Economics Flashcards
Factors that impact demand elasticity:
Substitutes
Portion of income spent on good
Time
Substitution effect
P↓ QD ↑
Income effect
P↓ QD ↑ or ↓ (normal / inferior goods)
Giffen good
P↑ QD ↑ (low income goods)
Veblen good
P↑ QD ↑ (luxury goods)
Factors of production
Land
Labour
Capital
Materials
Production function
relationship between output and the size of labour force / capital stock / productivity
Total revenue is greatest in the part of a demand curve that is:
unit elastic
Total revenue is maximized at the quantity at which own-price elasticity equals –1
A distinction between Giffen goods and Veblen goods is that:
Giffen goods are inferior goods, while Veblen goods are not inferior goods.
Shutdown point
P = AVC
The firm is only just covering its variable costs
Impact of increased demand in perfect competition
- In SR: there is an increase in price
- In LR: new firms will enter the industry when profits >0 and leave when profits <0.
When a firm operates under conditions of pure competition, marginal revenue always equals:
Price
When a firm operates under conditions of pure competition, MR always equals price. This is because, in pure competition, demand is perfectly elastic (a horizontal line), so MR is constant and equal to price.
In which market structure(s) can a firm’s supply function be described as its marginal cost curve above its average variable cost curve?
Perfect competition only.
The supply function is not well-defined in markets other than those that can be characterized as perfect competition.
Is monopolistic competition effiecient?
Not clear
Due to advertising costs, product innovation, excessive producers,
The demand for products from monopolistic competitors is relatively elastic due to:
the availability of many close substitutes. If a firm increases its product price, it will lose customers to firms selling substitute products at lower prices.
Cournot model:
- Duopoly, both firms have identical MC curves
- Both firms produce the same quantity in equilibrium
- Price is defined by the other firm’s price in the previous period
- Price is lower than a monopoly but higher than perfect competition.
Stackelberg model:
- Duopoly, one firm is the leader and chooses the price
- Other firm sets price according to this price
- In equilibrium, the ‘leader’ charges the higher price and receive greater proportion of total profits
When is price discrimination within a monopoly possible?
Two identifiable groups of consumers with different demand elasticities
No potential for resale of good between the groups
Characteristics of a natural monopoly
Significant economies of scale
- ATC declines as output increases
- High fixed costs, low marginal costs
e.g. Utilities
Two ways of regulating monopolies
Average cost pricing:
- Price is charged where ATC=AR.
- Output and social welfare ↑
- economic profit = 0
Marginal cost pricing:
- Price is charged where MC=AR.
- May lead to a loss / require govt. subsidies if MC < ATC.
When can you describe a firm’s supply curve?
Only in perfect competition - where supply is equal to the marginal cost curve above the AVC curve. It is constructed by simply summing the quantities supplied at each price across all firms in the market.
In monopolistic competition, oligopolies and monopolies there is no well-defined supply function.
N-firm concentration ratio
Sum of the percentage market shares of the N largest firms in an industry
- market share = firm sales / total market sales
- lower ratios = more competitive market, higher ratios indicate oligopoly
Disadvantages:
- Ignores barriers to entry
- Largely unaffected by mergers
Herfindahl-Hirschman Index (HHI)
Sum of the squared market shares of N largest firms in a market
- 0.1 - 0.18: moderately competitive
- 0.18+ : uncompetitive
Advantages:
- More sensitive to mergers than N-firm ratio and widely used by regulators.
Disadvantages:
- Ignores barriers to entry and demand elasticity
In a perfectly competitive industry, the short-run supply curve for the market is the:
sum of the individual supply curves for all firms in the industry.
The short-run supply curve for a firm is its marginal cost curve above the average variable cost curve. The short-run supply curve of the market is the sum of the supply curves for all firms in the industry.
GDP
Sum of the final market values of goods and services produced in that period.
Includes only the purchases of newly produced goods and services. The sale or resale of goods produced from previous periods is excluded.
Transfer payments made by the Govt. (e.g. unemployment, retirement and welfare benefits) are not economic output and are not included.
GDO (expenditure approach, ‘value-of-final-output-method’)
GDP is calculated by summing the amounts spent on goods and services produced in the period
GDP (income approach)
GDP is calculated by summing the amounts earned by households and companies during the period
GDP (‘sum-of-value-added-method’)
GDP is calculated by summing the additions to the value-added at each stage of production
Nominal GDP
GDP calculated at current market prices
Real GDP
GDP calculated using prices from a base year, removing impact of inflation
GDP deflator
A price index used to convert nominal GDP into real GDP
= (Nominal GDP / GDP calculated at base year prices) * 100
Under the income approach, GDP or Gross Domestic Income (GDI) equals
national income + capital consumption allowance + statistical discrepancy
Capital consumption allowance (CCA)
Measures the depreciation of physical capital from the production of goods and services over a period.
aka. the amount that would have to be reinvested to maintain the productivity of physical capital from one period to the next.
National income
Sum of all income received by all factors of production that go into the creation of the final output.
National income is the income received by all factors of production used in the generation of final output. Personal income measures the pretax income that households receive. Disposable income is personal income after taxes.
Total Income
C + S + T
Consumption + Savings + Net taxes
C + S + T = C + I + G + ( X - M )
Aggregate Demand
AD = C + I + G + ( X - M )
Reflects the -ve relationship when:
- Goods market is in equilibrium ( Income = Exp. )
- Money market is in equilibrium ( nominal money supply adjusted for inflation )
Why AD curve slopes downwards:
- Wealth effect: P↓, Nominal purchasing power ↑, C↑
- Interest rate effect: IR↓, P↓, C↑
- Real exchange rate effect: Exch. R↑, X↓, M↑, (X-M) ↓
Causes of a shift in LRAS curve
- Δ labour productivity
- Δ natural resources
- Δ physical capital
- Δ technology
Recessionary gap
When real GDP is less than full employment GDP
Inflationary gap
The increase in output (in the SR) following an increase in AD.
This then returns back to the equilibrium level of output as defined by the LRAS curve.
Stagflation
LRAS shifts to left
Combination of declining economic output and higher prices.
High unemployment and high inflation exist at the same time.
Five pillars of economic growth:
- Labour supply
- Human capital
- Physical capital stock
- Technology
- Natural resources
Potential GDP
aggregate hours worked * labour productivity
Growth in potential GDP
growth in labour force + growth in labour productivity
or
growth in technology + labour % share of national income + capital % share of national income
Sustainable rate of economic growth
the rate of increase in the economy’s productive capacity
An economy’s sustainable rate of growth depends on the growth rate of the labour supply and the growth rate of labour productivity. Due to diminishing marginal productivity, an economy generally cannot achieve long-term sustainable growth through continually increasing the stock of capital relative to labour (i.e., capital deepening).
The sustainable growth rate is positively affected by increases in the supply of natural resources, the supply of physical capital, or the supply or productivity of labor. An increase in government spending does not increase an economy’s sustainable growth rate.
Economic output, GDP, (Y) formula
Y = Total factor productivity (advances in technology) (A) * a Function of labour and capital f(L,K)
Y = A * f( L, K )
Labour productivity is most likely to increase as a result of:
Increase in physical capital.
Total factor productivity
Output growth in excess of that resulting from the growth in labour and capital.
Difference in values of sum-of-value added method and value-of-final-output method?
None
Business cycle
is characterized by GDP and the rate of unemployment:
- Expansion (real GDP is increasing)
- Peak (real GDP stops increasing and begins decreasing)
- Contraction or recession (real GDP is decreasing)
- Trough (real GDP stops decreasing and begins increasing).
Credit cycles
Cyclical fluctuations in interest rates and the availability of loans (credit)
Increase in the inventory-sales ratio
When an expansion is approaching its peak, sales growth begins to slow and unsold inventories accumulate.
Firms respond by reducing production leading to a contraction in the economy.
Problem with assessing the economy using just GDP growth (and not inventory-sales ratio)
Economic strength may seem strong when it is actually declining - this is because an increase in inventories counts as an increase in economic output, when it is actually a sign of falling sales.
Important determinants of the level of economic activity in the housing sector:
- Mortgage rates
- Housing costs relative to income
- Speculative activity
- Demographic factors
Characteristics of a trough
- GDP changes from negative to positive
- Unemployment rate high
- Spending on durable goods and housing ↑
- Inflation ↓
Characteristics of a expansion
- GDP ↑
- Unemployment ↓
- Investment in producers’ equipment and construction ↑
- Inflation ↑
- Imports ↑
Characteristics of a peak
- GDP growth rate ↓
- Unemployment ↓
- Consumption ↑
- Inflation ↑
Characteristics of a recession
- GDP growth rate -ve
- Unemployment ↑
- Consumption ↓
- Inflation ↓ (with lag)
- Imports ↓
Neoclassical school of thought
- AD and AS driven by technology
- Business cycles only SR deviations from the long-run equilibrium
Keynesian school of thought
- Economy defined by level of confidence
- Policy-makers should increase AD through monetary and fiscal policies.
New Keynesian school of thought
Prices cannot be decreased easily which presents additional barriers to the restoration of full employment
Monetarist school of thought
Variations in AD are due to the rate of growth in the money supply
- Slow and steady increase in the money supply best strategy
Austrian school of thought
Real business cycle theory (RBC) - emphasises the impact of ‘external shocks’ on economy (e.g. changes in technology)
- Policy-makers should not intervene with business cycles
Leading Indicators
- Weekly hours
- New orders
- Stock prices
- Building permits
- Yield curve
- Unemployment claims
Coincidental Indicators
- Industrial production
- Personal income
- Manufacturing and trade sales
- Employees on nonfarm payrolls
Lagging indicators
- Unemployment
- Inventory-sales ratio
- Commercial and industrial loans
- CPI
- Prime rate
- Manufacturing costs per unit of output
- Consumer credit/income ratio
Underemployment
When a worker is part-time and would prefer to work full-time or is employed in a low-paying job despite being highly qualified
Participation ratio
% of working-age population who are employed/actively seeking employment
Disinflation
Inflation rate that decreases over time but remains above 0
Headline inflation
Price indexes for all goods
Core inflation
Price indexes excluding food and energy
Three factors causing a Laspeyres index of consumer prices to be biased upwards
- New more expensive goods added to basket
- Improvements in good making it more expensive
- Substitution of goods
Hedonic pricing
Adjusting the price index for product quality
Fisher Index
Geometric mean of the Laspeyres index and the Paasche index.
Used to address bias from substituting in Laspeyres index, by using chained or chain-weighted price index
Paasche Index
Takes into account both the quantity purchased in both the base period and the current period.
(as opposed to just the current period in the Laspeyres index)
Autarky
A country that does not trade with other countries
World price
The price of a good or service in world markets for those to whom trade is not restricted.
absolute advantage
producing a good at a lower resource cost than another country.
comparative advantage
producing a good at a lower opportunity cost than another country.
Ricardian model of trade
one factor of production—labour
Heckscher-Ohlin model
two factors of production—capital and labour
Reasons for trade restrictions:
- Infant industry: protect domestic industries so they can grow and become internationally competitive
- National security/political reasons
- Protecting domestic jobs
- Protecting domestic industries
Free trade area
- No barriers to trade between countries
Customs Union
- No barriers to trade between countries
2. Common set of trade restrictions with non-member countries
Common Market
- No barriers to trade between countries
- Common set of trade restrictions with non-member countries
- No barriers to the movement of labour and capital
Economic Union
- No barriers to trade between countries
- Common set of trade restrictions with non-member countries
- No barriers to the movement of labour and capital
- Common institutions and economic policy
Monetary Union
- No barriers to trade between countries
- Common set of trade restrictions with non-member countries
- No barriers to the movement of labour and capital
- Common institutions and economic policy
- Single currency.
Common aims of capital restrictions imposed by governments
- Reduce domestic price volatility
- Maintain fixed exchange rates
- Keep interest rates low
- Protect strategic industries
Current Account
- Trade balance (merchandise/services)
- Income balance (foreign dividends/interest, unilateral transfers)
Capital Account
- Sales/purchases of physical assets
- natural resources
- intangible assets
- debt forgiveness
- death duties
- taxes
Financial Account
- Government-owned assets abroad (e.g. gold, foreign currencies, foreign securities)
- Foreign-owned assets in the country (e.g. domestic government and corporate securities, direct investment in the domestic country)
Balance of Payments equation
( X - M ) = S - I + ( T - G )
IMF
- Monetary cooperation
- Growth of trade
- Exchange stability
- Multilateral system of payments
- Overcome temporary BOP difficulties
World Bank
- Fight poverty
- Development and assistance
WTO
- Enforce global rules of trade
- Ensure trade flows are operational
- Dispute settlement process
- Multilateral trading system agreements
Voluntary export restraints
agreements to limit the volume of goods and services exported to another country.
Minimum domestic content rules
limitations imposed by a government on its domestic firms
Real exchange rate
nominal exchange rate * ( CPI base currency / CPI price currency )
Economic cost
Total opportunity costs of all factors of procuction
Economic profit
TR - total economic costs
Accounting profit
TR - total accounting costs
Normal profit
accounting profit just covers implicit costs (Zero economic profit)
Currency board arrangement
an explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate.
conventional fixed peg arrangement
a country pegs its currency within margins of ±1% versus another currency or a basket that includes the currencies of its major trading or financial partners.
Target zone exchange rate policy
permitted fluctuations in currency value relative to another currency or basket of currencies are wider (e.g., ±2%).
crawling peg
the exchange rate is adjusted periodically, typically to adjust for higher inflation versus the currency used in the peg
Managed floating exchange rate
Not target, managed through direct intervention or monetary policy
Independently floating exchange rate
Market determined
absorption approach
( X - M ) = ( S - I ) + ( T - G )
The sum of all income generated by factors of production that go into the creation of final output is called:
national income
Money neutrality
changes in the money supply only affect nominal variables and not real variables.
automatic stablisers
elements built into the government budget that reduce fluctuations in economic activity without the need for discretionary actions e.g. income taxes, transfer payments
speculative demand for money
where investing money is more risky than holding cash
forward points
Forward points = (Forward – Spot) × 10,000
interest rate parity
difference in IRs in two countries, same as difference in between SPOT exch. rates and FWRD exch rates
Fisher effect
differences in IRs due to differences in inflation
Purchasing power parity
rate of depreciation in one country’s currency = excess inflation rate in other country
Transaction demand for money
the quantity of money that all the Individuals and firms desire to keep on hand for the purpose of financing their forthcoming expenditure - determined by level of economic activity
Neutral interest rate
method of identifying contractionary/expansionary monetary policy
trend growth + inflation target
estimated growth in GDP
growth in labour force + growth in productivity
first-degree price discrimination
(perfect price discrimination) involves charging each customer their reservation price.
second-degree price discrimination
using the quantity purchased as the basis for the pricing of a particular good.
third-degree price discrimination
segregating customers by demographic or other traits
The most likely initial (short-run) effect of demand–pull inflation is an increase in
commodity prices
When considering the long-run aggregate supply curve, the long run is best described as the time required for which items to become variable?
Wages, prices, and expectations
crowding out
Gov Exp ↑ C ↓
- Govt’s take up all of the bank’s lending capacity, causing IR ↑
- Taxes ↑ to fund Govt. Exp
- Govt. exp putting private entities out of business
Quota rents
gains to foreign exporters who receive import licenses under a quota, if the domestic government does not charge for the import licenses
Voluntary Export Restraint (VER)
a trade restriction on the quantity of a good that an exporting country is allowed to export to another country. This limit is self-imposed by the exporting country.
Precautionary money demand
emergency savings (rise with GDP)
Fundamental assumption of monetary policy?
Money is not neutral in the short run.
If money were neutral in the short run, monetary policy would not be effective in influencing the economy.
The proposition that the real interest rate is relatively stable is most closely associated with
The Fisher effect
- based on the idea that the real interest rate is relatively stable. Changes in the nominal interest rate result from changes in expected inflation.
Ricardian Equivalence
Gov Exp ↑ Taxes ↑ - no impact
According to the Heckscher–Ohlin model, when trade opens:
the abundant factor gains relative to the scarce factor in each country.
