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Section 1: Introduction to Economics

Economics: study of rationing systems; study of how scarce resources are allocated to fulfill the
infinite wants of consumers.

Economic good: any good or service that has a price and is being rationed

Scarcity: excess of human wants over what can actually be produced to fulfill these wants

Free Good: a good with a zero opportunity cost of production (e.g. air, salt water)

Opportunity cost: the next best alternative foregone when an economic decision is made (not in
monetary terms)

Factors of Production: four resources that allow a country to produce its good (land, labor, capital
and management)

Factor Endorsements: the quantity and quality of factors of production available

Production Possibility Curve PPC: shows the maximum combination of goods and services that can
be produced by an economy in a given time period, if all resources in the economy are being used
fully/efficiently and the state of technology is fixed

Utility: a measure of usefulness and pleasure

Total utility: total satisfaction gained from consuming a certain quantity of a product

Marginal utility: extra utility gained from consuming one more unit of a product

Productivity: output per person

Positive statement: one that might be proven wrong or false by looking at facts

Normative statement: based on subjective opinions and cannot be proven right or wrong (look for
“ought” “should” “too much” “too little”)

Ceteris paribus: all other factors held fixed

Private sector: part of production in the economy that is owned by private individuals (firms)

Public sector: part of production

Durable Goods: consumed over time (e.g. cars, washing machines)

Non durable goods: consumed over a short period of time (e.g. ice cream)

Goods: tangible products

Services: intangible products

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Planned economy: decision as to what to produce, how to produce and who to produce for are
made by a central body, the government

Free market economy: prices are used to ration goods and services, production is in private hands.
Market forces (supply and demand) instead of government

Transition economy: country moving towards a free market economy from being a planned
economy

National income: value of all the goods and services produced in an economy in a given time period,
normally one year

Economic growth: increase in real national income over time

Potential growth: rate by which an economy could grow if all its resources were fully employed

Actual growth: increase in the amounts of goods and services actually produced

Economic development: an improvement in welfare (well-being), using not only monetary but also
education, health and social indicators (HDI)

Sustainable development: development that meets the needs of the present without compromising
the ability
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Section 2: Microeconomics

Microeconomics: the section of economics that deals with smaller, discrete economic agents and
their reactions to changing events

Demand: quantity of a good or service that consumers are willing and able to purchase at a given
price in a given time period

Law of Demand: as the price of a product falls, the quantity demanded of the product will usually
increase, ceteris paribus

Substitution effect: if the price of good X rises, all other goods automatically become relatively
cheaper, replacing good X

Income effect: if the price of good X rises, consumer’ real income (the purchasing power of income)
drops

Normal goods: products, for which the demand increases as income rises

Inferior goods: products, for which the demand decreases as income rises

Superior goods: products, for which the demand increases proportionally more as income rises

Substitutes: an increase in the price of one product will lead to an increased demand for the other
product

Complements: products that are purchased together

Supply: quantity of a good or service that producers are willing and able to produce at a given price
in a given time period

Law of Supply: as the price of a product rises, the quantity supplied of the product will usually
increase, ceteris paribus

Indirect taxes: additional payments on goods and services that are added to the price of a product

Subsidy: payment made by the government to firms that reduces the costs (per unit of output)

Equilibrium: state of rest, self-perpetuating in the absence of any outside disturbance

Elasticity: measure of responsiveness

Elasticity of demand: a measure of how much the demand for a product changes when there is a
change in one of the factors that determine demand

Price Elasticity of Demand (PED): a measure of how much the quantity demanded of a product
changes when there is a change in the price of the product

Cross elasticity of Demand (XED): a measure of how much the quantity demanded for a product
changes when there is a change in the price of another product
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Income Elasticity of Demand (YED): a measure of how much the quantity demanded for a product
changes when there is a change in the consumer’s income

Price elasticity of supply (PES): a measure of how much the quantity supplied of a product changes
when there is a change in the price of the product

Specific tax: fixed amount of a tax imposed on a product

Ad valorem tax: percentage tax imposed on a product

Short Run: the period of time in which at least one factor of production is fixed. All production takes
place in the short run.

Long Run: that period of time in which all factors of production are variable, but the state of
technology is fixed. All planning takes place in the long run.

Total product (TP): total output that a firm produces, using its fixed and variable factors in a given
time period.

Average product (AP): output that is produced by each unit of the variable factor. AP = TP/V

Marginal product (MP): extra output that is produced by using an extra unit of the variable factor.
MP= ΔTP/ΔV

Diminishing marginal returns: As extra units of a variable factor are added to a given quantity of a
fixed factor, the output from each additional unit of the variable factor will eventually diminish.

Diminishing average returns: As extra units of a variable factor are added to a given quantity of a
fixed factor, the output per unit of the variable factor will eventually diminish.

Total costs (TC): all fixed and variable costs, needed to produce a certain output in a given time
period, added together

Total fixed cost (TFC): the total cost of the fixed assets that a firm uses in a given time period.

Total variable cost (TVC): the total cost of the variable asset that a firm uses in a given time period.

Average total cost (ATC): the total cost per unit of output (=AFC+AVC)

Average fixed cost (AFC): the fixed cost per unit of output

Average variable cost (AVC): the variable cost per unit of output

Marginal cost (MC): the increase in total cost of producing an extra unit of output. ΔTP/Δq

Sunk costs: entry costs that are not recoverable upon exit

Economies of scale: any decreases in long-run average costs that come about when a firm alters all
of its factors of production in order to increase its scale of output.

Diseconomies of scale: any increases in the long-run average costs that come about when a firm
alters all of its factors of production in order to increase its scale of output.
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Revenue: income that a firm receives from selling its products, goods, and services over a certain
time period.

Total revenue (TR): total amount of money that a firm receives from selling a certain amount of a
good or service in a given time period (TR = p X q)

Average revenue (AR): revenue that a firm receives per unit of sales.

Marginal revenue (MR): extra revenue that a firm gains when it sells one more unit of a product in a
given time period. ΔTR/Δq

Profit: Total revenue minus total cost, including opportunity cost

Abnormal profits: when total revenues are greater than total costs, incl. opportunity cost

Normal profits: when total revenues equal total costs, incl. opportunity cost

Shut-down price: level of price that enables a firm to cover its variable costs. If price does not cover
average variable costs, the firm will shut down in the short run.

Break-even price: the price at which a firm is able to make a normal profit in the long run, i.e. it will
break even covering all of its costs including the opportunity cost.

Profit maximizing level of output: cost of producing another unit is equal to the revenue gained from
this unit. MC=MR

Homogeneous goods: exactly identical products, e.g. wheat

Productive efficiency: production at the lowest possible average cost (unit cost) MC=AC

Allocative efficiency: “socially optimum level of output” when suppliers are producing the optimal
mix of goods and services required by consumers MC=AR

Consumer surplus: the extra satisfaction (or utility) gained by consumers from paying a price that is
lower than that which they are prepared to pay.

Producer surplus: excess of actual earnings that a producer makes from a given quantity of output,
over and above the amount the producer would be prepared to accept for that output.

Pareto optimality: a market in equilibrium, with no external influences and no external effects

Community surplus: consumer + producer surplus

Public goods: goods that would not be provided at all in a free market – a good that is non-
excludable and non-rivalrous. E.g. national defense, flood barriers

Merit good: a good that will be underprovided by the market and therefore will be under consumed
e.g. education, health care, sports facilities

Demerit good: a good that will be over provided by the market and therefore will be over produced,
e.g. cigarettes, alcohol

Externality: when production or consumption of a good causes an effect upon a third party
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Giffen good: unique type of inferior good with upwards sloping demand curve “e.g. Irish potatoes”

Veblen good: a product for which the demand rises together with price, b/c satisfaction from
consuming expensive products.

Bandwagon effect: price rises due to expectations, e.g. stock market

Engel’s Law: as incomes increase, a declining proportion is spent on food because of the fixed
capacity of the human stomach

Commodities: primary products used as inputs in manufacturing

Collusive oligopoly: when two or more firms agree to fix prices or to engage in other anticompetitive
behavior

Section 3: Macroeconomics

Macroeconomics: the section of economics that considers such things as measuring all the economic
activity in the economy, inflation, unemployment and the distribution of income

Output method: measures the actual value of the goods and services produced

Income method: measures the value of all the incomes earned in the economy

Expenditure method: measures the value of all spending on goods and services in the economy

GDP (gross domestic product): value of all spending in the economy (C+I+G+(X-M))

: the total of all economic activity in a country

GNP (gross national product): total income that is earned by a country’s factors of production

: GNP = GDP + net property income from abroad

NNP (net national product): GNP – depreciation

Nominal GDP: value of GDP at constant prices

Real GDP: nominal GDP adjusted for inflation

Aggregate demand: total spending on goods and services in a period of time at a given price level
(C+I+G+(X-M))

Consumption: total spending by consumers on domestic goods and products

Investment: addition of capital stock to the economy

Replacement investment: spending on capital in order to maintain the productivity of existing capital

Induced investment: spending on capital to increase the output to respond to higher demand in the
economy
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Fiscal policy: set of government policies relating to its spending and taxation rates

Monetary policy: set of official policies governing the supply of money in the economy and the level
of interest rates in an economy.

Aggregate supply: total amount of goods and services that all industries in the economy will produce
at every given price level in a period of time

Business cycle(trade cycle): a pattern where there are periods of rising growth, followed by periods
of slowing growth or even falling growth.

Multiplier effect: any increase in aggregate demand will result in a proportionately larger increase in
the national income

Marginal propensity to consume (MPC): additional income spent on domestic goods and services

Accelerator theory: level of induced investment will be determined by the rate of change of national
income

Inflation: persistent increase in the average price level in the economy, measured with CPI
(consumer price index)

Deflation: persistent decrease in the average price level in the economy

Unemployment: people of working age who are without work, available for work and actively
seeking employment

Disequilibrium unemployment: occurs when there are any conditions prevailing the labor market
from clearing, i.e. reaching the labor market equilibrium.

Real wage unemployment (classical unemployment): caused by existence of minimum

wages above the labor market equilibrium

Demand deficient unemployment (cyclical unemployment): caused by periods of slower

growth or recession in the economy

Equilibrium unemployment: this is the natural unemployment that occurs when the labor market is
cleared, i.e. at equilibrium.

Frictional unemployment: short-term unemployment that occurs when people are in

between jobs, or have left education and are waiting to take up their first job.

Seasonal unemployment: the demand for certain types of workers falls naturally at certain
times of the year, e.g. farmers in cold winters

Structural unemployment: occurs when there is a permanent fall in the demand for a
particular type of labor, e.g. coal mining

Natural rate of unemployment: exists when the labor market is in equilibrium

Labor force (work force): economically active population

Direct tax: imposed on people’s income or wealth and on firm’s profits.

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Indirect tax (expenditure or consumption based taxes): a certain amount that government charges
on top of the price of a good or service

Progressive taxes: as incomes rise, people pay a higher proportion of this income in taxes

Regressive taxes: as income rises, people pay a smaller percentage of their income in taxes

Proportional taxes: if income paid in tax is constant for all income levels

Transfer payments: using tax revenues to redistribute income and provide different types of
assistance to groups in the economy to improve their living standards

Section 4: International Trade

International trade: exchange of goods and services between countries

Free trade: when there are no barriers put in place by governments or international organizations
and goods and services are allowed to move freely between countries

Absolute advantage: being able to produce a good using fewer resources than another country.

Comparative advantage: being able to produce a good at a lower opportunity cost than another
country

Tariff: tax charged on an imported good

Quota: physical limit on the numbers or value of goods that can be imported into a country

Voluntary export restraints: agreements between exporting and importing countries in which the
exporting country agrees to limit the quantity of exports of a specific good below a certain level

Administrative barriers: lengthy and complicated processes slowing down imports

Embargoes: extreme quota, complete ban

Globalization: the increased integration of national economies into global, rather than national
markets, prompted by liberalized capital flows, liberalized trade flows, significant advantages in
information technology and marked decreases in the costs of international transport

Trading bloc: a group of countries that join together in some form of agreement in order to increase
trade between themselves and/or to gain economic benefits from cooperation in some level

Preferential trading areas: a trading bloc that gives preferential access to certain products
from certain countries (usually eliminating tariffs) e.g. EU and ACP(African, Caribbean, Pacific)
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Free trade areas: an agreement made between countries, where the countries agree to trade
freely among themselves, but are able to trade with countries outside of the free trade area
in whatever way the wish e.g. NAFTA

Customs union: an agreement made between countries where the countries agree to trade
freely among themselves, and they also agree to adopt common external barriers against any
country attempting to import into the customs union e.g. EU

Common market: a customs union with common policies on product regulation, and free
movement of goods, services, capital, and labor e.g. EU

Economic and monetary union: a common market with a common currency e.g. Eurozone in
EU

Complete economic integration: final stage of economic integration, at which point the
individual countries involved would have no control of economic policy, full monetary union,
and complete harmonization of fiscal policy.

Trade creation: occurs when the entry of a country into a customs union leads to the production of a
good or service transferring from a high-cost producer to a low-cost producer.

Trade diversion: occurs when the entry of a country into a customs union leads to the production of
a good or service transferring from a low-cost producer to a high-cost producer.

Exchange rate: the value of one currency expressed in terms of another currency.

Fixed exchange rate: an exchange rate regime where the value of a currency is fixed, or pegged, to
the value of another currency, or to the average value of a selection of currencies, or to the value of
some other commodity, such as gold.

Floating exchange rate: an exchange rate regime where the value of a currency is allowed to be
determined solely by the demand for, and supply of, the currency on the foreign exchange market.

Purchasing power parity theory: in the long run, exchange rates should move towards levels that
would equalize the prices of an identical basket of goods and services

Balance of payments: a record of the value of all the transactions between the residents of one
country with the residents of all other countries in the world over a given period of time.

Current account: a measure of the flow of funds from trade in goods and services, plus other
income flows

Capital account: a measure of the buying and selling of assets between countries

Assets: anything that can be owned and has a value, e.g. land, real estate companies,
stocks etc.

Marshall-Lerner condition: a rule that tells us how successful a depreciation or devaluation of a

currency’s exchange rate will be as a means to improve a current account deficit in the balance of
payments

Terms of trade: index relating average export price to average import prices.
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Section 5: Development Economics

Dependency ratio: percentage of those who are non-productive (below 15, above 65), expressed as a
percentage of those of working age (15-65)

Crude birth rate: annual number of live births per 1000 of population

Capital widening: exists when extra capital is used with an increased amount of labor, but the ratio
of capital per worker does not change

Capital deepening: exists when there is an increase in the amount of capital for each worker

Capital flight: occurs when money and other assets flow out of country to seek a “safe haven” in
another country

Poverty trap: any linked combination of barriers to growth and development that forms a circle, thus
self-perpetuating unless the circle can be broken.

Foreign direct investment (FDI): long-term investment by private MNCs in countries overseas.

Micro-finance: provides financial services, such as small loans, savings accounts and insurance.

Aid: any assistance given to country that would not have been provided through normal market
forces.

Humanitarian aid: given in order to alleviate short-term suffering (droughts, wars, natural
disasters)

Development aid: given in order to alleviate poverty in the long run and improve the welfare
of individuals