Economic Terms

When a country experiences lower costs of producing a good than another country (i.e. produces more goods using the same resources).

Below is an example of how the absolute advantage between two countries works via a normal form matrix table. In this instance we have two countries and both produce two goods. Therefore the country that can produce the most units of each good given the same resources has the absolute advantage in the production of that good. 

In this example, one country has an equal absolute advantage in both goods (France makes 3 for every item made by Poland). There is no incentive to specialise or trade. This is an unlikely theoretical outcome. it is more likely that countries will either enjoy a reciprocal absolute advantage or a comparative advantage.

A general measure of poverty that classes an individual of living in poverty when they have insufficient income to afford the essentials of life.

 

Although the focus in this model is often the short term aggregate demand effects it is crucial to make the connection to productivity and aggregate supply. As investment will increase the use of capital in the productive process this has the potential to increase productivity, the productive capacity of the economy. This will help to shift LRAS and produce sustainable economic growth by increasing real output without inflationary consequences. 

 

The amount of a good actually supplied in a market. This may be different to planned supply due to production difficulties.

A tax that is based on a percentage of the cost of a good or service e.g. 40% of the cost of goods and services sold.

The following table and diagram detail the impact of a 40% ad valorem tax and demonstrates how the imposition of the tax will lead to a rotational shift in the supply curve:

A famous Scottish economist who authored the Wealth of Nations which, amongst other things, introduced concepts such as specialisation and the division of labour.

When economic agents form their inflation expectations on the basis that the future will be like the immediate past i.e. if the inflation rate was 2% last year it is likely to be close to 2% next year.

Below is a graphical representation of how adaptive expectations affect the economy. In this instance there is a positive aggregate demand shock that creates excess demand and introduces inflationary pressures into the economy. If workers in the economy hold adaptive expectations, they will expect that inflation rate to continue for the following years and therefore will demand higher wages to prevent a future fall in real income. The higher wages then push up production costs for firms and ultimately that forces producers to curb production, resulting in the inward shift of the SRAS curve.

The key concept to grasp is that adaptive expectations will mean you get a classic progression from A to B to C over a period of time. However, if agents possess rational expectations the change in prices will be anticipated and there will be a more immediate move from A to C without the emergence of a positive output gap.

A form of asymmetric information in which one side of the market has more information regarding the transaction of a product than the other side of the market. creating a form of market failure. The most commonly used example of adverse selection is the market for second-hand cars, in which sellers have superior knowledge of the true quality of the car over the car buyers. Creating a market with only low-quality cars.

However, there are also instances in which the buyers can have more information than the sellers. For instance, in the insurance market, buyers of insurance have superior information about their true health characteristics and future behaviour patterns than the insurance provider. This leads to the risk that an insurance product is more likely to attract high-risk than low-risk customers e.g. unhealthy people are more likely to take out health insurance policies.

This form of asymmetric information can only be removed if there are appropriate screening (health checks on the buyer of health insurance) or signalling (warranties on the second-hand cars to verify their quality) policies in place to correct the market failure.

 

An individual that has the express or implied authority to act on the behalf of another individual (principal) to help establish contractual relationships with another party e.g. estate agent, financial adviser, estate agent etc.

A key related concept is the principal agent problem. This highlights the inefficiencies that can arise when the objectives of an agent and principal are misaligned. 

The total demand for goods and services at any given price level over a given period of time (AD = C + I + G + X - M).

C = Consumption

I = Investment

G = Government Spending

X = Exports

M = Imports

The actual level of AD is analysed using the aggregate demand curve and measured via the real GDP expenditure method. This graph details the outcome in 2012: