Glossary

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Glossary - A

absolute advantage
a country has an absolute advantage over another country in the production of a good if it can produce that good more efficiently (with fewer inputs).

acquired endowments
resources a country builds for itself, like a network of roads or an educated population

adaptive expectations
expectations that respond or adapt to recent experience

adverse selection
the phenomenon that, as an insurance company raises its price, the best risks (those least likely to make a claim) drop out, so the mix of applicants changes adversely; now used more generally to refer to effects on the mix of workers, borrowers, products being sold, and so forth resulting from a change in wages (interest rates, prices) or other variables

affirmative action
actions by employers to seek out actively minorities and women for jobs and to provide them with training and other opportunities for promotion

aggregate consumption function
the relationship between aggregate consumption and aggregate income

aggregate demand-inflation curve
the curve that shows the negative relationship between inflation and spending

aggregate expenditures schedule
the relationship between aggregate expenditures and national income for a given real rate of interest

aggregate saving
the sum of the savings of all individuals in society

antitrust
laws that discourage monopoly and restrictive practices and encourage greater competition

appreciation
a change in the exchange rate that enables a unit of currency to buy more units of foreign currencies

asset price bubbles
asset price increases that are based solely on the expectation that prices will be higher in the future and not based on increases in the actual returns yielded by the asset

asymmetric information
a situation in which the parties to a transaction have different information, as when the seller of a used car has more information about its quality than the buyer

automatic stabilizer
expenditure that automatically increases or tax that automatically decreases when economic conditions worsen, and that, therefore, tends to stabilize the economy automatically

average cost
total costs divided by total output

average tax rate
the ratio of taxes to taxable income

average variable costs
total variable costs divided by total output

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Glossary - B

backward induction
see rollback

basic competitive model
the model of the economy that pulls together the assumptions of self-interested consumers, profit-maximizing firms, and perfectly competitive markets

basic research
fundamental research; it often produces a wide range of applications, but the output of basic research itself usually is not of direct commercial value. The output is knowledge, rather than a product; it typically cannot be patented.

beggar-thy-neighbor policies
restrictions on imports designed to increase a country’s national output, so-called because they increase that country’s output while simultaneously hurting the output of other countries

benefit taxes
taxes that are levied on a particular product, the revenues of which go for benefits to those who purchase the product

Bertrand competition
an oligopoly in which each firm believes that its rivals are committed to keeping their prices fixed and that customers can be lured away by offering lower prices

bilateral trade
trade between two parties

block grants
grants to states, which are given considerable discretion in how the money is spent

boom
a period of time when resources are being fully used and GDP is growing steadily

borrowed reserves
the reserves that banks have borrowed from the Fed

budget constraints
the limitations on consumption of different goods imposed by the fact that households have only a limited amount of money to spend (their budget). The budget constraint defines the opportunity set of individuals, when the only constraint that they face is money.

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Glossary - C

capital deepening
an increase in capital per worker

capital gain
the increase in the value of an asset between the time it is purchased and the time it is sold

capital goods investment
investment in machines and buildings (to be distinguished from investments in inventory, in research and development, or in training [human capital])

capital goods
the machines and buildings firms invest in, with funds from the capital market

capital inflows
money from abroad that is used to buy investments, to be deposited in U.S. banks, to buy U.S. government bonds, or to be lent in the United States for any reason

capital market
the various institutions concerned with raising funds and sharing and insuring risks, including banks, insurance markets, bond markets, and the stock market

capital outflows
money from the United States that is used to buy foreign investments or foreign government bonds, to be deposited in foreign banks or lent in foreign countries for any reason

cartel
a group of producers with an agreement to collude in setting prices and output

causation
the relationship that results when a change in one variable is not only correlated with but actually produces a change in another variable; the change in the second variable is a consequence of the change in the first variable, rather than both changes being a consequence of a change in a third variable

central planning
the system in which central government bureaucrats (as opposed to private entrepreneurs or even local government bureaucrats) determine what will be produced and how it will be produced

certificate of deposit (CD)
an account in which money is deposited for a preset length of time and yields a slightly higher return to compensate for the reduced liquidity

chain-weighted real GDP
the method of calculating real GDP in which the percentage increase in output from each year to the next is calculated by comparing the value of output of both years in the earlier year’s prices

circular flow
the way in which funds move through the capital, labor, and product markets between households, firms, the government, and the foreign sector

classical dichotomy
the independence of real variables from changes in nominal variables

closed economy
an economy that neither exports nor imports

Coase’s theorem
the assertion that, if property rights are properly defined, then people will be forced to pay for any negative externalities they impose on others and market transactions will produce efficient outcomes

collusion
when firms act jointly (more nearly as they would if there were a monopolist) to increase overall profits

command-and-control approach
the approach to controlling environmental externalities in which the government provides detailed regulations about what firms can and cannot do, including what technologies they can employ

commercial policies
policies directed at affecting either imports or exports

comparative advantage
a country has a comparative advantage over another country in one good as opposed to another good if its relative efficiency in the production of the first good is higher than the other country’s.

compensating wage differentials
differences in wages that can be traced to nonpecuniary attributes of a job, such as the degree of autonomy and risk

complement
two goods are complements if the demand for one (at a given price) decreases as the price of the other increases

constant returns to scale
a production function has constant returns to scale when equiproportionate increases in all inputs increase output proportionately.

constant, diminishing, or increasing returns to scale
when all inputs are increased by a certain proportion, output increases in equal, smaller, or greater proportion, respectively; increasing returns to scale are also called economies of scale

consumer price index
a price index in which the basket of goods is defined by what a typical consumer purchases

consumer protection legislation
laws aimed at protecting consumers, for instance by assuring that consumers have more complete information about items they are considering buying

consumer sovereignty
the idea that individuals are the best judges of what is in their own interests and promotes their well-being

consumer surplus
the difference between what a person would be willing to pay and what he actually has to pay to buy a certain amount of a good

contingency clauses
statements within a contract that make the level of payment or the work to be performed conditional upon various factors

corporation income taxes
taxes based on the income, or profit, received by a corporation

correlation
the relationship that results when a change in one variable is consistently associated with a change in another variable

countercyclical policies
policies designed to keep the economy at full employment by smoothing out fluctuations

countervailing duties
duties (tariffs) that are imposed by a country to counteract subsidies provided to a foreign producer

Cournot competition
an oligopoly in which each firm believes that its rivals are committed to a certain level of production and that rivals will reduce their prices as needed to sell that amount

credit channel
effect of monetary policy on output through its effect on credit availability

credit rationing
credit is rationed when no lender is willing to make a loan to a borrower or the amount lenders are willing to lend to borrowers is limited, even if the borrower is willing to pay more than other borrowers of comparable risk who are getting loans

cross subsidization
the practice of charging higher prices to one group of consumers in order to subsidize lower prices for another group

crowding out
a decrease in private investment resulting from an increase in government expenditures

currency board
a system in which the exchange rate between the local currency and foreign currency is fixed by law

cyclical unemployment
the increase in unemployment that occurs as the economy goes into a slowdown or recession

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Glossary - D

dead weight loss
the difference between what producers gain and (the monetary value of) what consumers lose, when output is restricted under imperfect competition; also, the difference between what the government gains and what consumers lose, when taxes are imposed

deflation
a persistent decrease in the general level of prices

demand curve
the relationship between the quantity demanded of a good and the price, whether for an individual or for the market (all individuals) as a whole

demand deposits
deposits that can be drawn upon instantly, like checking accounts

demand
the quantity of a good or service that a household or firm chooses to buy at a given price

demographic effects
effects that arise from changes in characteristics of the population such as age, birthrates, and location

depreciation
(a) the decrease in the value of an asset; in particular, the amount that capital goods decrease in value as they are used and become old; (b) a change in the exchange rate that enables a unit of one currency to buy fewer units of foreign currencies

depression
a strong downward fluctuation in the economy that is more severe than a recession

devaluation
a reduction in the rate of exchange between one currency and other currencies under a fixed exchange-rate system

developed countries
the wealthiest nations in the world, including Western Europe, the United States, Canada, Japan, Australia, and New Zealand

diminishing marginal utility
the principle that says that as an individual consumes more and more of a good, each successive unit increases her utility, or enjoyment, less and less

diminishing returns to scale
the principle that as one input increases, with other inputs fixed, the resulting increase in output tends to be smaller and smaller

discouraged workers
workers who would be willing to work but have given up looking for jobs and thus are not officially counted as unemployed

discretion
the ability to make explicit policy decisions in response to macroeconomic conditions

discretionary spending
government expenditures that are decided on an annual basis

distribution
the allocation of goods and services produced by the economy

diversification
spreading one’s wealth among a large number of different assets

dividends
that portion of corporate profits paid out to shareholders

division of labor
dividing a production process into a series of jobs, with each worker focusing on a limited set of tasks; the advantage of division of labor is that each worker can practice and perfect a particular set of skills.

dollarization
abandonment of the domestic currency in favor of the U.S. dollar

dominant strategy
strategy that works best no matter what the other player does in a game

dual economies
separations in many less developed countries (LDCs) between impoverished rural sectors and urban sectors that have higher wages and more advanced technology

dual use
technologies that have both a civilian and a military use

dumping
the practice of selling a good abroad at a lower price than at home, or below costs of production

dynamic efficiency
an economy that appropriately balances short-run concerns (static efficiency) with long-run concerns (focusing on encouraging R & D)

dynamic inconsistency
the problem of whether a government will actually carry out a promised course of action

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Glossary - E

earned income tax credit
a reduction in taxes provided to low income workers based on the amount of income they earn and the size of their family

economic rent
payments made to a factor of production that are in excess of what is required to elicit the supply of that factor

economies of scope
the situation that exists when it is less expensive to produce two products together than it would be to produce each one separately

efficiency wage theory
the theory that paying higher wages (up to a point) lowers total production costs, for instance by leading to a more productive labor force

efficiency wage
the wage at which total labor costs are minimized

efficient market theory
the theory that all available information is reflected in the current price of an asset

entitlements
programs that provide benefits automatically to individuals meeting certain criteria (such as age)

entry deterrence
the reduction of competition by preventing other firms from entering the market

entry-deterring practices
practices of incumbent firms designed to discourage the entry of rivals into the market

equilibrium price
the price at which demand equals supply

equilibrium quantity
the quantity demanded and supplied at the equilibrium price, where demand equals supply

equilibrium
a condition in which there are no forces (reasons) for change

European Union
an important regional trade bloc that now covers most of Europe

excess demand
the situation in which the quantity demanded at a given price exceeds the quantity supplied

excess reserves
reserves that banks hold beyond what is required

excess supply
the situation in which the quantity supplied at a given price exceeds the quantity demanded

exchange efficiency
the condition in which whatever the economy produces is distributed among people in such a way that there are no gains to further trade

exchange rate
the rate at which one currency (such as dollars) can be exchanged for another (such as euros, yen, or pounds)

exchange
the act of trading that forms the basis for markets

excise taxes
taxes on a particular good or service

expansions
a period in which real GDP is growing

expected return
the average return—a single number that combines the various possible returns per dollar invested with the chances that each of these returns will actually be paid

experimental economics
the branch of economics which analyzes certain aspects of economic behavior in a controlled, laboratory setting

export-led growth
the strategy that government should encourage exports in which the country has a comparative advantage to stimulate growth

exports
goods produced domestically but sold abroad

externality
a phenomenon that arises when an individual or firm takes an action but does not bear all the costs (negative externality) or receive all the benefits (positive externality)

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Glossary - F

factor demand
the amount of an input demanded by a firm, given the price of the input and the quantity of output being produced; in a competitive market, an input will be demanded up to the point where the value of the marginal product of that input equals the price of the input.

federal funds market
the market through which banks borrow and lend reserves

federal funds rate
the interest rate on overnight interbank loans

Federal Open Market Committee (FOMC)
the committee of the Federal Reserve System that sets monetary policy

financial investment
investment in stocks, bonds, or other financial instruments; these investments provide the funds that allow investments in capital goods.

fiscal deficit
the gap between the government’s expenditures and its revenues from sources other than additional borrowing

fiscal surplus
the amount by which government tax revenues exceed expenditures

fixed costs
the costs resulting from fixed inputs, sometimes called overhead costs

fixed exchange-rate system
an exchange rate system in which the value of each currency is fixed in relationship to other currencies

flexible or floating exchange-rate system
a system in which exchange rates are determined by market forces, the law of supply and demand, without government interference

flows
variables such as the output of the economy per year; stocks are in contrast to flows; flows measure the changes in stocks over a given period of time.

four-firm concentration ratio
the fraction of output produced by the top four firms in an industry

fractional reserve system
the system of banking in which banks hold a fraction of the amount on deposit in reserves

free trade
trade among countries that occurs without barriers such as tariffs or quotas

free-rider
someone who enjoys the benefit of a (public) good without paying for it; because it is difficult to preclude anyone from using a pure public good, those who benefit from the goods have an incentive to avoid paying for them (that is, to be a free-rider).

frictional unemployment
unemployment associated with people moving from one job to another or moving into the labor force

fringe benefits
compensation that is not in the form of direct cash to a worker, such as health insurance, retirement pay, and life insurance

full-employment deficit
what the deficit would be if the economy were at full employment

full-employment level of output
the level of output that the economy can produce under normal circumstances with a given stock of plant and equipment and a given supply of labor

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Glossary - G

gains from trade
the benefits that each side enjoys from a trade

game table
table showing the payoffs to each player of a game

game theory
theory designed to understand strategic choices, that is, to understand how people or organizations behave when they expect their actions to influence the behavior of others

game tree
diagram used to represent sequential games

GDP deflator
a weighted average of the prices of different goods and services, where the weights represent the importance of each of the goods and services in GDP

General Agreement on Tariffs and Trade (GATT)
the agreement among the major trading countries of the world that created the framework for lowering barriers to trade and resolving trade disputes; established after World War II, it has been succeeded by the World Trade Organization (WTO).

general equilibrium analysis
a simultaneous analysis of all capital, product, and labor markets throughout the economy; it shows, for instance, the impact on all prices and quantities of immigration or a change in taxes.

general equilibrium
the full equilibrium of the economy, when all markets clear simultaneously

gift and estate taxes
taxes imposed on the transfers of wealth from one generation to another

globalization
the closer integration of the countries of the world—especially the increased level of trade and movements of capital—brought on by lower costs of transportation and communication

green GDP
a measurement of national output that attempts to take into account effects on the environment and natural resources

green revolution
the invention and dissemination of new seeds and agricultural practices that led to vast increases in agricultural output in less developed countries (LDCs) during the 1960s and 1970s

gross domestic product (GDP)
the total money value of all final goods and services produced within a nation’s borders during a given period of time

gross national product (GNP)
a measure of the incomes of residents of a country, including income they receive from abroad but subtracting similar payments made to those abroad

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Glossary - H

horizontal equity
the principle that says that those who are in identical or similar circumstances should pay identical or similar amounts in taxes

horizontal merger
a merger between two firms that produce the same goods

human capital
the stock of accumulated skills and experience that make workers more productive

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Glossary - I

imperfect competition
any market structure in which there is some competition but firms face downward-sloping demand curves

imperfect information
a situation in which market participants lack information (such as information about prices or characteristics of goods and services) important for their decision making

imperfect substitutes
goods that can substitute for each other, but imperfectly so

implicit labor contract
an unwritten understanding between employer and employees that employees will receive a stable wage throughout fluctuating economic conditions

import function
the relationship between imports and national income

imports
goods produced abroad but bought domestically

incentives
benefits, or reduced costs, that motivate a decision maker in favor of a particular choice

income approach
the approach to calculating GDP that involves measuring the income generated to all of the participants in the economy

income effect
the reduced consumption of a good whose price has increased that is due to the reduction in a person’s buying power, or "real" income; when a person’s real income is lower, normally she will consume less of all goods, including the higher-priced good.

income elasticity of demand
the percentage change in quantity demanded of a good as the result of a 1 percent change in income (the percentage change in quantity demanded divided by the percentage change in income)

income-expenditure analysis
the analysis that determines equilibrium output by relating aggregate expenditures to income

incomplete markets
situations in which no market may exist for some good or for some risk, or in which some individuals cannot borrow for some purposes

increasing returns to scale
the principle that as one input increases, with other inputs fixed, the resulting increase in output is larger and larger

individual income taxes
taxes based on the income received by an individual or household

industrial policies
government policies designed to promote particular sectors of the economy

industrialized countries
see developed countries

infant industry argument for protection
the argument that industries must be protected from foreign competition while they are young, until they have a chance to acquire the skills to enable them to compete on equal terms

inferior good
a good the consumption of which falls as income rises

infinite elasticity
the situation that exists when any amount will be demanded (supplied) at a particular price, but nothing will be demanded (supplied) if the price increases (declines) even a small amount

inflation shocks
events that produce temporary shifts in the SRIA curve

inflation targeting
policies designed to stabilize the economy through countercyclical policies while ensuring that average inflation remains low

inflation
the rate of increase of the general level of prices

information
the basis of decision making that can affect the structure of markets and their ability to use society’s scarce resources efficiently

infrastructure
the roads, ports, bridges, and legal system that provide the necessary basis for a working economy

intellectual property
proprietary knowledge, such as that protected by patents and copyright

interest-rate parity condition
a condition assuming perfect capital mobility where expected returns are equal across countries in equilibrium

interest
the return a saver receives in addition to the original amount she deposited (loaned) and the amount a borrower must pay in addition to the original amount he borrowed

inventory investment
firms’ investment in raw materials or output on hand

investment function
the relationship between the level of real investment and the value of the real interest rate; also called the investment schedule

investment
from the national perspective, an increase in the stock of capital goods or any other expenditure designed to increase future output; from the perspective of the individual, any expenditure designed to increase an individual’s future wealth, such as the purchase of a share in a company. (Since some other individual is likely selling the share, that person is disinvesting, and the net investment for the economy is zero.)

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Glossary - J

job discrimination
discrimination in which disadvantaged groups have less access to better paying jobs

joint products
products that are naturally produced together, such as wool and mutton

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Glossary - L

labor force participation decision
the decision by an individual to seek work actively, that is, to participate in the labor market

labor force participation rate
the fraction of the working-age population that is employed or seeking employment

labor market
the market in which services of workers are bought and sold

land reform
the redistribution of land by the government to those who actually work the land

law of supply and demand
the law in economics that holds that, in equilibrium, prices are determined so that demand equals supply; changes in prices thus reflect shifts in the demand or supply curves.

learning by doing
the increase in productivity that occurs as a firm gains experience from producing and that results in a decrease in the firm’s production costs

learning curve
the curve describing how costs of production decline as cumulative output increases over time

less developed countries (LDCs)
the poorest nations of the world, including much of Africa, Latin America, and Asia

life-cycle saving
saving that is motivated by a desire to smooth consumption over an individual’s lifetime and to meet special needs that arise in various times of life; saving for retirement is the most important aspect of life-cycle saving.

liquidity
the ease with which an investment can be turned into cash

loanable funds market
the market in which the supply of funds is allocated to those who wish to borrow; equilibrium requires that saving (the supply of funds) equals investment (the demand for funds).

long run
a length of time sufficient to allow wages and prices to fully adjust to equilibrate supply and demand

long-run aggregate supply curve
the aggregate supply curve that applies in the long run, when wages and prices can adjust fully to ensure full employment

long-run inflation adjustment curve
curve depicting the relationship between the inflation rate and output in the long run, with full adjustment of inflationary expectations

luxury taxes
excise taxes imposed on luxuries, goods typically consumed disproportionately by the wealthy

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Glossary - M

M1, M2, M3
measures of the money supply: M1 includes currency and checking accounts; M2 includes M1 plus savings deposits, CDs, and money market funds; M3 includes M2 plus large-denomination savings deposits and institutional money-market mutual funds.

macroeconomics
the top-down view of the economy, focusing on aggregate characteristics

managed care
a health care system in which the health care provider, in return for a fixed fee per year, manages the care of the individual, including decisions about whether a specialist is required

managerial slack
the lack of managerial efficiency (for instance, in cutting costs) that occurs when firms are insulated from competition

marginal benefits
the extra benefits resulting, for instance, from the increased consumption of a commodity

marginal cost
the additional cost corresponding to an additional unit of output produced

marginal product
the amount output increases with the addition of one unit of an input

marginal propensity to consume
the amount by which consumption increases when income increases by a dollar

marginal propensity to import
the amount by which imports increase when income increases by a dollar

marginal propensity to save
the amount by which savings increase when income increases by a dollar

marginal rate of transformation
the amount of extra production of one good that one obtains from reducing the production of another good by one unit, moving along the production possibilities curve

marginal revenue
the extra revenue received by a firm for selling one additional unit of a good

marginal tax rate
the extra tax that will have to be paid as a result of an additional dollar of income

marginal utility
the extra utility, or enjoyment, a person receives from the consumption of one additional unit of a good

market clearing price
the price at which supply equals demand, so there is neither excess supply nor excess demand

market demand curve
the total amount of a particular good or service demanded in the economy at each price; it is calculated by "adding horizontally" the individual demand curves (that is, at any given price, it is the sum of the individual demands).

market economy
an economy that allocates resources primarily through the interaction of individuals (households) and private firms

market failures
situations in which a market economy fails to attain economic efficiency

market structure
term used to describe the organization of the market, such as whether there is a high degree of competition, a monopoly, an oligopoly, or monopolistic competition

market supply curve
the total amount of a particular good or service that all the firms in the economy together would like to supply at each price; it is calculated by "adding horizontally" the individual firm’s supply curves (that is, it is the sum of the amounts each firm is willing to supply at any given price).

marketable permits
a permit issued by the government, which can be bought and sold, that allows a firm to emit a certain amount of pollution

matching programs
programs in which federal outlays depend on state expenditures

medium of exchange
an item that can be commonly exchanged for goods and services throughout the economy

merit goods
goods that are determined by government to be good for people, regardless of whether people desire them for themselves or not

microeconomics
the bottom-up view of the economy, focusing on individual households and firms

monetary policy rule
the systematic relationship between the central bank’s setting of policy and the variables that it reacts to, such as inflation, cyclical unemployment, or the output gap

money multiplier
the amount by which a new deposit into the banking system (from the outside) is multiplied as it is loaned out, redeposited, reloaned, etc., by banks

money
any item that serves as a medium of exchange, a store of value, and a unit of account

monopolistic competition
the form of imperfect competition in which the market has sufficiently few firms that each one faces a downward-sloping demand curve, but enough that each can ignore the reactions of rivals to what it does

monopoly rents
see pure profit

monopoly
a market consisting of only one firm

moral hazard
the principle that says that those who purchase insurance have a reduced incentive to avoid what they are insured against

multilateral trade
trade between more than two parties

multiplier
the amount equilibrium output increases when the aggregate expenditures schedule shifts by a dollar

mutual fund
a fund that gathers money from different investors and purchases a range of assets; each investor then owns a portion of the entire fund.

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Glossary - N

Nash equilibrium
game equilibrium when both players execute their dominant strategies (that is, neither player would change his strategy if offered the chance to do so at the end of the game).

natural endowments
a country’s natural resources, such as good climate, fertile land, or minerals

natural monopoly
a monopoly that exists because average costs of production are declining beyond the level of output demanded in the market, thus making entry unprofitable and making it efficient for there to be a single firm

natural rate of unemployment
the unemployment rate when the economy is at potential GDP and cyclical unemployment is zero

net capital inflows
total capital inflows minus total capital outflows

net domestic product (NDP)
GDP minus the value of the depreciation of the country’s capital goods

neutrality of the money supply
the idea that changing the money supply has no real effects on the economy, which is a basic implication of the full-employment model

newly industrialized countries (NICs)
nations that have recently moved from being quite poor to being middle-income countries, including South Korea, Taiwan, Singapore, and Hong Kong

nominal GDP
the value of gross domestic product in a particular year measured in that year’s prices

nominal rate of interest
the percentage return on a deposit, loan, or bond; the nominal rate of interest does not take into account the effects of inflation.

nominal wage
the average wage not adjusted for changes in the prices of consumer goods

nonaccelerating inflation rate of unemployment (NAIRU)
the unemployment rate at which expected and actual inflation are equal and inflation remains stable

nonborrowed reserves
the difference between total reserves and borrowed reserves

nondiscretionary spending
expenditures that are determined automatically, such as interest payments and expenditures on entitlements

nonpecuniary attributes
aspects of a job other than the wage it pays

nonrival goods
goods whose consumption or use by one person does not exclude consumption by another person

nontariff barriers
barriers to trade that take forms other than tariffs (such as regulations which disadvantage foreign firms)

normal good
a good the consumption of which rises as income rises

normative economics
economics in which judgments about the desirability of various policies are made; the conclusions rest on value judgments as well as facts and theories.

North American Free Trade Agreement (NAFTA)
the agreement between Canada, the United States, and Mexico that lowered trade and other barriers among the countries

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Glossary - O

oligopoly
the form of imperfect competition in which the market has several firms, sufficiently few that each one must take into account the reactions of rivals to what it does

open economy
an economy that is actively engaged in international trade

open-market operations
central banks’ purchase or sale of government bonds in the open market

operating procedures
the manner in which a central bank chooses to implement monetary policy

opportunity cost
the cost of a resource, measured by the value of the next-best, alternative use of that resource

opportunity set
a summary of the choices available to individuals, as defined by budget constraints and time constraints

output gap
the percentage deviation of actual GDP from potential

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Glossary - P

Pareto efficient
a resource allocation is said to be Pareto efficient if there is no rearrangement that can make anyone better off without making someone else worse off.

partial equilibrium analysis
an analysis that focuses on only one or a few markets at a time

patent
a government decree giving an inventor the exclusive right to produce, use, or sell an invention for a period of time

payroll taxes
taxes based on payroll (wages) that is used to finance the Social Security and Medicare programs

perfect competition
a situation in which each firm is a price taker—it cannot influence the market price; at the market price, the firm can sell as much as it wishes, but if it raises its price, it loses all sales.

perfectly mobile capital
capital that responds quickly to changes in returns in different countries

Phillips curve
the trade-off between unemployment and inflation such that a lower level of unemployment is associated with a higher level of inflation

piece-rate system
a compensation system in which workers are paid specifically for each item produced

plant and equipment investment
purchases by firms of new capital goods

portfolio channel
effect of monetary policy on output through its effect on prices of various assets, in particular the prices of stocks

portfolio
an investor’s entire collection of assets and liabilities

positive economics
economics that describes how the economy behaves and predicts how it might change—for instance, in response to some policy change

positive externalities
phenomena that occur when an individual or firm takes an action but does not receive all the benefits

potential GDP
a measure of what the value of GDP would be if the economy’s resources were fully employed

present discounted value
how much an amount of money to be received in the future is worth right now

price ceiling
a maximum price above which market prices are not legally allowed to rise

price discrimination
the practice of a firm charging different prices to different customers or in different markets

price dispersion
a situation that occurs when the same item is sold for different prices by different firms

price elasticity of demand
the percentage change in quantity demanded of a good as the result of a 1 percent change in price (the percentage change in quantity demanded divided by the percentage change in price)

price elasticity of supply
the percentage change in quantity supplied of a good as the result of a 1 percent change in price (the percentage change in quantity supplied divided by the percentage change in price)

price floor
a minimum price below which market prices are not legally allowed to fall

price system
the economic system in which prices are used to allocate scarce resources

price taker
firms that take the price for the good or service they sell as given; the price is unaffected by their level of production.

price-level targeting
a rarely adopted policy designed to achieve a stable price level

price
the price of a good or service is what must be given in exchange for the good.

primary surplus
the sum of the measured surplus and interest payments on the debt

principal
the original amount a saver deposits in a bank (lends) or a borrower borrows

prisoner’s dilemma
a situation in which the noncooperative pursuit of self-interest by two parties makes them both worse off

private marginal cost
the marginal cost of production borne by the producer of a good; when there is a negative externality, such as air pollution, private marginal cost is less than social marginal cost.

private property
ownership of property (or other assets) by individuals or corporations; under a system of private property, owners have certain property rights, but there may also be legal restrictions on the use of property.

privatization
the process whereby functions that were formerly undertaken by government are delegated instead to the private sector

producer price index
a price index that measures the average level of producers’ prices

producer surplus
the difference between the price for which a producer would be willing to provide a good or service and the actual price at which the good or service is sold

product differentiation
the fact that similar products (like breakfast cereals or soft drinks) are perceived to differ from one another and thus are imperfect substitutes

product market
the market in which goods and services are bought and sold

product-mix efficiency
the condition in which the mix of goods produced by the economy reflects the preferences of consumers

production efficiency
the condition in which firms cannot produce more of some goods without producing less of other goods; the economy is on its production possibilities curve.

production function
the relationship between the inputs used in production and the level of output

production possibilities curve
a curve that defines the opportunity set for a firm or an entire economy and gives the possible combination of goods (outputs) that can be produced from a given level of inputs

production possibilities
the combination of outputs of different goods that an economy can produce with given resources

profits
total revenues minus total costs

progressive
describes a tax in which the rich pay a larger fraction of their income than the poor

property rights
the rights of an owner of private property; these typically include the right to use the property as she sees fit (subject to certain restrictions, such as zoning) and the right to sell it when and to whom she sees fit.

property taxes
taxes based on the value of property

protectionism
the policy of protecting domestic industries from the competition of foreign-made goods

public good
a good, such as national defense, that costs little or nothing for an extra individual to enjoy and the costs of preventing any individual from the enjoyment of which are high; public goods have the properties of nonrivalrous consumption and nonexcludability.

pure profit
the profit earned by a monopolist that results from its reducing output and increasing the price from the level at which price equals marginal cost; also called monopoly rents

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Glossary - Q

quantity equation of exchange
the equation MV = PY, which summarizes the relationship between the amount of money individuals wish to hold and the dollar value of transactions

quota rents
profits that result from the artificially created scarcity of quotas and accrue to firms that are allocated the rights to import

quotas
limits on the amount of foreign goods that can be imported

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Glossary - R

random walk
a term used to describe the way the prices of stocks move; the next movement cannot be predicted on the basis of previous movements.

rational choice
a process in which individuals weigh the costs and benefits of each possibility and in which the choices made are those within the opportunity set that maximizes net benefits

rational expectations
expectations based on an understanding of the structure of the economy and fully using all available information about the economy

rationing systems
any system of allocating scarce resources, applied particularly to systems other than the price system; rationing systems include rationing by coupons and rationing by queues.

real exchange rates
exchange rate adjusted for changes in the relative price levels in different countries

real GDP
the real value of all final goods and services produced in the economy, measured in dollars adjusted for inflation

real investment
the investment that is part of aggregate expenditures, such as the purchase of new factories and machines

real product wage
the wage divided by the price of the good being produced

real rate of interest
the real return to saving, equal to the nominal rate of interest minus the rate of inflation

real wage
the average wage adjusted for changes in the prices of consumer goods

recession
two consecutive quarters of a year during which GDP falls

regional trade blocs
immediate neighbors that not only agree to eliminate trading barriers, but also to facilitate the flow of capital and labor

regressive
describes a tax in which the poor pay a larger fraction of their income than the rich

regulatory capture
a term used to describe a situation in which regulators serve the interests of the regulated rather than the interests of consumers

relative price
the ratio of any two prices; the relative price of CDs and DVDs is just the ratio of their prices.

relatively elastic
a good is said to be relatively elastic when the price elasticity of its demand is greater than unity.

relatively inelastic
a good is said to be relatively inelastic when the price elasticity of its demand is less than unity.

rent seeking
the name given to behavior that seeks to obtain benefits from favorable government decisions, such as protection from foreign competition

repeated games
games that are played many times over by the same players

reputation
the "good will" of a firm resulting from its past performance; maintaining one’s reputation provides an incentive to maintain quality.

reservation wage
the wage below which an individual chooses not to participate in the labor market

residential investment
households’ purchases of new homes

restrictive practices
practices of oligopolists designed to restrict competition, including vertical restrictions like exclusive territories

retained earnings
that part of the net earnings of the firm that are not paid out to shareholders, but kept by the firm

revenue curve
the relationship between a firm’s total output and its revenues

revenues
the amount a firm receives for selling its products, equal to the price received multiplied by the quantity sold

right-to-work laws
laws that prevent union membership from being a condition of employment

risk aversion
the avoidance of bearing risk

rival goods
goods whose consumption or use by one person excludes consumption by another person

rollback
approach of starting from the end of the game and working backward to determine the best strategy, often used for strategic interactions that occur a repeated but fixed number of times

royalty
a fee charged by a patent holder that allows others to use its patent

rules
automatic adjustments of policy in response to macroeconomic conditions

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Glossary - S

sales tax
a tax imposed on the purchase of goods and services

scarcity
term used to describe the limited availability of resources, so that if no price were charged for a good or service, the demand for it would exceed its supply

search
the process by which consumers gather information about what is available in the market, including prices, or by which workers gather information about the jobs that are available, including wages

seasonal unemployment
unemployment that varies with the seasons, such as that associated with the decline in construction in winter

sequential game
a game in which players take turns and each can observe what choices were made in earlier moves

sharecropping
an arrangement, prevalent in many less-developed countries (LDCs) in which a worker works land, giving the landowner a fixed share of the output

short run
a length of time during which wages and prices do not fully adjust to equilibrate supply and demand

short-run aggregate production function
the relationship between output and employment in the short run, that is, with a given set of machines and buildings

short-run inflation adjustment curve
positively sloped curve that shows the rate of inflation at each level of output relative to potential GDP, for a given expected rate of inflation

short-run inflation-unemployment tradeoff
the trade-off between low unemployment and stable inflation in the short run occurring when low unemployment forces nominal wages to increase faster than productivity

shortage
a situation in which demand exceeds supply at the current price

signal
to convey information, for example a prospective worker’s earning a college degree to persuade an employer that he has desirable characteristics that will enhance his productivity

sin taxes
excise taxes on alcohol and tobacco

slope
the amount by which the value along the vertical axis increases as the result of a change in one unit along the horizontal axis; the slope is calculated by dividing the change in the vertical axis (the "rise") by the change in horizontal axis (the "run")

social insurance
insurance provided by the government to individuals, for instance, against disabilities, unemployment, or health problems (for the aged)

social marginal cost
the marginal cost of production, including the cost of any negative externality, such as air pollution, borne by individuals in the economy other than the producer

Social Security trust fund
government trust fund that collects the difference between Social Security tax revenue and expenditures, which was created in anticipation of an increase in the number of beneficiaries

static efficiency
the efficiency of the economy with given technology; taxes used to finance basic research and monopoly power resulting from patents cause a loss in static efficiency

statistical discrimination
differential treatment of individuals of different gender or race that is based on the use of observed correlations (statistics) between performance and some observable characteristics; it may even result from the use of variables like education in which there is a causal link to performance.

sticky prices
prices that do not adjust or adjust only slowly toward a new equilibrium

sticky wages
wages that are slow to adjust in response to a change in labor market conditions

stocks
variables like the capital stock or the money supply stock, that describe the state of the economy (such as its wealth) at a point of time; they are contrasted by flows.

store of value
something that can be accepted as payment in the present and exchanged for items of value in the future

strategic behavior
decision making that takes into account the possible reactions of others

strategic trade theory
the theory that protection can give a country a strategic advantage over rivals, for instance by helping reduce domestic costs as a result of economies of scale

structural unemployment
long-term unemployment that results from structural factors in the economy, such as a mismatch between the skills required by newly created jobs and the skills possessed by those who have lost their jobs in declining industries

substitutes
two goods are substitutes if the demand for one increases when the price of the other increases.

substitution effect
the reduced consumption of a good whose price has increased that is due to the changed trade-off, the fact that one has to give up more of other goods to get one more unit of the high-priced good; the substitution effect is associated with a change in the slope of the budget constraint.

sunk costs
costs that have been incurred and cannot be recovered

supply curve
the relationship between the quantity supplied of a good and the price, whether for a single firm or the market (all firms) as a whole

supply shocks
unexpected shifts in the aggregate supply curve, such as an increase in the international price of oil or a major earthquake that destroys a substantial fraction of a country’s capital stock

supply siders
economists who emphasize the importance of aggregate supply, in particular the responsiveness of supply to lower taxes and regulations; some argue that lowering tax rates leads to such large increases in inputs of capital and labor that total tax revenues may actually increase.

supply
the quantity of a good or service that a household or firm would like to sell at a particular price

surplus of labor
a great deal of unemployed or underemployed labor, readily available to potential employers

surplus
the magnitude of the gain from trade, the difference between what an individual would have been willing to pay for a good and what she has to pay

sustainable development
development that is based on sustainable principles; sustainable development pays particular concern to environmental degradation and the exploitation of natural resources.

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Glossary - T

tariffs
taxes imposed on imports

tax expenditure
the revenue lost from a tax subsidy

tax subsidies
subsidies provided through the tax system to particular industries or to particular expenditures, in the form of favorable tax treatment

theory
a set of assumptions and the conclusions derived from those assumptions put forward as an explanation for some phenomena

thin markets
markets with relatively few buyers and sellers

time constraints
the limitations on consumption of different goods imposed by the fact that households have only a limited amount of time to spend (twenty-four hours a day); the time constraint defines the opportunity set of individuals if the only constraint that they face is time.

time inconsistency
a phenomenon that occurs when it is not in the best interest of a player to carry out a threat or promise that was initially designed to influence the other player’s actions

time value of money
the fact that a dollar today is worth more than a dollar in the future

total costs
the sum of all fixed costs and variable costs

total factor productivity analysis
the analysis of the relationship between output and the aggregate of all inputs; total factor productivity growth is calculated as the difference between the rate of growth of output and the weighted average rate of growth of inputs, where the weight associated with each input is its share in GDP.

trade creation
new trade that is generated as a result of lowered tariff barriers

trade deficit
the excess of imports over exports

trade diversion
trade that is diverted away from outside countries as a result of lowering tariffs between the members of a trading bloc

trade secret
an innovation or knowledge of a production process that a firm does not disclose to others

trade-offs
the amount of one good (or one desirable objective) that must be given up to get more of another good (or to attain more of another desirable objective)

transactions costs
the extra costs (beyond the price of the purchase) of conducting a transaction, whether those costs are money, time, or inconvenience

transfer programs
programs directly concerned with redistribution, such as AFDC, TANF, and Medicaid, that move money from one group in society to another

Treasury bills (T-bills)
short-term government bonds that are available only in large denominations

trusts
organizations that attempted to control certain markets in the late nineteenth century; they were designed to allow an individual or group owning a small fraction of the total industry to exercise control.

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Glossary - U

unemployment rate
the ratio of the number of people seeking employment to the total labor force

union shops
unionized firms in which all workers are required to join the union as a condition of employment

unit of account
something that provides a way of measuring and comparing the relative values of different goods

unitary elasticity
a demand curve has unitary elasticity if the demand for the commodity decreases by 1 percent when the price increases by 1 percent. If demand has unitary elasticity, then expenditures on the good do not depend at all on price. A supply curve has unitary elasticity if the supply of the commodity increases by 1 percent when the price increases by 1 percent.

utility
the level of enjoyment an individual attains from choosing a certain combination of goods

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Glossary - V

value added
the value added in each stage of production is the difference between the value of the output and the value of the inputs purchased from other firms

value of the marginal product of labor
the value of the extra output produced by an extra unit of labor; it is calculated by multiplying the marginal product of labor times the price of the good which is being produced.

variable costs
the costs resulting from variable inputs

velocity
the speed with which money circulates in the economy, defined as the ratio of income to the money supply

vertical equity
the principle, that people who are better off should pay more taxes

vertical merger
a merger between two firms, one of which is a supplier or distributor for the other

voluntary export restraints
restraints on exports that are self-imposed by an exporting country, although often in response to a threat that if such constraints are not imposed, the importing country will impose import quotes

voting paradox
the fact that under some circumstances there may be no determinate outcome with majority voting: choice A wins a majority over B, B wins over C, and C wins over A

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Glossary - W

wage discrimination
paying lower wages to women or minorities

World Trade Organization (WTO)
the organization established in 1995 as a result of the Uruguay round of trade negotiations; replacing GATT, it is designed to remove trade barriers and settle trade disputes

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Glossary - z

zero elasticity
the situation that exists when the quantity demanded (or supplied) will not change, regardless of changes in price