advantage: One country is said to have an absolute advantage
demand: Aggregate demand is the total amount that all
Shows how much output is produced from capital and
Allocation of resources: Allocation of resources refers to the society’s decisions
Appreciation: An increase in the value of a currency. A nation’s currency is said to appreciate when exchange rates change so that a unit of its own currency can buy more units of foreign currency.
Asian Pacific Economic Cooperation (APEC) organization: An organization of 18 Asian nations that attempts to reduce trade barriers between their nations.
Asset: An asset of an individual or business firm is an item of value that the individual or firm owns.
Autarky: A situation in which each country is self-sufficient, so there is no trade.
Balanced budget: The situation in which total expenditures equals total revenues.
Balance of payments deficit: The balance of payments deficit is the amount by which the quantity supplied of a country’s currency (per year) exceeds the quantity demanded. Balance of payments deficits arise whenever the exchange rate is pegged at an artificially low level.
Barter: Barter is a system of exchange in which people directly trade one good for another, without using money as an intermediate step.
Bond: A promise or IOU to pay money in the future in exchange for money now.
Budget deficit: The difference between a government’s spending and its revenues from taxation during a specified period of time.
Business cycles: Another name for economic fluctuations.
Capital: See physical capital; see human capital
Capital account balance: The capital account balance includes purchases and sales of financial assets to and from citizens and companies of other countries.
value of a country’s sales less purchases of assets. A
Capital deepening: Increases in the stock of capital per worker.
Capital depreciation: The wear and tear of capital as it is used in production.
Capital gain: A capital gain is the difference between the price at which an asset is sold and the price at which it was bought.
Capital good: A capital good is an item used to produce other goods and services in the future, rather than being consumed. Factories and machines are examples.
Cartel: A group of firms that coordinate their pricing decisions, often by charging the same price.
Central bank: A banker’s bank; an official bank that controls the supply of money in a country.
Centrally planned economy: An economy in which a government bureaucracy decides how much of each good to produce, how to produce the goods and how to allocate the products among consumers.
Ceteris paribus: Latin meaning “other things being equal.”
Closed economy: A closed economy is one that does not trade with other nations in either goods or assets.
Comparative advantage: One country is said to have a comparative advantage over another in the production of a particular good relative to other goods if it produces that good less inefficiently as compared with the other country.
Concentration ratio: A measure of the degree of concentration in a market; the four-firm concentration ratio is the percentage of output produced by the four largest firms.
Constant-cost industry: An industry in which the average cost of production is constant, so the long-run supply curve is horizontal.
Consumer expenditure: Consumer expenditure is the total amount spent by consumers on newly produced goods and services (excluding purchases of new homes, which are considered investment goods).
Consumer Price Index (CPI): A price index that measures the cost of a fixed basket of goods chosen to represent the consumption pattern of individuals/households.
Consumption good: A consumption good is an item that is available for immediate use by households, one that satisfies people’s wants without contributing directly to the economy’s future production.
Contestable market: A market in which the costs of entering and leaving are very low, so the firms in the market are constantly threatened by the entry of new firms.
Contractionary policies: Government policy actions that lead to decreases in output.
Cost-of-living adjustments: Automatic increases in wages or other payments that are tied to a price index.
Countercyclical: Moving in the opposite direction of real GDP.
Creative destruction: The process by which competition for monopoly profits leads to technological progress.
Current account balance: The current account balance includes international purchases and sales of goods and services, cross-border interest and dividend payments, and cross-border gifts to and from private individuals and governments.
Cyclical unemployment: Cylcical unemployment is the portion of unemployment that is attributable to a decline in the economy’s total production. Cyclical unemployment rises during recessions and falls as prosperity is restored.
Deficit: The excess of total expenditures over total revenues.
Deflation: Deflation refers to s sustained decrease in the general price level.
Depreciation: Depreciation occurs when a nation’s currency loses value. The currency is said to depreciate when exchange rates change so that a unit of its currency can buy fewer units of foreign currency.
Depression: The common name for a severe recession.
Devaluation: A devaluation is a reduction in the official value of a currency.
Diminishing returns: As one input increases while the other inputs are held fixed, output increases but at a decreasing rate.
Discount rate: The discount rate is the interest rate the Federal Reserve charges on loans that it makes to member banks.
Diseconomies of scale: A situation in which an increase in the quantity produced increases the long-run average cost of production.
income is the sum of the incomes of all the individuals in the economy after all
taxes have been deducted and all transfer payments have been added.
of labor means breaking up a task into a number of smaller, more specialized tasks so that each worker can become more
adept at a particular job.
Dumping means selling goods in a foreign market at
lower prices than those charged in the home market or at prices lower
than production costs.
that last for a long period of time, such as household appliances.
costs plus implicit costs.
of GDP above or below normal trends.
growth occurs when an economy is able to produce more goods and services for
each consumer. Sustained increases
in real production of an economy over a period of time.
Economic model: An
economic model is a simplified, small scale version of some aspect of the
economy. Economic models are often
expressed in equations, by graphs, or in words.
revenue minus the total economic cost.
The study of the choices made by people who are faced with scarcity.
Economies of scale: A
situation in which an increase in the quantity produced decreases the long-run
average cost of production.
People who have jobs.
A person who has an idea for a business and
coordinates the production and sale of goods and services, taking risks in the
Effort used to coordinate the production and sale of
goods and services.
An equilibrium is a situation in which there are no inherent forces that
produce change. Changes away form
an equilibrium position will occur only as a result of “outside events” that
disturb the status quo. Equilibrium
refers to a situation in which neither consumers nor firms have any incentive to
change their behavior. They are
content to continue with things as they are.
level of GDP at which the demand for output equals the amount that is produced.
The common currency in
organization of European nations that has reduced trade barriers within Europe.
The exchange rate states the price, in terms of one currency, at which
another currency can be bought.
policy actions that lead to increases in output.
firm’s actual cash payments for its inputs.
A good produced in the home
country (for example, the United States) and sold in another country.
Export subsidy: An
export subsidy is a payment by the government to exporters to permit them to
reduce the selling prices of their goods so they can compete more effectively in
of production are the broad categories, land, labor, capital, exhaustible
natural resources, and entrepreneurship, into which we divide the economy’s
different productive inputs.
Final goods and
goods and services are those that are purchased by their ultimate users.
opening of financial markets to participants from foreign countries.
The government’s fiscal policy is the plan for spending and taxation.
It is designed to steer aggregate demand in some desired direction.
exchange rates are rates set by government decisions maintained by government
Fixed taxes are taxes that do not vary with the level of GDP.
Flexible exchange rates: A currency system in which exchange rates are determined by
Floating exchange rates: Floating exchange rates are rates determined in free markets
by the law of supply and demand.
Foreign exchange market: A
market in which people exchange on currency for another.
Foreign exchange market intervention:
The purchase or sale of currencies by governments to
influence the market exchange rate.
Franchise or licensing scheme:
A policy under which the government picks a single
firm to sell a particular good.
Frictional unemployment: Frictional
unemployment is unemployment that is due to normal turnover in the labor market.
It includes people who are temporarily between jobs because they are
moving or changing occupations, or are unemployed for similar reasons.
level of employment that occurs when the unemployment rate is at the natural
Full-employment or potential output:
The level of output that results when the labor
market is in equilibrium.
General Agreement on Tariffs and
Trade (GATT): An
international agreement that has lowered trade barriers between the United
States and other nations.
total of all past deficits.
Government purchases: Government purchases refer to the goods (such as airplanes
and paper clips) and services (such as school teaching and police protection)
purchased by all levels of government.
Gross domestic product (GDP): Gross
domestic product (GDP) is the sum of the money values of all final goods and
services produced in the domestic economy and sold on organized markets during a
specified period of time, usually a year.
GDP deflator: An
index that measures how the price of goods included in GDP changes over time.
purchases of investment goods such as new housing, machinery, factories,
equipment, tools, etc.
Gross national product (GNP):
The value of final goods and services produced both
internationally and domestically by a nation’s firms.
Growth rate: The
percentage rate of change of a variable.
group of related family members and unrelated individuals who live in the same
Human capital: The
knowledge and skills acquired by a worker through education and experience and
used to produce goods and services.
inflation rate exceeding 50% per month.
Implicit costs: The
opportunity cost of nonpurchased inputs.
good produced in a foreign country and purchased by residents of the home
country (for example, the United States).
Import quota: A limit
on the amount or value of a good that can be imported.
Income elasticity of demand: A measure of the responsiveness of the quantity demanded to
changes in consumer income; computed by dividing the percentage change in the
quantity demanded by the percentage change in income.
Increasing-cost industry: An
industry in which the average cost of production increases as the industry
grows, so the long-run supply curve is positively sloped.
Indexing refers to provisions in a law or a contract whereby monetary
payments are automatically adjusted whenever a specified price index changes.
Wage rates, pensions, interest payments on bonds, income taxes, and many
other things can be indexed in this way, and have been. Sometimes such contractual provisions are called escalator
union: A labor
organization that includes all types of workers from a single industry, for
example steelworkers or autoworkers.
new industry that is protected from foreign competitors.
Inflation: Inflation refers to sustained increase in the average level of prices.
percentage rate of change of the price level in the economy.
factors of production: Inputs
or factors of production are the labor, machinery, buildings, and natural
resources used to make outputs.
intermediate good is a good purchased for resale or for use in producing another
Monetary Fund (IMF): An
international organization that
works closely with national governments to promote financial policies that
facilitate world trade.
spending is the sum of the expenditures of business firms on new plant and
equipment and households on new homes. Financial
“investments” are not included, nor are resales of existing physical assets.
Invisible hand: The
invisible hand is a phrase used by Adam Smith to describe how, by pursuing their
own self-interests, people in a market system are “led by an invisible hand”
to promote societal well-being. The
term that economists use to describe how the price system can efficiently
coordinate economic activity without central government intervention.
Human effort, including both physical and mental effort, used to produce
goods and services.
The labor force is the number of people holding or seeking jobs; the
employed plus the unemployed.
productivity refers to the amount of output a worker turns out in an hour (or a
week or a year) of labor. It can be
measured as gross domestic product (GDP) in a given year divided by the total
number of paid work hours during that year.
That is, labor productivity is defined as GDP
per hour of labor.
Law of supply and demand: The
law of supply and demand states that, in a free market, the forces of supply and
demand generally push the price toward the level at which quantity supplied and
quantity demanded are equal.
liability of an individual or business firms is an item of value that the
individual or firm owes. Many
liabilities are known as debts.
Labor union: An
organized group of workers; the objectives of the organization are to increase
job security, improve working conditions, and increase wages and benefits.
Limit pricing: A
scheme under which a monopolist accepts a price below the normal monopoly price
to deter other firms from entering the market.
Liquid: Easily convertible to money on short notice.
Liquidity: An asset’s liquidity refers to the ease with which it can be converted into cash.
M1: The narrowly defined money supply, usually abbreviated M1, is the sum of all coins and paper money in circulation plus certain checkable deposit balances at banks and savings institutions.
M2: The broadly defined money supply, usually abbreviated M2, is the sum of all coins and paper money in circulation plus all types of checking account balances, plus share in money market mutual funds.
Marginal propensity to consume (MPC):
The marginal propensity to consume (MPC) is the ratio
of changes in consumption relative to changes in disposable income that produce
the change in consumption.
arrangement that allows buyers and sellers to exchange things or carry out
transactions. A buyer exchanges
money for a product, while a seller exchanges a product for money.
Market system: A
market system is a form of economic organization in which resource
allocation decisions are left to individual producers and consumers acting in
their own best interests without central direction.
is a doctrine that holds that exports are good for a country, whereas imports
process in which two or more firms combine their operations.
Mixed economy: A
mixed economy is one with some public influence over the workings of free
markets. There may also be some
public ownership mixed in with private property.
A market-based economic system under which government plays an important
role, including the regulation of markets, where most economic decision are
policy refers to actions that the Federal Reserve System takes in order to
change the equilibrium of the money market; that is, to alter the money supply,
move interest rates, or both.
Monetize the deficit: The
central bank is said to monetize the deficit when it purchases the bonds that
the government issues.
is the standard object used in exchanging goods and services.
In short, money is the medium of exchange.
Monopolistic competition: A market served by dozens of firms selling slightly different
market in which a single firm serves the entire market.
market in which there is a single buyer of an output.
Multinational corporation: An
organization that produces and sells goods and services throughout the world.
National debt: The
national debt is the federal government’s total indebtedness at a moment in
time. It is the result of previous
National income: National
income is the sum of the incomes that all individuals in the economy earned in
the forms of wages, interest, rents, and profits.
It excludes government transfer payments and is calculated before any
deductions are taken for income taxes.
Natural monopoly: A
market in which the entry of a second firm would make price less than average
cost, so a single firm serves the entire market.
Natural rate of unemployment:
economy’s self-correcting mechanism always tends to push the unemployment rate
back toward a specific rate o unemployment that we call the natural rate of
Net exports: Net
exports, symbolized by (X-IM), is the difference between U.S. exports and
U.S. imports. It indicates the
difference between what we sell to foreigners and what we buy from them.
Net worth: Net
worth is the value of all assets minus the value of all liabilities.
Nominal GDP: Nominal
GDP is calculated by valuing all outputs at current prices.
Nominal rate of interest: The nominal rate of interest is the percentage by which the
money the borrower pays back exceeds the money that he borrowed, making no
adjustment for any fall in purchasing power of this money that results from
that last of short periods of time, such as food.
Normal good: A
good for which an increase in income increases demand.
North American Free Trade Agreement (NAFTA):
An international agreement that lowers barriers to
trade between the United States, Mexico, and Canada (signed in 1994).
market served by a few firms.
Open economy: An
open economy is one that trades with other nations in goods and services perhaps
also trades in financial assets.
Open: A economy
is called relatively open if its exports and imports constitute a large share of
Open economy: An
economy with international trade.
Opportunity cost: The
opportunity cost of any decision is the value of the next best alternative that
the decision forces the decision maker to forgo. The opportunity cost of some decision is the value of the
next best alternative that must be given up because of that decision (for
example, working instead of going to school).
What you sacrifice to get something.
are the goods and services that consumers want to acquire.
Paradox of thrift: The
paradox of thrift is the idea that an effort by a nation to save more may simply
reduce national income and fail to raise total saving.
exclusive right to sell a particular good for some period of time.
Perfectly competitive market:
A market with a very large number of firms, each of
which produces the same standardized product and takes the market price as
objects used to produce goods and services.
Potential GDP is the real GDP that the economy would produce if its labor and other
resources were fully employed.
A pricing scheme under which a firm decreases its
price to drive a rival out of business, and increases the price when the other
Price ceiling: A
price ceiling is a legal maximum on the price that may be charged for a
Price discrimination: The process under which a firm divides consumers into two or
more groups and charges a different price for each group.
Price elasticity of demand:
A measure of the responsiveness of the quantity
demanded to changes in price; computed by dividing the percentage change in
quantity demanded by the percentage change in price.
Price elasticity of supply: A measure of the responsiveness of the quantity supplied to
changes in price computed by dividing the percentage change in quantity supplied
by the percentage change in price.
Price fixing: An
arrangement in which two firms coordinate their pricing decisions.
Price floor: A price
floor is a legal minimum on the price that may be charged for a commodity.
implicit agreement under which firms in a market choose a price leader, observe
that firm’s price and match it.
Price level: An
average of all the prices in the economy as measured by a price index.
Price support program: A
policy under which the government specifies a minimum price above the
Private investment expenditure:
Purchases of newly produced goods and services by
process of selling government-owned firms (public enterprises) to the private
in the same direction as real GDP.
Protectionist policies: Rules
that restrict the free flow of goods between nations, including tariffs (taxes
on imports), quotas (limits on total imports), voluntary export restraints
(agreements between governments to limit exports), and nontariff trade barriers
(subtle practices that hinder trade).
Productivity: is the
amount of output produced by a unit of input.
Progressive tax: A
progressive tax is one in which the average tax rate paid by an individual rises
as income rises.
Public good: A
good that is available for everyone to consume, regardless of who pays and
Purchasing power: The
purchasing power of a given sum of money is the volume of goods and services
that it will buy.
Purchasing Power Parity (PPP):
A theory of exchange rates, stating that the exchange
rate between two currencies is determined by the price levels in the two
Quota: A quota
specifies the maximum amount of a good that is permitted into the country from
abroad per unit of time.
Real Exchange Rate:
market exchange rate adjusted for prices.
Real GDP is calculated by
valuing outputs of different years at common prices. Therefore, real GDP is a far better measure than nominal GDP
of changes in total production. Real
GDP is the value of all the goods and services produced by an economy in a year,
evaluated in dollars of constant purchasing power. Hence, inflation does not raise real GDP.
Real GDP per
domestic product per person adjusted for changes in prices.
It is the usual measure of living standards across time and between
nominal interest rate minus the inflation rate.
Real rate of
real rate of interest is the percentage increase in purchasing power that the
borrower pays to the lender for the privilege of borrowing.
It indicates the increased ability to purchase goods and services that
the lender earns.
value of a sum of money in terms of the quantity of goods the money can buy.
Real wage rate: The
real wage rate is the wage rate adjusted for inflation. It indicates the volume of goods and services that money
wages will buy.
A recession is a period of time during which the total
output of the economy falls. Six
consecutive months of negative economic growth.
recessionary gap is the amount by which the equilibrium level of real GDP falls
short of potential GDP.
Relative price: An
item’s relative price is its price in terms of some other item rather than in
terms of dollars.
A policy under which the government specifies a maximum
rent that is below the equilibrium rent.
process under which a firm spends money to persuade the government to erect
barriers to entry and pick the firm as the monopolist.
Resources are the instruments provided by nature or by people that are
used to create goods and services. Natural
resources include minerals, the soil, water, and air.
Labor is a scarce resource, partly because of time limitations (the day
has only 24 hours) and partly because the number of skilled workers is limited.
Factories and machines are resources made by people.
These three types of resources are often referred to as land, labor,
and capital. They are also
called inputs or factors of production.
revaluation is an increase in the official value of
Run on a bank:
A run on a bank occurs when many depositors withdraw cash from their
accounts all at once.
Saving: Total income minus consumption
Scarcity: A situation in which resources are limited and can
be used in different ways, so we must sacrifice one thing for another.
Services: Reflect work done in which people play a prominent
role in delivery, ranging from haircutting to healthcare.
A service is an intangible product.
Social Insurance: A
system that compensates individuals for bad luck,
low skills, or misfortune.
Social security: A government program that provides retirement,
survivor, and disability benefits.
Spillover: A cost or benefit experienced by people who are
external to the decision about how much of a good to produce or consume.
Stabilization policy is the name give to government programs designed to
prevent or shorten recessions and to counteract inflation (that is, to stabilize
prices). Policy actions taken to
bring the economy closer to full employment or potential output.
Stagflation: Stagflation is inflation that occurs while the
economy is growing slowly (“stagnating”) or having a recession.
Stock of capital: The total of all the machines, equipment, and
buildings in the entire economy.
Structural unemployment: Structural
unemployment refers to workers who have lost their jobs because they have been
displaced by automation, because their skills are no longer in demand, or
because of similar reasons. The
part of unemployment that results from the mismatch of skills and jobs.
Substitutes: Two goods related in such a way that an increase in
the price of one good increases the demand for the other good.
surplus is an excess of quantity supplied over quantity demanded.
When there is a surplus, sellers cannot sell the quantities they desire
A tariff is a tax on
increase in output without increasing inputs.
Terms of trade:
The rate at which two
goods will be exchanged.
excess of imports over exports.
Trade surplus: The excess of exports over imports.
Trade adjustment assistance: Trade adjustment assistance provides special unemployment benefits, loans, retraining programs, and other aid to workers and firms that are harmed by foreign competition.
Transfer payments: Transfer payments are sums of money that the government gives certain individuals as outright grants rather than as payments for services rendered to employers. Some common examples are Social Security and unemployment benefits. Payments to individuals from governments that do not correspond to the production of goods and services.
Transition: The process of shifting from a centrally planned economy toward a mixed economic system, with markets playing a greater role in the economy.
Underemployed: Workers who hold a part-time job but prefer to work full time or hold jobs that are far below their capabilities.
Unemployment insurance: Payments received from the government upon becoming unemployed.
Unemployment rate: The unemployment rate is the number of unemployed people, expressed as a percentage of the labor force.
Value added: The sum of all the income (wages, interest, profits, rent) generated by an organization.
Variable: A variable is something measured by a number, it is used to analyze what happens to other things when the size of that number changes (varies). A measure of something that can take on different values.
Variable costs: Costs that vary as the quantity produced changes.
Voluntary export restraint (VER): A scheme under which an exporting country voluntarily decreases its exports.
World Trade Organization (WTO): An international organization that overseas GATT and other international trade agreements.
Worldwide sourcing: The practice of buying components for a product from nations throughout the world.