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DEFINITIONS MICRO AND MACRO ECONOMICS Scarcity is the fundamental economic problem, which is caused an excess of wants over the supply. Its forces us to make choices over production. The Production Possibility Curve shows the maximum combination of goods and services that an economy can produce. Eco...

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DEFINITIONS MICRO AND MACRO ECONOMICS Scarcity is the fundamental economic problem, which is caused by an excess of wants over the ‘natural’ supply. Its forces us to make choices over production. The Production Possibility Curve shows the maximum combination of goods and services that an economy can produce. Economies of scales and diminishing marginal returns cause the PPC to be concave as for each additional unit of X produced, the amount of Y needed to be sacrificed increases Economies of scale: reduction in the LR costs and MC arising from an increase in the size of an operating unit. Diseconomies of scale: Economic theory predicts that a firm may become less efficient if it becomes too large Marginal rate of transformation: amount of a good you have to give up in order to have one more unit of another good. It represents the PPC slope. Indifference curve: show how much of one good a society is prepared to trade-off in order to have an extra unit of another good. The IC is convex because of diminishing marginal utility (an additional unit provides less utility than the previous unit) Marginal Rate of substitution: slope of the IC curve. Shows how much of one good a society is prepared to give up (trade off) in order to have an extra unit of another good. Trade off: reallocation of resources. Instead of producing a certain amount of Y, produce an extra unit of X. “Trade off Y for X”. Allocatively efficient: production lies on an IC curve (within the PPC). Technically efficient: production lies on the PPC curve. Pareto efficiency: is achieved when the IC is tangential to the PPC (where the MRS = MRT). This is a situation at which nobody can be made better off without making somebody else worse off. Opportunity Cost: name given to the amount of Defence given up to get one more unit of Food. 1

(OC of the additional food) Comparative advantage: If one economy has a lower MRT, then it has a comparative advantage in the production of the good on the horizontal axis, as it has a lower opportunity cost. Absolute advantage: In a two-economy world, one country is more efficient at producing both/all goods Specialisation into comparative advantage can be beneficial for both economies as it allows a combination of goods to be produced that would lie beyond the PPC. (with trade) Autarky: Autarky is an economic policy to have a closed economy and not allow any external trade Price elasticity for demand: is a measure of the sensitivity of demand for a good to a change in price: %change in demand / %change in price Tax revenue: tax per unit x price per unit = A + B HOUSEHOLDS BEHAVIOUR Budget line: characterises the maximum amount of good that a consumer can afford. Its equation is M= px*x + py*y Constrained choice: consumer’s choice in the allocation of resources given its preferences (IC curve) and its budget line. Fundamental assumptions on preferences: 

Completeness: an individual is able to define, rank and articulate her preferences.

  

Transitivity: if x y and y z, then x z Ordinal ranking: preferences cannot be objectively measured and cardinally ranked Non satiation: greater quantities are always preferred to smaller quantities

Types of Indifference curve: 

Upward-sloping tail. After a certain point, no more is desired e.g. alcohol?

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Perfect substitutes: Indifference between the two creates a constant MRS and a linear IC with a slope of -1.

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Perfect complements: Goods must be consumed in fixed proportion therefore right2

angled ICs. 

Indifference about a good (neither good nor bad) would be reflected by horizontal/vertical ICs.

Types of good given an increase in money income.  

Normal good: demand rises by an equal amount (unit elastic) Necessity good: demand remains the same (perfectly inelastic)

 

Luxury good: demand rises by a proportionately greater amount (elastic) Inferior good: demand falls.

Giffen good: good so strongly inferior that income effect outweighs the substitution effect, resulting in an upward sloping demand curve in some region of price. Substitution effect or relative price effect: X is now cheaper than previously relative to Y. The individual Is therefore likely to switch from Y towards X to some extent. ab Income Effect: The budget constraint shifts outward, hence the individual can achieve a higher utility. They are therefore able to buy more X and Y regarding their preferences (normal good). bâ Total Effect: aâ, SE+IE Consumer surplus is the left hand side sum of what consumers would’ve been willing to pay and what they actually pay. Income-leisure trade-off is the trade-off between spending time working and enjoying leisure. Leisure time is on the x axis, with a Tmax vertical constraint and income, plotted on the y axis. The slope of the wage constraint represents the wage rate. The wage constraint excludes nonlabour income, which is added as a constant as it represents the money you earn without working. Finally, there is a time constraint which must be filled by Leisure and/or work. The inter-temporal budget line shows all combinations of current and future consumption that can be achieved given current income, future income (E) and the interest rate. The Marginal Rate of Time Preference shows the rate at which consumption today can be exchanged for consumption tomorrow while maintaining indifference.

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FIRM BEHAVIOUR Profit is defined as Total Revenue – Total Cost, where total cost includes the owner’s income. A profit is said to be normal if TR=TC. Total Revenue: is the total flow of income to a firm from selling a given quantity of output at a given price, less tax going to the government. TR = p(X) * X Marginal Revenue: is the revenue generated from selling one extra unit of a good or service. It can be positive or negative and also be obtained by deriving TR. Average Revenue: is the revenue per unit. It is found by dividing TR by the quantity sold. Hence, AR is equivalent to the price of the product. Total Cost is the sum of Total Fixed Costs and Total Variable Costs. Marginal Cost is the slope of TC and only depends on TVC. It shows the additional cost of producing an extra unit. Profit maximisation: profit is maximized when there is the greatest difference between TC and TR, or in other words, when their slope is the same – thus where MC = MR. Isoquant: measure the influence of outputs on the level of production or output that can be achieved. Diminishing return to labour: if one factor of production (number of workers) is increased whereas other factors are held constant (machines and workspace), the output per unit (of workers) will eventually decreased. Marginal product of labour: measure of the physical increase in the output of a firm or economy, it is the output that results from hiring one additional worker, all other factors remaining constant. Increasing return to labour: inverse of DRL. Decreasing return to scale: a proportionate increase in all input quantities resulting in a less than proportionate increase in output. The Marginal Rate of Technical Substitution shows how much one input should decrease if another input increases, whilst keeping total output constant. It is given by differentiating the 4

production function: X X(K,L) Supernormal profit: where MC=MR, P>SATC>SAVC (so AR>ATC) Abnormal profit: where MC=MR, SATC>P>SAVC Shut Down Rule: in the Long Run, (LATC=LAVC=) LAC>P, a firm should exist or not enter a market. (It is better not to produce anything in the SR). PRODUCT MARKET Perfect Competition: Many identical and small firms are all price-takers because of homogenous goods and perfect information. Free entry/exit and Bertrand price competition ensures that firms cannot charge less than the market price. Price taker: is not significant enough to influence the price of a good or service. Long run industry supply curve is perfectly elastic as price has no influence on output. However, if new firms are not as efficient as the former one, it will create a kinked LRSS curve, with an upward-sloping ‘tail’, representing the difference in efficiency. Welfare Loss: If a monopolist takes over in a previously perfectly competitive market, there is a substantial deadweight welfare loss as well as a large transfer of consumer to producer surplus. This is a result of the higher price, which converts consumer surplus into profit, and the reduced output, which reduces consumer and producer surplus. Deadweight loss: A reduction in net economic benefits resulting from an inefficient allocation of resources. Monopolistic competition: Monopolistic competition has many competing firms, however, unlike PC, firms have differentiated goods, which allows them to each have their own downward-sloping demand curve. There are no barriers to entry, so if supernormal profits are made, new firms will enter, and while firms’ products are not perfect substitutes, they are close enough substitutes to persuade rivals’ customers to switch their consumption. This would shift demand inwards until it reaches an equilibrium in which normal profit only is made.

Monopoly : Market situation where one producer (or a group of producers acting in concert) controls supply of a good or service, and where the entry of new producers is prevented or highly restricted. Monopolist firms (in their attempt to maximize profits) keep the price high and

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restrict the output, and show little or no responsiveness to the needs of their customers. Oligopoly: is a market structure in which a small number of firms has a large majority of market share and hence controls supply/prices. They offer largely similar products, differentiated mainly by heavy advertising and promotional expenditure, and can anticipate the effect of one another's marketing strategies.  Cournot : Adapt their supply to their competitor’s.  Collusive: firms collude. Similar to a monopoly. Best response: A firm’s profit-maximizing choice of output given the level of output by rival firms. Cartel: A group of producers that collusively determine the price and output in a market. Choke price: the price at which quantity demanded falls to zero. Prisonners’ diemma: situation in which there is a tension between the collective interest of all of the producers and the self-interest of individual producer (betray them). Sunk costs: costs that have already been incurred and cannot be recovered FACTOR MARKETS Labour market : MRPL = MPPL and MCL= wage = Lsupply In a monopsony, where the availability of suitable labour can be scarce, the Ls is upward sloping, as higher wages are needed to attract labour away from alternative occupations (or simply out of labour inactivity). MCL is equal to w + dw*L (new wage + the product of the change in wage and total labour) Under perfect competition, a minimum wage creates a new equilibrium where the new, higher w equals the MRPL (where margins are equated) MARKET STRUCTURE, EFFICIENCY AND FAILURE The minimum efficient scale is the lowest quantity of output at which LAC is minimised or all economies of scale are captured Natural monopoly: In an industry which has very high fixed, sunk costs, the MES will be very high, meaning that only one firm will be able to operate.

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Macro Final Goods Approach or Expenditure Approach: C+I+G+NX. GDP is the value of final goods and services produced in an economy. Income Approach: GDP is the sum of Incomes received by economic agents contributing to production in an economy. Value added Approach: GDP is the sum of the firm’s production minus the value of intermediate goods used in an economy. GDP: Gross domestic product. Value of final goods and services produced within the domestic borders. GNP: .. by domestic factors of production. Net factor payment: GNP-GDP Nominal GDP: sum of the quantities of final goods produced multiplied by their current prices. Real GDP: … multiplied by their constant prices. Paasches Quantity Index: calculates changes in Real GDP using final year prices as weights Laspeyres Index: … using initial prices as weights Fisher Index: average of the 2 previous index. Purchasing Power Parity (PPP) measures the difference in the value of one unit of currency in various countries. Therefore, real GDP per capita PPP is a sufficient measurement for the comparison of living standards between countries Unemployment is the number of people who do not have a job but are searching for one. Inflation is a sustained rise in the general level of prices. The inflation rate is the rate of change of inflation. The GDP Deflator is the ratio of nominal GDP to real GDP in a given year and gives the average

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price of produced output. The Consumer Price Index (CPI) is a survey which measures the average cost of living for consumers. It measures the average cost of a representative basket of goods and services over time. Paradox of Thrif: Keynesian model predicts saving will actually lower growth. Bond: loan with agreement to pay a fixed amount of interest plus repayment of the principal on maturity. Demand for money: Liquidity preference is the desire of the public to hold cash, explained by 3 motives according to Keynes: The precautionary motive (hold money due to uncertainty), the transaction motive (an increase in income leads to increased consumption requiring more liquidity) and finally the speculative asset motive (desire to hold one’s resources in liquid form to take advantage of future changes in the rate of interest or bond prices) Quantitative/Credit easing: Volatility: strong instability Crowding in: when a rise in G causes investment to rise. Crowding out: when an increase in G causes investment to fall. (increase in the interest rate is bigger than the increase in Y). Expansionary monetary policy: open market operation conduced by the Central Bank that consists in buying bonds to raise money supply, reducing consequently the interest rate (yield) and increasing output. Contractionary: the inverse Expansionary fiscal policy: government increases gov. spending (G), leading to an increase in output. Inflationary/Deflationary gap: when output is above/below its natural level. Liquidity trap: The liquidity trap is a situation in which interest rate are low and saving rate are high, making monetary policy ineffective. Consumers usually choose to avoid bonds and keep

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their fund in savings because of the belief i will rise. Quantity theory of money: proposes a positive relationship between change in the money supply and the long term price of goods. States that increasing the amount of money eventually leads to an equal % rise in the prices of products and services. Yield of a bond is inversely related to its price. Bargaining. The degree of bargaining power a worker has depends on the cost to the firm of replacing him and how hard it would be for the worker to find a new job if he was replaced. Here, both the nature of the job (skill and experience) and labour market conditions (unemployment rate) determines the degree of bargaining power. Efficiency Wages. Firms may want to incentivise productivity by offering a wage higher than their reservation wage. This depends on two factors: firstly, the degree of autonomy the job entails (morale and energy doesn’t matter as much for routine jobs) and secondly, labour market conditions (determines the number of quits and the wage needed to prevent them). The expected price level: Because both workers and firms care about real as opposed to nominal wages (workers will demand higher wages, firms will be more willing to raise wages), the price level will have an effect on wages. Wages are pre-determined before the actual price level is known – therefore the expected price level is a much better observation than the current price level. The unemployment rate: As discussed above, the unemployment rate (labour market conditions) is inversely related to the wage level, either because of changes in bargaining power or efficiency wage considerations. The equilibrium unemployment rate is called the natural rate of unemployment, although it is not ‘natural’ in logical meaning The natural level of output is the level of production when employment is equal to the natural level of employment The mark-up reflects the degree of competition in the goods market (whether price must equal marginal cost or not). Neutrality of money: states that changes in the aggregate money supply only affect nominal variables (prices, wages..), rather than real variable (GDP, unemployment, real prices…) Open economy: market mostly free from trade barriers and where exports and imports

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represent a large % of the GDP. The Balance of Payments records a country’s transactions with the rest of the world, and includes both trade (goods market) and financial (financial market) flows. It is composed of Current Account:  

Country’s net balance in trade of goods (NX) Net investment income (interest, profits and dividends inflow - outflow)



Net transfers (foreign aid inflows – outflows)

Capital Account: 

Country’s net holding of assets, denoted NFI.

The nominal exchange rate is the price of the domestic currency in terms of a foreign currency. An appreciation (or revaluation) is an increase in the exchange rate whereas a depreciation (or devaluation) is a decrease in the interest rate. In order to compare currencies, it is often better to use the real exchange rate, which is done by dividing the product of the price of domestic goods and the exchange rate by the GDP deflator. Capital mobility (f): ability of private funds to move capital form one country to another (in pursuit of higher returns). This mobility depends on the absence of currency restrictions on inflow/outflow of capital. Perfectly capital mobility=> horizontal BP curve, no problem as no tax (i=i$) Zero capital mobility=> vertical BP, diff and expensive to move capital. Sterilisation: form a monetary action in which CB seeks to limit the effect of inflows/outflows of capital on the money supply. Involves frequently purchases/sale of financial assets and is designed to offset the effect of foreign exchange intervention. This process is used to manipulate domestic currency. BOP deficit: means we increases imports and investors seek foreign assets. So it forces CB to sell some foreign $ to satisfy the excess of supply for $ and remove the BP deficit (keeping e fixed otherwise e increases and the deficit is automatically removed). BOP surplus: inverse process. The interest parity condition shows the relationship between domestic and foreign interest

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rates. It states that the domestic interest rate must be equal to the foreign interest rate minus the expected depreciation rate of the foreign currency The Marshall-Lerner Condition describes how a depreciation in the real exchange rate affects the trade balance. +formula The Mundell-Fleming Model describes the IS-LM model extended to an open economy. (with the BP curve) Utility function: measures welfare or satisfaction of a consumer as a function of consumption. Mathematical way to measure consumers’ preferences (outcomes with higher utility are preferred). It is therefore used to analyse human behaviour. Wealth: measures the total monetary value of the capital, goods and services, including net foreign balance and tangible assets owned by a person or a nation over a particular period of time. Endowment: financial asset under the form of a donation made to a non profit group, institution or individual Permanent Income Hypothesis: Friedman’s extension to the 2 period Fisher model. States that permanent change in income have a much larger impact on the consumption than temporary change in income. Lifecycle Hypothesis: Modigliani’s extension to the 2 period Fisher model. States that consumers want to consume a constant proportion of wealth every period (smooth consumption). Ricardian equivalence: Timing in tax changes are neutral. Discount rate: also called time preference is the choice consumers make regarding their cons...