Glossary of Economics

ability-to-pay principle

The idea that taxes should be levied on a person according to how well that person can shoulder the burden.

abnormal profit

The profit over and above normal profit.

above the line, below the line

In the balance of payments, the items in the current account are above the line that divides them from the items in the financial account, which appear below the line.

absolute advantage

Exists where a producer can produce a good using fewer factor inputs than another.

absolute poverty

A level of poverty where an individual does not have access to the basics of life — food, clothing and shelter.

accounting cost

Actual expenses plus depreciation charges for capital equipment.

accounting profit

Total revenue minus total explicit cost.

actual return

Return that an asset earns.

actual spending, saving or investment

The realized or ex post outcome resulting from actions of households and firms..

actuarially fair

Characterizing a situation in which an insurance premium is equal to the expected payout.

ad valorem tax

A tax levied as a percentage of the price of a good.

adaptive expectations

(1) A backward-looking method of forming expectations by adjusting for past mistakes. (2) A model which states that individuals and organizations base their expectations of inflation in the future on past actual inflation rates.

adverse selection

(1) Where a principal knows more about their situation than the agent, leading to the agent preferring not to do business with the principal. (2) Form of market failure resulting when products of different qualities are sold at a single price because of asymmetric information, so that too much of the low-quality product and too little of the high-quality product are sold.

advertising elasticity of demand

Percentage change in quantity demanded resulting from a 1-percent increase in advertising expenditures.

advertising-to-sales ratio

Ratio of a firm's advertising expenditures to its sales.


A person who is performing an act for another person, called the principal.

aggregate demand curve

A curve that shows the quantity of goods and services that households, firms and the government want to buy at each price level.

aggregate output

The total amount of output produced in the economy.

aggregate private spending

The sum of all nongovernment spending. Also called .

aggregate production function

The relation between the quantity of aggregate output produced and the quantities of inputs used in production.

aggregate risk

Risk that affects all economic actors at once.

aggregate supply curve

A curve that shows the quantity of goods and services that firms choose to produce and sell at each price level.

allocative efficiency

A resource allocation where the value of the output by sellers matches the value placed on that output by buyers.

American Recovery and Reinvestment Act (ARRA)

The fiscal stimulus program introduced in February 2009 by the US administration.


Policy of treating a onetime expenditure as an annual cost spread out over some number of years.


The difference between peak and trough and trend output.


Inflation expectations if they do not respond to actual inflation.


Tendency to rely heavily on one prior (suggested) piece of information when making a decision.

animal spirits

A term introduces by Keynes to refer to movements in consumption or investment that could not be explained by movements in currency variables.

annual chain linking

A method of calculation GDP volume measures based on prices in the previous year.

antitrust laws

Rules and regulations prohibiting actions that restrain, or are likely to restrain, competition.

appreciation (nominal)

An increase in the value of domestic currency in terms of foreign currency. Corresponds to an increase in the exchange rate .

appropriability (of research results)

The extend to which firms benefit from the results of their research and development efforts.


(1) Practice of buying at a low price at one location and selling at a higher price in another. (2) The proposition that the expected rates of return on two financial assets must be equal. Also called to distinguish it from riskless arbitrage, the proposition that the actual rates of return on two financial assets must be the same.

arc elasticity of demand

Price elasticity calculated over a range of prices.


Something that provides a flow of money or services to its owner.

asset beta

A constant that measures the sensitivity of an asset's return to market movements and, therefore, the asset's nondiversifiable risk.

asymmetric information

Situation in which a buyer and a seller possess different information about a transaction.

asymmetric shocks

A situation where changes in aggregate demand and/or supply differ from one country to another.

auction market

Market in which products are bought and sold through formal bidding processes.

automatic stabilizers

The fact that a decrease in output leads, under given tax and spending rules, to an increase in the budget deficit. This increase in the budget deficit in turn increases demand and thus stabilized output.

automomous spending or autonomous expenditure

The component of the demand for goods that does not depend on the level of output/demand.

average expenditure

Price paid per unit of a good.

average expenditure curve

Supply curve representing the price per unit that a firm pays for a good.

average fixed cost

Fixed costs divided by the quantity of output.

average product

Output per unit of a particular input.

average revenue

Total revenue divided by the quantity sold.

average tax rate

Total taxes paid divided by total income.

average total cost

Total cost divided by the quantity of output.

average variable cost

Variable costs divided by the quantity of output.


A policy is backloaded if it is to be implemented in the future rather than in the present.

balance of payments

A set of accounts that summarize a country's transactions with the rest of the world.

balanced budget

Where the total sum of money received by a government in tax revenue and interest is equal to the amount if spends, including on any debt interest owing.

balanced growth

The situations in which output, capital, and effective labor all grow at the same rate.

balanced trade

A situation in which exports equal imports.


Upper and lower limits on exchange rate movements.

bandwagon effect

Positive network externality in which a consumer wishes to possess a good in part because others do.

bank reserves

Holdings of central bank money by banks. The difference between what banks receive from depositors and what they lend to firms or hold as bonds

bank run

Simultaneous attempts by depositors to withdraw their funds from a bank.

bargaining power

The relative strength of each side in a negotiation or a dispute.

bargaining process

An agreed outcome between two interested and competing economic agents.

barrier to entry

Condition that impedes entry by new competitors.

barriers to entry

Anything which prevents a firm from entering a market or industry.


The exchange of one good or service for another.

base year

When constructing real GDP by evaluation quantities in different years using a given set of prices, the year to which this given set of prices corresponds.

Basel II, Basel III

International accords about the regulation of the banking sector.

basis points

A basis point is a hundredth of a percent. An increase of the interest rate by 100 basis points is a 1% increase in the is rate.

behavioral equation

An equation that captures some aspect of behavior.

benefits principle

The idea that people should pay taxes based on the benefits they receive from government services.

Bertrand model

Oligopoly model in which firms produce a homogeneous good, each firm treats the price of its competitors as fixed, and all firms decide simultaneously what price to charge.

bilateral exchange rate

The real exchange rate between two countries.

bilateral monopoly

Market with only one seller and one buyer.

birth rate

The number of people born per thousand of the population.

block pricing

Practice of charging different prices for different quantities or "blocks" of a good.


(1) A certificate of indebtedness. (2) Contract in which a borrower agrees to pay the bondholder (the lender) a stream of money. (3) A financial asset that promises a stream of known payments over some period of time.

bond rating

The assessment of a bond based on its default risk.

borrowing rate

The rate at which consumers or firms can borrow from a financial institution.

bounded rationality

The idea that humans make decisions under the constraints of limited, and sometimes unreliable information.

bracket creep

The increase in the marginal tax rate faced by individuals as their nominal income goes up and tax brackets remain unchanged in nominal terms.

brain drain

The emigration of many of the most highly educated workers to rich countries.

brand proliferation

A strategy designed to deter entry to a market by producing a number of products within a product line as different brands.


The means by which a business creates an identity for itself and highlights the way in which it differs from its rivals.


An increase in the price of a good based not on the fundamentals of demand or value, but instead on a belief that the price will keep going up.

budget constraint

The limit on the consumption bundles that a consumer can afford.

budget deficit

Where government tax revenue is less than spending and the government has to borrow to finance spending.

budget line

All combinations of goods for which the total amount of money spent is equal to income.

budget surplus

Where government tax revenue is greater than spending because it receives more money than it spends.


Practice of selling two or more products as a package.

business cycle

Fluctuation in economic activity such as employment and production.

business cycle theory

The study of macroeconomic fluctuations.


The equipment and structures used to produce goods and services.

capital account

Net capital transfers to and from the rest of the world.

capital accumulation

Increase in the capital stock.

Capital Asset Pricing Model (CAPM)

Model in which the risk premium for a capital investment depends on the correlation of the investment's return with the return on the entire stock market.

capital controls

Restrictions on the foreign assets domestic residents can hold and on the domestic assets foreigners can hold.

capital flight

A large and sudden reduction in the demand for assets located in a country.

capital ratio

Ratio of the capital of a bank to its assets.

capitalist economic system

A system which relies on the private ownership of factors of production to produce goods and services which are exchanged through a price mechanism and where production is operated primarily for profit.

cardinal utility function

Utility function describing by how much one market basket is preferred to another.


Market in which some or all firms explicitly collude, coordinating prices and output levels to maximize joint profits.

cash flow

The net flow of cash a firm is receiving.

catch-up effect

The property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.


A relation between cause and effect.

central bank

An institution designed to regulate the quantity of money in the economy.

central bank money

Money issued by the central bank. Also know as the and money.

central parity

The reference value around which the exchange rate is allowed to move under a fixed exchange rate system. The center of the band.

ceteris paribus (other things being equal)

A term used to describe analysis where one variable in the model is allowed to vary while others are held constant.

chain-weighted price index

Cost-ofliving index that accounts for changes in quantities of goods and services.

change in business inventories

In the national income and product accounts, the change in the volume of inventories held by businesses.

checkable deposits

Deposits at banks and other financial institutions against which checks can be written.

choice set

The set of alternatives available to the consumer.


The concept that new goods make old goods obsolete, that new production techniques make older techniques and worker skills obsolete, and so on.

classical dichotomy

The theoretical separation of nominal and real variables.

club goods

Goods that are excludable but non-rival in consumption.

Coase theorem

Principle that when parties can bargain without cost and to their mutual advantage, the resulting outcome will be efficient regardless of how property rights are specified.

Cobb-Douglas production function

Production function of the form q = AKαLβ, where q is the rate of output, K is the quantity of capital, and L is the quantity of labor, and where A, α, and β are constants.

Cobb-Douglas utility function

Utility function U(X,Y) = XaY1 – a, where X and Y are two goods and a is a constant.

coincident indicator

An indicator whose changes occur at the same time as changes in economic activity.


The asset pledged in order to get a loan. In case of default, the asset goes to the lender.

collateralized debt obligation (CDO)

Security based of an underlying portfolio of assets.

collective bargaining

The process by which unions and firms agree on the terms of employment.


An agreement among firms in a market about quantities in produce or prices to charge.

commodity money

Money that takes the form of a commodity with intrinsic value.

common currency

The currency used in the countries that are members of a common currency area.

common currency area

A geographical area throughout which a single currency circulates as the medium of exchange.

common property resource

Resource to which anyone has free access.

common resources

Goods that are rival but not excludable.

common-value auction

Auction in which the item has the same value to all bidders, but bidders do not know that value precisely and their estimates of it vary.

company cost of capital

Weighted average of the expected return on a company's stock and the interest rate that it pays for debt.

comparative advantage

The comparison among producers of a good according to their opportunity costs. A producer is said to have a comparable advertising in the production of a good if the opportunity cost is lower than that of another producer.

comparative statics

The comparison on one initial static equilibrium with another.

compensating differential

A difference in wages that arises to offset the non-monetary characteristics of different jobs.

compensation of employees

In the national income and product accounts, the sum of wages and salaries and of supplements to wages and salaries.

competitive advantage

The advantages a firm has over rivals which are both distinctive and defensible.

competitive market

A market in which there are many buyers and sellers so that each has a negligible impact on the market price.


Two goods for which an increase in the price of one leads to a decrease in the demand for the other.

completely inelastic demand

Principle that consumers will buy a fixed quantity of a good regardless of its price.


The accumulation of a sum of money in, say, a bank account, where the interest earned remains in the account to earn additional interest in the future.

concentration ratio

The proportion of total market share accounted for by a particular number of firms.


A housing unit i.e. individually owned but provides access to common facilities that are paid for and controlled jointly by an association of owners.

confidence band

When estimating the dynamic effect of one variable on another, the range of values where we can be confident the true dynamic effect lies.

Congressional Budget Office (CBO)

An office of Congress in charge of constructing and publishing budget projections.

constant cost industry

Industry whose long-run supply curve is horizontal.

constant returns to scale

(1) The proposition that a proportional increase (or decrease) of all inputs leads to the same proportional increase (or decrease) in output. (2) The property whereby long-run average total cost stays the same as the quantity of output changes.

constrained discretion

A monetary policy framework which acknowledges a clear goal (or target) but allows policymakers the freedom to respond to economic, financial and political shocks using all the data available and their collective judgement.

Consumer Prices Index (CPI)

A measure of the overall prices of the goods and services bought by a typical consumer/urban dweller.

consumer surplus

Difference between what a consumer is willing to pay for a good and the amount actually paid.


Spending by households on goods and services, with the exception of purchases of new housing.

consumption function

A function that relates consumption to its determinants.

consumption of fixed capital

Depreciation of capital.

contestable market

A market in which entry and exit are free and costless.

contract curve

Curve showing all efficient allocations of goods between two consumers, or of two inputs between two production functions.


When real output is lower than the previous time period.

contractionary open market operation

An open market operation in which the central bank sells bonds to decrease the money supply.

conventional monetary policy

The use of the policy rate as the main instrument to affect economic activity.


The tendency for countries with lower output per capita to grow faster, leading to convergence of output per capita across countries.


Association of businesses or people jointly owned and operated by members for mutual benefit.

cooperative game

Game in which participants can negotiate binding contracts that allow them to plan joint strategies.


The right of an individual or organization to own things they create in the same way as a physical object, to prevent others from copying or reproducing the creation.

core inflation rate

Inflation rate excluding volatile prices, such as the prices of food and energy.

corner solution

Situation in which the marginal rate of substitution of one good for another in a chosen market basket is not equal to the slope of the budget line.

corporate bond

A bond issued by a corporation.

corporate profits and business transters

In the national income and product accounts, firm's revenues minus costs (including interest payments) and minus depreciation.


A measure of the way two variables move together. A positive correlation indicates that the two variables tend to move in the same direction. A negative correlation indicates that the two variables tend to move in opposite directions. A correlation of zero indicates that there is not apparent relation between the two variables.

corridor system

A monetary arrangement where the central bank sets two rates: a rate at which it lends to banks, and a lower rate at which banks can lend to the central bank.


The value of everything a seller must give up to produce a good.

cost function

Function relating cost of production to level of output and other variables that the firm can control.

cost of living

How much money people need to maintain standards of living in terms of the goods and services they can afford to buy.

cost-benefit analysis

A study that compares the costs and benefits to society of providing a public good.

cost-of-living index

Ratio of the present cost of a typical bundle of consumer goods and services compared with the cost during a base period.

cost-push inflation

A short-run cause of accelerating inflation due to higher input costs of firms which are passed on a higher consumers prices.


A variable i.e. below trend when GDP is above trend.

coupon bond

A bond that promises multiple payments before maturity and one payment at maturity.

coupon payments

The payments before maturity on a coupon bond.

coupon rate

The ratio of the coupon payment to the face value of a coupon bond.

Cournot equilibrium

Equilibrium in the Cournot model, in which each firm correctly assumes how much its competitor will produce and sets its own production level accordingly.

Cournot model

Oligopoly model in which firms produce a homogeneous good, each firm treats the output of its competitors as fixed, and all firms decide simultaneously how much to produce.

crawling peg

An exchange rate mechanism in which the exchange rate is allowed to move over time according to a prespecified formula.

creative destruction

(1) The process where new technologies replace old ones and new skills are needed which render existing skills obsolete. (2) The proposition that growth simultaneously creates and destroys jobs.


The degree to which people and markets believe that a policy announcement will actually be implemented and followed through.

credit default swap

A means by which a bondholder can insure against the risk of default.

credit easing

Monetary policy measures aimed at increasing the supply of credit by banks.

credit risk

The risk a bank faces in defaults on loans.


A situation where the allocation of resources in the market is determined in part by political decision-making and favours rather than by economic forces.

cross-price elasticity of demand

A measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good.


A situation where a firm is willing to accept lower profits or losses on some products to deter competition where these lower profits or losses are subsidized by higher profits made on other products in that same market.

crowding out

A decrease in investment that results from government borrowing.


The paper banknotes and coins in the hands of the public.

currency board

An exchange rate system in which (i) the central bank stands ready to buy or sell foreign currency at the official exchange rate, (ii) the central bank cannot engage in opne market operations, i.e., buy or sell government bonds.

current account

In the balance of payments, the summary of a country's payments to and from the rest of the world.

current account balance

The sum of net exports, net income, and net transfers from the rest of the world.

current account deficit

A negative current account balance.

current account surplus

A positive current account balance.

Current Population Survey (CPS)

A large monthly survey of US households used, in particular, o compute the unemployment rate.

current yield

The ratio of the coupon payment to the price of a coupon bond.

cyclical deficit

A situation when government spending and income is disrupted by the deviations in the 'normal' economic cycle.

cyclical industries

Industries in which sales tend to magnify cyclical changes in gross domestic product and national income.

cyclical unemployment

The deviation of unemployment from its natural rate.

cyclically adjusted deficit

A measure of what the government deficit would be under existing tax and spending rules, if output were at its natural level. Also called a , , , or .

de-merit goods

Goods that are over-consumed if left to the market mechanism and which generate both private and social costs which are not taken into account by the decision maker.

dead labor

Labor used in the past to produce capital goods and raw materials used in the production of a good.

deadweight loss

The fall in total surplus that results from a market distortion, such as a tax.

death rate

The number of deaths per thousand of the population.

debt finance

Financing based on loans or the issurance of bonds.

debt monetization

The printing of money by the central bank to finance a deficit.

debt rescheduling

The rescheduling of interest payments of payment of principal, typically to decrease current payments.

debt restructuring

A decrease in the value of a debt, through a decrease in the value of the principal, or a decrease in interest payments.

debt-to-GDP ratio

The ratio of debt to gross domestic product. Also called simply the .

decreasing returns to capital

The property that increases in capital lead to smaller and smaller increases in output as the level of capital increases.

decreasing returns to labor

The property that increases in labor lead to smaller and smaller increases in output as the level of labor increases.

decreasing returns to scale

Situation in which output less than doubles when all inputs are doubled. decreasing-cost industry Industry whose long-run supply curve is downward sloping.

default risk

The risk that debt will not be repaid in full.


A fall in the price level over a period occurring when the inflation rate is less than 0 percent.

deflation spiral

A mechanism through which deflation increases the real interest rate, which in turn leads to lower activity, and leads to further deflation, a further increase in the real interest rate, and so on.

deflation trap

The situation of a country subject to a deflation spiral.

deflationary gap or output gap

The difference between full employment output and expenditure when expenditure is less than full employment output.

degree of economies of scope (SC)

Percentage of cost savings resulting when two or more products are produced jointly rather than individually.

degrees of freedom

The number of usable observations in a regression minus the number of parameters to be estimated.

demand curve

Relationship between the quantity of a good that consumers are willing tobuy and the price of the good.

demand deposits

(1) A bank account that allows depositors to write checks or get cash on demand, up to an amount equal to the account balance. (2) Balances in bank accounts that depositors can access on demand by using a debit card.

demand for domestic goods

The demand for domestic goods by people, firms, and governments, both domestic and foreign. Equal to the domestic demand for goods plus net exports.

demand schedule

A table that shows the relationship between the price of a good and the quantity demanded.

dependent variable

A variable whose value is determined by one or more other variables.

depreciation (nominal)

A decrease in the value of domestic currency in terms of a foreign currency. Corresponds to a decrease in the exchange rate.


A severe recession.

derived demand

A situation where demand is determined by the supply in another market. Demand for an input that depends on, and is derived from, both the firm's level of output and the cost of inputs.

descount factor

The value today of a dollar (or other national currency unit) at some time in the future.

deterministic trends

Trends that are constant, positive or negative, independent of time for the series being analyzed.


A decrease in the exchange rate in a fixed exchange rate system.


Difference between expected payoff and actual payoff.

diminishing marginal product

The property whereby the marginal product of an input declines as the quantity of the input increases.

diminishing marginal utility

The tendency for the additional satisfaction from consuming extra units of a good to fall.

direct finance

Financing through markets, through the issuance of bonds or equities.

direct taxes

A tax levied on income and wealth.

discount bond

A bond that promises a single payment at maturity.

discount rate

(1) The interest rate used to discount a sequence of future payments. Equal to the nominal interest rate when discounting future nominal payments and to the real interest rate when discounting future real payments. (2) The international rate at which the Federal Reserve lends on a short-term basis to the US banking sector.

discouraged worker

A person who has given up looking for employment.


The offering of different opportunities to similar individuals who differ only by race, ethnic group, gender, age or other personal characteristics.

diseconomies of scale

The property whereby long-run average total cost rises as the quantity of output increases.

diseconomies of scope

Situation in which joint output of a single firm is less than could be achieved by separate firms when each produces a single product.


The reduction in the rate of inflation.

disposable income

The income that remains once consumers have received transfers from the government and paid their taxes.

diversifiable risk

Risk that can be eliminated either by investing in many projects or by holding the stocks of many companies.


Practice of reducing risk by allocating resources to a variety of activities whose outcomes are not closely related.


The portion of a corporation's profits that the firm pays out each period to its shareholders.

divine coincidence

The proposition that, if inflation remains stable, this is a signal that output is equal to potential output.


The use of dollars in domestic transactions in a countr other than the United States.

domestic demand for goods

The sum of consumption, investment, and government spending.

dominant firm

Firm with a large share of total sales that sets price to maximize profits, taking into account the supply response of smaller firms.

dominant strategy

A strategy i.e. best for a player in a game regardless of the strategies chosen by the other players.

double coincidence of wants

A situation in exchange where two parties each have a good or service that the other wants and can thus enter into an exchange.

double marginalization

When each firm in a vertical chain marks up its price above its marginal cost, thereby increasing the price of the final product.


Alternative way of looking at the consumer's utility maximization decision: Rather than choosing the highest indifference curve, given a budget constraint, the consumer chooses the lowest budget line that touches a given indifference curve.


Market in which two firms compete with each other.

durable goods

Commodities that can be stored and have an average life of at least three years.

duration of unemployment

The period of time during which a worker's unemployed.

Dutch auction

Auction in which a seller begins by offering an item at a relatively high price, then reduces it by fixed amounts until the item is sold.


Movements of one or more economic variables over time.

Easterlin paradox

The proposition that higher income in a country is not associated with higher levels of happiness.


Statistical methods applied to economics.

economic activity

How much buying and selling goes on in the economy over a period of time.

economic agents

An individual, firm or organization that has an impact in some way on an economy.

economic cost

Cost to a firm of utilizing economic resources in production.

economic efficiency

Maximization of aggregate consumer and producer surplus.

economic growth

The increase in the amount of goods and services in an economy over a period of time.

economic mobility

The movement of people among income classes.

economic profit

Total revenue minus total cost, including both explicit and implicit costs.

economic rent

Amount that firms are willing to pay for an input less the minimum amount necessary to obtain it.

economic system

The way in which resources are organized and allocated to provide for the needs of an economy's citizens.

economically inactive

People who are not in employment or unemployed due to reasons such as being in full-time education, being full-time carers and raising families.


The study of how society manages its scarce resources.

economies of scale

The property whereby long-run average total cost falls as the quantity of output increases.

economies of scope

(1) Situation in which joint output of a single firm is greater than output that could be achieved by two different firms when each produces a single product. (2) A situation where a firm's average cost of production is reduced as a result of the production of a variety of products which can share factor inputs.


All the production and exchange activities that take place.

Edgeworth box

Diagram showing all possible allocations of either two goods between two people or of two inputs between two production processes.

effective demand

The amount that people are not only willing to buy at different prices but what they can and do actually purchase.

effective labor

The number of workers in an economy times the state of technology.

effective yield (or rate of return)

Percentage return that one receives by investing in a bond.


The property of a resource allocation.

efficiency wage

Wage that a firm will pay to an employee as an incentive not to shirk.

efficiency wage theory

Explanation for the presence of unemployment and wage discrimination which recognizes that labor productivity may be affected by the wage rate.

efficiency wages

Above-equilibrium wages paid by firms in order to increase worker productivity of maximizing the total surplus received by all members of society.

efficient markets hypothesis

The theory that asset prices reflect all publicly available information about the value of an asset.

efficient scale

The quantity of output that minimizes average total cost.


A measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants.

emissions fee

Charge levied on each unit of a firm's emissions.

emissions standard

Legal limit on the amount of pollutants that a firm can emit.


The number of people employed.

employment protection

The set of regulations determining the conditions under which a firm can lay off a worker.

employment rate

The ratio of employment to the labor force.

endogenous growth theory

A theory that the rate of economic growth in the long run, is determined by the rate of growth in total factor productivity and this total factor productivity is dependent on the rate at which technology progresses.

endogenous variable

A variable that depends on other variables in a model and is thus explained within the model.

endowment effect

Tendency of individuals to value an item more when they own it than when they do not.

Engel curve

A line showing the relationship between demand and levels of income.

English (or oral) auction

Auction in which a seller actively solicits progressively higher bids from a group of potential buyers.

entry limit pricing

A situation where a firm will keep prices lower than they could be in order to deter new entrants.

equal marginal principle

Principle that utility is maximized when the consumer has equalized the marginal utility per dollar of expenditure across all goods.


Equality between demand and supply (production).

equilibrium (or market-clearing) price

Price that equates the quantity supplied to the quantity demanded.

equilibrium condition

The condition aht supply be equal to demand.

equilibrium in dominant strategies

Outcome of a game in which each firm is doing the best it can regardless of what its competitors are doing.

equilibrium in the goods market

The conditon that the supply of goods be equal to the demand for goods

equilibrium or market price

The price where the quantity demanded is the same as the quantity supplied.

equilibrium quantity

The quantity bought and sold at the equilibrium price.

equipment and software investment

The purchase of machines and software by firms.


The property of distributing economic prosperity fairly among the members of society.

equity finance

Financing based of the issuance of shares.

equity premium

Risk premium required by investors to hold stocks rather than short-term bonds.


A European currency that replaced national currencies in 11 countries in 2002 and is now used in 19 countries.


The set of countries that share the euro as a common currency.

European Central Bank (ECB)

The overall central bank of the 19 countries comprising the European Monetary Union.

European Economic and Monetary Union

The European currency union that has adopted the euro as its common currency.

European Monetary System (EMS)

A series of rules that implemented bands for bilateral exchange rates between member countries in Europe from 1979 to 1998.

European Union

A political and economic organization of 28 European nations. Formely called the European Community.


The system made up of the ECB plus the national central banks of each of the 19 countries comprising the European Monetary Union.

ex-dividend price

The price of the stock just after the dividend has been paid.

excess demand

When the quantity demanded of a good exceeds the quantity supplied.

excess supply

When the quantity supplied of a good exceeds the quantity demanded.

exchange economy

Market in which two or more consumers trade two goods among themselves.


The property of a good whereby a person can be prevented from using it when they do not pay for it.

exogenous variable

A variable whose value is determined outside the model.

expactations hypothesis

The hupothesis that financial investors are risk neutral, which implies that expected returns on all financial assets have to be equal.


A period of positive GDP growth.

expansion path

Curve passing through points of tangency between a firm's isocost lines and its isoquants.

expansionary open market operatoin

An open market operaton in which the central bank buys bonds to increase the money supply.

expected present discount value

The value today of currenthe and expected future payments.

expected return

Return that an asset should earn on average.

expected utility

Sum of the utilities associated with all possible outcomes, weighted by the probability that each outcome will occur.

expected utility theory

The idea that preferences can and will be ranked by buyers.

expected value

Probability-weighted average of the payoffs associated with all possible outcomes.

explicit costs

Input costs that require an outlay of money by the firm.


Goods produced domestically and sold abroad leading to an inflow of funds into a country.

extension aggreements

Agreements to extend the result of negotiations between a set of unions and firms to all firms in a given sector.

extensive form of a game

Representation of possible moves in a game in the form of a decision tree.

extent of a market

Boundaries of a market, both geographical and in terms of range of products produced and sold within it.

external economies of scale

The advantages of large-scale production that arise through the growth and concentration of the industry.

external finance

Financing of firms through external funds (as opposed to retained earnings).


(1) Action by either a producer or a consumer which affects other producers or consumers, but is not accounted for in the market price. (2) The cost or benefit of one person's decision on the well-being of a bystander (a third party) which the decision maker does not take into account when making the decision.

face value (on a bond)

The single payment at maturity promised by a discount bond.

factors of production

Inputs into the production process (e.g., labor, capital, and materials).


A period of time during which, for reasons of fashion or overoptimism, financial investors are willing to pay more for a stock than its fundamental value.


The possibility of a theory being rejected as a result of the new observations or new data.

federal deposit insurance

Insurance provided by the US government that protects each bank depositor up to $250,000 per account.

federal funds market

The market where banks that have excess reserves at the end of the day lend them to banks that have insufficient reserves.

federal funds rate

The interest rate determined by equilibrium in the federal funds market. The interest rate affected most directly by changes in monetary policy.

Federal Reserve Bank (Fed)

The US central bank.

fertility of research

The degree to which spending on research and development translates into new ideas and new products.

final good

A good i.e. used directly for consumption or investment (as opposed to intermediate goods, which are used in the process of production).

financial account

The account showing the financial transactions between a country and the rest of the world.

financial account balance

The difference between what a country borrows from the rest of the world and what it lends to the rest of the world.

financial account deficit

A negative financial account balance.

financial account surplus

A positive financial account balance. The country borrows more from the rest of the world than it lends to the rest of the world. A financial account surplus corresponds to a current account deficit.

financial economy

That part of the economy associated with the buying and selling of assets on financial markets.

financial intermediaries

Financial institutions through which savers can indirectly provide funds to borrowers. Financial institutions which receives funds from people, firms, or other financial institutions and uses these funds to make loans or buy financial assets.

financial investment

The purchase of financial assets.

financial markets

Financial institutions through which savers can directly provide funds to borrowers.

financial system

The group of institutions in the economy that help to match one person's saving with another person's investment.

financial wealth

The value of all of one's financial assets minus all financial liabilities. Sometimes called wealth, for short.


A macroeconomic policy aimed at precisely hitting a given target, such as constant unemployment or constant output growth.

fire sale prices

Very low asset prices, reflecting the need for sellers to sell, and the absence of sufficient buyers, because of liquidity constraints.

first-degree price discrimination

Practice of charging each customer her reservation price.

first-price auction

Auction in which the sales price is equal to the highest bid.

fiscal austerity

A reduction in public spending or an increase in taxes, aimed at reducing the budget deficit.

fiscal contraction

A policy aimed at reducing the budget deficit through a decrease in government spending or an increase in taxation. Also called fiscal consolidation.

fiscal dominance

A situation in which monetary policy becomes subordinated to fiscal policy, e.g. example, when the central bank issues money to finance the deficit.

fiscal expansion

An increase in government spending or a decrease in taxation, which leads to an increase in the budget deficit.

fiscal federalism

A fiscal system for a group of countries involving a common fiscal budget and a system of taxes and fiscal transfers across countries.

fiscal multiplier

The size of the effect of government spending on output.

fiscal policy

A government's choice of taxes and spending.

Fisher effect

The one-for-one adjustment of the nominal international rate to the inflation rate.

fixed costs

Costs that are not determined by the quantity of output produced.

fixed exchange rate

An exchange rate between the currencies of two or more countries i.e. fixed at some level and adjusted only infrequently.

fixed input

Production factor that cannot be varied.

fixed investment

The purchase of equipment and structures (as opposed to inventory investment).

fixed-proportions production function

Production function with L-shaped isoquants, so that only one combination of labor and capital can be used to produce each level of output.

fixed-weight index

Cost-of-living index in which the quantities of goods and services remain unchanged.

flat money

Money without intrinsic value i.e. used as money because of government decree.

flexible inflation targeting

A way of conducting monetary policy to return inflation to target inflation over time.


The exchange rate is said to float when it is determined in the foreign exchange market, without central bank intervention.


A variable that can be expressed as a quantity per unit of time (such as income).

force of compounding

The large effects of sustained growth on the level of a variable.

foreign direct investment

(1) Capital investment i.e. owned and operated by a foreign entity. (2) The purchase of existing firms or assets, or the development of new firms by foreign investors.

foreign exchange

Foreign currency.

foreign exchange reserves

Foreign assets held by the central bank.

foreign portfolio investment

Investment i.e. financed with foreign money but operated by domestic residents.

four tigers

The four Asian economies of Singapore, Taiwan, Hong Kong, and South Korea.


Tendency to rely on the context in which a choice is described when making a decision.

framing effect

The differing response to choices dependent on the way in which choices are presented.

free entry (or exit)

Condition under which there are no special costs that make it difficult for a firm to enter (or exit) an industry.

free rider

Consumer or producer who does not pay for a nonexclusive good in the expectation that others will.

frictional unemployment

Unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills.

full employment

A point where those people who want to work at the going market wage level are able to find a job.

fully funded social security system

A retirement system in which the contributions of current workers are invested in financial assets, with the proceeds (principal and interest) given back to the workers when they retire.

fundamental analysis

The study of a company's accounting statements and future prospects to determine its value.

fundamental value (of a stock)

The present value of expected dividends.

future value

The amount of money in the future that an amount of money today will yield, given prevailing interest rates.


The group of 20 countries, representing about 85% of world production, which met regularly during the crisis and served as a forum for coordination of economic policies.


Situation in which players (participants) make strategic decisions that take into account each other's actions and responses.

game theory

(1) The prediction of outcomes from games. (2) The study of how people behave in strategic situations.

GDP at constant prices

Gross domestic product calculated using prices that existed at a particular base year which takes into account changes in inflation over time.

GDP at current or market prices

Gross domestic product calculated by multiplying the output of goods and services by the price of those goods and services in the reporting year.

GDP deflator

The ratio of nominal GDP to real GDP. A measure of the overall price level. Gives the average price of the final goods produced in the economy.

GDP growth

The growth rate of real GDP in year t, equal to Yt – Yt – 1/Yt ‐ 1.

general equilibrium

A theory where all markets in an economy are in equilibrium and the millions of individual decisions aggregate to balance supply and demand and result in an efficient allocation of resources.

general equilibrium analysis

Simultaneous determination of the prices and quantities in all relevant markets, taking feedback effects into account.

general-purpose technologies

Technologies that have applications across many sectors.


The act of formulating general concepts or explanations by inferring from specific instances of an event or behaviour.

geographical immobility

Where people are unable to take work because of the difficulties associated with moving to different regions.

geometric series

A mathematical sequence in which the ratio of one term to the preceding term remains the same. A sequence of the form 1 + c + c2 + … cn.

Giffen good

(1) A good for which an increase in the price raises the quantity demanded. (2) Good whose demand curve slopes upward because the (negative) income effect is larger than the substitution effect.

gig economy

A labor market in which workers have short-term, freelance or zero hours contracts with employers and where workers are more akin to being self-employed than employed.

Gini coefficient

A measure of the degree of inequality of income in a country. A Gini coefficient of zero corresponds to complete equality. A Gini coefficient of 1 corresponds to complete inequality (all the income going to one individual).

gold standard

A system in which a country fixed the price of its currency in terms of gold and stood ready to exchange gold for currency at the stated parity.

golden-rule level of capital

The level of capital at which steady-state consumption is maximized.

government bond

A bond issued by a government or a government agency.

government budget constraint

The budget constraint faced by the government. The constraint implies that an excess of spending over revenues must be financed by borrowing, and thus leads toan increase in debt.

government deficit

A situation where a government spends more than it generates in tax revenue over a period.

government failure

A situation where political power and incentives distort decision-making so that decisions are made which conflict with economic efficiency.

government purchases

In the national income and product accounts, the sum of the purchases of goods by the government plus compensation of government employees.

government spending

Spending on goods and services by local, state and national governments.

government transfers

Payments made by the government to individuals that are not in exchange for goods or services (e.g., Social Security payments).

Great Financial Crisis

The financial crisis which led to a worldwide recession in 2008 and 2009.

Great Moderation

The period from the mid-1980s to the mid-2000s when the volatility of output and the volatility of inflation both declined, characterized by relatively low inflation, high employment, low unemployment and stable and persistent growth.

Great Recession

The worldwide recession, triggered by the financial crisis, which started in 2008.

gross debt

The value of the government's financial liabilities (as opposed to net debt, the value of the government's financial liabilities minus the value of the government's financial assets).

gross domestic product (GDP)

The market value of all final goods and services produced within a country in a given period of time. Gross national product measures value added by domestic factors of production.

gross domestic product per capita

The market value of all goods and services produced within a country in a given period of time divided by the population of a country to give a per capita figure.

gross national product (GNP)

A measure of aggregate output in the national income and product accounts. The market value of the goods and services produced by labor and property supplied by US residents.

gross private domestic fixed investment

In the national income and product accounts, the sum of nonresidential investment and residential investment.

gross value added

The contribution of domestic producers, industries and sectors to an economy.


The steady increase in aggregate output over time.


A reduction in the nominal value of debt.

hard peg

A fixed exchange rate regime, with a strong commitment of the central bank to maintain the exchange rate fixed.

hedonic pricing

An approach to calculating real GDP that treats goods as providing a collection of characteristics, each with an implicit price.

heterodox economics

A term which represents an array of different schools of thought in economics that are outside what may be considered the mainstream or orthodox economics.


Short cuts or rules of thumb that people use in decision-making.

Hicksian substitution effect

Alternative to the Slutsky equation for decomposing price changes without recourse to indifference curves.


Workers newly employed by firms.

horizontal equity

The idea that taxpayers with similar abilities to pay taxes should pay the same amount.

horizontal integration

Organizational form in which several plants produce the same or related products for a firm.

housing wealth

The value of the housing stock.

human capital

(1) The accumulation of investments in people, such as education and on-the-job training. (2) Knowledge, skills, and experience that make an individual more productive and thereby able to earn a higher income over a lifetime.

human wealth

The labor-income component of wealth.


A period of extreme and accelerating increase in the price level.


An assumption, tentative prediction, explanation, or supposition for something.


A permanent effect of temporary shocks, e.g., the permanent effects of a recession on labor force participation.

ideal cost-of-living index

Cost of attaining a given level of utility at current prices relative to the cost of attaining the same utility at base-year prices.

identification problem

In econometrics, the problem of finding whether correlation between variables X and Y indicates a causal relation from X to Y, or from Y to X, or both. This problem is solved by finding exogenous variables, called instruments, that affect X and do not affect Y directly, or affect Y and do not affect X directly.


An equation that holds by definition, denoted by the K sign.

idiosyncratic risk

Risk that affects only a single economic actor.

imperfect competition

Exists where firms are able to differentiate their product in some way and so can have some influence over price.

implicit costs

Input costs that do not require an outlay of money by the firm.

import compression

The decrease in imports due to a decrease in domestic demand.

import quota

A limit on the quantity of a good that can be produced abroad and sold domestically.


(1) Goods produced abroad and purchased for use in the domestic economy leading to an outflow of funds from a country. (2) The purchases of foreign goods and services by domestic consumers, firms, and the government.

in-kind transfers

Transfers to the poor given in the form of goods and services rather than cash.

inclusive growth

Growth that benefits all.


The flow of revenue from work, rental income, interest, and dividends.

income effect

(1) Change in consumption that results when a price change moves the consumer to a higher or lower indifference curve. (2) Change in consumption of a good resulting from an increase in purchasing power, with relative prices held constant.

income elasticity of demand

Measure of how much quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income.

income-consumption curve

Curve tracing the utility-maximizing combinations of two goods as a consumer's income changes.

increasing returns to scale

Situation in which output more than doubles when all inputs are doubled.

increasing-cost industry

Industry whose long-run supply curve is upward sloping.

independent central bank

A central bank that makes decisions independently of the government.

independent variable

A variable i.e. taken as given in a relation or in a model.

index number

A number, such as the GDP deflator, that has no natural level and is thus set to equal some value (typically 1 or 100) in a given period.


The automatic correction of a money amount.

indexed bond

A bond that promises payments adjusted for inflation.

indifference curve

Curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction.

indifference map

Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent.

indirect taxes

Taxes on goods and services. In the United States, primarily sales taxes.

individual demand curve

Curve relating the quantity of a good that a single consumer will buy to its price.


A conclusion or explanation derived from evidence and reasoning.

inferior good

A good for which, ceteris paribus, an increase in income leads to a decrease in demand (and vice versa).

infinitely elastic demand

Principle that consumers will buy as much of a good as they can get at a single price, but for any higher price the quantity demanded drops to zero, while for any lower price the quantity demanded increases without limit.


An increase in the overall level of prices in the economy.

inflation rate

The rate at which the price level increases over time.

inflation targeting

The conduct of monetary policy to achieve a given inflation rate over time.

inflation tax

The revenue the government raises by creating money.

inflation-adjusted deficit

The correct economic measure of the budget deficit: The sum of the primary deficit and real interest payments (as opposed to the official deficit, which is the sum of the primary deficit and nominal interest payments).

inflationary gap

The difference between full employment output and actual expenditure when actual expenditure is greater than full employment output..

informational cascade

An assessment (e.g., of an investment opportunity) based in part on the actions of others, which in turn were based on the actions of others.

informationally efficient

Reflecting all available information in a rational way.


The inability of a debtor, be it a firm, a person, or the government, to repay its debt.


The rules which govern the interaction of human beings in the economy characterized by regulations, legislation, social norms and other human-derived conventions that govern behaviour in markets.

instrumental variable methods

In econometrics, methods of estimation that use instruments to estimate causal relations between different variables.


In econometrics, the exogenous variables that allow the identification problem to be solved.


In a linear relation between two variables, the value of the first variable when the second variable is equal to zero.

interest elasticity of demand and supply

The responsiveness of the demand and supply of loanable funds to changes in the interest rate.

interest rate

Rate at which one can borrow or lend money.

interest rate rule

A monetary policy rule in which the interest rate is adjusted in response to output and to inflation.

intermediate good

A good used in the production of a final good.

internal economies of scale

The advantages of large-scale production that arise through the growth of the firm.

internal finance

Financing of firms through internal funds (retained earnings).

internalizing an externality

Altering incentives so that people take account of the external effects of their actions.

International Monetary Fund (IMF)

The principal international economic organization, publishes the World Economic Outlook annually and the International Financial Statistics (IFS) monthly.

intertemporal choice

Where decisions made today can affect choices facing individuals in the future.

intertemporal price discrimination

Practice of separating consumers with different demand functions into different groups by charging different prices at different points in time.

intertemporal substitution effect

The response of economic actors to changes in the interest rate by changing consumption and savings decisions.

interventionist supply-side policies

Policies focused on improving the working of markets through investing in infrastructure, education and research and development.

inventory investment

The difference between production and sales.


Spending on capital equipment, inventories and structures, including household purchases of new housing.

investment or mutual fund

An institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds.

involuntary unemployment

Where people want work at going market wage rates but cannon find employment.

IS curve

A downward-sloping curve relating output to the interest rate. The curve corresponding to the IS relation, the equilibrium condition for the goods market.

IS relation

An equilibrium condition stating that the demand for goods must be equal to the supply of goods, or equivalently that investment must be equal to saving, the equilibrium condition for the goods market.

IS-LM model

A model based on equilibrium in the goods and the financial markets in a closed economy.

isocost line

Graph showing all possible combinations of labor and capital that can be purchased for a given total cost.

isoelastic demand curve

Demand curve with a constant price elasticity.


Curve showing all possible combinations of inputs that yield the same output.

isoquant map

Graph combining a number of isoquants, used to describe a production function.


A curve depicting the initial deterioration in the trade balance caused by a real depreciation, followed by an improvement in the trade balance.

job search

The process by which workers find appropriate jobs given their tastes and skills.

junior securities

Securities that are repaid after senior securities in case of insolvency.

junk bond

A bond with a high risk of default.

kinked demand curve model

Oligopoly model in which each firm faces a demand curve kinked at the currently prevailing price: at higher prices demand is very elastic, whereas at lower prices it is inelastic.

labor force

The number of people who are either working or looking for work.

labor hoarding

The decision by firms to keep some excess workers in response to a decrease in sales.

labor market rigidities

Restrictions on firms' ability to adjust their level of employment.

labor productivity

Average product of labor for an entire industry or for the economy as a whole. The ratio of output to the number of workers.

labor force participation rate (or economic activity rate)

The percentage of the adult population i.e. in the labor force.

Laffer curve

The relationship between tax rates and tax revenue.

lagging indicator

An indicator whose changes occur after changes in economic activity have occurred.


Function to be maximized or minimized, plus a variable (the Lagrange multiplier) multiplied by the constraint.


All the natural resources of the earth.

Laspeyres price index

Amount of money at current year prices that an individual requires to purchase a bundle of goods and services chosen in a base year divided by the cost of purchasing the same bundle at base-year prices.

law of demand

The claim that, other things equal (ceteris paribus) the quantity demanded of a good falls when the price of the good rises.

law of diminishing marginal returns

Principle that as the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease.

law of small numbers

Tendency to overstate the probability that a certain event will occur when faced with relatively little information.

law of supply

The claim that, ceteris paribus, the quantity supplied of a good rises when the price of a good rises.

law of supply and demand

The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.


Workers who lose their jobs either temporarily or permanently.

leading indicator

An indicator which can be used to foretell future changes in economic activity.

learning curve

Graph relating amount of inputs needed by a firm to produce each unit of output to its cumulative output.

least-squares criterion

Criterion of "best fit" used to choose values for regression parameters, usually by minimizing the sum of squared residuals between the actual values of the dependent variable and the fitted values.

lender of last resort

If a solvent bank cannot finance itself, it can borrow from the central bank, which acts as a lender of last resort.

Lerner Index of Monopoly Power

Measure of monopoly power calculated as excess of price over marginal cost as a fraction of price.

leverage ratio

Ratio of the assets of the bank to its capital (the inverse of the capital ratio).


Borrowing funds for investment in the expectation of a return.


The political philosophy according to which the government should choose policies deemed to be just, as evaluated by an impartial observer behind a 'veil of ignorance'.


The political philosophy according to which the government should punish crimes and enforce voluntary agreements but not redistribute income.

life (of a bond)

The length of time during which the bond pays interest, which ends with the repayment of principal.

life cycle

The regular pattern of income variation over a person's life.

life-cycle theory of consumption

The theory of consumption, developed initially by Franco Modigliani, that emphasizes that the planning horizon of consumers is their lifetime.

linear demand curve

Demand curve i.e. a straight line.

linear regression

Model specifying a linear relationship between a dependent variable and several independent (or explanatory) variables and an error term.

linear relation

A relation between two variables such that a one-unit increase in one variable always leads to an increase of n units in the other variable.


An asset is liquid if it can be sold quickly. A financial institution is liquid if it can sell its assets quickly.

liquidity facilities

The specific ways in which a central bank can lend to financial institutions.

liquidity preference

The term introduced by Keynes to denote the demand for money.

liquidity provision

The provision of liquidity to banks by the central bank.

liquidity risk

The risk that a bank may not be able to fund demand for withdrawals.

liquidity trap

The case where nominal interest rates are equal to zero, and monetary policy cannot, therefore, decrease them further.

living labor

Labor utilized in the production of the good itself.

living wage

An hourly rate set independently, based on an estimation of minimum household needs which provide an 'acceptable' standard of living in the UK.

LM curve

An upward-sloping curve relating the interest rate to output, the curve corresponding to the LM relation, the equilibrium condition for financial markets.

LM relation

An equilibrium condition stating that the demand for money must be equal to the supply of money.

loan-to-value ratio

The ratio of the loan that people can take as a proportion of the value of the house or apartment they buy.

logarithmic scale

A scale in which the same proportional increase is represented by the same distance on the scale, so that a variable that grows at a constant rate is represented by a straight line.


The agreement between politicians to exchange support on an issue.

long run

(1) A period of time extending over decades. (2) The period of time in which all factors of production can be altered.

long-run average cost curve (LAC)

Curve relating average cost of production to output when all inputs, including capital, are variable.

long-run competitive equilibrium

All firms in an industry are maximizing profit, no firm has an incentive to enter or exit, and price is such that quantity supplied equals quantity demanded.

long-run marginal cost curve (LMC)

Curve showing the change in long-run total cost as output is increased incrementally by 1 unit.

long-term interest rate

The interest rate on long-term bonds.

Lorenz curve

The relationship between the cumulative percentage of households and the cumulative percentage of income.

loss aversion

Tendency for individuals to prefer avoiding losses over acquiring gains.

Lucas critique

The proposition, put forth by Robert Lucas, that existing relations between economic variables may change when policy changes. An example is the apparent trade-off between inflation and unemployment, which may disappear if policymakers try to exploit it.

lump-sum tax

A tax i.e. the same amount for every person.


The sum of currency, traveler's checks, and checkable deposits—assets that can be used directly in transactions, also called narrow money.

Maastricht treaty

A treaty signed in 1991 that defined the steps involved in the transition to a common currency for the European Union.


Branch of economics that deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation.

macroprudential policy

Policies designed to limit the risk across the financial sector by focusing on improving 'prudential' standards of operation that enhance stability and reduce risk.

macroprudential tools

The instruments used to regulate the financial system, such as loan-to-value ratios or capital ratio requirements.

Malthusian trap

The case of an economy where increases in productivity lead to a decrease in mortality and an increase in population, leaving income per person unchanged.

marginal abatement cost

The cost expressed in terms of the last unit of pollution not emitted (abated).

marginal benefit

Benefit from the consumption of one additional unit of a good.

marginal changes

Small incremental adjustments to a plan of action.

marginal cost

The increase in total cost that arises from an extra unit of production.

marginal expenditure

Additional cost of buying one more unit of a good.

marginal expenditure curve

Curve describing the additional cost of purchasing one additional unit of a good.

marginal external benefit

Increased benefit that accrues to other parties as a firm increases output by one unit.

marginal external cost

Increase in cost imposed externally as one or more firms increase output by one unit.

marginal product

The increase in output that arises from an additional unit of input.

marginal product of labor

The increase in the amount of output from an additional unit of labor.

marginal propensity to save

The fraction of extra income that a household saves rather than consumes.

marginal rate of substitution (MRS)

Maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good.

marginal rate of technical substitution

The rate at which a consumer is willing to trade one good for another.

marginal rate of technical substitution (MRTS)

Amount by which the quantity of one input can be reduced when one extra unit of another input is used, so that output remains constant.

marginal rate of transformation

Amount of one good that must be given up to produce one additional unit of a second good.

marginal revenue

Change in revenue resulting from a one-unit increase in output.

marginal revenue product

(1) Additional revenue resulting from the sale of output created by the use of one additional unit of an input. (2) The extra revenue a firm gets from hiring an additional unit of a factor of production.

marginal social benefit

Sum of the marginal private benefit plus the marginal external benefit.

marginal social cost

Sum of the marginal cost of production and the marginal external cost.

marginal tax rate

The extra taxes paid on an additional unit of income.

marginal utility

Additional satisfaction obtained from consuming one additional unit of a good.

marginal value

Additional benefit derived from purchasing one more unit of a good.

mark to market

An accounting procedure which records the 'fair value' of an asset on financial institutions' balance sheets.


Collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or set of products.

market basket (or bundle)

List with specific quantities of one or more goods.

market definition

Determination of the buyers, sellers, and range of products that should be included in a particular market.

market demand curve

Curve relating the quantity of a good that all consumers in a market will buy to its price.

market economy

An economy that addresses the three key questions of the economic problem by allocating resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.

market failure

(1) Situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers. (2) Situation where scarce resources are not allocated to their most efficient use.

market for loanable funds

The market in which those who want to save supply funds, and those who want to borrow to invest demand funds.

market income inequality

Inequality of revenues before transfers and taxes (as opposed to disposable income inequality, inequality of revenues after transfers and taxes).

market mechanism

Tendency in a free market for price to change until the market clears.

market power

Ability of a single economic agent (or small group of agents) to have a substantial influence on market prices or output.

market price

Price prevailing in a competitive market.

market segments

The breaking down of customers into groups with similar buying habits or characteristics.

market share

The proportion of total sales in a market accounted for by a particular firm.

market signaling

Process by which sellers send signals to buyers conveying information about product quality.

market-orientated supply-side policies

Policies designed to free up markets to improve resource allocation through more effective price signals.


The ratio of the price to the cost of production.

Marshall-Lerner condition

The condition under which a real depreciation leads to an increase in net exports.


The length of time over which a financial asset (typically a bond) promises to make payments to the holder.

maximin criterion

The claim that the government should aim to maximize the well-being of the worst-off person in society.

maximin strategy

Strategy that maximizes the minimum gain that can be earned.

medium of exchange

An item that buyers hive to sellers when they want to purchase goods and services.

medium run

The period of time between the short run and the long run. Roughly, what happens between three and thirty years.

menu costs

The costs of changing prices.

merit goods

Goods which can be provided by the market but may be under-consumed as a result of imperfect information about the benefits.

method of Lagrange multipliers

Technique to maximize or minimize a function subject to one or more constraints.


Branch of economics that deals with the behavior of individual economic units—consumers, firms, workers, and investors— as well as the markets that these units comprise.

migration rate

The difference between the number of people entering a country from abroad and the number leaving.

minimum wage

The lowest price an employer may legally pay to a worker.

mixed bundling

Selling two or more goods both as a package and individually.

mixed strategy

Strategy in which a player makes a random choice among two or more possible actions, based on a set of chosen probabilities.

model of aggregate demand and aggregate supply

The model than many economists use to explain short-run fluctuations in economic activity around its long-run trend.

models of endogenous growth

Models in which accumulation of physical and human capital can sustain growth even in the absence of technological progress.

modified Phillips curve

The curve that plots the change in the inflation rate against the unemployment rate, also called accelerationist Phillips curve.

monetarism, monetarists

A group of economists in the 1960s, led by Milton Friedman, who argued that monetary policy had powerful effects on activity.

monetary base

Money issued by the central bank (currency and central bank reserves).

monetary contraction

A change in monetary policy that leads to an increase in the interest rate, also called monetary tightening.

monetary expansion

A change in monetary policy that leads to a decrease in the interest rate.

monetary neutrality

The proposition that changes in the money supply do not affect real variables.

monetary policy

The set of actions taken by the central bank in order to affect the money supply.

monetary-fiscal policy mix

The combination of monetary and fiscal policies in effect at a given time.


Financial assets (currency and checkable deposits) that can be used directly to buy goods.

money finance

Financing of the budget deficit through money creation.

money illusion

The proposition that people make systematic mistakes in assessing nominal versus real changes in incomes and interest rates.

money market

The market in which the commercial banks lend money to one another on a short-term basis.

money market funds

Non-bank financial institutions that receive funds from people and use them to buy short-term bonds.

money stock

The quantity of money circulating in the economy.

money supply

The quantity of money available in the economy.

monopolistic competition

Market in which firms can enter freely, each producing its own brand or version of a differentiated product.


Firm i.e. the sole seller of a product without close substitutes.


Market in which there is a single (or dominant) buyer.

monopsony power

Buyer's ability to affect the price of a good.

moral hazard

(1) When a party whose actions are unobserved can affect the probability or magnitude of a payment associated with an event. (2) Tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behaviour.

mortgage lenders

Institutions that make housing loans to households.

mortgage-based security (MBS)

Security based on an underlying portfolio of mortgages.

multilateral real exchange rate

The real exchange rate between a country and its trading partners, computed as a weighted average of bilateral real exchange rates, also called the trade-weighted real exchange rate or effective real exchange rate.

multiple regression analysis

Statistical procedure for quantifying economic relationships and testing hypotheses about them.


The ratio of the change in an endogenous variable to the change in an exogenous variable (e.g., the ratio of the change in output to a change in autonomous spending).

multiplier effect

The additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending.

Mundell-Fleming model

A model of simultaneous equilibrium in both goods and financial markets for an open economy.

mutual fund

Organization that pools funds of individual investors to buy a large number of different stocks or other financial assets.

narrow banking

Restrictions on banks that would require them to hold only shortterm government bonds.

Nash equilibrium

A situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen.

national debt

The accumulation of the total debt owed by a government.

national income

In the United States, the income that originates in the production of goods and services supplied by residents of the United States.

national income and product accounts (NIPA)

The system of accounts used to describe the evolution of the sum, composition, and distribution of aggregate output.

national saving

The total income in the economy that remains after paying for consumption and government purchases.

natural monopoly

Firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms.

natural rate hypothesis

The claim that unemployment eventually returns to its normal, or natural, rate, regardless of the rate of inflation.

natural rate of interest

The rate of interest consistent with a level of demand for goods equal to potential output.

natural rate of output

The output level in an economy when all existing factors of production (land, labor, capital and technology resources) are fully utilized and where unemployment is at its natural rate.

natural rate of unemployment

The unemployment rate at which price and wage decisions are consistent.

natural resources

The inputs into the production of goods and services that are provided by nature, such as land, rivers and mineral deposits.

negative externality

The costs imposed on a third party of a decision.

negative income tax

A tax system that collects revenue from high-income households and gives transfers to low-income households.

negatively correlated variables

Variables having a tendency to move in opposite directions.

neo-classical synthesis

A consensus in macroeconomics, developed in the early 1950s, based on an integration of Keynes' ideas and the ideas of earlier economists. The idea that markets can be slow to adjust in the short run due to sticky prices and sticky wages but revert to long-run classical principles which could be aided by appropriate use of fiscal and monetary policies.

net capital flows

Capital flows from the rest of the world to the domestic economy, minus capital flows to the rest of the world from the domestic economy (also, financial account balance).

net capital outflow

The purchase of foreign assets by domestic residents minus the purchase of domestic asserts by foreigners.

net debt

Value of government financial liabilities, minus the value of financial assets held by the government.

net exports

Spending on domestically produced goods and services by foreigners (exports) minus spending of foreign goods by domestic residents (imports), also called the trade balance. Or: In the national income and product accounts, the interest paid by firms minus the interest received by firms, plus interest received from the rest of the world minus interest paid to the rest of the world.

net national product (NNP)

Gross national product minus capital depreciation.

net present value (NPV) criterion

Rule holding that one should invest if the present value of the expected future cash flow from an investment is larger than the cost of the investment.

net transfers received

In the current account, the net value of foreign aid received minus foreign aid given.

network externality

Situation in which each individual's demand depends on the purchases of other individuals.

new classicals

A group of economists who interpret fluctuations as the effects of shocks in competitive markets with fully flexible prices and wages.

new growth theory

Developments in growth theory since the late 1980s that explore the determinants of technological progress and the role of increasing returns to scale in growth.

new Keynesians

A group of economists who believe in the importance of nominal rigidities in fluctuations, and who are exploring the role of market imperfections in explaining fluctuations.

nominal exchange rate

The price of domestic currency in terms of foreign currency. The number of units of foreign currency you can get for one unit of domestic currency.

nominal GDP

The production of goods and services valued at current prices.

nominal interest rate

The interest rate as usually reported without a correction for the effects of inflation. How many currency units one has to repay in the future in exchange for borrowing one currency unit today.

nominal price

Absolute price of a good, unadjusted for inflation.

nominal rigidities

The slow adjustment of nominal wages and prices to changes in economic activity.

nominal variables

Variables measured in monetary units.

non-accelerating inflation rate of unemployment

The rate of unemployment in the long run, consistent with a stable rate of inflation.

non-stationary data

Time-series data where the mean value can either rise or fall over time.

noncooperative game

Game in which negotiation and enforcement of binding contracts are not possible.

nondiversifiable risk

Risk that cannot be eliminated by investing in many projects or by holding the stocks of many companies.

nondurable goods

Commodities that can be stored but have an average life of less than three years.

nonexclusive good

Good that people cannot be excluded from consuming, so that it is difficult or impossible to charge for its use.

nonhuman wealth

The financial and housing component of wealth.

noninstitutional civilian population

The number of people potentially available for civilian employment.

nonresidential investment

The purchase of new capital goods by firms: structures and producer durable equipment.

nonrival good

Good for which the marginal cost of its provision to an additional consumer is zero.

normal good

A good for which, ceteris paribus, an increase in income leads to an increase in demand (and vice versa).

normal profit

The minimum amount required to keep factors of production in their current use.

normative analysis

Analysis examining questions of what ought to be.

normative statements

Claims that attempt to prescribe how the world should be.

North American Free Trade Agreement (NAFTA)

An agreement signed by the United States, Canada, and Mexico in which the three countries agreed to establish all of North America as a free trade zone.

not in the labor force

The number of people who are neither employed nor looking for employment.

objective well-being

Measures of the quality of life using specified indicators.

occupational immobility

Where workers are unable to easily move from one occupation to another.

official deficit

The difference between public spending, including nominal interest payments, and public revenues.

Okun coefficient

The effect of a change in the rate of growth of output on the change in the unemployment rate.

Okun's law

A 'law' which is based on observations that in order to keep the unemployment rate steady, real GDP needs to grow at or close to its potential.


Competition amongst the few ‐ a market structure in which only a few sellers offer similar or identical products and dominate the market, and entry by new firms is impeded.


Market with only a few buyers.

open market operation

The purchase or sale of government bonds by the central bank from ant to the banking sector for the purpose of increasing or decreasing the money supply.

openness in factor markets

The opportunity for people to choose where to live and work, and for firms to invest at home or abroad.

openness in financial markets

The opportunity for financial investors to choose between domestic and foreign financial assets.

openness in goods markets

The opportunity for consumers and firms to choose between domestic and foreign goods.

opportunity cost

Whatever must be given up to obtain some item. The value of the benefits foregone (sacrificed). Cost associated with opportunities forgone when a firm's resources are not put to their best alternative use.

opportunity cost of capital

Rate of return that one could earn by investing in an alternate project with similar risk.

optimal control

The control of a system (a machine, a rocket, an economy) by means of mathematical methods.

optimal control theory

The set of mathematical methods used for optimal control.

optimal currency area

The properties of a common currency area needed for it to function smoothly.

optimal strategy

Strategy that maximizes a player's expected payoff.

optimum currency area

A group of countries for which it is optimal to adopt a common currency and form a currency union.

option value of waiting

In the case of irreversible decisions, the option of waiting for uncertainty to be resolved so as to make a more informed decision.

ordinal utility function

Utility function that generates a ranking of market baskets in order of most to least preferred.

ordinary least squares (OLS)

A statistical method to find the best-fitting relation between two or more variables.

Organization for Economic Cooperation and Development (OECD)

An international organization that collects and studies economic data for many countries. Most of the world's rich countries belong to the OECD.

Organization of Petroleum Exporting Countries (OPEC)

A set of petroleumproducing countries, which long acted as a production cartel.

original Phillips curve

A relation between the unemployment rate and the rate of inflation (as opposed to the accelerationist Phillips curve, a relation between the unemployment rate and the change in the rate of inflation).

out of the labor force

People of working age not working (in the market economy) and not looking for a job.

output fluctuations

Movements in output around its trend, also called business cycles.

output gap

The difference between actual output and potential output.

output per person

A country's gross domestic product divided by its population.

outright open market operations

The outright sale or purchases of non-monetary assets to or from the banking sector by the central bank without a corresponding agreement to reverse the transaction at a later date.


An unrealistic belief that things will work out well.


An unrealistic belief that one can accurately predict outcomes.


Overestimating an individual's prospects or abilities.

Paasche index

Amount of money at current-year prices that an individual requires to purchase a current bundle of goods and services divided by the cost of purchasing the same bundle in a base year.

panel dataset

A dataset that gives the values of one or more variables for many individuals or many firms over some period of time.

paradox of saving

The result that an attempt by people to save more may lead both to a decline in output and to either unchanged or even lower saving. Also called the paradox of thrift.

parallel conduct

Form of implicit collusion in which one firm consistently follows actions of another.


A coefficient in a behavioral equation.

Pareto efficient allocation

Allocation of goods in which no one can be made better off unless someone else is made worse off.

Pareto improvement

When an action makes at least one economic agent better off without harming another economic agent.

partial equilibrium analysis

Determination of equilibrium prices and quantities in a market independent of effects from other markets.

participation rate

The ratio of the labor force to the total population of working age.


The legal right granted to a person or firm to exclude anyone else from the production or use of a new product or technique for a certain period of time. Or: The right conferred on the owner to prevent anyone else making or using an invention on manufacturing process without permission.

pay-as-you-go Social Security system

A retirement system in which the contributions of current workers are used to pay benefits to current retirees.

PAYGO (pay-as-you-go) rule

A budget rule requiring any new spending to be financed by additional revenues.

payments of factor income to the rest of the world

In the United States, income received by foreign capital and foreign residents.


Value associated with a possible outcome.

payoff matrix

A table showing the possible combination of outcomes (payoffs) depending on the strategy chosen by each player.


A point where related economic variables begin to decline.

peak-load pricing

Practice of charging higher prices during peak periods when capacity constraints cause marginal costs to be high.


The exchange rate to which a country commits under a fixed exchange rate system.

perfect complements

Two goods for which the MRS is zero or infinite. The indifference curves are shaped as right angles.

perfect price discrimination

A situation in which the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.

perfect substitutes

Two goods for which the marginal rate of substitution of one for the other is a constant.

perfectly competitive market

Market with many buyers and sellers, so that no single buyer or seller has a significant impact on price.

permanent income

A person's normal income.

permanent income hypothesis

A theory which suggests that consumers will smooth consumption over their lifetime in relation to their anticipated long-term average income.

permanent income theory of consumption

The theory of consumption, developed by Milton Friedman, that emphasizes that people make consumption decisions based not on current income but on their notion of permanent income.


Bond paying out a fixed amount of money each year, forever.

personal consumption expenditures

Spending on consumption goods and services by households.

personal disposable income

The income available to consumers after they have received transfers and paid taxes.

personal income

The income actually received by persons.

Phillips curve

A curve that shows the short-run trade-off between inflation and unemployment.

Pigovian tax

A tax enacted to correct the effects of a negative externality.

planned economic systems

Economic activity organized by central planners who decided on the answers to the fundamental economic questions.

planned spending, saving or investment

The desired or intended actions of households and firms.


The participants in a game. Depending on the context, players may be people, firms, governments, and so on.

point elasticity of demand

Price elasticity at a particular point on the demand curve.

policy coordination (of macroeconomic policies between two countries)

The joint design of macroeconomic policies to improve the economic situation in two countries.

policy rate

The interest rate set by the central bank.

political business cycle

Fluctuations in economic activity caused by the manipulation of the economy for electoral gain.

positional arms race

A situation where individuals invest in a series of measures designed to gain them an advantage but which simply offset each other.

positional externality

Purchases or decisions which alter the context of the evaluation by an individual of the positional good.

positive analysis

Analysis describing relationships of cause and effect.

positive equity

The positive difference between the principal borrowed on a house and its value.

positive externality

The benefits to a third party of a decision.

positive statements

Claims that attempt to describe the world as it is.

positively correlated variables

Variables having a tendency to move in the same direction.

potential output

The level of output associated with the unemployment rate being equal to the natural unemployment rate.

poverty line

An absolute level of income set by the government below which a family is deemed to be in poverty. In the UK and Europe this is measured by earnings less than 60 per cent of median income.

poverty rate

The percentage of the population whose family income falls below an absolute level called the poverty.

Prebisch-Singer hypothesis

A hypothesis suggesting that the rate at which primary products exchange for manufactured goods declines over time meaning that countries specialising in primary good production become poor.

predatory or destroyer pricing

A situation where firms hold price below average cost for a period to try and force out competitors or prevent new firms from entering the market.

predatory pricing

Practice of pricing to drive current competitors out of business and to discourage new entrants in a market so that a firm can enjoy higher future profits.

present discounted value

The current value of an expected future cash flow.

present value

The amount of money today that would be needed to produce, using prevailing interest rates, a given future amount of money.

price ceiling

A legal maximum on the price at which a good can be sold.

price discrimination

The business practice of selling the same good at different prices to different customers.

price elasticity of demand

Measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in price.

price elasticity of supply

Measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price.

price floor

A legal minimum on the price at which a good can be sold.

price leadership

Pattern of pricing in which one firm regularly announces price changes that other firms then match.

price level

A snapshot of the prices of goods and services in an economy at a particular period of time.

price of risk

Extra risk that an investor must incur to enjoy a higher expected return.

price rigidity

Characteristic of oligopolistic markets by which firms are reluctant to change prices even if costs or demands change.

price risk

The risk that an asset price falls, leading to a loss for the holder.

price signaling

Form of implicit collusion in which a firm announces a price increase in the hope that other firms will follow suit.

price support

Price set by government above free-market level and maintained by governmental purchases of excess supply.

price taker

Firm that has no influence over market price and thus takes the price as given.

price-consumption curve

A line showing the consumer optimum for goods as the price of one of the goods changes, assuming incomes and the price of the other goods are held constant.

price-setting relation

The relation between the price chosen by firms, the nominal wage, and the markup.

primary deficit

Government spending, excluding interest payments on the debt, minus government revenues (the negative of the primary surplus).

primary surplus

Government revenues minus government spending, excluding interest payments on the debt.


Person for whom another person, called the agent, is performing some act.

principal–agent problem

Problem arising when agents (e.g., a firm's managers) pursue their own goals rather than the goals of principals (e.g., the firm's owners).

prisoners' dilemma

Game theory example in which two prisoners must decide separately whether to confess to a crime: If a prisoner confesses, he will receive a lighter sentence and his accomplice will receive a heavier one, but if neither confesses, sentences will be lighter than if both confess. The game illustrates why cooperation is difficult to maintain even when it is mutually beneficial.

private goods

Goods that are both excludable and rival.

private saving

The income that households and firms have left after paying for taxes and consumption.

private sector

That part of the economy where business activity is owned, financed and controlled by private individuals.

private sector involvement

A reduction in the value of the debt held by the private sector in case of debt rescheduling or debt restructuring.

private-value auction

Auction in which each bidder knows his or her individual valuation of the object up for bid, with valuations differing from bidder to bidder.


The transfer of publicity owned assets to private sector ownership.


Likelihood that a given outcome will occur.


A variable i.e. above trend when GDP is above trend.

Producer Price Index

Measure of the aggregate price level for intermediate products and wholesale goods.

producer prices index

A measure of the prices of a basket of goods and services bought by firms.

producer surplus

(1) The amount a seller is paid for a good minus the seller's cost. (2) Sum over all units produced by a firm of differences between the market price of a good and the marginal cost of production.

product transformation curve

Curve showing the various combinations of two different outputs (products) that can be produced with a given set of inputs.

production function

(1) The relation between the quantity of output and the quantities of inputs used in production. (2) Function showing the highest output that a firm can produce for every specified combination of inputs.

production isoquant

A function representing all possible combinations of factor inputs that can be used to produce a given level of output.

production possibilities frontier

Curve showing the combinations of two goods that can be produced with fixed quantities of inputs.


The quantity of goods and services produced from each hour of a worker or factor of production's time.


Difference between total revenue and total cost.


The expected present discounted value of profits.

progressive tax

A tax for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers.

propagation mechanism

The dynamic effects of a shock on output and its components.

propensity to consume

The effect of an additional dollar of disposable income on consumption.

propensity to save

The effect of an additional dollar of disposable income on saving (equal to one minus the propensity to consume).

property rights

The exclusive right of an individual, group or organization to determine how a resource is used.

proportional tax (or flat tax)

A tax for which high-income and low-income taxpayers pay the same fraction of income.

proprietors' income

In the national income and product accounts, the income of sole proprietorships, partnerships, and tax-exempt cooperatives.

prospect theory

A theory that suggests people attach different values to gains and losses and do so in relation to some reference point.

public choice theory

The analysis of government behaviour, and the behaviour of individuals who interact with government.

public good

Nonexclusive and nonrival good: the marginal cost of provision to an additional consumer is zero and people cannot be excluded from consuming it.

public interest

Making decisions based on a principle where the maximum benefit is gained by the largest number of people at minimum cost.

public saving

That part of the economy where business activity is owned, financed and controlled by the state, and goods and services are provided by the state on behalf of the population as a whole. Or: Saving by the government, equal to government revenues minus government spending, also called the budget surplus. (A budget deficit represents public dissaving.)

purchasing power

Income in terms of goods.

purchasing power parity

(1) A theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries. (2) A method of adjustment used to allow for international comparisons of GDP.

pure bundling

Selling products only as a package.

pure strategy

Strategy in which a player makes a specific choice or takes a specific action.

QE1, QE2, QE3

The first, second, and third instances of unconventional monetary policy (quantitative easing) in the United States during the financial crisis.

quantitative easing

Purchases of financial assets by the central bank at the zero lower bound, leading to an increase in the balance sheet of the central bank.

quantity demanded

The amount of a good that buyers are willing and able to purchase at different prices.

quantity equation

The equation (M x V = P x Y), which relates the quantity of money, the velocity of money, and the currency value of the economy's output of goods and services.

quantity forcing

Use of a sales quota or other incentives to make downstream firms sell as much as possible.

quantity supplied

The amount of a good that asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the if rate.


Workers who leave their jobs for what they perceive as a better alternative.


Restrictions on the quantities of goods that can be imported.


A measure of fit, between zero and one, from a regression. An R2 of zero implies that there is no apparent relation between the variables under consideration. An R2 of one implies a perfect fit: all the residuals are equal to zero.

random walk

The path of a variable whose changes are impossible to predict.

random walk of consumption

The proposition that, if consumers are foresighted, changes in their consumption should be unpredictable.

rate-of-return regulation

Maximum price allowed by a regulatory agency is based on the (expected) rate of return that a firm will earn.

rating agencies

Firms that assess the creditworthiness of various debt securities and debt issuers.


The assumption that decision-makers can make consistent choices between alternatives.

rational expectations

(1) The formation of expectations based on rational forecasts, rather than on simple extrapolations of the past. (2) The theory according to which people optimally use all the information they have, including information about government policies, when forecasting the future.

rational ignorance effect

The tendency of a voter to not seek out information to make an informed choice in elections.

rational speculative bubble

An increase in asset prices based on the rational expectation of further increases in prices in the future.

reaction curve

Relationship between a firm's profit-maximizing output and the amount it thinks its competitor will produce.

real appreciation

An increase in the relative price of domestic goods in terms of foreign goods. An increase in the real exchange rate.

real business cycle models

Economic models that assume that output is always at its natural level. Thus, all output fluctuations are movements of the natural level of output as opposed to movements away from the natural level of output.

real depreciation

A decrease in the relative price of domestic goods in terms of foreign goods. A decrease in the real exchange rate.

real economy

That part of the economy which is concerned with the production of goods and services.

real exchange rate

The rate at which the goods and services of one country trade for the goods and services of another.

real GDP

The sum of quantities produced in an economy times their price in a base year. Also known as GDP in terms of goods, GDP in constant dollars, or GDP adjusted for inflation. The current measure of real GDP in the United States is called GDP in (chained) 2012 dollars.

real GDP per person

Ratio of real GDP to population.

real interest rate

The interest rate corrected for the effects of inflation. It tells us how many goods one has to repay in the future in exchange for borrowing the equivalent one good today.

real money balances

What money can actually buy given the ration of the money supply to the price level M/P.

real price

Price of a good relative to an aggregate measure of prices. Price adjusted for inflation.

real return

Simple (or nominal) return on an asset, less the rate of inflation.

real variables

Variables measured in physical units.

real wage

The money wage adjusted for inflation, measured by the ratio of the wage rate to price W/P.

receipts of factor income from the rest of the world

In the United States, income received from abroad by US capital or US residents.


A period of declining real incomes and rising unemployment. The technical definition gives recession occurring after two successive quarters of negative economic growth.

reference point

The point from which an individual makes a consumption decision.

refinancing rate

The interest rate at which the European Central Bank lends on a short-term basis to the euro area banking sector.


The output of ordinary least squares, gives the equation corresponding to the estimated relation between variables, together with information about the degree of fit and the relative importance of the different variables.

regression line

The best-fitting line corresponding to the equation obtained by using ordinary least squares.

regressive tax

A tax for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers.

regulatory capture

A situation where regulatory agencies become unduly influenced and dominated by the industries they are supposed to be regulating.

relative position

The idea that humans view their own position against a reference point which provides a means of comparison on feeling of well-being.

relative poverty

A situation where an individual is not able to access what would be considered acceptable standards of living in society.

relative prices

Price expressed in terms of how much of one good has to be given up in purchasing another.

rent seeking

(1) Where individuals or groups take actions to redirect resources to generate income (rents) for themselves or the group. (2) Spending money in socially unproductive efforts to acquire, maintain, or exercise monopoly.

rental income of persons

In the national income and product accounts, the income from the rental of real property, minus depreciation on this property.

rental rate

Cost per year of renting one unit of capital.

repeated game

Game in which actions are taken and payoffs received over and over again.

repo rate

The interest rate at which the Bank of England lends on a short-term basis to the UK banking sector.

repurchase agreement

The sale of a non-monetary asset together with an agreement to repurchase it at a set price at a specified future date.

research and development (R&D)

Activity aimed at discovering and developing new ideas and products.

reservation price

Maximum price that a customer is willing to pay for a good.

reservation wage

The wage that would make a worker indifferent between working and being unemployed.

reserve ratio

The ratio of bank reserves to checkable deposits.

residential investment

The purchase of new houses or apartments by people.


The difference between the actual value of a variable and the value implied by the regression line. Small residuals indicate a good fit.

retail banking

The core banking service of taking in deposits and making loans to households and business.


Total monetary flow of an asset as a fraction of its price.

returns to scale

Rate at which output increases as inputs are increased proportionately.


An increase in the exchange rate in a fixed exchange rate system.

Ricardian equivalence

The proposition that neither government deficits nor government debt have an effect on economic activity, also called the Ricardo-Barro proposition.


The probability of something happening which results in a loss or some degree of hazard or damage.

risk averse

Condition of preferring a certain income to a risky income with the same expected value.

risk loving

Condition of preferring a risky income to a certain income with the same expected value.

risk neutral

Condition of being indifferent between a certain income and an uncertain income with the same expected value.

risk premium

(1) Maximum amount of money that a risk-averse individual will pay to avoid taking a risk. (2) The difference between the expected rate of return on a risky asset and the safe interest.

risk premium on bonds

The additional interest rate a bond has to pay, reflecting the risk of default on the bond.

riskless (or risk-free) asset

Asset that provides a flow of money or services i.e. known with certainty.

risky asset

Asset that provides an uncertain flow of money or services to its owner.


The property of a good whereby one person's use diminishes other people's use.

sacrifice ratio

The number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point.

safe haven

A country i.e. considered safe by financial investors.


The perceived importance of a good or service.


Set of observations for study, drawn from a larger universe.


Those who make decisions based on securing a satisfactory rather than optimal outcome.


The sum of private and public saving

saving rate

The ratio of saving to GDP.

Say's law

An argument that production or supply is a source of demand, that supply creates its own demand.


The limited nature of society's resources.

Schengen area

Twenty-six countries, including Switzerland and Norway, who have agreed to allow free movement between their countries with no passport and border controls.


An action taken by an uninformed party to induce an informed party to reveal information.

sealed-bid auction

Auction in which all bids are made simultaneously in sealed envelopes, the winning bidder being the individual who has submitted the highest bid.

second-degree price discrimination

Practice of charging different prices per unit for different quantities of the same good or service.

second-price auction

Auction in which the sales price is equal to the second-highest bid.


The issuance of securities, based on an underlying portfolio of assets, such as mortgages, or commercial paper.


The revenues from the creation of money.

senior securities

Securities repaid before junior securities in case of insolvency.


Workers who are leaving or losing their jobs.

sequential game

Game in which players move in turn, responding to each other's actions and reactions.

sequential move games

Games where players make decisions in sequence with some players able to observe the strategic choices of others.


Products that cannot be stored and must be consumed at the place and time of purchase.

shadow banking system

(1) The set of nonbank financial institutions, from structured investment vehicles to hedge funds. (2) Financial intermediaries acting like banks but which are outside the scope of regulation.


A financial asset issued by a firm that promises to pay a sequence of payments, called dividends, in the future, also called stock.

shirking model

Principle that workers still have an incentive to shirk if a firm pays them a market-clearing wage, because fired workers can be hired somewhere else for the same wage.


Movements in the factors that affect aggregate demand and/or aggregate supply.

shoe leather cost

(1) The resources wasted when inflation encourages people to reduce their money holdings. (2) The costs of going to the bank to take money out of a checking account.

short run

(1) period of time in which some factors of production cannot be changed. (2) Period of time extending over a few years at most.

short-run average cost curve (SAC)

Curve relating average cost of production to output when level of capital is fixed.

short-term interest rate

The interest rate on a short-term bond (typically a year or less).


(1) Situation in which the quantity demanded exceeds the quantity supplied. (2) ituation in which quantity demanded is greater than quantity supplied at the going market price.


An action taken by an informed party to reveal private information to an uninformed party.

Single European Market

A (still not complete) EU-wide market throughout which labor, capital, goods and services can move freely.

skill-biased technological progress

The proposition that new machines and new methods of production require skilled workers to a greater degree than in the past.


In a linear relation between two variables, the amount by which the first variable increases when the second increases by one unit.

Slutsky equation

Formula for decomposing the effects of a price change into substitution and income effects.

snob effect

Negative network externality in which a consumer wishes to own an exclusive or unique good.

social rate of discount

Opportunity cost to society as a whole of receiving an economic benefit in the future rather than the present.

social security

Government benefits that supplement the incomes of the needy.

Social Security trust fund

The funds accumulated by the US Social Security system as a result of surpluses in the past.

social welfare function

The collective utility of society which is reflected by consumer and producer surplus.

socially necessary time

The quantity of labor necessary under average conditions of labor productivity to produce a given commodity.

Solow residual

The excess of actual output growth over what can be accounted for by the growth in capital and labor.

sovereign debt

The bonds issued by national governments to finance expenditure.

special interest effect

Where benefits to a minority special interest group are outweighed by the costs imposed on the majority.

specific tax

A fixed rate tax levied on goods and services expressed as a sum per unit.

speculative demand

Demand driven not by the direct benefits one obtains from owning or consuming a good but instead by an expectation that the price of the good will increase.

spending caps

Legislative limits on public spending.


(1) The difference between the interest rate on a risky bond and the interest rate on a safe bond. (2) The difference between the average interest banks earn on assets and the average interest rate paid on liabilities.

Stability and Growth Pact (SGP)

A set of rules governing public spending, deficits, and debt in the European Union.

Stackelberg model

Oligopoly model in which one firm sets its output before other firms do.


Period of falling output and rising prices. Combination of stagnation and inflation.

staggering of wage and price decisions

The fact that different wages are adjusted at different times, making it impossible to achieve a synchronized decrease in nominal wage inflation.

standard deviation

Square root of the weighted average of the squares of the deviations of the payoffs associated with each outcome from their expected values.

standard error of the regression

Estimate of the standard deviation of the regression error.

standard of living

Refers to the amount of goods and services that can be purchased by the population of a country. Usually measured by the inflation-adjusted (real) income per head of the population. Real GDP per person.

state of technology

The degree of technological development in a country or industry.

static expectations

The formation of expectations, on the assumption that the future will be like the past.

stationary data

Time-series data that has a constant mean value over time.

statistical discrepancy

A difference between two numbers that should be equal, coming from differences in sources or methods of construction for the two numbers.

steady state

In an economy without technological progress, the state of the economy where output and capital per worker are no longer changing. In an economy with technological progress, the state of the economy where output and capital per effective worker are no longer changing.

steady-state equilibrium

The point in a growing economy where investment spending is the same as spending on depreciation and the capital-output ratio remains constant.

stochastic trend

Where trend variables change by some random amount in each time period.

stock (or share or equity)

A variable that can be expressed as a quantity at a point in time (such as wealth), also a synonym for share. A claim to partial ownership and the future profits in a firm.

stock externality

Accumulated result of action by a producer or consumer which, though not accounted for in the market price, affects other producers or consumers.

stock of capital

Total amount of capital available for use in production.


An alternative term for inventories, also, an alternative term for shares.

store of value

An item that people can use to transfer purchasing power from the present to the future.

strategic interactions

An environment in which the actions of one player depend on and affect the actions of another player.


Rule or plan of action for playing a game.


The organized withdrawal of labor from a firm by a union.

structural change

A change in the economic structure of the economy, typically associated with growth.

structural deficit

A situation where a government's deficit is not dependent on movements in the economic cycle.

structural unemployment

Unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one.

structured investment vehicle

Financial intermediaries set up by banks. SIVs borrow from investors, typically in the form of short-term debt, and invest in securities.


In the national income and product accounts: plants, factories, office buildings, and hotels.

sub-prime market

Individuals not traditionally seen as being part of the financial markets because of their high credit risk.

subjective well-being

The way in which people evaluate their own happiness.

subprime mortgages

Mortgages with a higher risk of default by the borrower.


Payment to buyers and sellers to supplement income or lower costs and which thus encourages consumption or provides an advantage to the recipient. Payment reducing the buyer's price below the seller's price, i.e., a negative tax.


Two goods for which an increase in the price of one leads to an increase in the demand for the other (and vice versa).

substitution effect

Change in consumption of a good associated with a change in its price, with the level of utility held constant.

sudden stops

A sudden decrease in the willingness of foreign investors to hold the debt of a particular country.

sunk cost

Expenditure that has been made and cannot be recovered.

supply curve

Relationship between the quantity of a good that producers are willing to sell and the price of the good.

supply schedule

Table that shows the relationship between the price of a good and the quantity supplied.

supply shock

Event that directly alters firm's costs and prices, shifting the economy's AS curve and thus the Phillips curve.

supply siders

Group of economists in the 1980s who believed that tax cuts would increase activity by enough to increase tax revenues.


Situation in which the quantity supplied is greater than the quantity demanded at the going market price.


Where the perceived benefits of the combined operations of a merged organization are greater than those which would arise if the firms stayed separate.

systemic risk

The risk of failure across the whole of the financial sector.


A statistic associated with an estimated coefficient in a regression that indicates how confident one can be that the true coefficient differs from zero.

tacit collusion

When firm behaviour results in a market outcome that appears to be anti-competitive but has arisen because firms acknowledge that they are interdependent.


Tax on goods produced abroad and sold domestically.

tax incidence

The manner in which the burden of a tax is shared among participants in a market.

tax smoothing

The principle of keeping tax rates roughly constant, so that the government runs large deficits when government spending is exceptionally high and small surpluses the rest of the time.

Taylor rule

A rule, suggested by John Taylor, telling a central bank how to adjust the nominal interest rate in response to deviations of inflation from its target and of the unemployment rate from the natural rate.

technical efficiency

Condition under which firms combine inputs to produce a given output as inexpensively as possible.

technological change

Development of new technologies allowing factors of production to be used more effectively.

technological knowledge

Society's understanding of the best ways to produce goods and services.

technological progress

An improvement in the state of technology.

technological unemployment

Unemployment brought about by technological progress.

technology frontier

The state of technological knowledge.

term premium

The difference between the interest rate on a long-term bond and the interest rate on a short-term bond.

theory of consumer behavior

Description of how consumers allocate incomes among different goods and services to maximize their wellbeing.

theory of liquidity preference

Keynes' theory that the interest rate adjusts to bring money supply and money demand into balance.

theory of the firm

Explanation of how a firm makes cost-minimizing production decisions and how its cost varies with its output.

third-degree price discrimination

Practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group.

time inconsistency

In game theory, the incentive for one player to deviate from a previously announced course of action once the other player has moved.

time-series data

Observations on a variable over a time-period and which are ordered over time.

tit-for-tat strategy

Repeated-game strategy in which a player responds in kind to an opponent's previous play, cooperating with cooperative opponents and retaliating against uncooperative ones.

Tobin's q

The ratio of the value of the capital stock, computed by adding the stock market value of firms and the debt of firms and dividing the sum by the replacement cost of capital.

total cost

Total economic cost of production, consisting of fixed and variable costs.

total expenditure

The amount paid by buyers, computed as the price of the good times the quantity purchased.

total factor productivity growth

The rate of technological progress.

total revenue

The amount received by sellers of a good, computed as the price of the good times the quantity sold.

total surplus

The total value to buyers of the goods, as measured by their willingness to pay, minus the cost to sellers of providing those goods.

total utility

The satisfaction gained from the consumption of a good.

total wealth

The sum of human wealth and nonhuman wealth.

toxic assets

Nonperforming assets, from subprime mortgages to nonperforming loans.

tradable goods

Goods that compete with foreign goods in domestic or foreign markets.

trade balance

The difference between exports and imports, also called net exports.

trade deficit

An excess of imports over exports.

trade policy

A government policy that directly influences the quantity of goods and services that a country imports or exports.

trade surplus

A positive trade balance, i.e., exports exceed imports.


The loss of the benefits from a decision to forego or sacrifice one option, balanced against the benefits incurred from the choice made.

tradeable emissions permits

System of marketable permits, allocated among firms, specifying the maximum level of emissions that can be generated.

Tragedy of the Commons

A parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole.

transaction costs

The forces that resist the decision-making of economic actors in interacting in markets.

transfer earnings

The minimum payment required to keep a factor of production in its current use.

transfer payment

A payment for which no good or service is exchanged.

transfer prices

Internal prices at which parts and components from upstream divisions are "sold" to downstream divisions within a firm.

transfers to persons

Unemployment, retirement, health, and other benefits paid by the state.

Treasury bill (T-bill)

A US government bond with a maturity of up to one year.

Treasury bond

A US government bond with a maturity of 10 years or more.

Treasury Inflation Protected Securities (TIPS)

US government bonds that pay the real (rather than the nominal) interest rate.

Treasury note

A US government bond with a maturity of one to 10 years.


The underlying long-tern movement in a data series.

Troubled Asset Relief Program (TARP)

The program introduced in October 2008 by the US administration, aimed at buying toxic assets and, later, providing capital to banks and other financial institutions in trouble.


The point where related economic variables begin to rise.

twin deficits

The budget and trade deficits that characterized the United States in the 1980s.

two-part tariff

Form of pricing in which consumers are charged both an entry and a usage fee.


Practice of requiring a customer to purchase one good in order to purchase another.

unconventional monetary policy

Monetary policy measures used to increase economic activity when the policy rate reached the zero lower bound.

uncovered interest parity relation

An arbitrage relation stating that domestic and foreign bonds must have the same expected rate of return, expressed in terms of a common currency.

underground economy

That part of a nation's economic activity i.e. not measured in official statistics, either because the activity is illegal or because people and firms are seeking to avoid paying taxes.


A loan is underwater if its value is higher than the value of the collateral it corresponds to. For example, a mortgage is underwater if its value exceeds the price of the corresponding house.


Number of people not working but looking for a job.

unemployment insurance

Unemployment benefits paid by the state to the unemployed.

unemployment rate

The ratio of the number of people unemployed to the labor force.


A worker association that bargains with employers over wages and working conditions.

union density

A measure of the proportion of the workforce i.e. unionized.

unit of account

The yardstick people use to post prices and record debts.

usable observation

An observation for which the values of all the variables under consideration are available for regression purposes.

user cost of capital

The cost of using capital over a year, or a given period of time. The sum of the real interest rate and the depreciation rate, also called the rental cost of capital.

user cost of production

Opportunity cost of producing and selling a unit today and so making it unavailable for production and sale in the future.


The political philosophy according to which the government should policies to maximize the total utility of everyone in society.


Satisfaction derived from the consumption of a certain quantity of a product or a given market basket.

utility function

Formula that assigns a level of utility to individual market baskets.

utility possibilities frontier

Curve showing all efficient allocations of resources measured in terms of the utility levels of two individuals.


The worth to an individual of owning an item represented by the satisfaction derived from its consumption and their willingness to pay to own it.

value added

The value a firm adds in the production process, equal to the value of its production minus the value of the intermediate inputs it uses in production.

value of complete information

Difference between the expected value of a choice when there is complete information and the expected value when information is incomplete.

value of the marginal product

The marginal product of an input times the price of the output.


Extent to which possible outcomes of an uncertain event differ.

variable costs

Costs that are dependent on the quantity of output produced.

variable profit

Sum of profits on each incremental unit produced by a firm, i.e., profit ignoring fixed costs.

velocity of money

The rate at which money changes hands.

vertical equity

The idea that taxpayers with a greater ability to pay taxes should pay larger amounts.

vertical integration

Organizational form in which a firm contains several divisions, with some producing parts and components that others use to produce finished products.


Index of stock market volatility.

voluntary unemployment

Where people choose to remain unemployed rather than take jobs which are available.

wage indexation

A provision that automatically increases wages in response to an increase in prices.

wage-setting relation

The relation between the wage chosen by wage setters, the price level, and the unemployment rate.

war of attrition

When both parties to an argument hold their grounds, hoping that the other party will give in.


The total of all stores of value, including both money and non-monetary assets.

welfare economics

The study of how the allocation of resources affects economic well-being. Or: Normative evaluation of markets and economic policy.

welfare effects

Gains and losses to consumers and producers.

wholesale banking

That part of banking dealing with corporate finance and investment in financial instruments.

wholesale funding

Financing through the issuance of short-term debt rather than through deposits.

willingness to pay

The maximum amount that a buyer will pay for a good.

winner's curse

Situation in which the winner of a common-value auction is worse off as a consequence of overestimating the value of the item and thereby overbidding.

world price

The price of a good that prevails in the world market for that good.


The failure of a firm to operate at maximum efficiency due to a lack of competitive pressure and reduced incentives to control costs.


The ratio of the coupon payment to the value of the bond.

yield curve

The relation between yield and maturity for bonds of different maturities, also called the term structure of interest rates.

yield to maturity

The constant interest rate that makes the price of an n-year bond today equal to the present value of future payments, also called the n-year interest rate.

zero economic profit

A firm is earning a normal return on its investment—i.e., it is doing as well as it could by investing its money elsewhere.

zero lower bound

The lowest interest rate the central bank can achieve before it becomes more attractive to hold cash than to hold bonds.