Unit I Key Terms

Chapter One Key Terms

choice: a selection among alternative goods, services, or actions.

command economy: an economy in which the government determines prices and production; also called a centrally planned economy.

comparative advantage: a situation in which a person or group can produce one good at a lower opportunity cost than another person or group.

division of labor: the division of production into various parts in which different groups of workers specialize.

economic interaction: exchanges of goods and services between people.

economics: the study of how people deal with scarcity.

freely determined price: a price that is determined by the individuals and firms interacting in markets.

gains from trade: improvements in income, production, or satisfaction owing to the exchange of goods or services.

government failure: a situation in which the government makes things worse than the market, even though there may be market failure.

incentive: a device that motivates people to take action, usually so as to increase economic efficiency.

increasing opportunity cost: a situation in which producing more of one good requires giving up an increasing amount of production of another good.

international trade: the exchange of goods and services between people or firms in different nations.

market: an arrangement by which economic exchanges between people take place.

market economy: an economy characterized by freely determined prices and the free exchange of goods and services in markets.

market failure: any situation in which the market does not lead to an efficient economic outcome and in which there is a potential role for government.

opportunity cost: the value of the next-best forgone alternative that was not chosen because something else was chosen.

production possibilities: alternative combinations of production of various goods that are possible, given the economy's resources.

production possibilities curve: a curve showing the maximum combinations of production of two goods that are possible, given the economy's resources.


scarcity: the situation in which the quantity of resources is insufficient to meet all wants.

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Chapter Two Key Terms

capitalism: an economic system based on a market economy in which capital is individually owned, and production and employment decisions are decentralized.

ceteris paribus: "all other things being equal"; refers to holding all other variables constant or keeping all other things the same when one variable is changed.

circular flow diagram: a diagram illustrating the flow of funds through the economy as people buy and sell in markets.

controlled experiments: empirical tests of theories in a controlled setting in which particular effects can be isolated.

Council of Economic Advisers: a three-member group of economists appointed by the president of the United States to analyze the economy and make recommendations about economic policy.

economic model: an explanation of how the economy or part of the economy works.

economic variable: any economic measure that can vary over a range of values.

experimental economics: a branch of economics that uses laboratory experiments to analyze economic behavior.

gross domestic product (GDP): a measure of the value of all the goods and services newly produced in an economy during a specified period of time.

macroeconomics: the branch of economics that examines the workings and problems of the economy as a whole—GDP growth and unemployment.

microeconomics: the branch of economics that examines individual decision-making at firms and households and the way they interact in specific industries and markets.

mixed economy: a market economy in which the government plays a very large role.

negatively related: a situation in which an increase in one variable is associated with a decrease in another variable; also called inversely related.

normative economics: economic analysis that makes recommendations about economic policy.

positive economics: eco-nomic analysis that explains what happens in the economy and why, without making recommendations about economic policy.

positively related: a situation in which an increase in one variable is associated with an increase in another variable; also called directly related.

relative price: the price of a particular good compared to the price of other things.

socialism: an economic system in which the government owns and controls all the capital and makes decisions about prices and quantities as part of a central plan.


End of Unit I Key Terms.