KEY TERMS

allocative efficiency
when the mix of goods produced represents the mix that society most desires

budget constraint (or budget line)  shows the possible combinations of two goods that are affordable given a consumer’s limited income

circular flow diagram

a diagram that views the economy as consisting of households and firms interacting in a goods and services market and a labor market

command economy
an economy where economic decisions are passed down from government authority and where the government owns the resources

comparative advantage

when a country can produce a good at a lower cost in terms of other goods; or, when a country has a lower opportunity cost of production

consumer equilibrium  point on the budget line where the consumer gets the most satisfaction; this occurs when the ratio of the prices of goods is equal to the ratio of the marginal utilities.

diminishing marginal utility  the common pattern that each marginal unit of a good consumed provides less of an addition to utility than the previous unit

exports

products (goods and services) made domestically and sold abroad

fiscal policy

economic policies that involve government spending and taxes

globalization

the trend in which buying and selling in markets have increasingly crossed national borders

goods and services market

a market in which firms are sellers of what they produce and households are buyers

gross domestic product (GDP)

measure of the size of total production in an economy

imports

products (goods and services) made abroad and then sold domestically

income effect  a higher price means that, in effect, the buying power of income has been reduced, even though actual income has not changed; always happens simultaneously with a substitution effect

labor market

the market in which households sell their labor as workers to business firms or other employers

law of diminishing marginal utility  As we consume more of a good or service, the utility we get from additional units of the good or service tends to become smaller than what we received from earlier units

law of diminishing returns

as we add additional increments of resources to producing a good or service, the marginal benefit from those additional increments will decline

macroeconomics

the branch of economics that focuses on broad issues such as growth, unemployment, inflation, and trade balance

marginal utility  the additional utility provided by one additional unit of consumption

marginal utility per dollar  the additional satisfaction gained from purchasing a good given the price of the product MU/Price

market

interaction between potential buyers and sellers; a combination of demand and supply

market economy

an economy where economic decisions are decentralized, private individuals own resources, and businesses supply goods and services based on demand

microeconomics

the branch of economics that focuses on actions of particular agents within the economy, like households, workers, and business firms

model

see theory

monetary policy

policy that involves altering the level of interest rates, the availability of credit in the economy, and the extent of borrowing

private enterprise

system where private individuals or groups of private individuals own and operate the means of production (resources and businesses)

production possibilities frontier (PPF)

a diagram that shows the productively efficient combinations of two products that an economy can produce given the resources it has available.

productive efficiency

when it is impossible to produce more of one good (or service) without decreasing the quantity produced of another good (or service)

substitution effect  when a price changes, consumers have an incentive to consume less of the good with a relatively higher price and more of the good with a relatively lower price; always happens simultaneously with an income effect

sunk costs  costs that we make in the past that we cannot recover

theory

a representation of an object or situation that is simplified while including enough of the key features to help us understand the object or situation

total utility  satisfaction derived from consumer choices

traditional economy

typically an agricultural economy where things are done the same as they have always been done

underground economy

a market where the buyers and sellers make transactions in violation of one or more government regulations