Exam ITerm ID SignificanceCompetitive marketmarket with large number of independently acting buyers and sellers who cannot individually influence priceCompetitive markets come to rest with a price and quantity mutually satisfactory to the buyers and sellers (as if by and invisible hand, they reach market clearing prices and quantities) Entrepreneurship Human resource that brings together other resources and is motivated by profit (self-interest)Entrepreneurs bear risk; are innovatorsMinimum wage lawLegal price floor imposed in the labor marketIf set above equilibrium wage, creates unemployment or surplus of labor; concentrated on least-skilled workers; unions support higher minimum wages Real GDP The value of all domestically produced goods and services evaluated at constant pricesIndicator of the real level of economic activity (the quantities of goods and services produced domestically)Explicit and implicit economic costsExplicit = “out of pocket” costs; costs paid in moneyImplicit = value of alternatives foregone when a decision is made (no direct money payment)Both costs must be taken into consideration if economic decisions are to be ‘rational’; even when explicit costs are not made, implicit costs are real and often quite sizeableLegal price floor Prices set by law below which legal transactions cannot occurIf set above the equilibrium prices, can result in excess supply or surplusesOpportunity cost Alternatives foregone when a choice is made Both explicit and implicit opportunity costs are necessary for rational decision makingCapital Human-made aids to production; goods usedto produce other goods; plant, equipment, machinery, etc.More capital, ceteris paribus, implies higher economic growthParity price ratio Index of farm prices/index of non-farm prices x 100Often cited in agricultural policy discussion about raising farm prices; indicator of how the farm sector is doing economically; when the ratio fell below 100% in the 30s, there was political pressure to establish price supports (floors) which resulted insurplusesPrice elasticity ofdemandE D=|%∆ Q d%∆ P| (absolute value of percentage change in quantity demanded over percentage change in price); measure ofhow responsive buyers are to changes in price of a good/service, ceteris paribusRelationship with TR (TR=PxQ; If ED>1 (elastic), Pand TR change in opposite direction; if ED<1 (inelastic), P and TR change in same direction); relationship with economic tax incidenceMPCΔC/ΔYD, the marginal propensity to consume, which is the proportion of additional current disposable income thatis spent on consumptionIt is the slope of the consumption function. According to Keynes, 0<MPC<1APC C/YD, the average propensity to consume, or the proportion of current disposable income spent on consumptionAt the break-even level, APC=1 (implies zero saving), APC>1 => dissaving, APC<1 => saving. According to Keynes, as disposable income increase, APC decreases (YD↑=>APC↓)Exam IIHow inflation affects creditors and debtorsUnanticipated inflation reduces creditors’ real income while benefit debtors who repay their loans with dollars of lower purchasing powerIf inflation is anticipated, they will increase nominal interest rates in an effort to preserve real ratesQuantity Theory of Money%∆MS+%∆V=%∆P+%∆Q With %∆V=0%, %∆P (inflation or deflation) depends on %∆MS compared to %∆Q (%∆MS>%∆Q=>%∆P>0=> inflation and (%∆MS<%∆Q=>%∆P<0=> deflation)Three functions of moneyMedium of exchangeUnit of accountStore of valueFacilitates exchanges of material goods and servicesFacilitates estimates of comparative values; “common denominator” valuing goods and servicesAllows purchasing power to be stored over time; how well money performs over time depends on changes in the price levelUnemployment Percentage of the labor force without jobs; Economy produces less than it could (GDP gap); non-economic costs such as political and family instability, higher crime rates, health problems among the chronically unemployed3 types of unemploymentStructural – workers lack marketable skills;Frictional – workers voluntarily changing jobs and new entrants into the labor force;Cyclical – joblessness associated with the upsand downs of the business cycleEconomy produces less than it could (GDP gap); non-economic costs such as political and family instability, higher crime rates, health problems among the chronically unemployed;Frictional unemployment is desirable when it increases worker productivity or efficiency and improves job “matches”; it is assumed to be ~5%.Economic costs of unemploymentGDP gap (dollar value of all goods and services not produced domestically due to involuntary joblessness)Involuntary unemployment means that we are not producing as many material goods & services as we could; non-economic costs may also be mentionedThree policies to combat inflationHigher legal reserve requirementsHigher discount rateSell bonds in open market operationsCommercial banks hold larger reserves, so less money in the economy => MS↓Commercial banks and public have more difficulty(more expensive) borrowing=> MS↓Fed gives out bonds and takes in cash=> MS↓Inventory adjustment mechanismIf planned TE does not equal ASK,(line showing planned and actual expenditure), then the economy is not in equilibriumInventory adjustments presumably bring the economy to rest. If, for example planned TE > ASK, there will be an unintended drop (or decumulation) of inventories, and vice versaGDP gap Difference between actual (equilibrium) Ye and noninflationary full-employment Y*, where Y*>Ye ; dollar value of all goods and services not produced due to involuntary joblessnessThe gap indicates unemployment as the problem; measure of the economic costs of unemploymentExcess reserves Total reserves – legally required reserves = excess reservesOnly legal source of funds that commercial banks can lend; if banks hold positive excess reserves, money supply changes are not as large as they could beDifferent interest ratesa)Differences in default riskb)Differences in term to maturityc)Differences in tax treatmenta)Risk that a lender may not be paid back; i.e. the borrower will default on their promise to repay the loan (US gov’t Treasury bonds have zero default riskb)How long until the IOU must be repaid (highermaturity=> higher interest rate)c)Interest rate paid on IOUs issued by state or localgov’t is not subject to income tax