Economics

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Twelve Principles of Economics	1. Scarce resources 2. Opportunity cost 3. Marginal analysis (cost/benefit analysis) 4. Incentives 5. Gains from trade 6. Equilibrium (and transition periods) 7. Efficient allocation 8. Market mechanism and efficiency 9. Government intervention 10. Spending = income (less spending = more income) 11. Too little spending (negatively effects the economy) 12. Government policy (Keynesian economics, taxation, monetary policy, spending)
Models	Simplified representations of reality which allow economists to observe and make test on the economy.
Production Possibility Frontier (PPF)	Maximum quantity of one good which can be produced for any given quantity of the other good How to judge relation between trade-offs and opportunity cost
Law of Diminishing Returns	If you produce more of good A, you will begin to neglect good B; therefore it is less efficient to focus any attention on good B.
Comparative Advantage	David Ricardo It is better to specialize in making a good which you have a low opportunity cost in making, and trade with someone who has a lower opportunity cost in the production of something you need.
Positive vs. Normative Economics	Positive economics: describes how the economy actually functions (think descriptive) Normative economics: describes or offers solutions to how an economy should be or should work (think prescriptive)
Supply and Demand (extreme basics)	As prices fall, demand increases Prices of supply rise with demand
Equilibrium (Supply & Demand)	Intersection between the supply and demand curves Market usually finds this point organically, but if not sometimes government intervenes (Keynesian economics)
Competitive Market	Based on supply and demand Demand dictates which goods and services the consumers want/would pay money for Supply shifts to meet demand and adjusts costs accordingly Assumes perfect competition
Demand Curve	Goes from the top left of the graph to bottom right with a negative correlation Prices high, low demand. Prices low, high demand.
Ceteris Paribus	A way of keeping variables static in order to test one aspect of the economy. Literally, "all things remaining equal" (Though it is hardly ever true and possibly simplifying way too much)
Shift in Demand Curve	Rightward shift: greater demand Leftward shift: fall in demand Can be caused by price changes, income changes, change in taste or expectations, change in consumer population.
Normal Goods	Goods which respond normally to the logic of the market mechanism
Inferior Goods	Goods which gain negative social associations; sometimes from being "cheap", and so it becomes less popular
Substitutes	Goods which have a desirable alternative which will replace the brand-name or most popular good sufficiently and much more cheaply. Examples: "knock-off" brand names, or ebooks replacing real books
Complementary Goods	Goods which require a second good to go with it; must go along with each other. Example: petrol and a car
Supply Curve	Supply curve on a graph runs from the bottom left to the top right, with a positive correlation. Price down, supply up. Price up, supply down.
Shift in Supply Curve	Leftward shift: fall in supply Rightward shift: increase in supply Caused by change in price of inputs (resources needed to produce the good), change in price of related/complementary goods, technological progress, change in expectations and change in producer population.
Trial and Error	A way of finding equilibrium, according to market mechanism. A supplier tries out a price, and if no one buys or too many people buy it, they adjust the price accordingly until equilibrium is met.
Equilibrium Adjustment (Surplus and Shortage)	Equilibrium adjusts in different situations in order to restore equilibrium. Surplus situation of supply: price goes down, demand comes up Shortage situation of supply: prices goes up, demand goes down Creates a new equilibrium position
Invisible Hand of the Market	Adam Smith's idea that the market mechanism is self regulating and will keep supply and demand at equilibrium organically He believed that government intervention distorts the market mechanism
Price Ceiling	Government policy where there is a maximum price that a seller is allowed to charge for a good or service (pushes the price down)
Price Floor	Government policy where there is a minimum which a seller can charge for goods or services; minimum price a buyer is required to pay. Pushes prices up above equilibrium
Consequences of Price Ceilings	1. Inefficiently low quantity 2. Inefficient allocation to customers (the people who want/need the good can't necessarily get it) 3. Wasted resources 4. Inefficiently low quality; inferior products produced by sellers, even though demand might allow for a higher quality product 5. Rise of black market goods
Consequences of Price Floors	1. Inefficiently low quantity 2. Inefficient allocation of sales among sellers 3. Wasted resources 4. Inefficiently high quality (sellers might play with quality in order to sell at a higher price, even though many buyers would be willing to pay less for a worse product) 5. Rise in black market goods (below price floor)
Binding or Non-binding	If the price ceiling is set above the market equilibrium, it is non-binding (doesn't affect the market) If the price ceiling is set below the market equilibrium it is binding (it will affect the "natural" market)
Quota	Upper limit on a good which can be bought/sold, or a lower limit on a good which must be bought/sold. Sometimes there is a necessity of a license (the limited right to sell a good or service)
Quota Rent	Term given to government policies which drive a wedge between the demand price and the supply price (even if there are customers who would be willing to pay more, or suppliers who are willing to sell for less)
Minimum Wage Debate (against and for)	Against minimum wage: causes unemployment, causes inflation, discourages further education, promotes under-the-table work (black market) For minimum wage: promotes equity, prevents exploitation, stimulates consumption, increases work ethic, incentive for joining the work force
Gains from Trade	Suggests that if two economies trade goods and specialize, they can focus on the good in which they have a comparative advantage in producing
Asian Miracle (According to Paul Krugman)	Highly Performing Asian Economies (HPAE) have had unique growth (and equity) where the middle class benefits and not just the elites. (Japan, Malaysia, Thailand, Indonesia) Krugman thinks: climate, technology, labour/capital/resources, culture, "perspiration rather than inspiration"
Heckscher-Ohlin Factor	"A model of international trade in which a country has a comparative advantage in a good whose production is intensive in the factors that are abundantly available in that country" (Krugman glossary)
Leontief and Prebisch (3 concepts)	1. Importance of human capital 2. Manufactured goods more important than agricultural goods (because they have long term higher value in the market) 3. Rates of exchange will change over time depending on what goods you are producing
World Market (Domestic vs. World Prices)	When the world price is lower than the domestic price, then import (at a lower price, consumer gain > producer loss) When the world price is higher than domestic price, then export (at a higher price, producer gain > consumer loss)
Four Types of Globalization	1. Thin globalization: lateral, extensity, such as the silk trade in the 13th century 2. Expansive: extensity, impact, such as the Dutch East Indies Company 17th century 3. Diffuse: extensity, intensity, velocity 4. Thick: extensity, intensity, velocity, impact; today's globalization
Macroeconomics	Concerns overarching demand, supply, trends (not individual circumstances), policies Key terms: fiscal policy (government spending/taxes), monetary policy (controlling money supply, regulation)
Microeconomics	Focuses on the individual, particular business models, and investment decisions
4 Business Cycle Theories	1. Seasonal: within one year 2. Short-run: 2-3 years, most commonly used to study trends 3. Medium term (Juglar theory): 7-11 years, which is the distance between economic "peaks" 4. Long-run: >11 years, long-term development of the economy
Business Cycle Theory	Recession - expansion - recession again High demand and low supply makes producers strive to supply more until there is a surplus, and supply goes past the point of demand, and so a return to recession. Time-lag between investment and expansion/growth
Cobweb Model	Nicholas Kaldor (1908-1986) Business cycle circles the equilibrium price on a supply and demand graph, in attempts to get to equilibrium. Looks like a cobweb because of the shape made if you graph where supply and demand is around equilibrium
Consequences of The Great Depression	Major worldwide depression of the 1930's Made the government realized they really knew nothing about the economy and would need to find ways to intervene with the economy Made countries realize the need to cooperate internationally, because if every country worked based off self-interest, the depression would get worse (avoid protectionist policies)
The Great Depression	"Black Monday" Wall Street stock market crashed (Oct 28, 1929) Depreciation of currencies (especially pounds and American dollars) High unemployment Lasted 43 months
Say's Law	Each supply creates it's own demand
National Accounts	Developed during the Great Depression (1937) by Simon Kuznets Large data sets which record information in an economy (consumer spending, sales, investments, etc) Used to assess how the economy is performing Indicates economic development/growth Can be used to compare input/output of countries
Stocks	A share in the ownership of a company held by a shareholder
Dividends	Payment from corporation to shareholders (distribution or DIVIDE(nd) of profits)
Bond	Borrowing in the form of an IOU which pays interest (earn income from interest of investment)
Government Transfer	Payments made by the government to individuals for which no good or service is provided/available Often in the form of social insurance or tax benefits (subsidies, health care insurance, unemployment insurance)
Disposable Income	Total household income (minus taxes) which is available for consuming or saving (choice of individual)
Private Savings	Disposable income minus consumer spending
Exports and Imports	Exports: goods and services sold to other countries Imports: goods and services purchased from other countries
Inventories	Stock of goods and/or raw materials (input materials)
Investment Spending	Spending on physical capital (infrastructure, machinery) and on changes to inventories
Gross Domestic Product (GDP)	All official cash transactions which happen within the borders of an economy (country) Included in GDP: domestically produced goods and services, capital goods, new infrastructure and changes to inventory. GDP = consumer spending + investment spending + government purchases + sales to foreigners - import
Real GDP	Total value of goods and services each year; calculated using prices from a selected base year (for comparison)
Nominal GDP	Value of all final goods and services produced in the economy in given year; calculated using current prices of the year being studied (therefore affected by things like inflation)
Unemployment Rate	The percent of the total amount of people in the labour force who are unemployed Indicates how easy/hard it is to find a job Indicates how a country is doing economically Can either overstate or understate the true level of unemployment
Labour Force	All possible workers, aged 16+, who either have a job (employed) or are actively in the job search (unemployed)
Natural Unemployment (2 Types) and causes	Frictional Unemployment: Unemployment due to the time the worker spends in the job search (between jobs, school, etc) Cyclical Unemployment: What happens when the state of the economy is out of the control of the individual worker (recession, depression, etc) and are therefore unable to work Causes: changes in characteristics of labour force (demographics), change in labour market institutions (unions, temp agencies, new technology), change in government policies
Unnatural Unemployment (1 type) and causes	Structural Unemployment: more people are seeking jobs in a particular labour market than there are jobs available (at current minimum wage); even when the economy is at the peak of the business cycle Technological change can cause structural unemployment (technology replaces worker, or technology requires worker to be come more skilled) More job seekers than jobs Causes: minimum wage, labour unions, efficiency wages (incentives), government policies, skills mismatch
Discouraged Workers	Non-workers who have given up because they have experienced such difficulty finding a job (in the past 4 weeks)
Marginally Attached Workers	Possible workers who were available and looking for work but stopped (in the past year, but NOT in past 4 weeks)
Underemployed Workers	Workers who have a job, but it is not what they are trained for. Workers who work part time because they cannot find full time work (even though they would prefer it)
Jobless Recovery	Period where the real GDP is growing, but unemployment rate is still rising (as opposed to going down, as it should)
Inflation (External and Internal Factors)	Sustained increases in prices; usually it goes up but sometimes it goes down, like when technological advancements allow for cheaper production External factors example: agriculture prices increase due to poor harvest internationally Internal factores example: rising business costs
Cost-Push Inflation	Goods and services become more costly because of the price of an input good Example: Price oil rises which cause airline ticket prices rise
Demand-Pull Inflation	Strong demand pushes prices up Example: during holidays air line ticket prices rise because of the high demand
Inflation Rate	Yearly percentage change in inflation (usually based on the consumer price index)
Consumer Price Index (CPI)	Most common measurement of total price level; measures cost of the market based on a typical family (based on a "basket of goods")
Aggregate Price Level	Measure of overall prices in an economy, based on the market basket (hypothetical set of consumer purchases)
Price Index	Cost of purchasing basket of goods in a given year. Cost is normalized so that it is equal to 100 in selected base year
Interest Rate	Price (% of amount borrowed) which a lender charges for the use of savings for one year (cost of borrowing)
Nominal and Real Interest Rates	Nominal interest rate: interest rate expressed in dollars Real interest rate: nominal interest rate minus rate of inflation
Disinflation	The process the government uses in order to actively bring down inflation (often if the inflation rate is above 2-3%) Difficult to bring down, but sometimes necessary because high inflation can cause unemployment
Commodity Money	Original principle of money; based on the standard value for the material it was made of (usually silver, copper or gold); still stood for "value" the way ours does today
Fiat Money	When the value of money is agreed upon (the way it is today) Example: when we see a $50 bill, we get excited not because the physical bill is worth a lot but because we have agreed that it is worth a lot
Money Supply (3 types)	Total value of financial assets is considered to be money supply M1: Narrow money (all cash and easily convertable assets) M2: M1 + short-run deposits (debit, credit, ATM) M3: M1 + M2 + long-run deposits (secondary shares, stocks)
Banking	Takes deposits of money from consumers and puts that money into investments
Bank Reserves	Bank reserves is the money held back from investment in order to be available for withdrawls - never the full amount which has been deposited, based on the assumption that everyone wont want all their money at once
Reserve Ratio	The prescribed amount the bank must hold back from investment in order to have money available for withdrawls. Decided by organizers, and never the equal amounts of cash/deposits
Bank Runs	This happens when everyone removes all their money from banks, often at times of crisis (depressions/recessions) Can be extremely dangerous for banks
Gold Standard (Monetary System)	Existed between 1878-1936 Meant that money supply = gold reserve Collapsed after the Great Depression
Bretton Woods Monetary System	Designed in 1944 as a new economic system; implemented in 1946 Modelled after ideas of John Maynard Keynes Stabilized gold standard based on the US dollar
Current Monetary System (no real name)	Implemented after the Bretton Woods system, and involves variable exchange rates, which are less stable but more accurate The first truly worldwide system; offers opportunities for regional agreements (such as the EuroZone)
EuroZone	Economic system developed at the Treaty of Maastricht (1999/2002) Incorporated strict criteria: maximum government deficit of 3%, debt and GDP max of 60%, etc Not all European Countries are in the EuroZone
Washington Consensus	International ideology concerning bank systems was agreed upon and incorporated: The World Bank Ideology contained the so-called "10 Commandments" (such as market mechanism, free international trade, privatization, etc)
10 Commandments (Washington Consensus)	1. Fiscal policy discipline 2. Pro-growth public spending 3. Tax reform (less tax for the rich) 4. Market interest rate 5. Competitive exchange rates 6. Trade liberalization 7. FDI liberalization 8. Privatization 9. Deregulation 10. Property Right Security
Monetary Policy according to Milton Friedman (key terms)	Pro-market mechanism, anti-government spending Against the Keynesian economics and Bretton Woods system Neo-liberalism: Reagan & Thatcher Expansionary & Contractionary monetary policy
Expansionary Monetary Policy	Country should increase money supply, in order to lower interest rates and allow the market mechanism to take over Involves higher consumer spending
Contractionary Monetary Policy	Country should reduce money supply, allowing higher interest rates to limit the market mechanism This worked in China, but there it is risky because it can cause spike in inflation
Subprime Crisis (key points)	The US promoted home ownership, and banks gave out too many loans without enough checks to make sure the people receiving the loans could pay back. In 2007, house prices began to fall and people could not pay off their mortgages. Some blame the use of a bad economic model
Rule of 70	Small improvements in growth rates which get magnified over time (power of compounding) 70 / % growth rate = doubling time for a variable Example: if real GDP/capita is growing at an annual rate of 3.5%, how fast will it double? 70 / 3.5 = 20 years
Convergence Hypothesis	International differences in real GDP/ capita tend to narrow over time
Aggregate Production Function	Hypothetical function which shows how productivity (real GDP per worker) depends on quantity of physical capital per worker, human capital per worker and state of technology
Total Factor Productivity (TFP)	The amount of output that can be produced with a given amount of factor input When TFP increases, the economy can produce more output with the same quantity of physical capital, human capital and labour
Information Technology Paradox	Robert Solow New technology does not yield full potential if it used in old ways Productivity only takes off when people change their way of doing business in order to take advantage of new technology
Thomas Malthus (Malthusian Trap)	Malthus feared the dangers of population growth, and was pessimistic about the future. He believed that as the population grew, limited resources (mainly food) would cause widespread famine and disease, and so keep populations in check. He discounted arguments in favour of technological advancements by saying that they only delay the inevitable.
Sustainable Long-Run Economic Growth	Long-run economic growth which can continue in the face of our finite planet (limited supplies of resources + limited ability to absorb environmental damage)
Deficit	When a governments budget revenue is less than its expenditures More money leaving the country than entering
Savings-Investment Identity	Accounting fact which states that savings and investment spending are always equal for the economy as a whole
Asset Price Theory	Traditional theory concerning rational considerations and expectations; assuming efficient market and free market mechanism
Loss Situation (Illiquidity & Insolvency)	Illiquidity: don't have the money, but you can pay off debt immediately if you get some Insolvency: can't handle the debt in the long-run; this is the step before bankruptcy
Financial Market	Similar to the commodity market, but instead of supply you have loans (which can be shaped by the government), and instead of demand you have the perception of investment opportunities
Recession vs Depression	Recession: consecutive quarters with negative growth in GDP Depression: sustained recession
Aggregate Demand	Aggregate output demanded by households, firms, the government, and the rest of the world.
Wealth Effect	As prices rise, purchasing power decreases (more money is needed to buy the same things) Spending then goes down because people can't afford to spend
Interest Rate Effect	Middle classes save more and so are more worried about inflation If savings worth goes down, then interest rates increase So as they see inflation rising, they may start saving more
Aggregate Demand Shift	Increase of aggregate demand sees shift to the right: people feel optimistic, they go out and spend more, and equilibrium is reestablished Decrease of aggregate demand sees a shift to the left: people become pessimistic and tend to save rather than spend
Short-Run Aggregate Supply Curve	Aggregate price level and aggregate output supplied in the short run "Short-run" because production costs can be assumed to be fixed.
Short-Run Aggregate Supply Shift	Shift to the right of the short-run aggregate supply curve: prices, fall, income increases, nominal wages go down, sometimes productivity increases Shift to the left of the SRAS curve: decreased income, higher prices, lower productivity
Long-run Aggregate Supply Curve	Similar to the short-run aggregate supply curve, but not effected by short-run factors, but by long-term economic growth determinants
Recessionary and Inflationary Gaps	Recessionary: when actual output < potential output Inflationary Gap: when the potential output < actual output
T-Account	"A simple tool that summarizes a business's financial position by showing, in a single table, the business's assets and liabilities, with assets on the left and liabilities on the right." (Krugman glossary)
Embedded Liberalism	Requires open trade market system and that individual countries have autonomy in order to make economic decisions within that countries Part of the "Bretton Woods Era"
Post-Bretton Woods (Neoliberalism)	Reaganism & Thatcherism: anti-government spending Return to the idea that a market economy would fix its own problems and establish equilibrium (invisible hand, self-regularity) Washington Consensus 10 Commandments "Trickle-down economics"
Fiscal Policy	The use of taxes, government transfers/purchases in order to shift the aggregate demand curve Can be expansionary or contractionary
Social Insurance Programs	Government programs (transfer payments) intended to protect families against economic hardship (such as health insurance, social insurance, unemployment insurance)
Expansionary Fiscal Policy	Policies intended to increase aggregate demand Create fuel for economy in order to close the recessionary gap Implemented by government policies, government transfers: infusing government money into the economy
Contractionary Fiscal Policy	Policies intended to reduce aggregate demand Closes inflationary gap by reducing government spending (or implementing higher taxes) and reducing government transfers Brings economy back down to equilibrium
Multiplier Effect	The multiplier magnifies new spending into greater levels of income and output because each round of spending becomes income for someone else (GDP counted separately each time the same money changes hands)
Multiplier	Ratio of the change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change
Types of Fiscal Policy (name the 2)	1. Automatic Stabilizer 2. Discretionary Fiscal Policy
Automatic Stabilizer	Government spending and taxation rules which cause fiscal policy to be automatically expansionary when the economy contracts, and automatically contractionary when the economy expands
Discretionary Fiscal Policy	Fiscal policy which is the result of deliberate actions by policy makers Example: Obama stimulus
Budget Balance (and Surplus/Deficit)	Balanced budget: Government saving = tax revenues - government purchases - government transfers When there is a positive budget balance, there is a surplus (need for contractionary fiscal policy) When there is a negative budget balance, there is a deficit (need for expansionary fiscal policy)
Deficit vs Debt	Deficit: difference between the amount the government spends and the amount it receives over a given period Debt: sum owed by the government at a particular time *Related but not the same and they tell different stories
Implicit Liabilities	Spending promises made by governments which are effectively a debt, despite the fact that they are not included in usual debt statistics Example: pensions (as a promise of future payment)
Debt GDP Ratio	Measures the "health" of an economy Indicates potential taxes which governments could collect Dependant on increase or decrease of debt + GDP
Capital Flows	Capital flowing from one country to another
Balance of Payments	Sources of cash - uses of cash = net money Goal: net money at least balances out (otherwise there could be a deficit or surplus) For international transactions: Payments from foreigners - payments to foreigners = net money
Balance of Payments on Current Account	Transactions which don't create liabilities Current account = country's balance of payments on goods and services + net international transfer payments + factor income
Balance of Payments on Goods and Services	Difference between exports and imports in a given period
Merchandise Trade Balance	Difference between a country's exports and imports of goods; doesn't include services
Balance of Payments on Financial Account	Difference between sales of assets to foreigners and purchases of assets from foreigners during a given period
Gross National Product (GNP)	GDP + international factor income (money made abroad)
International Capital Flows	Capital flows from countries with more savings than their borrowers want, so they loan to the country where savings is less than what borrowers want Determined by political stability, growth rate
Exchange Rate	Prices at which currencies are traded in the foreign exchange market Can either appreciate or depreciate
Foreign Exchange Market	Based on international supply and demand (for US $) Based on exchange rates Equilibrium exchange rate shifts as supply/demand shifts
Real vs Nominal Exchange Rates	Real exchange rate: exchange rate adjusted for international difference in aggregate price levels Nominal exchange rate: the price of a currency as a value of a number of units of another currency
Purchasing Power Parity (PPP)	Economic theory that estimates exchange rate adjustments requried for the exchange to be equal to each currency's purchasing power Often based on the cost of "basket of goods" where the cost would be the sam in both countries being compared Example: Big Mac Index
Exchange Rate Policy (Fixed or Floating)	Governing policy for the exchange rates Fixed exchange rate: rate which is held at or near a particular target against some other currency (often US $) Floating exchange rate: rate which is allowed to fluctuate with the market
Exchange Market Intervention	Government buys or sells currency in the foreign exchange market IF a country wants to fix its exchange rate above equilibrium, it buys another currency and sells its own IF a country wants to fix its exchange rate below equilibrium, it must sell another currency and buy back its own
Foreign Exchange Reserve	Governments maintain stocks of foreign currency to buy their own currency on the foreign exchange market
International Business Cycle	One country's imports are another country's exports: creates a link between business cycles in different countries Floating exchange rates may weaken that link

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