Aggregate Demand Aggregate demand is the total amount that all consumers, business firms, and government agencies are willing to spend on final goods and services.

Asset An asset of an individual or business firm is an item of value that the individual or firm owns.

Top

Balance of Payments Deficit The balance of payments deficit is the amount by which the quantity supplied of a country's currency (per year) exceeds the quantity demanded. Balance of payments deficits arise whenever the exchange rate is pegged at an artificially high level.

Balance of Payments Surplus The balance of payments surplus is the amount by which the quantity demanded of a country's currency (per year) exceeds the quantity supplied. Balance of payments surpluses arise whenever the exchange rate is pegged at an artificially low level.

Balance Sheet A balance sheet is an accounting statement listing the values of all the assets on the left-hand side and the values of all the liabilities and net worth on the right-hand side.

Budget Deficit The budget deficit is the amount by which the government's expenditures exceed its receipts during a specified period of time, usually 1 year.

Top

Capital it refers to an inventory (a stock) of plant, equipment and other productive resources held by a business firm, an individual, or some other organization.

Closed Economy An economy is called relatively open if its exports and imports constitute a large share of its GDP. An economy is considered relatively closed if they constitute a small share.

Comparative Advantage One country is said to have a comparative advantage over another in the production of a particular good relative to other goods if it produces that good less inefficiently as compared with other country.

Consumer Expenditure Consumer expenditure, symbolized by the letter C, is the total amount spent by consumers on newly produced goods and services (excluding purchases of new homes, which are considered investment goods).

Consumption Function The consumption function is the relationship between total consumer expenditures and total disposable income in the economy, holding all other determinants of consumer spending constant.

Correlated Two variables are said to be correlated if they tend to go up or down together. But correlation need not imply causation.

Cross Elasticity of Demand The cross elasticity of demand for product X to a change in the price of another product Y, is the ratio of the percentage change in quantity demanded of X to the percentage change in the price of Y that brings about the change in quantity demanded.

Cyclical Unemployment Cyclical unemployment is the portion of unemployment that us
Attributable to a decline in the economy's total production. Cyclical unemployment rises during recessions and falls as prosperity is restored.

Top

Deflation it refers to a sustained decrease in the general price level.

Demand Curve A demand curve is the graphical depiction of a demand schedule. It shows how the quantity demanded of some product during a specified period of time will change as the price of that product changes, holding all other determinants of quantity constant.

Devaluation A devaluation is the reduction is the official value of a currency.

Direct Taxes Direct taxes are taxes levied directly on people.

Disposable Income Disposable income is the sum of the incomes of all the individuals in the economy after all taxes have been deducted and all transfer payments have been added.

Top

Economic Growth Economic growth occurs when an economy is able to produce more goods and services for each consumer.

Economies of Scale Production is said to involve economies of scale, also referred to as increasing returns to scale, if, when all input quantities are doubled, the quantity of output is more than doubled.

Entrepreneurship it is the act of starting new firms, introducing new products and technological innovations, and, in general, taking the risks that are necessary in seeking out business opportunities.

Equilibrium An equilibrium is a situation in which there are no inherent forces that produce change. Changes away from an equilibrium position will occur only as a result of "outside events" that disturb the status quo.

Exchange Rate The exchange rate states the price, in terms of one currency, at which another currency can be bought.

Expenditure Schedule An expenditure schedule shows the relationship between national income (GDP) and total spending.

Exponential Growth Exponential growth is growth at a constant percentage rate.

Top

Factors of Production Inputs or factors of production are the labor, machinery, buildings and natural resources used to make outputs.

Final Goods and Services Final goods and services are those that are purchased by their ultimate users.

Fiscal Policy The government's fiscal policy is its plan for spending and taxation. It is designed to steer aggregate demand in some desired direction.

Fixed Exchange Rate Fixed exchange rates are rates set by government decisions and maintained by government actions.

Floating Exchange Rates Floating exchange rates are rates determined in free markets by the law of supply and demand.

Frictional Unemployment Frictional unemployment is unemployment that is due to normal turnover in the labor market. It includes people who are temporarily between jobs because they are moving or changing occupations, or for similar reasons.

Top

Government Purchases Government purchases, symbolized by the letter G, refer to goods (such as airplanes and paper clips) and services (such as school teaching and police protection) purchased by all levels of government.

Gross Domestic Product (GDP) Gross domestic product (GDP) is a measure of the size of an economy. It is, roughly speaking, the money value of all the goods and services produced in a year.

Top

Income Effect The income effect is a portion of the change in quantity of a good demanded when its price changes. A rise in price cuts the consumer's purchasing power (real income), which leads to a change in the quantity demanded of that commodity. That change is the income effect.

Increasing Returns to Scale Production is said to involve economies of scale, also referred to as increasing returns to scale, if, when all input quantities are doubles, the quantity of output is more than doubled.

Indirect Taxes Indirect taxes are taxes levied on specific economic activities.

Inferior Good An inferior good is a commodity whose quantity demanded falls when the purchaser's real income rises, all other things remaining equal.

Inflation Inflation refers to a sustained increase in the average level of prices.

Innovation Innovation, the next step after something is invented, is the act of putting the new idea into practical use.

Inputs Inputs or factors of production are the labor, machinery, buildings, and natural resources used to make outputs.

Interest it is the payment for the use funds employed in the production of capital; it is measured as a percentage per year of the value of the funds tied up in the capital.

Intermediate Good An intermediate good is a good purchased for sale or for use in producing another good.

Investment it is the flow of resources into the production of new capital. It is the labor, steel and other inputs devoted to the construction of factories, warehouses, railroads and other pieces of capital during some period of time.

Investment Spending Investment spending, symbolized by the letter I, is the sum of the expenditures of business firms on new plant and equipment and households on new homes. Financial "investments" are not included, nor are re-sales of existing physical assets.

Top

Labor Productivity Labor productivity refers to the amount of output a worker turns out in an hour (or a week or a year) of labor. It can be measured as total national output (GDP) in a given year divided by the total number of hours of work performed for pay in the country during that year. That is, labor productivity is defined as GDP per hour of labor.

Laissez-Faire Laissez-Faire refers to a program of minimal government interference with the workings of the market system. The term means that people should be left alone in carrying out their economic affairs.

"Law" of Diminishing Marginal Utility the "law" of diminishing marginal utility asserts that the additional units of a commodity are worth less and less to a consumer in money terms. As the individual's consumption increases, the marginal utility of each additional unit declines.

Law of Supply and Demand The law of supply and demand states that, in a free market, the forces of supply and demand generally push the price toward the level at which quantity supplied and quantity demanded are equal.

Liability A liability of an individual or business firm is an item of value that the individual or firm owes. Many liabilities are known as debts.

Liquidity An asset's liquidity refers to the ease with which it can be converted into cash.

Long Run The long run is a period of time long enough for all of the firm's sunken commitments to come to an end.

Top

Marginal Profit Marginal profit is the addition to total profit resulting from one more unit of output.

Marginal Propensity to Consume (MPC) The marginal propensity to consume (MPC) is the ratio of the change in consumption to the change disposable income that produces the change in consumption. On a graph, it appears as the slope of the consumption function.

Marginal Utility The marginal utility of a commodity to a consumer (measured in money terms) is the maximum amount of money that he or she is willing to pay for one more unit of that commodity.

Market Power Market power is the ability of a firm to raise its price significantly above the competitive price level and to maintain this high price profitably for a considerable period.

Merger A merger occurs when two previously independent firms are combined under a single owner or group of owners. A horizontal merger is the merger of two firms producing similar products, as when one toothpaste manufacturing firm purchases another. A vertical merger involves the joining of two firms, one of which supplies an ingredient of the other's product, as when an automaker acquires a tire manufacturing firm. A conglomerate merger is a union of two unrelated firms, as when a defense contractor joins a firm that produces videotapes.

Mixed Economy A mixed economy is one in which there is some public influence over the workings of free markets. There maybe also some public ownership mixed in with private property.
Monetary Policy Monetary policy refers to actions that the Federal Reserve System takes in order to change the equilibrium of the money market; that is, to alter the money supply, move interest rates, or both.

Monopolistic Competition Monopolistic competition refers to a market in which products are heterogeneous but which is otherwise the same as a market that is perfectly competitive.

Top

National Debt The national debt is the federal government's total indebtedness at a moment in time. It is the result of previous deficits.

National Income National income is the sum of the incomes that all individuals in the economy earned in the forms of wages, interest, rents, and profits. It excludes transfer payments and is calculated before any deductions are taken for income taxes.

Natural Rate of Unemployment The economy's self-correcting mechanism always tends to push the unemployment rate back toward a specific rate of unemployment that we call the natural rate of unemployment.

Net Exports Net exports, symbolized by (X-IM), is the difference between exports and imports. It indicates the difference between what we sell to foreigners and what we buy from them.

Nominal GDP Nominal GDP is GDP calculated be valuing all outputs at current prices.

Nominal Rate of Interest The nominal rate of interest is the percentage by which the money the borrower pays back exceeds the money that he borrowed, making no adjustment for any fall in the purchasing power of this.

Top

Oligopoly An oligopoly is a market dominated by a few sellers at least several of which are large enough relative to the total market to be able to influence the market price.

Open Economy An economy is called relatively open if its exports and imports constitute a large share of its GDP. An economy is considered relatively closed if they constitute a small share.

Opportunity Cost The opportunity cost of any decision is the value of the next best alternative that the decision forces the decision maker to forgo.

Outputs Outputs are the goods and services that consumers want to acquire.

Top

Partnership A partnership is a firm whose ownership is shared by a fixed number of proprietors.

Perfect Competition Perfect competition occurs in an industry when that industry is made up of many small firms producing homogeneous products, information is perfect, and there is no impediment to entry or exit of firms.

Portfolio Diversification Portfolio diversification means including a number and variety of stocks, bonds, and other such items in an individual owns airline stocks, for example, diversification requires the purchase of a stock or bond in a very different industry, such as a breakfast cereal producer.

Potential GDP Potential GDP is the real GDP that the economy would produce if its labor and other resources were fully employed.

Poverty Line The poverty line is an amount of income below which a family considered "poor".

Price Ceiling A price ceiling is a legal maximum on the price that maybe charged for a commodity.

Price Discrimination Price discrimination is the sale of a given product at different to different customers of the firm, when there is no difference in the cost of supplying different customers. Prices are also discriminatory if it costs more to supply one customer than another, but they are charged the same price.

(Price) Elasticity of Demand The (price) elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in price that brings about the change in quantity demanded.

Price Floor A price floor is a legal minimum on the price that maybe charged for a commodity.

Price War In a price war, each competing firm is determined to sell at a price that is lower than the prices of its rivals, usually regardless of whether that price covers the pertinent cost. Typically, in such a price war, Firm a cuts its price below Firm B's; then B retaliates by undercutting A, and so on and on until one or more of the firms surrender and let themselves be undersold.

Private Good A private good is a commodity or service characterized by both excludability and depletability.

Privatization Privatization is the return of a government firm to private ownership.

Production Possibilities Frontier A production possibilities frontier shows the different combinations of various goods that a producer or an economy can turn out, given the available resources and existing technology.

Productivity Productivity is the amount of output produced by a unit of input.

Public Good A public good is a commodity or service whose benefits are not depleted by an additional user and for which it is generally difficult or impossible to exclude people from its benefits, even if the people are unwilling to pay for them.

Purchasing Power The purchasing power of a given sum of money is the volume of goods and services that will buy.

Pure Monopoly A pure monopoly is an industry in which there is only one supplier of a product for which there are no close substitutes and in which, because of scale economies, it is very hard or impossible for another firm to coexist.

Top

Quantity Demanded The quantity demanded is the number of units that consumers want to buy over a specified period of time.

Quantity Supplied The quantity supplied is the number of units that sellers want to sell over a specified period of time.

Quota A quota specifies the maximum amount of a good that is permitted into the country from abroad per unit of time.

Top

Rational Decision A rational decision is one that serves the objectives of the decision maker, whatever those objectives may be. Such objectives may include a firm's desire to maximize the welfare of its citizens, or another government's desire to maximize its military might. The term rational connotes neither approval nor disapproval of the objective itself.

Real GDP Real GDP is the value of all the goods and services produced by an economy in a year, evaluated in dollars of constant purchasing power. Hence, inflation does not raise real GDP.

Real Rate of Interest The real rate of interest is the percentage increase in purchasing power that the borrower pays to the lender for the privilege of borrowing. It indicates the increased ability to purchase goods and services that the lender earns.

Real Wage Rate The real wage rate is the wage rate adjusted for inflation. It indicates the volume of goods and services that money wages will buy.

Recession A recession is a period of time during which the total output of the economy falls.

Recessionary Gap The recessionary gap is the amount by which the equilibrium level of real GDP falls short of potential GDP.

Relative Price An item's relative price in terms of some other item rather than in terms of dollars.

Required Reserves Required reserves are the minimum amount of reserves (in cash or the equivalent) required by law. Normally, required reserves are proportional to the volume of deposits.

Resources Resources are the instruments provided by nature or by people that are used to create goods and services. Natural resources include minerals, the soil, water and air. Labor is a scarce resources partly because of time limitations (the day has only 24 hours), and partly because the number of skilled workers is limited. Factories and machines are resources made by people. These three types of resources are often referred to as land, labor and capital. They are also called inputs or factors of production.

Retained Earnings Plowback (or retained earnings) is the portion of a corporation's profits that management decides to keep and invest back into the firm's operations rather than to pay out directly to stockholders in the form of dividends.

Revaluation A revaluation is an increase in the official value of a currency.

Top

Shortage A shortage is an excess of quantity demanded over quantity supplied. When there is a shortage, buyers cannot purchase the quantities they desire.

Short Run The short run is a cost period of time over which some of the firm's, but not all, commitments will have ended.

Socialism Socialism is a method of economic organization in which the state owns the means of production.

Specialization Specialization means that a country devotes its energies and resources to only a small proportion of the world's productive activities.

Stagflation Stagflation is inflation that occurs while the economy is growing slowly ("stagnating") or having a recession.

Structural Unemployment Structural unemployment refers to workers who have lost their jobs because they have been displaced by automation, because their skills are no longer in demand, or for similar reasons.

Substitutes Two goods are called substitutes if an increase in the quantity consumed of one cut the quantity demanded of the other, all other things remaining constant.

Supply-Demand Diagram A supply-demand diagram graphs the supply and demand curves together. It depicts the equilibrium price and quantity.

Top

Takeover A takeover is the acquisition by an outside group (the raiders) of a controlling proportion of a company's stock. When the old management opposes the takeover attempt, it is called a hostile takeover attempt.

Tariff A tariff is a tax on imports.

Tax Deduction A tax deduction is a sum of money that may be subtracted before the taxpayer computes his or her taxable income.

Tax Exempt A particular source of income is tax exempt if income from that source is not taxable.

Total Profit The total profit of a firm is its net earnings during some period of time. It is equal to the total amount of money the firms gets from sales of its products (the firm's total revenue) minus the total amount that it spends to make those products (total cost).

Total Utility The total utility of a quantity of a good to a consumer ( measured in money terms) is the maximum amount of money that he or she is willing to give in exchange for it.
Unemployment Rate The unemployment rate is the number of unemployed people, expressed as a percentage of the labor force.

Top

Unlimited Liability Unlimited liability is a legal obligation of a firm's owner(s) to pay back company debts with whatever resources he or she owns.

Top

Variable Taxes Variable taxes are taxes that do vary with the level of GDP.

Velocity Velocity indicates the number of times per year that an "average dollar" is spent on goods and services. It is the ratio of nominal GDP to the number of dollars in the money stock. That is: Velocity =Nominal GDP/Money Stock

Top

Wage-Price Controls Wage-Price controls are legal restrictions on the ability of industry and labor to raise wages and prices.

Source of definitions:

Economics Principles and Policy. William J. Baumo and Allan S. Binder.
7th Edition, 1998. 

Top