AP Macroeconomics: Unit 1


The social science concerned with the efficient use of scarce resources to achieve the maximum satisfaction of economic wants

economic perspective

A viewpoint that envisions individuals and institutions making rational decisions by comparing the marginal benefits and marginal costs associated with their actions.

marginal analysis

Comparisons of marginal benefits & marginal costs

scientific method

The procedure for the systematic pursuit of knowledge involving the observation of facts and the formulation and teasing of hypotheses to obtain theories, principles and laws

theoretical economics

The process of deriving and applying economic theories and principles


Statements about economic behavior or the economy that enable prediction of the probable effects of certain actions


Statements of the nature of the relationship between two or more sets of facts.

other-things-equal assumption

The assumption that factors other than those being considered are held constant. Economists use this to construct their generalizations.

policy economics

The formulation of courses of action to bring about desired economic outcomes or to prevent undesired occurrences.


The sacrifice of some or all of one economic goal, good, or service to achieve some other goal, good, or service.


The part of economics concerned with the economy as a whole


A collection of specific economic units treated as if they were one unit.


The part of economics concerned with such individual units as industries, firms, and households and with individual markets, specific goods and services, and product and resource prices.

positive economics

The analysis of facts or data to establish scientific generalizations about economic behavior. Focuses on facts and cause-and-effect relationships

normative economics

The part of economics involving value judgments about what the economy should be like; focused on which economic goals and policies should be implemented; policy economics.

fallacy of composition

The false notion that what is true for the individual (or part) is necessarily true for the group (or whole).

after this, therefore because of this" fallacy

The false belief that when one event precedes another, the first event must have caused the second event.

economizing problem

The choices necessitated because society's economic wants for goods and services are unlimited but the resources available to satisfy these wants are limited (scarce).


The want-satisfying power of a good or service; the satisfaction or pleasure a consumer obtains from the consumption of a good or service.

economic resources

The land, labor , capital and entrepreneurial ability that are used in the production of goods and services; production agents; factors of production.


Natural resources ("free gifts of nature") used to produce goods and services


Human-made resources used to produce goods and services; goods that do not directly satisfy human wants; also called capital goods.


Spending for the production and accumulation of capital and additions to inventories.


People's physical and mental talents and efforts that are used to help produce goods and services

entrepreneurial ability

The human resource that combines the other resources to produce a product, makes nonroutine decisions, innovates, and bears risks.

factors of production

Economic resources: land, capital, labor, and entrepreneurial ability.

full employment

The use of all available resources to produce want-satisfying goods and services

full production

Employment of available resources so that the maximum amount of (or total value of) goods and services is produced; occurs when both productive efficiency and allocative efficiency are realized

productive efficiency

The production of a good or service in the least costly way

allocative efficiency

The production of that particular mix of goods and services most wanted by society; the output of each product at which its marginal cost and marginal benefit are equal.

consumer goods

Products and services that satisfy human wants directly.

capital goods

Human-made resources used to produce goods and services; goods that do not directly satisfy human wants; also called capital.

production possibilities table

Lists of different combinations of two products that can be produced with a specific set of resources (and with full employment and productive efficiency)

production possibilities curve

Shows the different combinations of two goods or services that can be produced in a full-employment, full-production economy where the available supplies of resources and technology are fixed.

opportunity cost

The amount of other products that must be forgone or sacrificed to produce a unit of a product.

law of increasing opportunity costs

The principle that as the production of a good increases, the opportunity cost of producing an additional unit rises.

economic growth

An outward shift in the production possibilities curve that results from an increase in resource supplies or quality or an improvement in technology

economic system

A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem; a method of organizing an economy, such as market and command

market system

All the product and resource markets of a market economy and the relationships among them; a method that allows the prices determined in those markets to allocate the economy's scarce resources and to communicate and coordinate the decisions made by consu


An economic system in which property resources are privately owned and markets and prices are used to direct and coordinate economic activities.

command system

A method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; command economy.

resource market

A market in which households sell and firms buy resources or the services of resources.

product market

A market in which products are sold by firms and bought by households.

circular flow model

The flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firms to households and from households to firms.


Any institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of a particular good or service.


A schedule or a curve that shows the various amounts of a product (/resource) that consumers (/businesses) are willing and able to purchase at each of a series of possible prices during a specified period of time.

law of demand

The principal that, other things equal, an increase in a product's price will reduce the quantity of it demanded, and conversely for a decrease in price.

diminishing marginal utility

Each buyer of a product will derive less satisfaction ( or benefit, or utility) from each successive unit of the product consumed.

income effect

A change in the quantity demanded of a product that results from the change in real income (purchasing power) produced by a change in the product's price.

substitution effect

Suggests that at a lower price, buyers have the incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive.

demand curve

A curve demonstrating demand (its downward slope reflects the law of demand- the inverse relationship between price and quantity)

determinants of demand

Factors other than price that determine the quantities demanded of a good or service.

normal goods

A good or service whose consumption increases when income increases and falls when income decreases, price remaining constant

inferior goods

A good or service whose consumption declines as income rises (and conversely), price remaining constant.

substitute good

Products or services that can be used in place of each other. When the price of one falls, the demand for the other product falls; conversely, when the price of one product rises, the demand for the other product rises.

complementary good

Products and services that are used together. When the price of one falls, the demand for the other increases (and conversely).

change in demand

A shift of the entire demand curve to the left (a decrease in demand) or right (an increase in demand).

change in quantity demanded

A movement from one point to another point- from one price-quantity combination to another- on a fixed demand schedule or demand curve.


The amount of a good or service that sellers will offer at various prices during some period.

law of supply

The principle that, other things equal, an increase in the price of a product will increase the quantity of it supplied, and conversely for a price decrease.

supply curve

A curve illustrating supply.

determinants of supply

Resource prices, technology, taxes and subsidies, prices of other goods, price expectations and the number of sellers in the market.

change in supply

A change in the quantity supplied of a good or service at every price; a shift of the supply curve to the left or right.

change in quantity supplied

A movement from one point to another on a fixed supply curve. The cause of this is a change in the price of the specific product being considered.


The amount by which the quantity supplied of a product exceeds the quantity demanded at a specific (above-equilibrium) price.


The amount by which the quantity demanded of a product exceeds the quantity supplied at a particular (below-equilibrium) price.

equilibrium price

The price in a competitive market at which the quantity demanded and the quantity supplied are equal, there is neither a shortage nor a surplus, and there is no tendency for price to rise or fall.

equilibrium quantity

1. The quantity demanded and supplied at the equilibrium price in a competitive market.
2. The profit-maximizing output of a firm

rationing function of prices

The ability of market forces in competitive markets to equalize quantity demanded and quantity supplied and to eliminate shortage and surpluses via changes in prices.

private property

The right of private persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital and other property.

freedom of enterprise

The freedom of firms to obtain economic resources, to use those resources to produce products of the firm's own choosing, and to sell their products in markets of their choice.

freedom of choice

The freedom of owners of property resources to employ or dispose of them as they see fit, of workers to enter any line of work for which they are qualified, and of consumers to spend their incomes in a manner that they think is appropriate.


That which each firm, property owner, worker, and consumer believes is best for itself and seeks to obtain.


The presence in a market of independent buyers and sellers competing with one another and the freedom of buyers and sellers to enter and leave the market.

roundabout production

The construction and use of capital to aid in the production of consumer goods.


The use of the resources of an individual, a firm, a region, or a nation to concentrate production on one or a small number of goods and services.

division of labor

The separation of the work required to produce a product into a number of different tasks that are performed by different workers; specialization of workers.

medium of exchange

Any item sellers generally accept and buyers generally use to pay for a good or service


The exchange of one good or service for another good or service.


Any item that is generally acceptable to sellers in exchange for goods and services.

Four Fundamental Questions

1. what to produce
2. how to produce it
3. how to divide the total output
4. how to ensure economic flexibility.

economic costs

A payment that must be made to obtain and retain the services of a resource; the income a firm must provide to a resource supplier to attract the resource away from an alternative use; equal to the quantity of other products that cannot be produced when r

normal profit

The payments for (cost of) the entrepreneur's contributions.

economic profit

The total revenue of a firm less its total costs.

expanding industry

An industry whose firms earn economic profits and for which an increase in output occurs as new firms enter the industry.

declining industry

An industry in which economic profits are negative (losses are incurred) and that will, therefore, decrease its output as firms leave it.

consumer sovereignty

Determination by consumers of the types and quantities of goods and services that will be produced with the scarce resources of the economy; consumers' direction of production through their dollar votes.

dollar votes

The "votes" that consumers and entrepreneurs cast for the production of consumer and capital goods, respectively, when they purchase those goods in product and resource markets.

derived demand

The demand for a resource that depends on the demand for the producers it helps to produce.

guiding function of prices

The ability of price changes to bring about changes in the quantities of products and resources demanded and supplied.

creative destruction

The creation of new products and production methods completely destroys the market positions of firms that are wedded to existing products and older ways of doing business.

invisible hand

The tendency of firms and resource suppliers that seek to further their own self-interests in competitive markets to also promote the interest of society.

Functional Distribution of Income

the division of national income into wage and salaries, proprietors' income, corporate profits, interest and rent.

Personal Distribution of Income

The manner in which the economy's personal or disposable income is divided among different income classes or different households or families.

Durable good

A consumer good with an expected life (use) of 3 or more years

Nondurable Good

A consumer good with an expected life (use) of less than 3 years


An (intangible) act or use for which a consumer, firm, or government is willing to pay.


A physical establishment that performs one or more functions in the production, fabrication, and distribution of goods and services.


An organization that employs resources to produce a good or service for profit and owns and operates one or more plants.


A group of (one or more) firms that produce identical or similar products

Sole Proprietorship

An unincorporated firm owned and operated by one person


An unincorporated firm owned an operated by two or more persons


A legal entity ("person") chartered by a state or the Federal government that is distinct and separate from the individuals who own it.


An ownership share in a corporation


A financial device through which a borrower ( a firm or government) is obligated to pay the principal and interest on a loan at a specific date in the future.

Limited liability company

An unincorporated business whose owners are protected by limited liability

Double taxation

The taxation of both corporate net income (profits) and the dividends paid from this net income when they become the personal income of households.

Principal-Agent Problem

A conflict of interest that occurs when agents (workers or managers) pursue their own objectives to the detriment of the principals' (stockholders') goals.


A market structure in which the number of sellers is so small that each seller is able to influence the total supply and the price of the good or service.

Spillover benefit

A benefit obtained without compensation by third parties from the production or consumption of sellers or buyers. Example: a beekeeper benefits when a neighboring farmer plants clover

Spillover cost

A cost imposed without compensation on third parties by the production or consumption of sellers or buyers. Example: A manufacturer dumps toxic chemicals into a river, killing the fish sought by sport fishers.

Exclusion principle

The ability to exclude those who do not pay for a product from receiving its benefits

Public good

A good or service that is indivisible and to which the exclusion principle does not apply; a good or service with these characteristics provided by government.

Free-rider problem

The inability of potential providers of an economically desirable but indivisible good or service to obtain payment from those who benefit, because the exclusion principle is not applicable.

Quasi-public good

A good or service to which the exclusion principle could apply but that has such a large spillover benefit that government sponsors its production to prevent an underallocation of resources.

Government Purchases

Expenditures by government for goods and services that government consumes in providing public goods and for public (or social) capital that has a long lifetime; the expenditures of all governments in the economy for those final goods and services.

Transfer payment

A payment of money (or goods and services) by a government to a household or firm for which the payer receives no good or service directly in return.

Personal income tax

A tax levied on the taxable income of individuals, households, and unincorporated firms

Marginal tax rate

The tax rate paid on each additional dollar of income

Average tax rate

Total tax paid divided by total (taxable) income, as a percentage

Payroll Tax

A tax levied on employers of labor equal to a percentage of all or part of the wages and salaries paid by them and on employees equal to a percentage of all or part of the wages and salaries received by them.

Excise tax

A tax levied on the production of a specific product or on the quantity of the product purchased

Sales tax

A tax levied on the cost (at retail) of a broad group of products

Property tax

A tax on the value of property (capital, land, stocks and bonds, and other assets) owned by firms and households

Fiscal federalism

The system of transfers (grants) by which the Federal government shares its revenues with state and local governments

Multinational corporations

Firms that own production facilities in two or more countries and produce and sell their products globally

Comparative advantage

A lower relative or comparative cost than that of another producer

Terms of trade

The rate at which units of one product can be exchanged for units of another product; the price of a good or service; the amount of one good or service that must be given up to obtain 1 unit of another good or service

Foreign exchange market

A market in which the money (currency) of one nation can be used to purchase (can be exchanged for) the money of another nation.

Exchange rate

The rate of exchange of one nation's currency for another nation's currency


An estimate of the amount of capital worn out or used up (consumed) in producing the gross domestic product


An increase in the value of the dollar relative to the currency of another nation, so a dollar buys a larger amount of the foreign currency ad thus of foreign goods.

Protective tariff

A tariff designed to shield domestic producers of a good or service from the competition of foreign producers

Import quota

A limit imposed by a nation on the quantity (or total value) of a good that may be imported during some period of time.

Nontariff barriers

All barriers other than protective tariffs that nations put in place to impede international trade, including import quotas, licensing requirements, unreasonable product-quality standards, unnecessary bureaucratic detail in customs procedures and so on.

Export subsidies

Government payments to domestic producers to enable them to reduce the price of a good or service to foreign buyers.

Smoot-Hawley Tariff Act

Legislation passed in 1930 that established very high tariffs. Its objective was to reduce imports and stimulate the domestic economy, but it resulted only in retaliatory tariffs by other nations.

Reciprocal Trade Agreements Act

A 1934 Federal law that authorized the president to negotiate up to 50 percent lower tariffs with foreign nations that agreed to reduce their tariffs on U.S. goods

Most - favored- nation clause

An agreement by the United States to allow some other nation's exports into the United States at the lowest tariff level levied by the United States, then or at any later time.

General Agreement on Tariffs and Trade (GATT)

The international agreement reached in 1947 in which 23 nations agreed to give equal and nondiscriminatory treatment to one another, to reduce tariff rates by multinational negotiations, and to eliminate import quotas. It now includes most nations and has

World Trade Organization (WTO)

An organization established in 1994 to replace GATT to oversee the provisions of the Uruguay Round and resolve any disputes stemming from it.

European Union (EU)

An association of 15 European nation that has eliminated tariffs and import quotas among them, established common tariffs for goods imported from outside the member nations, allowed the free movement of labor and capital among them, and created other comm

Trade block

A group of nations that lower or abolish trade barriers among members. Examples include the European Union and the nations of the North American Free Trade Agreement

North American Free Trade Agreement (NAFTA)

A 1993 agreement establishing, over a 15-year period, a free-trade zone composed of Canada, Mexico, and the United States