| Absolute advantage | One person has an absolute advantage over another if he or she takes fewer hours to perform a task than the other person.
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| Accommodating policy | A policy that allows the effects of a shock to occur.
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| Aggregate demand (AD) | Total planned spending on final goods and services.
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| Aggregate demand (AD) curve | Shows the relationship between aggregate demand and inflation; because short-run equilibrium output equals aggregate demand, the aggregate demand curve also shows the relationship between short-run equilibrium output and inflation; increases in inflation reduce aggregate demand and short-run equilibrium output, so the aggregate demand curve is downward-sloping.
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| Aggregate supply shock | Either an inflation shock or a shock to potential output; adverse aggregate supply shocks of both types reduce output and increase inflation.
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| Aggregation | The adding up of individual economic variables to obtain economywide totals.
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| Anchored expectations | When people's expectations of future inflation do not change even if inflation rises temporarily.
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| Appreciation | An increase in the value of a currency relative to other currencies.
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| Assets | Anything of value that one owns.
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| Attainable point | Any combination of goods that can be produced using currently available resources.
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| Autarky | A situation in which a country is economically self-sufficient; that is, it does not trade with other nations.
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| Automatic stabilizers | Provisions in the law that imply automatic increases in government spending or decreases in taxes when real output declines.
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| Autonomous expenditure | The portion of planned aggregate expenditure that is independent of output.
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| Average benefit | Total benefit of undertaking n units of an activity divided by n.
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| Average cost | Total cost of undertaking n units of an activity divided by n.
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| Average labor productivity | Output per employed worker.
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| Average tax rate | Total taxes divided by total before-tax income.
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| Balance-of-payments deficit | The net decline in a country's stock of international reserves over a year.
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| Balance-of-payments surplus | The net increase in a country's stock of international reserves over a year.
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| Balance sheet | A list of an economic unit's assets and liabilities on a specific date.
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| Bank reserves | Cash or similar assets held by commercial banks for the purpose of meeting depositor withdrawals and payments.
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| Banking panic | An episode in which depositors, spurred by news or rumors of the imminent bankruptcy of one or more banks, rush to withdraw their deposits from the banking system.
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| Barter | The direct trade of goods or services for other goods or services.
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| Bequest saving | Saving done for the purpose of leaving an inheritance.
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| Board of Governors | The leadership of the Fed, consisting of seven governors appointed by the president to staggered 14-year terms.
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| Bond | A legal promise to repay a debt, usually including both the principal amount and regular interest payments.
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| Boom | A particularly strong and protracted expansion.
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| Buyer's reservation price | The largest dollar amount the buyer would be willing to pay for a good.
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| Buyer's surplus | The difference between the buyer's reservation price and the price he or she actually pays.
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| Capital gains | Increases in the value of existing assets.
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| Capital good | A long-lived good that is used in the production of other goods and services.
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| Capital inflows | Purchases of domestic assets by foreign households and firms.
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| Capital losses | Decreases in the value of existing assets.
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| Capital outflows | Purchases of foreign assets by domestic households and firms.
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| Cash on the table | Economic metaphor for unexploited gain from exchange.
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| Central bank independence | When central bankers are insulated from short-term political considerations and are allowed to take a long-term view of the economy.
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| Change in demand | A shift of the entire demand curve.
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| Change in supply | A shift of the entire supply curve.
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| Change in the quantity demanded | A movement along the demand curve that occurs in response to a change in price.
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| Change in the quantity supplied | A movement along the supply curve that occurs in response to a change in price.
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| Closed economy | An economy that does not trade with the rest of the world.
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| Comparative advantage | One person has a comparative advantage over another if his or her opportunity cost of performing a task is lower than the other person's opportunity cost.
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| Complements | Two goods are complements in consumption if an increase in the price of one causes a leftward shift in the demand curve for the other (or if a decrease causes a rightward shift).
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| Compound interest | The payment of interest not only on the original deposit but on all previously accumulated interest.
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| Constant | A quantity that is fixed in value.
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| Consumer price index (CPI) | For any period, measures the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year.
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| Consumption expenditure | Spending by households on goods and services such as food, clothing, and entertainment.
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| Consumption function | The relationship between consumption spending and its determinants, in particular, disposable (after-tax) income.
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| Consumption possibilities | The combination of goods and services that a country's citizens might feasibly consume.
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| Contraction | See Recession.
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| Contractionary monetary policy | An increase in interest rates by the Fed, made with the intention of reducing an expansionary gap; also known as monetary tightening.
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| Contractionary policies | Government policy actions designed to reduce planned spending and output.
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| Core rate of inflation | The rate of increase of all prices except energy and food.
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| Coupon payments | Regular interest payments made to the bondholder.
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| Coupon rate | The interest rate promised when a bond is issued; the annual coupon payments are equal to the coupon rate times the principal amount of the bond.
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| Credibility of monetary policy | The degree to which the public believes the central bank's promises to keep inflation low, even if doing so may impose short-run economic costs.
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| Crowding out | The tendency of increased government deficits to reduce investment spending.
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| Cyclical unemployment | The extra unemployment that occurs during periods of recession.
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| Deflating (a nominal quantity) | The process of dividing a nominal quantity by a price index (such as the CPI) to express the quantity in real terms.
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| Deflation | A situation in which the prices of most goods and services are falling over time so that inflation is negative.
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| Demand curve | A schedule or graph showing the quantity of a good that buyers wish to buy at each price.
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| Demand for money | The amount of wealth an individual or firm chooses to hold in the form of money.
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| Dependent variable | A variable in an equation whose value is determined by the value taken by another variable in the equation.
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| Deposit insurance | A system under which the government guarantees that depositors will not lose any money even if their bank goes bankrupt.
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| Depreciation | A decrease in the value of a currency relative to other currencies.
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| Depression | A particularly severe or protracted recession.
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| Devaluation | A reduction in the official value of a currency (in a fixed-exchange-rate system).
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| Diminishing returns to capital | If the amount of labor and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production.
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| Diminishing returns to labor | If the amount of capital and other inputs in use is held constant, then the greater the quantity of labor already employed, the less each additional worker adds to production.
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| Discount rate | The interest rate that the Fed charges commercial banks to borrow reserves.
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| Discount window lending | The lending of reserves by the Federal Reserve to commercial banks.
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| Discouraged workers | People who say they would like to have a job but have not made an effort to find one in the past four weeks.
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| Disinflation | A substantial reduction in the rate of inflation.
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| Diversification | The practice of spreading one's wealth over a variety of different financial investments to reduce overall risk.
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| Dividend | A regular payment received by stockholders for each share that they own.
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| Duration | The length of an unemployment spell.
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| Economic surplus | The economic surplus from taking any action is the benefit of taking the action minus its cost.
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| Economics | The study of how people make choices under conditions of scarcity and of the results of those choices for society.
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| Efficiency (or economic efficiency) | Condition that occurs when all goods and services are produced and consumed at their respective socially optimal levels.
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| Efficient point | Any combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of the other.
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| Entrepreneurs | People who create new economic enterprises.
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| Equation | A mathematical expression that describes the relationship between two or more variables.
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| Equilibrium | A balanced or unchanging situation in which all forces at work within a system are canceled by others.
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| Equilibrium price and equilibrium quantity | The price and quantity of a good at the intersection of the supply and demand curves for the good.
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| Excess demand (or shortage) | The difference between the quantity supplied and the quantity demanded when the price of a good lies below the equilibrium price; buyers are dissatisfied when there is excess demand.
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| Excess supply (or surplus) | The difference between the quantity supplied and the quantity demanded when the price of a good exceeds the equilibrium price; sellers are dissatisfied when there is excess supply.
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| Expansion | A period in which the economy is growing at a rate significantly above normal.
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| Expansionary gap | A negative output gap, which occurs when actual output is higher than potential output (Y < Y*).
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| Expansionary monetary policy | A reduction in interest rates by the Fed, made with the intention of reducing a recessionary gap; also known as monetary easing.
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| Expansionary policies | Government policy actions intended to increase planned spending and output.
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| Federal funds rate | The interest rate that commercial banks charge each other for very short-term (usually overnight) loans; because the Fed frequently sets its policy in terms of the federal funds rate, this rate is closely watched in financial markets.
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| Federal Open Market Committee (or FOMC) | The committee that makes decisions concerning monetary policy.
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| Federal Reserve System (or Fed) | The central bank of the United States; also called the Fed.
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| Final goods or services | Goods or services consumed by the ultimate user; because they are the end products of the production process, they are counted as part of GDP.
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| Financial intermediaries | Firms that extend credit to borrowers using funds raised from savers.
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| Fiscal policy | Decisions that determine the government's budget, including the amount and composition of government expenditures and government revenues.
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| Fisher effect | The tendency for nominal interest rates to be high when inflation is high and low when inflation is low.
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| Fixed cost | A cost that does not vary with the level of an activity.
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| Fixed exchange rate | An exchange rate whose value is set by official government policy.
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| Flexible exchange rate | An exchange rate whose value is not officially fixed but varies according to the supply and demand for the currency in the foreign exchange market.
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| Flow | A measure that is defined per unit of time.
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| Foreign exchange market | The market on which currencies of various nations are traded for one another.
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| Fractional-reserve banking system | A banking system in which bank reserves are less than deposits so that the reserve-deposit ratio is less than 100 percent.
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| Frictional unemployment | The short-term unemployment associated with the process of matching workers with jobs.
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| Government budget deficit | The excess of government spending over tax collections (G – T).
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| Government budget surplus | The excess of government tax collections over government spending (T – G); the government budget surplus equals public saving.
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| Government purchases | Purchases by federal, state, and local governments of final goods and services; government purchases do not include transfer payments, which are payments made by the government in return for which no current goods or services are received, nor do they include interest paid on the government debt.
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| Gross domestic product (GDP) | The market value of the final goods and services produced in a country during a given period.
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| Hyperinflation | A situation in which the inflation rate is extremely high.
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| Income effect | The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer's purchasing power.
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| Income-expenditure multiplier | The effect of a one-unit increase in autonomous expenditure on short-run equilibrium output.
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| Independent variable | A variable in an equation whose value determines the value taken by another variable in the equation.
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| Indexing | The practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index. Indexing prevents the purchasing power of the nominal quantity from being eroded by inflation.
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| Induced aggregate demand | The portion of aggregate demand that is determined within the model.
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| Induced expenditure | The portion of planned aggregate expenditure that depends on output Y.
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| Inefficient point | Any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other.
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| Inferior good | A good whose demand curve shifts leftward when the incomes of buyers increase.
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| Inflation dove | Someone who is not strongly committed to achieving and maintaining low inflation.
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| Inflation hawk | Someone who is committed to achieving and maintaining low inflation, even at some short-run cost in reduced output and employment.
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| Inflation-protected bonds | Bonds whose holders receive a nominal interest rate each year equal to the fixed real rate plus the actual rate of inflation during that year.
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| Inflation shock | A sudden change in the normal behavior of inflation, unrelated to the nation's output gap.
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| Inside lag (of macroeconomic policy) | The delay between the date a policy change is needed and the date it is implemented.
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| Intermediate goods or services | Goods or services used up in the production of final goods and services and therefore not counted as part of GDP.
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| International capital flows | Purchases or sales of real and financial assets across international borders.
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| International reserves | Foreign currency assets held by a government for the purpose of purchasing the domestic currency in the foreign exchange market.
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| Investment | Spending by firms on final goods and services, primarily capital goods.
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| Labor force | The total number of employed and unemployed people in the economy.
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| Law of one price | If transportation costs are relatively small, the price of an internationally traded commodity must be the same in all locations.
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| Liabilities | The debts one owes.
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| Life-cycle saving | Saving to meet long-term objectives, such as retirement, college attendance, or the purchase of a home.
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| Long-run aggregate supply (LRAS) line | A vertical line showing the economy's potential output Y*.
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| Long-run equilibrium | A situation in which actual output equals potential output and the inflation rate is stable; graphically, long-run equilibrium occurs when the AD curve, the SRAS line, and the LRAS line all intersect at a single point.
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| M1 | Sum of currency outstanding and balances held in checking accounts.
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| M2 | All the assets in M1 plus some additional assets that are usable in making payments but at greater cost or inconvenience than currency or checks.
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| Macroeconomic policies | Government actions designed to affect the performance of the economy as a whole.
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| Macroeconomics | The study of the performance of national economies and the policies that governments use to try to improve that performance.
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| Marginal benefit | The marginal benefit of an activity is the increase in total benefit that results from carrying out one additional unit of the activity.
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| Marginal cost | The marginal cost of an activity is the increase in total cost that results from carrying out one additional unit of the activity.
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| Marginal propensity to consume (mpc) | The amount by which consumption rises when disposable income rises by $1; we assume that 0 < mpc < 1.
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| Marginal tax rate | The amount by which taxes rise when before-tax income rises by one dollar.
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| Market | The market for any good consists of all buyers or sellers of that good.
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| Market equilibrium | Occurs when all buyers and sellers are satisfied with their respective quantities at the market price.
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| Market equilibrium value of the exchange rate | The exchange rate that equates the quantities of the currency supplied and demanded in the foreign exchange market.
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| Maturation date | The date at which the principal will be repaid.
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| Medium of exchange | An asset used in purchasing goods and services.
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| Menu costs | The costs of changing prices.
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| Microeconomics | The study of individual choice under scarcity and its implications for the behavior of prices and quantities in individual markets.
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| Monetary policy | Determination of the nation's money supply.
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| Money | Any asset that can be used in making purchases.
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| Money demand curve | Shows the relationship between the aggregate quantity of money demanded M and the nominal interest rate i; because an increase in the nominal interest rate increases the opportunity cost of holding money, which reduces the quantity of money demanded, the money demand curve slopes down.
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| Multiplier | See Income-expenditure multiplier.
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| Mutual fund | A financial intermediary that sells shares in itself to the public, then uses the funds raised to buy a wide variety of financial assets.
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| National saving | The saving of the entire economy, equal to GDP less consumption expenditures and government purchases of goods and services, or Y – C – G.
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| Natural rate of unemployment, u* | The part of the total unemployment rate that is attributable to frictional and structural unemployment; equivalently, the unemployment rate that prevails when cyclical unemployment is zero, so the economy has neither a recessionary nor an expansionary output gap.
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| Net capital inflows | Capital flows that are equal to foreign purchases of domestic assets (which bring funds into the country) minus domestic purchases of foreign assets (which send funds out of the country); that is, capital inflows minus capital outflows.
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| Net exports | Exports minus imports.
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| Nominal exchange rate | The rate at which two currencies can be traded for each other.
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| Nominal GDP | A measure of GDP in which the quantities produced are valued at current-year prices; nominal GDP measures the current dollar value of production.
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| Nominal interest rate | The annual percentage increase in the nominal value of a financial asset; also known as the market interest rate.
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| Nominal quantity | A quantity that is measured in terms of its current dollar value.
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| Normal good | A good whose demand curve shifts rightward when the incomes of buyers increase.
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| Normative analysis | Addresses the question of whether a policy should be used; normative analysis inevitably involves the values of the person doing the analysis.
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| Normative economic principle | One that says how people should behave.
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| Okun's law | States that each extra percentage point of cyclical unemployment is associated with about a 2 percentage point increase in the output gap, measured in relation to potential output.
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| 100 percent reserve banking | A situation in which banks' reserves equal 100 percent of their deposits.
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| Open economy | An economy that trades with other countries.
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| Open-market operations | Open-market purchases and open-market sales.
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| Open-market purchase | The purchase of government bonds from the public by the Fed for the purpose of increasing the supply of bank reserves and the money supply.
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| Open-market sale | The sale by the Fed of government bonds to the public for the purpose of reducing bank reserves and the money supply.
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| Opportunity cost | The opportunity cost of an activity is the value of the next-best alternative that must be forgone to undertake the activity.
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| Output gap, Y* – Y | The difference between the economy's potential output and its actual output at a point in time.
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| Outside lag (of macroeconomic policy) | The delay between the date a policy change is implemented and the date by which most of its effects on the economy have occurred.
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| Outsourcing | A term increasingly used to connote having services performed by low-wage workers overseas.
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| Overvalued exchange rate | An exchange rate that has an officially fixed value greater than its fundamental value.
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| Parameter | See Constant.
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| Participation rate | The percentage of the working-age population in the labor force (that is, the percentage that is either employed or looking for work).
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| Peak | The beginning of a recession, the high point of economic activity prior to a downturn.
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| Planned aggregate expenditure (PAE) | Total planned spending on final goods and services.
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| Policy reaction function | Describes how the action a policymaker takes depends on the state of the economy.
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| Portfolio allocation decision | The decision about the forms in which to hold one's wealth.
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| Positive analysis | Addresses the economic consequences of a particular event or policy, not whether those consequences are desirable.
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| Positive economic principle | One that predicts how people will behave.
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| Potential output, Y* | The maximum sustainable amount of output (real GDP) that an economy can produce also known as potential GDP or full-employment output.
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| Precautionary saving | Saving for protection against unexpected setbacks, such as the loss of a job or a medical emergency.
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| Price ceiling | A maximum allowable price, specified by law.
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| Price index | A measure of the average price of a given class of goods or services relative to the price of the same goods and services in a base year.
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| Price level | A measure of the overall level of prices at a particular point in time as measured by a price index such as the CPI.
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| Principal amount | The amount originally lent.
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| Private saving | The saving of the private sector of the economy is equal to the after-tax income of the private sector minus consumption expenditures (Y – T – C); private saving can be further broken down into household saving and business saving.
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| Production possibilities curve | A graph that describes the maximum amount of one good that can be produced for every possible level of production of the other good.
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| Protectionism | The view that free trade is injurious and should be restricted.
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| Public saving | The saving of the government sector is equal to net tax payments minus government purchases (T – G).
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| Purchasing power parity (PPP) | The theory that nominal exchange rates are determined as necessary for the law of one price to hold.
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| Quantity equation | Money times velocity equals nominal GDP: M x V = P x Y.
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| Quota | A legal limit on the quantity of a good that may be imported.
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| Rate of inflation | The annual percentage rate of change in the price level, as measured, for example, by the CPI.
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| Rational person | Someone with well-defined goals who tries to fulfill those goals as best he or she can.
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| Real exchange rate | The price of the average domestic good or service relative to the price of the average foreign good or service, when prices are expressed in terms of a common currency.
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| Real GDP | A measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices; real GDP measures the actual physical volume of production.
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| Real interest rate | The annual percentage increase in the purchasing power of a financial asset; the real interest rate on any asset equals the nominal interest rate on that asset minus the inflation rate.
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| Real quantity | A quantity that is measured in physical terms—for example, in terms of quantities of goods and services.
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| Real wage | The wage paid to workers measured in terms of purchasing power; the real wage for any given period is calculated by dividing the nominal (dollar) wage by the CPI for that period.
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| Recession (or contraction) | A period in which the economy is growing at a rate significantly below normal.
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| Recessionary gap | A positive output gap, which occurs when potential output exceeds actual output (Y* > Y).
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| Relative price | The price of a specific good or service in comparison to the prices of other goods and services.
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| Reservation price | The highest price someone is willing to pay to obtain any good or service, or the lowest payment someone would accept for giving up a good or performing a service.
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| Reserve requirements | Set by the Fed, the minimum values of the ratio of bank reserves to bank deposits that commercial banks are allowed to maintain.
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| Reserve-deposit ratio | Bank reserves divided by deposits.
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| Revaluation | An increase in the official value of a currency (in a fixed-exchange-rate system).
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| Rise | See Slope.
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| Risk premium | The rate of return that financial investors require to hold risky assets minus the rate of return on safe assets.
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| Run | See Slope.
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| Saving | Current income minus spending on current needs.
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| Saving rate | Saving divided by income.
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| Seller's reservation price | The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost.
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| Seller's surplus | The difference between the price received by the seller and his or her reservation price.
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| Short-run aggregate supply (SRAS) line | A horizontal line showing the current rate of inflation, as determined by past expectations and pricing decisions.
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| Short-run equilibrium | A situation in which inflation equals the value determined by past expectations and pricing decisions, and output equals the level of short-run equilibrium output that is consistent with that inflation rate; graphically, short-run equilibrium occurs at the intersection of the AD curve and the SRAS line.
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| Short-run equilibrium output | The level of output at which output Y equals planned aggregate expenditure PAE; the level of output that prevails during the period in which prices are predetermined.
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| Shortage | See Excess demand.
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| Skill-biased technological change | Technological change that affects the marginal products of higher-skilled workers differently from those of lower-skilled workers.
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| Slope | In a straight line, the ratio of the vertical distance the straight line travels between any two points (rise) to the corresponding horizontal distance (run).
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| Socially optimal quantity | The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good.
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| Speculative attack | A massive selling of domestic currency assets by financial investors.
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| Stabilization policies | Government policies that are used to affect planned aggregate expenditure, with the objective of eliminating output gaps.
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| Stock | A measure that is defined at a point in time.
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| Stock (or equity) | A claim to partial ownership of a firm.
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| Store of value | An asset that serves as a means of holding wealth.
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| Structural policy | Government policies aimed at changing the underlying structure, or institutions, of the nation's economy.
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| Structural unemployment | The long-term and chronic unemployment that exists even when the economy is producing at a normal rate.
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| Substitutes | Two goods are substitutes in consumption if an increase in the price of one causes a rightward shift in the demand curve for the other (or if a decrease causes a leftward shift).
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| Substitution effect | The change in the quantity demanded of a good that results because buyers switch to substitutes when the price of the good changes.
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| Sunk cost | A cost that is beyond recovery at the moment a decision must be made.
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| Supply curve | A graph or schedule showing the quantity of a good that sellers wish to sell at each price.
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| Supply-side policy | A policy that affects potential output.
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| Surplus | See Excess supply.
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| Target inflation rate | The public announcement by the Fed of a numerical inflation rate target and a willingness to subordinate all other objectives to that number.
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| Tariff | A tax imposed on an imported good.
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| Total surplus | The difference between the buyer's reservation price and the seller's reservation price.
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| Trade balance (or net exports) | The value of a country's exports less the value of its imports in a particular period (quarter or year).
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| Trade deficit | When imports exceed exports, the difference between the value of a country's imports and the value of its exports in a given period.
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| Trade surplus | When exports exceed imports, the difference between the value of a country's exports and the value of its imports in a given period.
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| Transfer payments | Payments the government makes to the public for which it receives no current goods or services in return.
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| Trough | The end of a recession; the low point of economic activity prior to a recovery.
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| Unattainable point | Any combination of goods that cannot be produced using currently available resources.
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| Undervalued exchange rate | An exchange rate that has an officially fixed value less than its fundamental value.
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| Unemployment rate | The number of unemployed people divided by the labor force.
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| Unemployment spell | A period during which an individual is continuously unemployed.
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| Unit of account | A basic measure of economic value.
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| Value added | For any firm, the market value of its product or service minus the cost of inputs purchased from other firms.
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| Variable | A quantity that is free to take a range of different values.
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| Velocity | A measure of the speed at which money circulates, or equivalently, the value of a transaction completed in a period of time divided by the stock of money required to make those transactions; numerically, V = (P x Y)/M, where V is velocity, P x Y is nominal GDP, and M is the money supply whose velocity is being measured.
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| Vertical intercept | The value taken by the dependent variable when the independent variable equals zero.
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| Wealth | The value of assets minus liabilities.
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| Wealth effect | The tendency of changes in asset prices to affect households' wealth and thus their spending on consumer goods.
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| Worker mobility | The movement of workers between jobs, firms, and industries.
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| World price | The price at which a good or service is traded on international markets.
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