Basic Economic Concepts: every key term you need (+ practice quiz)

More AP Macroeconomics guides

• Supply, Demand, Elasticity
• National Income & Price
• Financial Sector
• Long-Run Growth

Macroeconomics Definition

Study of entire economy: aggregate output, employment, price levels, international trade. Focuses on big picture, not individual markets.

Microeconomics vs Macroeconomics

Micro: individual consumers, firms, markets. Macro: national/global economy, GDP, unemployment, inflation, growth.

Production Possibilities Curve (PPC)

Shows maximum production combos of two goods with given resources. Curved = increasing opportunity cost. Shift = growth or resource change.

Opportunity Cost

What you give up to get something else. For economy: producing more of good A means producing less of good B.

Efficiency vs Inefficiency

Point ON PPC = efficient (max output). Point inside PPC = inefficient (wasted resources). Can't produce beyond PPC.

Comparative Advantage

Country has comparative advantage if lower opportunity cost to produce good. Differs from absolute advantage (higher productivity).

Specialization & Trade

Countries specialize in products where they have comparative advantage, trade for others. Both benefit relative to autarky.

Economic Growth

Outward shift of PPC; increases maximum production capability. Driven by: capital accumulation, technological progress, labor growth, resources.

GDP (Gross Domestic Product)

Market value of all final goods/services produced within country in given period. Measures economic output/growth.

GDP vs GNP

GDP: produced within country (geography-based). GNP: produced by country's citizens (citizenship-based). GDP used in US.

Nominal vs Real GDP

Nominal: current prices. Real: adjusted for inflation (constant dollars). Real GDP shows true growth, accounting for price changes.

Business Cycles

Expansion (growth), peak (maximum), recession (decline ≥2 quarters), trough (minimum). Cycle repeats; differs in length/severity.

Unemployment Rate

Percentage of labor force unemployed. Labor force = employed + unemployed (exclude: children, retirees, students, institutionalized).

Types of Unemployment

Frictional: job searching. Structural: skills mismatch. Cyclical: due to recession. Natural rate: frictional + structural.

Inflation Definition

Increase in average price level of goods/services. Measured by CPI (Consumer Price Index). 2-3% annual inflation considered normal.

Deflation vs Stagflation

Deflation: declining prices (rare, problematic). Stagflation: inflation + stagnation (high inflation + unemployment).

Unit 1 Summary

Macroeconomics studies national output (GDP), employment, prices, growth. Opportunity cost drives specialization/trade. Business cycles characterize economic fluctuations.

Terms of Trade

The exchange rate between two goods that both trading partners accept. Mutually beneficial trade requires the ratio to fall strictly between the two countries' opportunity costs.

Output per Unit of Input

An output-based productivity table: the country producing more of a good per worker has the absolute advantage. Comparative advantage still requires computing opportunity cost ratios.

Input per Unit of Output

An input-based table (hours per unit) inverts the reading: fewer hours per unit means absolute advantage, and opportunity cost is the ratio of hours, not output.

Constant Opportunity Cost

A straight-line PPC. Resources are perfectly adaptable between the two goods, so the trade-off ratio never changes as production shifts.

Bowed-Out PPC Logic

Resources are specialized, so shifting them to a good they suit poorly costs ever more of the other good. This produces increasing opportunity cost and a concave curve.

Capital Goods and Future PPC

Choosing a point with more capital goods and fewer consumer goods today shifts the whole PPC outward faster in the future. It is an intertemporal trade-off.

Partial PPC Shift

A technology gain in only one industry rotates the PPC outward along that good's axis while the other intercept stays fixed.

Marginal Analysis Rule

Rational actors expand an activity while marginal benefit exceeds marginal cost and stop where MB = MC. Sunk costs are irrelevant to this comparison.

Allocative vs Productive Efficiency

Productive efficiency is any point on the PPC; allocative efficiency is the single point on the PPC that best matches society's preferences.

Circular Flow: Factor Market

Households sell land, labor, capital, and entrepreneurship to firms, receiving rent, wages, interest, and profit in return.

Circular Flow: Product Market

Firms sell finished goods and services to households; the money flow runs opposite to the physical flow of goods.

Leakages and Injections

Leakages (saving, taxes, imports) drain the circular flow; injections (investment, government spending, exports) refill it. Equilibrium requires them to be equal.

Discouraged Workers

People who want work but stopped searching. They leave the labor force, so the measured unemployment rate falls even though joblessness has not improved.

Underemployment

Part-time workers wanting full-time work and workers in jobs far below their skill level count as fully employed, so the official rate understates labor market slack.

Labor Force Participation Rate

Labor force divided by the working-age population, times 100. It falls when people retire, return to school, or become discouraged.

Full Employment Output

The real GDP produced when cyclical unemployment is zero and only frictional plus structural unemployment remain. Also called potential output or Y-sub-f.

Substitution Bias in the CPI

Because the CPI basket is fixed, it ignores consumers switching away from goods whose prices rose. This makes the CPI overstate the true cost-of-living increase.

CPI vs GDP Deflator

CPI covers a fixed basket of consumer goods including imports; the deflator covers all domestically produced output with current-year weights.

Rule of 70

Years to double a quantity is approximately 70 divided by the annual percent growth rate. At 3.5 percent growth, real GDP doubles in about 20 years.

Nominal vs Real Interest Rate

Fisher relationship: real rate is approximately nominal rate minus inflation rate. Unexpected inflation lowers the realized real rate.

Winners and Losers from Inflation

Unanticipated inflation helps fixed-rate borrowers and hurts lenders and people on fixed nominal incomes, because dollars repaid buy less.

COLA Indexing

Cost-of-living adjustments tie wages or benefits to the CPI, protecting real purchasing power from anticipated inflation but not from measurement bias.

Menu Costs and Shoe-Leather Costs

Menu costs are the real resources spent repricing goods; shoe-leather costs are the effort of holding less cash during inflation. Both are efficiency losses.

GDP Omissions

GDP excludes household production, volunteer work, and the underground economy, and ignores leisure, pollution, and income distribution.