ECON 114Important Notes

and Review

W2013-14 Term 2

FIGURE 2.1:The Circular Flow

MARKET OF CONSUMPTION

MARKET OF PRODUCTION

Positive versus Normative Analysis

Positive statements: claims that attempt to describe the world as it is

Normative statements: claims that attempt to prescribe how the world should be

Nominal Income Real Income

Nominal Income – (CPI * 100) = Real Income

GDP is…

GDP = C + I + G + NX (Y) = Consumption + Investment + Govt Purchases + Net Export

Note Net Capital Outflow = Net Exports NCO = NX

Shifts in the Demand Curve

Factors that shift the demand curve (continued):Prices of related goods:

Substitutes: two goods for which an increase in the price of one leads to an increase in the demand for the other

Complements: two goods for which an increase in the price of one leads to a decrease in the demand for the other

Meat VS Mining

Coal Mining VSOil Mining

The Supply Curve: The Relationship Between Price and Quantity Supplied

Quantity supplied: the amount of a good that sellers are willing and able to sell

Law of supply: the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises

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Supply schedule: a table that shows the relationship between the price of a good and the quantity supplied

Supply curve: a graph of the relationship between the price of a good and the quantity supplied

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The Supply Curve: The Relationship Between Price and Quantity Supplied

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Equilibrium price: the price that balances quantity supplied and quantity demanded (people buy product at $$$)

Equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price (people buying # of products)

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Equilibrium

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FIGURE 4.8:The Equilibrium of Supply and Demand

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This is an example

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Surplus: quantity supplied > quantity demanded

Shortage: quantity supplied < quantity demanded

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Equilibrium

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FIGURE 4.9:Markets Not in Equilibrium

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Elasticity:

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• A measure of the responsiveness of quantity demanded or quantity supplied to a change in on of its determinants

PRICE ELASTICITY =

Income Elasticity of Demand:

It measures how the quantity demanded chagnges as consumers’ income changes and calculated as

I ncome  Elasticityof  Demand

=% Change   in  Quantity  Demanded% Change   in  Income

Financial Markets: The Bond Market

Bond: a certificate of indebtedness that specifies the obligation of the borrower to the holder of the bond

Debt finance: the sale of a bond to raise money

Characteristics: bond’s termbond’s credit risk

Someone borrows some $$$$ (money)

If Buying a Bond lending moneyIf Selling a Bond borrowing money

Bond is really small chunks of a loanEx: $1M loan = 10 000 of $100 bonds

National saving (S): the total income in the economy that remains after paying for consumption and government purchases

Some Important Identities

Let T denote the taxes collected by government minus transfer payments.

National saving can then be expressed in either of two ways:

or

Some Important Identities

Private saving: the income that households have left after paying for taxes and consumption

Public saving: the tax revenue that the government has left after paying for its spending

Some Important Identities

Budget surplus:

Budget deficit:

Some Important Identities

T=TaxesG=Government Spending

Suppose GDP equals $10 million, consumption equals $6.5 million, the government spends $2 million and has a budget deficit of $300 000.

Find public saving, taxes, private saving, national saving, and investment.

Active Learning A. Calculations

Given: Y (is GDP) = 10.0, C = 6.5, G = 2.0, G – T = 0.3

Public saving = T – G = – 0.3

Taxes: T = G – 0.3 = 1.7

Private saving = Y – T – C = 10 – 1.7 – 6.5 = 1.8

National saving = Y – C – G = 10 – 6.5 = 2 = 1.5

Investment = national saving = 1.5

Active Learning Answers: Part A

Use the numbers from the preceding exercise but suppose now that the government cuts taxes by $200 million.

In each of the following two scenarios, determine what happens to public saving, private saving, national saving, and investment.

1. Consumers save the full proceeds of the tax cut.

2. Consumers save 1/4 of the tax cut and spend the other 3/4.

Active Learning B. Calculations

In both scenarios, public saving falls by $200 million, and the budget deficit rises from $300 million to $500 million.

1. If consumers save the full $200 million, national saving is unchanged, so investment is unchanged.

2. If consumers save $50 million and spend $150 million, then national saving and investment each fall by $150 million.

Active Learning Answers: Part B

Net Export

= Total Exports – Total Imports

ECON 114Macro-Economics

Definitions for each chapter

Chapter 1business cycle fluctuations in economic activity, such as employment and production (p. 15)

economics the study of how society manages its scarce resources (p. 4)

efficiency the property of society getting the most it can from its scarce resources (p. 5)

equity the property of distributing economic prosperity fairly among the members of society (p. 5)

externality the impact of one person's actions on the well-being of a bystander (p. 12)

incentive something that induces a person to act (p. 8)

inflation an increase in the overall level of prices in the economy (p. 14)

marginal changes small incremental adjustments to a plan of action (p. 7)

market economy an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services (p. 10)

market failure a situation in which a market left on its own fails to allocate resources efficiently (p. 12)

market power the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices (p. 12)

opportunity cost whatever must be given up to obtain some item (pp. 7, 55)

productivity the quantity of goods and services produced from each hour of a worker 's time (pp. 13, 145)

property rights the ability of an individual to own and exercise control over scarce resources (p. 12)

rational people people who systematically and purposefully do the best they can to achieve their objectives (p. 7)

scarcity the limited nature of society's resources (p. 4)

Chapter 2

circular-flow diagram

a visual model of the economy that shows how dollars flow through markets among households and firms (p. 24)

macroeconomics the study of economy-wide phenomena, including inflation, unemployment, and economic growth (pp. 29, 100)

microeconomics the study of how households and firms make decisions and how they interact in markets (pp. 29, 100)

normative statements claims that attempt to prescribe how the world should be (p. 30)

positive statements claims that attempt to describe the world as it is (p. 30)

production possibilities frontier

a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology (p. 26)

Chapter 3

absolute advantage the comparison among producers of a good according to their productivity (p. 55)

comparative advantage the comparison among producers of a good according to their opportunity cost (p. 55)

exports goods and services that are produced locally and sold abroad (pp. 60, 274)

imports goods and services that are produced abroad and sold locally (pp. 60, 274)

opportunity cost whatever must be given up to obtain some item (pp. 7, 55)

Chapter 4 Part 1competitive market a market in which there are many buyers and many sellers so that each has a negligible

impact on the market price (p. 68)

complements two goods for which an increase in the price of one leads to a decrease in the demand for the other (p. 73)

demand curve a graph of the relationship between the price of a good and the quantity demanded (p. 70)

demand schedule a table that shows the relationship between the price of a good and the quantity demanded (p. 69)

Equilibrium a situation in which the price has reached the level where quantity supplied equals quantity demanded (p. 79)

equilibrium price the price that balances quantity supplied and quantity demanded (p. 79)

equilibrium quantity the quantity supplied and the quantity demanded at the equilibrium price (p. 79)

inferior good a good for which, other things equal, an increase in income leads to a decrease in demand

law of demand the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises (p. 69)

law of supply the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises (p. 75)

law of supply and demand

the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance (p. 81)

Chapter 4 Part 2market a group of buyers and sellers of a particular good or service (p. 68)

normal good a good for which, other things equal, an increase in income leads to an increase in demand (p. 72)

quantity demanded the amount of a good that buyers are willing and able to purchase (p. 69)

quantity supplied the amount of a good that sellers are willing and able to sell (p. 75)

shortage a situation in which quantity demanded is greater than quantity supplied (p. 80)

substitutes two goods for which an increase in the price of one leads to an increase in the demand for the other (p. 72)

supply curve a graph of the relationship between the price of a good and the quantity supplied (p. 76)

supply schedule a table that shows the relationship between the price of a good and the quantity supplied (p. 75)

surplus a situation in which quantity supplied is greater than quantity demanded (p. 80)

Chapter 5consumption spending by households on goods and services, with the exception of purchases of new housing (p. 105)

GDP deflator a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100 (p. 110)

government purchases spending on goods and services by local, territorial, provincial, and federal governments (p. 106)

gross domestic product (GDP)

the market value of all final goods and services produced within a country in a given period of time (p. 102)

investment spending on capital equipment, inventories, and structures, including house- hold purchases of new housing (p. 106)

macroeconomics the study of economy-wide phenomena, including inflation, unemployment, and economic growth (pp. 29, 100)

microeconomics the study of how house- holds and firms make decisions and how they interact in markets (pp. 29, 100)

net exports the value of a nation's exports minus the value of its imports; also called the trade balance (pp. 106, 274)

nominal GDP the production of goods and services valued at current prices (p. 109)

real GDP the production of goods and services valued at constant prices (p. 109)

Chapter 6

consumer price index (CPI)

a measure of the overall cost of the goods and services bought by a typical consumer (p. 124)

core inflation the measure of the underlying trend of inflation (p. 127)

indexation the automatic correction of a dollar amount for the effects of inflation by law or contract (p. 132)

inflation rate the percentage change in the price index from the preceding period (p. 126)

nominal interest rate

the interest rate as usually reported without a correction for the effects of inflation (p. 133)

real interest rate the interest rate corrected for the effects of inflation (p. 133)

Chapter 7

catch-up effect the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich (p. 151)

diminishing returns the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases (p. 150)

human capital the knowledge and skills that workers acquire through education, training, and experience (p. 146)

natural resources the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits (p. 146)

physical capital the stock of equipment and structures that are used to produce goods and services (p. 145)

productivity the quantity of goods and services produced from each hour of a worker 's time (pp. 13, 145)

technological knowledge

society's under- standing of the best ways to produce goods and services (p. 146)

Chapter 8 Part 1

bond a certificate of indebtedness (p. 169)

budget deficit a shortfall of tax revenue from government spending (p. 177)

budget surplus an excess of tax revenue over government spending (p. 177)

crowding out a decrease in investment that results from government borrowing (p. 184)

financial intermediaries

financial institutions through which savers can indirectly provide funds to borrowers (p. 172)

financial markets financial institutions through which savers can directly provide funds to borrowers (p. 169)

financial system the group of institutions in the economy that help to match one person's saving with another person's investment (p. 168)

Chapter 8 Part 2government debt the sum of all past budget deficits and surpluses (p. 183)

government net debt the difference between the value of government financial liabilities and financial assets (p. 186)

market for loanable funds the market in which those who want to save supply funds and those who want to borrow to invest demand funds (p. 178)

mutual fund an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds (p. 172)

national saving (saving) the total income in the economy that remains after paying for consumption and government purchases (p. 176)

private saving the income that house- holds have left after paying for taxes and consumption (p. 176)

public saving the tax revenue that the government has left after paying for its spending (p. 177)