Section I.B.2. Economics Flashcards
1
Q
Marginal utility
A
- Concept that value increases for each unit of consumption up to a point at which value begins decreasing for each additional unit consumed
2
Q
Austrian school of economic thought
A
- This school is similar to neoclassical but considers the role of the money supply and government actions
- Government intervention may cause a boom-and-bust cycle
- Friedrich (F.A.) Hayek a pioneer of Austrian economic theory
3
Q
John Maynard Keynes
A
- A British economist known for his work in macroeconomic theory and business cycles
- Refuted neoclassical economics theories that suggested free market forces would effectively correct or manage swings in cycles and unemployment
- Recommended government intervention during recessions and short-term economic disruptions
- Keynesian economic theory suggests that in the short-run, economic productivity is highly impacted by aggregate demand (spending) and this demand is not equal to the capacity of an economy. Especially in times of recession, the economy is influenced by myriad factors that can cause economic and financial disruptions. Hence, government intervention is necessary to correct these short-run inefficiencies.
4
Q
Milton Freidman
A
- A U.S. economist, statistician, and scholar who taught at the University of Chicago
- Known for his work on monetary policy
- Won the Nobel Prize in Economics in 1976
- Opposed Keynesian theories, supported “monetarism”, and opposed the creation of the Federal Reserve
- Believed in letting free markets operate with minimal intervention from the government and that small, incremental expansion of the money supply was optimal
5
Q
Monetarism
A
- Monetarists contend that inflation is a function of how much money a government prints
- Advocate for a steady increase in the money supply and a limited role of government
- Those following the monetarist school of thought object to the Keynesian approach because Keynesian theory:
1.) does not consider the role of the money supply
2.) is not logical in light of utility-maximizing market participants
3.) ignores the long-term cost of government intervention
4.) does not consider the unpredictability of the timing of fiscal policy changes on the economy
6
Q
Elasticities
A
- Elasticity (for purposes of this module) is the measurement of how demand changes based on incremental changes in price
- Price elasticity of demand can be calculated in this way: the ratio of change (in percentage) in the quantity to the percentage change in price
- Substitute goods are similar, comparable goods that may satisfy consumer demand if prices rise
- Complimentary goods add value to the consumer when used in tandem (these range from strong to weak)
- Price elasticity of demand = % change in quantity demanded / % change in price
7
Q
Micro-economic theory
A
- The study of the actions of individual consumers and businesses as it pertains to buying, selling, and the prices paid for goods and services
- The utility function is a core component of micro-economic theory
8
Q
Macro-economic theory
A
- The study of National and global economies and their interactions with each other
- Gross domestic product, interest rates, trade surplus or deficit, currency exchange, and other key data are analyzed
9
Q
Fiscal policy
A
- Actions taken by government to manage the economy primarily through tax policy and government spending
- Attempt to manage or control unemployment, inflation, and business cycles
- Demand-side policy
- The impact of a government’s fiscal policy can be seen in a number of different ways including personal consumption (spending) and saving, debt levels, business investment, exchange rates, etc.
- Expansionary fiscal policy (e.g., tax reduction, government spending on infrastructure and capital projects, etc.) is often used to encourage growth and risk-taking
- Contractionary fiscal policy (e.g., tax increases, government budget cuts, etc.) is often used to slow down growth to avoid excess inflation or bubbles
10
Q
Monetary policy
A
- Actions, usually taken by a central bank, that seek to manage the economy through determining interest rates and the money supply
- Demand-side policy
- Core objectives are to maximize employment, promotes stable growth, and maintain acceptable levels of inflation
Central banks enact monetary policy by controlling the money supply through open market operations, setting the discount rate and reserve requirements
11
Q
Supply-side policies
A
- Goal: to create and environment in which workers and owners of capital have the maximum incentive and ability to produce and develop goods
- Supply-spiders focus on how tax policy can be used to improve incentives to work and invest
12
Q
Central bank
A
- A governmental or quasi-governmental entity responsible for overseeing a country’s monetary system
- Goals may include controlling inflation, stabilizing the local currency, and maintaining full employment
- Activities may include issuing currency, regulating credit, bank oversight, serve banking needs of government, act as a lender of last resort, and manage exchange reserves
13
Q
Yield spreads
A
- The difference in yield percentage between two debt instruments or categories of debt
14
Q
Yield curve
A
- Graphical illustration of the relationship between yields and maturities
- A normal yield curve is upward sloping due to higher yields for longer maturities
- Information on expected future short-term rates can be implied from the yield curve
- Expectations of a rise in short-term rates and an increase in the liquidity premium are examples of situations likely leading to an increase in the yield curve
- A flat or inverted yield curve may indicate a recession is forthcoming (there is historical evidence to support this theory, but recession is not a certain outcome)
15
Q
Impact of leverage on profitability
A
- Operating leverage refers to the sensitivity of a company’s profits to changes in revenue. The higher the fixed costs relative to variable costs that a company must meet regardless of sales, the larger the impact that a decline in revenue will have on income. These fixed costs include, but are not limited to, debt payments.
- In general, operating margin is earnings before interest and taxes as a portion of sales. The changes in one relative change to the other measures the amount of operating leverage.
- Thus, when the economy is shrinking and sales for a company are decreasing, those companies with more operational leverage, often see a greater negative impact on margins (profits). More simply put, revenue is decreasing while fixed operational expenses remain flat (do not decrease), therefore profits go down.
- This is a simplistic example but similar to the kind of business cycle concept and application question you might see on the exam
16
Q
Cyclical industries
A
- Above-average sensitivity to the state of the economy
- Examples include producers of consumer durables (e.g., autos) and capital goods (i.e., goods used by other firms to produce their own products)
- High betas
