Term
| The long run average cost (LRAC) curve illustrates the relationship between |
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Definition
The long run average cost (LRAC) curve illustrates the relationship between the lowest attainable average total cost and output when all factors of production are variable.
The LRAC curve is also known as a planning curve because it shows the expected per-unit cost of producing
various levels of output using different combinations of factors of production. |
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Term
| Total Product, Marginal Product and Average Product |
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Definition
Total product (TP) is the maximum output that a given quantity of labor can produce when working with a given quantity of capital units.
• Marginal product (MP) is the increase in total product brought about by hiring one more unit of labor, while holding quantities of all other factors of production constant.
• Average product (AP) equals total product of labor divided by the quantity of labor units employed.
1. MP intersects AP from above through the maximum point of AP.
2. When MP is above AP, AP rises, and when MP is below AP, AP falls. |
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Term
OLIGOPOLIES
Kinked Demand Curve Model |
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Definition
The kinked demand curve model assumes that if a firm operating in an oligopoly increases its price, others will not follow suit and the firm will suffer a large decrease in quantity
demanded (elastic demand).
However, if the firm were to reduce its price, competitors would follow its lead, and the increase in quantity demanded for the firm would not be significant (inelastic demand).
These two contrasting shapes of the demand curve i.e., relatively elastic
above current prices, and relatively inelastic below current prices, results in a kink in the firm’s demand curve and a break in its marginal revenue curve.
It would take a significant change in cost of production (one that forces the MC curve to shift outside the range between Point A and B) to change the firm’s profit maximizing output level. |
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Term
| Compare and contrast monopolistic competition and perfect competition. |
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Definition
A firm in monopolistic competition generally produces lower output and charges a higher price than a firm in perfect competition.
The outcome is not allocatively efficient. |
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Term
| Monopolistic competition is characterized by: |
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Definition
A large number of firms.
Product differentiation.
Firms competing on quality, price and marketing.
Low barriers to entry and exit.
-- While they may be able to
earn economic profits in the short run, firms in monopolistic competition only make normal profits in the long run. |
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Term
| Total product (TP) is the |
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Definition
maximum output that a given quantity of labor can produce while working with a fixed quantity of capital.
All points on the TP curve are technologically efficient.
Initially TP increases at an increasing rate and then only increases at a decreasing rate. |
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Term
| Marginal product (MP) is the |
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Definition
increase in total product brought about by hiring one more unit of labor, while holding quantities of all other factors of production constant.
MP is the slope of the TP curve.
It rises initially as the firm benefits from increasing marginal returns (due to specialization and division of labor).
Later however, MP falls as a result of diminishing marginal returns (due to inefficiency and over- crowdedness). |
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Term
| In order to increase wages for their members, unions can |
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Definition
.Restrict the supply of labor: While this will successfully increase wages for union members, it will also have the undesirable effect of reducing the quantity of labor employed.
• Reduce the elasticity of demand for labor: While this step does not eliminate the tradeoff between wage rates and employment levels, it does reduce the size of this tradeoff.
• Increase the demand for labor: This can be achieved by:
o Increasing the marginal product of union members
o Encouraging import restrictions.
o Supporting minimum wage laws.
o Supporting immigration restrictions.
o Increasing demand for goods produced by unionized workers. |
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Term
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Definition
An efficiency wage is an above-market wage rate that a firm pays employees to attract the most productive workers.
A firm will set the efficient wage at the level where the marginal increase in productivity from the higher wage equals the marginal cost of the higher wage. |
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Term
| Price elasticity demand's range. |
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Definition
Ep = 1 --> unit elastic
If quantity demanded does not change at all in response to a change in price, the numerator of the elasticity formula will be zero, and the calculated value of price elasticity will also be zero. This is known as perfectly inelastic demand. Ep = 0 (vertical line)
If quantity demanded changes by an infinitely large percentage in response to even the slightest change in price, the denominator in the elasticity formula will be close to zero (effectively zero), and the calculated value of price elasticity will be infinity. This is known as perfectly elastic demand. Ep = infinity (horizontal line)
0 < Ep < 1 --> Relatively inelastic
Ep > 1 --> Relatively elastic |
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Term
| Factors That Effect Price Elasticity of Demand. |
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Definition
Availability of Close Substitutes: If a consumer can easily switch away from a good, her ability to respond to a price increase (by reducing consumption of the good) is high, and demand for that product is relatively elastic.
Proportion of Income Spent on the Good: If a relatively small proportion of a consumer’s income is spent on a good (e.g. soap), she will not significantly cut down on consumption if prices increase.
However, if consumption of the good takes up a larger proportion of her income, (e.g. automobiles) she might be forced to reduce quantity demanded significantly when the price of the good increases.
Time Elapsed Since Price Change: The longer the time that has elapsed since the price change, the more elastic demand will be. |
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Term
| Cross Elasticity of Demand |
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Definition
Cross elasticity of demand measures the responsiveness of demand for a particular good to a change in price of another good.
Substitutes:
A high value indicates that the products are very close substitutes. Formula head in the same direction. Therefore cross elasticity of demand for substitutes is positive.
Complements:
A high absolute number indicates very close complements.
If the price of one rises, consumers will significantly reduce their demand for the other.
For complements, the numerator and denominator of the cross elasticity formula head in opposite directions. Therefore, the cross elasticity of demand for complements is negative. |
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Term
Income Elasticity of Demand
Normal good
Inferior good
Necessity |
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Definition
Income elasticity measures the responsiveness of demand for a particular good to a change in income.
EI > 1 --> Normal good (income elastic) Luxury goods
As income rises, the percentage increase in demand exceeds the percentage change in income.
As income increases, a consumer spends a higher proportion of her income on the product.
0 < EI < 1 --> Normal good (income inelastic) Necessities
As income rises, the percentage increase in demand is less than the percentage increase in income.
As income increases, a consumer spends a lower proportion of her income on the product.
EI < 0 --> Inferior good
As income rises, there is a negative change in demand.
The amount spent on the good decreases as income rises. |
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Term
Elasticity of Supply
Factors That Effect Elasticity of Supply |
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Definition
The price elasticity of supply measures the sensitivity of quantity supplied to changes in price.
Factors:
Availability of Substitute Resources:
If the resources required to produce a good are easily available, or if these resources can easily be substituted in the production process, elasticity of supply for the product will be high.
Time Frame for Supply Decision
There are three time frames for the supply decision:
1. The momentary supply curve shows the response of quantity supplied immediately following a price change.
2. The short run supply curve illustrates the response of quantity supplied to a price change when only some of the technologically possible production advances have been made (e.g. hiring or laying off labor).
3. The long run supply curve shows the response of quantity supplied to a change in price after all technological advances in production have been embraced.
With a longer time frame, price elasticity of supply will be higher (more elastic). |
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Term
| Does elasticity of demand rise or fall as we move down a straight line demand curve? |
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Definition
Price elasticity decreases as we move down a straight-line demand curve.
A high price elasticity means that quantity demanded is very responsive to changes in price, and a low elasticity means that quantity demanded is not very responsive to changes in price.
The responsiveness of quantity demanded to changes in price decreases as we move down a straight line demand curve. |
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Term
| Total Revenue and Price Elasticity |
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Definition
If demand is relatively elastic, TR will increase.
If demand is relatively in-elastic, TR will decrease.
If demand is unit elastic, TR will not change.
• If the price cut increases total revenue, demand is relatively elastic.
• If the price cut decreases total revenue, demand is relatively inelastic.
• If the price cut does not change total revenue, demand is unit elastic. |
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Term
Consumer Surplus
Producer Surplus |
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Definition
Consumer surplus occurs when a consumer is able to purchase a good or service for less than the maximum she is willing and able to pay for it.
It equals the difference between the price that consumers are willing and able to pay for a good (indicated by the demand curve) and what they actually pay for the good (the market price).
Producer surplus occurs when a supplier is able to sell a good or service for more than the price that she is willing and able to sell it for.
It equals the difference between the market price and the price at which producers are willing and able to sell their product (indicated by the supply curve). |
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Term
| fairness principle (utilitarianism and the symmetry principle) |
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Definition
utilitarianism -
It is not fair if the results are not fair.
the maximum benefit accrues to the maximum number of people when wealth is transferred from the rich to the poor, until absolute equality is achieved.
Weakness:
Wealth is transferred from the rich to the poor through progressive taxes--> results in a disincentive to work, so less labor is supplied in the economy.
Further, taxes on capital income reduce savings, which results in a lower than efficient quantity of capital being utilized.
The reduction in the quantity of labor and capital reduces the total size of the economy.
The second source of inefficiency associated with wealth transfers are the administrative costs involved. Administrative costs include the costs of collecting taxes and the costs incurred by taxpayers to get their returns audited
symmetry principle -
It is not fair if the rules are not fair. People in similar situations should be treated similarly
An unequal distribution of income in the economy will be tolerable as long as everyone has an equal opportunity to earn a higher income through hard work and perseverance.
fairness requires that:
• The government must establish and protect private property rights.
• Private property can be transferred between individuals only through voluntary exchange.
The symmetry principal advocates that everything that holds value in society should be owned by individuals and it is the government’s responsibility to protect private property by enforcing relevant laws |
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Term
| The impact of taxes on supply, demand, and market equilibrium |
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Definition
An imposition of a tax on buyers reduces demand, while an imposition on producers reduces supply.
• Actual tax burden does not depend on whom the tax is imposed upon.
• If the demand curve is more inelastic, consumers will actually bear a greater burden of the tax in the form of a reduction in consumer surplus.
• If the supply curve is more inelastic, producers will actually bear a greater burden of the tax in the form of a reduction in producer surplus.
• The more inelastic the demand and supply curves, the lower the total dead weight loss to society from tax imposition, and greater the tax revenue for the government. |
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Term
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Definition
• An increase in realized prices for producers.
• An increase in output.
• A decrease in prices paid by consumers.
• Dead weight losses from overproduction. |
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Term
| Production quotas result in: |
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Definition
• Production quotas limit the production of a good in an economy in order to raise
realized prices for producers.
• They result in inefficiency because at the quantity corresponding to the quota (q ), MB exceeds MC, resulting in a dead weight loss due to underproduction. |
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Term
| Illegal Goods: Effect of the penalty on suppliers and consumers |
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Definition
If the penalty on suppliers is greater than the penalty on buyers, supply will shift by a greater magnitude, and prices would actually rise.
Were a heavier penalty imposed on consumers,the shift in demand would be more significant, and prices would actually fall. |
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Term
| Differentiate between economic rent and opportunity costs and dependance on elasticity of supply |
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Definition
The income earned by a resource or factor of production is composed of opportunity cost and economic rent.
Opportunity cost represents the income that the factor would earn in its next best alternative use, and is the minimum amount of compensation required by the resource for its current use.
Any amount that a resource receives in excess of its opportunity cost is known as economic rent.
When the supply curve is perfectly inelastic, the factor’s entire income is composed of economic rent
When supply is perfectly elastic, the factor’s entire income is composed of opportunity cost
If supply is neither elastic nor inelastic, it will be upward sloping and income will be composed of economic rent and opportunity cost. |
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Term
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Definition
The real wage rate equals the nominal wage rate adjusted for inflation.
It is a measure of purchasing power, or the quantity of goods and services that can be purchased with an hour’s
work.
Generally speaking, the higher the rate of productivity growth in an economy, the higher the rate of real wage rate growth. |
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Term
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Definition
Frictional unemployment results from the constant economic changes that create the need for people to switch jobs and for businesses to search for workers.
While these unemployed people are searching for suitable jobs, they are frictionally unemployed.
Frictional unemployment is temporary and voluntary, and is a healthy phenomenon in any dynamic, growing economy.
Frictional unemployment levels are greatly influenced by unemployment compensation.
The higher the number of unemployed people covered by unemployment insurance and/or the higher the unemployment benefits paid out, the longer the average time taken by job search activities, and greater the amount of frictional unemployment. |
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Term
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Definition
Structural unemployment results from structural changes in the economy that make some skills obsolete and leave previously employed people jobless.
These structural changes may
arise due to changes in technology or international competition |
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Term
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Definition
Cyclical unemployment is the unemployment generated as an economy goes through the phases of a business cycle.
Cyclical unemployment decreases during expansions and increases during recessions. |
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Term
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Definition
| An economy reaches its full employment level when it operates at full capacity and does not suffer from any cyclical unemployment. |
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Term
| Natural rate of unemployment |
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Definition
This is the level of unemployment that exists when an economy is operating at full employment.
It is composed of frictional and structural unemployment. |
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Term
| Relation between unemployment and real GDP |
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Definition
When an economy operates at full
employment, its real GDP equals its potential GDP. Business cycles cause real GDP to fluctuate around potential GDP and by extension, cause the level of unemployment to fluctuate
around the natural rate of unemployment.
During an expansion, real GDP exceeds potential GDP, which results in an
unemployment rate that is lower than the natural rate of unemployment.
During a recession, real GDP is lower than potential output so unemployment exceeds the natural rate. |
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Term
| Inflation and inflation rate |
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Definition
Inflation is defined as a persistent increase in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services.
The primary measure of price inflation is the inflation rate, which equals the percentage change in a price index over a period.
Inflation rate = ((Current CPI - Last year’s CPI)/ Last year’s CPI) * 100 |
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Term
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Definition
New goods
quality changes
commodity substitution bias
outlet substitution
It is estimated that the CPI causes an upward bias in the inflation rate of approximately 1%. |
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Term
| CPI and steps to calculate CPI |
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Definition
CPI = [Cost of CPI basket at current prices /Cost of CPI basket at base prices] * 100
1. Selection of the CPI basket
2. Monthly price survey
3. Calculate the CPI |
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Term
Long-run aggregate supply (LRAS): The long run aggregate supply curve shows the
relationship between |
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Definition
potential GDP and the price level (vertical line)
The LRAS curve (potential GDP) shifts when there is a change in the full-employment quantity of labor and/or capital (including human capital) in the economy, or when there are changes in technology. |
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Term
| Short-run aggregate supply (SRAS): Shows relationship between: |
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Definition
the quantity of real GDP supplied and the price level when the money
wage rate and prices of other factors of production are assumed constant.
The SRAS curve is constructed with three assumptions:
1. Prices of final goods and services are variable.
2. Prices of factors of production are constant.
3. Potential GDP is constant.
A change in the prices of goods and services represents a movement along the SRAS curve.
• Changes in prices of factors of production and in potential GDP cause shifts in the SRAS curve.
For example, an increase in money wages shifts the supply curve to
the left because of a rise in cost of production. |
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Term
| Money wages can change for two reasons |
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Definition
• Unemployment: An increase in unemployment above the natural rate puts a downward pressure on wages as there are abundant resources in the economy. A decrease in unemployment below the natural rate puts an upward pressure on money wages as producers struggle to find unutilized resources.
• Expected inflation: If workers expect inflation to rise in the future, i.e. the purchasing power of their wages to fall, they will demand higher wages. |
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Term
| A perfectly competitive industry is characterized by |
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Definition
1. There are a large number of buyers and sellers, and each of them is small relative to the size of the market.
2. There are absolutely no barriers to entry or exit.
3. All producers sell an identical product.
4. Established firms have no advantage over new entrants.
5. There is perfect information. Buyers and sellers are all well-informed about prices. |
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Term
the demand curve facing each
INDIVIDUAL producer in a perfectly competitive environment is |
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Definition
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Term
| Economic profit scenario in a perfectly competitive industry |
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Definition
1. There are no LR economic profits in a perfectly competitive industry.
2. In the LR, price equals minimum average cost.
3. In LR equilibrium, each firm produces less than the amount it was producing when economic profits were being made in the industry. However, the industry as whole produces more than it was previously.
4. The only viable explanation for this is that there must be more firms in the industry in the long run than there were when firms were making economic profits in the short run. |
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Term
| Economic LOSS scenario in a perfectly competitive industry |
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Definition
1. There are no long run economic profits in a perfectly competitive industry.
2. Price equals minimum average cost in the long run.
3. Each remaining firm produces more than the amount it was producing when economiclosses were prevalent in the industry. The industry however, now produces less.
4. The only way this is possible is that there must be fewer firms in the industry in the long run than there were when economic losses were being made in the short run. |
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Term
Discuss how a permanent change in demand or changes in technology
affect price, output, and economic profit |
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Definition
A permanent reduction in demand results in lower prices.
Perfectly competitive firms that were previously making normal profits will now suffer economic losses.
Lower prices force each firm to reduce output, where its marginal cost curve intersects the new (lower) marginal revenue curve.
The reduction in each firm’s output results in a decrease in quantity supplied.
Economic losses prompt some firms to exit the industry.
Their exit reduces market supply and boosts prices for all remaining firms back up.
These firms see an upward shift in their individual demand curves and now once again produce at their original profit maximizing levels, q , where they earn normal profits |
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Term
External diseconomies.
slope of long run supply curves of:
constant-cost industries
decreasing-cost industries
increasing-cost industries |
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Definition
External diseconomies are factors outside the control of the firm that increase average costs for individual firms as industry output increases.
In constant-cost industries, supply increases by as much as the initial increase in demand such that prices return to their original levels in the long run. As a result, the long run supply curve is perfectly ELASTIC.
In industries with external economies (decreasing-cost industries), the presence of a larger number of firm lowers costs for all firms. As a result, the magnitude of shift in supply is greater than that of the initial shift in demand, and prices fall below original levels. The long run supply curve for decreasing-cost industries is DOWNWARD sloping
In industries with external diseconomies (increasing-cost industries), an increase in demand boosts prices, but as more firms enter, average costs for all firms rise. Therefore, supply increases by less than the initial increase in demand. This results in prices that are higher than original levels, and a long run supply curve that is UPWARD sloping |
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Term
The effects of taxes on savings
The effects of taxes on labor
Lucas wedge |
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Definition
A tax on labor only REDUCES the level of potential output.
A tax on capital income reduces the quantity of savings and investment and SLOWS the growth rate of potential GDP.
This creates an ever-increasing gap between what potential GDP actually is and what it could have been.
This gap is known as the Lucas wedge. |
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Term
| The Laffer curve illustrates the relationship between |
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Definition
tax rates and tax revenues.
Upward Sloping Region:
• Increases in tax rates lead to
an increase in tax revenue.
• Decreases in tax rates lead to
a decrease in tax revenue.
Downward Sloping Region:
• Increases in tax rates lead to
a decrease in tax revenue.
• Decreases in tax rates lead to
an increase in tax revenue. |
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Term
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Definition
Fiscal policy refers to the use of government spending and taxation policies in order to meet macroeconomic objectives.
Changes in the level and composition of taxes and government spending impact the Federal budget. |
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Term
| budget surplus and deficit |
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Definition
• A balanced budget is when government spending equals tax revenue (G = T).
• A budget deficit involves a net excess of government spending over tax revenue (G > T). A budget deficit is associated with expansionary fiscal policy.
• A budget surplus occurs when government spending is less than tax revenue
(G < T). A budget surplus is associated with contractionary fiscal policy.
A budget surplus increases the supply of loanable funds, reduces real interest rates, and increases the amount of investment in an economy. |
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Term
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Definition
A budget deficit on the other hand, decreases the supply of loanable
funds, increases real interest rates, and decreases the amount of investment in an economy.
This tendency of budget deficits to reduce investment in an economy is known as the crowding-out effect. |
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Term
| the government expenditure multiplier is stronger than the tax multiplier. True or False? |
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Definition
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Term
| Limitations of Discretionary Fiscal Policy |
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Definition
Recognition lag: This refers to the time that it takes the government to figure out that the economy is not functioning at potential output
2. Law-making lag: The government might have recognized the need for action, but its implementation may be delayed in getting the necessary approvals.
3. Impact lag: This refers to the time it takes for a fiscal stimulus to flow through the economy and generate the changes in consumption patterns that are desired. |
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Term
Automatic stabilizers
Types |
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Definition
Automatic stabilizers work in the absence of explicit action by the government to bring the economy towards full employment.
1. Induced taxes: Revenue from income taxes rises in an expansion and falls in a recession. In a recession, when tax revenues fall due to lower total incomes, the budget moves towards a deficit, which is exactly the budgetary position that is required to deal with the demand shortfall. In an expansion, tax revenues rise and take the budget towards a surplus, which is the budgetary stance required to cool down the economy.
2. Needs-tested spending: These are government programs that pay benefits to qualified individuals and businesses (e.g. unemployment benefits). In a recession (expansion), the unemployment rate exceeds (is less than) the natural rate, and the amount of
unemployment benefits paid out by the government increases (decreases). This increase (decrease) in government spending leads the budget towards a deficit (surplus), and stimulates (reduces) aggregate demand. |
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Term
| Cyclical and Structural Fiscal Balances |
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Definition
1. The structural balance is a persistent surplus or deficit. Explicit government action is required to eliminate this balance. The structural balance is the deficit or surplus that would occur even if the economy were functioning at full employment.
2. The cyclical balance is temporary and only arises when the economy is not operating at its potential output. It vanishes once full employment is restored. The cyclical balance equals the actual fiscal balance minus the structural balance. |
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Term
| When a rent ceiling is imposed below the equilibrium market price, |
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Definition
A rent ceiling that is imposed below the current equilibrium market price results in a reduction in both price and quantity.
Producers are adversely affected by both these
movements, so producer surplus falls. As far as consumers are concerned, they benefit from lower prices, but suffer from lower quantities, so consumer surplus could increase or decrease depending on the relative change in price and quantity after the imposition of the ceiling. |
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Term
When a minimum wage is imposed above the equilibrium market price, which of the
following is most likely?
A. Equilibrium price falls while equilibrium quantity increases
B. Equilibrium price rises while equilibrium quantity falls
C. Equilibrium price and quantity both rise. |
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Definition
B. A minimum wage that is imposed above the current equilibrium market wage rate results in
an increase in price, but a decrease in equilibrium quantity. |
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Term
| Monopsony in the Labor Market |
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Definition
A monopsony is a market in which there is only one buyer for a product, so in case of a monopsony labor market, there is only one employer who hires labor
A profit-maximizing monopsonist will hire a quantity of labor where the marginal cost of hiring labor equals the marginal revenue product of labor.
A monopsony in the labor market results in a lower wage rate and a lower employment level compared to a competitive labor market.
The ability of a monopsony to reduce the wage rate and employment levels to make an economic profit depends on the elasticity of supply of labor.
The more elastic the supply of labor, the less power a monopsony has to reduce the wage rate and employment to increase profits. |
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Term
| The macroeconomic long run and short run -- money wage are constant or not?? |
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Definition
The macroeconomic long run is the time frame long enough for money (nominal) wages to change so that the economy achieves full employment. Over the long run:
• An economy’s real GDP equals its potential GDP.
• Real wage rates remain constant at the level where full employment is achieved.
The macroeconomic short run is the time period during which money wages are assumed CONSTANT. In the short run:
• Real GDP can be above, below or at potential GDP.
• Real wages fluctuate with varying price levels.
-- money wages are assumed constant in the long run, while real wages are assumed constant in the long run. |
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Term
| LR Adjustment to an Inflationary Gap |
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Definition
Assume that the government increases its expenditure, which shifts demand to the right (increase).
Consequently, the price level rises and there is an inflationary gap as real GDP expands above potential GDP.
The increase in price level reduces real wages so workers demand an increase in their money wages.
Producers, who are already operating above capacity, accede to the demand for higher wages because they are eager to retain workers (as the resources of the economy are already stretched) and maintain output levels given the high product prices.
The increase in money wages and cost of production reduces supply. SRAS moves to the left. Eventually, long-run equilibrium is
restored, but at a higher price level.
Conclusion: initially, prices rise in the short run as the economy operates in an inflation gap. Eventually, long run supply falls and takes prices |
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Term
| LR Adjustment to a Deflationary Gap |
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Definition
A reduction in government expenditure causes the AD curve to shift to the left to AD1, which reduces prices and results in a deflationary gap.
The economy is in short-run equilibrium but not in long-run equilibrium as it operates below its potential GDP.
The lower price level equates to an increase in real wages. Producers, who are working below capacity and suffering from low prices, will try to reduce money wages.
Workers will have to accept lower wages because there are ample (unemployed) resources in the economy.
Lower wages reduce costs of production and shift the SRAS curve to the right to SRAS1 bringing the economy to a new long run equilibrium at a lower price level. |
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Term
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Definition
Aggregate demand shows the relationship between the quantity of real GDP demanded and the price level.
AD = C + G + I + (X-M)
where:
C = Consumption expenditure.
G = Government expenditure.
I = Investment expenditure.
X - M = Net exports.
The aggregate demand curve is downward sloping.
While changes in price levels explain movements along the aggregate demand curve, three
factors explain shifts in the aggregate demand curve
1. Expectations about future incomes, inflation, and profits.
2. Fiscal and monetary policy.
3. World economy |
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