Introduction To Economics 2 PDF

Dear Readers,
We present to you some basic study notes for the subject economics. As you all know that
the course for the economics is very vast and not possible to cover it fully. So we have
compiled a few basic concepts of economics. Go through them to get a hang of the subject.
These notes have been compiled using various sources.
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INTRODUCTION TO ECONOMICS:
Definition of Economics
Economists study the economy. In the economy, goods
and services are produced, exchanged, and consumed.
So, economics is the study of the production, exchange,
and consumption of goods and services.
The subject matter of economics can be approached
from two levels of analysis: macroeconomics and
microeconomics. Microeconomics looks at the
production, exchange, and consumption of goods and
services at the level of an individual producer of the
good or the market in which a single good or service is
exchanged or an individual consumer of the product.
The key word is individual; microeconomics deals with
the behavior of the individual entities that make up the
economy.
Macroeconomics deals with the entire national
economy. Rather than being concerned with the
production of a single good or service, say, vacuum
cleaners, macroeconomics looks at the total production
of all goods and services including vacuum cleaners,
coffee makers, and frozen pizza. Rather than worrying
about why the price of gasoline has risen or fallen over
the last several weeks macroeconomics is concerned
with the inflation rate, a measure of how the average
price of all goods and services has changed.
Scarcity
Economics isthe study of the allocation of scarce
resources among competing and insatiable needs so
as to maximize welfare.
Economists assume that people do not act randomly.
Instead, people's behavior has a purpose. We assume
that people act in their own rational self-interest.
People make the choices they believe leave them best
off.
Economics resources are used to produce goods and
services. There are three categories of economic
resources:
1.
land - raw materials and natural resources
2.
labor - workers
3.
capital - buildings, machinery, factories,
equipment
4.
Each of the resources exists in a finite, limited
quantity.
We assume that people have unlimited wants. There is
always something that people want more of. Since we
have a limited amount of resources, we can produce a
limited amount of goods and services. No matter how
large that amount is, we cannot produce enough to
satisfy everyone's unlimited wants. This is known as
scarcity and much of economics looks at how people
cope with scarcity.
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Opportunity Costs
Because resources are scarce, people must make
choices. A choice is a comparison of alternatives. For
example, suppose I had a choice of having Kix, Cheerios,
or Lucky Charms for breakfast, and I decided to eat the
Lucky Charms. When I chose to eat the Lucky Charms I
was simultaneously choosing not to eat Cheerios and
not to eat Kix. I gave up the chance to eat the Cheerios
or the Kix. What I gave up has a value. This value is
called the opportunity cost.
Every choice has an opportunity cost. Opportunity cost
is the value of the next best alternative. Since I chose the
Lucky Charms, my opportunity cost is the Cheerios or
the Kix, whichever I most prefer.
For an accountant, the cost of an activity is the out-ofpocket expenses, all of the money paid to undertake the
activity. For an economist, the cost of an activity is
everything given up for it, including opportunity costs.
For example, what are the total costs of a college
education?
Tuition
$44,000
Books
3,200
beer costs
4,800
transportation
4,800
opportunity costs
56,000
total costs
$112,800
Instead of attending college you could be doing

something else such as working or backpacking across
Europe. That something has a value to you; the value of
whatever you would have done if you had not attended
college is the opportunity cost of going to college.Let's
say you would have found a job making sandwiches at
Sheetz and would have made $14,000 a year. Then, your
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opportunity cost of attending college would be the

wages you could have earned instead.
Marginal Costs and Marginal Benefits
Most decisions are not of the all or nothing variety. Most
decisions involve choosing a little more or a little less of
something. Rational decision making involves
comparing the costs and benefits of that incremental
change. Loosely put, the additional costs of undertaking
some activity are called the marginal costs. The
additional benefits of engaging in that activity are called
the marginal benefits. If the marginal benefits are
greater than the marginal costs, do it; otherwise, do not.
Should you have come to class today? Let's compare the
marginal costs and benefits.
marginal costs
gas, other car expenses
paper & ink used
opportunity costs (sleeping)
Breakfast
total marginal costs
2.00
2.51
$5.26
Production Possibilities Frontier
What it shows: the maximum combinations of two

goods an economy can produce with its existing
resources and technology; an economy can produce at
points on or inside its PPC but points outside the curve
are unattainable
full employment: points inside the PPC are
inefficient and represent large scale unemployment
because the economy could produce more of both goods
while points on the PPC are efficient and consistent with
full-employment of resources
Shape: the PPC is concave or bowed out away from
the origin because of increasing opportunity costs
resulting from specialized resources (resources are not
equally suited to producing all products)
Shifts: the PPC will shift outwards reflecting an
increased capability to produce goods and services
when (1) there are increases in the quantity or quality
of resources or (2) if there is technological
improvement
Circular Flow
$2.00
0.25
1.00
2.00
$5.25
marginal benefits
Knowledge
higher lifetime income due to better
economics gradeearned because you
learned about opportunity costs in class
today
were able to socialize with other students
total marginal benefits
economics grade earned because you

learned about opportunity costs in class
today
were able to socialize with other students
spent 50 minutes with me
total marginal benefits
$0.50
0.25
2.00
$2.75
So, since the marginal costs of attending class today are

greater than the marginal benefits, rational behavior
dictates that you should not have come to class
today.But, many of you did attend class today. There are
two possible explanations. One, you've all behaved
irrationally. You came to class knowing that the
marginal benefits were smaller than the marginal costs.
However, it is not a good idea to assume that so many
people have behaved irrationally. So, second, we have
incorrectly measured the costs and benefits.
Marginal costs
gas, other car expenses
$2.00
paper & ink used
0.25
opportunity costs (sleeping)
1.00
Breakfast
2.00
total marginal costs
$5.25
marginal benefits
Knowledge
higher lifetime income due to better
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$0.50
0.25
The circular flow diagram shows the interactions

among the various actors and sectors of the economy.
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An economic actor is any entity that makes an economic

decision.
Households
Households have two important roles in the economy:
1. households own the economic resources (land,
labor, and capital) and supply them to business firms in
return for income (rent, wages, and interest)
2. households spend part of this income on the goods
and services produced by firms
Business Firms
Businesses produce goods and services using the
economic resources supplied by households. There are
approximately 24 million businesses in the U.S. The
most numerous are proprietorships. A proprietorship
is owned by one person who receives all the profits and
is responsible for all the debts incurred by the business
(unlimited liability). The advantages of a proprietorship
are (1) the owner has complete control of the business,
(2) there is little legal complication involved in starting
a proprietorship, and (3) the profits of the business are
part of the income of the proprietor and, therefore, are
taxed under the personal income tax. The disadvantages
of a proprietorship are (1) the difficulty in raising funds
for the business and (2) the proprietor's unlimited
liability for the debts of the business.
A The second form of business is the partnership. A
partnership consists of two or more owners who share
the profits and responsibility for the firm's losses. A
partnership has the same tax advantage as a
proprietorship: the profits of the business are treated as
the personal income of the partners. More owners also
givespartnerships access to a larger source of funds for
the business. On the disadvantage side partnerships are
legally complicated: whenever there is a change in
ownership the partnership is automatically dissolved.
Also, the partners have unlimited liability for the debts
of the business.
Most large businesses are organized as corporations. A
corporation is a legal entity owned by shareholders
whose liability for the firm's debts is limited to the
value of the stock they own (limited liability). One
disadvantage faced by a corporation is that it is subject
to double taxation: dividends paid to shareholders are
taxed once under the corporate income tax and then
again under the personal income tax. A second
disadvantage is the separation of ownership from
control. Those managing the corporation may not act in
the best interests of the shareholders.
Government
The government taxes, spends, and regulates. All levels
of government together purchase about 20% of all the
goods and services produced each year.
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Financial Sector
The financial sector acts as an intermediary between
savers and investors. The financial sector includes
financial markets such as stock and bond markets and
financial intermediaries like banks, mutual funds, and
insurance companies.
International Sector
The American economy has extensive interactions with
the rest of the world. Trade in goods, services, and
income is one such interaction. Exports are products
made in this country and sold abroad; imports are
foreign made products purchased by Americans.
Supply and Demand, Part 1
The three basic economic questionsmarkets and
pricesdemandsupply
The Three Basic Economic Questions
All societies must deal with scarcity and, therefore,
must have some way of answering 3 basic economic
questions:
1. What goods and services are produced and in what
quantities?
2. How are they produced?
3. Who gets the goods and services that are produced?
There are two extreme systems for answering these
questions. In a communist economy, the government
decides all the answers. In a capitalist economy, the
questions get answered through the interaction of
buyers and sellers in the market.
Communist economy:
government ownership of resources
government allocation of resources and the

goods and services produced
Capitalist economy:
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$5
4
3
2
1
private ownership of resources

use of markets to allocate resources and the
goods and services produced
Most actual economies contain a mix of private and
government decision making.
Markets and Prices

A market is a place or service that enables buyers and
sellers to exchange goods and services.
3 functions of price:
1.
provides incentives
2.
means of rationing scarce supplies
3.
signaling mechanism
DEMAND:
Demand is the amount people are willing to
purchase at each possible price. The amount of the
product people are willing to purchase at a specific
price is called quantity demanded.
A demand schedule is a list of the quantity demanded at
different prices. When constructing a demand schedule,
everything else that might affect demand is held
constant. Consider the following demand schedule for
pizza:
Price Quantity Demanded
($/slice) (number of slices)
$5
2
4
5
3
8
2
12
1
17
The demand curve is a graph of the demand schedule.
Supply
Supply is the amount producers are willing to offer for
sale at each possible price. The amount sellers are
willing to offer at a particular price is called quantity
supplied. The supply schedule for pizza would be
constructed by adding up the quantities that each
producer offers for sale at each price, holding constant
everything else that affects the supply of pizza.
Price Quantity Supplied
($/slice) (number of slices)
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18
15
8
2
1
The supply curve is a graph of the supply schedule.

Equilibriumsupply and demand curvesshifts of the
demand curvethings that shift the demand
curveEquilibrium
Equilibrium is a situation in which there is no tendency
for change. A market will be in equilibrium when there
is no reason for the market price of the product to rise
or to fall. This occurs at the price where quantity
demanded equals quantity supplied. At this price, the
amount that consumers wish to buy is exactly the same
as the amount that producers wish to sell.
Quantity Demanded Price Quantity Supplied
2
5
8
12
17
$5
4
3
2
1
18
15
8
2
1
Equilibrium occurs at a price of $3. The equilibrium

quantity is 8 slices of pizza. When the price is above the
equilibrium of $3, quantity supplied is greater than
quantity demanded. Firms are unable to sell all they
want to at that price. There is an excess supply and this
surplus creates pressure for the price to fall. If the price
is below equilibrium, there is excess demand and the
shortage creates pressure for the price to rise. Only at
the equilibrium price is there no pressure for price to
rise or fall.
Supply and Demand Curves
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Demand and supply curves are simply graphs of

demand and supply schedules. Equilibrium occurs
where the supply and demand curves intersect at an
equilibrium price of $3 and an equilibrium quantity
bought and sold of 8. Excess supply or excess demand at
any price is simply the horizontal distance between the
supply and demand curves.
Shifts of the Demand Curve
An increase in demand means that consumers wish to purchase

more of the good at every price than before. Graphically, the demand
curve shifts up to the right. As a result of an increase in demand, the
equilibrium price rises as does the equilibrium quantity bought and
sold. Notice that an increase in demand has no effect on the supply
curve. Firms do increase production, but only in response to the
higher market price.
A decrease in demand, on the other hand, means that people wish to

purchase less of this good at every price than before. The demand
curve shifts down to the left. The equilibrium price and quantity both
decrease. Again, the shift of the demand curve has no effect on the
supply curve. From the point of view of producers, all that has
happened is that the market price has fallen. So, firms decrease the
quantity supplied. The supply curve itself does not shift. A movement
along the supply curve occurs.
Things that Shift the Demand Curve
changes in tastes/preferences
2. inferior goods
changes in income
1. normal goods
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changes in expected future prices
changes in the prices of related goods

1. substitutes

things that shift the supply curve elasticity
Things that Shift the Supply Curve
o
o
2. complements
changes in the population of potential buyers
o
o
o
o
changes in the prices of inputs

higher costs
supply decreases
lower costs
supply increases
new technology
new technology
supply increases
changes in the of other potential output
rise in the price of cupcakes more profitable to
produce cupcakes devote more resources to the
production of cupcakes supply of doughnuts
decreases
fall in the price of cheese less profitable to produce
cheese devote fewer resources to the production of
cheese supply of ice cream increases
changes in the number of producers
more sellers supply increases
fewer sellers supply decreases
changes in expected future prices
expect higher prices supply decreases now
expect lower prices supply increases now
Elasticity
We want to measure the magnitude by which
consumers change the quantity demanded in response
to a change in the price of the product. The more elastic
demand is, the more responsive it is to price changes.
percentage change in quantity demanded
price elasticity of demand = ---------------------------------percentage change in price
The price elasticity of demand
tells us the percentage change in quantity

demanded resulting from a 1% change in price
is always negative, so the negative sign is

dropped
when the price elasticity of demand is
greater than 1, demand is elastic: consumers

respond a lot to a price change
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equal to 1, demand is unit elastic

less than 1, demand is inelastic: consumers do
not respond much to a change in price
price elasticity of demand determinants of elasticity
and total revenueprice discrimination
Price Elasticity of Demand
The price elasticity of demand measures the
magnitude by which consumers change the quantity
demanded in response to a change in the price of the
product. The more elastic demand is, the more
responsive it is to price changes.
percentage change in quantity demanded
price elasticity of demand = ----------------------------------percentage change in price
Determinants of Price Elasticity of Demand

1. existence of substitutes: the more substitutes
available for a product, the more elastic its demand
2. luxury or a necessity: the demand for luxuries is
relatively elastic
3. importance of the product in the consumer's total
budget: the greater the portion of the consumer's
budget, the more elastic the demand
Video on Home Heating Oil
4.
5.
definition of the market: the more widely defined

the market, the more inelastic the demand, e.g.
food vs. green beans
time period under consideration: the longer the
time period, the more elastic
Elasticity and Total Revenue

Total revenue (TR) is equal to price times quantity sold.
if demand is elastic, a rise in price causes a fall in

TR
if demand is inelastic, a rise in price causes TR to

increase
Price Discrimination
Price discrimination refers to charging different
customers different prices for the same product, e.g.
senior citizens discounts on movie tickets. Firms can
increase their profits by charging a higher price to
customers with inelastic demand and a lower price to
customers with demand that is elastic.
Heating oil prices rose because the cold winter increased the demand for heating
oil. Heating oil suppliers hold very little inventory, so the supply curve is very
steep: the supply of heating oil responds very little to changes in price.
Price Ceilings and Floors
There are 4 alternatives to the market as a way of

allocating a scarce good:
1.
standing in line
2.
preferred customers
3.
rationing by coupon
4.
black market
Costs
relationship between output and resources costs in the
short run
A price floor is a legal minimum price. An example is the

minimum wage. A price floor creates an excess supply
or surplus. A price ceiling is a legal maximum price.
Rent control is an example. A price ceiling leads to a
situation of excess demand or a shortage.
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Relationship Between Output and Resources

A business firm is an organization that brings together
different resources to produce a good or service and is
controlled by a single management.
The goal of a business firm is to maximize profits.
Profits are equal to the firm's revenues minus its
economic costs.
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Accounting costs consist of businesses direct, out-ofpocket costs. However, the time and funds invested in a
firm could have been used in some other business. The
foregone return on the entrepreneur's time and money
that could have been used in another business is an
opportunity cost. This opportunity cost is part of the
costs of doing business so we add it to accounting costs
to get economic cost. A business can earn an accounting
profit yet have zero economic profits. Remember that
from now on, costs always include these opportunity
costs and that cost always means economic cost.
In the short-run, the size of a firm's capital stock is fixed.
They are unable to change it. Other resources, such as
labor, are variable inputs in the short run. In the longrun, all input levels can be changed.
Assume that a firm uses two resources, labor and
capital, to produce a good or service. Capital is a fixed
resource while labor can be used in varying quantities.
Total Output
Total output is the maximum output that can be
produced when variable resources are added to a fixed
amount of capital.
0
0
1
15
15
2
34
19
3
48
14
4
60
12
5
62
2
6
60
-2
The table above exhibits the law of diminishing
returns: the addition of resources increases output but
eventually does so at a decreasing rate. In other words,
the extra output of the group must eventually fall.
Costs in the Short Run
There are two types of costs in the short-run:
1.
fixed costs: those costs that do not change as
output increases and are incurred even if no output is
produced at all, e.g. interest, depreciation, fire insurance
2.
variable costs: those costs that do increase as
output increases
Total Costs (TC) = Total Fixed Costs (TFC) + Total
Variable Costs (TVC)
Extra Output of the Group

Extra output of the group equals the additional units of
output which result from using one more unit of the
variable resource.
Here's an example of making these calculations:
Extra Output
number of workers Total Output of the Group
Average Total Cost (ATC)

ATC = TC/Q
Average Fixed Cost (AFC)
AFC = TFC/Q
Average Variable Cost (AVC)
AVC = TVC/Q
Marginal Cost (MC) is the change in total cost when the

firm increases output by one unit.
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Q
0
1
2
3
4
5
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TFC
35
35
35
35
35
35
TVC
0
24
40
60
85
116
TC
35
59
75
95
120
151
AFC
AVC
ATC
35
17.5
11.7
8.8
7
24
20
20
21.2
23.3
59
37.
31.
30
30.
Profit Maximization
demand curve facing the firmbarriers to entryfinding
profits graphically
Demand Curve Facing the Firm
We assume that firms choose the price and quantity
produced so as to maximize profits. A firm's choices for
the price and quantity produced depend on the
environment in which it operates. One important factor
is the demand curve facing the firm.
With
perfectly
elastic
demand the
firm has no
control over
price. It only
chooses the
quantity to
produce.
A firm facing a downward sloping demand curve chooses both

the price and quantity produced so as to maximize profits.
profits for a long time and can raise prices without fear
of immediate new competition.
Desktop publishing has low fixed costs: just a

computer and a printer. It is easy for new firms to enter
the market. Therefore, desktop publishers will not make
above-normal profits for long.
Profits and Market Structure
Facing a perfectly
inelastic
demand
curve, the firm only
chooses the price
since the quantity is
determined by how
much
consumers
want.
Firms would prefer to face the most inelastic demand
curves possible. Firms can reduce elasticity by reducing
the availability of substitutes. One way is to distinguish
or differentiate your product from those of your
competitors. Differentiation can occur through
advertising, price, service, quality, location, et cetera.
Barriers to Entry
A firm's environment not only depends on the demand
for its product but also on the ease of entry into the
market.A barrier to entry is anything that makes it
difficult or costly for a firm to enter a market. Some
barriers to entry are created by the government:
patents and copyrights, zoning, and licensing are
examples. Other barriers to entry are economic in
nature. One such barrier to entry is fixed or sunk costs.
These are costs which must be paid before any output is
even produced.
Airlines have huge fixed costs. An airline must

lease planes, gets at airports, and landing rights. They
must tie into a computerized reservation system, and so
on. These high fixed costs make it hard for new firms to
enter the market. So airlines may make above-normal
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profit maximizationmarket structure

Profit Maximization
We assume that the goal of firms is to maximize profits.
We could compare total revenue and total cost at every
level of output in order to find the profit maximizing
level of output. An alternative is to compare marginal
revenue and marginal cost.
marginal cost
additional cost of producing one more unit of output
marginal revenue
additional revenue obtained from selling one more unit
of output
As long as the marginal revenue from selling a unit of
output is greater than the marginal cost of producing
that unit of output the firm will make a profit on that
unit of output.
if MR > MC produce more output to increase

profits
if MR < MC costs more to produce another

unit of output than the firm can sell it for produce
less output to increase profits
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A profit maximizing firm will continue to expand

production as long as marginal revenue is greater than
marginal cost. Here's another example:
1.50
1.00
7.50
2.50
-1.50
Price QD TR TC
MR MC
Profits
11
-2
3.50
-7.00
$5
$0
$3
$-3
15.50 -1
4.50
-15.50
3.50
$4
$0.50 0.50
When the firm can produce fractional units of the good, profits are
maximized at the quantity at which MR = MC. Graphically, this occurs
where the marginal revenue and marginal cost curves intersect. Drop
straight down from the point of intersection to find the profit
maximizing quantity of output, Q*. To find the profit maximizing price,
follow Q* up to the demand curve and over to the vertical axis.
Market Structureelements of market structure:

1.
number of firms in the market
2.
degree to which products produced by firms are
perceived to be different
3.
ease of entry into market
Perfect Competition
1.
many buyers and many sellers
2.
identical products
3.
free entry and exit
Since there are many firms each selling exactly the same
product, buyers do not care which firm they purchase
the item from; all buyers look at is the price. So, a firm
in a perfectly competitive market must charge the same
price as all other firms or they will sell no output at all.
The demand curve facing a perfectly competitive firm is
horizontal at the market price.
Free entry into and free exit from the industry means
that firms in a perfectly competitive market earn only a
normal profit in the long run.
Monopoly
1.
many buyers and a single seller
2.
unique product
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3.
entry is impossible
A monopolist faces the market demand curve. Since
entry is impossible a monopolist can earn an economic
profit over the long run.
Monopolistic Competition
1.
many buyers and many sellers
2.
slightly different products
3.
free entry and exit
Monopolistic competitors tend to compete on the basis
of product differentiation and by introducing new
products, for example, light beer, then ice beer, then low
carb beer.
Oligopoly
1.
many buyers and just a few sellers
2.
identical or slightly different products
3.
entry is difficult
Oligopolists need to take into account how the other
firms in the industry will react to their business
decisions. For example, Ford will consider what it
thinks General Motors will do when Ford is making its
styling and pricing decisions for its new cars.
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nominal and real interest ratespresent valuestock

marketswhat determines the price of a share of
stock?
Nominal and Real Interest Rates
Financial Markets
The interest rate is the fee for using money, expressed in annual
percentage terms. The interest rate is determined by the supply and
demand for money. The demand for money comes from those with a
shortage of funds, borrowers or investors. The supply of money
comes from those with a surplus of funds, lenders or savers.
The interest rate is determined by the equilibrium of money supply
and money demand.
Market interest rates are nominal interest rates,

interest rates unadjusted for inflation. A nominal
interest rate can be divided into two components: the
increase in purchasing power the lenders demands for
the use of her money (the real interest rate) and the
expected rate of inflation. Since inflation reduces the
purchasing power of money, lenders will build the
expected inflation rate into the interest rate they charge
borrowers in order to protect themselves from the loss
of purchasing power. So, the nominal interest rate
equals the real interest rate plus the expected
inflation rate. Real interest rates can actually turn out
to be negative. This is like paying someone to borrow
your money. Suppose the interest rate you receive on
your savings account is 1%. Then, the nominal interest
rate is 1%. Inflation is likely to be 2.5% this year, so the
real interest rate on your savings account is -1.5%.
Present Value
We want to compare the dollar amounts received at
different points of time in the future. The problem is
that dollars received in the future are not as valuable as
today's dollars. The concept of present value is used to
compare dollars amounts received/spent at different
points in time.
Present value is the value today of some amount to be
received in the future. If I put $100 in the bank and
receive 5% interest, I will have $105 in 1 year. So, the
present value of $105 to be received in 1 year is $100.
$100 now is the same as getting $105 1 year from now
because $100 will grow into $105 in a year.
present value
$1
of $1 to = ------------be received
n
in n years
(1 + i)
where i = interest rate
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For example, the present value of $100 to be received

next year (with i = 5%) equals ($100)/(1 + 0.05) =
($100)/(1.05) = $95.
The higher the interest rate, the lower the present value
of money to be received in the future.
Stock Markets
Shares of ownership in a corporation are bought and
sold in stock markets.
kinds of stock markets:
primary v. secondary
exchanges v. over-the-counter markets
What Determines the Price of a Share of Stock

Owners of a share of stock have two sources of potential
profits: (1) dividends and (2) capital gain/loss. These
two sources of potential profit for the shareholder
depend on the profitability of the business.
The efficient markets hypothesis argues that all
available information about a company and its business
prospects is reflected in the price of the company's
stock.
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The incentive to profit from mispricing contributes to

making the stock market efficient. Suppose the market
price of a share of Harley Davidson stock is $59 but
your forecast of Harley's future returns suggests the
price should be $80. The demand for Harley Davidson
stock will go up, driving the price up until it reaches
$80. If you believe that Harley Davidson stock is
overvalued, you can profit by selling the stock short. So
long as the transactions costs of buying and selling
financial instruments are low, traders can profit by
eliminating deviations from the price that the available
information predicts.
o
o
Gross Domestic Productgross domestic productGDP as a

measure of welfare
Unemployment and Inflation business cycles measuring

unemployment inflation
Gross Domestic Product

GDP is the value of all currently produced goods and
services produced within the borders of an
economy sold on the market during a particular time
interval but not resold.
Currently produced goods and services means that
GDP excludes
1.
any used items such as houses and cars
2.
any transaction in which money is transferred
without any accompanying good or service in return,
e.g. government transfer payments, inheritances
Produced within the borders of an economy means
that GDP includes production that takes place in U.S.,
without regard to whether the production is done by
U.S. or foreign factors of production, e.g. Japanese cars
produced in Kentucky
Sold on the market means that
goods and services are valued at their market

prices
GDP excludes things not exchanged on the

market like housework and volunteer work
Not resold means that
GDP only counts final products (those

purchased by the ultimate user). Intermediate goods
intended for resale or further processing are excluded
lest we be guilty of double-counting.
Business Cycles
The American economy experienced increasing material
wealth and productivity over the century.
GDP as a Measure of Welfare

GDP is not a perfect measure of economic wellbeing.
GDP includes some items that clearly do not

contribute to economic welfare (for example, repairing
the damage from hurricanes increases GDP) and
excludes other that clearly do such as volunteer work
and housework
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underground economy
unreported income from legal sources
income from illegal sources
Nominal and Real GDP
Nominal GDP is the sum of this year's output valued at
this year's prices. The problem is that nominal GDP
changes when prices change and when the quantity of
output changes. We want to separate the desirable
increase in the quantity of output from the undesirable
increase in prices.
Real GDP is the sum of this year's output valued at base
year prices. Prices from the base year are used to
calculate real GDP for all years.
However, the growth of output has not been smooth:

periods of rising output are followed by periods of
falling output. These fluctuations in economic activity
are called business cycles.
A recession is a decline in total output, income,

employment, and trade usually lasting 6 months to a
year, and marked by widespread contractions in many
sectors of the economy.
Measuring Unemployment
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The labor force consists of those people with jobs and

those people looking for work. The labor force
participation rate measures the fraction of the civilian, non
institutionalized population of those 16 years of age or
older who are in the labor force.
A person is unemployed if they are looking for a job but unable to

find one. The unemployment rate is calculated by dividing the
number of unemployed people by the size of the labor force.
The official unemployment rate may overstate or

understate the true amount of unemployment:
overstate
1. no check on those who say they are unemployed
understate
1. part-time workers who cannot find a full-time job

are, nonetheless, counted as fully employed
2. discouraged workers who have given up looking for
a job are not counted as unemployed
Inflation
The consumer price index (CPI) tracks changes in the prices

paid by consumers for a representative or market basket of
goods and services. The CPI attempts to measure the "cost of
living". The cost of the market basket of goods and services is
set equal to 100 in the base year. The CPI for any year is equal to
100 +/- the percent change in the cost of the market basket
since the base year. If the CPI equals 150, the cost of living has
risen 50 percent since the base year; the cost of living has risen
80 percent since the base year if the consumer price index
equals 180. The Bureau of Labor Statistics has a page
offrequentlyasked questions about the CPI.
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The inflation rate is the percentage change in the consumer

price index.
Aggregate Demand and Aggregate Supply

aggregate demandaggregate supplymacroeconomic
equilibriumshifts of the AD curve
Aggregate Demand
We want to develop a model of the economy that will let
us address issues such as what causes a recession and
what are sources of inflation. The model will look at
demand and supply for the economy as a whole.
Aggregate demand is the total amount of spending at
each possible price level. Aggregate demand is equal to
consumption spending + investment spending +
government spending on goods and services + exports imports.
The aggregate demand curve is downward sloping:
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1. real balances effect - a fall in the price level increase

the purchasing power of consumers' wealth so
consumption spending rises
2. foreign purchases effect - a fall in the price level
makes domestic goods relatively cheaper compared
to foreign goods so imports fall and exports rise
3. interest rate effect - a fall in the price level reduces
the inflation rate so interest rates fall, meaning that
any spending that is interest rate sensitive such as
consumption and investment spending rises
Aggregate Supply
Aggregate supply is the level of GDP available at each
possible price level.
The aggregate supply curve is upward sloping over
much of its relevant range.
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Macroeconomic Equilibrium
Equilibrium occurs at the intersection of the aggregate

demand and aggregate supply curves. Equilbrium
need not be at the full employment level of GDP
Shifts of the AD Curve

Aggregate demand (AD) is the total amount of spending
at each possible price level.
AD = C + I + G + EX - IM
taxes
o a reduction in taxes leaves households with more
disposable income so consumption spending
rises AD increases and the AD curve shifts up to the
right
o a tax increase leaves households with less
disposable income to spend AD decreases and the
AD curve shifts down to the left
interest rates
o lower interest rates decrease the cost of borrowing
money so households and business borrow more to
spend and invest in new capital AD curve shifts up
to the right
o higher interest rates make money more costly for
households and businesses to borrow so
consumption and investment spending fall AD curve
shifts down to the left
consumer and business confidence
o more optimistic AD curve shifts up to the right
o more pessimistic AD curve shifts down to the left
government spending
o government spending is one of the components of
aggregate demand so an increase in government
spending causes AD to increase AD curve shifts up
to the right
o decrease in government spending AD curve shifts
down to the left
strength of the dollar
The U.S. economy is linked to the rest of the world
through exchange rates. An exchange rate is the
price of one national currency in terms of another.
Suppose an American tourist in Mexico buys a
bottle of Kahlua for 85 pesos and that the exchange
rate is $1 = 7.9060 pesos. Then, that bottle of
Kahlua costs $10.75 in terms of US dollars.
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If the exchange rate goes to $1 = 8.0230 pesos, the

dollar appreciates and a bottle of Kahlua now costs
$10.59. Therefore, when the dollar appreciates,
foreign goods become less expensive to
American buyers and imports rise.
o If the exchange rate went instead to $1 = 7.5015
pesos, the dollar depreciates and a bottle of Kahlua
now costs $11.33. So, when the dollar
depreciates, foreign goods become more
expensive to American buyers and imports fall.
Suppose A Mexican tourist in York buys a 6-pack if
Yuengling Black and Tan for $5.75. At $1 = 7.9060
pesos, the beer costs 45.46 pesos.
o When the dollar appreciates to 8.0230 pesos, the
beer costs 46.13 pesos. Therefore, when the dollar
appreciates, American goods become more
expensive to foreign buyers and exports fall.
o If the dollar depreciates to 7.5015 pesos, the beer
costs 43.13 pesos. So, when the dollar
depreciates, American goods become less
expensive to foreign buyers and exports rise.
So,
o a rise in the value of the dollar increases imports
and reduces exports AD curve shifts down to the left
o a fall in the value of the dollar lowers imports and
increases exports AD curve shifts up to the left
Aggregate Demand and Aggregate Supply,
Continued
shifts of the AS curvecauses of inflationcauses of a
recessionShifts of the AS Curve
input prices
o
higher input prices AS curve shifts up to the left
o
lower input prices AS curve shifts down to the
right
productivity
o
higher productivity AS curve shifts down to the
right
o
lower productivity AS curve shifts up to the left
government regulation
o
more regulation AS curve shifts up to the left
o
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less regulation AS curve shifts down to the right
Causes of Inflation
1.
demand-pull inflation - increase in aggregate
demand
2.
cost-push inflation - decrease in aggregate supply
Causes of a Recession
1.
a fall in aggregate demand
A fall in aggregate demand shifts the AD curve to

the left: total spending in the economy decreases at
every price level. In response to the fall in demand,
some firms lower prices but others reduce output
and employment. Real GDP falls below the full
employment level.
2.
decrease in aggregate supply (supply shock)
A supply shock such as a rise in oil prices causes the

AS curve to shift up to the left: the economy's total
output falls
Fiscal Policy
Expansionary and Contractionary Fiscal Policy
Fiscal policy involves the taxing and spending policies of
the government.
expansionary fiscal policy (to fight a recession by
increasing aggregate demand)
1. increase government spending
2. cut taxes
contractionary fiscal policy (to deal with inflation by
reducing aggregate demand)
1. decrease government spending
2. raise taxes
The Tax System
Federal Government
personal income taxes
social security taxes
corporate income taxes
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excise taxes
State and Local Governments
sales taxes
income taxes
property taxes
progressive tax
tax is a higher percentage of income for those with
higher incomes than those with lower incomes
proportional tax
tax is the same percentage of income for those with
higher incomes as those with lower incomes
regressive tax
tax is a lower percentage of income for those with
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The overall tax system (including income, sales, and

property taxes at all levels of government) in the United
States is nearly proportional.
Income
Group
bottom
20%
second
20%
middle
20%
fourth
20%
top 20%
Average
Pre-tax
Income
Total
Government
Taxes Paid
Taxes as a
Percentage
of Income
$7,946
$1,449
18%
$20,319
$2,847
14%
$35,536
$5,622
16%
$56,891
$9,835
17%
$116,666
$21,623
19%
between expenditures and revenues. It does so by

selling Treasury bills, notes, and bonds.
The national debt is the total amount owed by the
federal government to owners of government
securities.
National Debt in Historical Perspective: In the old days,

there was little debt in large part because there was
little federal government. Debt-to-GDP ratio up to
perhaps 30% of GDP in a war, but little outside of a war.
In fact, Andrew Jackson paid off the national debt in
1834 but it reappeared following the Panic of 1837.
Federal Government's Budget

Tax Revenues $1880.1 billion (2004)
income taxes 8091 b
social security taxes 733.4 b
corporate income taxes 189.4 b

Outlays $2292.2 billion
social security 491.5 b
national defense 454.1 b
discretionary no-defense 440.9 b
net interest on public debt 160.2 b
Medicare 297.4 b
Medicaid 176.2 b
Budget deficit = Revenues - Outlays = 1880.1 b - 2292.2
b = $412.1 billion
National Debt
When the government overspends, the U.S.
Treasury must borrow to finance the difference
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Up until World War I there was pattern of running up

debt to finance a war, but then run the debt/GDP ratio
down close to zero after a war. This hasn't happened
following our 20th century wars. In 1913 debt was 3%
of GDP; 1930 debtof 20% of GDP; 1975 debt of 25% of
GDP. Now, the debt is about 48% of GDP and rising.
With the end of World War I, however, government
spending did not go all the way back down to its prewar share of GDP. Whether it would eventually have
done so or not in the absence of a Great Depression is
unclear--but with the Great Depression and the
movement of the federal government into
infrastructure and civilian spending in a big way,
government expenditures shot up to nearly ten percent
of GDP.
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And then came World War II, the Korean War, and the
postwar military-industrial buildup associated with the
Cold War.
Taxes kept pace--and the underlying growth of the
American economy steadily reduced the outstanding
national debt as a share of GDP. (The debt to GDP ratio
went down from 112% at the end of WWII to about
25% in the mid-1970s.)
Since the end of the 1970s the debt-to-GDP ratio has
doubled and there has been an almost steady increase
in share of GDP devoted to spending while revenues
have been relatively constant as a share of GDP).
Three reasons for persistent budget deficits in the
1980s and 1990s and their recent reemergence:
the post-1973 slowdown in economic growth- the

government's budget automatically heads towards
deficit during a recession as tax revenues
automatically fall and spending rises
the Reagan and recent Bush tax cuts - led to a fall

in tax revenues as a percent of GDP
emergence of political immunity against budget

deficits - no longer politically disadvantageous to
run budget deficits
Why Worry about Deficits and the Debt?
1. Can the government go bankrupt?
o no
2. passing the debt burden to future generation
o interest payments mean that future generations will
pay more of their tax dollars to the government's
creditors and less for highways, education, and
defense
3. crowding out
o government borrowing reduces private spending by
raising interest rates
1990's Deficit Reduction
Budget deficits shrunk over the 1990's and a surplus
briefly appeared. Deficit reduction in the 1990's was
the result of (1) higher income and excise taxes
enacted by Presidents G.H.W. Bush and Clinton and (2)
reduced military and entitlement spending including
Medicare, Medicaid, and food stamps. The
reappearance of large budget deficits in 2002 is largely
the result of the Bush tax cuts.
Fiscal Policy
expansionary and contractionary fiscal policythe tax
systemfederal
government's
budgetnational
debtnational debt in historical perspectivewhy worry
about deficits and the debt?1990's deficit
reductionExpansionary and Contractionary Fiscal
Policy
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Fiscal policy involves the taxing and spending policies of

the government.
expansionary fiscal policy (to fight a recession by
increasing aggregate demand)
1.
increase government spending
2.
cut taxes
contractionary fiscal policy (to deal with inflation by
reducing aggregate demand)
1.
decrease government spending
2.
raise taxes
The Tax System
Federal Government
personal income taxes
social security taxes
corporate income taxes
excise taxes
State and Local Governments
sales taxes
income taxes
propoerty taxes
progressive tax
tax is a higher percentage of income for those with
proportional tax
tax is the same percentage of income for those with
higher incomes as those with lower incomes
regressive tax
tax is a lower percentage of income for those with
The overall tax system (including income, sales, and
property taxes at all levels of government) in the United
States is nearly proportional.
Income
Group
bottom
20%
second
20%
middle
20%
fourth
20%
top 20%
Average
Pre-tax
Income
Total
Government
Taxes Paid
Taxes as a
Percentage
of Income
$7,946
$1,449
18%
$20,319
$2,847
14%
$35,536
$5,622
16%
$56,891
$9,835
17%
$116,666
$21,623
19%
Federal Government's Budget

Tax Revenues $1880.1 billion (2004)
income taxes 8091 b
social security taxes 733.4 b
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corporate income taxes 189.4 b
Outlays $2292.2 billion
social security 491.5 b
national defense 454.1 b
discretionary no-defense 440.9 b
net interest on public debt 160.2 b
Medicare 297.4 b
Medicaid 176.2 b
The national debt is the total amount owed by the

federal government to owners of government securities.
Budget deficit = Revenues - Outlays = 1880.1 b - 2292.2

b = $412.1 billion
National Debt
When the government overspends, the U.S. Treasury
must borrow to finance the difference between
expenditures and revenues. It does so by selling
Treasury bills, notes, and bonds.
National Debt in Historical Perspective
In the old days, there was little debt in large part because there was little federal government. Debt-to-GDP ratio up to
perhaps 30% of GDP in a war, but little outside of a war. In fact, Andrew Jackson paid off the national debt in 1834 but it
reappeared following the Panic of 1837.
Up until World War I there was pattern of running up

debt to finance a war, but then run the debt/GDP ratio
down close to zero after a war. This hasn't happened
following our 20th century wars. In 1913 debt was 3%
of GDP; 1930 debtof 20% of GDP; 1975 debt of 25% of
GDP. Now, the debt is about 48% of GDP and rising.
With the end of World War I, however, government
spending did not go all the way back down to its prewar share of GDP. Whether it would eventually have
done so or not in the absence of a Great Depression is
unclear--but with the Great Depression and the
movement of the federal government into
infrastructure and civilian spending in a big way,
www.bankersadda.com
government expenditures shot up to nearly ten percent

of GDP.
And then came World War II, the Korean War, and the
postwar military-industrial buildup associated with the
Cold War.
Taxes kept pace--and the underlying growth of the
American economy steadily reduced the outstanding
national debt as a share of GDP. (The debt to GDP ratio
went down from 112% at the end of WWII to about
25% in the mid-1970s.)
Since the end of the 1970s the debt-to-GDP ratio has
doubled and there has been an almost steady increase
in share of GDP devoted to spending while revenues
have been relatively constant as a share of GDP).
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Three reasons for persistent budget deficits in the

1980s and 1990s and their recent reemergence:
the post-1973 slowdown in economic growth- the
government's budget automatically heads towards
deficit during a recession as tax revenues
automatically fall and spending rises
the Reagan and recent Bush tax cuts - led to a fall in
tax revenues as a percent of GDP
emergence of political immunity against budget
deficits - no longer politically disadvantageous to
run budget deficits
Why Worry about Deficits and the Debt?
1. Can the government go bankrupt?
o no
2. passing the debt burden to future generation
o interest payments mean that future generations will
pay more of their tax dollars to the government's
creditors and less for highways, education, and
defense
3. crowding out
o government borrowing reduces private spending by
raising interest rates
Why Are Some Countries So Rich and Others So
Poor?
Characteristics of Rich Nations
stable democratic governments with a rule of

law and respect for political, civil, and economic rights
capitalist
committed to free trade
lots of investment in capital goods
well educated workforce with a long life

expectancy
located away from the equator
well
developed
transportation
and
communication systems
Characteristics of Poor Nations
dictatorships or ex-communist governments
involved in wars, revolutions, and coups
export lots of raw materials
located near equator
rapid population growth

What is Money?
medium of exchange
store of value
unit of account
Why Money?
Money was created to reduce the costs of exchange.
Specialization in the production process increases
output. But, while each individual may specialize as a
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producer, she still wants to consume a variety of goods

and services. Some exchange system must be devised so
that each individual can enjoy the fruits of the
specialization of others.
customary exchanges
barter - double coincidence of wants, lack of a

unit of account
indirect exchange
Searches by potential barterers for some double
coincidence of wants will be extremely time consuming
in a large, highly specialized economy with millions of
products and people. Barter was abandoned and a
system of indirect exchange was adopted instead.
Indirect exchange significantly reduces the time spent
on any one transaction.
In spite of widely different tastes within a society, there
will be a small number of commodities most everybody
is will to accept for exchange purposes. Everyone will
maintain an inventory of the generally accepted
commodities and virtually all exchanges will be made
with these commodities. We then have a medium of
exchange and a store of value. Prices will be listed in
terms of these generally accepted commodities, making
them units of account. These generally accepted
commodities take on the functions of money.
Desirable Characteristics of Money
divisible
durable
transportable
easily recognizable
Monetary Aggregates
M1
M1 = currency + checking deposits
M2
M2 = M1 + small savings deposits
M3
M3 = M2 + large savings deposits
Monetary Policy
Federal Reservetools of monetary policyexpansionary
monetary policycontractionary monetary policy
Federal Reserve
Monetary policy involves control of the quantity of
money in the economy. The Federal Reserve is
responsible for monetary policy in the United States.
organization:
1.
District Banks
2.
Board of Governors (chairman is Alan
Greenspan)
3.
Federal Open Market Committee
Tools of Monetary Policy
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1. open market operations

Open market operations is the buying and selling of
government bonds by the Federal Reserve. When the
Federal Reserve buys a government bond from a bank,
that bank acquires money which it can lend out. The
money supply will increase. An open market purchase
puts money into the economy.
2.
the decrease in interest rates causes
consumption and investment spending to rise and so
aggregate demand rises
3.
the increase in aggregate demand causes real
GDP to rise
2. discount rate
When the Federal Reserve makes a loan to a member
bank, the loan is called a discount loan. The interest rate
on a discount loan is called the discount rate.
Lowering the discount rate encourages banks to take
out more discount loans while raising the rate
discourages banks from borrowing from the Fed.
Therefore, lowering the discount rate puts money into
the economy; raising the discount rate takes money out
of the economy.
3. reserve ratio
The reserve ratio is the percentage of deposits banks
are required to hold as vault cash and not loan out..
Lowering the reserve ratio allows banks to loan out a
greater fraction of deposits and the money supply
would increase. Raising the reserve ratio would cause
the money supply to shrink.
Expansionary Monetary Policy

To increase the money supply, the Federal Reserve can
buy government bonds (an open market

purchase)
lower the discount rate
lower the reserve ratio

Expansionary monetary policy is appropriate when the
economy is in a recession and unemployment is a
problem.
Changes in the money supply affect the economy
through a 3 step process.
1.
an increase in the money supply causes interest
rates to fall
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Contractionary Monetary Policy

To decrease the money supply, the Federal Reserve can
sell government bonds (an open market sale)
raise the discount rate
raise the reserve ratio

Contractionary monetary policy is appropriate when
inflation is a problem.
1.
a decrease in the money supply causes interest
rates to rise
2.
the increase in interest rates causes
consumption and investment spending to fall and so
aggregate demand falls
3.
the decrease in aggregate demand causes real
GDP to fall
Comparative Advantage and the Gains from Trade
Comparative Advantage and Trade
Let's assume that Joe Paterno can mow his lawn faster
than anyone else. But just because he can mow his lawn
fast, does this mean he should?
Let's say Joe Paterno can mow his lawn in 2 hours while
a neighborhood kid can mow Joe Paterno's lawn in 4
hours. Because he can mow the lawn in less time, Joe
Paterno has an absolute advantage in mowing lawns.
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An individual has an absolute advantage in producing a

good if they can produce it using fewer resources than
can someone else.
However, is mowing his lawn the best use of Paterno's
time? Suppose that in the same 2 hours it takes him to
mow his lawn, he could give a motivational speech at a
Chamber of Commerce luncheon for $5,000.
Paterno's opportunity cost (the value of his next best
alternative) of mowing the lawn is $5,000.
In contrast, the neighborhood kid's next best alternative
is to work at McDonalds where he earns $7.50 an hour.
So, in the 4 hours it would take her to mow Joe
Paterno's lawn, he could have earned $30. The
neighborhood kid's opportunity cost of mowing Joe
Paterno's lawn is $30.
Joe Paterno has an absolute advantage in mowing lawns
because he can do the work in less time. But, the
neighborhood kid has a comparative advantage in
mowing lawns because he has the lower opportunity
cost. A person or a country has a comparative
advantage when they can produce a good at a lower
opportunity cost compared to someone else.
The gains from trade are enormous. Rather than

mowing his lawn, Paterno should give the speech and
hire the neighborhood kid to mow the lawn. As long as
Paterno pays him more than $30 and less than $10,000,
both of them are better off.
Countries can benefit from specialization and trade with
one another in the same way individuals can. The gains
from trade do not disappear at national borders.
Without trade countries must consume at a point on
their production possibilities frontiers. With trade, a
country can consume at a point outside of its PPF.
An Example
In the absence of trade a country must consume the
goods and services it produces. The production
possibilities frontier shows combinations of goods a
country can produce. Without trade countries must
consume at a point on their PPF's. With trade, a country
can consume at a point outside of its PPF.
USA
China
food
5
3
clothing
3
1
Suppose the table above shows output per worker per day in the food and clothing sectors of the American and Chinese
economies. Also, suppose that there are 16 workers in each country and that both countries prefer equal amounts of
food and clothing.
In the absence of trade, USA will devote 6 workers to

food production and 10 to clothing, thereby producing
and consuming 30 units of food and 30 units of clothing.
China will have 4 workers producing food and 12
making clothing, leading to the production of 12 units of
food and 12 units of clothing.
The gains from trade come from differences in
opportunity costs. Recall that opportunity costs are
equal to the amount given up divided by the amount
gained.
food
clothing
USA
5
3
China
3
1
USA opportunity costs
3/5
5/3
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China opportunity costs
1/3
The opportunity cost of producing food is lower in

China. Therefore, China has the comparative advantage
in producing food and ought to specialize in producing
food. The USA has the comparative advantage in
clothing production and should concentrate on
producing clothing.
Terms of trade:amount of a good a country must give
up to obtain another good from the other country
The limits of the terms of trade are determined by the
opportunity costs of the two countries. For example, the
terms of trade clothing will be between 5/3 and 3.
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Suppose the terms of trade are 2 units of food per unit

of clothing.
countries are consuming at points that lie outside of

their production possibilities frontiers, combinations of
food and clothing that are beyond their own individual
resource capabilities.
Trade Policy
If the USA produces only clothing, it will produce 48

units. If China produces only food it makes 48 units of
food.
Suppose the USA trades 16 units of clothing to China for
32 units of food.
Winners and Losers from Trade

In the absence of trade, the domestic price is
determined by the equilibrium between domestic
supply and demand. Once a country opens up to trade,
the price of an item becomes the world price. The world
price is determined by world supply and demand.
The USA ends up consuming 32 units of food and 32

units of clothing, compared to 30 of each before trade.
China ends up consuming 16 units of food and 16 units
of clothing, compared to 12 of each before trade. Both
For an import good, the price falls to the world price, making
consumers better off. Domestic producers are worse off
because the lower price leans less profits. Domestic production
of the good falls.
For an export item, the domestic price rises to the world

price, making consumers worse off. Domestic producers
are better off because the higher price leans higher
profits. Domestic production of the good rises.
Tariffs
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A tariff is a tax on imports.
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The tariff raises the domestic price above the

world price. Consumers are losers because they
pay a higher price and buy less of the product.
Since the domestic price rises, domestic firms
increase output and see their profits rise.
Import Quotas
A quota is a limit on the amount of imports. For

example, the U.S. allows 1 million tons of sugar to be
imported but no more than that.
The quota has the same effects on

producers and consumers as a tariff.
The domestic price rises above the
world price.
Other Barriers to Trade
export subsidies
health & safety standards
government procurement policies

Arguments for Protectionism
1. save and promote domestic jobs - although costs
outweigh benefits
2. infant industries - a subsidy is less costly
3. national defense - ignores stockpiling and
purchases from friendly countries
4. "fair" trade - unlikely to force other countries to
lower their trade barriers
www.bankersadda.com
www.careerpower.in

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Dear Readers,

Instead of attending college you could be doing

opportunity cost of attending college would be the

Production Possibilities Frontier

What it shows: the maximum combinations of two

economics grade earned because you

So, since the marginal costs of attending class today are

The circular flow diagram shows the interactions

An economic actor is any entity that makes an economic

government ownership of resources

government allocation of resources and the

private ownership of resources

Markets and Prices

The supply curve is a graph of the supply schedule.

Supply and Demand, Part 2

Equilibrium occurs at a price of $3. The equilibrium

Demand and supply curves are simply graphs of

An increase in demand means that consumers wish to purchase

A decrease in demand, on the other hand, means that people wish to

changes in expected future prices

changes in the prices of related goods

Supply and Demand, Part 3

changes in the population of potential buyers

changes in the prices of inputs

tells us the percentage change in quantity

is always negative, so the negative sign is

greater than 1, demand is elastic: consumers

equal to 1, demand is unit elastic

Determinants of Price Elasticity of Demand

definition of the market: the more widely defined

Elasticity and Total Revenue

if demand is elastic, a rise in price causes a fall in

if demand is inelastic, a rise in price causes TR to

Price Ceilings and Floors

There are 4 alternatives to the market as a way of

A price floor is a legal minimum price. An example is the

Relationship Between Output and Resources

Extra Output of the Group

Average Total Cost (ATC)

Marginal Cost (MC) is the change in total cost when the

A firm facing a downward sloping demand curve chooses both

Desktop publishing has low fixed costs: just a

Airlines have huge fixed costs. An airline must

profit maximizationmarket structure

if MR > MC produce more output to increase

if MR < MC costs more to produce another

A profit maximizing firm will continue to expand

Market Structureelements of market structure:

nominal and real interest ratespresent valuestock

Market interest rates are nominal interest rates,

For example, the present value of $100 to be received

exchanges v. over-the-counter markets

What Determines the Price of a Share of Stock

The incentive to profit from mispricing contributes to

Gross Domestic Productgross domestic productGDP as a

Unemployment and Inflation business cycles measuring

Gross Domestic Product

goods and services are valued at their market

GDP excludes things not exchanged on the

GDP only counts final products (those

GDP as a Measure of Welfare

GDP includes some items that clearly do not