Economics Flashcards
Stagflation describes
an economy suffering rising unemployment and rising price levels. It is caused by a leftward shift in short-run aggregate supply (SRAS). The fall in unemployment may lead to lower input prices and labor costs for producers. They will then be able to increase their short-run aggregate supply, possibly resulting in full employment. However, this process can be too slow, and therefore policymakers might try to use fiscal and monetary policy to remove stagflation, but the possibility is a permanent higher price level.
The potential growth rate in output
long-term growth rate of the labor force
+
long-term labor productivity growth rate (output per worker)
The goods included in the GDP calculation
must have been produced during the measurement period, and they must have an objective price that is determined by the market. Transfer payments, such as unemployment or welfare benefits, are excluded from the GDP calculation
Demand function
What influences the quantity of a good consumers are willing to buy, i.e. demand?
- Price
- Income
- Price of substitutes
- Price of complements
if economy is in equilibrium
G + X + I = t + M + S
Factors that influence price elasticity of demand
- Closeness of substitutes
- Products that can be more readily substituted with other products
will have a higher elasticity - Percentage of income spent on the good
- The greater the percentage of budget spent, the greater elasticity
- Time elapsed since price change
- The greater the time since the price change, the greater the elasticity
- The extent to which the good is seen as necessary
- The less the good is seen as necessary the greater the elasticity
Perfectly elastic
> Infinity
The smallest possible increase in price
causes an infinitely large decrease in the
quantity demanded
Elastic
> Less than infinity but greater than 1
The percentage decrease in the quantity
demanded exceeds the percentage
increase in price
Unit elastic
> 1
The percentage decrease in the quantity
demanded equals the percentage
increase in price
Inelastic
> Greater than zero but less than 1
The percentage decrease in the quantity
demanded is less than the percentage
increase in price
Perfectly inelastic
> Zero
The quantity demanded is the same at
all prices
Close substitutes
> Large
The smallest possible increase in price
of one good causes an infinitely large
increase in the quantity demanded of the
other goods
Substitutes
Positive
If the price of one good increases, the
quantity demanded of the other good
also increases
Unrelated goods
> Zero
If the price of one good increases, the
quantity demanded of the other good
remains the same
Complements
> Negative
If the price of one good increases, the
quantity demanded of the other good
decreases
Income elastic (normal good)
> Greater than 1
The percentage increase in the quantity
demanded is greater than the
percentage increase in income
Income elastic
(normal good) necessity
> Less than 1 but greater than zero
The percentage increase in the quantity
demanded is less than the percentage
increase in income
Negative income
elastic (inferior good)
> Less than zero
When income increases, quantity demanded decreases
Substitution and income effects
Substitution effect:
If the price of a good declines, then it becomes more of a bargain relative to other goods. Therefore, other goods are substituted for this particular good.
Income effect:
As the price declines, the consumers’ real income increases as they have to spend less on the same amount of goods. For normal goods, as income increases, more of this good is purchased.
Normal and inferior goods
Effects of a price decrease on demand
Substitution Effect: Normal
Increase
Income Effect: Normal
Increase
Substitution Effect: Inferior
Increase
Income Effect: Inferior
Decrease
Generally the income effect has less of an impact than the substitution effect.
Therefore the consumer still ends up buying more at the lower price
Exceptions to the law of demand – Giffen good
Effects of a price decrease on demand
Decrease in demand:
Subs effect: Incr
Income effect : decr
BUT
Income effect > Substitution effect
- If the income effect has a greater impact than the substitution effect for an inferior
good, then a decrease in price would result in a decrease in quantity demanded
and hence a positively sloped demand curve - All Giffen goods are inferior, but not all inferior goods are Giffen
Exceptions to the law of demand – Veblen goods
- Veblen goods are goods that increase in desirability as price increases, such as a
high status good - E.g. luxury cars
- This creates a positively sloped demand curve
Marginal product
- Increase in total product that results from a one-unit increase in the quantity of labour
employed, with all other inputs remaining the same
Law of diminishing marginal returns
- Where a firm uses more of a variable input with a given quantity of fixed inputs the
marginal product of the variable input eventually diminishes