Economics: Definitions and Theories

Definition Introduction to Economics Real The value of money with inflation discounted. Basic Economic goods are scarce while wants are unlimited: therefore, resources must be economic allocated. problem Opportunity The benefit foregone of the next best alternative. cost Production A PPC shows the different combinations of economic goods and services which an possibility economy is able to produce if all resources are fully and efficiently employed. It curve shows scarcity and opportunity cost. Microeconomics: Markets The amount of a good or service which an individual is both willing and able to buy Demand per period of time. The amount of a good or service which a firm is willing and able to offer for sale per Supply period of time. Consumer The difference between the amount consumers are willing to pay for a good or surplus service and the amount paid. Producer The difference between the price at which producers are willing to supply a good or surplus service and the price received. Inferior goods which take up all or nearly all of the consumers income, thus resulting Giffen goods in a perverse demand curve. Veblen goods Conspicuous goods which result in a perverse demand curve. Microeconomics: Elasticities A measure of the responsiveness of quantity demanded to a change in price. Price elasticity %QD MT of demand (over a range), Point elasticity = P = %P OM A measure of the responsiveness of quantity demanded to changes in income. Income %QD elasticity of , measures whether a good is no change, inferior, or normal. Y = demand %Y No change Consumption of this good does not vary with changes in income. Y = 0 good Inferior good Consumption of this good falls with a rise in income, and vice versa. Y = ve Normal good Consumption of this good rises with a rise in income, and vice versa. Y = + ve A measure of the responsiveness of quantity demanded of one good or service to a change in the price of another. Cross elasticity %QD of A of demand , measures strength of a substitute ( Cross = + ve ) or a Cross = %P of B complement ( Cross = ve ). An unrelated goods cross elasticity is 0. A measure of the responsiveness of quantity supplied to a change in price. Elasticity of %QS supply of S = %P Perfectly QD/QS does not change at all with changes in price, = 0 inelastic Inelastic QD/QS changes by a smaller percentage than price does, = less than 1 Unit elasticity QD/QS changes by exactly the same percentage as price does, = 1 Elastic QD/QS changes by a larger percentage than price does, = more than 1 Perfectly Consumers/producers are prepared to buy/supply all they can at one price but none elastic at all at another. = 1

Definition Momentary Supply is completely inelastic as no factors of production are variable. supply Short-run Supply is restricted by fixed factors as only one factor of production is variable and is supply thus inelastic. Long-run All factors of production and costs are now variable and thus supply is elastic. supply Very long-run Research and development is possible and all factors of production are variable. supply Microeconomics: Government intervention A price ceiling imposed by the government above which firms cannot set prices Maximum usually to achieve social aims, e.g. encourage consumption of goods with positive price externalities. Minimum A guaranteed price imposed by the government usually to aid struggling suppliers, e.g. price farmers and minimum wage laws. A tax levied on certain goods or services which can either be ad-valorem or specific; Indirect tax decreases supply. Direct tax A tax on an incomes and wealth, e.g. income tax, company/profit tax. Subsidy Government grants or gifts to businesses which offset costs, increasing supply. Macroeconomics: Measuring national income A measure of final goods and services produced in an economy annually without GDP calculating net property income from abroad and capital depreciation. A measure of final goods and services produced in an economy annually which GNP includes net property income from abroad but not capital depreciation. A measure of final goods and services produced in an economy annually which NNP calculates both net property income from abroad and capital depreciation. GDP GDP per capita Calculated as: Population Standard of Comprised of three factors: materialistic goods, wealth and quality of life. living Microeconomics: Market failure Spill-over effects of either production or consumption of a good where the social Positive benefit exceeds the private benefit (consumption) or where the private cost exceeds externalities the social cost (production). Spill-over effects of either production or consumption of a good where the private Negative benefit exceeds the social benefit (consumption) or where the social cost exceeds the externalities private cost (production). Goods which are under-valued and under-consumed because it brings about positive Merit goods externalities. Examples are education and health. Goods which are over-valued and over-consumed because they have negative Demerit goods externalities. Examples are alcohol and tobacco. Social This is where the marginal social cost equals the marginal social benefit; it is the point optimum level of true Pareto efficiency. Private goods Goods/services whose consumption implies that it is not available for another; i.e. and services there is rivalry. There is non-rivalry, as if one consumer benefits from the good/service, others may Public goods still benefit as well, and non-excludability, as once it is provided no one can be and services excluded from benefiting from the good/service. Caused by public goods as there is the non-excludability factor: some people pay for Free-rider the benefits of the goods while others dont. Thus, the private sector does not problem provide these goods, resulting in an example of market failure. 2

Definition Productive efficiency Technical efficiency Allocative efficiency Production at the minimum average cost. Greatest average product. Also known as Pareto efficiency or economic efficiency. The point where P = MC, or where it is impossible to make someone better off without making another worse off.

Consumer Consumer choices determine the allocation of resources in the economy. sovereignty Microeconomics: Market failure, Theory of the firm Competition among the very many; the number of firms is so great that no one can Perfect influence the price and are price-takers. The product is homogenous and there is no competition competition, no need for advertising by individual firms, perfect knowledge and freedom of entry. This is an example of market success. Competition among the many; firms have a certain influence over a price range as the Imperfect product is differentiated. There is a role of advertising, imperfect knowledge, noncompetition price competition and freedom of entry. Competition among the few, where there is product differentiation, advertising, Oligopoly imperfect knowledge and non-price competition. Firms are interdependent as they can influence the price and there is thus price rigidity. There are also barriers to entry. Duopoly Competition between two; characteristics are as of an oligopoly. A market situation in which there is a single seller of a good or service with no good Monopoly substitutes; the firm is the price-maker. There is a role for advertising, barriers to entry and imperfect knowledge. This is an example of market failure. Profit maximizing This occurs where MC = MR. output Microeconomics: Agricultural markets; International economics: protectionism Buffer stock Fixed price where the government buys the commodity in the case of excess supply scheme and sells from its stocks in the case of a shortage. Income Prices are set using an imaginary unit elastic demand curve in order to create income support stability in agricultural markets. scheme International Agreement between producing and consuming countries to improve global market commodity for a specific commodity usually to reduce instability and uncertainty. agreement Production Agreement between producing countries to limit the amount of a commodity quota system supplied: a cartel. Macroeconomics: Macroeconomic models, demand-side and supply-side policies Government policy concerned with altering government spending and taxation to Fiscal policy address macroeconomic goals. Monetary Government policy concerned with altering interest rates and controlling the money policy supply to address macroeconomic goals. Full The physical upper limit to output in the short-run, when all resources in an economy employment are used fully and efficiently. Aggregate Comprised of consumption, government spending, investment and exports, with all demand import content subtracted. Aggregate The value of goods and services produced (i.e. national income). supply A fall in the value of money when the economy is at or approaching the point of full Inflation employment. 3

Reflation Multiplier Balanced budget multiplier Investment Marginal efficiency of capital Business outlook Accelerator theory PSNCR PSDR

Definition An attempt to expand the economy when it is below the point of full employment without suffering inflation. A Keynesian concept which indicates how much national income will change by if components of J, W or C are altered. It is the ratio of the change in national income 1 1 to the permanent change in AD which caused it. k = = MRL 1-MPC An equal increase in both G and T will increase national income by the same amount, i.e. the balanced budget multiplier is 1. Expenditure on real capital by firms. Rate of discount that makes the present value of the future income stream of an investment exactly equal to its initial cost. Theory stating that investment is determined by the level of interest rates. Theory stating that investment is determined by factors which determine firms confidence in the situation of the economy. Theory stating that changes in national income, especially consumption, will cause exaggerated changes in the level of investment. The public sector net cash requirement, when G exceeds T, and whose accumulation results in the national debt. The public sector debt repayment, when government revenue exceeds spending, whose accumulation results in a budget surplus. Comprised of government spending and taxation.

The Budget Crowding out Occurs when public sectors compete with private sectors for resources. theory Automatic Fiscal measures which respond to changes in the economy independently of any stabilizers political action. Discretionary Deliberate changes in fiscal policy. measures Macroeconomics: Distribution of income A measure of income distribution and equality, related to the Lorenz curve, which measures the cumulative % of money income against the cumulative % of families. Gini coefficient Area between perfect equality and actual distribution Gini coefficient of inequality = Triangle area under perfect equality A diagram of tax rates (e.g. %) against tax revenue, showing that decreasing tax rates Laffer curve may increase tax revenue by increasing incentive. Regressive tax A tax where a greater proportion falls on low earners. (MRT is less than ART) Progressive tax A tax where a greater proportion falls on high earners. (MRT exceeds ART) Proportional A tax with a fixed percentage irrespective of income. (MRT = ART) tax Per capita/poll A tax of a fixed amount irrespective of income. Gross income Income before tax. Net income Income after taxes, i.e. disposable income. Tax avoidance Legal arrangement of financial affairs to avoid/minimize amount of tax paid. Tax evasion Illegal dodging of taxes. Occurs when a low-paying job and a slightly higher-paying job yield similar Poverty trap disposable incomes due to the latter job no longer allows for qualification of welfare benefits while income tax and social security must still be paid. Occurs when a low-paying job and unemployment yield similar disposable incomes Unemployment due to the amount that income tax and social security takes up of the income and the trap unemployment benefits received. 4

Definition Macroeconomics: unemployment and inflation Money supply The total amount of money circulating in the economy, e.g. cash, bank deposits. Liquidity The ease of which money can change forms without loss. Banks can lend on a multiple as every loan is a deposit. Credit 100 Credit multiplier = multiplier Cash/liquidity ratio Open market The buying or selling of government bonds on the open market by the central bank. operations Floating debt Short term debt: Treasury bills. Funded debt Long term debt: stocks/securities/bonds. Retail price A method of measuring inflation through calculating weighted averages by surveying index consumption basket and attaching values to each item. Wholesale A method of measuring inflation by using factory prices, i.e. costs, to predict retail price index price inflation. Comprehensive measure of inflation as it includes capital goods and exports. GDP GDP Deflator , where real GDP = volume of G&S in the economy. Inflation = Real GDP A Keynesian explanation of inflation where excess demand causes higher prices as there is a scope for higher profits, which increases the prices of factors of production, Demand pull i.e. costs, as there is more competition for them. Of these costs, wages will increase as inflation well, causing an increase in consumption. Higher demand will thus lead to higher prices. Cost push Higher costs, especially wages, lead to a fall in S and higher production costs which inflation lead to higher prices (as well as a wage-price spiral). Quantity Changes in the money supply cause changes in the average price per transaction; i.e. theory an increase in the money supply leads to inflation; MV = PT. Natural rate of A Monetarist concept with which a rate of 0% inflation is associated. unemployment A rise in the money supply will lead to an increase in national income and Friedmans employment in the short-run, but in the long-run will lead to a return to the NRU theory only at higher prices. Liquidity The demand for money is from a desire to hold cash and remain liquid in order to preference wait for a speculative opportunity to arise. theory Keynesian An increase in MS leads to a fall in R via the liquidity preference theory, which leads transmission to an increase in I via the MEC theory, which leads to an increase in AD, which mechanism either, via k, leads to an increase in national income and employment, or inflation. Phillips Curve Diagram showing an inverse relationship between wage inflation and unemployment. NonA point where although there is still inflation, it is non-accelerating, found on the accelerating Expectations Augmented Phillips Curve, which shows the Monetarist view of rate of inflation based upon the concept of voluntary employment. unemployment Wage-push Trade union power allows higher wages to be demanded and granted, fuelling inflation consumption and production costs, leading to inflation. Wage-wage Competition between labor groups to maintain difference in wages drives up demand inflation for higher wages. Import price Inflation caused by rise in commodity prices, depreciation of currency, worsened inflation terms of trade, etc. Price push or Increase in market power allows firms to pass on costs to consumer prices more profits push easily, resulting in inflation. inflation 5

Progressive tax system Supply-side measures Demand-side measures

Definition Low tax thresholds and high rates cause higher wages to be demanded as the money illusion is decreased. Measures targeting lowering the NRU (Monetarists) which include policies regarding wages, capital markets, entrepreneurship, competition and efficiency, and the improvement of infrastructure. Measures targeting the level of aggregate demand. As the government is initiating these policies, they will consist of altering the level of government spending, taxation and/or monetary policy. Other policies may target investment, savings, consumption and export/imports.

Economic A rise in real GNP growth Recession A fall in the real GNP over two consecutive quarters. International economics: Balance of payments Balance of A classified record of all economic transactions, both income and expenditure, Payments between a country and the rest of the world. Balance of A record of exports and imports relating to goods. trade Invisible A record of exports and imports relating to services. balance Current Comprised of both the visible (goods) imports and exports and invisible (services) account imports and exports, i.e. the balance of trade and the invisible balance respectively. - Deficit A deficit occurs when the value of imports exceeds that of exports. - Surplus A surplus occurs when the value of exports exceeds that of imports. Capital flows Tracks transactions in assets and liabilities, e.g. shares, loans, property. International economics: Reasons for trade, terms of trade Theory of Trade will be advantageous if each of two countries (or more) specializes in the comparative production of those goods and services in which it has a comparative advantage, or in advantage which it has the least comparative disadvantage. Constant Assumption that when one unit of productive effort is doubled, output is doubled as return to scale well. Decreasing Assumption that when one unit of productive effort is doubled, output is less than return to scale doubled. Increasing Assumption that when one unit of productive effort is doubled, output is more than return to scale doubled. 1. The physical rate of exchange of goods and services which, to be mutually beneficial, must lie between the domestic production rations of the countries involved. Terms of trade Index of export prices 2. Terms of trade = 100 Index of import prices International economics: Exchange rates Exchange rate The value of a currency in relation to another on the foreign exchange market. Capital flowing across national borders seeking the highest yield, e.g. the highest Hot money interest rate. Freely floating A currency measured in terms of another where its value is determined by market exchange rate forces, e.g. the US dollar. Managed A currency measured in terms on another whose value is determined by the exchange rate government who attempts to keep the rate within a band, e.g. the VN dong. Appreciation A rise in the external value of a currency against another in a freely floating system. Revaluation A rise in the external value of a currency against another in a managed system. Depreciation A fall in the external value of a currency against another in a freely floating system. Devaluation A fall in the external value of a currency against another in a managed system. 6

Definition Purchasing When the value of a common currency is equalized; artificial exchange rate based on power parity the cost of living within two countries rather than market rates. International economics: Balance of payments problems Automatic Considered as one of the advantages of the freely floating exchange rate system, in adjustment theory, a balance of payments deficit/surplus will be corrected by automatic process movements in the currency. MarshallFor depreciation to improve the balance of payments, the sum of the price elasticities Lerner of demand for exports and imports must exceed one; otherwise, the automatic condition adjustment process cannot proceed. The balance of payments will worsen before improving due to a supply lag for J-curve effect exports and domestic products, high import content and the time period (for P ). Expenditure Restrictionary fiscal and monetary policies. reduction Expenditure Diversion of expenditure to the domestic substitute. switching International economics: Free trade and protectionism Numerous policies through which imports are reduced in order to protect the Protectionism domestic industry, e.g. through tariffs or quotas. A type of protectionism which places a total ban on trade, restricting the only supply Embargo of the good or service to the domestic industry. Quota A type of protectionism which places a physical limit on imports. A type of protectionism in which an indirect tax is levied on imports to protect Tariff domestic producers. Voluntary A type of protectionism in which the exporting company agrees to a voluntary quota export of exports; beneficial for them in markets with an inelastic demand. restraints Exchange A type of protectionism in which the central bank monopolizes the supply of foreign controls exchange by limiting it. Import A type of protectionism in which permission to import must be granted. licensing Administrative A type of protectionism in which imported goods are discriminated against, as the barriers government seeks to increase costs by demanding health, safety, etc. requirements. Area in which goods and services may flow freely, i.e. without tariffs, from one Free trade area member to another. Countries outside the area are subject to protectionist measures applied independently by members. Example: ASEAN. A free trade area; however, members levy common and coordinated external barriers Customs union to countries outside of the area. Example: earlier EU. Customs union A customs union with a higher degree of cooperation; there is a free movement of and economic factors of production, a common currency and common domestic policies. Example: union present EU. New trade from one country to another; a country commences trade with another Trade creation country in an area in which it had not traded previously. Trade Re-routed trade; one country ceases trade from another and engages in trade of the diversion same good or service from a different country. Microeconomics: Theory of the firm FC Costs that do not vary with output, e.g. rent. AFC = Fixed costs Q VC Costs that do vary with output, e.g. raw materials, labor. AVC = Variable cost Q Definition 7

Average cost Marginal cost Law of diminishing marginal returns Average product Marginal product Long-run average costs Long-run marginal costs Economies of scale Diseconomies of scale Constant returns to scale Internal economies of scale Internal diseconomies of scale External economies of scale External diseconomies of scale Revenue Total revenue Average revenue Marginal revenue Accounting costs Normal profit Supernormal profit Quantity adjuster Constant cost industry Increasing cost industry

Total cost ; AC = AFC + AVC Output Change in total costs when the rate of production is increased/decreased by one unit; slope of total cost. If more and more of a variable factor of production is used in combination with fixed factors, then the marginal product will eventually decline first, after which the average product will as well. Determines the shape of VC, AVC, AC and TC. TP A measure of productivity; AP = Var. FOP Change in total product as a result of changing the variable factor of production by one unit; slope of total product. Plots the SRAC of producing at the lowest cost methods; shape is determined by economies and diseconomies of scale. Change in total cost when output is adjusted by one unit after the plant size has been readjusted to produce a certain quantity at minimum LRAC. A fall in long-run average costs as the scale of production rises with increases in plant size. A rise in long-run average costs as the scale of production rises with increases in plant size. No change in long-run average costs as the scale of production rises with increases in plant size. Economies of scale arising from cost changes within the firm itself as it grows, e.g. purchasing economies (option of bulk-buying), financial economies, marketing economies, managerial economies, production economies, increased dimensions. AC =
Diseconomies of scale arising from cost changes within the firm itself as it grows, e.g. management problems. Economies of scale arising from cost changes outside of the firm from a growth in the industry, e.g. agglomeration (attraction to region of associated firms to provide materials), improved infrastructure, growth of skilled labor pool, collusion. Diseconomies of scale arising from cost changes outside of the firm from a growth in the industry, e.g. congestion, shortage of skilled labor or land. Income from sales (sales do not have to be equal to output). Price x quantity sold. TR AR = = Price Q. sold Change in total revenue when one more or one less unit is sold; slope of total revenue. Total costs of production. Level of profit needed to keep firms from exiting the industry; viewed as a cost. Profit exceeding normal profit which attracts new firms into the industry. A firm in perfect competition can only adjust its quantity supplied in the short-run. Assumption that costs do not change with an increase in the number of firms in the industry. An increase in the number of firms in the industry will raise costs of production due to higher competition for resources. 8

Definition Decreasing cost industry Price discrimination Cross subsidization Sales maximizing Marginal cost pricing X-inefficiency Creative destruction Contestable markets Hit-and-run competition Game theory Limit pricing Price wars Price leadership An increase in the number of firms in the industry will decrease costs of production. When a firm sells a good or service to different buyers at two or more different prices, for reasons not associated with costs of production. Losses made in one sector subsidized by a more profitable sector of the business. The point where AC = AR (= D) The point where P = MC. Developed when monopolies become complacent and no longer seek to cut all costs as there is no incentive to be as efficient as it can due to a lack of competition. Appearance of a close substitute to a monopolys good or service via product development, which breaks down the monopoly. A market in which there are weak barriers to entry and thus the threat of potential entry forces monopolies to either act as if there was competition or to not take full advantage of their monopoly power. In a market with low costs of entry and exit, a new firm, lured by super-normal profits, may enter and take advantage of the situation, leaving once prices begin declining. Collusion is more profitable for firms in an oligopoly or a duopoly as there is no guesswork involved, if there is enough trust between them. Existing firms set highest price without allowing entry to discourage firms from entering the industry, as a new entry would decrease prices to a point of losses immediately. When firms attempt to undercut one another to drive the other out of the industry. When firms follow the pricing decisions of one firm in the industry due to the lack of a will to challenge that firms market dominance; form of tacit collusion.