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Comprehensive Outline for Economic Concepts and Theory

Outlined by Lambers CPA Review

 Supply and Demand

o The market matches buyers and sellers of good and services.
o Demand is the quantity of a good or service that consumers are willing and able
to purchase at various prices.
 Law of demand - the price of a product and the quantity demanded
are inversely related.
 Substitution effect - when prices decrease, buyer will enter the market.
The product will be cheaper relative to other goods and is substituted for
 Income effect - people buy more when prices are lower.
 Normal goods - commodities for which demand is
negatively related to income.
 Inferior goods - commodities for which demand is
negatively related to income.
 Substitutes - increase is price of one product will generate
an increase in demand for another.
 Complements - increase in the price for one product will
generate a decrease in demand for another. Bread prices go up,
jelly demand goes down
o Demand curves
 Elasticity of demand - the parentage change in quantity demanded
divided by the percentage change in price.
o Supply is the amount of goods or services that producers are willing to offer at a
given price.
 Law of supply - the price of a product and the quantity supplied are
positively related.
 Price elasticity of supply - percentage change in quantity supplied
divided by the percentage change in price.
 Equilibrium - the point at which the demand and supply curves intersect.
o Law of diminishing returns - a fixed amount of production resources, the
addition of increments of labor will produce diminishing returns.
o Law of diminishing marginal utility - useful will decline as consumers
acquired additional units of a product.

 GDP and Business Cycles

o National income - the measure of the output and performance of a nations’
 Gross domestic product (GDP) - the total market value of all final goods
and services produced within the US whether domestic or foreign during a
 Gross national product (GNP) - value of output produced with the US
owned resources regardless of their location. GNP is GDP plus output of US
owned resources abroad minus foreign owned resources in the US.
 Measurement of GDP can use one of two approaches.
 Income approach - GDP is sum of various types of income such
as wages, interest, rents, indirect business taxes, net foreign income.
 Expenditure approach - GDP is sum of spending such as
personal consumption spending, gross private domestic investment,
government purchases, net exports.
 Net domestic product - GDP - deprecation (consumption of fixed assets)
 National income - NDP + US net income earned abroad - indirect
business taxes such as sales taxes.
 Personal income - NI - corporate taxes - social security
contributions + transfer payments
 Disposable income - PI - personal income taxes
o Business cycles
 Peak phase - economy has reached its highest level of production (GDP).
 Trough - low levels of economic activity and under use of resources.
 Recovery (expansion) - increasing economic activity.
 Recession - activity severely contracts.
 Depression - conditions are similar but longer lasting.
o Economic indicators
 Consumer price index (CPI) - based on prices of 364 goods and services
over time.
 Leading indicators such as new orders, building permits, weekly
 Lagging indicators - unemployment consumer credit,
o Employment
 Natural rate of unemployment - the long-term rate that would exist even
if there were no cyclical unemployment.
 Full employment - when the real rate of unemployment is equal to the
natural rate.
 Frictional unemployment - employees are between jobs.
 Structural unemployment - includes those who have skills but do not
match the required skill levels. by employers.
 Cyclical unemployment - downturn in the business cycle.

 Fiscal Economics
o Deals with the ability of the economy to generate and maintain full employment
over the long run without government intervention. Three assumptions about this
 The difference between savings plans and investment plans is fundamental
to an understanding of changes in the level of income.
 Price flexibility cannot be relied upon to provide full employment.
 Equilibrium GDP does not necessarily provide full employment.
o Multiplier - a change in consumption, investment, net exports or government
spending results in a multiplied change in equilibrium GDP.
 Marginal propensity to consume (MPC) - the percentage of additional
income that is consumed.
 Marginal propensity to save (MPS) - the percentage of additional income
that is saved.
 MPC + MPS = 1 or MPS = 1 - MPC

 Money and the Economy

o M1 - coins and currency, checking deposits
o M2 - M1 plus savings, small time deposits, money market accounts.
o Monetary policy by the FED is designed to control the economy through the
supply of money in the banking system. Tools to accomplish this are:
 Reserves
 Discount rates

 Unemployment, Inflation, Deflation, Government

o Unemployment - types
 Frictional - caused by the normal workings of the labor market.
 Structural - aggregate demand is sufficient to provide full employment but
the distribution of demand does not relate to labor force.
 Cyclical
 Seasonal
 Regional
 Technological.
o Inflation
 Cost-push - increased production costs are passed on to the consumer.
 Demand-pull - demand for goods and services is excessive.
 Consumer price index
o Government’s role
 Taxation
 Progressive
 Regressive
 Proportional
 Direct taxes are paid by the taxpayer directly such as income taxes.
 Indirect taxes are paid by someone else even though the individual
will eventually pay the taxes.

 International Trade
o Comparative advantage - countries should produce products when they have
the competitive advantage for sale and buy when they do not.
 Production possibilities curve - represents the tradeoffs between two
alternative goods that can be produced from the same amount of resources.

 Trade Barriers
o The following items are barriers to successful trade.
 Tariffs - consumption taxes to restrict imports.
 Antidumping taxes
 Import quotas
 Embargo - total ban on some kinds of imports.

 Foreign Currency Rates and Markets

o Exchange rate determination
 Spot rate - rate paid for immediate delivery of a currency.
 Forward exchange rate - future price of currency.
o Avoiding the problem through hedging.
 Purchased or selling forward contracts.

 Balance of Payments
o Balance of trade is difference between total exports and imports of goods.