- Scarcity forces trade-offs, for people and for societies.
- Society's trade-offs include guns and butter, the environment and income, efficiency and equality.
- Opportunity cost is what you give up, including time and income forgone.
- Costs you would pay either way are not costs of the choice.
- scarcity
- the limited nature of a society's resources
- economics
- the study of how a society manages its scarce resources
- trade-off
- giving up some of one thing to get more of another
- opportunity cost
- whatever must be given up to obtain something
- efficiency
- getting the most from scarce resources (the size of the pie)
- equality
- sharing the benefits evenly (how the pie is divided)
Watch out: Counting only money paid out. Time has a cost because of what you could have done with it; and costs that you would pay whichever way you choose are not costs of the choice.
- Rational people compare marginal benefit with marginal cost.
- Average cost can mislead a "one more" decision.
- Value depends on the marginal unit: water and diamonds.
- People respond to incentives, so policies can have indirect, unintended effects.
- rational
- systematically doing the best one can to reach one's goals with the options available
- marginal change
- a small adjustment to an existing plan
- marginal benefit
- the extra benefit from one more unit
- marginal cost
- the extra cost of one more unit
- incentive
- something that leads a person to act, such as a reward or penalty
Watch out: Using average cost or benefit to make a decision at the margin. The airline's average cost per seat is 500, but the cost of filling an empty seat is almost nothing. Decisions about "one more" need the cost and benefit of one more.
- Models simplify on purpose; the art is choosing assumptions that don't matter for the question.
- Circular flow: households and firms meet in markets for goods and for factors of production.
- The PPF shows efficiency, trade-offs, opportunity cost and growth.
- Microeconomics studies markets; macroeconomics the whole economy.
- model
- a simplified representation of how the economy, or part of it, works
- factors of production
- the inputs used to make goods and services: labour, land and capital
- circular-flow diagram
- a model of how money, goods and factors flow between households and firms through markets
- production possibilities frontier
- a graph of the output combinations an economy can produce with its resources and technology
- efficiency
- getting the most from scarce resources; on the PPF, being on the frontier
- microeconomics
- the study of how households and firms decide and interact in markets
- macroeconomics
- the study of economy-wide events, such as inflation, unemployment and growth
Watch out: Treating a model's simplicity as a flaw. A model leaves things out on purpose, like a map. The question is whether what it leaves out matters for the question being asked.
- Positive statements say what is, and evidence can test them.
- Normative statements say what ought to be, and need values as well as facts.
- Economists disagree because of different scientific judgements and different values.
- On many questions, large majorities of economists agree.
- positive statement
- a claim about how the world is, which evidence can test
- normative statement
- a claim about how the world ought to be, which involves values
- policy adviser
- an economist's role in recommending how to improve the world
- value judgement
- a view about what is better or worse, which facts alone cannot settle
Watch out: Treating any statement with numbers as positive and any statement with feeling as normative. The test is not tone but whether evidence alone could settle it. "Unemployment is too high" sounds factual but is normative: "too high" is a judgement.
- Law of demand: a higher price means a smaller quantity demanded, other things equal.
- Market demand adds individual quantities at each price.
- The good's own price moves you along the curve; income, related prices, tastes, expectations and the number of buyers shift it.
- Normal and inferior goods; substitutes and complements.
- market
- a group of buyers and sellers of a particular good or service
- competitive market
- a market with so many buyers and sellers that each has a negligible effect on the price
- quantity demanded
- the amount buyers are willing and able to buy at a given price
- law of demand
- other things equal, the quantity demanded falls when the price rises
- demand curve
- a graph of the relationship between price and quantity demanded
- normal good
- a good whose demand rises when income rises
- inferior good
- a good whose demand rises when income falls
- substitutes
- goods for which a fall in the price of one reduces demand for the other
- complements
- goods for which a fall in the price of one raises demand for the other
Watch out: Saying "demand fell" when the price of the good rose. A higher price reduces the quantity demanded (a movement along the curve), not demand (the whole curve). Keep "demand" for shifts caused by the other variables.
- Law of supply: a higher price means a larger quantity supplied.
- Input prices, technology, expectations and the number of sellers shift supply.
- Equilibrium is where the curves cross; surpluses and shortages push the price towards it.
- Three steps: which curve, which way, compare equilibria.
- quantity supplied
- the amount sellers are willing and able to sell at a given price
- law of supply
- other things equal, the quantity supplied rises when the price rises
- supply curve
- a graph of the relationship between price and quantity supplied
- equilibrium
- the point where quantity supplied equals quantity demanded
- equilibrium price
- the price that balances quantity supplied and quantity demanded
- surplus
- quantity supplied greater than quantity demanded (excess supply)
- shortage
- quantity demanded greater than quantity supplied (excess demand)
Watch out: Confusing "supply" with "quantity supplied", as with demand. A higher price raises the quantity supplied (along the curve). A cheaper input raises supply (the whole curve shifts right). And when demand rises, price rises and then quantity supplied rises along the supply curve: supply itself has not changed.
- Money is a medium of exchange, a unit of account and a store of value.
- Commodity money has intrinsic value; fiat money is money by decree.
- The money stock includes currency and bank deposits; credit cards are not money.
- A central bank oversees banks and controls the money supply, mainly through open-market operations.
- money
- the assets people regularly use to buy goods and services from each other
- medium of exchange
- what buyers give sellers when they buy goods and services
- unit of account
- the yardstick for posting prices and recording debts
- store of value
- an item that carries purchasing power from the present into the future
- liquidity
- how easily an asset can be converted into the medium of exchange
- commodity money
- money that takes the form of a commodity with intrinsic value
- fiat money
- money without intrinsic value, used as money by government decree
- currency
- notes and coins in the hands of the public
- demand deposits
- bank balances that can be spent on demand
- central bank
- an institution that oversees the banking system and regulates the quantity of money
- money supply
- the quantity of money available in the economy
Watch out: Counting credit cards as money. A card payment is a short-term loan from the card issuer, paid off later with money from a bank account. A debit card, by contrast, draws directly on a deposit, which is money.
- GDP: the market value of all final goods and services produced within a country in a period.
- It measures both total income and total spending.
- Y = C + I + G + NX; new housing is investment; transfers are left out.
- Mankiw's US 2009 figures: GDP over 14 trillion dollars, 46,372 per person.
- gross domestic product (GDP)
- the market value of all final goods and services produced within a country in a given period
- consumption
- household spending on goods and services, except new housing
- investment
- spending on capital equipment, inventories and structures, including new housing
- government purchases
- spending on goods and services by all levels of government
- transfer payment
- a government payment not made in exchange for a good or service
- net exports
- exports minus imports
- intermediate good
- a good used up in producing another good
- gross national product (GNP)
- the total income earned by a country's permanent residents
Watch out: Adding transfer payments or imports into GDP. Pensions and benefits move income between people without paying for new output; imports are produced abroad. Both are left out (imports are subtracted to cancel their appearance in C, I or G).
- Nominal GDP: current prices. Real GDP: base-year prices. Deflator: nominal ÷ real × 100.
- Real GDP measures growth; the deflator measures inflation.
- GDP leaves out leisure, home production, the environment and distribution.
- Still, higher GDP per person goes with longer, healthier, more literate lives.
- nominal GDP
- the production of goods and services valued at current prices
- real GDP
- the production of goods and services valued at constant (base-year) prices
- GDP deflator
- nominal GDP ÷ real GDP × 100: a measure of the price level
- base year
- the year whose prices are used to value output in every year
- recession
- a period of falling real GDP
Watch out: Reading a rise in nominal GDP as growth. Nominal GDP can rise purely because prices rose. Only real GDP tells you whether the economy produced more.
- Adults are employed, unemployed (without work and looking) or not in the labour force.
- Unemployment rate = unemployed ÷ labour force; participation = labour force ÷ adult population.
- Natural rate: normal unemployment; cyclical: the swing around it.
- The official rate misses discouraged workers and other kinds of underuse.
- labour force
- the employed plus the unemployed
- unemployment rate
- the percentage of the labour force that is unemployed
- labour-force participation rate
- the percentage of the adult population in the labour force
- natural rate of unemployment
- the normal rate of unemployment around which the actual rate moves
- cyclical unemployment
- the deviation of unemployment from its natural rate
- discouraged workers
- people who would like to work but have given up looking
Watch out: Reading every fall in the unemployment rate as good news. It can fall because discouraged people stop looking and leave the labour force, as in the worked example. Check the participation rate too.
- Inflation doesn't in itself make people poorer: prices are also incomes.
- Costs: shoeleather, menu costs, relative-price variability, tax distortions, confusion.
- Unexpected inflation redistributes wealth between borrowers and lenders.
- Deflation also has costs and is often a symptom of deeper problems.
- inflation fallacy
- the mistaken belief that inflation in itself reduces people's living standards
- shoeleather costs
- the resources wasted when inflation leads people to hold less money
- menu costs
- the costs of changing prices
- relative-price variability
- the drift in relative prices that occurs because prices change at different times
- capital gain
- the profit from selling an asset for more than was paid for it
- deflation
- a fall in the overall level of prices
Watch out: Saying inflation reduces everyone's purchasing power. In the long run, incomes rise with prices. The costs of inflation are the six listed above, not a general fall in living standards.