Glossary (See related pages) Adaptive Expectations   Expectations based in some way on the past. Aggregate Demand (AD) Curve   A curve that shows how a change in the price level will change aggregate expenditures on all goods and services in an economy. Aggregate Demand Management   Government’s attempt to control the aggregate level of spending in the economy. Aggregate Expenditures   The total amount of spending on final goods and services in the economy; consumption (spending by consumers), investment (spending by business), spending by government, and net foreign spending on U.S. goods (the difference between U.S. exports and U.S. imports). Aggregate Production (AP)   The total amount of goods and services produced in every industry in an economy. Annuity Rule   The present value of any annuity is the annual income it yields divided by the interest rate. Art of Economics   The application of the knowledge learned in positive economics to the achievement of the goals one has determined in normative economics. Asset Management   How a bank handles its loans and other assets. Automatic Stabilizer   Any government program or policy that will counteract the business cycle without any new government action. Autonomous Expenditures   Expenditures that do not systematically vary with income. Balance of Merchandise Trade   The difference between the value of goods exported and the value of goods imported. Balance of Payments   A country’s record of all transactions between its residents and the residents of all foreign nations. Balance of Payments Constraint   Limitations on expansionary domestic macroeconomic policy due to a shortage of international reserves. Balance of Trade   The difference between the value of the goods and services a country imports and the value of the goods and services it exports. Bank   A financial institution whose primary function is accepting deposits for, and lending money to, individuals and firms. Bar Graph   A graph where the area under each point is filled in to look like a bar. Basic Needs   Adequate food, clothing, and shelter. Bond   A promise to pay a certain amount of money plus interest in the future. Brain Drain   The outflow of the best and brightest students from developing countries to developed countries. Bretton Woods System   An agreement about fixed exchange rates that governed international financial relationships from the period after the end of World War II until 1971. Business   A private producing unit in our society. Business Cycle   The upward or downward movement of economic activity, or real GDP, that occurs around the growth trend. Capitalism   An economic system based on the market in which the ownership of the means of production resides with a small group of individuals called capitalists. Cash Flow Accounting System   An accounting system entering expenses and revenues only when cash is received or paid out. Central Bank   A type of bankers’ bank whose financial obligations underlie an economy’s money supply. Classical Growth Model   A model of growth that focuses on the role of capital accumulation in the growth process. Classicals   Macroeconomists who generally favor laissez faire or nonactivist policies. Comparative Advantage   The ability to be better suited to the production of one good than to the production of another good. Competitiveness   The ability of a country to sell its goods to other countries. Conditionality   The making of loans that are subject to specific conditions. Constant Returns to Scale   A situation in which long-run average total costs do not change with an increase in output. Also: Output will rise by the same proportionate increase as all inputs. Consumer Price Index (CPI)   A measure of prices of a fixed basket of consumer goods, weighted according to each component’s share of an average consumer’s expenditures. Consumer Sovereignty   The principle that the consumer’s wishes determine what’s produced. Consumption   Spending by households on goods and services. Contractionary Monetary Policy   Monetary policy that decreases the money supply and increases interest rates. Contractual Intermediary   A financial institution that holds and stores individuals’ financial assets. Convergence Hypothesis   The hypothesis that per capita income in countries with similar institutional structures will grow toward the same level of income per person. Convertibility on the Current Account   An exchange rate system that allows people to exchange currencies freely to buy goods and services, but not to buy assets in other countries. Coordinate System   A two-dimensional space in which one point represents two numbers. Corporation   A business that is treated as a person, legally owned by its stockholders. Its stockholders are not liable for the actions of the corporate “person.” Cost-Push Inflation   Inflation that occurs when the economy is below potential output. Countercyclical Fiscal Policy   Fiscal policy in which the government offsets any change in aggregate expenditures that would create a business cycle. Credentialism   When the academic degrees, or credentials, become more important than the knowledge learned. Crowding Out   The offsetting of a change in government expenditures by a change in private expenditures in the opposite direction. Currency Stabilization   Buying and selling of a currency by the government to offset temporary fluctuations in supply and demand for currencies. Currency Support   Buying of a currency by a government to maintain its value at above its long-run equilibrium value. Current Account   The part of the balance of payments account in which all short-term flows of payments are listed. Cyclical Unemployment   Unemployment resulting from fluctuations in economic activity. Debt   Accumulated deficits minus accumulated surpluses. Debt Service   The interest rate on debt times the total debt. Decreasing Returns to Scale   A situation when output rises by a smaller proportionate increase than all inputs. Deficit   A shortfall of revenues under payments. Deflation   A continuous fall of the price level. Demand   A schedule of quantities of a good that will be bought per unit of time at various prices, other things constant. Demand Curve   The graphic representation of the relationship between price and quantity demanded. Demand-Pull Inflation   Inflation that occurs when the economy is at or above potential output. Demerit Good or Activity   Good or activity that government believes is bad for people even though they choose to use the good or engage in the activity. Depository Institution   A financial institution whose primary financial liability is deposits in checking or savings accounts. Depreciation   A measure of the decline in value of an asset that occurs over time through use. Also: A decrease in the value of a currency. Depression   A large recession. Direct Relationship   A relationship in which when one variable goes up, the other goes up too. Discount Rate   The rate of interest the Fed charges for loans it makes to banks. Division of Labor   The splitting up of a task to allow for specialization of production. Dual Economy   The existence of two sectors: a traditional sector and an internationally oriented modern market sector. E-commerce   Buying and selling over the Internet. Economic Decision Rule   If the marginal benefits of doing something exceed the marginal costs, do it. If the marginal costs of doing something exceed the marginal benefits, don’t do it. Economic Force   The necessary reaction to scarcity. Economic Model   A framework that places the generalized insights of a theory in a more specific contextual setting. Economic Policy   An action (or inaction) taken by government to influence economic actions. Economic Principle   A commonly held economic insight stated as a law or general assumption. Economic Takeoff   A stage when the development process becomes self-sustaining. Economics   The study of how human beings coordinate their wants and desires, given the decision-making mechanisms, social customs, and political realities of the society. Economies of Scale   Situation when long-run average total costs decrease as output increases. Efficiency   Achieving a goal as cheaply as possible. Also: using as few inputs as possible. Embargo   A total restriction on the import or export of a good. Employment–Population Ratio   The number of people who are working as a percentage of people available to work. Entrepreneurship   The ability to organize and get something done. Also: Labor services that involve high degrees of organizational skills, concern, oversight responsibility, and creativity. Equation of Exchange   An equation stating that the quantity of money times the velocity of money equals the price level times the quantity of real goods sold. Equilibrium   A concept in which opposing dynamic forces cancel each other out. Equilibrium Income   The level of income toward which the economy gravitates in the short run. Equilibrium Price   The price toward which the invisible hand drives the market. Equilibrium Quantity   The amount bought and sold at the equilibrium price. Euro   The currency used by the 12 members of the European Union. Excess Demand   Situation when quantity demanded is greater than quantity supplied. Excess Reserves   Reserves held by banks in excess of what banks are required to hold. Excess Supply   Situation when quantity supplied is greater than quantity demanded. Exchange Rate   The price of one country’s currency in terms of another currency. Excise Tax   A tax that is levied on a specific good. Expansion   An upturn that lasts for at least two consecutive quarters of a year. Expansionary Monetary Policy   Monetary policy that increases the money supply and decreases the interest rate. Expected Inflation   Inflation people expect to occur. Expenditures Multiplier   A number that tells how much income will change in response to a change in autonomous expenditures. External Debt   Government debt owed to individuals in foreign countries. Externality   An effect of a decision on a third party not taken into account by the decision maker. Extrapolative Expectations   Expectations that a trend will continue. Fallacy of Composition   The false assumption that what is true for a part will also be true for the whole. Fed Funds   Loans of excess reserves banks make to one another. Federal Funds Market   The market in which banks lend and borrow reserves. Federal Funds Rate   The interest rate banks charge one another for Fed funds. Federal Open Market Committee (FOMC)   The Fed’s chief body that decides monetary policy. Federal Reserve Bank (the Fed)   The U.S. central bank whose liabilities (Federal Reserve notes) serve as cash in the United States. Feudalism   An economic system in which traditions rule. Final Output   Goods and services purchased for their final use. Financial and Capital Account   The part of the balance of payments account in which all long-term flows of payments are listed. Financial Assets   Assets such as stocks or bonds, whose benefit to the owner depends on the issuer of the asset meeting certain obligations. Financial Institution   A business whose primary activity is buying, selling, or holding financial assets. Financial Liabilities   Liabilities incurred by the issuer of a financial asset to stand behind the issued asset. Fine-Tuning   Fiscal policy designed to keep the economy always at its target or potential level of income. Fiscal Policy   The deliberate change in either government spending or taxes to stimulate or slow down the economy. Also, the charging of taxes and spending to affect the level of output in the economy. Fixed Exchange Rate   When the government chooses a particular exchange rate and offers to buy and sell its currency at that price. Flexible Exchange Rate   When the government does not enter into foreign exchange markets at all, but leaves the determination of exchange rates totally up to market forces. Foreign Aid   Funds that developed countries lend or give to developing countries. Forex Market   The foreign exchange market. Free Rider   A person who participates in something for free because others have paid for it. Free Trade Association   A group of countries that have reduced or eliminated trade barriers among themselves. Frictional Unemployment   Unemployment caused by people entering the job market and people quitting a job just long enough to look for and find another one. Full Convertibility   An exchange rate system in which individuals may change dollars into any currency they want for whatever legal purpose they want. Functional Finance   A theoretical proposition that governments should make spending and taxing decisions on the basis of their effect on the economy, not on the basis of some moralistic principle that budgets should be balanced. GDP Deflator   An index of the price level of aggregate output, or the average price of the components of GDP, relative to a base year. General Agreement on Tariffs and Trade (GATT)   A regular international conference to reduce trade barriers held from 1947 to 1995. It has been replaced by the World Trade Organization (WTO). Global Corporation   Corporation with substantial operations on both the production and sales sides in more than one country. Globalization   The integration of world economies. Gold Specie Flow Mechanism   The long-run adjustment mechanism that maintained the gold standard. Gold Standard   The system of fixed exchange rates in which the value of currencies was fixed relative to the value of gold and gold was used as the primary reserve asset. Government Failure   A situation in which the government intervention in the market to improve market failure actually makes the situation worse. Government Spending   Goods and services that government buys. Graph   A picture of points in a coordinate system in which points denote relationships between numbers. Gross Domestic Product (GDP)   The total market value of all final goods and services produced in an economy in a one-year period. Gross National Product (GNP)   The aggregate final output of citizens and businesses of an economy in a one-year period. Households   Groups of individuals living together and making joint decisions. Human Capital   The skills that are embodied in workers through experience, education, and on-the-job training, or, more simply, people’s knowledge. Hyperinflation   Inflation that hits triple digits—100 percent or more per year. Increasing Returns to Scale   A situation when output rises by a greater proportionate increase than all inputs. Induced Expenditures   Expenditures that change as income changes. Industrial Revolution   A time when technology and machines rapidly modernized industrial production and mass produced goods replaced handmade goods. Inefficiency   Getting less output from inputs that, if devoted to some other activity, would produce more output. Inefficient   Achieving a goal in a more costly manner than necessary. Infant Industry Argument   The argument that with initial protection, an industry will be able to become competitive. Inflation   A continual rise in the price level. Inflation Tax   An implicit tax on the holders of cash and the holders of any obligations specified in nominal terms. Inflationary Gap   A difference between equilibrium income and potential income when equilibrium income exceeds potential income. Infrastructure Investment   Investment in the underlying structure of the economy. Inherent Comparative Advantage   Comparative advantage that is based on factors that are relatively unchangeable. Input   What is put into a production process to achieve an output. Insider/Outsider Model   An institutionalist story of inflation where insiders bid up wages and outsiders are unemployed. Institutions   The formal and informal rules that constrain human behavior. Interest Rate   The price paid for the use of a financial asset. Interest Rate Effect   The effect that a lower price level has on investment expenditures through the effect that a change in the price level has on interest rates. Intermediate Products   Products used as inputs in the production of some other product. Internal Debt   Government debt owed to other governmental agencies or to its own citizens. International Effect   As the price level falls (assuming the exchange rate does not change), net exports will rise. Interpolation Assumption   The assumption that the relationship between variables is the same between points as it is at the points. Inverse Relationship   A relationship between two variables in which when one goes up, the other goes down. Inverted Yield Curve   A yield curve in which the short-term rate is higher than the long-term rate. Investment   Spending for the purpose of additional production. Invisible Hand   The price mechanism; the rise and fall of prices that guides our actions in a market. Invisible Hand Theory   A market economy, through the price mechanism, will tend to allocate resources efficiently. Keynesians   Macroeconomists who generally favor activist government policy. Labor Force   Those people in an economy who are willing and able to work. Labor Force Participation Rate   The percentage of the total population at least 16 years old who either work or are actively looking for work. Laissez-Faire   An economic policy of leaving coordination of individuals’ actions to the market. Law of Demand   Quantity demanded rises as price falls, other things constant. Also can be stated as: Quantity demanded falls as price rises, other things constant. Law of Diminishing Marginal Productivity   As more and more of a variable input are added to an existing fixed input, eventually the additional output one gets from that additional input is going to fall. Also, increasing one input, keeping all others constant, will lead to smaller and smaller gains in output. Law of One Price   The wages of workers in one country will not differ significantly from the wages of (equal) workers in another institutionally similar country. Law of Supply   Quantity supplied rises as price rises, other things constant. Also can be stated as: Quantity supplied falls as price falls, other things constant. Learning by Doing   As we do something, we learn what works and what doesn’t, and over time we become more proficient at it. Also: To improve the methods of production through experience. Liability Management   How a bank attracts deposits and what it pays for them. Limited Capital Account Convertibility   An exchange rate system that allows full current account convertibility and partial capital account convertibility. Limited Liability   The liability of a stockholder (owner) in a corporation; it is limited to the amount the stockholder has invested in the company. Line Graph   A graph where the data are connected by a continuous line. Linear Curve   A curve that is drawn as a straight line. Long-Run Aggregate Supply (LAS) Curve   A curve that shows the long-run relationship between output and the price level. Long-Run Phillips Curve   A vertical curve at the unemployment rate consistent with potential output. (It shows the trade-off [or complete lack thereof] when expectations of inflation equal actual inflation.) M1   Currency in the hands of the public, checking account balances, and traveler’s checks. M2   M1 plus savings deposits, small-denomination time deposits, and money market mutual fund shares, along with some esoteric financial instruments. Macroeconomic Externality   An externality that affects the levels of unemployment, inflation, or growth in the economy as a whole. Macroeconomics   The study of the economy as a whole, which includes inflation, unemployment, business cycles, and growth. Marginal Benefit   Additional benefit above the benefits already derived. Marginal Cost   Additional cost over and above the costs already incurred. Marginal Propensity to Expend (mpe)   The ratio of the change in aggregate expenditures to a change in income. Market Demand Curve   The horizontal sum of all individual demand curves. Market Economy   An economic system based on private property and the market in which, in principle, individuals decide how, what, and for whom to produce. Market Failure   A situation in which the invisible hand pushes in such a way that individual decisions do not lead to socially desirable outcomes. Market Force   An economic force that is given relatively free rein by society to work through the market. Market Supply Curve   The horizontal sum of all individual supply curves. Also: Horizontal sum of all the firms’ marginal cost curves, taking account of any changes in input prices that might occur. Mercantilism   An economic system in which government determines the what, how, and for whom decisions by doling out the rights to undertake certain economic activities. Merit Good or Activity   A good or activity that government believes is good for you, even though you may not choose to consume the good or engage in the activity. Microeconomics   The study of individual choice, and how that choice is influenced by economic forces. Minimum Wage Law   A law specifying the lowest wage a firm can legally pay an employee. Monetary Base   Vault cash, deposits at the Fed, plus currency in circulation. Monetary Policy   A policy of influencing the economy through changes in the banking system’s reserves that influence the money supply and credit availability in the economy. Monetary Regime   A predetermined statement of the policy that will be followed in various situations. Money   A highly liquid financial asset that’s generally accepted in exchange for other goods, is used as a reference in valuing other goods, and can be stored as wealth. Money Multiplier   (1 +c )/(r + c), where r is the percentage of deposits banks hold in reserve and c is the ratio of money people hold in currency to the money they hold as deposits. Monopoly Power   The ability of individuals or firms currently in business to prevent other individuals or firms from entering the same kind of business. Mortgage   A special name for a secured loan on real estate. Most-Favored Nation   A country that will be charged as low a tariff on its exports as any other country. Movement along a Demand Curve   The graphical representation of the effect of a change in price on the quantity demanded. Movement along a Supply Curve   The graphical representation of the effect of a change in price on the quantity supplied. Multiplier Effect   The amplification of initial changes in expenditures. Multiplier Equation   An equation that tells us that income equals the multiplier times autonomous expenditures. Net Domestic Product (NDP)   The sum of consumption expenditures, government expenditures, net exports, and investment less depreciation. That is, GDP less depreciation. Net Exports   Spending on goods and services produced in the United States that foreigners buy (exports) minus goods and services produced abroad that U.S. citizens buy (imports). Net Foreign Factor Income   Income from foreign domestic factor sources minus foreign factor income earned domestically. Net Investment   Gross investment less depreciation. New Classical Macroeconomics   A theoretical approach to macroeconomics that revived many pre-Keynesian theoretical ideas of the macro economy. New Growth Theory   A theory that emphasizes the role of technology rather than capital in the growth process. Nominal Deficit   The deficit determined by looking at the difference between expenditures and receipts. Nominal GDP   GDP calculated at existing prices. Nominal Interest Rate   The interest rate you actually see and pay when borrowing, or receive when lending. Nominal Output   The total amount of goods and services measured at current prices. Nonlinear Curve   A curve that is drawn as a curved line. Normative Economics   The study of what the goals of the economy should be. Official Reserves   Government holdings of foreign currencies. Okun’s Rule of Thumb (sometimes called Okun’s Law)   A 1 percentage-point change in the unemployment rate will be associated with a 2 percent change in output in the opposite direction. Open Market Operations   The Fed’s buying and selling of government securities. Opportunity Cost   The benefit you might have gained from choosing the next-best alternative. Output   A result of a productive activity. Outsourcing   The relocation of production once done in the United States to foreign countries. Partially Flexible Exchange Rate   When the government sometimes buys or sells currencies to influence the exchange rate, while at other times the government simply accepts the exchange rate determined by supply and demand forces, that is, letting private market forces operate. Partnership   A business with two or more owners. Passive Deficit   The part of the deficit that exists because the economy is operating below its potential level of output. Patent   The legal protection of a technical innovation that gives the person holding it sole right to use that innovation. (Note: A patent is good for only a limited time.) Pay-as-You-Go System   A system in which payments to current beneficiaries are funded through current payroll taxes. Per Capita Growth   Producing more goods and services per person. Per Capita Real Output   Real GDP divided by the total population. Permanent Income Hypothesis   A proposition that expenditures are determined by permanent or lifetime income. Personal Consumption Expenditure (PCE) Deflator   A measure of prices of goods that consumers buy that allows yearly changes in the basket of goods that reflect actual consumer purchasing habits. Phillips Curve   A representation of the relationship between inflation and unemployment. (Note: There is both a short-run and a long-run relationship.) Pie Chart   A circle divided into “pie pieces,” where the undivided pie represents the total amount and the pie pieces reflect the percentage of the whole pie that the various components make up. Policy Change   A change in one aspect of government’s actions, such as monetary policy or fiscal policy. Policy Coordination   The integration of a country’s policies to take account of their global effects. Positive Economics   The study of what is, and how the economy works. Positive Externality   The positive effect of a decision on others not taken into account by the decision maker. Also, when the effects of a decision not taken into account by the decision maker are beneficial to others. Potential Income   The level of income that the economy technically is capable of producing without generating accelerating inflation. Potential Output   Output that would materialize at the target rate of unemployment and the target rate of capacity utilization. Also, the highest amount of output an economy can produce from existing production processes and resources. Precautionary Motive   Holding money for unexpected expenses and impulse buying. Present Value   A method of translating a flow of future income or savings into its current worth. Price Ceiling   A government-imposed limit on how high a price can be charged. In other words, a government-set price below the market equilibrium price. Price Floor   A government-imposed limit on how low a price can be charged. In other words, a government-set price above equilibrium price. Price Index   A number set at 100 in the base year that summarizes what happens to a weighted composite of prices of a selection of goods (often called a market basket of goods) over time. Principle of Increasing Marginal Opportunity Cost   In order to get more of something, one must give up ever increasing quantities of something else. Private Good   A good that, when consumed by one individual, cannot be consumed by another individual. Private Property Right   Control a private individual or firm has over an asset. Procyclical Fiscal Policy   Changes in government spending and taxes that increase the cyclical fluctuations in the economy instead of reducing them. Producer Price Index (PPI)   An index of prices that measures average change in the selling prices received by domestic producers of goods and services over time. Production Function   The relationship between the inputs (factors of production) and outputs. Production Possibility Curve   A curve measuring the maximum combination of outputs that can be obtained from a given number of inputs. Production Possibility Table   A table that lists a choice’s opportunity costs by summarizing what alternative outputs can be achieved with given inputs. Productive Efficiency   Achieving as much output as possible from a given amount of inputs or resources. Productivity   Output per unit of input. Profit   What’s left over from total revenues after all the appropriate costs have been subtracted. Also, a return on entrepreneurial activity and risk taking. Public Finance   Government’s taxing and spending policies. Public Good   A good that if supplied to one person must be supplied to all and whose consumption by one individual does not prevent its consumption by another individual. That is, a good that is nonexclusive and nonrival.