Praxis Economics key terms

The value of the next-best alternative given up when a choice is made. It includes both explicit monetary costs and the implicit value of forgone options, and it underlies every scarcity-driven decision.

The condition in which limited resources cannot satisfy all human wants. Because resources are finite, individuals and societies must choose among competing uses, which creates opportunity costs and makes trade-offs unavoidable.

A curve showing the maximum combinations of two goods an economy can produce given its resources and technology. Points on the curve are efficient, points inside are inefficient, and its bowed shape reflects increasing opportunity cost.

Comparing the additional benefit of one more unit of an activity with its additional cost. Optimal decisions occur where marginal benefit equals marginal cost, a rule applied to output, consumption, and policy choices.

Positive statements describe what is and can be tested against evidence; normative statements express value judgments about what ought to be. The distinction separates factual economic analysis from policy advocacy and opinion.

A Latin phrase meaning "all other things held constant." Economists isolate the effect of one variable by assuming others do not change, which allows construction of demand, supply, and other behavioral relationships.

A diagram showing how households supply factors of production to firms and receive income, while firms produce goods and services purchased by households. It illustrates the interdependence of product and resource markets and the role of government and trade.

The principle that, all else equal, quantity demanded falls as price rises and rises as price falls. The inverse relationship produces a downward-sloping demand curve and reflects diminishing marginal utility and substitution effects.

Non-price factors that move an entire demand curve, including income, tastes, prices of related goods, expectations, and number of buyers. A change in these shifts demand rather than causing movement along the curve.

Non-price determinants that move the entire supply curve, such as input costs, technology, taxes and subsidies, expectations, and number of sellers. Changes in these alter quantity supplied at every price.

The principle that, all else equal, quantity supplied rises as price rises. Higher prices cover rising marginal costs, producing an upward-sloping supply curve that reflects producers' profit incentives.

The price at which quantity demanded equals quantity supplied, leaving no shortage or surplus. Market forces push price toward this level; a price above it creates a surplus and one below creates a shortage.

The percentage change in quantity demanded divided by the percentage change in price. Demand is elastic when the value exceeds one and inelastic when below one; availability of substitutes and share of budget influence it.

The percentage change in quantity supplied divided by the percentage change in price. Supply is more elastic when producers can adjust inputs quickly, such as over longer time horizons or with flexible production capacity.

A method for judging elasticity: if price and total revenue move in opposite directions, demand is elastic; if they move together, demand is inelastic; if revenue is unchanged, demand is unit elastic.

A legal maximum price, such as rent control. Set below equilibrium, it creates a shortage, reduces quality or supply, and generates non-price rationing; set above equilibrium, it has no effect.

A legal minimum price, such as the minimum wage or agricultural supports. Set above equilibrium, it creates a surplus and may require government purchases or quotas; set below equilibrium, it is nonbinding.

The difference between what consumers are willing to pay and the price they actually pay, represented by the area below the demand curve and above price. It measures gains from trade accruing to buyers.

The loss of total surplus when a market produces less than the efficient quantity, as with taxes, price controls, or monopoly. It captures mutually beneficial trades that no longer occur.

Normal goods see demand rise when income rises; inferior goods see demand fall when income rises as consumers switch to preferred alternatives. Income elasticity distinguishes the two types.

Substitutes satisfy similar needs, so a price rise in one raises demand for the other. Complements are used together, so a price rise in one lowers demand for the other. Cross-price elasticity measures these relationships.

The principle that each additional unit of a good consumed yields less extra satisfaction than the prior unit. It explains downward-sloping demand and why consumers diversify spending across goods.

Explicit costs are actual payments for inputs; implicit costs are the opportunity value of resources the owner already controls, such as forgone wages or rent. Economic profit subtracts both, unlike accounting profit.

Total revenue minus total cost, where total cost includes both explicit and implicit costs. Zero economic profit means the firm earns exactly a normal return, indicating resources are earning their opportunity cost.

Fixed costs do not change with output in the short run, such as rent; variable costs rise with output, such as materials. Their sum is total cost, and average fixed cost declines as output expands.

The change in total cost from producing one additional unit. Because marginal cost generally rises with output in the short run, it determines the profit-maximizing quantity and the shape of the supply curve.

The rule that a firm produces where marginal revenue equals marginal cost. Producing less forgoes profitable units; producing more adds cost exceeding revenue. The rule applies in every market structure.

The additional revenue from selling one more unit. Under perfect competition it equals price; for a firm facing a downward-sloping demand curve it is less than price because selling more requires lowering price on all units.

A market with many small buyers and sellers, identical products, free entry and exit, and full information. Firms are price takers, and long-run economic profit is driven to zero by entry.

A market with a single seller protected by barriers to entry such as patents, control of key resources, or economies of scale. The monopolist sets marginal revenue equal to marginal cost but prices above marginal cost, creating deadweight loss.

Charging different prices to different buyers for the same product based on willingness to pay. It requires market power and separation of buyers, and it can raise seller profit while reducing consumer surplus.

An oligopoly is a market dominated by a few interdependent firms whose decisions affect one another. Game theory models strategic behavior, including the prisoner's dilemma, where cooperation is difficult despite mutual gains.

Firms agreeing to restrict output or fix prices to raise joint profit, as a cartel does. Such agreements are unstable because each member gains by cheating, and they are illegal under antitrust law in many countries.

Costs or benefits of a transaction borne by third parties. Negative externalities cause overproduction and positive ones cause underproduction, so markets fail to reach the socially efficient quantity without taxes, subsidies, or regulation.

Goods that are nonrival and nonexcludable, such as national defense. Because users cannot be charged and free riding is rational, private markets undersupply them and government provision or funding is typically needed.

A situation in which an unregulated market fails to allocate resources efficiently, arising from externalities, public goods, market power, asymmetric information, or immobile resources. It provides a rationale for government intervention.

The market value of all final goods and services produced within a country's borders in a given period. It excludes intermediate goods and transfers, and it can be measured by expenditure or income approaches.

Nominal GDP is measured at current prices; real GDP is adjusted for inflation using a base-year price index. Real GDP is the preferred measure of output growth because it removes price changes.

A measure of the average price of a fixed basket of consumer goods relative to a base period. Its percentage change is the commonly reported inflation rate, though substitution bias may overstate true inflation.

A sustained rise in the general price level, reducing money's purchasing power. Demand-pull inflation comes from excess spending; cost-push inflation comes from rising input costs. Unexpected inflation redistributes wealth between borrowers and lenders.

The number of unemployed persons actively seeking work divided by the labor force. It excludes discouraged workers and part-time workers seeking full-time jobs, so it may understate labor market weakness.

The unemployment rate consistent with stable inflation, combining frictional and structural unemployment. Cyclical unemployment is the deviation from this rate over the business cycle.

The model relating the economy's total quantity demanded and supplied to the price level. A downward-sloping aggregate demand curve and upward-sloping short-run supply curve determine equilibrium output and prices and explain business cycles.

Government use of spending and taxation to influence aggregate demand, output, and employment. Expansionary policy raises spending or cuts taxes; contractionary policy does the reverse. Automatic stabilizers and lags complicate timing.

Central bank actions to influence money supply, interest rates, and credit conditions. Expansionary policy lowers rates to stimulate spending; contractionary policy raises them to fight inflation. Tools include open market operations and reserve requirements.

The quantity of money in circulation, measured in aggregates such as M1 (currency and checkable deposits) and M2 (M1 plus savings deposits and small time deposits). Central banks influence it to affect interest rates.

The ratio of the money supply to the monetary base, approximately the reciprocal of the reserve requirement ratio. It describes how bank lending expands deposits, though currency holding and excess reserves reduce its size.

The process by which an initial change in spending produces a larger change in equilibrium output, because recipients spend part of their income. Its size depends on the marginal propensity to consume.

The fraction of each additional dollar of disposable income that households spend. It determines the size of the spending multiplier, which equals one divided by one minus the marginal propensity to consume.

The reduction in private investment caused by government borrowing raising interest rates. It weakens the stimulative effect of expansionary fiscal policy, especially when the economy is near full employment.

A curve showing the short-run inverse relationship between inflation and unemployment. The long-run curve is vertical at the natural rate, so sustained lower unemployment requires accepting permanently higher inflation.

The ability to produce a good at a lower opportunity cost than a trading partner. Specializing according to comparative advantage and trading raises total output even if one party has an absolute advantage in everything.

The ability to produce more output with the same resources, or the same output with fewer resources, than another producer. It differs from comparative advantage, which governs the gains from specialization and trade.

The rate at which one good exchanges for another in trade, or the ratio of export prices to import prices. Mutually beneficial trade occurs between the two parties' internal opportunity cost ratios.

A tariff is a tax on imports; a quota limits import quantity. Both restrict trade, raise domestic prices, protect domestic producers, reduce consumer surplus, and create deadweight loss.

A record of a country's transactions with the rest of the world, comprising the current account (goods, services, income, transfers) and the financial account (asset flows). Accounts balance in total by construction.

The price of one currency in terms of another. Depreciation makes exports cheaper and imports dearer, affecting net exports, inflation, and capital flows; regimes range from floating to fixed.

Broad improvement in living standards, including income growth, health, education, and reduced poverty, beyond mere increases in output. Measures such as the Human Development Index capture these dimensions.

An increase in an economy's real output over time, driven by growth in labor, capital, and technology. Sustained growth raises living standards and shifts the production possibilities frontier outward.

The skills, knowledge, and health embodied in workers that raise productivity. Investment in education and health is a major source of long-run growth and is central to development policy.