Praxis Economics cheat sheet

Opportunity cost of a choice = value of the single best forgone alternative; sunk costs are excluded from forward-looking decisions.

Production possibilities frontier: points on the curve are efficient, inside are inefficient, outside are unattainable given current resources and technology; the frontier shifts out with resource growth or better technology.

Comparative advantage: compute each producer's opportunity cost of one unit of X as (units of Y given up)/(units of X gained); the lower ratio specializes in X. Absolute advantage compares output per input, not opportunity cost.

Marginal analysis rule: take an action while marginal benefit exceeds marginal cost; the optimal quantity is where MB = MC.

Circular flow: households supply factors of production to firms and receive income, then spend on goods; leakages (saving, taxes, imports) reduce the spending flow and injections (investment, government spending, exports) add to it.

Positive statements are testable claims about what is; normative statements contain value judgments about what ought to be.

Ceteris paribus means holding all other variables constant; a movement along a curve reflects a price change, a shift reflects a change in a non-price determinant.

Law of increasing opportunity cost: as more of a good is produced, the opportunity cost per additional unit rises, giving the PPF its bowed-out shape.

Elasticity of demand = % change in quantity demanded / % change in price; use the midpoint formula: (ΔQ/avg Q)/(ΔP/avg P). |E| > 1 elastic, |E| < 1 inelastic, |E| = 1 unit elastic.

Total revenue test: if price and total revenue move in opposite directions, demand is elastic; if they move together, demand is inelastic.

Elasticity is higher with more close substitutes, a larger share of income, more time to adjust, and for luxuries rather than necessities.

Profit maximization for any market structure occurs where MR = MC; a competitive firm's supply curve is its MC curve above minimum AVC.

Short-run shutdown rule: shut down if price falls below minimum average variable cost; exit the industry in the long run if price stays below minimum average total cost.

Perfect competition long-run equilibrium: P = MR = MC = minimum ATC, with zero economic profit. A monopoly sets MR = MC and charges a price on the demand curve above MR, creating deadweight loss.

A price ceiling below equilibrium creates a shortage; a price floor above equilibrium creates a surplus; both reduce total surplus. A tax drives a wedge between buyer price and seller price, and the more inelastic side bears more of the burden.

Externality rule: a negative externality causes marginal social cost above marginal private cost, so the market overproduces; a positive externality causes marginal social benefit above marginal private benefit, so the market underproduces. Pigouvian tax or subsidy internalizes the gap.

Gini coefficient ranges from 0 (perfect equality) to 1 (perfect inequality); a Lorenz curve farther from the 45-degree line indicates greater inequality.

GDP = C + I + G + (X − M); it counts final goods produced within a country's borders in a period, excludes intermediate goods, transfer payments, and used-good sales.

Real GDP = (Nominal GDP / price index) × 100; the GDP deflator = (Nominal GDP / Real GDP) × 100.

Unemployment rate = unemployed / labor force × 100, where the labor force is employed plus unemployed; discouraged workers are outside the labor force and understate the rate.

Types of unemployment: frictional (job search), structural (skills or location mismatch), cyclical (recession-driven). Full employment corresponds to the natural rate, with only frictional and structural unemployment.

CPI = (cost of basket in current year / cost of basket in base year) × 100; inflation rate = % change in CPI. Unexpected inflation hurts lenders and fixed-income recipients and helps borrowers.

Quantity theory: MV = PY; money growth in excess of real output growth tends to raise the price level.

Expansionary monetary policy (buy bonds, lower the reserve ratio, lower the discount or policy rate) raises the money supply, lowers interest rates, and shifts aggregate demand right.

Expansionary fiscal policy (higher government spending, lower taxes) shifts aggregate demand right; the multiplier = 1/(1 − MPC), and the tax multiplier = −MPC/(1 − MPC).

Phillips curve: short-run trade-off between inflation and unemployment; the long-run curve is vertical at the natural rate, so sustained inflation requires accelerating money growth.

Balance of payments: current account + capital/financial account + statistical discrepancy = 0; a current account deficit is matched by a financial account surplus (net capital inflow).

A depreciation of a currency makes exports cheaper and imports dearer, improving the trade balance with a lag (J-curve); appreciation does the reverse.

Comparative advantage, not absolute advantage, is the basis for gains from trade; the terms of trade lie between the two countries' domestic opportunity costs.

A tariff raises domestic price, reduces imports, creates deadweight loss from consumption and production distortion, and generates tariff revenue; a quota transfers rent to quota holders.

Floating exchange rates adjust through market supply and demand; a fixed rate requires central-bank intervention or interest-rate adjustment to defend the peg.

Purchasing power parity predicts exchange rates adjust so identical baskets cost the same; it holds better in the long run than the short run.

Economic development indicators: GDP per capita, HDI (income, education, life expectancy), literacy, and income distribution; growth accounting attributes output growth to capital, labor, and total factor productivity.

Policies for development include investment in human capital, property-rights institutions, trade openness, infrastructure, and microfinance; foreign aid effectiveness depends on governance.