Economics For Dummies®, 2nd Edition Visit www.dummies.com/cheatsheet/economics to view this book's cheat sheet Table of Contents Introduction About This Book Conventions Used in This Book What You’re Not to Read Foolish Assumptions How This Book Is Organized Part I: Economics: The Science of How People Deal with Scarcity Part II: Microeconomics: The Theories of Consumer and Firm Behavior Part III: Applying the Theories of Microeconomics Part IV: Macroeconomics: The Science of Economic Growth and Stability Part V: The Part of Tens Icons Used in This Book Where to Go from Here Part I: Economics: The Science of How People Deal with Scarcity Chapter 1: Discovering What Economics Is and Why You Should Care Considering a Little Economic History Pondering just how nasty, brutish, and short life used to be Identifying the institutions that raise living standards Looking toward the future Framing Economics as the Science of Scarcity Sending Microeconomics and Macroeconomics to Separate Corners Getting up close and personal: Microeconomics Zooming out: Macroeconomics and the big picture Understanding How Economists Use Models and Graphs Introducing your first model: The demand curve Drawing your own demand curve Chapter 2: Cookies or Ice Cream? Exploring Consumer Choices Describing Human Behavior with a Choice Model Pursuing Personal Happiness Using utility to measure happiness Taking “selfless” actions into account Noting how self-interest can promote the common good You Can’t Have Everything: Examining Limitations Resource constraints Technology constraints Time constraints Opportunity cost: The unavoidable cost Making Your Choice: Deciding What and How Much You Want Exploring Violations and Limitations of the Economist’s Choice Model Understanding uninformed decision-making Making sense of irrationality Chapter 3: Producing the Right Stuff the Right Way to Maximize Human Happiness Figuring Out What’s Possible to Produce Classifying resources Diminishing returns: Getting less of a good thing A little here, a little there: Allocating resources Graphing your production possibilities Reaching new frontiers with better technology Deciding What to Produce Comparing market results and government interventions Opting for a mixed economy Promoting Technology and Innovation Part II: Microeconomics: The Theories of Consumer and Firm Behavior Chapter 4: Supply and Demand Made Easy Deconstructing Demand Prices and other stuff: Looking at what affects quantity demanded Graphing the demand curve Opportunity costs: Setting the slope of the demand curve Elasticity: Looking at extreme demand cases Sorting Out Supply Graphing the supply curve Using elasticity to understand extreme supply cases Bringing Supply and Demand Together Market equilibrium: Seeking a balance Demonstrating the stability of the market equilibrium Adjusting to new market equilibriums when supply or demand changes Price Controls: Keeping Prices Away from Market Equilibrium Setting upper limits with price ceilings Propping up prices with price floors Chapter 5: Getting to Know Homo Economicus, the Utility-Maximizing Consumer Constrained Optimization: Getting the Most Happiness for Your Money Choosing by Ranking Getting Less from More: Diminishing Marginal Utility Choosing Among Many Options When Facing a Limited Budget Trying to buy as much (marginal) utility as you can Purchasing the best combination of two goods to maximize total utility Aiming for equal marginal utility per dollar Deriving Demand Curves from Diminishing Marginal Utility Seeing how price changes affect quantities demanded Graphing the price and quantity changes to form a demand curve Chapter 6: The Core of Capitalism: The Profit-Maximizing Firm A Firm’s Goal: Maximizing Profits Facing Competition Listing the requirements for perfect competition Taking prices but setting quantities Distinguishing between accounting profits and economic profits Analyzing a Firm’s Cost Structure Focusing on costs per unit of output Examining average variable costs Watching average fixed costs fall Tracking the movement of average total costs Focusing on marginal costs Noticing where marginal cost equals average cost Comparing Marginal Revenues with Marginal Costs Finding where marginal revenue equals marginal cost Visualizing profits Visualizing losses Pulling the Plug: When Producing Nothing Is Your Best Bet Distinguishing between the short run and the long run in microeconomics The short-run shutdown condition: Variable costs exceed total revenues The long-run shutdown condition: Total costs exceed total revenues Chapter 7: Why Economists Love Free Markets and Competition Ensuring That Benefits Exceed Costs: Competitive Free Markets Examining the traits of a properly functioning market Analyzing the efficiency of free markets Measuring everyone’s gains with total surplus When Free Markets Lose Their Freedom: Dealing with Deadweight Losses Coming up short: The deadweight loss from a price ceiling Death and taxes: Finding the deadweight loss of a tax Hallmarks of Perfect Competition: Zero Profits and Lowest Possible Costs Understanding the causes and consequences of perfect competition Peering into the process of perfect competition Graphing how profits guide firm entry and exit Chapter 8: Monopolies: How Badly Would You Behave If You Had No Competition? Examining Profit-Maximizing Monopolies Zeroing in on the problems monopolies cause Identifying the source of the problem: Decreasing marginal revenues Choosing an output level to maximize profits Comparing Monopolies with Competitive Firms Looking at output and price levels Deadweight losses: Quantifying the harm caused by monopolies Losing efficiency Considering Examples of Good Monopolies Encouraging innovation and investment with patents Reducing annoyingly redundant competitors Keeping costs low with natural monopolies Regulating Monopolies Subsidizing a monopoly to increase output Imposing minimum output requirements Regulating monopoly pricing Breaking up a monopoly into several competing firms Chapter 9: Oligopoly and Monopolistic Competition: Middle Grounds Oligopolies: Looking at the Allure of Joining Forces Sharing power over prices Cartel behavior: Trying to imitate monopolists Noting the criteria for coordinating a cartel Understanding Incentives to Cheat the Cartel Fleshing out the Prisoner’s Dilemma Enforcing the agreement: Resolving the dilemma with credible threats Seeing that OPEC is trapped in a Prisoner’s Dilemma Using an enforcer to help OPEC members stick to quotas Regulating Oligopolies Breaking up dominant firms Attempting to apply antitrust laws Studying a Hybrid: Monopolistic Competition Benefiting from product differentiation Facing profit limits Part III: Applying the Theories of Microeconomics Chapter 10: Property Rights and Wrongs Allowing Markets to Reach Socially Optimal Outcomes Examining Externalities: The Costs and Benefits Others Feel from Your Actions Noting the effects of negative externalities Accepting positive amounts of negative externalities Dealing with negative externalities Calculating the consequences of positive externalities Subsidizing things that provide positive externalities Tragedy of the Commons: Overexploiting Commonly Owned Resources Having a cow: Overgrazing on a commonly owned field Sleeping with the fishes: Extinctions caused by poor property rights Avoiding the tragedy Chapter 11: Market Failure: Asymmetric Information and Public Goods Facing Up to Asymmetric Information Realizing that asymmetric information limits trade Souring on the lemons problem: The used car market Issuing insurance when you can’t tell individuals apart Providing Public Goods Taxing to provide public goods Enlisting philanthropy to provide public goods Providing a public good by selling a related private good Ranking new technology as a public good Chapter 12: Taking the Pulse of Health Economics and Finance Defining Health Economics and Health Finance Noting the Limits of Health Insurance Adverse selection: Looking at who buys insurance Combating adverse selection Comparing Healthcare Internationally Inflated Demand: Suffering from “Free” and Reduced-Cost Healthcare Diverting funds to lower-value uses Rationing healthcare Facing shortages and higher prices Trying to combat inefficiency with bureaucracy Investigating Singapore’s Secrets Exploring cost-saving features Weighing costs and benefits of medical procedures Supporting cost-cutting innovations Trying to copy Singapore’s success Part IV: Macroeconomics: The Science of Economic Growth and Stability Chapter 13: Measuring the Macroeconomy: How Economists Keep Track of Everything Getting a Grip on the GDP (and All Its Parts) Leaving some things out of GDP Tallying up what counts in GDP Accounting for the tides of incomes and assets Following the funds, around and around Counting stuff when it’s made, not when it’s sold Watching GDP rise with the good, the bad, and the ugly Diving In to the GDP Equation “C” is for consumption (that’s good enough for me!) “I” is for investment in capital stock The big “G” (government, that is) Measuring foreign trade with “NX” Making Sense of International Trade and Its Effect on the Economy “Trade deficit” ain’t fightin’ words Considering assets — not just cash Wielding a comparative advantage Chapter 14: Inflation Frustration: Why More Money Isn’t Always a Good Thing Buying an Inflation: When Too Much Money Is a Bad Thing Balancing money supply and demand Giving in to the inflation temptation Tallying up the effects of inflation Measuring Inflation Creating your very own market basket Calculating the inflation rate Setting up a price index Determining the real standard of living with the price index Identifying price index problems Pricing the Future: Nominal and Real Interest Rates Using the Fisher equation Realizing that predictions aren’t perfect Chapter 15: Understanding Why Recessions Happen Introducing the Business Cycle Striving for Full-Employment Output Returning to Y*: The Natural Result of Price Adjustments Responding to Economic Shocks: Short-Run and Long-Run Effects Defining some critical terms The tao of P: Looking at price adjustments in the long run A shock to the system: Adjusting to a shift in aggregate demand Dealing with fixed prices in the short run Putting together the long and short of it Heading toward Recession: Getting Stuck with Sticky Prices Cutting wages or cutting workers Adding up the costs of wages and profits Returning to Y* with and without government intervention Achieving Equilibrium with Sticky Prices: The Keynesian Model Adjusting inventories instead of prices Boosting GDP in the Keynesian model Chapter 16: Fighting Recessions with Monetary and Fiscal Policy Stimulating Demand to End Recessions Aiming for full-employment output Back to work: Shifting the AD curve to the right Generating Inflation: The Risk of Too Much Stimulation Weak Property Rights Cause All Environmental Problems Environmental problems stem from poorly defined or nonexistent property rights that allow polluters to ignore the costs that they impose on others Therefore, economists favor the creation and enforcement of property rights systems that force people to take all costs into account People always need to some polluting After all, even if you don’t want gas-guzzling SUVs causing lots of pollution, you probably still want ambulances and fire trucks to operate even though they, too, pollute the environment The difference is that the benefits to society outweigh the costs of pollution in the case of the emergency vehicles As I discuss in Chapter 10, strong property rights are the key to ensuring that people weigh the complete costs and benefits of causing pollution Property rights force people to take into account not only personal costs but also the costs that their actions impose on others International Trade Is a Good Thing Opening your country to international trade means opening your country to new ideas and innovations Competition causes local businesses to innovate to match the best offerings of companies from around the world Throughout history, the richest and most dynamic societies have been the ones open to international trade Of course, what economists have in mind when they think of the benefits of international trade is free trade, where companies compete across borders to provide people with the best goods and services at the lowest prices Economists strongly condemn the government subsidies and trade restrictions that impede free trade and that try to rig the game in one country’s favor Government Can Provide Public Goods Economists view the existence of public goods as one of the most important justifications for government intervention in the economy Although private philanthropy can provide some public goods, many are so expensive that they can be provided only if the government uses taxes to fund them Consequently, public goods are typically government-provided Private firms can provide goods and services only if they can at least break even doing so To break even (or make a profit), whatever a firm is selling has to be excludable, which means that only those paying for the good or service receive it As I explain in Chapter 11, some goods and services are not excludable For instance, a lighthouse provides warning services to all ships in the vicinity regardless of whether the ships’ captains pay the lighthouse keeper The private lighthouse quickly goes bankrupt because only a few captains are fair-minded enough to pay for the service Goods and services that are not excludable are called public goods because they’re essentially open to the public and can’t be kept private Because private firms can’t make a profit producing public goods, you typically need governments to provide them Unlike private firms, governments can force people to pay for public goods Governments this by levying taxes and using the tax revenues to pay for public goods, such as national defense, police departments, lighthouses, public fireworks displays, basic scientific research, and so on Preventing Inflation Is Easy High rates of inflation are caused by the government’s increasing the money supply too rapidly A growing economy always has a growing demand for money because with more stuff to buy, you need more money with which to buy it If you want to keep the overall level of prices constant, the correct response is to increase the money supply at the same rate that demand is increasing If the supply of money increases faster than the demand, the value of money falls, creating an inflation In other words, you need more money to buy the same amount of stuff as before, so prices go up The way to prevent an inflation is to make sure that the government increases the money supply at the same rate that the demand for money increases Modern central banks such as the Federal Reserve Bank in the United States can this quite easily, so there’s no excuse for high rates of inflation Chapter 20 Ten Great Ways to Become Informed about Economic Issues In This Chapter Locating good publications related to economics Tracking down cutting-edge economic research Gaining personal experience with the problems and pitfalls facing entrepreneurs Uncovering government economic data In this chapter, I list ten strategies you can pursue to become a better economist Some expose you to the best of current policy debates and research, and others send you off to get first-hand experience with being an entrepreneur, facing down city hall, or investigating the mountains of data published by the government Sort Through the Popular Press Some popular publications not only keep you well-informed about current events but also help you interpret those events from an economic paradigm Among English-language publications, The Economist magazine, The Wall Street Journal newspaper, and The Financial Times newspaper all tend to present the news in terms of choices with trade-offs rather than as moral dilemmas with either-or policy prescriptions Peruse Economics Blogs Economics blogs allow you to get opinions and commentary directly from experts To find some worthwhile blogs, search online for “best economics blogs” and click through your options Several prominent blogs and bloggers are Marginal Revolution, The Money Illusion, EconBrowser, Free Exchange, Economist’s View, Paul Krugman, Megan McArdle, and Greg Mankiw Absorb Think-Tank Policy Papers The past few decades have seen the rise of numerous private think tanks These think tanks pay full-time salaries to experts to come up with better public policies Many think tanks have a strong political bent, so when you read their policy papers, understand that they’re most likely part of an ongoing debate and not necessarily the whole truth Nevertheless, the truth lies out there someplace Consider visiting the Web sites of think tanks such as The American Enterprise Institute, The Brookings Institution, The Cato Foundation, The Urban Institute, The Centre for European Studies, The Center for Economic and Policy Research, The Economic Policy Institute, The Heritage Foundation, The Center for American Progress, and the Hoover Institution Review the Latest Research Cutting-edge economic research is produced by PhDs for PhDs and often contains a lot of difficult math and statistics But in most cases, nonexperts can easily understand the abstracts, introductions, and conclusion sections I highly recommend that you look into cutting-edge research — you’ll find that economists are hard at work on an incredibly diverse and fascinating array of topics, many of which will interest you personally One great source for the latest research is VoxEU (www.voxeu.org), which has summaries of current research written for the average person Another great resource is the working papers listed at the National Bureau of Economic Research (www.nber.org) And if you really want cutting edge, try New Economic Papers (http://nep.repec.org), where virtually all new economics working papers written in English are organized by topic Investigate Entrepreneurship A great way to discover the challenges of entrepreneurship is to suppose that you’re trying to open up a specific type of business — say, a wine bar Going down to City Hall and looking into the various health permits, safety permits, and business licenses that you’d need for that specific type of business is very illuminating, as is investigating how easily you’d be able to find and hire good employees Then consider how you may fund your business What terms does your local bank demand on small business loans? Could you borrow the money you would need from friends and family? And would you be willing to risk your own money on the venture? Talk to All Stakeholders Modern economies are mixed economies, meaning that production and distribution are regulated by a combination of market forces and government regulations Adding to the mix are labor unions and consumer advocacy groups that attempt to influence what gets made, how it gets made, and how the benefits are distributed An interesting exercise is to go to a large factory and talk to its managers, its workers, and — if they’re unionized — to the workers’ union reps Then go talk to the government inspectors and regulators who see to it that the factory is obeying the law And then see whether you can speak with any environmental advocacy groups or consumer watchdog groups that are concerned by what that firm is doing or what that firm’s industry as a whole is doing Getting this full range of opinions can give you a deep understanding of how a mixed economic system works and where you may find room for improvement Dissect the Tax System Find out about how your local, state, and national governments tax you, your neighbors, and local businesses In the United States, handy places to look for this information are at the Web sites of the Internal Revenue Service, state departments of taxation (often also called state tax boards or state franchise tax boards), and local tax authorities such as county assessor’s offices Other great resources include research institutes, such as The Tax Foundation, and advocacy groups, such as the National Taxpayer’s Union Peruse Your City’s Budget You probably have a good sense about what local spending priorities should be in your city’s budget Thus, seeing what your city is actually spending money on can be enlightening Check out your city’s budget online And while you’re at it, go attend your local town or city council meeting to see in-person the debates regarding how best to spend the limited local budget Uncover Government Policy Papers National governments have a lot of money to throw around Quite a bit of it gets directed toward producing research to better inform legislators and bureaucrats about specific public policy issues and how potential new laws may affect individual people, firms, or the government itself (in terms of things such as tax collections) These policy papers are often nonpartisan and quite balanced in their analysis, making them especially helpful to you if you’re deeply interested in getting all points of view on a particular issue In the United Sates, some of the best sources for government policy papers are the Congressional Budget Office and the Federal Reserve System Get to Know Government Data Making good decisions about how to improve the world is difficult unless you actually have good data on what the world is currently like As it turns out, governments statisticians and accountants often produce the most timely, extensive, and easily accessed data available anywhere So before you finish making up your mind on any particular topic, take the time to see whether relevant government data exists State and local governments also publish extensive data, but here are some of the top sources published by the U.S Federal government: The Economic Report of the President brings together nearly ever major macroeconomic statistic collected for the United States, and its Web site has downloadable spreadsheets for quarterly and annual data going back to the 1960s The Energy Information Agency has every sort of statistic you may want related to energy, including pollution data and data on renewables The Bureau of Labor Statistics has all sorts of labor-force and unemployment data, down to the level of cities and counties The FRED database maintained by the Kansas City Federal Reserve Bank has extensive domestic and international financial data and great interactive software for making graphs Each of the 15 executive departments of the federal government — Agriculture, Defense, Commerce, and so on — collects and publishes interesting data Appendix Glossary This glossary contains common economics terms Words set in italic type are terms that are defined separately in this glossary aggregate demand: The total demand for goods and services in an economy aggregate supply: The total supply of goods and services in an economy allocatively efficient: When an economy’s limited supply of resources is allocated to the production of the goods and services that consumers most greatly desire to consume antitrust laws: Laws that regulate monopolies and cartels asset-price bubble: A situation in which the price of an asset rises above its true value; usually driven by speculative purchases financed with borrowed money asymmetric information: A situation in which either the buyer or the seller knows more about the quality of the good that he or she is negotiating over than does the other party capital: Machines, factories, and infrastructure used to produce output cartel: A group of firms that colludes and acts as a single coordinated whole to restrict output and drive up prices; formerly called trusts collateral: An asset pledged to guarantee the repayment of a loan in the event that the borrower fails to make his or her contractually obligated loan payments on schedule command economy: An economy in which all economic activity is directed by the government comparative advantage: The argument, developed by David Ricardo, that each country should specialize in the production of the goods and services that it can deliver at lower costs than other countries; doing so increases total worldwide output and raises living standards Consumer Price Index (CPI): The Bureau of Labor Statistics’ market basket (bundle of goods and services) used to measure changes in the prices of goods and services bought by a typical family of four consumer surplus: The benefit consumers get when they can buy something for less than the maximum amount that they’re willing to pay for it deadweight loss: The amount by which total surplus (the sum of consumer surplus and producer surplus) is reduced whenever output is less than the socially optimal output level deflation: When the overall level of prices in the economy is falling demand: The whole range of quantities that a person with a given income and preferences will demand at various possible prices demand curve: A line on a graph that represents how much of a good or service buyers will consume at various prices depreciation: A decrease in the economy’s stock of capital caused by wear and tear or obsolescence (when an older machine or tool, despite being in good working order, is no longer wanted because it’s been made outdated by new technologies) diminishing marginal utility: A situation in which each additional, or marginal, unit of a good or service that you consume brings less utility (happiness) than the previous unit diminishing returns: A situation in which each additional unit of a resource used in a production process brings forth successively smaller amounts of output economic costs: Total costs, including money spent on production and opportunity cost (the value of the best alternative forgone) economic profits: Any monies collected by a firm above and beyond what is required to keep an entrepreneur owner interested in continuing in business economics: The study of how people allocate scarce resources among alternative uses externality: A cost or benefit that falls not on the person(s) directly involved in an activity but on others; externalities can be positive (benefits) or negative (costs) factors of production: Inputs (resources) used to create goods and services, including land, labor, capital, and entrepreneurship financial markets: Markets in which either people trade the property rights to assets (such as real estate or stocks) or savers lend money to borrowers fiscal policy: A government’s policy on taxes and spending; increased government spending and/or lower tax rates help to fight recessions fixed costs: Costs that have to be paid even if a firm isn’t producing anything full employment: When every worker who wants a full-time job can obtain one full-employment output (Y*): The quantity of output produced in the economy when there’s full employment in the labor market gross domestic product (GDP): The value of all goods and services produced in the economy in a given period of time, usually a quarter or a year; the sum (denoted by the variable Y) of expenditures on consumption, investment, government purchases, and exports less expenditures on imports, or Y = C + I + G + EX – IM human capital: The knowledge and skills that people use to help them produce output hyperinflation: A very high rate of inflation; defined by some authors to be a rate of inflation in excess of 20 or 30 percent per month increasing returns: A situation in which each additional unit of a resource used in a production process brings forth successively larger amounts of output inflation: When the overall level of prices in the economy is rising inflation rate: A measure of how the overall level of prices in the economy changes over time; if the inflation rate is positive, prices are rising; if the inflation rate is negative, prices are falling insolvent: Being unable to honor one’s financial obligations because one’s financial obligations exceed the combined value of current assets and future income interest rate: The price someone has to pay to borrow money investment: Spending to increase the economy’s stock of capital as well as the value of any increases in inventories invisible hand: Adam Smith’s famous idea that when firms are constrained by competition, each firm’s greed causes it to act in a socially optimal way, as if guided to the right thing by an invisible hand laissez faire: See market economy law of demand: The fact that for most goods and services, price and quantity demanded have an inverse relationship (as one goes up, the other goes down) long-run shutdown condition: A situation in which a firm’s total revenues exceed its variable costs but are less than its total costs; the firm will operate until its fixed cost contracts expire (in the long run) macroeconomics: The study of the economy as whole, concentrating on economy-wide factors such as interest rates, inflation, and unemployment; macroeconomics also encompasses the study of economic growth and how governments use monetary and fiscal policy to try to moderate the harm caused by recessions marginal cost: How much total costs increase when you produce one more unit of output marginal utility: The change in total utility (happiness) that results from consuming the next unit of a good or service; marginal utility can be positive or negative market basket: A bundle of goods and services selected to measure inflation; economists define a market basket, such as the Consumer Price Index, and then track how much money it takes to buy this basket from one period to the next market economy: An economy in which the private decisions of consumers, resource suppliers, and firms determine how resources are allocated, with only limited interventions from the government; often referred to as a laissez-faire (“to leave alone”) economic system market failures: Situations in which markets deliver nonoptimal social outcomes; common causes of market failure are asymmetric information, monopoly, externalities, and public goods microeconomics: The part of economics that studies individual people and individual businesses; for people, microeconomics studies how they behave when faced with decisions about where to spend their limited budgets; for businesses, it studies how profit-maximizing firms behave individually and how they behave when competing against each other in markets monetary policy: Using changes in the money supply to change interest rates in order to stimulate or slow down economic activity monopolistic competition: A situation in which many firms with slightly different products compete; production costs are above what could be achieved by perfectly competitive firms, but society benefits from the product differentiation monopoly: A firm that has no competitors in its industry; it produces less output, has higher costs, generates a deadweight loss, and sells its output for a higher price than it would if constrained by competition; these negative outcomes usually generate government regulation natural monopoly: An industry in which one large producer can produce output at a lower cost than many small producers; it undersells its rivals and ends up as the only firm surviving in its industry nominal interest rates: Interest rates that measure the returns to a loan in terms of money borrowed and money returned (as opposed to real interest rates) nominal prices: The price as it’s actually observed in current dollars; contrasts with real prices, which adjust for inflation nominal wages: Wages measured in current dollars; contrasts with real wages, which adjust for inflation oligopoly: An industry with only a few firms; if they collude, they form a cartel to reduce output and drive up profits the way a monopoly does opportunity cost: The value of the best forgone alternative option; what you give up in order to pursue a particular option perfect competition: A situation in which numerous small firms producing identical products compete against each other in a given industry; perfect competition leads to firms’ producing the socially optimal output level at the minimum possible cost per unit price ceiling: A market intervention in which the government ensures that the price of a good or service stays below the free-market price price floor: A market intervention in which the government keeps the price of a good or service above its free-market price Prisoner’s Dilemma: A situation in which a pair of prisoners (or firms) has to decide whether or not to cooperate; the dilemma is that although the individual incentives favor not cooperating, both players would be better off if they could figure out a way to cooperate producer surplus: The gain that producers receive when they can sell their output at a price higher than the minimum amount for which they’re willing to make it production possibilities frontier (PPF): A graph economists use to help them visualize the tradeoffs you make when you efficiently reallocate inputs from producing one thing to producing another; sometimes referred to as the production possibilities curve productively efficient: Producing a given good or service at the lowest possible cost public goods: Goods or services that can’t be profitably produced by private firms because the goods or services are impossible to provide to just one person; if you provide them to one person, you have to provide them to everybody; because all consumers hope somebody else will pay for public goods so they can get them for free, usually nobody ends up paying quantity demanded: How much of a good or service a consumer will demand at a specific price, given his or her income and preferences quantity theory of money: The theory that the overall level of prices in the economy is proportional to the quantity of money circulating in the economy rational expectations: The theory that people will optimally change their behavior in response to policy changes; depending on the situation, their behavioral changes can greatly limit the effectiveness of policy changes real interest rates: Interest rates that compensate for inflation by measuring the returns to a loan in terms of units of stuff lent and units of stuff returned (as opposed to nominal interest rates) real prices: How much of one kind of thing (such as hours worked) you have to give up to get a good or service, no matter what happens to nominal prices real wages: Nominal wages adjusted for inflation; wages measured not in terms of current dollars (as nominal wages are) but rather in terms of how much output can be purchased with those current dollars recession: A period of time during which an economy’s total output falls recovery: The period after a recession ends and during which an economy’s total output expands; continues until the next recession begins scarcity: The fact that people don’t have enough resources to satisfy all their wants; the phenomenon that creates the need for economics short-run shutdown condition: A situation in which a firm’s total revenues are less than its variable costs and the firm is better off shutting down immediately and losing only its fixed costs socially optimal output level: The output level that maximizes the benefits that society can get from its limited supply of resources sticky prices: Prices that are slow to adjust to shocks; price stickiness can cause recessions to linger supply and demand: An economic model of markets that separates buyers from sellers and then summarizes each group’s behavior with a single line on a graph; the buyers’ behavior is captured by the demand curve, and the sellers’ behavior is captured by the supply curve; by putting these two curves on the same graph, economists can show how buyers and sellers interact in markets to determine how much of any particular item will be sold, as well as the price at which it will be sold supply curve: A line on a graph that represents how much of a good or service sellers will produce at various prices total surplus: The sum of producer surplus and consumer surplus Tragedy of the Commons: The idea that if a resource is open to public use, it typically becomes rapidly exhausted or ruined because each person’s personal incentive is to use it up before anyone else can; this problem can be solved by private property rights, which give owners an incentive to conserve the resource and harvest it at sustainable rates utility: A measure of happiness that economists suppose people use to compare all possible things that they may experience variable costs: Costs that vary with the amount of output produced wealth: Anything that has value because it produces a flow of desirable goods and services or because it could produce a flow of desirable goods and services wages: The prices paid for the use or services of labor per unit of time To access the cheat sheet specifically for this book, go to www.dummies.com/cheatsheet/economics Find out "HOW" at Dummies.com ... Wiley, the Wiley Publishing logo, For Dummies, the Dummies Man logo, A Reference for the Rest of Us!, The Dummies Way, Dummies Daily, The Fun and Easy Way, Dummies. com, Making Everything Easier!,... Papers Get to Know Government Data Appendix: Glossary Cheat Sheet Economics For Dummies , 2nd Edition by Sean Flynn, PhD Economics For Dummies , 2nd Edition Published by Wiley Publishing, Inc 111... Microeconomics and Macroeconomics to Separate Corners The main organizing principle I use in this book is to divide economics into two broad pieces, macroeconomics and microeconomics: Microeconomics