What are the three basic questions economic questions a society must answer? (1) What products do we produce?

(2) How do we produce the product? (3) Who consumes the product? The four elements of the economic way of thinking are (1) use assumptions to simplify the analysis. (2) explore the relationship between two variables by isolating variables or Ceteris paribus, (3) thank at the margin, and (4) rational people respond to incentives. Scarcity-the resources we use to produce goods and services are limited. Positive analysis- answers the question what is? or what will be? Normative analysis- Answers the question what ought to be? Economic model- a simplified representation of an economic environment, often employing a graph. Variable- a measure of something that can take on different values. Ceteris paribus- the Latin expression meaning that other variables are held fixed. Marginal change- a small one unit change in value. Factors of production- the resources used to produce goods and services; also known as production inputs or resources. Natural resources- Resources provided by nature and used to produce goods and services. Labor- human effort, including both physical and mental effort, used to produce goods and services. Physical capital- the stock of equipment, machines, structures, and infrastructure that is used to produce goods and services. Human capital- the knowledge and skills acquired by a worker through education and experience and used to produce goods and services. Entrepreneurship- the effort used to coordinate the factors of production, natural resources, labor, physical capital, and human capital, and human capital, to produce and sell products. Principle of opportunity cost- the opportunity cost of something is what you sacrifice to get it. Production possibilities curve- a curve that shows the possible combinations of production the an economy can produce, given that an economy can produce, given that its productive resources are fully employed and efficiently used. Marginal principle- Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost. Marginal benefit- the additional benefit resulting from a small increase in some activity. Marginal cost- the additional cost resulting from a small increase in some activity. Principle of voluntary exchange- a voluntary exchange between two people makes both people better off. Principle of diminishing returns- suppose output is produced with two or more inputs fixed. Beyond some point- called the point of diminishing returns- output will increase at a decreasing rate. Realnominal principle- what people care about is the real value of money or income-its purchasing power- not its face value. Nominal value- the face value of money. Real value- the value of an amount of money in terms of what it can buy. Comparative advantage- the ability of one person or nation to produce a good at a lower opportunity cost than another person or nation. Absolute advantagethe ability of one person or nation to produce a product at a lower resource cost than another person or nation. Import- a good or service produced in a foreign country and purchased by residents of the home country. Exports- goods or services produced in the home country (for example, the United States) and sold in another country . Market economy an economy in which people specialize and exchange goods and services in markets. Although it appears that markets arose naturally, a number of social and government inventions have made them work better: * Contracts specify the terms of exchange between strangers. * Insurance reduces the risk entrepreneurs face. * Patents increase the profitability of inventions, encouraging firms to develop new products and production processes. * Accounting rules provide potential investors with reliable information about the financial performance of a firm. Centrally planned economy- an economy in a government bureaucracy decides how much of each good to produce, how to produce the goods, and who gets the good. Perfectly competitive market- a market with many sellers and buyers of a homogeneous product and no barriers of entry (no single buyer or seller can affect the market price). Quantity demand- the amount of a product that consumers are willing and able to buy. Demand schedule- a table that shows the relationship between the price of a product and the quantity demand, ceteris paribus. Individual demand curve- a curve that shows the relationship between the price of a good and quantity demand by an individual consumer, ceteris paribus. Law of demand- there is a negative relationship between price and quantity demand, ceteris paribus. Change in quantity demand- a change in the quantity consumer are willing and able to buy when the price changes; represented graphically by movement along the demand curve. Market demand curve- a curve showing the relationship between price and quantity demand by all consumers, ceteris paribus . Quantity supplied- the amount of a product that firms are willing and able to sell. Supply schedule- a table that shows the relationship between the price of a product and quantity supplied, ceteris paribus. Individual supply curve- a curve showing the relationship by a single firm, ceteris paribus . Law of supply- there is a positive relationship between price and quantity supplied, ceteris paribus. Change in quantity supplied- a change in the quantity firms are willing and able to sell when the prices changes; represented graphically by movement along the supply curve . Minimum supply price- the lowest price at which a product will be supplied. Market supply curve- a curve showing the relationship between the market price and the quantity supplied by all firms. Ceteris paribus. Why the market supply curve is positively sloped?? The market supply curve is positively sloped, consistent with the law of supply. Market equilibrium- a situation in which the quantity demand equals the quantity supplied at the prevailing market price. Excess demand- a situation in which, at the prevailing price, the quantity demand exceeds the quantity supplied. Excess supply- a situation in which the quantity supplied exceeds the quantity demanded at the prevailing price. Chang in demand- a shift of the demand curve caused by a change in a variable other than the price of the product . Normal good- a good for which an increase in income increases demand. Inferior good- a good for which an increase in income decreases demand. Substitutes- two goods for which a decrease in the price of one good increases the demand for the other good. Complements- two goods for which a decrease the demand for the other goods. What types of changes will increase the demand and shift the demand curve to the right? * increase in income, decrease in income, increase in price of a substitute good, decrease in price of a complementary good, increase in population, shift in consumers, expectations of higher future prices. Change in supply- a shift of the curve caused by a change in a variable other than the price of the product. Inflation- sustained increases in the average prices of all goods and services. Gross domestic product (GDP)- the total market value of final goods and services produced within an economy in a given year (only new products are counted). Intermediate goods- goods used in production process that are not final goods and services . Real-GDP- a measure of GDP that controls for changes in prices. Nominal GDP- the value of GDP in current dollars. Economic growth- sustains increased in the real GDP of an economy over a longer period of time. Consumption expenditurespurchases of newly produced goods and services by households . Private investment expenditures- purchases of newly produced goods and services by firms. Gross investment- total new investment expenditures. Depreciation- reduction in the value of capital goods over a one-year period due to physical wear and also to obsolescence; also called capital consumption allowed. Net investmentgross investment minus depreciation. Government purchases- purchases of newly produced goods and services by local, state, and federal government. Transfer payments- payments from the government to individual that do not correspond to individuals that do not correspond to the production of goods and services. Impart- a good of service produced in a foreign country and purchased by residents of the home country. Export- a good or service produced in home country and sold in another country . Trade deficit- the excess of imports over exports. Trade surplus- the excess of exports over imports. Trade surplus-the excess of exports over imports. National income- the total income earned by a nations residents both domestically and abroad in the production of goods and services. Gross national product- GDP plus net income earned abroad. Personal income- income, including transfer payments, received by household . Personal disposable income- personal income that households retain after patting income taxes. Value added- the sum of all the income, wages, interest, profits, and rent, generated by an organization. For a firm we can measure value added by the dollar value of the firms sales minus the dollar value of the firms sales minus the doll ar value of the good and services purchased from other firms. GDP deflator- an index that measures how the prices included in GDP change over time. Chain-weighted-index- a method for calculating changes in prices that uses an average of base year from neighboring years . Recession- commonly defined as six consecutive months of declining in the GDP. Peak- the date at which the recession starts. Trough- the date at which the output stops falling in a recession. Expansion-the period after a trough in the business cycle during which the economy recovers. Depression- the common name for a severe recession. Classical models- Economic models that assume wages and prices adjust to changes in demand and supply. Production function- the relationship between the level of output of a good and the factors of output of production that are inputs to production. Stick of capital- the total of all machines, equipment, and buildings in an entire economy. Real wage- the wage rate paid to employees adjusted for changes in price level. Full-employment output- the level of output tht results when the labor market is in equilibrium and the economy is producing at full employment. Real business cycle theory- the economic theory that emphasizes how shocks to technology can cause fluctuations in economic activity.