MIDTERM Flashcards
economy
from the word “who manages a household”
scarcity
limited nature of society’s resources
what is economics`
the study of how society manages scarce resources
how ppl make decisions and interact
analyze trend affecting economy
efficiency vs equity
efficicency: society gets most out of resources
equity: resources distributed fairly among members
trade-off: if more effective, less equitable and v.v.
opportunity cost
direct costs + indirect costs
what you give up in order to gain an item, can be intangible i.e. time spent making money
rational people
systematically and purposefully do the best they can to achieve their objectives
marginal changes
incremental adjustments to EXISTING PLAN of action
incentive
smth that induces a person to act
i.e. gasoline tax increases # electric cars
how does trade impact countries
allows countries to specialize in what they are best at, and diversify types of g/s
both countries are better off
market economy
economy that allocates resources through decisions of many firms and households
adam smith
wrote book that sound households and markets are guided by the invisible hand
invisible hand
leads to desirable market outcomes naturally, thru prices adjustments by buyers and sellers
if the gov prevents price adjustments, it can impede the insivible hand
productivity
amount of g/s produced from each hour of a worker’s time
standard of living is determined by how productive economy is
how does economics use the scientific method
uses observation, theory, more observation
cannot manipulate economy, therefore examines historical experiments
assumptions
simply complex concepts and make easier to understand
i.e. assume society only makes 2 g/s
economic models
diagrams and equns to explain world, using assumptions to simply
focus on what is important
circular flow model
visual model of economy to show cash flow throughout
factors of productions
inputs from firms to make g/s
i.e. labour, land, capital
markets for goods/services
households are BUYERS
firms are SELLERS
markets for FOP
households are SELLERS
firms are BUYERS
production possibilities frontier
graph showing combos of output an economy can produce given available factors
efficient vs inefficent
efficient: get most from resources available
inefficient: produce less than could, i.e. within production possibilities frontier
macro vs microeconomics
microeconomics - study of households and firms making decisions and interact
macroeconomics - study of economy-wide phenomena i.e. inflation, unemployment, economic growth
scientist vs policy adviser
economists are scientists when try to EXPLAIN world
policy advisers when try to IMPROVE world
positive vs normative statement
positive statement - descriptive, explain how world is
normative statement - prescriptive, explain how world should be
why aren’t economists always listened to
passing a law/policy is long and complicated process
sometimes public disagrees, or difficult to arrange w media
what do economists disagree on
- validity of the theories about the world works i.e. what is true
- have different values i.e. diff normative views
specialization and trade
by trading what you are most efficient at, you gain what you don’t have
increases consumption and leads to optimal on PPF
absolute vs comparative advantage
absolute - compare based on PRODUCTIVITY i.e. who makes the most or needs the least FOP
comparative - compare based on OPPORTUNITY COST i.e. who gives up least to produce a good
can you have multiple advantages?
can have absolute advantage in more than one g/s
CANNOT have comparative advg in both g/s, because opportunity cost in one is high and the other low
i.e. comp advg when make 10 beef vs 1 chicken, but no advg when make 1 chicken vs 10 beef
how to benefit from specialization via trade
benefit when there is a COMPARATIVE advantage
gain g/s at a good price, lower than their opportunity cost of making it
the price must be b/w BOTH parties opportunity costs i.e. A has opp cost 2 and B has opp cost 4, price can be b/w 2-4
when should canada trade?
when another country has a comparative advantage, so Canada doesn’t lose opportunities
gross domestic product (GDP)
market value of all g/s produced within a country in a given time
measures total income of a nation
how does GDP measure income = expenditure
income - shows amount earned from households buying g/s
expenditure - shows amount spent by firms to pay wages, rent, etc.
how to calculate nominal GDP
price x quantity
what doesn’t GDP include
intermediate goods - unfinished products for resale/processing
used or secondhand items - if car is resold
illegal or not marketed items
financial assets
when is GDP recorded
when a g/s is first produced
not included if sold much later
GDP equation
Y = C + I + G + NX
G
government expenditures
purchases by gov for local, territorial, provincial, federal gov
doesn’t include transfer payments i.e. pension, EI
NX
net exports
|exports - imports|
exports contribute to GDP bcs final goods made in Canada
imports are recorded in ANOTHER COUNTRY because produced somewhere else, subtracted from GDP so no overestimation
I
investment
spending on capital equip, new houses, inventories
inventories shown in GDP because they show production not yet sold
C
consumption
main part of GDP, 60%
spending by households on g/s, NOT new homes
Y
GDP
gross operating surplus
income of corps and gov businesses
gross mixed income
income paid to unincorp businesses i.e. sole proprietorships
taxes less subsidies
taxes are income to gov
subsidies are payments by gov to producer, therefore deducted from GDP
statistical discrepancy
the difference b/w the 2 calculations of GDP (income vs expenditure approach)
GNP
gross national product
GDP - foreign income paid to foreigners + foreign income received by Canadians
i.e. if Canadian works for US, income goes to GNP
nominal vs real GDP
nominal GDP: production of g/s sold at current prices i.e. price changes year to year
real GDP: production of g/s at constant prices, reflects changes in amounts produced i.e. price stays at base year price, only quantities vary
GDP deflator
price index that says how much prices rise in a year
is 100 in base year bcs no changes b/w nominal and real gdp
inflation
economy’s overall price level is rising
inflation rate
% change in GDP deflator b/w years
measures price differences
does GDP show economic health?
ignores pop size, environ quality, income distribution
GDP can be high, but people may be suffering
does not represent economic health of QOL
consumer price index
CPI
measures overall cost of g/s bought by a typical consumer, to measure cost of living over time
what happens when CPI increases
we must spend more to achieve the same standard of living
basket of goods and services
over 600 items
basket NEVER CHANGES
represents avg purchases of pop of min 30,000
CPI inflation rate
difference in CPI between years, to measure changes
core inflation
measure of the underlying trend in inflation
excludes fruits/veg, gas, oil, mortgage interest and CPI basket
what causes inaccuracy in CPI
- commodity substitution bias
- introduction of new goods
- unmeasured quality change
introduction of new goods
increases variety for consumers, increases value of dollars
need FEWER dollars for standard living
inc in dollar value isn’t shown in CPI
commodity substitution bias
rising prices causes substitute to cheaper items
not shown in CPI bcs items aren’t in basket of g/s
0.1% higher CPI
unmeasured quality change
if a good’s quality dec, dollar value dec even if PRICE IS SAME
if quality up, dollar value up
price will be adjust if bcs of quality change, unrecorded if bcs of inflation
- don’t always realize change is bcs of quality
GDP deflator vs CPI
GDP deflator - no imports, domestic g/s, no fixed basket
CPI - imports, ALL g/s bought by consumers, fixed basket
indexation
automatic correction of a dollar amount for the effects of inflation by law
i.e. pension adjusted to inflation
COLA
cost of living allowance
automatically raises wages when CPI increases
nominal interest rate
interest rate is NOT corrected for inflation
market interest rate, what bank pays for savings deposit
includes inflation premium to cover loss of principal’s purchasing power
real interest rate
interest rate corrected for inflation
tells the purchasing power of dollars
financial system
group of institutes in economy that match a person’s savings to another’s investment
financial markets
institutes where savers can DIRECTLY give funds to borrowers
i.e. bond market, stock market
bond
certificate of indebtedness
term: interest rate depends on this, time until maturity
credit risk
probability that you will NOT pay fully, increase interest rate if suspect so
junk bonds
issued by financially unstable corps to raise money
high interest rates bcs less secure than gov bonds or other corps
stock
ownership in a firm and claim to profits
equity finance
the sale of a stock to raise money
price determined by supply and demand
stock index
avg of a group of stock prices, used to indicate economic conditions
financial intermediaries
institutes where savers can INDIRECTLY supply funds to borrowers
- banks
- mutual fund
banks
take deposits from savers and use them to make loans to borrowers
mutual funds
institute that sells shares to the public and uses the proceeds to buy stocks and bonds
shareholders benefit if value of portfolio inc
- diversify bonds and stocks, decrease risk
- give ppl access to skills of pro money managers (doesn’t necessarily gain bcs of salaries)
national savings
S
total income in economy after paying for consumption and government purchases
stocks vs bonds
stocks
- pay dividends
- never mature
- inc risk
- higher return
bonds
- pay interest
- fixed maturity
both
- subject to credit risk
- taxed returns
market for loanable funds
market where savers SUPPLY funds to borrowers who DEMAND funds
saving
source of supply for loanable funds
investment
source of demand for loanable funds
interest rate
price of a loan
- return on savings
- cost of borrowing
supply of loanable funds
as interest rates inc, savings inc
more attractive rewards
POSITIVE relationship, as IR up, LF up
how does supply of loanable funds shift
public savings increase supply by shifting right
gov deficits decrease supply, shift left
demand for loanable funds
as interest rates inc, demand dec
more costly to have loanable funds
only will make investment if ROR is higher than borrowing cost, since make more profit
equilibrium rate of interest R*
shortage of loanable funds:
- if IR lower than R*, less loans are given than demanded
- increases IR
surplus of loanable funds:
- if IR higher than R*, more supplied than demanded
- dec IR because all are competing for borrowers
saving incentives
encourage saving i.e. lower tax on interest income
will save more if get higher returns on saving
consumption taxes i.e. HST discourage spending
tax policies impact on supply (LF)
increase supply of saving at ANY interest rate, since encourage saving
shift right, causing R* to lower
investment incentives
investment tax credit: gives tax advantages to firms building factories or buying equip (dec corp income tax)
cause demand to inc, shift right
crowding out
decrease in investment because of gov borrowing
gov issues bonds when in deficit, competing with corps
impacts of gov deficits
- decreased supply (shift left)
- increased interest rates (discourages investment)
- lower growth rate and standard living
vicious vs virtuous cycle
vicious cycle: deficits cause dec LF, inc IR, discourage investment and slow econ growth
- lead to more deficit
virtuous cycle: cause inc LF, dec IR, improve investment and lead to more surplus
discouraged worker
NOT in labour force, stopped searching for a job
not in labour force
retired, full-time student, discouraged worker, disability income
cyclical unemployment
fluctuations around the natural rate of unemployment
cause real GDP to fall below potential GDP
frictional unemployment
result of the time it takes to search for a job that suits skills and needs
will ALWAYS be frictional unemployment because of sectoral shifts: laid off due to changes in corp structure
structural unemployment
result of fewer jobs available than demanded
happens when wages are set ABOVE equilibrium
labour supply curve
as wage rates inc, labour inc because more ppl are willing to supply hours of labour
labour market equilibrium
when at equilibrium, some people are unemployed because they don’t want to work at the equilibrium wage
they are OUTSIDE LF because choose to not work
minimum wage laws
if min wage above equil, dec demand for labour and excess supply
results in structural unemployment
union
worker association that bargains w employer over working conditions
30% canadians, earn 10-20% more
collective bargaining: unions and firms agree on terms of employment
efficiency wages
above equilibrium wages to inc productivity, result in structural unemployment
can dec labour turnover, improve labour health, etc.
