Economics: Key Concepts and Principles
Economics: Key Concepts
Economics: Social science that analyzes the most efficient way to use our scarce resources.
Scarcity: We have unlimited wants but limited resources.
Opportunity Cost: Most desirable alternative given up when you make a choice.
Factors of Production: Land, labor, capital.
Absolute Advantage: The producer that can produce the most output or requires the least amount of inputs (resources).
Comparative Advantage: The producer with the lowest opportunity cost.
Terms of Trade: Both countries can benefit from trade if they each have a relatively lower opportunity cost. Terms of trade: the agreed upon condition that would benefit both countries.
Private Sector: Part of the economy that is run by individuals and businesses.
Public Sector: Part of the economy that is controlled by the government.
Factor Payment: Payment for the factors of production namely rent, wages, interest, and profit.
Transfer Payments: When the government redistributes income.
Subsidies: Government payment to businesses.
The Law of Demand: There is an inverse relationship between price and quantity demanded.
The Law of Supply: There is a direct relationship between price and quantity supplied.
GDP (Gross Domestic Product): The dollar value of all final goods and services produced within a country’s borders in one year.
GDP per capita (per person): GDP divided by the population. It identifies on average how many products each person makes.
Not included in the GDP:
- Intermediate goods: Goods inside the final goods don’t count.
- Non-production transactions: Financial transactions (nothing produced) and used goods (old cars, used clothes).
- Non-market and illegal activities: Things made at home, drugs, etc.
Two ways of calculating GDP:
Expenditures Approach: Add up all the spending on final goods and services produced in a given year. GDP = C + I + G + (M-X)
Income Approach: Add up all the income that resulted from selling all final goods and services produced in a given year. GDP = rent + wages + interest + profit
Nominal GDP: GDP measured in current prices. It does not account for inflation from year to year.
Real GDP: GDP expressed in constant, or unchanged, dollars. Real GDP adjusts for inflation. Real GDP is the best measure of economic growth.
A recession is a 6-month period of decline in real GDP.
Unemployment: Workers that are actively looking for a job but aren’t working.
The Unemployment Rate: The percent of people in the labor force who want a job but are not working. Unemployment rate = (number of unemployed / number of labor force) x 100. Labor Force: Number of people 16 and over that are willing and able to work.
Labor Force Participation Rate: Percent of the population in the labor force.
Types of Unemployment
- Frictional unemployment: Temporary unemployment or being between jobs. Individuals are qualified workers with transferable skills.
- Seasonal unemployment: A specific type of frictional unemployment which is due to the time of year and the nature of the job.
- Structural unemployment: Changes in the labor force make some skills obsolete. These workers don’t have transferable skills, and these jobs will never come back. Workers must learn new skills to get a job.
- Technological unemployment: Type of structural unemployment where automation and machinery replace workers.
- Cyclical unemployment: Unemployment caused by a recession. As demand for goods and services falls, demand for labor falls, and workers are fired.
The natural rate of unemployment:
Frictional and structural unemployment is present at all times because people will always be between jobs or replaced by technology.
The Natural Rate of Unemployment (NRU): Frictional plus structural unemployment. The amount of unemployment that exists when the economy is healthy and growing.
Full Employment Output (Y): The real GDP created when there is no cyclical unemployment.
Criticism of the Unemployment Rate: The unemployment rate can misdiagnose the actual unemployment rate because of discouraged workers: some people are no longer looking for a job because they have given up.
Underemployed Workers: Someone who wants more hours but can’t get them is still considered employed.
What is Inflation? Inflation is raising the general level of prices and reducing the “purchasing power” of money. When inflation occurs, each dollar of income will buy fewer goods than before. Unexpected inflation helps borrowers but hurts lenders and people on fixed incomes.
Nominal Wages: Wages measured by dollars rather than purchasing power.
Real Wage: Wage adjusted for inflation.
Real Interest Rates: The percentage increase in purchasing power that a borrower pays (adjusted for inflation).
Real: Nominal interest rate – expected inflation.
Nominal Interest Rates: The percentage increase in money that the borrower pays not adjusting for inflation.
Nominal: Real interest rate + expected inflation.
The Consumer Price Index (CPI): The most commonly used measure of inflation for consumers.
How it works: The base year is given and the index number as well. CPI = (price of market basket / price of market basket in the base year).
The GDP Deflator includes only those goods and services produced domestically. Imported goods are not a part of GDP and therefore don’t show up in the GDP deflator.
Causes of Inflation
- The government prints too much money to pay debts and end up with hyperinflation.
- Demand-pull inflation: Demand-pulls up prices, “too many dollars chase too few goods.”
- Cost-push inflation: Production cost increases prices. A negative supply shock increases the cost of production and forces producers to increase prices.
What is Aggregate Demand? All the goods and services (real GDP) that buyers are willing and able to purchase at different price levels. The demand for everything by everyone in the US. There is an inverse relationship between the price level and real GDP.
Stagflation: Cuando la oferta agregada se desplaza hacia la izquierda, el nivel de precios sube, la cantidad disminuye.
Economic Growth: Es la idea de que el GDP aumenta a largo plazo, cuando hay un aumento en la inversión, habrá más capital, por lo que una gran demanda se desplazará hacía la derecha.
La oferta agregada a largo plazo también se desplazaría a la derecha.
The Phillips Curve: Muestra la relación entre la inflación y el desempleo.
A corto plazo, hay una relación con la pendiente negativa, es decir una relación negativa entre estas dos, obtienes una alta inflación o conoces un alto desempleo.
A largo plazo es vertical, no hay relación entre la inflación y el desempleo.
Fiscal Policy: Es el cambio en el gasto público y los impuestos cuando la economía va mal.
Expansionary Fiscal Policy (the GAS): Laws that reduce unemployment and increase GDP (close a recessionary gap).
- Increase government spending.
- Decrease taxes (increasing disposable income).
- Combinations of the one.
Contractionary Fiscal Policy (the brake): Laws that reduce inflation, decrease GDP (close an inflationary gap).
- Decrease government spending.
- Increase taxes (decreasing disposable income).
- Combinations of the two.
The Multiplier Effect: Es la idea cuando la gente gasta eso se convierte en ingresos de otra persona.
MPC and MPS: Marginal propensity to consume (MPC) – How much people consume rather than save when there is a change in income.
MPC = Change in consumption / change in income
MPC and MPS: Marginal propensity to save (MPS) – How much people save rather than consume when there is a change in income.
MPS = Change in savings / change in income
Problems with Fiscal Policy
- The national debt is the accumulation of all the budget deficits over time.
- A budget deficit is when the government’s expenditures exceed its revenue.
- If the government deficit spends, it increases interest rates and crowds out investors and consumers.
Unit 4
Why do we use money? The barter system: Goods and services are traded directly. There is no money exchanged.
Commodity Money: Something that performs the function of money and has intrinsic value, examples: gold, silver, cigarettes.
Fiat Money: Something that serves as money but has no other value uses, example: paper money, coins, digital currency.
Functions of Money
- A medium of exchange: Money can easily be used to buy goods and services with no complications of the barter system.
- A unit of account: Money measures the value of all goods and services. Money acts as a measurement of value.
- A store of value: Money allows you to store purchasing power for the future.