Scarcity - means that society has limited resources and therefore cannot produce all the goods and

services people wish to have.

- the limited nature of society’s resources

Economics is the study of how society manages its scarce resources.

Economists - study how people make decisions: how much they work, what they buy, how much they
save, and how they invest their savings. Economists also study how people interact with one another.

- analyze forces and trends that affect the economy as a whole, including the growth in
average income, the fraction of the population that cannot find work, and the rate at which
prices are rising

Efficiency - means that society is getting the maximum benefits from its scarce resources.

Equality - means that those benefits are distributed uniformly among society’s members.

Opportunity cost - what you give up to get that item.

Rational people - people who systematically and purposefully do the best they can to achieve their
objectives.

Marginal change - a small incremental adjustment to a plan of action. Margin means “edge,” so marginal
changes are adjustments around the edges of what you are doing

Market economy - an economy that allocates resources through the decentralized decisions of many
firms and households as they interact in markets for goods and services.

Property rights - the ability of an individual to own and exercise control over scarce resources.

Market failure - a situation in which a market left on its own fails to allocate resources efficiently.

externality - the impact of one person’s actions on the well-being of a bystander.

market power - the ability of a single economic actor (or small group of actors) to have a substantial
influence on market prices.

Productivity - the quantity of goods and services produced from each unit of labor input.

Inflation - an increase in the overall level of prices in the economy.

business cycle - the irregular and largely unpredictable fluctuations in economic activity, as measured by
the production of goods and services or the number of people employed.

circular-flow diagram a visual model of the economy that shows how dollar flow through markets
among households and firms.

production possibilities frontier a graph that shows the combinations of output that the economy can
possibly produce given the available factors of production and the available production technology.

microeconomics the study of how households and firms make decisions and how they interact in
markets.
macroeconomics the study of economy wide phenomena, including inflation, unemployment, and
economic growth.

market a group of buyers and sellers of a particular good or service.

competitive market a market in which there are many buyers and many sellers so that each has a
negligible impact on the market price.

gross domestic product (GDP) the market value of all final goods and services produced within a country
in a given period of time

consumption spending by households on goods and services, with the exception of purchases of new
housing

investment spending on capital equipment, inventories, and structures, including household purchases
of new housing. By contrast, because GDP measures expenditure on goods and services, here the word
investment means purchases of goods (such as capital equipment, structures, and inventories) used to
produce other goods and services in the future

government purchases spending on goods and services by local, state, and federal governments

net exports spending on domestically produced goods by foreigners (exports) minus spending on foreign
goods by domestic residents (imports)

nominal GDP the production of goods and services valued at current prices

real GDP the production of goods and services valued at constant prices

GDP deflator a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100

inflation rate is the percentage change in some measure of the price level from one period to the next.

consumer price index (CPI) a measure of the overall cost of the goods and services bought by a typical
consumer

producer price index a measure of the cost of a basket of goods and services bought by firms

physical capital the stock of equipment and structures that are used to produce goods and services

human capital the knowledge and skills that workers acquire through education, training, and
experience

the inputs used to produce goods and services—labor, capi tal, and so on—are called the factors of
production.

natural resources the inputs into the production of goods and services that are provided by nature, such
as land, rivers, and mineral deposits

technological knowledge society’s understanding of the best ways to produce goods and services

Diminishing returns the property whereby the benefit from an extra unit of an input declines as the
quantity of the input increases
catch-up effect the property whereby countries that start off poor tend to grow more rapidly than
countries that start off rich

A capital investment that is owned and operated by a foreign entity is called foreign direct investment

An investment that is financed with foreign money but operated by domestic residents is called foreign
portfolio investment

brain drain—the emigration of many of the most highly educated workers to rich countries, where these
workers can enjoy a higher standard of living

inward-oriented policies. These policies attempt to increase productivity and living standards within the
country by avoiding interaction with the rest of the world

financial system the group of institutions in the economy that help to match one person’s saving with
another person’s investment

financial markets financial institutions through which savers can directly provide funds to borrowers

bond a certificate of indebtedness

It identifies the time at which the loan will be repaid, called the date of maturity

term—the length of time until the bond matures.

a bond that never matures, called a perpetuity. This bond pays interest forever, but the principal is
never repaid.

credit risk—the probability that the borrower will fail to pay some of the interest or principal

Such a failure to pay is called a default

tax treatment—the way the tax laws treat the interest earned on the bond
, when state and local governments issue bonds, called municipal bonds

The sale of stock to raise money is called equity finance

stock a claim to partial ownership in a firm

the sale of bonds is called debt finance

financial intermediaries financial institutions through which savers can indirectly provide funds to
borrowers

Banks are the financial intermediaries with which people are most familiar. A primary job of banks is to
take in deposits from people who want to save and use these deposits to make loans to people who
want to borrow

mutual fund an institution that sells shares to the public and uses the proceeds to buy a portfolio of
stocks and bonds

national saving the total income in the economy that remains after paying for consumption and
government purchases

private saving the income that households have left after paying for taxes and consumption

public saving the tax revenue that the government has left after paying for its spending

budget surplus an excess of tax revenue over government spending

budget deficit a shortfall of tax revenue from government spending

market for loanable funds the market in which those who want to save supply funds and those who
want to borrow to invest demand funds

loanable funds refer to all income that people have chosen to save and lend out, rather than use for
their own consumption, and to the amount that investors have chosen to borrow to fund new
investment projects

crowding out a decrease in investment that results from government borrowing