Economics

Economics

Introduction to Economics

Economics is the study of how society allocates scarce resources and goods. Resources are the inputs that society uses to produce output, called goods. Resources include inputs such as labor, capital, and land. Goods include products such as food, clothing, and housing as well as services such as those provided by barbers, doctors, and police officers. These resources and goods are considered scarce because of society’s tendency to demand more resources and goods than are available. While most resources and goods are scarce, ...
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An economic policy is a course of action that is intended to influence or control the behavior of the economy. Economic policies are typically implemented and administered by the government. Examples of economic policies include decisions made about government spending and taxation, about the redistribution of income from rich to poor, and about the supply of money. The effectiveness of economic policies can be assessed in one of two ways, known as positive and normative economics. Positive and normative economics Positive ...
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The prefix micro means small, indicating that microeconomics is concerned with the study of the market system on a small scale. Microeconomics looks at the individual markets that make up the market system and is concerned with the choices made by small economic units such as individual consumers, individual firms, or individual government agencies ...
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Economics-Economic-Analysis
Economic analysis is marginal analysis In marginal analysis, one examines the consequences of adding to or subtracting from the current state of affairs. Consider, for example, an employer’s decision to hire a new worker. The employer must determine the marginal benefit of hiring the additional worker as well as the marginal cost. The marginal benefit of hiring the worker is the value of the additional goods or services that the new worker could produce. The ...
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Demand, Supply, Elasticity

In every market, there are both buyers and sellers. The buyers’ willingness to buy a particular good (at various prices) is referred to as the buyers’ demand for that good. The sellers’ willingness to supply a particular good (at various prices) is referred to as the sellers’ supply of that good. The buyers’ demand is represented by a demand schedule, which lists the quantities of a good that buyers are willing to purchase at different ...
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Economics-Supply
The buyers’ demand for goods is not the only factor determining market prices and quantities. The sellers’ supply of goods also plays a role in determining market prices and quantities. Like the buyers’ demand, the sellers’ supply can be represented in three different ways: by a supply schedule, by a supply curve, and algebraically. An example of a supply schedule for a certain good X is given in Table, and the corresponding supply curve is drawn in Figure. Note that as the ...
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In addition to understanding how equilibrium prices and quantities change as demand and supply change, economists are also interested in understanding how demand and supply change in response to changes in prices and incomes. The responsiveness of demand or supply to changes in prices or incomes is measured by the elasticity of demand or supply. Price elasticity of demand and supply. The price elasticity of demand is given by the formula: The price elasticity of supply is given by a ...
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Economics-Equilibrium-Analysis
In the market for any particular good X, the decisions of buyers interact simultaneously with the decisions of sellers. When the demand for good X equals the supply of good X, the market for good X is said to be in equilibrium. Associated with any market equilibrium will be an equilibrium quantity and an equilibrium price. The equilibrium quantity of good X is that quantity for which the quantity demanded of good X exactly equals the quantity supplied of good X. The equilibrium price for good X is that price per unit of good X that ...
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Unemployment, Inflation, GDP

Economics-GDP
GDP is defined as the market value of all final goods and services produced domestically in a single year and is the single most important measure of macroeconomic performance. A related measure of the economy’s total output product is gross national product (GNP), which is the market value of all final goods and services produced by a nation in a single year.   GDP or GNP? The difference between GDP and GNP is rather technical. GDP includes only goods and services produced by a nation’s ...
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Economics-Nominal-GDP-Real-GDP-and-Price-Level
Nominal GDP is GDP evaluated at current market prices. Therefore, nominal GDP will include all of the changes in market prices that have occurred during the current year due to inflation or deflation. Inflation is defined as a rise in the overall price level, and deflation is defined as a fall in the overall price level. In order to abstract from changes in the overall price level, another measure of GDP called real GDP is often used. Real GDP is GDP ...
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Economics-Unemployment-Rate
The unemployment rate measures the percentage of the total civilian labor force that is currently unemployed. The formula for the unemployment rate is given by  The civilian labor force consists of all civilians (non‐military personnel), 16 years of age or older, who are willing to work and are not incarcerated. The number of people unemployed is determined according to certain criteria. In the U.S., an unemployed person is a member of the civilian labor force who is ...
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Aggregate Demand & Aggregate Supply

In macroeconomics, the focus is on the demand and supply of all goods and services produced by an economy. Accordingly, the demand for all individual goods and services is also combined and referred to as aggregate demand. The supply of all individual goods and services is also combined and referred to as aggregate supply. Like the demand and supply for individual goods and services, the aggregate demand and aggregate supply for an economy can be represented by a ...
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The aggregate supply curve depicts the quantity of real GDP that is supplied by the economy at different price levels. The reasoning used to construct the aggregate supply curve differs from the reasoning used to construct the supply curves for individual goods and services. The supply curve for an individual good is drawn under the assumption that input prices remain constant. As the price of good X rises, sellers’ per unit costs of providing good X do ...
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When the aggregate demand and SAS (short-run aggregate supply) curves are combined, as in Figure , the intersection of the two curves determines both the equilibrium price level, denoted by P *, and the equilibrium level of real GDP, denoted by Y * .
  If it is further assumed that the economy is fully employing all of its resources, the equilibrium level of real GDPY *, will correspond to the natural level of real GDP, and the LAS curve may be drawn as a vertical line at Y *, ...
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Classical & Keynesian Theories: Output, Employment

The fundamental principle of the classical theory is that the economy is self‐regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy’s resources are fully employed. While circumstances arise from time to time that cause the economy to fall below or to exceed the natural level of real GDP, self‐adjustment mechanisms exist within the market system that work ...
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Keynes’s theory of the determination of equilibrium real GDP, employment, and prices focuses on the relationship between aggregate income and expenditure. Keynes used his income‐expenditure model to argue that the economy’s equilibrium level of output or real GDP may not corresPond to the natural level of real GDP. In the income‐expenditure model, the equilibrium level of real GDP is the level of real GDP that is consistent with the current level of aggregate expenditure. If the current ...
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Money & Banking

What is money? Money is any good that is widely used and accepted in transactions involving the transfer of goods and services from one person to another. Economists differentiate among three different types of money: commodity money, fiat money, and bank money. Commodity money is a good whose value serves as the value of money. Gold coins are an example of commodity money. In most countries, commodity money has been replaced with fiat money. Fiat money is a good, ...
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Money is often defined in terms of the three functions or services that it provides. Money serves as a medium of exchange, as a store of value, and as a unit of account. Medium of exchange Money’s most important function is as a medium of exchange to facilitate transactions. Without money, all transactions would have to be conducted by barter, which involves direct exchange of one good or service for another. The difficulty with a barter system is that in order to obtain a ...
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The demand for money is affected by several factors, including the level of income, interest rates, and inflation as well as uncertainty about the future. The way in which these factors affect money demand is usually explained in terms of the three motives for demanding money: the transactions, the precautionary, and the speculative motives. Transactions motive The transactions motive for demanding money arises from the fact that most transactions involve an exchange of money. Because it is necessary to have money available ...
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There are several definitions of the supply of money. M1 is narrowest and most commonly used. It includes all currency (notes and coins) in circulation, all checkable deposits held at banks (bank money), and all traveler’s checks. A somewhat broader measure of the supply of money is M2, which includes all of M1 plus savings and time depositsheld at banks. An even broader measure of the money supply is M3, which includes all of M2 plus large denomination, long‐term time deposits—for example, certificates of deposit (CDs) in amounts over $100,000. Most ...
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Fiscal & Monetary Policy

Fiscal policy is carried out by the legislative and/or the executive branches of government. The two main instruments of fiscal policy are government expenditures and taxes. The government collects taxes in order to finance expenditures on a number of public goods and services—for example, highways and national defense.   Budget deficits and surpluses When government expenditures exceed government tax revenues in a given year, the government is running a budget deficit for that year. The budget deficit, which is the difference between government expenditures and tax ...
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Monetary policy is conducted by a nation’s central bank. In the U.S., monetary policy is carried out by the Fed. The Fed has three main instruments that it uses to conduct monetary policy: open market operations, changes in reserve requirements, and changes in the discount rate. Recall from the earlier discussion of money and banking that open market operations involve Fed purchases and sales of U.S. government bonds. When the Fed purchases government bonds, it increases the reserves of the banking ...
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Theory of Consumer

The consumer equilibrium condition determines the quantity of each good the individual consumer will demand. As the example above illustrates, the individual consumer’s demand for a particular good—call it good X—will satisfy the law of demand and can therefore be depicted by a downward‐sloping individual demand curve. The individual consumer, however, is only one of many participants in the market for good X. The market demand curve for good X includes the quantities of good X demanded by all participants in the market for good X. The market demand ...
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Individuals consume goods and services because they derive pleasure or satisfaction from doing so. Economists use the term utility to describe the pleasure or satisfaction that a consumer obtains from his or her consumption of goods and services. Utility is a subjective measure of pleasure or satisfaction that varies from individual to individual according to each individual’s preferences.For example, if an individual’s choices for a Saturday evening are to watch television, go out to dinner, or go to ...
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When consumers make choices about the quantity of goods and services to consume, it is presumed that their objective is to maximize total utility. In maximizing total utility, the consumer faces a number of constraints, the most important of which are the consumer’s income and the prices of the goods and services that the consumer wishes to consume. The consumer’s effort to maximize total utility, subject to these constraints, is referred to as the consumer’s problem. The solution to the consumer’s problem, which entails ...
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The consumer’s choice of how much to consume of various goods depends on the prices of those goods. If prices change, the consumer’s equilibrium choice will also change. To see how, consider again the example considered above where the consumer must decide how much to consume of goods 1 and 2. Suppose that the price of good 1 increases from $2 per unit to $3 per unit, while the price of good 2 remains unchanged at $1 ...
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The difference between the maximum price that consumers are willing to pay for a good and the market price that they actually pay for a good is referred to as the consumer surplus. The determination of consumer surplus is illustrated in Figure , which depicts the market demand curve for some good.   The market price is $5, and the equilibrium quantity demanded is 5 units of the good. The market demand curve reveals that consumers are willing ...
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Theory of the Firm

The theory of the consumer is used to explain the market demand for goods and services. The theory of the firm provides an explanation for the market supply of goods and services. A firm is defined as any organization of individuals that purchases factors of production (labor, capital, and raw materials) in order to produce goods and services that are sold to consumers, governments, or other firms. The theory of the firm assumes that the firm’s primary objective is to maximize profits. In maximizing profits, firms are ...
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The firm’s primary objective in producing output is to maximize profits. The production of output, however, involves certain costs that reduce the profits a firm can make. The relationship between costs and profits is therefore critical to the firm’s determination of how much output to produce. Explicit and implicit costs A firm’s explicit costs comprise all explicit payments to the factors of production the firm uses. Wages paid to workers, payments to suppliers of raw materials, and ...
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In the short‐run, some factors of production are fixed. Corresponding to each different level of fixed factors, there will be a different short‐run average total cost curve (SATC). The average total cost curve is just one of many SATCs that can be obtained by varying the amount of the fixed factor, in this case, the amount of capital. Long‐run average total cost curve. In the long‐run, all factors of production are variable, and hence, all costs are variable. The long‐run average ...
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Perfect Competition

When economists analyze the production decisions of a firm, they take into account the structure of the market in which the firm is operating. The structure of the market is determined by four different market characteristics: the number and size of the firms in the market, the ease with which firms may enter and exit the market, the degree to which firms’ products are differentiated, and the amount of information available to both buyers and ...
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The demand and supply curves for a perfectly competitive market are illustrated in Figure (a); the demand curve for the output of an individual firm operating in this perfectly competitive market is illustrated in Figure (b).   Note that the demand curve for the market, which includes all firms, is downward sloping, while the demand curve for the individual firm is flat or perfectly elastic, reflecting the fact that the individual takes the market price, P, as given. The difference ...
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In determining how much output to supply, the firm’s objective is to maximize profits subject to two constraints: the consumers’ demand for the firm’s product and the firm’s costs of production. Consumer demand determines the price at which a perfectly competitive firm may sell its output. The costs of production are determined by the technology the firm uses. The firm’s profits are the difference between its total revenues and total costs.  Total revenue and marginal ...
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In the long‐run, firms can vary all of their input factors. The ability to vary the amount of input factors in the long‐run allows for the possibility that new firms will enter the market and that some existing firms will exit the market. Recall that in a perfectly competitive market, there are no barriers to the entry and exit of firms. New firms will be tempted to enter the market if some of the existing firms in the market are earning positive ...
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Monopoly

In a perfectly competitive market, there are many firms, none of which is large in size. In contrast, in a monopolistic market there is only one firm, which is large in size. This one firm provides all of the market’s supply. Hence, in a monopolistic market, there is no difference between the firm’s supply and market supply.   Three conditions characterize a monopolistic market structure. First, there is only one firm operating in the market. Second, there are high barriers to entry.These barriers are ...
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Because the monopolist is the market’s only supplier, the demand curve the monopolist faces is the market demand curve. You will recall that the market demand curve is downward sloping, reflecting the law of demand. The fact that the monopolist faces a downward‐sloping demand curve implies that the price a monopolist can expect to receive for its output will not remain constant as the monopolist increases its output.   Price‐searching behavior. Unlike a perfectly competitive firm, the monopolist does ...
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A monopolist produces less output and sells it at a higher price than a perfectly competitive firm. The monopolist’s behavior is costly to the consumers who demand the monopolist’s output. The cost of monopoly that is borne by consumers is illustrated in Figure . The firm’s marginal cost curve is drawn as a horizontal line at the market price of $5.   In a perfectly competitive market, the firm’s marginal revenue curve is also equal to the market price of ...
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In the discussion of a perfectly competitive market structure, a distinction was made between short‐run and long‐run market behavior. In the long‐run, all input factors are assumed to be variable, making it possible for firms to enter and exit the market. The consequence of this entry and exit of firms was that each firm’s economic profits were reduced to zero in the long‐run. The distinction between the short‐run and the long‐run is not as important ...
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The monopolist’s profit maximizing level of output is found by equating its marginal revenue with its marginal cost, which is the same profit maximizing condition that a perfectly competitive firm uses to determine its equilibrium level of output. Indeed, the condition that marginal revenue equal marginal cost is used to determine the profit maximizing level of output of every firm, regardless of the market structure in which the firm is operating. In order to determine the profit ...
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Monopolistic Competition & Oligopoly

Perfect competition and pure monopoly represent the two extreme possibilities for a market’s structure. The structure of almost all markets, however, falls somewhere between these two extremes. This section considers two market structures, monopolistic competition and oligopoly, which lie between the extreme cases of perfect competition and monopoly. Monopolistic competition, as its name suggests, is a combination of monopoly and competition. However, monopolistic competition is more closely related to perfect competition than to monopoly. Oligopoly is also a combination of ...
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Oligopoly is the least understood market structure; consequently, it has no single, unified theory. Nevertheless, there is some agreement as to what constitutes an oligopolistic market. Three conditions for oligopoly have been identified. First, an oligopolistic market has only a few large firms.This condition distinguishes oligopoly from monopoly, in which there is just one firm. Second, an oligopolistic market has high barriers to entry. This condition distinguishes oligopoly from perfect competition and monopolistic competition in which there are ...
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Because the monopolistically competitive firm’s product is differentiated from other products, the firm will face its own downward‐sloping “market” demand curve. This demand curve will be considerably more elastic than the demand curve that a monopolist faces because the monopolistically competitive firm has less control over the price that it can charge for its output. The firm’s control over its price will depend on the degree to which its product is differentiated from competing firms’ products. If the firm’s ...
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As mentioned above, there is no single theory of oligopoly. The two that are most frequently discussed, however, are the kinked‐demand theory and the cartel theory. The kinked‐demand theory is illustrated in Figure and applies to oligopolistic markets where each firm sells a differentiated product. According to the kinked‐demand theory, each firm will face two market demand curves for its product. At highprices, the firm faces the relatively elastic market demand curve, labeled MD 1 in Figure .   Corresponding to MD 1 is the marginal revenue curve labeled MR 1.At low prices, the firm faces the relatively inelastic market ...
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A cartel is defined as a group of firms that gets together to make output and price decisions. The conditions that give rise to an oligopolistic market are also conducive to the formation of a cartel; in particular, cartels tend to arise in markets where there are few firms and each firm has a significant share of the market. In the U.S., cartels are illegal; however, internationally, there are no restrictions on cartel formation. The organization of ...
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The difference between the short‐run and the long‐run in a monopolistically competitive market is that in the long‐run new firms can enter the market, which is especially likely if firms are earning positive economic profits in the short‐run. New firms will be attracted to these profit opportunities and will choose to enter the market in the long‐run. In contrast to a monopolistic market, no barriers to entry exist in a monopolistically competitive market; hence, it ...
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An illustration of the monopolistically competitive firm’s profit‐maximizing decision is provided in Figure .   The firm maximizes its profits by equating marginal cost with marginal revenue. The intersection of the marginal cost and marginal revenue curves determines the firm’s equilibrium level of output, labeled Q in this figure. The firm finds the price that it can charge for this level of output by looking at the market demand curve; if it provides Q units of output, it can charge ...
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Labor Market

In addition to making output and pricing decisions, firms must also determine how much of each input to demand. Firms may choose to demand many different kinds of inputs. The two most common are labor and capital.   The demand and supply of labor are determined in the labor market.The participants in the labor market are workers and firms. Workers supply labor to firms in exchange for wages. Firms demand labor from workers in exchange for wages. The firm’s demand for labor. The firm’s demand for labor is a derived demand; it is derived from ...
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A labor market in which there is only one firm demanding labor is called a monopsony. The single firm in the market is referred to as the monopsonist. An example of a monopsony would be the only firm in a “company town,” where the workers all work for that single firm.   Wage‐searching behavior. Because the monopsonist is the sole de‐mander of labor in the market, the monopsonist’s demand for labor is the market demand for labor. The supply of labor that ...
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While each labor market is different, the equilibrium market wage rate and the equilibrium number of workers employed in every perfectly competitive labor market is determined in the same manner: by equating the market demand for labor with the market supply of labor. The determination of equilibrium market wage and employment is illustrated in Figure .    The equilibrium market wage is W, and the equilibrium number of workers employed is Q. At wage rates greater than W, the demand for labor would be ...
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In a monopsony market, the monopsonist firm—like any profit‐maximizing firm—determines the equilibrium number of workers to hire by equating its marginal revenue product of labor with its marginal cost of labor. Figure illustrates the monopsony labor market equilibrium, using the supply and cost data from Table . The marginal revenue product of labor equals the marginal cost of labor when the firm employs 3 workers. The equilibrium market wage rate is determined by the market labor supply ...
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Capital Market

While labor is measured in terms of the number of workers hired or the number of hours worked, it is difficult to measure capital in terms of physical units because there are so many different types of capital goods. Capital goods, therefore, are simply measured in terms of their market or dollar value.   Capital stock. The market value of capital goods at a given point in time, for example, at the end of a year, is referred to as the capital stock. A firm’s capital ...
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The demand and supply for different types of capital take place in capital markets. In these capital markets, firms are typically demanders of capital, while households are typically suppliers of capital. Households supply capital goods indirectly, by choosing to save a portion of their incomes and lending these savings to banks. Banks, in turn, lend household savings to firms that use these funds to purchase capital goods.   Loanable funds. The term loanable funds is used to describe funds that are available for borrowing. Loanable funds consist ...
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Firms purchase capital goods to increase their future output and income. Income earned in the future is often evaluated in terms of its present value. The present value of future income is the value of having this future income today.   Present value formula.The present value of receiving $20,000 one year from now can be calculated using the present value formula. The formula for finding the present value of X dollars received t years from now at the current market interest rate r is ...
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