Economics Chapters Finals

ellisderooij
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ellisderooij
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Important concepts from the Macroeconomics book

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Question Answer
Economic Interaction How my choices affect your choices, and vice versa
Opportunity Cost What you must give up in order to get it; true cost
Trade-offs at the margin Comparing the costs and benefits of doing a little bit more of an activity versus doing a little bit less
Resource Anything that can be used to produce something else
Individual choice The decision by an individual of what to do, which necessarily involves a decision of what not to do
4 principles 1. Choices are necessary because resources are scarce 2. The true cost of something is its Opportunity Cost 3. "How much" is a decision at the Margin 4. People usually respond to incentives, exploiting opportunities to make themselves better off
Incentive Anything that offers a reward to people who change their behaviour
5-9 principles 5. There are gains from trade 6. Markets move towards equilibrium 7. Resources should be used efficiently to achieve society's goals 8. Markets usually lead to efficiency 9. when markets don't achieve efficiency government intervention can improve society's welfare
Equilibrium An economic situation is in equilibrium when no individual would be better of doing something else.
Efficiency An economy is efficient if it takes all opportunities to make some people better off withouth making other people worse off.
Equity Means that everyone gets his or her fair share. Since people can disgree about what's fair, equity isn't as well defined a concept as efficiency.
Principles 10-12 10. One Person's Spending is Another Persons Income 11. Overall spending sometimes gets out of line with the economy's productive capacity 12. Government policies can change spending
Inflation A too high overall spending, causes a rise in prices throughout the economy
Model Simplified representation of a real situation that is used to better understand real-life situations.
Other things equal assumption All other relevant factors remain unchanged
Production Possibility Frontier The PPF illustrates the trade-offs facing an economy that produces only two goods. It shows the maximum quantity of one good that can be produced for any given quantity produced of the other.
Efficient in Production If the economy as a whole could not produce more of any one good without producing less of something else
Factors of Production Reference to a resource that is not used up in production (for example the workers and their machines, but the metal they use to make something cannot be used again)
Comparative Advantage A country has a comparative advantage in producing a good or service if its opportunity cost of producing the good or service is lower than other countries.
Absolute Advantage A country has an absolute advantage in producing a good or service if the country can produce more output per worker than other countries.
Barter trade Trade takes the form of barter when people directly exchange goods or services that they have for goods or servives that they want
Circular-flow diagram Represents the transactions in an economy by flows around a circle
Markets for goods and services; Factor Markets Markets on which companies sell their goods and services to housholds; Factor markets are the ones on which firms buy the resources they need to produce those goods and services
Income distribution An economy's income distribution is the way in which total income is divided among the owners of the various factors of production (less and high skilled workers and owners of capital and land)
Positive economics versus Normative economics Positive economics tend to be descriptive (forecasting etc.) whereas Normative economics are prescriptive (how the world should work)
Causal relationship; dependent and independent variable A causal relationship exists between two variables when the value taken by one variable directly influences or determines the other value. The determining variable is the independent one and the determined variable is the dependent one
Curve; and linear relationships A curve is the line on the graph that depicts two variables. If the curve is a straight line it has a linear relationship, but is it curved it is a nonlinear relationship
Tangent line straight line that just touches, or is tangent to, a nonlinear curve at a particular point. The slope of that curve is at that point equal to that of the nonlinear curve
Omitted Variable An unobserved variable that through its influence on other variables, creates the erroneous appearance of a direct causal relationship among those variables
Reverse causality The error of rc is committed when the true direction of causality between two variables is reversed
Competitive Market A market in which there are many buyers and many sellers of the same good or service, none can influence the price of the good or service (model of supply and demand)
Shift of the demand curve A change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve
Movement along the demand curve A change in the quantity demanded of a good arising from a change in the good's price
Substitute Complement 1. Two goods are substitutes when a rise in the price of one of the goods leads to an increase in the demand of the other good 2. Two goods are complements if a rise in the price of one good leads to a decrease in the demand for both goods
Normal Goods Inferior Goods 1. When a rise in income increases the demand for a good (the normal case) 2. When a rise in income decreases the demand for a good
Individual Demand Curve Illustrates the relationship between quantity demanded and price for an individual consumer
Market-Clearing Price Same as Equilibrium Price
Shortage (excess demand) When the price is lower than equilibrium, more buyers will want to buy that good, but there are not enough sellers
Property Rights The rights of owners of valuable items, whether resources or goods, to dispose of those items as they choose
Economic Signal Any piece of information that helps people make better economic decisions
Market Failure When markets fail to be efficient
Price Controls; Price Ceiling; Price Floor Legal restrictions on how high or low a market price may go; Maximum price sellers are allowed to charge for a good or service; Minimum price buyers are required to pay for a good or service
Deadweight Loss Loss in total surplus that occurs whenever an action or policy reduces the quantity transacted below the efficient market equilibrium quantity
Ricardian model of International Trade Analyzes international trade under the assumption that opportunity costs are constant
Factor intensity The factor intensity of production of a good is a measure in relatively greater quantities than other factors in production
Heckscher Ohlin Model According to this model, a country has a comparative advantage in a good whose production is intensive in the factors that are abundantly available in that country
Domestic Demand Curve Shows how the quantity of a good demanded by domestic consumers depends on the price of that good
Offshore Outsourcing Takes place when businesses hire people in another country to perform various tasks
Self-Regulating Economy In a self-regulating economy problems such as unemployment are resolved withouth government intervention, through the working of the invisible hand
Keynesian Economics Economic slumps are caused by inadequate spending, and they can be mitigated by government intervention
Monetary Policy Uses changes in the quantity of money to alter interest rates and affect overall spending
Fiscal Policy Uses changes in government spending and taxes to affect overall spending
Recessions and Expansion Contractions are periods of economic downturn when output and employment are falling Recoveries are periods of economic upturn when output and employment are rising
Business Cycle The short-run alternation between recessions and expansions
Inflation and Deflation Overall rising or fallin of prices
Trade Deficit or Surplus A country runs a trade deficit when it buys more goods from foreign countries than it sells them and with surplus that is the other way around
National Accounts Keep track of the flows of money between different sectors of the economy
Stock Share in the ownership of a company held by a shareholder
Inventories Stocks of goods and raw materials held to facilitate business operations
Net Exports The difference between the value of exports and the value of imports
Price Index Measures the cost of purchasing a given market basket in a given year, where that cost is normalized so that it is equal to 100 in the selected base year
Rule of 70 Time it takes a variable to double: 70/annual growth rate of variable
Convergence Hypothesis International differences in real GDP per capita tend to narrow over time
Loanable Funds Market Hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders
Crowding Out Occurs when a government budget deficit drives up the interest rate and leads to reduced investment spending
Fisher Effect According to the Fisher effect, an increase in expected future inflation drives up the nominal interest rate, leaving the expected real interest rate unchanged
Marginal Propensity to Consume (MPC) The increase in consumer spending when disposable income rises by 1$
Marginal Propensity to Save (MPS) The increase in household savings when disposable income rises by 1$
Autonomous Change in Aggregate Spending Initial change in the desired level of spending by firms or else at a given level of the real GDP
Multiplier The ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change
Consumption Function An equation showing how an individual household's consumer spending varies with the household's current disposable income
Aggregate Consumption Function The relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending
Accelerator Principle Higher growth of GDP leads to higher planned investment spending, but a lower growth rate of real GDP leads to lower planned investment spending
Inventory Investment The value of the change in total inventories held in the economy during a given year (Inventories are stocks of goods held to satisfy future sales)
Income Expenditure Equilibrium When aggregate output, measured by real GDP, is equal to planned aggregate spending
Income-Expenditure Equilibrium GDP The level of real GDP at which real GDP equals planned aggregate spending
Keynesian Cross Diagram that identifies income-expenditure equilibrium as the point where the planned aggregate spending line crosses the 45-degree line
The Paradox of Thrift Many individual actions together can have a different and worse outcome than intended; when all households save for tough times, while this actually creates an even tougher time
Rise in Interest Rate Causes a decrease in investment spending because it makes the cost of borrowing higher
Sticky Wages Nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages
Potential Output The level of real GDP the economu would produce if all prices, including nominal wages were fully flexible
Stagflation Stagnation plus inflation; Combination of inflation and falling aggregate output
Recessionary Gap When aggregate output is below potential output
Inflationary Gap When aggregate output is above potential output
Stabilization Policy The use of government policy to reduce the severity of recessions and rein in excessively strong expansions
Maturity Transformation The conversion of short-term liabilities into long-term assets
Maturity Transformation The conversion of short-term liabilities (deposits) into long-term assets (loans)
Banking Crisis Occurs when a large part of the depository banking sector or the shadow banking sector fails or threatens to fail
Asset Bubble The price of an asset is pushed unreasonably high, due to expectations of further price gains
Financial Contagion Vicious downward spiral among depository banks or shadow banks; each bank's failure worsens fears and increases the likelihood that another bank will fail too
Credit Crunch When potential borrowers either can't get credit at all, or must pay very high interest rates; causing them to cut back on spending, pushing the economy into a recession
Debt Overhang Occurs when a vicious circle of deleveraging (process of reducing the level of one's debt by rapidly selling one's assets) leaves a borrower with high debt but diminished assets ( think of the housing crisis, people bought expensive house, now worth a lot less but still have to pay interest of the mortgage )
Keynesian Economics Everyone uses it without knowing; Rests on two main tenets: Changes in aggregate demand affect aggregate output, employment and prices; and changes in business confidence cause the business cycle
Macroeconomic Policy Activism The use of monetary and fiscal policy to smooth out the business cycle
Monetarism Asserts that GDP will grow steadily if the money supply grows steadily
Discretionary Monetary Policy The use of changes in the interest rate or the money supply to stabilize the economy
Monetary Policy Rule A formula that determines the central bank's actions
Velocity of Money The ratio of nominal GDP to the money supply; M * V = P * Y M= Money Supply, V= Velocity, P= aggregate price level, Y= real GDP
Natural Rate Hypothesis Because inflation is eventually embedded into expectations, to avoid accelerating inflation over time the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate
Political Business Cycle Results when politicians use macroeconomic policy to serve political ends
New Classical Macroeconomics Is an approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output
Rational Expectations View that individuals and firms make decisions optimally using all available information
New Keynesian Economics Market imperfections can lead to price stickiness for the economy as a whole
Real Business Cycle Theory Claims that fluctuations in the rate of growth of total factor productivity cause the business cycle
Great Moderation Consensus Combines a belief in monetary policy as the main tool of stabilization, with skepticism toward the use of fiscal policy, and an acknowledgement of the policy constraints imposed by the natural rate of unemployment and the political business cycle
Current Account Or Balance of Payments on Current Account; Balance of payments on goods and services plus net international transfer payments and factor income
Balance of Payments on Goods and Services Difference between a country's exports and imports during a given period
Trade Balance (Merch Trade Balance) Difference between a country's imports and exports of goods
Financial Account (Balance of Payments on Financial Accounts / Capital Account) The difference between a country's sales of assets to foreigners and its purchases of assets from foreigners during a given period
Equilibrium Exchange Rate The rate at which the quantity of a currency demanded in the foreign exchange market is equal to the quantity supplied
Real Exchange Rates Rates adjusted for international differences in aggregate price levels
Purchasing Power Parity The PPP between two countries' currencies is the nominal exchange rate at which a given basket of goods and services would cost the same amount in each country
Exchange Rate Regime; Fixed and Floating Exchange Rate A rule governing policy toward the exchange rate; It is fixed when a government keeps the exchange rate against some other currency at or near a target; It is floating when the government lets the market forces determine the exchange rate
Exchange Market Intervention Government purchases or sales of currency in the foreign exchange market
Foreign Exchange Reserves Stocks of foreign currency that governments maintain to buy their own currency on the foreign exchange market
Foreign Exchange Controls Licensing Systems that limit the right of individuals to buy foreign currency
Social Insurance Government programs intended to protect families against economic hardship
Expansionary Fiscal Policy Increases aggregate demand; - Increase in government purchases of goods and services - Cut in taxes - Increase in government transfers
Lump-Sum Taxes Taxes that don't depend on the taxpayer's income
Automatic Stabilizers Government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands
Discretionary Fiscal Policy Fiscal policy that is the result of deliberate actions by policy makers rather than rule
Cyclically Adjusted Budget Balance An estimate of what the budget balance would be if real GDP were exactly equal to potential output
Fiscal Year Runs from October 11 to Semptember 30 and is labeled according to the calendar year in which it ends
Public Dept Government debt held by individuals and istitutions outside the government
Debt-GDP Ratio The government's debt as a percentage of GDP
Implicit Liabilities Spending promises made by governments that are effectively a dept despite the fact that they are not included in the usual debt statistics
Currency in Circulation Cash held by the public
Checkable Bank Deposits Bank accounts on which people can write checks
Money Supply The total value of financial assets in the economy that are considered money
Money is: A medium of exchange, and a store of value (holding purchasing power over time)
Unit of Account A measure used to set prices and make economic calculations
Commodity (Backed) Money A good used as a medium of exchange that has intrinsic value in other uses; Medium with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods
Fiat Money Medium of exchange whose value derives entirely from its official status as a means of payment (US dollar)
Monetary Aggregate An overall measure of the money supply
Near-Moneys Financial assets that can't be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits
Bank Reserves The currency banks hold in their vaults plus their deposits at the Federal Reserve
T-Account Tool for Analyzing a business's financial position by showing, in a single table, the business's assests and liabilities
Reserve Ratio The fraction of bank deposits that a bank holds as reserves
Bank Run Phenomenon in which many of a bank's depositors try to withdraw their funds due to fears of a bank failure
Deposit Insurance Guarantees that a bank's depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account
Reserve Requirements Rules set by the Federal Reserve that determine the minimum reserve ratio for banks
Discount Window An arrangement in which the Federal Reserve stands ready to lend money to banks in trouble
Excess Reserves A bank's reserves over and above its required reserves
Monetary Base The sum of currency in circulation and bank reserves
Money Multiplier The ratio of the money supply to the monetary base
Central Bank Institution that oversees and regulates the banking system and controls the monetary base
Federal Funds Market Allows banks that fall short of the reserve requirements to borrow funds from banks with excess reserves
Federal Funds Rate The interest rate determined in the federal funds market
Discount Rate Rate of interest the Fed charges on loans to banks
Open Market Operation A purchase or sale of government debt by the Fed
Leverage A financial institution engages in leverage when it finances its investments with borrowed funds
Balance Sheet Effect The reduction in a firm's net worth due to falling asset prices
Vicious Cycle of Deleveraging Takes place when asset sales to cover losses produce negative balance sheet affects on other firms and force creditors to call in their loans, forcing sales of more assets and causing further declines in asset prices
Subprime Lending Lending to home-buyers who don't meet the usual criteria for being able to afford their payments
Securitization A pool of loans is assembled and shares of that pool are sold to investors
Money Demand Curve Shows the relationship between the interest rate and the quantity of money demanded
Liquidity Preference Model of the Interest Rate The interest rate is determined by the supply and demand for money
Money Supply Curve Shows how the quantity of money supplied varies with the interest rate
Taylor Rule for Monetary Policy A rule that sets the federal funds rate according to the level of the inflation rate and either the output gap of the unemployment rate
Inflation Targetting Occurs when the centrabl bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target
Monetary Neutrality Changes in the money supply should not have real effects on the economy
Classical Model of the Price Level The real quantity of money is always at its long-run equilibrium level
Inflation Tax The reduction in the value of money held by the public caused by inflation
Okun's Law The negative relationship between the output gap and cyclical unemployment
Short-Run Phillips Curve The negative short-run relationship between the unemployment rate and the inflation rate
NAIRU Non Accelerating Inflation Rate of Unemployment The unemployment rate at which inflation does not change over time
Long-Run Phillips Curve Shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience
Disinflation The process of bringing down inflation that is embedded in expectations
Debt deflation The reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation
Zero Bound There is a zero bound on the nominal interest rate; it cannot go below zero
Liquidity Trap The economy is in a trap when conventional monetary policy is ineffective because nominal interest rates are up against the zero bound
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