persist over a large enough range of output that if one firm supplies the entire market, no other firm can enter without facing a cost disadvantage Barriers to entry prevent or discourage competitors from entering the market.

Key terms

monopoly

a situation in which one firm produces all of the output in a market

copyright

a form of legal protection to prevent copying, for commercial purposes, original works of authorship, including books and music

intellectual property

the body of law including patents, trademarks, copyrights, and trade secret law that protect the right of inventors to produce and sell their inventions

natural monopoly

economic conditions in the industry, for example, economies of scale or control of a critical resource, that limit effective competition

patent

a government rule that gives the inventor the exclusive legal right to make, use, or sell the invention for a limited time

barriers to entry

the legal, technological, or market forces that may discourage or prevent potential competitors from entering a market

trademark

an identifying symbol or name for a particular good and can only be used by the firm that registered that trademark

Chapter 10

Monopolistic Competition and Oligopoly

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Summary

Monopolistic competition refers to a market where many firms sell differentiated products. A profit-maximizing monopolistic competitor will seek out the quantity where marginal revenue is equal to marginal cost. Differentiated products can arise from characteristics of the good or service, location from which the firm sells the product, intangible aspects of the product, and perceptions of the product The perceived demand curve for a monopolistically competitive firm is downward-sloping, which shows that it is a price maker and chooses a combination of price and quantity.

Key terms

oligopoly

when a few large firms have all or most of the sales in an industry

monopolistic competition

many firms competing to sell similar but differentiated products

monopolistically competitive industry

earning economic profits, the industry will attract entry until profits are driven down to zero in the long run

monopolistically competitive firm

downward-sloping, which shows that it is a price maker and chooses a combination of price and quantity

monopolistic competitor

more elastic than the perceived demand curve for a monopolist, because the monopolistic competitor has direct competition, unlike the pure monopolist

differentiated product

a product that consumers perceive as distinctive in some way

product differentiation

any action that firms do to make consumers think their products are different from their competitors'

Chapter 11

Monopoly and Antitrust Policy

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Summary

Antitrust laws seek to ensure active competition in markets, sometimes by preventing large firms from forming through mergers and acquisitions, sometimes by regulating business practices that might restrict… A four-firm concentration ratio is one way of measuring the extent of competition in a market. A corporate merger involves two private firms joining together. An acquisition refers to one firm buying another firm.

Key terms

concentration ratio

an early tool to measure the degree of monopoly power in an industry; measures what share of the total sales in the industry are accounted for by the largest firms, typically the…

four-firm concentration ratio

the percentage of the total sales in the industry that are accounted for by the largest four firms

antitrust laws

laws that give government the power to block certain mergers, and even in some cases to break up large firms into smaller ones

Herfindahl-Hirschman Index (HHI)

approach to measuring market concentration by adding the square of the market share of each firm in the industry

merger

when two formerly separate firms combine to become a single firm

market share

the percentage of total sales in the market

acquisition

when one firm purchases another

tying sales

a situation where a customer is allowed to buy one product only if the customer also buys another product

Chapter 12

Environmental Protection and Negative Externalities

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Summary

An externality, which is sometimes also called a spillover, can have a negative or a positive impact on the third party. If those parties imposing a negative externality on others had to account for the broader social cost of their behavior, they would have an incentive to reduce the production of whatever is causing the negative… In the case of a positive externality, the third party obtains benefits from the exchange between a buyer and a seller, but they are not paying for these benefits. If the parties generating benefits to others would somehow receive compensation for these external benefits, they would have an incentive to increase production of whatever is causing the positive externality.

Key terms

externality

a market exchange that affects a third party who is outside or “external” to the exchange; sometimes called a “spillover”

positive externality

a situation where a third party, outside the transaction, benefits from a market transaction by others

negative externality

a situation where a third party, outside the transaction, suffers from a market transaction by others

market failure

When the market on its own does not allocate resources efficiently in a way that balances social costs and benefits; externalities are one example of a market failure

additional external cost

additional costs incurred by third parties outside the production process when a unit of output is produced

property rights

the legal rights of ownership on which others are not allowed to infringe without paying compensation

command-and-control regulation

laws that specify allowable quantities of pollution and that also may detail which pollution-control technologies one must use

Chapter 13

Positive Externalities and Public Goods

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Summary

New technology often has positive externalities; that is, there are often spillovers from the invention of new technology that benefit firms other than the innovator. If inventors could receive a greater share of the broader social benefits for their work, they would have a greater incentive to seek out new inventions Competition creates pressure to innovate. However, if one can easily copy new inventions, then the original inventor loses the incentive to invest further in research and development.

Key terms

public good

good that is nonexcludable and non-rival, and thus is difficult for market producers to sell to individual consumers

positive externalities

beneficial spillovers to a third party or parties

social benefits

the sum of private benefits and external benefits

nonexcludable

when it is costly or impossible to exclude someone from using the good, and thus hard to charge for it

external benefits (or positive externalities)

beneficial spillovers to a third party of parties, who did not purchase the good or service that provided the externalities

free rider

those who want others to pay for the public good and then plan to use the good themselves; if many people act as free riders, the public good may never be provided

intellectual property

the body of law including patents, trademarks, copyrights, and trade secret law that protect the right of inventors to produce and sell their inventions

private benefits

the benefits a person who consumes a good or service receives, or a new product's benefits or process that a company invents that the company captures

Chapter 14

Labor Markets and Income

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Summary

For a firm which is not perfectly competitive, the appropriate concept is the marginal revenue product, which we define as the marginal product of labor multiplied by the firm’s marginal revenue. Profit maximizing firms employ labor up to the point where the market wage is equal to the firm’s demand for labor. A monopsony is the sole employer in a labor market. The monopsony can pay any wage it chooses, subject to the market supply of labor.

Key terms

monopsony

a labor market where there is only one employer

point where the market wage

equal to the firm’s demand for labor

discrimination

actions based on the belief that members of a certain group or groups are in some way inferior solely because of a factor such as race, gender, or religion

affirmative action

active efforts by government or businesses that give special rights to minorities in hiring, promotion, or access to education to make up for past discrimination

perfectly competitive labor market

a labor market where neither suppliers of labor nor demanders of labor have any market power; thus, an employer can hire all the workers they would like at the going market wage

first rule of labor markets

an employer will never pay a worker more than the value of the worker's marginal productivity to the firm

bilateral monopoly

a labor market with a monopsony on the demand side and a union on the supply side

Chapter 15

Poverty and Economic Inequality

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Summary

The poverty rate is what percentage of the population lives below the poverty line, which the amount of income that it takes to purchase the necessities of life determines. Poverty and income inequality are not the same thing. A poverty trap occurs when government-support payments decline as the recipients earn more income. Income inequality refers to the disparity between those with higher and lower incomes.

Key terms

poverty

the situation of being below a certain level of income one needs for a basic standard of living

poverty trap

antipoverty programs set up so that government benefits decline substantially as people earn more income—as a result, working provides little financial gain

income inequality

when one group receives a disproportionate share of total income or wealth than others

poverty line

the specific amount of income one requires for a basic standard of living

income

a flow of money received, often measured on a monthly or an annual basis

poverty rate

percentage of the population living below the poverty line

Lorenz curve

a graph that compares the cumulative income actually received to a perfectly equal distribution of income; it shows the share of population on the horizontal axis and the…

Medicaid

a federal-state joint program enacted in 1965 that provides medical insurance for certain (not all) people with a low-income, including those near the poverty line as well as…

Chapter 16

Information, Risk, and Insurance

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Summary

In goods markets, buyers facing imperfect information about products may depend upon money-back guarantees, warranties, service contracts, and reputation. In capital markets, lenders facing imperfect information about borrowers may require detailed loan applications and credit checks, cosigners, and collateral In labor markets, employers facing imperfect information about potential employees may turn to resumes, recommendations, occupational licenses for certain jobs, and employment for trial periods. Many make economic transactions in a situation of imperfect information, where either the buyer, the seller, or both are less than 100% certain about the qualities of what they are buying or selling.

Key terms

insurance

method of protecting a person from financial loss, whereby policy holders make regular payments to an insurance entity; the insurance firm then remunerates a group member who…

imperfect information

a situation where either the buyer or the seller, or both, are uncertain about the qualities of what they are buying and selling

collateral

something valuable—often property or equipment—that a lender would have a right to seize and sell if the buyer does not repay the loan

cosigner

another person or firm who legally pledges to repay some or all of the money on a loan if the original borrower does not

occupational license

licenses issued by government agencies, which indicate that a worker has completed a certain type of education or passed a certain test

service contract

the buyer pays an extra amount and the seller agrees to fix anything specified in the contract that goes wrong for a set time period

money-back guarantee

a promise that the seller will refund the buyer’s money under certain conditions

quality of products

highly imperfect, it may be difficult for a market to exist

Chapter 17

Financial Markets

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Summary

Corporate bonds are issued by firms; municipal bonds are issued by cities, state bonds by U.S. States, and Treasury bonds by the federal government through the U.S. A company's stock is divided into shares. We call a company’s first stock sale to the public the initial public offering (IPO).

Key terms

venture capital

financial investments in new companies that are still relatively small in size, but that have potential to grow substantially

bond

a financial contract through which a borrower like a corporation, a city or state, or the federal government agrees to repay the amount that it borrowed and also a rate of…

Treasury bond

a bond issued by the federal government through the U.S. Department of the Treasury

initial public offering (IPO)

the first sale of shares of stock by a firm to outside investors

shares

a firm's stock, divided into individual portions

stock

a specific firm's claim on partial ownership

municipal bonds

a bond issued by cities that wish to borrow

corporate bond

a bond issued by firms that wish to borrow

Chapter 18

Public Economy

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Summary

Logrolling refers to a situation in which two or more legislators agree to vote for each other’s legislation, which can then encourage pork-barrel spending in many districts The theory of rational ignorance says voters will recognize that their single vote is extremely unlikely to influence the outcome of an election. We define pork--barrel spending as legislation whose benefits are concentrated on a single district while the costs are spread widely over the country. As a consequence, they will choose to remain uninformed about issues and not vote.

Key terms

rational ignorance

the theory that rational people will not vote if the costs of becoming informed and voting are too high or because they know their vote will not be decisive in the election

logrolling

the situation in which groups of legislators all agree to vote for a package of otherwise unrelated laws that they individually favor

pork-barrel spending

spending that benefits mainly a single political district

single district while the costs

spread widely over the country

special interest groups

groups that are small in number relative to the nation, but well organized and thus exert a disproportionate effect on political outcomes

median voter theory

theory that politicians will try to match policies to what pleases the median voter preferences

voting cycle

the situation in which a majority prefers A over B, B over C, and C over A

Chapter 19

The Macroeconomic Perspective

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Summary

To avoid double counting, GDP counts only final output of goods and services, not the production of intermediate goods or the value of labor in the chain of production Economists generally express the size of a nation’s economy as its gross domestic product (GDP), which measures the value of the output of all final goods and services produced within the country in a year. We can divide what is produced in the economy into durable goods, nondurable goods, services, structures, and inventories. Economists measure GDP by taking the quantities of all goods and services produced, multiplying them by their prices, and summing the total.

Key terms

double counting

a potential mistake to avoid in measuring GDP, in which output is counted more than once as it travels through the stages of production

service

product which is intangible (in contrast to goods) such as entertainment, healthcare, or education

sum of what

purchased in the economy or what is produced

intermediate good

output provided to other businesses at an intermediate stage of production, not for final users; contrast with “final good and service”

nominal value

the economic statistic actually announced at that time, not adjusted for inflation; contrast with real value

gross domestic product (GDP)

the value of the output of all final goods and services produced within a country in a year

real value

an economic statistic after it has been adjusted for inflation; contrast with nominal value

structure

building used as residence, factory, office building, retail store, or for other purposes

Chapter 20

Economic Growth

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Summary

The Industrial Revolution facilitated the extensive process of economic growth, that economists often refer to as modern economic growth. We can measure productivity, the value of what is produced per worker, or per hour worked, as the level of GDP per worker or GDP per hour. Since the early nineteenth century, there has been a spectacular process of long-run economic growth during which the world’s leading economies—mostly those in Western Europe and North America—expanded GDP per capita… In the last half-century, countries like Japan, South Korea, and China have shown the potential to catch up.

Key terms

Industrial Revolution

the widespread use of power-driven machinery and the economic and social changes that occurred in the first half of the 1800s

value of what

produced per worker, or per hour worked, as the level of GDP per worker or GDP per hour

modern economic growth

the period of rapid economic growth from 1870 onward

labor productivity

the value of what is produced per worker, or per hour worked (sometimes called worker productivity)

aggregate production function

the process whereby an economy as a whole turns economic inputs such as human capital, physical capital, and technology into output measured as GDP per capita

contractual rights

the rights of individuals to enter into agreements with others regarding the use of their property providing recourse through the legal system in the event of noncompliance

production function

the process whereby a firm turns economic inputs like labor, machinery, and raw materials into outputs like goods and services that consumers use

rule of law

the process of enacting laws that protect individual and entity rights to use their property as they see fit. Laws must be clear, public, fair, and enforced, and applicable to…

Chapter 21

Unemployment

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Summary

A person without a job must be willing and able to work and actively looking for work to be counted as unemployed; otherwise, a person without a job is counted as out of the labor force. We can divide the adult population into those in the labor force and those out of the labor force. Economists define the unemployment rate as the number of unemployed persons divided by the number of persons in the labor force (not the overall adult population). Unemployed individuals experience loss of income and stress.

Key terms

out of the labor force

those who are not working and not looking for work—whether they want employment or not; also termed “not in the labor force”

unemployment rate

the percentage of adults who are in the labor force and thus seeking jobs, but who do not have jobs

person without a job

counted as out of the labor force

implicit contract

an unwritten agreement in the labor market that the employer will try to keep wages from falling when the economy is weak or the business is having trouble, and the employee will…

insider-outsider model

those already working for the firm are “insiders” who know the procedures; the other workers are “outsiders” who are recent or prospective hires

labor force participation rate

this is the percentage of adults in an economy who are either employed or who are unemployed and looking for a job

relative wage coordination argument

across-the-board wage cuts are hard for an economy to implement, and workers fight against them

underemployed

individuals who are employed in a job that is below their skills

Chapter 22

Inflation

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Summary

Economists often express the price level in terms of index numbers, which transform the cost of buying the basket of goods and services into a series of numbers in the same proportion to each other, but with an… We measure the inflation rate as the percentage change between price levels or index numbers over time The most commonly cited measure of inflation is the Consumer Price Index (CPI), which is based on a basket of goods representing what the typical consumer buys. The Core Inflation Index further breaks down the CPI by excluding volatile economic commodities.

Key terms

inflation

a general and ongoing rise in price levels in an economy

basket of goods and services

a hypothetical group of different items, with specified quantities of each one meant to represent a “typical” set of consumer purchases, used as a basis for calculating how the…

Consumer Price Index (CPI)

a measure of inflation that U.S. government statisticians calculate based on the price level from a fixed basket of goods and services that represents the average consumer's…

core inflation index

a measure of inflation typically calculated by taking the CPI and excluding volatile economic variables such as food and energy prices to better measure the underlying and…

index number

a unit-free number derived from the price level over a number of years, which makes computing inflation rates easier, since the index number has values around 100

substitution bias

an inflation rate calculated using a fixed basket of goods over time tends to overstate the true rise in the cost of living, because it does not take into account that the person…

base year

arbitrary year whose value as an index number economists define as 100; inflation from the base year to other years can easily be seen by comparing the index number in the other…

International Price Index

a measure of inflation based on the prices of merchandise that is exported or imported

Chapter 23

The International Trade and Capital Flows

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Summary

The current account balance includes the trade in goods, services, and money flowing into and out of a country from investments and unilateral transfers The trade balance measures the gap between a country’s exports and its imports. In most high-income economies, goods comprise less than half of a country’s total production, while services comprise more than half. As we will see below, a trade deficit necessarily means a net inflow of financial capital from abroad, while a trade surplus necessarily means a net outflow of financial capital from an economy to other countries

Key terms

current account balance

a broad measure of the balance of trade that includes trade in goods and services, as well as international flows of income and foreign aid

unilateral transfers

“one-way payments” that governments, private entities, or individuals make that they sent abroad with nothing received in return

financial capital

the international flows of money that facilitates trade and investment

country

a net borrower from the rest of the world

national savings and investment identity

the total of private savings and public savings (a government budget surplus)

balance of trade (trade balance)

the gap, if any, between a nation’s exports and imports

merchandise trade balance

the balance of trade looking only at goods

Chapter 24

The Aggregate Demand/Aggregate Supply Model

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Summary

Neoclassical economists emphasize Say’s law, which holds that supply creates its own demand. The downward-sloping aggregate demand (AD) curve shows the relationship between the price level for outputs and the quantity of total spending in the economy. Keynesian economists emphasize Keynes’ law, which holds that demand creates its own supply. The upward-sloping short run aggregate supply (SRAS) curve shows the positive relationship between the price level and the level of real GDP in the short run.

Key terms

aggregate demand/aggregate supply model

a model that shows what determines total supply or total demand for the economy, and how total demand and total supply interact at the macroeconomic level

neoclassical economists

economists who generally emphasize the importance of aggregate supply in determining the size of the macroeconomy over the long run

aggregate demand (AD)

the amount of total spending on domestic goods and services in an economy

aggregate demand (AD) curve

the total spending on domestic goods and services at each price level

aggregate supply curve

near-horizontal on the left and near-vertical on the right

Keynes’ law

“demand creates its own supply”

Say’s law

“supply creates its own demand”

Chapter 25

The Keynesian Perspective

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Summary

The latter is an example of a macroeconomic externality. Aggregate demand is the sum of four components: consumption, investment, government spending, and net exports. Consumption will change for a number of reasons, including movements in income, taxes, expectations about future income, and changes in wealth levels. Investment will change in response to its expected profitability, which in turn is shaped by expectations about future economic growth, the creation of new technologies, the price of key inputs, and tax incentives for…

Key terms

macroeconomic externality

occurs when what happens at the macro level is different from what happens at the micro level; an example would be where, because of the coordination argument, upward sloping…

latter

an example of a macroeconomic externality

coordination argument

downward wage and price flexibility requires perfect information about the level of lower compensation acceptable to other laborers and market participants

expansionary fiscal policy

tax cuts or increases in government spending designed to stimulate aggregate demand and move the economy out of recession

sticky wages and prices

a situation where wages and prices do not fall in response to a decrease in demand, or do not rise in response to an increase in demand

expenditure multiplier

Keynesian concept that asserts that a change in autonomous spending causes a more than proportionate change in real GDP

contractionary fiscal policy

tax increases or cuts in government spending designed to decrease aggregate demand and reduce inflationary pressures

real GDP

the amount of goods and services actually sold in a nation

Chapter 26

The Neoclassical Perspective

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Summary

The neoclassical perspective argues that, in the long run, the economy will adjust back to its potential GDP level of output through flexible price levels. A rational expectations perspective argues that people have excellent information about economic events and how the economy works and that, as a result, price and other economic adjustments will happen very quickly. In adaptive expectations theory, people have limited information about economic information and how the economy works, and so price and other economic adjustments can be slow Thus, the neoclassical perspective views the long-run AS curve as vertical.

Key terms

neoclassical perspective

the philosophy that, in the long run, the business cycle will fluctuate around the potential, or full-employment, level of output

rational expectations

the theory that people form the most accurate possible expectations about the future that they can, using all information available to them

adaptive expectations

the theory that people look at past experience and gradually adapt their beliefs and behavior as circumstances change

economy

approaching full employment

physical capital per person

the amount and kind of machinery and equipment available to help a person produce a good or service

expected inflation

a future rate of inflation that consumers and firms build into current decision making

Chapter 27

Money and Banking

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Summary

M2 includes all of M1, plus savings deposits, time deposits like certificates of deposit, and money market funds There are two types of money: commodity money, which is an item used as money, but which also has value from its use as something other than money; and fiat money, which has no intrinsic value, but is declared by a… Money serves several functions: a medium of exchange, a unit of account, a store of value, and a standard of deferred payment. We measure money with several definitions: M1 includes currency and money in checking accounts (demand deposits).

Key terms

money

whatever serves society in four functions: as a medium of exchange, a store of value, a unit of account, and a standard of deferred payment

money market fund

the deposits of many investors are pooled together and invested in a safe way like short-term government bonds

commodity money

an item that is used as money, but which also has value from its use as something other than money

demand deposit

checkable deposit in banks that is available by making a cash withdrawal or writing a check

fiat money

has no intrinsic value, but is declared by a government to be the country's legal tender

medium of exchange

whatever is widely accepted as a method of payment

savings deposit

bank account where you cannot withdraw money by writing a check, but can withdraw the money at a bank—or can transfer it easily to a checking account

time deposit

account that the depositor has committed to leaving in the bank for a certain period of time, in exchange for a higher rate of interest; also called certificate of deposit

Chapter 28

Monetary Policy and Bank Regulation

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Summary

A bank run occurs when there are rumors (possibly true, possibly false) that a bank is at financial risk of having negative net worth. The most prominent task of a central bank is to conduct monetary policy, which involves changes to interest rates and credit conditions, affecting the amount of borrowing and spending in an economy. Some prominent central banks around the world include the U.S. Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank of England

Key terms

bank run occurs when there

rumors (possibly true, possibly false) that a bank is at financial risk of having negative net worth

deposit insurance

an insurance system that makes sure depositors in a bank do not lose their money, even if the bank goes bankrupt

bank run

when depositors race to the bank to withdraw their deposits for fear that otherwise they would be lost

central bank

institution which conducts a nation’s monetary policy and regulates its banking system

reserve requirement

the percentage amount of its total deposits that a bank is legally obligated to either hold as cash in their vault or deposit with the central bank

inflation targeting

a rule that the central bank is required to focus only on keeping inflation low

quantitative easing (QE)

the purchase of long term government and private mortgage-backed securities by central banks to make credit available in hopes of stimulating aggregate demand

open market operations

the central bank selling or buying Treasury bonds to influence the quantity of money and the level of interest rates

Chapter 29

Exchange Rates and International Capital Flows

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Summary

In the foreign exchange market, people and firms exchange one currency to purchase another currency. On the supply side of the foreign exchange market for the trading of U.S. The demand for dollars comes from those U.S. Export firms seeking to convert their earnings in foreign currency back into U.S.

Key terms

international capital flows

flow of financial capital across national boundaries either as portfolio investment or direct investment

foreign exchange market

the market in which people use one currency to buy another currency

portfolio investment

an investment in another country that is purely financial and does not involve any management responsibility

appreciating

when a currency is worth more in terms of other currencies; also called “strengthening”

depreciating

when a currency is worth less in terms of other currencies; also called “weakening”

dollarize

a country that is not the United States uses the U.S. dollar as its currency

soft peg

an exchange rate policy in which the government usually allows the market to set the exchange rate, but in some cases, especially if the exchange rate seems to be moving rapidly…

arbitrage

the process of buying a good and selling goods across borders to take advantage of international price differences

Chapter 30

Government Budgets and Fiscal Policy

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Summary

When a government spends more than it collects in taxes, it is said to have a budget deficit. When a government collects more in taxes than it spends, it is said to have a budget surplus. If government spending and taxes are equal, it is said to have a balanced budget. Fiscal policy is the set of policies that relate to federal government spending, taxation, and borrowing.

Key terms

balanced budget

when government spending and taxes are equal

budget deficit

when the federal government spends more money than it receives in taxes in a given year

budget surplus

when the government receives more money in taxes than it spends in a year

proportional tax

a tax that is a flat percentage of income earned, regardless of level of income

automatic stabilizers

tax and spending rules that have the effect of slowing down the rate of decrease in aggregate demand when the economy slows down and restraining aggregate demand when the economy…

contractionary fiscal policy

fiscal policy that decreases the level of aggregate demand, either through cuts in government spending or increases in taxes

discretionary fiscal policy

the government passes a new law that explicitly changes overall tax or spending levels with the intent of influencing the level of overall economic activity

expansionary fiscal policy

fiscal policy that increases the level of aggregate demand, either through increases in government spending or cuts in taxes

Chapter 31

The Impacts of Government Borrowing

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Summary

The theory of Ricardian equivalence holds that changes in private saving will offset changes in government borrowing or saving. A change in any part of the national saving and investment identity suggests that if the government budget deficit changes, then either private savings, private investment in physical capital, or the trade balance—or… The government need not balance its budget every year. However, a sustained pattern of large budget deficits over time risks causing several negative macroeconomic outcomes: a shift to the right in aggregate demand that causes an inflationary increase in the price level…

Key terms

Ricardian equivalence

the theory that rational private households might shift their saving to offset government saving or borrowing

twin deficits

deficits that occur when a country is running both a trade and a budget deficit

Head Start program

a program for early childhood education directed at families with limited educational and financial resources

Chapter 32

Macroeconomic Policy Around the World

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Summary

Macroeconomic policy goals for most countries strive toward low levels of unemployment and inflation, as well as stable trade balances. Economists analyze countries based on their GDP per person and ranked as low-, middle-, and high-income countries. Low-income are those earning less than $1,025 (less than 1%) of global income. They currently have 18.5% of the world population.

Key terms

growth consensus

a series of studies that show, statistically, that 70% of the differences in income per person across the world is explained by differences in physical capital (savings/investment)

converging economy

economy of a country that has demonstrated the ability to catch up to the technology leaders by investing in both physical and human capital

East Asian Tigers

the economies of Taiwan, Singapore, Hong Kong, and South Korea, which maintained high growth rates and rapid export-led industrialization between the early 1960s and 1990…

middle-income country

a nation with per capita income between $1,025 and $12, 475 and that has shown some ability, even if not always sustained, to catch up to the technology leaders in high-income…

high-income country

nation with a per capita income of $12,475 or more; typically has high levels of human and physical capital

low-income country

a nation that has a per capita income of less than $1,025; a third of the world’s population

Chapter 33

International Trade

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Summary

A country has an absolute advantage in those products in which it has a productivity edge over other countries; it can produce more of a product. Countries that specialize based on comparative advantage gain from trade If other countries specialize in the area of their comparative advantage as well and trade, the highly productive country is able to benefit from a lower opportunity cost of production in other countries A country has a comparative advantage when it can produce a good at a lower cost in terms of other goods.

Key terms

absolute advantage

when one country has more resources, more productive resources, or a natural endowment to produce a good compared to another country; when a country can produce more of a good…

gain from trade

a country that can consume more than it can produce as a result of specialization and trade

highly productive country

able to benefit from a lower opportunity cost of production in other countries

value chain

how a good is produced in stages

splitting up the value chain

many of the different stages of producing a good happen in different geographic locations

intra-industry trade

international trade of goods within the same industry

tariffs

taxes that governments place on imported goods

Chapter 34

Globalization and Protectionism

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Summary

There are three tools for restricting the flow of trade: tariffs, import quotas, and nontariff barriers. When a country places limitations on imports from abroad, regardless of whether it uses tariffs, quotas, or nontariff barriers, it is said to be practicing protectionism. Protectionism will raise the price of the protected good in the domestic market, which causes domestic consumers to pay more, but domestic producers to earn more In thinking about labor practices in low-income countries, it is useful to draw a line between what is unpleasant to think about and what is morally objectionable.

Key terms

protectionism

government policies to reduce or block imports

line between what

unpleasant to think about and what is morally objectionable

nontariff barriers

ways a nation can draw up rules, regulations, inspections, and paperwork to make it more costly or difficult to import products

import quotas

numerical limits on the quantity of products that a country can import

national interest argument

the argument that there are compelling national interests against depending on key imports from other nations

anti-dumping laws

laws that block imports sold below the cost of production and impose tariffs that would increase the price of these imports to reflect their cost of production

common market

economic agreement between countries to allow free trade in goods, services, labor, and financial capital between members while having a common external trade policy

disruptive market change

innovative new product or production technology which disrupts the status quo in a market, leading the innovators to earn more income and profits and the other firms to lose…