Chapter 2: Thinking Like an Economist
Some vocabulary terms in the Workbook
Aggregate income and aggregate expenditures
Resource owners supply land, labor, capital and entrepreneurial talent. They earn income
for this. The income received by those who supply "land" is called rent; for labor, the
income component is "wages and salaries"; for capital, it is "interest on capital" which
includes items such as dividends, and for entrepreneurship, the reward is "profit".
Collectively, these income components make up "
are expenditures on final goods and services incurred by the 4
sectors; households, firms, government and the foreign sector. The spending component incurred by
households is called Consumption (C), by firms: Gross Private Investment (I); by the Government:
Government Purchases (G) (not to be confused by “Government Spending” which also includes transfer
payments); and by the foreign sector: Net Exports (XM) Net exports = exports(X)
taken out because they represent expenditures on goods produced in foreign countries, not on domestically
Factor markets is the same thing as "factors of production markets" i.e. the resource market or the input
market. In other words, in the market factors of production are traded.
Also see text, pg. 24
An important result of circular flow model is that aggregate income (earned by resource owners)
must equal aggregate expenditures on final goods and services.
Workbook, pg. 7
The Law of Increasing Opportunity Cost (or Law of Increasing Marginal Opportunity Cost)
States that the cost of producing additional units of a good or service increases as more of that product is
This law holds because resources are relatively specialized. If production obeys the Law of IOC, then the PPF
(bowed toward the origin), as opposed to linear. A
r PPF implies that the opportunity cost
remains constant, not increasing. Note that in either situation (concave or linear) there is a tradeoff; the only
difference is that in the case of a concave PPF, the tradeoff is increasing, meaning it gets more costly to
produce additional units, whereas, in the case of a linear PPF, the tradeoff is constant.
Please see solution to Q2 posted on page 3 here.
Real flows vs. nominal flows
flows are denoted in current dollar values, that is, in market prices. For example, if you receive
$30 an hour this is your nominal wage. Nominal variables are observed. The sticker prices on item, the interest
rate on your credit card, the amount in your checking account -- all these are nominal variables.