Basic Economics.pdf

Basic Economics
Abu Rayhan
Econ ‘12’
Economics: L. Robbins, ―Economics is a science which studies human behavior as a relationship between ends
and scarce means which have alternative uses‖.
Microeconomics: Microeconomics is the study of examining every individual economic activity, industries, and
their interaction. It mainly observes how a person earns and spends his income.
Macroeconomics: It is the branch of economics, which deals with the economic functioning and its
performance, decision making, and structure as a whole.
Microeconomics is the branch of economics that concentrates on the behavior and performance of the
individual units, i.e. consumers, family, industry, firms. Here, the demand plays a key role in determining the
quantity and the price of a product along with the price and quantity of related goods (complementary goods)
and substitute products, so as to make a judicious decision regarding the allocation of scarce resources,
concerning their alternative uses.
Examples: Individual Demand, Price of a product, etc.
Macroeconomics is the branch of economics that concentrates on the behavior and performance of aggregate
variables and those issues which affect the whole economy. It includes regional, national and international
economies and covers the major areas of the economy like unemployment, poverty, general price level, GDP
(Gross Domestic Product), imports and exports, economic growth, globalization, monetary/ fiscal policy, etc. It
helps in resolving the various problems of the economy, thereby enabling it to function efficiently.
Examples: Aggregate Demand, National Income, etc.
Basis for
comparison
Microeconomics Macroeconomics
Meaning The branch of economics that studies
the behavior of an individual consumer,
firm, family is known as
Microeconomics.
The branch of economics that studies the
behavior of the whole economy, (both national
and international) is known as Macroeconomics.
Deals with Individual economic variables Aggregate economic variables
Business
Application
Applied to operational or internal issues Environment and external issues
Scope Covers various issues like demand,
supply, product pricing, factor pricing,
production, consumption, economic
welfare, etc.
Covers various issues like, national income,
general price level, distribution, employment,
money etc.
Importance Helpful in determining the prices of a
product along with the prices of factors
of production (land, labor, capital,
entrepreneur etc.) within the economy.
Maintains stability in the general price level and
resolves the major problems of the economy like
inflation, deflation, reflation, unemployment and
poverty as a whole.
Limitations It is based on unrealistic assumptions,
i.e. In microeconomics it is assumed
that there is a full employment in the
society which is not at all possible.
It has been analyzed that 'Fallacy of Composition'
involves, which sometimes doesn't proves true
because it is possible that what is true for
aggregate may not be true for individuals too.

Positive Economics: Positive Economics is a branch of economics that has an objective approach, based on
facts. It analyses and explains the casual relationship between variables. It explains people about how the
economy of the country operates. Positive economics is alternatively known as pure economics or descriptive
economics.
Normative Economics: The economics that uses value judgments, opinions, beliefs is called normative
economics. This branch of economics considers values and results in statements that state, ‗what should be the
things‘. It incorporates subjective analyses and focuses on theoretical situations.
Normative Economics suggests how the economy ought to operate. It is also known as policy economics, as it
takes into account individual opinions and preferences. Hence, the statements can neither be proven right nor
wrong.
Basis for
comparison
Positive economics Normative economics
Meaning A branch of economics based on
data and facts is positive economics.
A branch of economics based on values,
opinions and judgement is normative
economics.
Nature Descriptive Prescriptive
What it does? Analyses cause and effect
relationship.
Passes value judgement.
Perspective Objective Subjective
Study of What actually is What ought to be
Testing Statements can be tested using
scientific methods.
Statements cannot be tested.
Economic issues It clearly describes economic issue. It provides solution for the economic
issue, based on value.
Elasticity is the measurement of how responsive an economic variable is to a change in another variable.
Elasticity can be quantified as the ratio of the change in one variable to the change in another variable, when the
later variable has a causal influence on the former. It is a tool for measuring the responsiveness of a variable, or
of the function that determines it, to changes in causative variables in unitless ways.
Consumer demand theory relates preferences for the consumption of both goods and services to the
consumption expenditures; ultimately, this relationship between preferences and consumption expenditures is
used to relate preferences to consumer demand curves. The link between personal preferences, consumption and
the demand curve is one of the most closely studied relations in economics. It is a way of analyzing how
consumers may achieve equilibrium between preferences and expenditures by maximizing utility subject to
consumer budget constraints.
Production theory is the study of production, or the economic process of converting inputs into
outputs. Production uses resources to create a good or service that is suitable for use, gift-giving in a gift
economy, or exchange in a market economy.
Costs of production: The cost-of-production theory of value states that the price of an object or condition is
determined by the sum of the cost of the resources that went into making it. The cost can comprise any of

the factors of production: labor, capital, land. Technology can be viewed either as a form of fixed
capital (e.g. plant) or circulating capital (e.g. intermediate goods).
Opportunity cost: The opportunity cost of any activity is the value of the next-best alternative thing you may
have done instead. Opportunity cost depends only on the value of the next-best alternative. It doesn‘t matter
whether you have 5 alternatives or 5,000.
Opportunity costs can tell you when not to do something as well as when to do something. For example, you
may like waffles, but you like chocolate even more. If someone offers you only waffles, you‘re going to take it.
But if you‘re offered waffles or chocolate, you‘re going to take the chocolate. The opportunity cost of eating
waffles is sacrificing the chance to eat chocolate.
Perfect competition is a situation in which numerous small firms producing identical products compete against
each other in a given industry. A good example would be that of digital marketplaces, such as eBay, on which
many different sellers sell similar products to many different buyers.
Imperfect competition: In economic theory, imperfect competition is a type of market structure showing
some but not all features of competitive markets.
Monopolistic competition is a situation in which many firms with slightly different products compete.
Production costs are above what may be achieved by perfectly competitive firms, but society benefits from the
product differentiation. Examples of industries with market structures similar to monopolistic competition
include restaurants, cereal, clothing, shoes, and service industries in large cities.
A monopoly is a market structure in which a market or industry is dominated by a single supplier of a particular
good or service. Because monopolies have no competition they tend to sell goods and services at a higher price
and produce below the socially optimal output level. Although not all monopolies are a bad thing, especially in
industries where multiple firms would result in more problems than benefits (i.e. natural monopolies).
 Natural monopoly: A monopoly in an industry where one producer can produce output at a lower cost than
many small producers.
An oligopoly is a market structure in which a market or industry is dominated by a small number of firms
(oligopolists). Oligopolies can create the incentive for firms to engage in collusion and form cartels that reduce
competition leading to higher prices for consumers and less overall market output.[6]
Alternatively, oligopolies
can be fiercely competitive and engage in flamboyant advertising campaigns.
 Duopoly: A special case of an oligopoly, with only two firms. Game theory can elucidate behavior in duopolies
and oligopolies.[7]
A monopsony is a market where there is only one buyer and many sellers.
An oligopsony is a market where there are a few buyers and many sellers.
Game theory is a major method used in mathematical economics and business for modeling competing
behaviors of interacting agents. The term "game" here implies the study of any strategic interaction between
people. Applications include a wide array of economic phenomena and approaches, such
as auctions, bargaining, acquisitions pricing, fair division, duopolies, oligopolies, social
network formation, agent-based computational economics, general equilibrium, mechanism design, and voting
systems, and across such broad areas as experimental economics, behavioral economics, information
economics, industrial organization, and political economy.

Labor economics seeks to understand the functioning and dynamics of the markets for wage labor. Labor
markets function through the interaction of workers and employers. Labor economics looks at the suppliers of
labor services (workers), the demands of labor services (employers), and attempts to understand the resulting
pattern of wages, employment, and income. In economics, labor is a measure of the work done by human
beings.
Welfare economics is a branch of economics that uses microeconomics techniques to evaluate well-
being from allocation of productive factors as to desirability and economic efficiency within an economy, often
relative to competitive general equilibrium. It analyzes social welfare, however measured, in terms of economic
activities of the individuals that compose the theoretical society considered.
Information economics or the economics of information is a branch of microeconomic theory that studies
how information and information systems affect an economy and economic decisions.
Supply schedule: A supply schedule is a table that shows the relationship between the price of a good and the
quantity supplied. Under the assumption of perfect competition, supply is determined by marginal cost. That is,
firms will produce additional output while the cost of producing an extra unit of output is less than the price they
would receive.
Demand schedule: A demand schedule, depicted graphically as the demand curve, represents the amount of
some goods that buyers are willing and able to purchase at various prices, assuming all determinants of demand
other than the price of the good in question, such as income, tastes and preferences, the price of substitute goods,
and the price of complementary goods, remain the same. Following the law, the demand curve is almost always
represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good
Equilibrium: Generally speaking, an equilibrium is defined to be the price-quantity pair where the quantity
demanded is equal to the quantity supplied. It is represented by the intersection of the demand and supply
curves.
Market equilibrium: A situation in a market when the price is such that the quantity demanded by consumers is
correctly balanced by the quantity that firms wish to supply. In this situation, the market clears.
Changes in market equilibrium: Practical uses of supply and demand analysis often center on the different
variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative
statics of such a shift traces the effects from the initial equilibrium to the new equilibrium.
Demand curve shifts: When consumers increase the quantity demanded at a given price, it is referred to as
an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right.
At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2.
Supply curve shifts: When technological progress occurs, the supply curve shifts. For example, assume that
someone invents a better way of growing wheat so that the cost of growing a given quantity of wheat decreases.
Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply
curve S1 outward, to S2—an increase in supply.
Partial equilibrium: Partial equilibrium, as the name suggests, takes into consideration only a part of the
market to attain equilibrium.

Jain proposes (attributed to George Stigler): "A partial equilibrium is one which is based on only a restricted
range of data, a standard example is price of a single product, the prices of all other products being held fixed
during the analysis
Price elasticity of supply: The price elasticity of supply measures how the amount of a good that a supplier
wishes to supply changes in response to a change in price.
Elasticities of scale: Elasticity of scale or output elasticity measures the percentage change in output induced by
a collective percent change in the usages of all inputs.
Price elasticity of demand: Price elasticity of demand is a measure used to show the responsiveness, or
elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the
percentage change in quantity demanded in response to a one percent change in price (ceteris paribus, i.e.
holding constant all the other determinants of demand, such as income).
Cross-price elasticity of demand is a measure of the responsiveness of the demand for one product to changes
in the price of a different product. It is the ratio of percentage change in the former to the percentage change in
the latter. If it is positive, the goods are called substitutes because a rise in the price of the other good causes
consumers to substitute away from buying as much of the other good as before and into buying more of this
good. If it is negative, the goods are called complements
Explicit costs are opportunity costs that involve direct monetary payment by producers. The explicit
opportunity cost of the factors of production not already owned by a producer is the price that the producer has
to pay for them. For instance, if a firm spends $100 on electrical power consumed, its explicit opportunity cost is
$100.[5]
This cash expenditure represents a lost opportunity to purchase something else with the $100.
Implicit costs (also called implied, imputed or notional costs) are the opportunity costs that are not reflected in
cash outflow but implied by the failure of the firm to allocate its existing (owned) resources, or factors of
production to the best alternative use. For example: a manufacturer has previously purchased 1000 tons of steel
and the machinery to produce a widget. The implicit part of the opportunity cost of producing the widget is the
revenue lost by not selling the steel and not renting out the machinery instead of using it for production.
Quick Reference to Basic Market Structures
Market
Structure
Seller Entry
Barriers
Seller
Number
Buyer Entry
Barriers
Buyer
Number
Perfect
Competition
No Many No Many
Monopolistic
competition
No Many No Many
Monopoly Yes One No Many
Duopoly Yes Two No Many
Oligopoly Yes Few No Many
Monopsony No Many Yes One
Oligopsony No Many Yes Few

Scarcity refers to the limited availability of a commodity, which may be in demand in the market. The concept
of scarcity also includes an individual capacity to buy all or some of the commodities as per the
available resources with that individual.
Consumer surplus is an economic measure of consumer benefit. It is calculated by analyzing the difference
between what consumers are willing and able to pay for a good or service relative to its market price, or what
they actually do spend on the good or service. A consumer surplus occurs when the consumer is willing to pay
more for a given product than the current market price.
A producer surplus is a difference between how much of a good the producer is willing to supply versus how
much he receives in the trade. The difference or surplus amount is the benefit the producer receives for selling
the good in the market. A producer surplus is generated by market prices in excess of the lowest price producers
would otherwise be willing to accept for their goods.
Market price is a familiar economic concept: it is the price that a good or service is offered at, or will fetch, in
the marketplace. It is of interest mainly in the study of microeconomics. Market value and market price are
equal only under conditions of market efficiency, equilibrium, and rational expectations.
In economics, returns to scale and economies of scale are related terms that describe what happens as the scale
of production increases. They are different, non-interchangeable concepts.
Elasticity is a measure of a variable's sensitivity to a change in another variable. In business and economics,
elasticity refers the degree to which individuals, consumers or producers change their demand or the amount
supplied in response to price or income changes. It is predominantly used to assess the change in
consumer demand as a result of a change in a good or service's price.
Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in
relation to its price change. Expressed mathematically, it is:
Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price
Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good to a change
in real income of consumers who buy this good, keeping all other things constant. The formula for calculating
income elasticity of demand is the percent change in quantity demanded divided by the percent change in
income.
Cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demanded
of one good when the price for another good changes. Also called cross price elasticity of demand, this
measurement is calculated by taking the percentage change in the quantity demanded of one good and dividing
it by the percentage change in price of the other good.
The unemployment rate is the share of the labor force that is jobless, expressed as a percentage. It is a lagging
indicator, meaning that it generally rises or falls in the wake of changing economic conditions, rather than
anticipating them. When the economy is in poor shape and jobs are scarce, the unemployment rate can be
expected to rise. When the economy is growing at a healthy rate and jobs are relatively plentiful, it can be
expected to fall.

'Seasonal Adjustment': A statistical technique designed to even out periodic swings in statistics or movements
in supply and demand related to changing seasons. Seasonal adjustments provide a clearer view of no seasonal
changes in data that would otherwise be overshadowed by the seasonal differences.
Absolute advantage is the ability of a country, individual, company or region to produce a good or service at a
lower cost per unit than another entity that produces the same good or service. Entities with absolute advantages
can produce a product or service using a smaller number of inputs or a more efficient process than another
entity producing the same product or service.
General Examples of Absolute Advantage
If the United States produces 700 million gallons of wine per year, while Italy produces 4 billion gallons of wine
per year, Italy has an absolute advantage because it produces many more gallons of wine – the output – in the
same amount of time – the input – as the United States.
Using another example, Jane can knit a sweater in 10 hours, and Kate can knit a sweater in eight hours. Kate has
an absolute advantage over Jane because it takes her fewer hours to produce a sweater.
Absolute advantage also explains why it makes sense for countries, individuals and businesses to trade. Since
each has advantages in producing certain products and services, both entities can benefit from trade. So, if Jane
can produce a painting in five hours, but Kate requires nine hours to produce a comparable painting, Jane has an
absolute advantage over Kate in painting. Remember, Kate has an absolute advantage over Jane in knitting
sweaters. If Jane and Kate specialize in the products they each have an absolute advantage in and buy the
products they lack absolute advantage in from each other, they both benefit.
Comparative advantage is an economic term that refers to an economy's ability to produce goods and services
at a lower opportunity cost than trade partners. A comparative advantage gives a company the ability to sell
goods and services at a lower price than its competitors and realize stronger sales margins. The law of
comparative advantage is popularly attributed to English political economist David Ricardo and his book
―Principles of Political Economy and Taxation‖ in 1817, although it is likely that Ricardo's mentor James Mill
originated the analysis.
Specialization is a method of production whereby an entity focuses on the production of a limited scope of
goods to gain a greater degree of efficiency. Many countries, for example, specialize in producing the goods and
services that are native to their part of the world, and they trade for other goods and services. This specialization
is, therefore, the basis of global trade, as few countries have enough production capacity to be completely self-
sustaining.
The production possibility frontier (PPF) is a curve depicting all maximum output possibilities for two goods,
given a set of inputs consisting of resources and other factors. The PPF assumes that all inputs are used
efficiently.
Factors such as labor, capital and technology, among others, will affect the resources available, which will
dictate where the production possibility frontier lies. The PPF is also known as the production possibility curve
or the transformation curve.
The Pareto Efficiency is a concept named after Italian economist Vilfredo Pareto that measures the efficiency
of the commodity allocation on the PPF. The Pareto Efficiency states that any point within the PPF curve is
considered inefficient because the total output of commodities is below the output capacity. Conversely, any
point outside the PPF curve is considered to be impossible because it represents a mix of commodities that will
take more resources to produce than can be obtained.

Therefore, any mix of two commodities, given limited resources, is only efficient when it lies on the PPF curve,
with one commodity on the X axis and one commodity on the Y axis. Achieving the Pareto Efficiency means
that an economy is operating at maximum potential and lies directly on the PPF.
Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a
country's borders in a specific time period. Though GDP is usually calculated on an annual basis, it can be
calculated on a quarterly basis as well (in the United States, for example, the government releases an annualized
GDP estimate for each quarter and also for an entire year).
GDP includes all private and public consumption, government outlays, investments, private inventories, paid-in
construction costs and the foreign balance of trade (exports are added, imports are subtracted). Put simply, GDP
is a broad measurement of a nation‘s overall economic activity – the godfather of the indicator world.
Economic growth is an increase in the capacity of an economy to produce goods and services, compared from
one period of time to another. It can be measured in nominal or real terms, the latter of which is adjusted
for inflation. Traditionally, aggregate economic growth is measured in terms of gross national product (GNP) or
gross domestic product (GDP), although alternative metrics are sometimes used.
Within finance, the current market value (CMV) is the approximate current resale value for a financial
instrument. Just as with any other object of value, the current market value offers interested parties a price for
which they can enter into a transaction. The current market value is usually taken as the closing price for listed
securities or the price offered for over-the-counter (OTC) securities.
A recession is a significant decline in economic activity that goes on for more than a few months. It is visible in
industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession
is two consecutive quarters of negative economic growth as measured by a country's gross domestic product
(GDP), although the National Bureau of Economic Research (NBER) does not necessarily need to see this occur
to call a recession.
A standard of living is the level of wealth, comfort, material goods and necessities available to a certain
socioeconomic class or a certain geographic area. The standard of living includes factors such as income, gross
domestic product (GDP), national economic growth, economic and political stability, political and religious
freedom, environmental quality, climate and safety. The standard of living is closely related to quality of life.
Value added describes the enhancement a company gives its product or service before offering the product to
customers. Value-added applies to instances where a firm takes a product that may be considered a
homogeneous product, with few differences (if any) from that of a competitor, and provides potential customers
with a feature or add-on that gives it a greater perception of value.
A value-added tax (VAT) is a consumption tax placed on a product whenever value is added at each stage of
the supply chain, from production to the point of sale. The amount of VAT that the user pays is on the cost of
the product, less any of the costs of materials used in the product that have already been taxed.
Operating income is an accounting figure that measures the amount of profit realized from a business's
operations, after deducting operating expenses such as wages, depreciation and cost of goods sold (COGS).
Operating income takes a company's gross income, which is equivalent to total revenue minus COGS, and
subtracts all operating expenses. A business's operating expenses are costs incurred from normal operating
activities and include items such as office supplies and utilities.

Net exports are the value of a country's total exports minus the value of its total imports. It is a measure used to
calculate aggregate a country's expenditures or gross domestic product in an open economy. In other words, net
exports equal the amount by which foreign spending on a home country's goods and services exceeds the home
country's spending on foreign goods and services.
Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to
account for declines in value over time. Businesses depreciate long-term assets for both tax and accounting
purposes. For tax purposes, businesses can deduct the cost of the tangible assets they purchase as business
expenses; however, businesses must depreciate these assets in accordance with IRS rules about how and when
the deduction may be taken.
Gross national income is the sum of a nation's gross domestic product and the net income it receives from
overseas.
A trade surplus is an economic measure of a positive balance of trade, where a country's exports exceed its
imports.
Trade Balance = Total Value of Exports - Total Value of Imports
A trade surplus occurs when the result of the above calculation is positive. A trade surplus represents a net
inflow of domestic currency from foreign markets. It is the opposite of a trade deficit, which represents a net
outflow, and occurs when the result of the above calculation is negative. In the United States, trade balances are
reported monthly by the Bureau of Economic Analysis.
Relative value is a method of determining an asset's value that takes into account the value of similar assets.
This is in contrast with absolute value, which looks only at an asset's intrinsic value and does not compare it to
other assets. Calculations that are used to measure the relative value of stocks include the enterprise value (EV)
ratio and price-to-earnings (PE) ratio.
Stagflation is a condition of slow economic growth and relatively high unemployment, or
economic stagnation, accompanied by rising prices, or inflation. It can also be defined as inflation and a decline
in gross domestic product (GDP). Stagflation is an economic problem defined in equal parts by its rarity and by
the lack of consensus among academics on how exactly it comes to pass.
Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the
purchasing power of currency is falling. Central banks attempt to limit inflation — and avoid deflation — in
order to keep the economy running smoothly.
Hyperinflation is extremely fast or out-of-control inflation. Hyperinflation occurs when price increases are so
wild that the concept of inflation is meaningless. Although hyperinflation is considered to be rare, it occurred as
many as 55 times in the 20th century in countries such as China, Germany, Russia, Hungary and Argentina.
Deflation is the general decline in prices for goods and services occurring when the inflation rate falls below
0%. Deflation happens naturally when the money supply of an economy is fixed. In times of deflation, the
purchasing power of currency and wages are higher than they otherwise would have been. This is distinct from
but similar to price deflation, which is a general decrease in the price level.
A deflationary spiral is a downward price reaction to an economic crisis leading to lower production, lower
wages, decreased demand and still lower prices. Deflation occurs when general price levels decline, as opposed

to inflation which is when general price levels rise. When deflation occurs, central banks and monetary
authorities can enact expansionary monetary policies to spur demand and economic growth. If monetary policy
efforts fail, however, due to greater-than-anticipated weakness in the economy or because target interest rates
are already zero or close to zero, a deflationary spiral may occur even with an expansionary monetary policy in
place. Such a spiral amounts to a vicious circle, where a chain of events reinforces an initial problem.
The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of
consumer goods and services, such as transportation, food and medical care. It is calculated by taking price
changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to
assess price changes associated with the cost of living; the CPI is one of the most frequently used statistics for
identifying periods of inflation or deflation.
The producer price index (PPI) is a family of indexes that measures the average change in selling prices
received by domestic producers of goods and services over time. The PPI measures price changes from the
perspective of the seller and differs from the consumer price index (CPI), which measures price changes from
the purchaser's perspective. The PPI considers three areas of production: industry-based, commodity-based and
commodity-based final demand-intermediate demand. It was known as the wholesale price index, or WPI,
until 1978.
Utility is an economic term introduced by Daniel Bernoulli referring to the total satisfaction received from
consuming a good or service. The economic utility of a good or service is important to understand because it
will directly influence the demand, and therefore price, of that good or service. A consumer's utility is hard to
measure, however, but it can be determined indirectly with consumer behavior theories, which assume that
consumers will strive to maximize their utility.
Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or
service. Marginal utility is an important economic concept because economists use it to determine how much of
an item a consumer will buy. Positive marginal utility is when the consumption of an additional item increases
the total utility. Negative marginal utility is when the consumption of an additional item decreases the total
utility.
The Law of Diminishing Marginal Utility states that all else equal as consumption increases the marginal
utility derived from each additional unit declines. Marginal utility is derived as the change in utility as an
additional unit is consumed. Utility is an economic term used to represent satisfaction or happiness. Marginal
utility is the incremental increase in utility that results from consumption of one additional unit.
Total utility is the aggregate level of satisfaction or fulfillment that a consumer receives through the
consumption of a specific good or service. Each individual unit of a good or service has its own marginal utility,
and the total utility is simply the sum of all the marginal utilities of the individual units. Classical economic
theory suggests that all consumers want to get the highest possible level of total utility for the money they spend.
An indifference curve is a graph that shows a combination of two goods that give a consumer equal satisfaction
and utility, thereby making the consumer indifferent. Indifference curves are heuristic devices used in
contemporary microeconomics to demonstrate consumer preference and the limitations of a budget. Later
economists adopted the principles of indifference curves in the study of welfare economics.

Basis for
comparison
Cardinal utility Ordinal utility
Meaning Cardinal utility is the utility wherein the
satisfaction derived by the consumers
from the consumption of good or
service can be expressed numerically.
Ordinal utility states that the satisfaction
which a consumer derives from the
consumption of good or service cannot be
expressed numerical units.
Approach Quantitative Qualitative
Realistic Less More
Measurement Utils Ranks
Analysis Marginal Utility Analysis Indifference Curve Analysis
Promoted by Classical and Neo-classical Economists Modern Economists
A budget constraint occurs when a consumer is limited in consumption patterns by a certain income. A budget
constraint represents all the combinations of goods and services that a consumer may purchase given
current prices within his or her given income. Consumer theory uses the concepts of
a budget constraint and a preference map to analyze consumer choices. Both concepts have a
ready graphical representation in the two-good case.
Factors of production are an economic term that describes the inputs that are used in the production of goods
or services in order to make an economic profit. The factors of production include land, labor, capital and
entrepreneurship. These production factors are also known as management, machines, materials and labor, and
knowledge has recently been talked about as a potential new factor of production.
Production Function: The function that explains the relationship between physical inputs and physical
output (final output) is called the production function. We normally denote the production function in the
form:
Q = f(X1, X2)
Where Q represents the final output and X1 and X2 are inputs or factors of production.
Total Product: In simple terms, we can define Total Product as the total volume or amount of final output
produced by a firm using given inputs in a given period of time.
Marginal Product: The additional output produced as a result of employing an additional unit of the variable
factor input is called the Marginal Product. Thus, we can say that marginal products is the addition to Total
Product when an extra factor input is used.
Marginal Product = Change in Output/ Change in Input
Thus, it can also be said that Total Product is the summation of Marginal products at different input levels.
Total Product = Ʃ Marginal Product
Average Product: It is defined as the output per unit of factor inputs or the average of total product per unit of
input and can be calculated by dividing the Total Product by the inputs (variable factors).
Average Product = Total Product/ Units of Variable Factor Input

The law of diminishing marginal returns states that, at some point, adding an additional factor of production
results in smaller increases in output. For example, a factory employs workers to manufacture its products, and,
at some point, the company operates at an optimal level. With other production factors constant, adding
additional workers beyond this optimal level will result in less efficient operations.
The isoquant curve is a graph, used in the study of microeconomics, that charts all inputs that produce a
specified level of output. This graph is used as a metric for the influence that the inputs have on the level of
output or production that can be obtained. The isoquant curve assists firms in making adjustments to inputs to
maximize outputs, and thus profits.
Isoquant Curve vs. Indifference Curve
The isoquant curve is a contoured line that is drawn through points that produce the same quantity of output,
while the quantities of inputs – usually two or more – are changed. The mapping of the isoquant curve addresses
cost minimization problems for producers. The indifference curve, on the other hand, helps to map out the utility
maximization problem that consumers face.
The isocost line is an important component when analyzing producer‘s behavior. The isocost line illustrates all
the possible combinations of two factors that can be used at given costs and for a given producer‘s budget. In
simple words, an isocost line represents a combination of inputs which all cost the same amount.
The Short-run Cost is the cost which has short-term implications in the production process, i.e. these are used
over a short range of output. These are the cost incurred once and cannot be used again and again, such as
payment of wages, cost of raw materials, etc.
Long Run: The long run is a period of time in which all factors of production and costs are variable. In the long
run, firms are able to adjust all costs, whereas, in the short run, firms are only able to influence prices through
adjustments made to production levels. Additionally, while a firm may be a monopoly in the short term, they
may expect competition in the long run.
Short Run: The short run is the concept that, within a certain period in the future, at least one input is fixed
while others are variable. In economics, it expresses the idea that an economy behaves differently depending on
the length of time it has to react to certain stimuli. The short run does not refer to a specific duration of time but
rather is unique to the firm, industry or economic variable being studied. A key principle guiding the concept of
short run and long run is that in the short run, firms face both variable and fixed costs, which means that output,
wages and prices do not have full freedom to reach a new equilibrium.
Fixed Cost: A fixed cost is an expense or cost that does not change with an increase or decrease in the number
of goods or services produced or sold. Fixed costs are expenses that have to be paid by a company, independent
of any business activity. It is one of the two components of the total cost of running a business, the other
being variable costs.
A variable cost is a corporate expense that changes in proportion with production output. Variable costs
increase or decrease depending on a company's production volume; they rise as production increases and fall as
production decreases.
In economics, average cost and/or unit cost is equal to total cost (TC) divided by the number of goods
produced (the output quantity, Q). It is also equal to the sum of variable costs (total variable costs divided by Q)

plus average fixed costs (total fixed costs divided by Q). Average costs may be dependent on the time period
considered (increasing production may be expensive or impossible in the short term, for example). Average
costs affect the supply curve and are a fundamental component of supply and demand.
The average cost method is an inventory costing method in which the cost of each item in an inventory is
calculated on the basis of the average cost of all similar goods in the inventory. The average cost method is
calculated by dividing the cost of goods in inventory by the total number of items available for sale.
The marginal cost of production is the change in total cost that comes from making or producing one
additional item. The purpose of analyzing marginal cost is to determine at what point an organization can
achieve economies of scale.
 Average Total Cost (ATC) = Total Cost / Q (Output is quantity produced or ‗Q‘)
 Average Variable Cost (AVC) = Total Variable Cost / Q
 Average Fixed Cost (AFC) = ATC – AVC
 Total Cost (TC) = (AVC + AFC) X Output (Which is Q)
 Total Variable Cost (TVC) = AVC X Output
 Total Fixed Cost (TFC) = TC – TVC
 Marginal Cost (MC) = Change in Total Costs / Change in Output
 Marginal Product (MP) = Change in Total Product / Change in Variable Factor
 Marginal Revenue (MR) = Change in Total Revenue / Change in Q
 Average Product (AP) = TP / Variable Factor
 Total Revenue (TR) = Price X Quantity
 Average Revenue (AR) = TR / Output
 Total Product (TP) = AP X Variable Factor
 Economic Profit = TR – TC > 0
 A Loss = TR – TC < 0
 Break Even Point = AR = ATC
 Profit Maximizing Condition = MR = MC
A unit cost is the total expenditure incurred by a company to produce, store and sell one unit of a particular
product or service. Unit costs include all fixed costs, or overhead costs, and all variable costs, or direct material
and labor costs. Determining the unit cost is a quick way to check if a company is producing a product
efficiently.
Breakeven Point (BEP): Breakeven point is the price level at which the market price of a security is equal to
the original cost. For options trading, the breakeven point is the market price that an underlying asset must reach
for an option buyer to avoid a loss if they exercise the option. For a call buyer, the breakeven point is the strike
price plus the premium paid, while breakeven for a put position is the strike price minus the premium paid.
Economies of Scale: Economies of scale refer to reduced costs per unit that arise from increased total output of
a product. For example, a larger factory will produce power hand tools at a lower unit price, and a larger
medical system will reduce cost per medical procedure.
Gross Profit: Gross profit is the profit a company makes after deducting the costs associated with making and
selling its products, or the costs associated with providing its services. Gross profit will appear on a company's
income statement, and can be calculated with this formula:
Gross profit = Revenue - Cost of Goods Sold

Gross profit is also called sales profit and gross income.
Marginal Profit: Marginal profit is the profit earned by a firm or individual when one additional (marginal)
unit is produced and sold. It is the difference between marginal cost and marginal product (also known
as marginal revenue), and is often used to determine whether to expand or contract production, or to stop
production altogether. Under mainstream economic theory, a company will maximize its overall profits when
marginal cost equals marginal product, or when marginal profit is exactly zero.
Operating Profit: Operating profit is an accounting figure that measures the profit earned from a company's
ongoing core business operations, thus excluding deductions of interest and taxes. This value also does not
include any profit earned from the firm's investments, such as earnings from firms in which the company has
partial interest. Operating profit can be calculated using the following formula:
Operating Profit = Operating Revenue - Cost of Goods Sold (COGS) - Operating Expenses - Depreciation -
Amortization
Net Income - NI: Net income - NI is equal to net earnings (profit) calculated as sales less cost of goods sold,
selling, general and administrative expenses, operating expenses, depreciation, interest, taxes and other
expenses. This number appears on a company's income statement and is an important measure of how profitable
the company is.
Net income also refers to an individual's income after taking taxes and deductions into account.
In geometry, an envelope of a family of curves in the plane is a curve that is tangent to each member of the
family at some point, and these points of tangency together form the whole envelope. Classically, a point on the
envelope can be thought of as the intersection of two "infinitesimally adjacent" curves, meaning the limit of
intersections of nearby curves. This idea can be generalized to an envelope of surfaces in space, and so on to
higher dimensions.
Revenue: Revenue is the amount of money that a company actually receives during a specific period, including
discounts and deductions for returned merchandise. It is the top line or gross income figure from which costs are
subtracted to determine net income.
Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or
amount sold. Revenue is also known as sales on the income statement.
Operating Revenue: Operating revenue is revenue generated from a company's primary business
activities. For example, a retailer produces revenue through merchandise sales, and a physician derives revenue
from the medical services he/she provides. What constitutes operating revenue varies per business or industry.
Total revenue is the total receipts a seller can obtain from selling goods or service to buyers. It can be written as
P × Q, which is the price of the goods multiplied by the quantity of the sold goods.
Total Revenue: The income earned by a seller or producer after selling the output is called the total revenue. In
fact, total revenue is the multiple of price and output. The behavior of total revenue depends on the market
where the firm produces or sells.
―Total revenue is the sum of all sales, receipts or income of a firm.‖ Dooley
Total revenue may be defined as the ―product of planned sales (output) and expected selling price.‖ Clower and
Due

Average Revenue:
Average revenue refers to the revenue obtained by the seller by selling the per unit commodity. It is obtained by
dividing the total revenue by total output.
―The average revenue curve shows that the price of the firm‘s product is the same at each level of output.‖
Stonier and Hague
Marginal Revenue:
Marginal revenue is the net revenue obtained by selling an additional unit of the commodity. ―Marginal revenue
is the change in total revenue which results from the sale of one more or one less unit of output.‖ Ferguson.
Thus, marginal revenue is the addition made to the total revenue by selling one more unit of the good. In
algebraic terms, marginal revenue is the net addition to the total revenue by selling n units of a commodity
instead of n – 1.
Market: A market is a medium that allows buyers and sellers of a specific good or service to interact in order to
facilitate an exchange. This type of market may either be a physical marketplace where people come together to
exchange goods and services in person, as in a bazaar or shopping center, or a virtual market wherein buyers and
sellers do not interact, as in an online market. Market can also refer to the general market where securities are
traded. This form of the term may also refer to specific securities markets and may take place in person or
online. The term "market" can also refer to people with the desire and ability to buy a specific product or
service.
Equity Market: An equity market is a market in which shares are issued and traded, either through exchanges
or over-the-counter markets. Also known as the stock market, it is one of the most vital areas of a market
economy because it gives companies access to capital and investors a slice of ownership in a company with the
potential to realize gains based on its future performance.
Black Market: A black market is economic activity that takes place outside government-sanctioned channels.
Black market transactions usually occur ―under the table‖ to let participants avoid government price controls or
taxes.
Shadow Market: A shadow market includes any unregulated private market in which individuals or entities can
purchase assets or property that is not currently publicly traded. The purpose of a shadow market is to shield
participants from the oversight and transparency of conventional marketplaces which often include significant
documentation. Because activity and transactions on a shadow market occur largely unrecognized, it offers
participants the opportunity for strategies or schemes otherwise unavailable in public markets.
Fixed Exchange Rate: A fixed exchange rate is a regime applied by a country whereby the government
or central bank ties the official exchange rate to another country's currency or the price of gold. The purpose of a
fixed exchange rate system is to keep a currency's value within a narrow band.
Interest Rate: Interest rate is the amount charged, expressed as a percentage of principal, by a lender to a
borrower for the use of assets. Interest rates are typically noted on an annual basis, known as the annual
percentage rate (APR). The assets borrowed could include cash, consumer goods, and large assets such as a
vehicle or building.
Firm: A firm is a business organization, such as a corporation, limited liability company or partnership, that
sells goods or services to make a profit. While most firms have just one location, a single firm can consist of one
or more establishments, as long as they fall under the same ownership and utilize the same Employer

Identification Number (EIN). The title "firm" is typically associated with business organizations that practice
law, but the term can be used for a wide variety of business operation units, such as accounting. "Firm" is often
used interchangeably with "business" or "enterprise."
Industry: An industry is a group of companies that are related based on their primary business activities. In
modern economies, there are dozens of industry classifications, which are typically grouped into larger
categories called sectors. Individual companies are generally classified into an industry based on their largest
sources of revenue. For example, while an automobile manufacturer might have a financing division that
contributes 10% to the firm's overall revenues, the company would be classified in the automaker industry by
most classification systems.
In economics and econometrics, the Cobb–Douglas production function is a particular functional form of
the production function, widely used to represent the technological relationship between the amounts of two or
more inputs (particularly physical capital and labor) and the amount of output that can be produced by those
inputs. The Cobb–Douglas form was developed and tested against statistical evidence by Charles Cobb and Paul
Douglas during 1927–1947
Constant elasticity of substitution (CES), in economics, is a property of some production functions and utility
functions. Specifically, it arises in a particular type of aggregator function which combines two or more types of
consumption goods, or two or more types of production inputs into an aggregate quantity. This aggregator
function exhibits constant elasticity of substitution.
Cartel: A cartel is an organization created from a formal agreement between a group of producers of a good or
service to regulate supply in an effort to regulate or manipulate prices. In other words, a cartel is a collection of
otherwise independent businesses or countries that act together as if they were a single producer and thus are
able to fix prices for the goods they produce and the services they render without competition.
Price Leadership: Price leadership is when a leading firm in its sector determines the price of goods or
services. This can leave the leader's rivals with little choice but to follow its lead and match the prices if they are
to hold onto their market share. Alternatively, competitors may also choose to lower their prices in the hope of
gaining market share.
Market Share: Market share represents the percentage of an industry, or market's total sales, that is earned by a
particular company over a specified time period. Market share is calculated by taking the company's sales over
the period and dividing it by the total sales of the industry over the same period. This metric is used to give a
general idea of the size of a company in relation to its market and its competitors.
Dominant firm:
Firm that controls at least half of the market in which it operates and has no significant competition. Its
competitors are mostly small firms who compete with each other for the remaining market share
Pareto Efficiency: Pareto efficiency, or Pareto optimality, is an economic state where resources cannot be
reallocated to make one individual better off without making at least one individual worse off. Pareto efficiency
implies that resources are allocated in the most efficient manner, but does not imply equality or fairness.
Externality: An externality is a positive or negative consequence of an economic activity experienced by
unrelated third parties. Pollution emitted by a factory that spoils the surrounding environment and affects the

health of nearby residents is an example of a negative externality. The effect of a well-educated labor force on
the productivity of a company is an example of a positive externality.
A positive externality (also called "external benefit" or "external economy" or "beneficial externality") is the
positive effect an activity imposes on an unrelated third party. Similar to a negative externality, it can arise
either on the production side, or on the consumption side
A negative externality (also called "external cost" or "external diseconomy") is an economic activity that
imposes a negative effect on an unrelated third party. It can arise either during the production or the
consumption of a good or service. Pollution is termed an externality because it imposes costs on people who are
"external" to the producer and consumer of the polluting product
Linear Programming (LP): Linear programming is a mathematical method that is used to determine the best
possible outcome or solution from a given set of parameters or list of requirements, which are represented in the
form of linear relationships. It is most often used in computer modeling or simulation in order to find the best
solution in allocating finite resources such as money, energy, manpower, machine resources, time, space and
many other variables. In most cases, the "best outcome" needed from linear programming is maximum profit or
lowest cost.
Macroeconomics
Gross National Product – GNP: Gross national product (GNP) is an estimate of total value of all the final
products and services turned out in a given period by the means of production owned by a country's residents.
GNP is commonly calculated by taking the sum of personal consumption expenditures, private domestic
investment, government expenditure, net exports and any income earned by residents from overseas
investments, minus income earned within the domestic economy by foreign residents. Net exports represent the
difference between what a country exports minus any imports of goods and services.
GNP is related to another important economic measure called gross domestic product (GDP), which takes into
account all output produced within a country's borders regardless of who owns the means of production. GNP
starts with GDP, adds residents' investment income from overseas investments, and subtracts foreign residents'
investment income earned within a country.
Gross Domestic Product – GDP: Gross domestic product (GDP) is the monetary value of all the finished
goods and services produced within a country's borders in a specific time period. Though GDP is usually
calculated on an annual basis, it can be calculated on a quarterly basis as well (in the United States, for example,
the government releases an annualized GDP estimate for each quarter and also for an entire year).
GDP includes all private and public consumption, government outlays, investments, private inventories, paid-in
construction costs and the foreign balance of trade (exports are added, imports are subtracted). Put simply, GDP
is a broad measurement of a nation‘s overall economic activity – the godfather of the indicator world.
Gross National Income (GNI): Gross national income is the sum of a nation's gross domestic product and the
net income it receives from overseas.
Net National Product – NNP: Net national product (NNP) is the monetary value of finished goods and services
produced by a country's citizens, overseas and domestically, in a given period (i.e., the gross national
product (GNP) minus the amount of GNP required to purchase new goods to maintain existing stock
(i.e., depreciation).

Inflation: Inflation is the rate at which the general level of prices for goods and services is rising and,
consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation — and
avoid deflation — in order to keep the economy running smoothly.
Demand-Pull Inflation: Demand-pull inflation is used by Keynesian economics to describe what happens when
price levels rise because of an imbalance in the aggregate supply and demand. When the aggregate demand in an
economy strongly outweighs the aggregate supply, prices go up. Economists describe demand-pull inflation as a
result of too many dollars chasing too few goods.
Demand-pull inflation results from strong consumer demand. Many individuals purchasing the same good will
cause the price to increase, and when such an event happens to a whole economy for all types of goods, it is
called demand-pull inflation.
Cost-Push Inflation: Cost-push inflation is a situation in which the overall price levels go up (inflation) due to
increases in the cost of wages and raw materials.
Cost-push inflation develops because the higher costs of production factors decreases in aggregate supply (the
amount of total production) in the economy. Since there are fewer goods being produced (supply weakens) and
demand for these goods remains consistent, the prices of finished goods increase (inflation).
Mixed Demand Inflation: The problem of identifying the basic nature-and fundamental source of inflation
continues. Does inflation arise from the demand side of the goods, factor and asset markets or from the supply
side or from some combination of the two—the so-called mixed inflation. Many economists have come to
believe that the actual process of inflation is neither due to demand-pull alone, nor due to cost-push alone, but
due to a combination of both the elements of demand-pull and cost-push—called mixed inflation.
Causes of inflation
Inflation means there is a sustained increase in the price level. The main causes of inflation are either excess
aggregate demand (economic growth too fast) or cost push factors (supply-side factors).
Summary of Main causes of inflation
1. Demand-pull inflation – aggregate demand growing faster than aggregate supply (growth too rapid)
2. Cost-push inflation – higher oil prices feeding through into higher costs
3. Devaluation – increasing cost of imported goods, also boost to domestic demand
4. Rising wages – higher wages increase firms costs and increase consumers‘ disposable income to spend more.
5. Expectations of inflation – causes workers to demand wage increases and firms to push up prices.

Stagflation: Stagflation is a condition of slow economic growth and relatively high unemployment, or
economic stagnation, accompanied by rising prices, or inflation. It can also be defined as inflation and a decline
in gross domestic product (GDP). Stagflation is an economic problem defined in equal parts by its rarity and by
the lack of consensus among academics on how exactly it comes to pass.
Economic Growth: Economic growth is an increase in the capacity of an economy to produce goods and
services, compared from one period of time to another. It can be measured in nominal or real terms, the latter of
which is adjusted for inflation. Traditionally, aggregate economic growth is measured in terms of gross national
product (GNP) or gross domestic product (GDP), although alternative metrics are sometimes used.
Inflationary Gap: An inflationary gap is a macroeconomic concept that describes the difference between the
current level of real gross domestic product (GDP) and the anticipated GDP that would be experienced if an
economy is at full employment, also referred to as the potential GDP. For the gap to be considered inflationary,
the current real GDP must be the higher of the two metrics.
Deflationary gap: This is the difference between the full employment level of output and actual output. For
example, in a recession, the deflationary gap may be quite substantial, indicative of the high rates of
unemployment and underused resources. A deflationary gap is also known as a negative output gap.
Causes of deflationary gap
 Fall in aggregate demand (AD) due to
 Fall in exports (global recession)
 Fall in investment (due to banking collapse and credit crunch)
 Fall in consumer spending (e.g. higher interest rates, falling wages.)
 Economic growth well below the average trend rate of growth (AD increasing at slower rate than productive
capacity)
Unemployment: Unemployment occurs when a person who is actively searching for employment is unable to
find work. Unemployment is often used as a measure of the health of the economy. The most frequent measure
of unemployment is the unemployment rate, which is the number of unemployed people divided by the number
of people in the labor force.
Natural rate of unemployment: This is the summation of frictional and structural unemployment that excludes
cyclical contributions of unemployment (e.g. recessions). It is the lowest rate of unemployment that a stable
economy can expect to achieve, given that some frictional and structural unemployment is inevitable.
Economists do not agree on the level of the natural rate, with estimates ranging from 1% to 5%, or on its
meaning – some associate it with "non-accelerating inflation". The estimated rate varies from country to country
and from time to time.
Full Employment: Full employment is an economic situation in which all available labor resources are being
used in the most efficient way possible. Full employment embodies the highest amount of skilled and unskilled
labor that can be employed within an economy at any given time. Any remaining unemployment is considered
to be frictional, structural or voluntary.
Causes of unemployment
A look at the main causes of unemployment – including demand deficient, structural, frictional and real wage
unemployment.

Structural unemployment: This reflects a mismatch between the skills and other attributes of the labour force
and those demanded by employers. Rapid industry changes of a technical and/or economic nature will usually
increase levels of structural unemployment; for example, widespread implementation of new machinery or
software will require future employees to be trained in this area before seeking employment. The process
of globalization has contributed to structural changes in labor markets.
Cyclical Unemployment: Cyclical unemployment is a factor of overall unemployment that relates to the regular
ups and downs, or cyclical trends in growth and production, that occur within the business cycle. When business
cycles are at their peak, cyclical unemployment will tend to be low because total economic output is being
maximized. When economic output falls, as measured by the gross domestic product (GDP), the business
cycle is low and cyclical unemployment will rise.
Regional unemployment: When structural unemployment affects local areas of an economy, it is called
‗regional‘ unemployment. For example, unemployed coal miners in South Wales and ship workers in the North
East add to regional unemployment in these areas.
Classical unemployment: Classical unemployment is caused when wages are ‗too‘ high. This explanation of
unemployment dominated economic theory before the 1930s, when workers themselves were blamed for not
accepting lower wages, or for asking for too high wages. Classical unemployment is also called real
wage unemployment.
Seasonal unemployment: Seasonal unemployment exists because certain industries only produce or
distribute their products at certain times of the year. Industries where seasonal unemployment is common
include farming, tourism, and construction.
Frictional unemployment: Frictional unemployment, also called search unemployment, occurs when
workers lose their current job and are in the process of finding another one. There may be little that can be done
to reduce this type of unemployment, other than provide better information to reduce the search time. This
suggests that full employment is impossible at any one time because some workers will always be in the process
of changing jobs.
Voluntary unemployment: Voluntary unemployment is defined as a situation when workers choose not to
work at the current equilibrium wage rate. For one reason or another, workers may elect not to participate in the
labor market. There are several reasons for the existence of voluntary unemployment including excessively
generous welfare benefits and high rates of income tax. Voluntary unemployment is likely to occur when the
equilibrium wage rate is below the wage necessary to encourage individuals to supply their labor.

Hidden unemployment: Hidden, or covered, unemployment is the unemployment of potential workers that are
not reflected in official unemployment statistics, due to the way the statistics are collected. In many countries,
only those who have no work but are actively looking for work (and/or qualifying for social security benefits)
are counted as unemployed. Those who have given up looking for work (and sometimes those who are on
Government "retraining" programs) are not officially counted among the unemployed, even though they are not
employed.
The statistic also does not count the "underemployed"—those working fewer hours than they would prefer or in
a job that doesn't make good use of their capabilities. In addition, those who are of working age but are currently
in full-time education are usually not considered unemployed in government statistics. Traditional unemployed
native societies who survive by gathering, hunting, herding, and farming in wilderness areas, may or may not be
counted in unemployment statistics. Official statistics often underestimate unemployment rates because of
hidden unemployment.
Long-term unemployment is defined in European Union statistics, as unemployment lasting for longer than
one year.
Business Cycle: The business cycle describes the rise and fall in production output of goods and services in an
economy. Business cycles are generally measured using rise and fall in real – inflation-adjusted – gross
domestic product (GDP), which includes output from the household and nonprofit sector and the government
sector, as well as business output. "Output cycle" is therefore a better description of what is measured. The
business or output cycle should not be confused with market cycles, measured using broad stock market
indices; or the debt cycle, referring to the rise and fall in household and government debt.
The different phases of business cycles are shown in Figure-1:
There are basically two important phases in a business cycle that are prosperity and depression. The other phases
that are expansion, peak, trough and recovery are intermediary phases.
Figure-2 shows the graphical representation of different phases of a business cycle:

As shown in Figure-2, the steady growth line represents the growth of economy when there are no business
cycles. On the other hand, the line of cycle shows the business cycles that move up and down the steady growth
line.
Stabilization Policy: A stabilization policy is a macroeconomic strategy enacted by governments and central
banks to keep economic growth stable, along with price levels and unemployment. Ongoing stabilization policy
includes monitoring the business cycle and adjusting benchmark interest rates to control aggregate demand in
the economy. The goal is to avoid erratic changes in total output, as measured by gross domestic product (GDP),
and large changes in inflation; stabilization of these factors generally leads to moderate changes in the
employment rate, as well.
Consumption Function: The consumption function, or Keynesian consumption function, is an economic
formula that represents the functional relationship between total consumption and gross national income. It was
introduced by British economist John Maynard Keynes, who argued the function could be used to track and
predict total aggregate consumption expenditures.
The consumption function is represented as:
Where: C = Consumer spending; A = Autonomous consumption; M = Marginal propensity to consume; D =
Real disposable income.
Saving Function: Saving function or the propensity to save expresses the relationship between saving and the
level of income. It is simply the desire of the households to hoard a part of their total disposable income.
Symbolically, the functional relation between saving and income can be defined as S= f(Y).
We know,
Y= C + S;
Thus, S= Y-C;
Where, Y= Income; S= Saving; C= Consumption
The equation shows that the remaining amount after the deduction of total expenditure from total income is
saving. Thus, saving is that part of income which is not spent on consumption
Marginal Propensity To Consume (MPC): The marginal propensity to consume (MPC) is the proportion of an
aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving
it. Marginal propensity to consume is a component of Keynesian macroeconomic theory and is calculated as the
change in consumption divided by the change in income. MPC is depicted by a consumption line, which is a
sloped line created by plotting change in consumption on the vertical "y" axis and change in income on the
horizontal "x" axis.
Marginal Propensity to Save (MPS): A marginal propensity to save refers to the proportion of an aggregate
raise in pay that a consumer spends on saving rather than on the consumption of goods and services. The
marginal propensity to save is a component of Keynesian macroeconomic theory and is calculated as the change
in savings divided by the change in income.
Marginal propensity to save =
change in saving
change in income
MPS is depicted by a savings line: a sloped line created by plotting change in savings on the vertical y axis and
change in income on the horizontal X axis.

Marginal Propensity To Import (MPM): The marginal propensity to import (MPM) is the amount imports
increase or decrease with each unit rise or decline in disposable income. The marginal propensity to import is
thus the change in imports induced by a change in income. An economy with a positive marginal propensity to
consume is likely to have a positive marginal propensity to import. This is because a portion of goods consumed
is likely to be imported.
MPM is calculated as dIm/dY, meaning the derivative of the import function (Im) with respect to the derivative
of the income function (Y).
Average Propensity To Save: The average propensity to save (APS) is an economic term that refers to the
proportion of income that is saved rather than spent on goods and services. Also known as the savings ratio, it is
usually expressed as a percentage of total household disposable income (income minus taxes). The inverse of
average propensity to save is the average propensity to consume (APC).
Average Propensity To Consume: The average propensity to consume (APC) refers to the percentage of
income spent on goods and services rather than on savings. A person can determine the percentage of income
spent by dividing the average household consumption, or what is spent, by the average household income, or
what is earned. The inverse of the average propensity to consume is the average propensity to save (APS).
Personal Income: Personal income refers to all income collectively received by all individuals or households in
a country. Personal income includes compensation from a number of sources including salaries, wages and
bonuses received from employment or self-employment; dividends and distributions received from investments;
rental receipts from real estate investments and profit-sharing from businesses.
Discretionary Income: Discretionary income is the amount of an individual's income that is left for
spending, investing or saving after paying taxes and paying for personal necessities, such as food, shelter and
clothing. Discretionary income includes money spent on luxury items, vacations, and nonessential goods and
services. Because discretionary income is the first to shrink amid a job loss or pay reduction, businesses that sell
discretionary goods tend to suffer the most during economic downturns and recessions.
National Savings Rate: The national savings rate is an estimate from the U.S. Commerce Department's Bureau
of Economic Analysis (BEA) of the amount of income left over after subtracting consumption costs and
expenditures. The National Savings Rate, though it is referred to as a "savings rate," does not actually measure
the amount of money Americans are saving orinvesting for the long-term. The rate is in fact a type of quotient
that shows declining or increasing trends of savings and how the economy of the country is performing.
National savings include money left over by individuals, businesses, and government after their expenditures are
accounted for.
Disposable Income: Disposable income, also known as disposable personal income (DPI), is the amount of
money that households have available for spending and saving after income taxes have been accounted for.
Disposable personal income is often monitored as one of the many key economic indicators used to gauge the
overall state of the economy.
Investment: An investment is an asset or item acquired with the goal of generating income or appreciation. In
an economic sense, an investment is the purchase of goods that are not consumed today but are used in the
future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will
provide income in the future or will later be sold at a higher price for a profit.

The investment function is a summary of the variables that influence the levels of aggregate investments. It can
be formalized as follows:
I=f(r,ΔY,q)
Where r is the real interest rate, Y the GDP and q is Tobin's q. The signs under the variables simply tell us if the
variable influences investment in a positive or negative way (for instance, if real interest rates were to rise,
investments would correspondingly fall).
Gross Investment: Gross investment includes the total of all investments made in a country during one year.
The country, however, does not benefit from the all of the money invested in machines and equipment because
some machines age during the year. They do not work as well, and therefore contribute less to overall
production.
Net Investment: Net investment equals gross investment, minus annual wear and tear. Another word for the
wearing out of machines is depreciation. Net investment represents the actual amount o
The two types of investments are discussed below:
(i) Autonomous Investment:
Investment may be autonomous and induced. Usually, investment decision is governed by output and/or the rate
of interest.
If investment does not depend either on income/output or the rate of interest, then such investment is called
autonomous investment. Thus, autonomous investment is independent of the level of income.
(ii) Induced Investment:
Investment that is dependent on the level of income or on the rate of interest is called induced investment.
Investment that would respond to a change in national income or in the rate of interest is called induced
investment.
Business Fixed Investment: Business fixed investment means investment in the machines, tools and equipment
that businessmen buy for use in further production of goods and services.
Residential Investment: Residential investment refers to the expenditure which people make on constructing or
buying new houses or dwelling apartments for the purpose of living or renting out to others. Residential
investment varies from 3 per cent to 5 per cent of GDP in various countries.
The marginal efficiency of capital (MEC) is that rate of discount which would equate the price of
a fixed capital asset with its present discounted value of expected income.
The term ―marginal efficiency of capital‖ was introduced by John Maynard Keynes in his General Theory, and
defined as ―the rate of discount which would make the present valueof the series of annuities given by the
returns expected from the capital asset during its life just equal its supply price‖.
Multiplier: In economics, a multiplier refers to an economic factor that, when increased or changed, causes
increases or changes in many other related economic variables. In terms of gross domestic product,
the multiplier effect causes gains in total output to be greater than the change in spending that caused it. The
term is usually used in reference to the relationship between government spending and total national income.
Types of multiplier:
Employment Multiplier: It refers to type of a multiplier measure by Kahn‘s where the number of employment
is created, activated and supplied from the base or primary jobs. let‘s suppose in cosmetic products the
multiplier is 1.5, means that for every job in the cosmetic products industry effects 1.5 other jobs. Generally, this

means that if employment increases by one job in cosmetic company, then 1.5 other jobs are created throughout
the economy.
Fiscal Multiplier: It‘s referring to that type of multiplier where an increment of government spending tends to
leave a larger impact on the national income (GDP). The Mechanism used in this case is that an initial increment
of spending by the Govt leads to increase consumption, this increment of consumption will make an income of
another and hence further increase the level of expenditure that results in an overall increase in national income
of the country.
Money Multiplier: Money Multiplier is generally the amount of money that banks generate with each dollar of
reserves. Reserve is the amount of deposit that banks reserve for all the reserve that wants to reserve in the bank
than to lend. The money multiplier is the ratio of deposits to reserves in the banking system. The higher the
reserve ratio, the tighter will be the money supply, which will result lesser excess reserve and would be lower
multiplier effect for every dollar deposited. The larger the money supply, the lower the reserve requirements
which means more money is being generated for every dollar deposited.
Income Multiplier:
An injection of investment will ultimately result many times higher increase in the income of an individual or to
nation caused by that initial investment. That is why it‘s called income multiplier or investment multiplier at the
same time.
Negative/Reverse Multiplier: The negative multiplier refers to such situation in the economy where a minor
decline in investment will trigger a huge decline in the business activity.
Tax Multiplier: Tax multiplier can be thought in negative or downward multiplier because if an increase in
government spending leads in ever larger increase in GDP, then a contradictory case would be an increase in
tax, decreasing GDP or spending. Obviously higher taxes reduces the amount of money people used to consume
and this reduction indicates less spending in the market and a leakage from the circular flow of income.
Investment Multiplier: An investment multiplier refers to the concept that any increase in public or private
investment spending has a more than proportionate positive impact on aggregate income and the general
economy. The multiplier attempts to quantify the additional effects of a policy beyond those immediately
measurable. The larger an investment's multiplier, the more efficient it is at creating and distributing wealth
throughout an economy.
Deposit Multiplier: The deposit multiplier, also referred to as the deposit expansion multiplier, is a function
that describes the amount of money a bank creates in additional money supply through the process of lending
the available capital it has in excess of the bank's reserve requirement. Simply put, it's the ratio of bank reserves
to the bank deposits.
Demand: Demand is an economic principle referring to a consumer's desire and willingness to pay a price for a
specific good or service. Holding all other factors constant, an increase in the price of a good or service will
decrease demand, and vice versa. Think of demand as your willingness to go out and buy a certain product. For
example, market demand is the total of what everybody in the market wants.
Aggregate Demand: Aggregate demand is an economic measurement of the sum of all final goods and services
produced in an economy, expressed as the total amount of money exchanged for those goods and services. Since
aggregate demand is measured by market values, it only represents total output at a given price level and does
not necessarily represent quality or standard of living.

Aggregate Supply: Aggregate supply, also known as total output, is the total supply of goods and services
produced within an economy at a given overall price level in a given period. It is represented by the aggregate
supply curve, which describes the relationship between price levels and the quantity of output that firms are
willing to provide. Normally, there is a positive relationship between aggregate supply and the price level.
Money Supply: The money supply is the entire stock of currency and other liquid instruments circulating in a
country's economy as of a particular time. The money supply can include cash, coins and balances held in
checking and savings accounts. Economists analyze the money supply and develop policies revolving around it
through controlling interest rates and increasing or decreasing the amount of money flowing in the economy.
Sticky Wage Theory: The sticky wage theory hypothesizes that pay of employees tends to have a slow
response to the changes in the performance of a company or of the economy. According to the theory,
when unemployment rises, the wages of those workers that remain employed tend to stay the same or grow at a
slower rate than before rather than falling with the decrease in demand for labor. Specifically, wages are often
said to be sticky-down, meaning that they can move up easily but move down only with difficulty.
Stickiness in general is also often called ―nominal rigidity‖ and the phenomenon of sticky wages is also often
referred to as ―wage stickiness.‖
Supply Shock: A supply shock is an unexpected event that changes the supply of a product or
a commodity resulting in a sudden change in its price. Supply shocks can be negative (decreased supply) or
positive (increased supply); however, they are almost always negative and rarely positive. Assuming aggregate
demand is unchanged, a negative supply shock in a product or a commodity causes its price to spike
upward while a positive supply shock exerts downward pressure on its price.
Absolute Income: Economist John Maynard Keynes created a theory of consumption based on people's
absolute income. According to Keynes, consumers would spend a smaller percentage of their income as their
absolute income grew larger, simultaneously increasing their savings rate. Data supported the theory, but when
aggregate income grew there was not a similar growth in the aggregate savings rate. Still, standard economics
asserts that individuals view their income and financial position in absolute terms.
Relative Income: James Duesenberry introduced the relative income hypothesis, which demonstrates that
people make decisions, including savings and consuming, based not only on absolute income but on relative
income as well. Duesenberry argued that consumers view their own social position and status in relation to
others, and then behave accordingly. For instance, a consumer will consider his income as it relates to the
income of another before making purchase decisions.
Permanent Income Hypothesis: The Permanent Income Hypothesis is a theory of consumer spending which
states that people will spend money at a level consistent with their expected long term average income. The
level of expected long term income then becomes thought of as the level of "permanent" income that can be
safely spent. A worker will save only if his or her current income is higher than the anticipated level of
permanent income, in order to guard against future declines in income.

Life-Cycle Hypothesis (LCH): The Life-Cycle Hypothesis (LCH) is an economic theory that pertains to the
spending and saving habits of people over the course of a lifetime. The concept was developed by Franco
Modigliani and his student Richard Brumberg. LCH presumes that individuals plan their spending over
their lifetimes, taking into account their future income. Accordingly, they take on debt when they are young,
assuming future income will enable them to pay the debt off. They then save during middle age in order to
maintain their level of consumption when they retire. This results in a "hump-shaped" pattern in which wealth
accumulation is low during youth and old age, and high during middle age.
Expected Rate of Inflation:
Investor and public expectations of current or future inflation. These expectations may or may not be rational,
butthey may affect how the market reacts to changes in target interest rates. For example, the market usually res
pondswell to a cut in interest rates, but if investors expect inflation to go higher in the near future and the Feder
al Reserve cuts rates, the market may not react positively.
Phillips Curve: The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation
and unemployment have a stable and inverse relationship. The theory claims that with economic growth comes
inflation, which in turn should lead to more jobs and less unemployment. However, the original concept has
been somewhat disproven empirically due to the occurrence of stagflation in the 1970s, when there were high
levels of both inflation and unemployment.
Figure 1 Phillips Curve
Stabilization Policy: A stabilization policy is a macroeconomic strategy enacted by governments and central
banks to keep economic growth stable, along with price levels and unemployment. Ongoing stabilization policy
includes monitoring the business cycle and adjusting benchmark interest rates to control aggregate demand in
the economy. The goal is to avoid erratic changes in total output, as measured by gross domestic product (GDP),
and large changes in inflation; stabilization of these factors generally leads to moderate changes in the
employment rate, as well.
Monetary Policy: Monetary policy consists of the actions of a central bank, currency board or other regulatory
committee that determine the size and rate of growth of the money supply, which in turn affects interest rates.
Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government
bonds, and changing the amount of money banks are required to keep in the vault (bank reserves).
The Federal Reserve is in charge of monetary policy in the United States.

Fiscal Policy: Fiscal policy refers to the use of government spending and tax policies to influence
macroeconomic conditions, including aggregate demand, employment, inflation and economic growth.
The three stances of fiscal policy are:
 Neutral fiscal policy is usually undertaken when an economy is in neither a recession nor a boom. The amount
of government deficit spending (the excess not financed bytax revenue) is roughly the same as it has been on
average over time, so no changes to it are occurring that would have an effect on the level of economic activity.
 Expansionary fiscal policy involves government spending exceeding tax revenue by more than it has tended to,
and is usually undertaken during recessions.
 Contractionary fiscal policy occurs when government deficit spending is lower than usual.
Government spending or expenditure includes all government consumption, investment, and transfer
payments. Government spending can be financed by government borrowing, or taxes. Changes in government
spending is a major component of fiscal policy used to stabilize the macroeconomic business cycle.
Taxes: Taxes are involuntary fees levied on individuals or corporations and enforced by a government entity -
whether local, regional or national - in order to finance government activities. In economics, taxes fall on
whomever pays the burden of the tax, whether this is the entity being taxed, like a business, or the end
consumers of the business's goods.
Transfer Payment: A transfer payment, in the United States, is a one-way payment to a person for which no
money, good, or service is given or exchanged. Transfer payments are made to individuals by the federal
government through various social benefit programs. These types of payments are executed by the United States
to individuals through programs such as Social Security.
Social Security: Social Security is an important part of the Old-Age, Survivors, and Disability
Insurance program and run by the Social Security Administration. This is a social welfare and insurance plan
managed by the U.S. federal government that pays benefits to retirees, workers who become disabled and
survivors of deceased workers. Social Security's benefits include retirement income, disability
income, Medicare and Medicaid, and death and survivorship benefits. Social Security is one of the largest
government programs in the world, paying out hundreds of billions of dollars per year.
Retirement benefits may begin as early as age 62 at a discounted rate, and the amount you receive in retirement
increases from the 62 through 70. You do not have to take benefits at 70 years old, but there is no
monetary benefit to waiting beyond that age Social Security bases the amount of income one receives on
" average indexed monthly earnings" during the 35 years in which you earned the most. Spouses are also
eligible to receive Social Security benefits, even if they have limited or non-existent work histories. A divorced
spouse can also receive spousal benefits, if the marriage lasted 10 years or longer.
A budget is a financial plan for a defined period of time, usually a year. It may also include planned sales
volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. Companies,
governments, families and other organizations use it to express strategic plans of activities or events in
measurable terms.
A budget is the sum of money allocated for a particular purpose and the summary of intended expenditures
along with proposals for how to meet them. It may include a budget surplus, providing money for use at a future
time, or a deficit in which expenses exceed income.

Balanced Budget: A balanced budget is a situation in financial planning or the budgeting process where total
revenues are equal to or greater than total expenses. A budget can be considered balanced in hindsight after a
full year's worth of revenues and expenses have been incurred and recorded. A company's operating budget for
an upcoming year can also be called balanced based on predictions or estimates.
What is a 'Budget Deficit'?
A budget deficit occurs when expenses exceed revenue, and it is an indicator of financial health. The
government generally uses this term in reference to its spending rather than business or individuals. Accrued
government deficits form the national debt.
What is a 'Budget Surplus'
A budget surplus is a period when income or receipts exceed outlays or expenditures. A budget surplus often
refers to the financial states of governments; individuals prefer to use the term 'savings' instead of the term
'budget surplus.' A surplus is an indication that the government is being effectively managed.
What is 'Balance Of Trade - BOT'?
The balance of trade is the difference between the value of a country's imports and exports for a given period.
The balance of trade is the largest component of a country's balance of payments. Economists use the BOT to
measure the relative strength of a country's economy. The balance of trade is also referred to as the trade balance
or the international trade balance.
What is a 'Trade Surplus'
A trade surplus is an economic measure of a positive balance of trade, where a country's exports exceed its
imports.
Trade Balance = Total Value of Exports - Total Value of Imports
A trade surplus occurs when the result of the above calculation is positive. A trade surplus represents a net
inflow of domestic currency from foreign markets. It is the opposite of a trade deficit, which represents a net
outflow, and occurs when the result of the above calculation is negative. In the United States, trade balances are
reported monthly by the Bureau of Economic Analysis.
What is the 'Balance of Payments (BOP)'
The balance of payments is a statement of all transactions made between entities in one country and the rest of
the world over a defined period of time, such as a quarter or a year.
What is a 'Trade Deficit'?
A trade deficit is an economic measure of international trade in which a country's imports exceeds its exports. A
trade deficit represents an outflow of domestic currency to foreign markets. It is also referred to as a
negative balance of trade (BOT).
What is 'Foreign Direct Investment - FDI'
Foreign direct investment (FDI) is an investment made by a firm or individual in one country into business
interests located in another country. Generally, FDI takes place when an investor establishes foreign business
operations or acquires foreign business assets, including establishing ownership or controlling interest in a
foreign company. Foreign direct investments are distinguished from portfolio investments in which an investor
merely purchases equities of foreign-based companies.

What is a 'Current Account Deficit'?
The current account deficit is a measurement of a country‘s trade where the value of the goods and services it
imports exceeds the value of the goods and services it exports. The current account includes net income, such as
interest and dividends, and transfers, such as foreign aid, although these components make up only a small
percentage of the total current account. The current account represents a country‘s foreign transactions and,
like the capital account, is a component of a country‘s balance of payments.
Definition of capital mobility – easy for physical assets and finance to move across geographical boundaries.
Capital immobility – when capital faces restrictions on the free movement.
Definition of 'Policy Mix'
The combination of fiscal and monetary policy a nation's policymakers use to manage the economy. The policy
mix is the combination of a country's monetary policy and fiscal policy. These two channels influence growth
and employment, and are generally determined by the central bank and the government (e.g., the United States
Congress) respectively
Purchasing power parity (PPP) is a neoclassical economic theory that states that the exchange rate between
two countries is equal to the ratio of the currencies' respectivepurchasing power. Theories that invoke the
purchasing power parity assume that in some circumstances (for example, as a long-run tendency) it would cost
exactly the same number of, for example, US dollars to buy euros and then buy a market basket of goods as it
would cost to directly purchase the market basket of goods with dollars. A fall in either currency's purchasing
power would lead to a proportional decrease in that currency's valuation on the foreign exchange market.
The concept of purchasing power parity allows one to estimate what the exchange rate between two currencies
would have to be in order for the exchange to be at par with the purchasing power of the two countries'
currencies. Using that PPP rate for hypothetical currency conversions, a given amount of one currency thus has
the same purchasing power whether used directly to purchase a market basket of goods or used to convert at the
PPP rate to the other currency and then purchase the market basket using that currency. Observed deviations of
the exchange rate from purchasing power parity are measured by deviations of the real exchange rate from its
PPP value of 1.

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