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72 Cards in this Set

  • Front
  • Back
The study of markets
The economic problem
figuring out how to satisfy unlimitted wants with limitted resources
one of the four factors of production
earns rent
one of the four factors of production
earns wages
one of the four factors of production
earns interest
one of the four factors of production
earn profits
things that have tangible substance
goods that have an economic life greater than or equal to 3 years
goods that have an economic life of less than 3 years
intangibles (health care, transportation, etc.)
Ceteris paribus
Assumption of "all else being equal"
Pitfalls of Economic Analysis
Correlation and Causality
Other Conditions Fallacy
Fallacy of Composition
Law of Unintended Consequences/Ignoring Secondary Effects
Correlation and Causality
causality implies correlation
correlation DOES NOT imply causality
Spurious correlation
two variables have correlation, but there isn't causality
(i.e. there is a 79% correlation that if an NFC team or old AFC team wins the superbowl, then the stock market increases)
Other conditions fallacy
"what happened in the past will happen in the future"
-->yes, but only if all other conditions stay the same, which is rare, and almost impossible to measure
Fallacy of composition
if you (wrongly) say that what is true of part is true of the whole (this is why we need large sample sizes)
Law of unintended consequences/Ignoring secondary effects
When government policy, designed to achieve a certain goal, yields unintended side effects
i.e. Alcohol prohibition (people were poisoned; crime rate increased)
Aggregate demand
total spending on final goods and services
AD = C + I + G + Net X
What do households spend money on?
C - Consumption spending
What do business firms spend money on?
I - Investment spending
-->firms spending on new plants/structures/buildings; new equipment/machinery; new residential structures; change in inventories
What does the government spend money on?
G - Government spending on goods and services
Net exports
= (Exports) - (Imports)
Measure of economic output
5 factors that influence home production vs. buying from a firm
1. specialization/skills needed
2. opportunity cost
3. avoiding taxes
4. technological advancements
5. reduction of transaction costs
Economic functions of the government
1. establish & enforce "rules of the game"
2. promote employment
3. regulate natural monopolies
4. provide public goods
5. deal with externalities
6. promote equal income distribution
natural monopolies
a case wehre it makes sense to have one producer because there are very high fixed costs
public goods
goods where consumption by one person doesn't diminish the amount available for others
(lighthouses, parks, national defense)
free riders
people who consume but don't pay

solution: government provides public goods and taxes everyone
when there is a social cost > production cost
graduated/progressive income tax
the more you make, the higher your taxes
Marginal tax rate
tax rate on one more $ of income
average tax rate
(taxes paid)/(income)
flat tax
constant marginal tax rate regardless of income
regressive tax
marginal tax rate decreases as income increases
gross domestic product;
output of all final goods and services produced in United States
flow variable
a variable measured over a period of time ("per year")
i.e. GDP, wage rate
stock variable
a variable measured at a point in time
i.e. money holdings, money supply, capital stock
budget deficit
(federal outlays/year) - (federal revenue/year)
= new federal borrowing per year
(flow variable)
federal debt
the total value of all federal borrowing (how much debt the government owes)
= how much debt the government owes
(stock variable)
price level
average price of final goods and services
real GDP
the quantity of final goods and services produced
why does aggregate demand slope down?
1. a decrease in price level, leads to an increase in money holdings, which leads to an increase in comsumption spending

2. as the price level goes down, exports increase, and imports decrease. --> net exports increases. As net exports increase, aggregate demand increases. THEREFORE, as P decreases, Net X increases, and Aggregate demand increases
what shifts aggregate demand?
1. a change in consumer optimism

2. change in wealth

3. change in government spending
explicit labor contract
legally binding
type held by labor unions
implicit labor contract
not legally binding
sets the wage rate (usually) for one year
Profit margin
= (profit per unit) - (cost per unit)
Why does aggregate supply slope up?
as P increases, the profit margin increases. therefore, firms produce more output, which leads to an increase in Real GDP (Y)
increase in P leads to increase in Y --> upward sloping
Leftward shift of aggregate supply:
businesses are willing to produce the same amount of goods but they are charging a higher price
this is a result of higher input costs
Rightward shift of aggregate supply:
this means businesses are willing to produce the same amount of goods for a lower price
this is a result of lower input costs
If there is excess supply, then there is a tendency for price to...
If there is excess demand, then there is a tendency for price to...
supply-side recession
you're paying higher prices for lower output (result of an increase in input costs)
what is wrong with using the percent change in real GDP to measure economic growth?
real GDP does not adjust for population changes.
solution--compute percent change in real GDP per capita
what is the preferred measure of economic growth?
(percent change in real GDP) / (number of hours)
= labor productivity growth
Rule of 72
72 / (average annual growth rate %) = number of years for series to double
what causes economic growth?
Y = Real GDP = output
K = capital stock = stock of buildings/machinery
L = labor input = # of hours worked
A = state of technology

Y = (A) x f(K, L)
Labor productivty
= output per worker
= Y/L
= (Real GDP)/(# of hours worked)
Equation for labor productivity growth
Labor productivity growth = (rate of technological advancement) + (.25)(growth of capital per worker)

(Percent change in Y/L) = (Percent change in A) + (.25)(Percent change in (K/L))
What 2 factors does labor productivity growth depend on?
1. technological advancement
2. growth of capital per worker
What is needed to facilitate technological advancement (5 factors)
1. patent law
2. property law
3. educated population
4. receptive to change
5. government funding
How does the government promote savings, and therefore the growth of capital per worker?
1. reducing tax rates on taxable income

2. tax deferred accounts (401k, Roth IRA)
Why can immigrants cost the border and experience a extreme increase in standard of living?
the opportunity costs for people in a rich country is much higher.

capital & technology
Nominal GDP
= value of GDP @ current year prices

= (each year's output) x (that year's prices)
Real GDP
= each year's output @ base year's prices

= (each year's output) x (base year's prices)
Price Index
"GDP Deflator"
measures the average price of final goods and services

= (Nominal GDP)/(Real GDP)

Price Index = 1.28
--> The average price of cars and wheat increased 28% from 2007 (base year) to 2009 (current year)
Why do we use nominal GDP?
to calculate price index
Consumer Price Index
measures the cost of living

= (Cost in year x) / (Cost in base year) = CPI in year x

**use a constant, fixed quantity, but the price of a base year
Why was the 1920s such a good time economically?
Aggregate supply was shifting rightward because of technology, which led to lower prices and higher output
What were the two economic problems developing in the late 1920s
1. distribution of income and wealth--gap was widening

2. stock market boom--created a speculative bubble
Greater fool theory
Keynes - people will pay too much if you think there's a greater fool than you willing to pay even more
Why did the federal reserve increase increase interest rates?
to kill off stock market rally--they thought banks were feeding the speculative bubble by providing loans to brokers
what factors influence the slope of aggregate supply?
profit margin
(input costs)
what factors influence the slope of aggregate supply?
profit margin
(input costs)