Economics Definitions

Contents:
1.0 Foundation of economics
1.1 Competitive markets-demands and supply
1.2 Elasticity
1.3 Government intervention
1.4 Market failure
2.1 The level of overall economic activity
2.2 Aggregate demand and aggregate supply
2.3 Macroeconomic objectives
2.4 Fiscal policy
2.5 Monetary policy
2.6 Supply-side policy

Microeconomics
1.0 Foundation of Economics
Social science is a study of people in society and how they interact with each other.

Microeconomics studies the behaviors of INDIVIDUALS within an economy: consumers and

producers in particular markets.

Macroeconomics takes a wider view and studies an economy as a whole.

Scarcity is the basic economic problem that human wants exceed the ability to produce goods
and services from our limited resources to satisfy these wants.

Economics is a study of choices leading to the best possible use of scarce resources in order to
best satisfy unlimited human needs and wants.

Sustainability refers to maintaining the ability of the environment and the economy to
continue to produce and satisfy needs and wants into the future.

Opportunity cost is the next best alternative foregone (sacrificed) when an economic decision
is made.

Economic goods are goods whose production involves the sacrifice of scarce resources and so
have an opportunity cost. They are relatively scarce and so will have a price.

Free goods do not have an opportunity cost. They are not relatively scarce and so will have a
price.
Factors of production are the resources of land, labor, capital, and management
(entrepreneurship) that are used in the production of an economy’s outputs.

Land is the natural resources that an economy is endowed with.

Labor is the human work used in the production including both physical and mental
(intellectual) contribution to production.

Capital is the tools and technologies that is made by humans and used to produce goods and
services. It occurs as a result of investment.

Management (entrepreneurship) is the factor of production that brings together the other three
factors of production with the aim of making profit.

The three basic economic questions that must be answered by any economy are:
·What to produce?
·How to produce?
·For whom to produce?

Resources allocation (Rationing system) : the way that scarce factors of production (land,
labor, capital, and management) are used (allocated) to meet unlimited demand.

Planned economy (commanded economy) is an economy in which the state determines prices
and output of goods and services.

Free market economy is an economy in which markets and producers determine price and
output.

Mixed economy is an economy in which decisions are determined by both market forces and
the state. It is a combination of a free market system and a planned economy.

A production possibility curve (frontier) shows the maximum combinations of goods and
services that can be produced by an economy in a given time period, if all the resources in the
economy are being used fully and efficiently and the state of technology is fixed.

The circular flow of income model shows that in any given time period, the value of output
produced in an economy is equal to the total income generated in producing that output,
which is equal to the expenditures made to purchase that output.

Leakages (withdraws): income not passed on by households to domestic firms in circular flow
of income.

Injections: addition to income of domestic firms besides expenditure of households.

Positive economics deals with the areas of the subject that can be proven to be right or wrong.

Normative economics deals with areas of the subject that are open to personal opinion and
belief.

Ceteris paribus means “all other things being equal (constant)”.

Rational economic decision-making is an assumption that people behave rationally, i.e.

consumers will seek to maximize their utility (benefits) and producers will seek to maximize
their profits.

Refutation is a method used in the natural sciences and social sciences where any proposition
must be subjected to an empirical test in order to see if it can be disproven or refuted. If it
disproven or refuted, then the proposition must be rejected.

Laissez faire: the view that if market forces are left alone unimpeded by government
intervention the outcome will be efficient.

Say’s law: a proposition stating that the supply of goods creates its own demand.

Circulating economy: an economic system that looks beyond the linear take-make-dispose
model and aims to redefine growth, focusing on society-wide benefits. It is based on three
principles: design out waste, keep products and materials in use, and regenerate natural
systems.

1.1 Competitive markets-demands and supply

A market is a place, physical or virtual, where buyers and sellers of goods and services meet
to make an exchange.

Competitive market is the market for a good with large numbers of buyers and sellers, where
the single seller has very little or no market power.

Demand is the quantity of a good or service that consumers are willing and able to buy at a
given price in a given time period.

The law of demand states that as the price of a good increases, the quantity demanded of the
good decreases, ceteris paribus.

A demand curve shows the (negative) relationship between the price and the quantity
demanded of a good over a range of prices.

A normal good is a good for which the demand rises as consumer income rises. A normal
good has positive income elasticity.
An inferior good is a good for which the demand falls as consumer income rises. An inferior
good has negative income elasticity.

A substitute good (substitute) is one which can be used in place of each other, so demand for
one will increase when the price of another good increases.

Complementary goods (complements) are goods used in combination with each other
(consumed together), so demand for one will decrease when the price of the other increases.

The substitute effect: if the price of a good falls, the consumer substitutes (buys more) of the
now less expensive good.

The income effect: consider again a fall in price, this means that the consumer’s real income
(or purchasing power) has increased. Therefore, as price falls and real income increases,
quantity demanded of the good increases.

Utility is the satisfaction that consumers gain from consuming something.

Marginal utility is the extra satisfaction that consumers receive from consuming one more
unit of a good.

The law of diminishing marginal utility: as consumption of a good increases, marginal utility,
or the extra utility the consumer receives, decreases with each additional unit consumed.

Supply is the quantity of a good or services that producers are willing and able to produce at a
given price in a given time period.

The law of supply states that as the price of a good increases, the quantity supplied of the
good increases, ceteris paribus.

A supply curve shows the (positive) relationship between the price and the quantity supplied
of a good over a range of prices.

Joint supply is goods which are produced together, or where the production of one good
involves the production of another product.

Joint supply is production of goods that are derived from a single (the same) product, so that
it is not possible to produce more of one without producing more of the other.

Competitive supply (supply substitutes) refers to goods that can be produced in a similar way,
with similar inputs and processes.
Competitive supply refers to production of one or the other by a firm; the goods compete for
the same resources, and producing more of one means producing less of the other.

Supply shocks: random (sudden, unexpected, or unpredictable) events that can disrupt the
normal supply of goods and services.

The short run is the period of time in which the number of firms in an industry and at least
one factor of production is fixed, so just some adjustments are possible. All production takes
place in the short run.

The long sun is the period of time in which the number of firms and all factors of production
are variable, but the state of technology is fixed, so all adjustments are possible Firms can
change its scale of operations in the long run. All planning takes place in the long run.

Total product (TP) is the total output that a firm produces, using its fixed and variable factors
(inputs) in a given time period.

Marginal product (MP) is the extra output from one more unit of labor. It is the change in the
total product attributable to the last worker hired.

The law of diminishing marginal returns shows that as more and more of a variable resource
(typically labor) is added to fixed resources (land and capital), beyond a certain point, the
output from each additional unit of the variable factor will eventually diminish.

Marginal costs are the extra costs when producing an extra unknit of product.

Market equilibrium is the point where quantity demanded is equal to quantity supplied. This
creates market clearing price and quantity where there is no excess demand or excess supply.

Market equilibrium occurs at the price where quantity demanded and quantity supplied are
equal (also called market-clearing price).

Equilibrium price (market clearing price) is market price for which quantity demanded equals
quantity supplied. No excess demand or supply exists at such a price.

Excess demand (shortage) is where quantity demanded is greater than quantity supplied. It
occurs where the price of a good is lower than equilibrium price.

Excess supply (surplus) is where quantity supplied is greater than quantity demanded. It
occurs where the price of a good is higher than equilibrium price.

Price mechanism is the forces of demand and supply. It is the means to allocate resources
through demand and supply in a market arriving at an equilibrium price. Prices act as a signal
and an incentive to producers and consumers to produce/ consume more or less.
Consumer surplus is the (additional) benefit consumers receive when they pay a price below
what they are willing to pay.

Producer surplus is the (additional) benefit producers receive when they receive a price above
the one that they were willing to receive.

Community (social) surplus is the sum of consumer and producer surplus. It is the total
benefit to society or the welfare of society.

Allocative efficiency is achieved if the society produces enough of a good so that the
marginal benefit is equal to the marginal cost (MB=MC)

Marginal benefit (MB) is the extra benefit (utility) that consumers gain from consuming an
additional unit of a good.

Marginal cost (MC) is the extra cost to producers from producing an additional unit of a
product.

Bias (cognitive bias) is a term from psychology that refers to systematic errors in thinking or
evaluating.

Nudge is a method designed to influence consumers’ choices in a predictable way, without

offering financial incentives or imposing sanctions, and without limiting choice.

Choice architecture is a design of particular ways or environments in which people make

choices; it is based on the idea that consumers make decisions in a particular context and that
choices of decision-makers are influenced by how options are presented to them.

Default choice is a choice that is made by default, which means doing the option that results
when one does not do anything.

Restricted choice is a choice that is limited by government or other authority.

Mandated choice is a choice between alternative that is made mandatory by the government
or other authority.

Profit maximization (rational producer behavior): determining the level of output that the firm
should produce to make profit as large as possible, where total revenue minus cost is greatest.

Revenue maximization is an alternative to the profit maximization firm goal. Firms may try to
maximize their sales revenues that arise from larger quantity sold.
Growth maximization: firms may set their target to achieve growth in the short run, rather
than profits.

Market share: refers to the percentage of total sales in a market that is earned by a single firm.

Satisficing: a firm aims to perform satisfactorily, rather than to a maximum level, in order to
pursue other goals.

Corporate social responsibility (CSR): a business includes “public interest” in its decision
making. It adopts an ethical code that accepts responsibility for the impact of tis activities on
workforce, consumers, local community, and environment.

1.2 Elasticity
Price elasticity of demand (PED) is a measure of the responsiveness of quantity demanded of
a good to a change in price, along a given demand curve.

Primary commodities/ products are raw materials used as inputs in the manufacturing process
and traded in international markets.

Manufactured products: goods that have been processed by workers

The primary sector refers to agriculture, mining, forestry, and fishing.

The secondary sector refers to manufacturing (industry) and construction

The tertiary sector refers to services.

Income elasticity of demand (YED) is the measure of the responsiveness of demand (and
hence a shifting demand curve) for a good to change in consumers’ income.

An Engel curve is a graph that shows how quantity demanded varies with the level of
consumer income. It shows the relationship between income and the demand for a product
over time.

Primary products are products of the primary industry and are usually basic foodstuffs or
important raw materials.

Price elasticity of supply (PES): is the measure of the responsiveness of quantity supplied of a
good to change in the price, along a given supply curve.

1.3 Government intervention

A price ceiling (maximum price) is a maximum legally allowable price for a good, set by the
government, below the market price, aiming to protect (low-income) consumers.
A price floor (minimum price) is a minimum legally allowable price for a good, set by the
government, above the equilibrium price, aiming to protect producers.

Minimum wages: a form of price floor, a legal minimum price for labor, set by the
government. The government wants to protect workers, ensure them to earn enough to lead a
reasonable existence.

An indirect tax is a tax imposed upon expenditure on goods and services.

A subsidy is a payment from the government from the government to a firm, for the purpose
of increasing the production and the supply of a good.

1.4 Market failure

Common pool resources are resources that are not owned by anyone, do not have a price and
are available for anyone to use without payment or any other restrictions.

Rivalrous: a good is rivalrous if tis consumption by one person reduces its availability for
someone else.

Excludable: a good is excludable if it is possible to exclude people from using the good.

Sustainability refers to the use of resources that need to satisfy the needs of future generation.

Market failure is a failure of the market to achieve allocative efficiency, resulting in an over-
allocation of resources, or an under-allocation of resources.

Externality occurs when the actions of consumers or producers give rise to negative or
positive side-effects on other people who are not part of these actions, and whose interests are
not take into consideration.

Negative production externality arises if the production of a product creates external

(spillover) costs to a third party but the external costs are not reflected in the market price.

Carbon tax is a tax per unit of carbon emission of fossil fuels.

Tradable permits (cap and trade schemes) is a policy involving permits to pollute issued to
firms by government or an international body. These permits to pollute can be traded in a
market.

Negative consumption externality arises if the consumption of a product creates external

(spillover) costs to a third party but the external costs are not reflected in the market price.

A demerit good is one whose consumption creates external costs. It is considered to be

harmful to people and that would be over-provided and over-consumed in a free market
economy.

Positive production externality arises if the production of a product creates external

(spillover) benefits to a third party but the external costs are not reflected in the market price.

Positive consumption externality arises if the consumption of a product creates external

(spillover) benefits to a third party but the external costs are not reflected in the market price.

A merit good is one whose consumption creates external benefits. It is considered to be

beneficial for people and would be under-provided and under-consumed in a free market
economy.

Public goods are goods that are both non-rivalrous and non-excludable, and are typically
provided by the government.

Free-rider problem: people benefit from a public good but do not have to pay for it.

Contracting out by the public sector to the private sector occurs when a government makes an
agreement (or contract) with a private firm to carry out an activity that the government was
previously doing itself.

Asymmetric information refers to something more than just missing information; it refers to
the situation where buyers and sellers do not have equal access to information.

Adverse selection refers to situations where one party in a transaction has more information
about the quality of the product being sold than the other party.

Screening is a method used by the party with the limited information, in this case the buyer.

Signaling is a method used by the party that has more information, in this case the seller.

Moral hazard refers to situations where one party takes risks, but do not face the full costs of
these risks because the full costs of the risks are borne by the other party.

Macroeconomics
2.1 The level of overall economic activity
Output approach measures the actual value of final goods and services produced domestically

Income approach measures the value of all the incomes earned in the economy

Expenditure approach measures the value of all spending on goods and services in the
economy.

Gross domestic product (GDP) is the total value of all final goods and services produced
within a country over a time period.

Gross national income (GNI) is the total income received by the residents of a country, equal
to the value of all final goods and services produced by the factors of production supplied by
the country’s residents regardless of where the factors are located.

Nominal GDP (GDP at current prices, money GDP) is the value, in current prices, of all final
goods and services produced in a country within a given time period.

Real GDP (GDP at constant prices) is the value, in constant prices, of all final goods and
services produced in a country within a given time period, usually measured a against a
predetermined base year.

GDP deflator (price deflator) is a general price index that includes all kinds of goods.

GDP per capita (GDP per head/ person) is the total GDP divided by population size in a
country.

Business cycles consists of short-run fluctuations in the growth of real output, which are
alternating period of expansion (increasing real output) and contraction (decreasing real
output).

OECD better life index is an alternative measure to standard national income accounting that
measures economic well-being in a number of dimensions that take into account quality of
life.

Happiness index is an alternative measure to standard national income accounting that

measures economic well-being using numerous quality of life dimensions in addition to real
GDP per capita.

Happy planet index (HPI) is an alternative measure to standard national income accounting
that takes into account environmental sustainability and inequalities.

2.2 Aggregate demand and aggregate supply

Aggregate demand (AD) is the total amount of real output (Real GDP) that consumers, firms,
the government and foreigners want to buy at each possible price level, over a particular time
period.

Consumption ： the total spending by households (consumers) on domestic consumer goods

and services.

Interest rates: is the price of borrowed money or the return of saving money.

Disposable income: after-tax incomes that households can use for saving and consumption.

Investment: the addition of capital stock to the economy.

Government spending: spending by government on goods and services.

Net exports: export revenues minus income expenditure.

Aggregate supply (AS) is the total of all goods and services produced in an economy at every
given price level in a given period of time.

The short run supply curve (SRAS) shows a positive relationship between the price level and
the quantity of real output produced by firms when resources’ price do not change.

Long-run aggregate supply (LRAS) is the aggregate quantity of goods and services supplied
when the economy is operating at full employment.

Full employment level of output (or potential output, Yp) refers to the output level that is
produced by an economy when labor market is in equilibrium and thus there is only natural
unemployment.

Spare capacity refers to availability of resources including physical capital and labor that are
not used.

Deflationary (recessionary) gap exists where real GDP is less than potential GDP

Inflationary gap exists where real GDP is larger than potential GDP.

2.3 Macroeconomic Objectives

Unemployment is defined as people of working age who are without work, available for work
(willing & able to work), and actively seeking employment.

Underemployment refers to people of working age with part-time jobs when they would
rather work full time, or with jobs that do not make full use of their skills and education.

Cyclical (demand-deficient) unemployment exists when the economy is in a deflationary gap,

usually occurring during the downturns of the business cycle.

Natural unemployment exists when the labor market is in equilibrium and the economy is
producing at the full employment level of output. It is made up of frictional, seasonal, and
structural unemployment.

Frictional unemployment is the short-term unemployment that occurs when people are in
between jobs, or they have finished education & are waiting to take up their first job.

Seasonal unemployment is short-term unemployment that occurs on a seasonal basis as the

demand for some types of labor falls at certain times of the year.

Structural unemployment exists when in the long term the pattern of demand and production
methods change, and there is a permanent fall in the demand for a particular type of labor.
There is a mismatch between skills and the jobs available.

Inflation is a persistent increase in the average price level in the economy, usually measured
through the calculation of a consumer price index (CPI)

Disinflation is a falling rate of inflation.

Deflation is a persistent fall in the average price level in the economy. It implies negative
inflation rates.

Consumer price index (CPI) is a measure of the cost of living for the typical household, and
compares the value of a basket of goods and services in one year with the value of the same
basket in a base year.

Weight price index (CPI) is a price index that weights the various goods and services
according to their relative importance in consumer spending.

Demand-pull inflation is a persistent increase in the average price level that comes about as a
result of increase in aggregate demand.

Cost-push inflation is a persistent increase in the average price level that comes about as a
result of increase in the costs of production and thus a decrease in aggregate supply.

Hyperinflation is defined as occurring when the price level increases by more than 50% per
month, thought it can reach thousands or even millions of points per year.

Deferred consumption means that consumers postpone spending. Consumers postpone

making purchase when they see falling prices as they expect to see price will continue to fall.

The short run Philips curve (SRPC) is a curve that shows a negative relationship or a "trade-
off" between the inflation rate and the unemployment rate in the short run.

Stagflation is the situation where an economy is facing stagnant growth, with the combination
of high unemployment and high inflation. It is the result of a decrease in SRASdue to factors
including negative supply shocks.

The long run Phillips curve (LRPC) is a vertical line at the natural rate of unemployment that
illustrates the view that there is no trade-off between the inflation rate and the unemployment
rate.

Natural rate of unemployment is the rate of unemployment that exists when the economy is
producing at the full employment level of output and the labor market is in equilibrium. It is
consistent with a stable rate of inflation. Long-run Philips curve (LRPC) is vertical at this rate
of unemployment.

Economic growth is an increase in the total output of goods and services (real GDP) in an
economy over time.

Short-term growth (Actual growth): an increase in actual output (real GDP) through time.

Long-term growth (Potential growth): an increase in potential output (or production

possibilities). It refers to a rightward shift of LRAS curve or an outward shift of PPC.

Government debt (national debt, or public debt), refers to the amount of money that a
government owes to lenders outside of the government itself.

Budget deficit refers to government expenditures are larger than tax revenue.

Budget surplus refers to government expenditures are smaller than tax revenue.

Sustainable debt refers to a level of debt where the borrowing government has enough
revenues to meet its debt obligations (payment of interest and repayment of borrowed
amount) without accumulating arrears (overdue debt payments) while also allowing economic
growth to continue at an acceptable level.

Debt serving refers to the payments that must be made in order to repay the principal plus the
interest payment.

Credit rating is an assessment of the ability of a borrower to pay back loans, usually carried
out by agencies that are qualified to do this.

Economic inequality refers to the degree that people in a population differ in their ability to
satisfy their economic needs; it means inequalities in living conditions that arise due to
monetary factors.

Lorenz curve is used to show the degree of income inequality in an economy.

Gini coefficient (index) is a measure of income inequality within the population of a country.

Poverty refers to an inability to satisfy minimum consumption needs.

Absolute poverty refers to a situation where a person or family does not have enough income
to meet basic human needs.

Poverty line refers to a minimum income level; to measure the absolute poverty.

Relative poverty is a concept that compares the income of individuals or households in a

society with median incomes

Minimum income standards (MIS): what people in a population believe are the essentials for
a minimum acceptable standard of living that allows people to participate in society.

Multidimensional poverty index (MPI) by UNDP: it measures poverty in three dimensions:

health, education and living standard.

Direct taxes are taxes paid directly to the government authorities by tax payers.

Indirect taxes are taxes placed on expenditure and are paid by consumers through higher
prices.

Progressive taxation: as income increases, the fraction of income paid as taxes increase; there
is an increasing tax rate.

Marginal tax rate is defined as the tax rate paid on additional income, on the last amount of
tax paid, expressed as a percentage.

Average tax rate is tax paid divided by total income expressed as a percentage.

Progressive taxation: as income increases, average tax rate increases.

Proportional taxation: as income increases, the fraction of income paid as taxes remains
constant, there is a constant tax rate.

Regressive taxation: as income increases, the fraction of income paid as taxes decreases; there
is a decreasing tax rate.

Transfer payments are payments made by the government to individuals specifically for the
purpose of redistributing income away from certain groups and towards other groups; they
transfer income from those who work and pay taxes towards those who need assistance.

Universal basic income is a method intended to provide residents in a country with a sum of
money that they would receive regardless of any other income they may have.

2.4 Fiscal policies

Demand-side policies (demand management policies) are macroeconomic policies aimed at
changing the level of AD in the economy deliberately in order to achieve macroeconomic
objectives. They include fiscal and monetary policy.

A budget deficit exists when planned government spending exceeds planned government
revenue.

A budget surplus exists when planned government revenue exceeds planned government
spending.

A balanced budget exists when planned government spending is equal to planned government
revenue.

Fiscal policy is the government’s use of spending taxes to influence the overall level of AD in
the economy to promote macroeconomic goals.

Expansionary fiscal policy is an increase in government spending and/or decrease in taxes

aimed at increasing AD level to close a recessionary gap and move an economy towards its
full-employment level of output.

Contractionary (deflationary) fiscal policy is a decrease in the government spending and/or

increase in taxes aimed at decreasing AD to close an inflationary gap and moving the
economy to its full-employment level of output and price stability.

Discretionary fiscal policy is a deliberate change in spending and taxes undertaken by

governments when the explicit aim to manage the level of AD in the economy.

Automatic stabilizers are features of fiscal policy, e.g. unemployment benefits and direct tax
revenues, that automatically counter-balance fluctuations in economic activity

Crowding out is an effect where governments increase spending to simulate an economy, they
need to run budget deficit and borrow money from the public, forcing up interest rates and
‘crowding out’ private consumption and investments. Thus this reduces the desired effect of
expansionary fiscal policy.

The Keynesian multiplier is the ration of the induced change in national income to the
increase in the level of injections.

Multiplier effect: an injection (I,G,X) into economy will result in a larger increase in national
income. Thus fiscal policy is a powerful tool to lift an economy out of a recession.
2.5 Monetary policy
Central bank is the monetary authority of a country or government’s bank.

Interest rate is the price of credit or borrowed money.

Required reserves are deposits that banks have received but have not loaned out, they are the
funds that banks must legally keep.

Minimum reserve requirement (or minimum reserve ratio) is the portion of reservable
liabilities that commercial banks must hold onto, rather than lend out or invest.

Money creation: when a bank makes a loan from its reserves, the money supply increases.

Minimum lending rate: the interest rate central bank changes when lending to commercial
banks.

Quantitative easing (QE) is a form of monetary policy in which a central bank purchases
long-term government bonds from the open market in order to increase the money supply and
encourage economic activity.

Monetary policy is the set of central bank’s policies concerning money supply and interest
rate. It may be used to manage the level of aggregate demand and may be expansionary or
contractionary.

Expansionary (loose or easy) monetary policy is the policies by the central bank to increase
the money supply and reduce interest rates. This will increase consumption and investment,
and thus increase AD.

Contractionary (tight) monetary policy is the policies by the central bank to decrease the
money supply and increase interest rates. Thus will reduce consumption and investment, and
thus decrease AD.

Ratchet effect: the price level moves up when there is an increase in AD, and remains the
same level until there is a further increase in AD.

2.6 Supply-side policy

Supply-side policies aim at increasing potential output of an economy by increasing the
quantity and/or improving the quality of the factors of production, thus shifting the long-run
aggregate supply (LRAS) curve to the right.

Interventionist supply-side policies are government-led attempts to increase the productive

capacity of the country.

Market-based supply-side policies are intended to reduce government intervention to its

minimum thereby allowing free market to increase efficiency and improve incentives.

Deregulation: a type of S-side policy where the government reduces the number, type or
severity of regulations governing the behavior of firms (business operation).

Privatization: sell the public government-owned (nationalized) firms to private sector.

Trade liberation: encourage free trade, less trade barriers, open competition and improves
efficiency of domestic firms.

Anti-monopoly regulation (anti-trust laws): open up market to more firms increases output
and decreases price.

Contracting out to the private sector: this is a policy operation whereby governments make a
contractual agreement with private firms to provide goods and services to the government.