Economics Terms & Concepts

Question 1

Economics

Answer 1

Economics is the social science that studies the production, distribution, and consumption of goods and services. It can also be described as how people use scarce resources to satisfy unlimited needs and wants.

Question 2

Economics - Marginal Analysis

Answer 2

Marginal analysis is an examination of the additional benefits of an activity compared to the additional costs incurred by that same activity. Companies use marginal analysis as a decision-making tool to help them maximize their potential profits. Marginal refers to the focus on the cost or benefit of the next unit or individual, for example, the cost to produce one more widget or the profit earned by adding one more worker.

Question 3

Economic - Equilibrium Analysis

Answer 3

In economics, general equilibrium theory attempts to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that the interaction of demand and supply will result in an overall general equilibrium. It both studies economies using the model of equilibrium pricing and seeks to determine in which circumstances the assumptions of general equilibrium will hold.

Question 4

Microeconomics / Micro Analysis

Answer 4

Microeconomics is the study of the economic decision making of businesses and consumers.

Question 5

Macroeconomics / Macro Analysis

Answer 5

Macroeconomics is the study of the economy as a whole, such as: Inflation, unemployment, economic output, business cycles, fiscal policy, monetary policy, international trade, and the study of economic systems.

Question 6

Economics - Positive Vs. Normative Analysis

Answer 6

Positive economics and normative economics are two standard branches of modern economics. Positive economics describes and explains various economic phenomena, or “what is”, while normative economics focuses on the value of economic fairness or what the economy “should” or “ought” be.

Question 7

Economy

Answer 7

An economy is an area of the production, distribution, or trade, and consumption of goods and services by different agents. Understood in its broadest sense, ‘The economy is defined as a social domain that emphasize the practices, discourses, and material expressions associated with the production, use, and management of resources’. Economic agents can be individuals, businesses, organizations, or governments. Economic transactions occur when two parties agree to the value or price of the transacted good or service, commonly expressed in a certain currency. However, monetary transactions only account for a small part of the economic domain.

Question 8

The Basic Economic Problem

Answer 8

It is often said that the central purpose of economic activity is the production of goods and services to satisfy our changing needs and wants. The basic economic problem is about scarcity and choice.

Question 9

Scarcity

Answer 9

Scarcity refers to the basic economic problem, the gap between limited – that is, scarce – resources and theoretically limitless wants. This situation requires people to make decisions about how to allocate resources efficiently, in order to satisfy basic needs and as many additional wants at possible. Any resource that has a non-zero cost to consume is scarce to some degree, but what matters in practice is relative scarcity. Scarcity is also referred to as “paucity.”

Question 10

Opportunity Cost

Answer 10

Opportunity cost represents the benefits an individual, investor, or business misses out on when choosing one alternative over another. While financial reports do not show opportunity cost, business owners can use it to make educated decisions when they have multiple options before them.

Question 11

Production Possibilities Frontier (PPF)

Answer 11

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

Question 12

Law of Supply and Demand

Answer 12

The Law of Supply and Demand is a theory that explains the interaction between the supply of a resource and the demand for that resource. The theory defines the effect that the availability of a particular product and the desire (or demand) for that product has on its price. Generally, low supply and high demand increase price. In contrast, the greater the supply and the lower the demand, the price tends to fall.

Question 13

Equilibrium

Answer 13

Equilibrium is the state in which market supply and demand balance each other, and as a result, prices become stable. Generally, an over-supply for goods or services causes prices to go down, which results in higher demand. The balancing effect of supply and demand results in a state of equilibrium.

Question 15

Utility

Answer 15

Utility is an economic term introduced by Daniel Bernoulli (1700-1782) 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.

Question 16

Marginal Benefit

Answer 16

A marginal benefit is an additional satisfaction or utility that a person receives from consuming an additional unit of a good or service. A person’s marginal benefit is the maximum amount he is willing to pay to consume that additional unit of a good or service. In a normal situation, the marginal benefit decreases as consumption increases.

Question 17

Resources

Answer 17

Resources, otherwise known as ‘Factors of Production’, include land, labor, capital, and entrepreneurship - everything it takes to produce the stuff that you and I buy on a regular basis in our economy.

Question 18

Economic Growth

Answer 18

An increase in the amount of goods and services produced per head of the population over a period of time.

Question 19

Sustainable Economic Growth

Answer 19

Sustainable economic growth is economic development that attempts to satisfy the needs of humans, but in a manner that sustains natural resources and the environment for future generations.

Question 20

Market Economy / Unplanned Economy

Answer 20

A market economy, or unplanned economy, is an economic system in which economic decisions and the pricing of goods and services are guided solely by the aggregate interactions of a country’s individual citizens and businesses. There is little government intervention or central planning. This is the opposite of a centrally ‘planned’ economy, in which government decisions drive most aspects of a country’s economic activity. Compare with Command Economy and Mixed Economy.

Question 21

Invisible Hand

Answer 21

Some economists believe that the economy is guided by an ‘invisible hand ‘ - a term coined by English economist Adam Smith in his book The Wealth of Nations. Basically, the idea is that buyers and sellers will make decisions based upon what’s best for them - in their self-interest. And, the sum of these interests creates the best result for an economy.

Question 22

Adam Smith

Answer 22

Adam Smith (1723-1790) contended that the invisible hand was a self-regulating mechanism and that individuals within the economic system would pursue their individual interests to maximize their own benefits, creating a state of equilibrium, which is a state in which all economic forces (such as supply and demand) are totally balanced. He believed that this would lead to a completely free market economy, in which Individuals can freely pursue their own benefit through being both a consumer and a worker, where a trickle-down effect (or when a consumer purchases something, it helps a producer, who in turn might hire another worker) is created.

Question 23

Market Economy - Advantages

Answer 23

In theory: Competition leads to efficiency, innovation is encouraged, a large variety of goods and services are available, economic activity is encouraged, and freedom of individual choice is possible.

Question 24

Market Economy - Disadvantages

Answer 24

In theory: Disparity in wealth and mobility exists, environmental damage results, there tends to be a reduced social safety net, poor working conditions can result, and questionable priorities can result.

Question 25

Mixed Economy / Unplanned and Planned Economy

Answer 25

In most cases, and particularly with reference to Western economies, the term ‘mixed economy’ refers to a capitalist market economy characterized by the predominance of private ownership of the means of production with profit-seeking enterprise and the accumulation of capital as its fundamental driving force. In such a system, markets are subject to varying degrees of regulatory control and governments wield indirect macroeconomic influence through fiscal and monetary policies with a view to counteracting capitalism’s history of boom/bust cycles, unemployment, and income disparities. In this framework, varying degrees of public utilities and essential services operate under public ownership and state activity is often limited to providing public goods and universal civic requirements - such as healthcare, physical infrastructure and management of public lands. Compare with Market Economy and Command Economy.

Question 26

Factors of Production

Answer 26

Factors of production, otherwise know as ‘resources’ necessary for production, are the resources used by a company to produce goods and services. The universally recognized factors of production include land, labor, and capital. Some scholars include enterprise - entrepreneurship - as a fourth factor while many argue that it should fall under labor.

Question 27

Karl Marx

Answer 27

Karl Marx (1818-1883) believed that capitalism was a form of exploitation, or a situation where an individual is not receiving benefits to meet his or her needs. Specifically, that it was an exploitative economic system that disadvantaged the workers who sell their labor (the proletariat) at the expense of the bourgeoisie (the business owners). Marx believed that the proletariat should control the factors of production (the facilities or resources required to produce goods), wherein the society would become communist, which is a society where land and labor are owned by everyone.

Question 28

Command Economy / Planned Economy

Answer 28

A command economy, or planned economy, is a system where the government, rather than the free market, determines what goods should be produced, how much should be produced and the price at which the goods are offered for sale. It also determines investments and incomes. The command economy is a key feature of any communist society. Cuba, North Korea, and the former Soviet Union are examples of countries that have command economies, while China maintained a command economy for decades before transitioning to a mixed economy that features both communistic and capitalistic elements. Compare with Market Economy and Mixed Economy.

Question 29

Incentives

Answer 29

Incentives are rewards that motivate people to behave in certain ways that we want them to.

Question 30

Economic Incentives

Answer 30

Economic incentives motivate you to act in a certain way because they can lead to the achievement of your particular preferences, such as earning a profit or obtaining power (needs, wants, and desires). They are either extrinsic or intrinsic. Opposite of Economic Disincentives.

Question 31

Economic Disincentives

Answer 31

Economic disincentives are any factors that motivate an individual from following a particular path. For example, if pay for a particular task is too low, that prospective employee may choose that avoid following that particular employment route. Taxes can also be a form of disincentives when used in certain situations. Opposite of Economic Incentives.

Question 32

Economic Incentives - Extrinsic Incentives

Answer 32

Extrinsic incentives come from outside of a person. These are the typical economic incentives that you probably think about all of the time. Extrinsic incentives include cash rewards, bonuses, income, and profits. However, it’s not all about money. External incentives can include such things as peer recognition, fame, social status and power. Some of these incentives will work better than others, depending upon your preferences. Someone may care more about social status, for example, than money. See also Intrinsic Incentives.

Question 33

Economic Incentives - Intrinsic Incentives

Answer 33

Intrinsic incentives are psychological incentives and are internal to the person. Getting satisfaction from work is an intrinsic incentive. The feeling of making a difference in the world is also an intrinsic motivation - regardless of whether you actually make a difference or not. Sometimes extrinsic motivations will trump intrinsic motivations. For example, the idea of building a home for the poor makes you feel good, but you will gladly accept pay to do it, which ends your spirit of volunteering. See also Extrinsic Incentives.

Question 34

Economic Incentives - Extrinsic Incentives - Monetary Incentives

Answer 34

Bonuses/commissions, merit pay, profit sharing, stock options, and vacation time (beyond an employee’s normal paid time).

Question 35

Economic Incentives - Extrinsic Incentives - Non-Monetary Incentives

Answer 35

Healthcare benefits, life insurance, promotion, vehicle or vehicle allowance, charitable donations made in an employee’s name, gift cards, and luxury gifts.

Question 36

Economic Incentives - Extrinsic Incentives - Monetary and Non-Monetary Incentives - Advantages and Disadvantages

Answer 36

Monetary incentives are not usually as effective as non-monetary incentives because employees don’t see a clear and direct correlation between the benchmark and the incentive, they create a sense of inequality, they encourage cut-throat competition between employees to sabotage the work of their colleagues to attain the incentive, and they aren’t very tangible when added as an addendum on a paycheck. Non-Monetary incentives are usually more effective because employees show greater enthusiasm and appreciation for tangible things they can use, enjoy, or show off and brag about to others. And the more they can use or show off these incentives, the more likely they are to think of the employer in a favorable light.

Question 37

Explicit Cost

Answer 37

Explicit costs are tangible out-of-pocket costs for a firm—for example, payments for wages and salaries, rent, or materials. See also Implicit Cost.

Question 38

Implicit Cost

Answer 38

Implicit costs are the opportunity cost of resources already owned by the firm and used in business—for example, expanding a factory onto land already owned or training a new employee when those training hours could be used for work. See also Explicit Cost.

Question 39

Marginal Cost

Answer 39

Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit. It is most often used among manufacturers as a means of identifying an optimum production level. Marginal cost of production is best used to determine when a company can reach an economy of scale to optimize production and overall operations. Marginal Cost = Change in Costs / Change in Quantity. If the marginal cost is less than the price you charge per item, you can expand production.

Question 40

Equation for Marginal Cost

Answer 40

Marginal Cost = Change in Costs / Change in Quantity. If the marginal cost is less than the price you charge per item, you can expand production.

Question 41

Economies of Scale

Answer 41

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. See also Diseconomies of Scale.

Question 42

Diseconomies of Scale

Answer 42

Diseconomies of scale happen when a company or business grows so large that the costs per unit increase. It takes place when economies of scale no longer function for a firm. With this principle, rather than experiencing continued decreasing costs and increasing output, a firm sees an increase in marginal costs when output is increased. Diseconomies of scale can occur for variety of reasons, but the cause usually comes from the difficulty of managing an increasingly large workforce. See also Economies of Scale.

Question 43

The Tragedy of the Commons

Answer 43

The Tragedy of the Commons (Garrett Hardin - 1915-2003) is an economic problem in which every individual tries to reap the greatest benefit from a given resource. As the demand for the resource overwhelms the supply, every individual who consumes an additional unit directly harms others who can no longer enjoy the benefits. Generally, the resource of interest is easily available to all individuals; the tragedy of the commons occurs when individuals neglect the well-being of society in the pursuit of personal gain. E.g. The Grand Banks fisheries off the coast of Newfoundland and Gulf of Mexico Dead Zone.

Question 43

Debate the role of private property as an incentive in conserving and improving scarce resources, including renewable and nonrenewable natural resources.

Answer 43

In theory, private property encourages people to protect their resources, including renewable and nonrenewable resources, and ensure long-term sustainability, discouraging the Tragedy of the Commons. In regards to environmental protection, responsible land ownership has saved many endangered species because treating their habitat as private property protects them under a citizen’s rights against other people’s pollution. In relation to economics, private companies are motivated by people’s purchasing habits, and if people demand sustainable products, the companies must provide them in order to stay competitive.