Fundamentals of Economics
The cross price elasticity of demand
A measure of the relationship between a percentage change in the market price of product X and consequential percentage change in the quantity demanded of product Y
Production Possibilities Frontier
A model of a two-good economy that shows how much the economy can producing using all of its factors of production efficiently.
Long Run
A time horizon long enough for the seller to adjust all inputs. Thus, if you observe a business with no fixed costs, then it is in the long run state.
Imports
Include all final goods and services produced by foreigners outside the US and purchased by a member of the domestic population.
Suppose the economy is in an inflationary gap. Which of the following public policies could help the economy get back to potential real GDP?
Increase the discount rate
M2 (money supply)
It includes everything in M1 (currency, traveler's checks, demand deposits, and other checkable deposits) plus savings deposits, small time deposits, money market mutual funds, and a few other minor categories.
The open economy effect
It is a factor in the negative slope of the aggregate demand curve. When the price level falls, it causes the real exchange rate to depreciate. The depreciation of the real exchange rate increases the quantity of exports and decreases the quantity of imports and therefore it increases the net exports or exports minus imports. Because of this increase in net exports, the quantity demanded of real GDP increases.
If an economy is producing below its potential real GDP, then
It is in a deflationary gap
Government Spending (G)
It is made up of all the final goods and services bought by the government. For example, lumber and raw materials purchased and deployed to Iraq for the reconstruction effort. Transfer payments are NOT included.
Investment Spending (I)
It is made up of all the final goods and services that become part of the business of residential capital stock, including newly constructed buildings
Consumption Spending (C)
It is made up of all the goods and services that are ultimately bought and used by households, except for newly constructed buildings
Net Exports (NX)
It is made up of the difference between exports (E) and imports (I)
The governments fiscal policy
It's plan for managing demand through governments power to tax individuals and businesses and its power to spend and transfer tax revenues that it collects.
The location of which curve depends on the economy's supply of land, supply of capital, supply of labor, entrepreneurial ability, and productivity of its scarce resources; it does not depend on the price level?
Long-run aggregate supply
Per Capita
Means that total GDP is divided by the US population
As the income of consumers increases, the demand for beef increases. Beef is called
Normal good
Diseconomies of scale
Occur over a range of output in which average total costs increase as output increases.
Economies of Scale
Occur over a range of production in which average total costs decline as output increases.
Constant economies of scale
Occur over a range of production where average total costs remain constant as output increases.
Economies of scope
Occur when an organization can produce several products together at less cost than could a group of single product firms operating independently.
Structural unemployment
Occurs because the number of jobs available in the labor market is insufficient to provide jobs for all that want a job.
Perfect competition
Occurs in an industry in which there are many buyers and many sellers — an industry in which the good is homogeneous, and an industry in which all who want to enter the industry are free to do so and any business may exit at a time of their choosing.
Fiat money
Paper money that has no intrinsic value; it derives its status as money from the power of the state. It otherwise has no real value.
Factors of production
Productive resources used to produce goods and services such as labor, capital, land, and entrepreneurial activity.
Open Market operations
Purchases and sales of government securities by the Federal Reserve Bank in an effort to influence the money supply. When the Federal reserve decides to purchase government securities, it is choosing to increase the money supply; and when it decides to sell government securities, it is choosing to reduce the money supply
Mid Point Formula
Quantity is always on the top
The wealth effect
Tells us that a decrease in the price level makes consumers feel wealthier because each nominal dollar can purchase more goods and services, relative to before the price level decrease. This causes an increase in real GDP demanded at every price level.
M1 (money supply)
The most narrowly defined; includes currency, traveler's checks, demand deposits, and other checkable deposits.
The market demand function contains one additional independent variable
The number of buyers in the market
Comparative Advantage
The one who has the lowest opportunity cost has a comparative advantage in that activity.
Economic expansion (or recovery)
The positive movement from trough to peak. Real GDP is larger than the previous period.
Which of the following is not an element of the market demand curve for wine?
The price of a wine bottling machine; it is a cost of producing wine and therefore not an element of the demand function
The real exchange rate
The rate at which foreign made goods can be bought or sold for domestic made goods.
Reserve deposit ratio
The ratio of bank reserves divided by the checkable deposits
Classical dichotomy
The separation of real and nominal variables
Monetary policy
The setting of the money supply by policy makers at the central bank.
Short Run
The time horizon within which business is unable to adjust at least one input because there is a fixed cost of some kind.
The Unemployment rate
The unemployment rate is defined as the percent of people who do want a job right now, have been looking for work, but have not found a job that they would take divided by the labor force.
Natural rate of unemployment
The unemployment that exists when the economy is operating at potential real GDP. It excludes cyclical unemployment.
Wage
The unit price one pays for the services of labor
Interest
The unit price one pays for the use of capital
Equilibrium price
To calculate a market demand schedule, you should sum up how many sheets of plywood each is willing to purchase at every market price. This is how you also calculate the market supply schedule. Find the market price where the quantity demanded equals the quantity supplied.
Absolute Advantage
To have a absolute advantage in something means that one has the lowest absolute production cost relative to those with whom they are compared.
Inflation rate formula
(Current year CPI ) - (Earlier Year CPI) / (Earlier Year CPI) x100
Consumer price index calculation
(Price of item today/price of item in base year) x item weight For the item weight, multiply the cost by the amount and add them all together
The three basic functions of money
1. A medium of exchange 2. A store of value 3. A unit-of-account
The aggregate expenditure has 4 main components:
1. Consumption Spending 2. Investment Spending 3. Government Spending 4. Net Exports
The Central bank (The Federal Reserve Bank in the US) has three tools to alter money supply:
1. Open market operations 2. Reserve requirement changes 3. Changes to the Federal Reserve's discount rate
Shut-Down rule
A business should shut down if production at the profit maximizing quantity (where MR=MC) generates total revenues that are less than variable costs. In all other cases, the business should stay open.
monetary neutrality
A change in the money supply causes the price level to change and it has no effect on the real value people place on goods and services.
The profit effect
A concept that sticky wages in the short run: 1. Induce firms to increase the production of goods and services when the price level increases 2. Induce firms to decrease their production of goods and services when the price level decreases because it leads to an increase in real profits.
Sunk cost
A cost that has already been committed and cannot be recovered
A monopolist
A firm that is the only seller of a good. The good the monopolist sells is heterogenous because they are the only one that sells the good. The market that the monopolist sells its product in has barriers to entry.
Price floor
A government imposed and legally enforced minimum market price. Whenever a price floor is above the equilibrium price, the quantity supplied with exceed the quantity demanded. When this happens, there will be a quantity surplus at the price floor. However, if the government imposed price floor is below the equilibrium price, then the price floor has no effect on the market.
Real GDP per capita
A measure of the market value of the average domestic labor force production of final goods and services, controlling for inflationary and deflationary shifts in the price level.
The income elasticity of demand
A measure of the relationship between a percentage change in income and consequential percentage change in the quantity demanded of a product
The price elasticity of demand
A measure of the relationship between a percentage change in the market price of a product and a consequential percentage change in the quantity demanded of a product
The elasticity of supply
A measure of the relationship between a percentage change in the market price of a product and consequential percentage change in the quantity supplied of the product
Which curve reflects the real gross domestic product demanded by all groups in the economy at any given price level?
Aggregate demand
Misperceptions, sticky wages, and sticky prices are each theories that explain why in the short run the
Aggregate supply curve has a positive slope
The negative movement from peak to trough of a business cycle is called ______ because over this segment of the business cycle, real GDP is smaller than in the previous period.
An economic contraction
The menu costs effect
Argues that because it can be expensive to change menus and pricing boards and because business owners don't want to constantly tell their customers that they have changed their prices, they don't do it often. This implies that when there is a change in the price level because of a contraction in the economy, for example, producers keep their prices unchanged.
The misperception effect
Argues that in the short run, producers are temporarily fooled about what is really causing price changes in the markets in which they sell their products. Because of these misperceptions, producers respond to changes in the price level despite no change in a product's real price, and this response leads to an upward sloping curve.
Increasing Opportunity Cost
As more and more of an economy's factors of production are employed in the production of a good, the economy must sacrifice the production of other goods at an increasing rate.
The Law of Demand
As the price of a good increases, ceteris paribus, the quantity demand of the good decreases
The Law of Supply
As the price of the good increases, ceteris paribus, the quantity supplied of the good increases.
Automatic stabilizers
Automatically stimulate the economy when it enters a deflationary gap and automatically cools the economy down when it enters an inflationary gap. They are just-in-time fiscal policy, because they operate without policymakers having to take any deliberate action. Examples include unemployment insurance, welfare benefits, and income taxes.
Checkable deposits calculation
Bank reserves/ desired reserve deposit ratio
Reserve deposit ratio calculation
Calculated by taking bank reserves and dividing them by checkable deposits.
The largest component of the United States' real GDP is
Consumption
Joint costs
Costs that do not change with changes in the scope of production
Fixed costs
Costs that do not vary with changes in the quantity produced.
Variable costs
Costs that do vary with changes in the quantity produced.
Marginal Cost
Equal to the change in the total cost that arises from an extra unit of production. It is calculated by taking the change in total cost and dividing it by the change in the quantity produced.
Average fixed costs
Equals the fixed cost divided by the quantity produced
Nominal Gross Domestic Product
Equals the market value of final goods and services produced at current year prices. It does NOT determine increase in price or increase in product sold.
Total cost
Equals the sum of fixed costs and variable costs
Average total cost
Equals the total cost divided by the quantity produced, or it is the sum of average fixed cost plus average variable cost.
Average Variable costs
Equals variable cost divided but the quantity produced
Consider the market for pizza, which is a complement to beer. Suppose the price of beer decreases. Which of the following accurately describes how the pizza market is affected?
Equilibrium price increases, and equilibrium quantity increases.
Economists frequently say that there is no such thing as a free lunch. What do they mean by this?
Even if someone literally offers you a free lunch, there is an opportunity cost to the resources that are used to produce your free lunch.
Commodity money
Exists when some intrinsically valuable good also serves as money. Gold is an example because it has value even if it were not used as money.
(T/F) Small time deposits are deposits against which checks may be written.
False; A small time deposit is a type of money, which is defined as a deposit that earns a fixed rate of interest if held for a specific period of time. The time period can range from several months to several years. Small time deposits are commonly referred to as certificates of deposit or CDs.
(T/F) An increase in the required reserve deposit ratio causes the money supply to increase.
False; An increase in the required reserve deposit ratio will lead to a decrease in money supply.
(T/F) An increase in the value of money from one period to the next is called inflation.
False; An increase in the value of money from one period to the next is called deflation.
(T/F) The money supply increases when the Federal reserve board increases the federal reserve discount rate (Discount rate on loans)
False; When the discount rate increases, it discourages banks from borrowing reserves, reducing the quantity of reserves in the banking system which in turn reduces the money supply.
(T/F) Suppose the price elasticity of demand for home heating oil is -0.4. The number tells us that a one percent increase in the price of home heating oil causes a 0.4% increase in the quantity demanded of home heating oil.
False; a negative number tells us that a one percent increase in the price of oil cause a 0.4 percent decrease in the quantity demanded of home heating oil.
(T/F) Currency is defined as paper bills, traveler's checks and coins in the hand of the public.
False; currency is defined as the paper bills and coins in the hands of the public.
(T/F) If the production possibilities frontier between reading pages of a history text and reading pages of a biology text is linear, then the opportunity cost of reading additional pages of history is increasing.
False; if it is linear then the opportunity cost is constant. If the PPF curve is bowed-out, then the opportunity cost of each additional unit would increase.
(T/F) A money market fund is an open-end mutual fund which invests only in stocks and bonds.
False; it is an open-end mutual fund which invests only in money markets.
(T/F) The aggregate demand curve reflects the nominal gross domestic product demanded by all groups in the economy at any given price level.
False; it reflects the real gross domestic product
(T/F) Real gross domestic product (GDP) dollars measures the economic value of all final goods and services produced by domestic citizens around the world, adjusted for changes in the price level.
False; real GDP is a measure of the market value of final goods and services produced inside the boundaries of the domestic economy, controlling for inflationary and deflationary shifts in the price level. In calculating domestic product, it does not matter that a business is owned by an individual from the domestic economy or a foreign nation.
(T/F) The Federal Open Market Committee decides on changes to the fiscal policy.
False; the FOMC considers changes to the monetary policy, most important of which is open market operations.
(T/F) Comparative advantage is the main concept demonstrated in a production possibilities frontier.
False; the most fundamental principle in economics is opportunity cost which is demonstrated by the production possibilities frontier model.
(T/F) There are ten regional Federal reserve banks throughout the country
False; there are 12 regional federal reserve banks
(T/F) The idea that the money supply affects only nominal variables and not real variables is formally known as the classical dichotomy.
False; this is known as monetary neutrality
Exports
Final goods and services produced in the US and purchased by foreigners living outside the US
The most commonly used measure of an economy's output is called
Gross domestic product
If corn producer A is more productive than relative to corn producer B, then economists say that corn producer A:
Has an absolute advantage in the production of corn
Suppose that the economy is in an inflationary gap. Which of the following public policies could help the economy get back to potential gross domestic product?
Have the Federal reserve sell government bonds
In words, what does it mean when an economic consultant states: Cafe Ana's elasticity of supply of fine meals is equal to +3.
If the market price increases by 1 percent, then Cafe Ana's quantity supplied of fine meals will increase by 3 percent.
A deflationary gap occurs when an economy's
Real GDP is less than its potential real GDP
Real Gross Domestic Product
Real Gross Domestic product is a measure of the market value of the production of the final goods and services after an adjustment has been made for changes in the price level.
The aggregate demand curve
Reflects the real gross domestic product demanded by all groups in the economy at any given price level. It is negatively sloped because of the interest rate effect, the wealth effect, and the open economy effect
The short run aggregate supply curve
Reflects the total quantity of goods and services that producers in the economy are willing and able to produce at any given price level. It is upward sloping because of the profit effect, the misperception effect, and the menu cost effect.
The market price of land is called:
Rent
The profit maximizing rule
States that a business maximizes profits when it produces where the marginal revenue from selling another unit equals the marginal cost of producing an additional unit. Marginal revenue = Marginal cost
The Long run exit decision
States that a business should exit the industry if production at the profit maximizing quantity (MR=MC) generates total revenues that are less than total cost, otherwise stay open
The interest rate effect
Tells us that a reduction in the price level causes people to convert cash to interest bearing assets. An increase in supply of loanable funds causes a south-east shift of the supply of loanable funds, which leads to a lower interest rate. Because the interest rate is equal to the price of investment goods, a decrease in the interest rate causes an increase in spending on investment goods (I), which by definition increases real GDP.
The Consumer Price Index
The Consumer Price Index (CPI) measures changes over time in the cost of buying a "market basket" of goods and services purchased by a typical family.
The Producer Price Index
The Producer Price Index (PPI) measure the change over time in the cost of buying a "market basket" of inputs purchased by producers.
The National Income Identity
The accounting concept which states that, in a time period, aggregate expenditure on wages, interest, rents, and profits is equal to nominal GDP is equal to consumption spending, investment spending, government spending, and net exports. C+I+G+NX = Aggregate expenditure = Nominal GDP
The inflationary gap
The amount by which the equilibrium level of real GDP exceeds the potential real GDP.
The deflationary gap
The amount by which the equilibrium level of real GDP falls short of potential real GDP.
Marginal Revenue
The change in total revenue generated from an additional unit sold. It is calculated by taking the change in total revenue divided by the change in the quantity sold.
The measure of the cost of a basket of goods and services in any period relative to the cost of the same basket of goods and services of the base year is called
The consumer price index
Opportunity Cost
The cost of what you give up to partake in that activity.
Price elasticity of demand categories: 2. A coefficient with an absolute value of greater than one
The demand curve is elastic around the prices analyzed. A one percent price change generates a greater than one percent change in the quantity demanded. When elastic, consumers significantly change their quantity demanded when the market price changes.
Price elasticity of demand categories: 1. A coefficient with an absolute value of less than one
The demand curve is inelastic around the prices analyzed. A one percent price change generates a less than one percent change in the quantity demanded When inelastic, consumers do NOT radically change their quantity demanded when the market price changes.
Price elasticity of demand changes: 3. A coefficient with an absolute value of one
The demand curve is unit elastic or of unitary elasticity A one percent change in price generates an equal one percent change in the quantity demanded.
The economy's potential real GDP
The economy's maximum sustainable output level given the supply of factors of production, the state of technology, and formal and informal institutions supporting the economy.
Profit
The income earned (or lost) by an entrepreneur for running a business.
A product is an inferior good when
The income elasticity coefficient is negative. A one percent increase in income causes a negative percentage change in the quantity demanded of the good.
A product is a normal good when
The income elasticity of demand coefficient is positive. A one percent change in income causes a positive percentage change in the quantity demanded of the good
The Inflation rate
The inflation rate is a percentage change in a price index between two periods.
The long run aggregate supply curve
The location of the long run aggregate supply curve depends on the economy's supply of land, capital, labor, and entrepreneurial ability and the productivity of these resources and not the price level. It is located at the economy's potential real GDP
A permanent increase in productivity in the economy causes
The long run aggregate supply curve to shift to the right
A permanent decrease in productivity in the economy causes
The long-run aggregate supply curve to shift to the left
The accountants hired by Bling, Blong, and Blatt law Firm have calculated that at the profit maximizing quantity total fixed costs equal $56,272,000 total variable costs equal $213,235,000 and total revenue equals $213,236,000. Because of this information, Bling, Blong, and Blatt Law Firm decided
To stay open because shutting down would be more expensive
If the country's imports are greater than its exports, the country has a
Trade deficit
(T/F) Frictional unemployment occurs because it takes time for workers to search for new jobs that best suit their tastes and job skills.
True
(T/F) In the base year, the nominal GDP and the real GDP are the same
True
(T/F) One explanation for a positively sloped short run aggregate supply curve is that businesses sometimes mistake changes in the price level for a change in the value that consumers have for their product.
True
(T/F) Open market operations are purchases and sales of government securities by the Federal Reserve Bank in an effort to change the money supply.
True
(T/F) The aggregate demand curve reflects the real gross domestic product demanded by all groups in the economy at any given price level.
True
(T/F) The circular flow diagram demonstrates that the expenditures on final goods and services in the domestic economy is equal to the total income paid for the scarce factors of production used to produce those final goods and services.
True
(T/F) The menu cost effect tells us that when there is a real price level decrease in the economy, businesses do not quickly change the price of their products. This behavior generates a real price increase for their products, thereby decreasing the quantity that they sell.
True
(T/F) Nominal gross domestic product (GDP) measures the economic value of all goods and services produced inside the boundaries of a country, not adjusted for the changes in the price level.
True; Nominal GDP is equal to the value of final goods and services produced inside the boundaries of the domestic economy at the current year's prices.
(T/F) Consider the steak market, where the demand for steak is downward sloping and the supply of steak is upward sloping. A per unit tax on buyers of steak would cause the market price to decrease and the quantity demanded to decrease.
True; a per unit tax on steak makes buying steak less attractive. Therefore, the demand curve will shift to the south-west, causing the market price to decrease and the quantity demanded to decrease
(T/F) Federal Reserve notes are printed by a division of the Treasury Department
True; all federal reserve notes are printed at the Bureau of Engraving and Printing at the Department of Treasury, but they are issued by the regional Federal Reserve banks.
(T/F) For all price elasticity of demand calculations, you will get a negative number.
True; because all demand curves are negatively sloped
(T/F) The long aggregate supply curve shifts to the right when government permanently lowers trade barriers.
True; if there is a permanent decrease in trade barriers, then the short run aggregate supply curve shifts to the south-east and the long run aggregate supply curve shifts to the right. If lowering of trade barriers is temporary, then only the short run aggregate supply curve will shift to the south-east.
(T/F) Suppose the cross price elasticity of demand for home heating oil with respect to the price of natural gas is +0.6. This number tells us that home heating oil and natural gas are substitute goods.
True; the coefficients of cross price elasticity can be positive or negative. If the coefficient of the cross price elasticity is negative, then the two goods are complements. If the coefficient of the cross price elasticity is positive, then the two goods are substitutes.
(T/F) The negative movement from peak to trough of a business cycle is called an economic contraction because over this segment of the business cycle real GDP is smaller than in the previous period.
True; the negative movement from peak to trough is called an economic contraction. Over this range of the business cycle, real GDP in a given period is smaller than in the previous period. If the contraction moves below the trend line for two or more quarters of a year, then it is called a recession.
(T/F) If the price level increases, the value of money decreases.
True; the price level and the value of money are directly related.
Cyclical unemployment
Unemployment that occurs because of declines in the economy's aggregate output (GDP) during economic contractions and recessions.
Assume that the economy is currently at potential real gross domestic product. Which of the following would put the economy in an inflationary gap?
greater stock market wealth