absolute advantage The ability to produce more of a good than all other producers.
absolute (or money) prices The price of a good measured in units of currency.
aggregate demand curve The negative relationship between all spending on domestic output and the average price level of that output.
aggregate income The sum of all income earned by suppliers of resources in the economy.
aggregate spending (GDP) The sum of all spending from four sectors of the economy.
aggregate supply curve The positive relationship between the level of domestic output produced and the average price level of that output.
aggregation The process of summing the microeconomic activity of households and firms into a macroeconomic measure of economic activity.
all else equal The assumption that all other variables are held constant so that we can predict how a change in one variable affects a second. Also known as the “ceteris paribus” assumption.
appreciating currency An increase in the price of one currency relative to another currency.
asset demand for money The amount of money demanded as an asset is inversely related to the real interest rate.
assets of a bank Anything owned by the bank or owed to the bank.
automatic stabilizers Fiscal policy mechanisms that automatically regulate, or stabilize, the macroeconomy as it moves through the business cycle.
autonomous consumption The amount of consumption that occurs no matter the level of disposable income.
autonomous investment The level of investment determined by investment demand and independent of GDP.
autonomous saving The amount of saving that occurs no matter the level of disposable income.
balanced-budget multiplier A change in government spending offset by an equal change in taxes results in a multiplier effect equal to one.
balance of payments statement A summary of the payments received by the United States from foreign countries and the payments sent by the United States to foreign countries.
balance sheet or T-account A tabular way to show a bank’s assets and liabilities.
base (or reference) year The year that serves as a reference point for constructing a price index and comparing real values over time.
bond A certificate of indebtedness from the issuer to the bond holder.
budget deficit Exists if government spending exceeds the tax revenue collected.
budget surplus Exists if tax revenue collected exceeds government spending.
business cycle The periodic rise and fall in economic activity around its long-term growth trend.
capital (or financial) account This account shows the flow of investment on real or financial assets between a nation and foreigners.
capitalist market system (capitalism) An economic system based upon the fundamentals of private property, freedom, self-interest, and prices.
circular flow of economic activity (or circular flow of goods and services) A model that shows how households and firms circulate resources, goods, and incomes through the economy. This basic model is expanded to include the government and the foreign sector.
Classical school A macroeconomic model that explains how the economy naturally tends to come to full employment in the long run.
closed economy A model assuming no foreign sector (imports and exports).
comparative advantage The ability to produce a good at lower opportunity cost than all other producers.
complementary goods Two goods that provide more utility when consumed together than when consumed separately.
consumer price index (CPI) The price index that measures the average price level of the items in the base year market basket. This is the main measure of consumer inflation.
consumer surplus The difference between a buyer’s willingness to pay and the price actually paid.
consumption and saving schedules Tables that show the direct relationships between disposable income and consumption and saving.
consumption function A positive relationship between disposable income and consumption.
consumption possibility frontier The line that illustrates all possible combinations of goods that two nations can consume with specialization and trade.
contraction A period where real GDP is falling.
contractionary fiscal policy Lower government spending or higher net taxes to shift AD to the left to full employment and reduce inflationary pressures.
contractionary monetary policy Decreases in the money supply to increase real interest rates, shift AD to the left to full employment, and reduce inflationary pressures.
cost of living adjustment An annual adjustment to a salary (or pension) so that the purchasing power of that income remains constant. This adjustment is typically based upon the change in the consumer price index.
crowding-out effect Typically the result of government borrowing to fund deficit spending, this is the decline in spending in one sector due to an increase in spending from another sector.
current account This account shows current import and export payments of both goods and services and investment income sent to foreign investors and investment income received by U.S. citizens who invest abroad.
debt financing A firm’s way of raising investment funds by issuing bonds to the public.
decision to invest A firm invests in projects if the expected rate of return is at least as great as the real interest rate.
deflation A decline in the overall price level.
demand curve Shows the quantity of a good demanded at all prices.
demand-pull inflation Inflation that results from stronger AD as it increases in the upward-sloping range of AS.
demand schedule A table showing quantity demanded for a good at all prices.
depreciating currency A decrease in the price of one currency relative to another currency.
depression A prolonged, deep trough in the business cycle.
determinants of demand The external factors that shift demand to the left or right.
determinants of supply The external factors that influence supply. When these variables change, the entire supply curve shifts to the left or right.
discount rate The interest rate commercial banks pay on short-term loans from the Fed.
discouraged workers Citizens who have been without work for so long that they become tired of looking for work and drop out of the labor force. Because these citizens are not counted in the ranks of the unemployed, the reported unemployment rate is understated.
disequilibrium Any price where the quantity demanded does not equal the quantity supplied.
disposable income (DI) The income a consumer has to spend or save once he or she has paid out net taxes.
dissaving Another way of saying that saving is less than zero.
domestic price The equilibrium price of a good in a nation without trade.
double counting The mistake of including the value of intermediate stages of production in GDP on top of the value of the final good.
economic growth The increase in an economy’s PPF over time.
economics The study of how society allocates scarce resources.
equation of exchange The equation says that nominal GDP (P × Q ) is equal to the quantity of money (M ) multiplied by the number of times each dollar is spent in a year (V ).
equilibrium GDP The level of real GDP where real domestic production is equal to real domestic spending.
equity financing The firm’s method of raising funds for investment by issuing shares of stock to the public.
excess demand The difference between quantity demanded and quantity supplied. A shortage.
excess reserves The portion of a deposit that may be loaned to borrowers.
excess supply The difference between quantity supplied and quantity demanded. A surplus.
exchange rate The amount of one currency you must give up to get one unit of the second currency.
expansion A period where real GDP is growing.
expansionary fiscal policy Increases in government spending or lower net taxes meant to shift AD to the right toward full employment and lower the unemployment rate.
expansionary monetary policy Increases in the money supply meant to decrease real interest rates, shift AD to the right toward full employment, and reduce the unemployment rate.
expected rate of return (r ) The rate of profit the firm anticipates receiving on investment expenditures.
exports Goods and services produced domestically but sold abroad.
factors of production Inputs or resources that go into the production function to produce goods and services.
fiat money Paper and coin money with no intrinsic value but used to make transactions because the government declares it to be legal tender.
final goods Goods that are ready for their final use by consumers and firms.
financial account See capital account .
the firm An organization that employs factors of production to produce a good or service that it hopes to profitably sell.
fiscal policy Deliberate changes in government spending and net tax collection to affect economic output, unemployment, and the price level.
foreign sector substitution effect The process of domestic consumers looking for foreign goods when the domestic price level rises, thus reducing the quantity of domestic output consumed.
fractional reserve banking A system in which only a fraction of the total money deposited in banks is held in reserve.
full employment Exists when the economy is experiencing no cyclical unemployment.
functions of money Money serves as a medium of exchange, a unit of account, and a store of value.
future value If r is the current interest rate, the future value of $1 invested today for a period of one year is $1 × (1 + r ).
GDP price deflator The price index that measures the average price level of goods and services that make up GDP.
gross domestic product (GDP) The market value of the final goods and services produced within a nation in a given period of time.
human capital The amount of knowledge and skills that labor can apply to the work that they do.
imports Goods produced abroad but consumed domestically.
income effect Due to a higher price, the change in quantity demanded that results from a change in the consumer’s purchasing power (or real income).
inferior goods A good for which demand decreases with an increase in consumer income.
inflation An increase in the overall price level.
inflation rate The percentage change in the price level from one year to the next
inflationary gap The amount by which equilibrium real GDP exceeds full employment GDP.
interest rate effect The process of reduced domestic consumption due to a higher price level causing an increase in the real interest rate.
intermediate goods Goods that require further modification before they are ready for their final use.
investment demand The negative relationship between the real interest rate and the cumulative dollars invested.
investment spending Spending on physical capital, inventories, and new construction.
investment tax credit A reduction in taxes for firms that invest in new capital like a factory or piece of equipment.
Keynesian school A macroeconomic model that believes the economy is unstable and does not naturally move to full employment in the long run.
labor force The sum of all individuals 16 years and older who are either currently employed (E ) or unemployed (U ). LF = E + U .
law of comparative advantage Nations can mutually benefit from trade so long as the relative production costs differ.
law of demand All else equal, when the price of a good rises, the quantity demanded of that good falls.
law of diminishing marginal returns As successive units of a variable input are added to a fixed input, beyond some point the marginal product declines.
law of increasing costs As more of a good is produced, the greater is its opportunity (or marginal) cost.
law of increasing marginal cost As a producer produces more of a good, the marginal cost rises. This is very similar to the idea of increasing opportunity costs in Chapter 5 .
law of supply All else equal, when the price of a good rises, the quantity supplied of that good rises.
liability of a bank Anything owned by depositors or lenders to the bank.
liquidity A measure of how easily an asset can be converted to cash.
loanable funds market A hypothetical market where borrowers (investors) demand more funds at a lower real interest rate and lenders (savers) supply more funds at a higher real interest rate.
long run A period of time long enough for the firm to alter all production inputs, including the plant size.
M 1 The most liquid measure of money supply, including cash, checking deposits, and traveler’s checks.
M 2 M 1 plus savings deposits, small time deposits, and money market and mutual funds balances.
macroeconomic long run A period of time long enough for input prices to have fully adjusted to market forces, all input and output markets are in equilibrium, and the economy is operating at full employment (GDPf ).
macroeconomic short run A period of time during which the prices of goods and services are changing in their respective markets but the input prices have not yet adjusted to those changes in the product markets.
marginal The next unit, or increment of, an action.
marginal analysis Making decisions based upon weighing the marginal benefits and costs of that action. The rational decision maker chooses an action if the MB ≥ MC.
marginal benefit (MB) The additional benefit received from the consumption of the next unit of a good or service.
marginal cost (MC) The additional cost of producing one more unit of output.
marginal propensity to consume (MPC) The change in consumption caused by a change in disposable income. The slope of the consumption function.
marginal propensity to save (MPS) The change in saving caused by a change in disposable income. The slope of the saving function.
marginal tax rate The rate paid on the last dollar earned, calculated by taking the ratio of the change in taxes divided by the change in income.
market A group with buyers and sellers of a good or service.
market basket A collection of goods and services used to represent what is consumed in the economy.
market economy An economic system in which resources are allocated through the decentralized decisions of firms and consumers.
market equilibrium Exists at the only price where the quantity supplied equals the quantity demanded. Or, it is the only quantity where the price consumers are willing to pay is exactly the price producers are willing to accept.
money demand The negative relationship between the nominal interest rate and the quantity of money demanded as an asset plus the quantity of money demanded for transactions.
money market The interaction of money demand and money supply determines the “price” of money, the nominal interest rate.
money multiplier Equal to one over the reserve ratio, this measures the maximum amount of new checking deposits that can be created by a single dollar of excess reserves.
money supply The fixed quantity of money in circulation at a given point in time as measured by the central bank.
multiplier effect The idea that a change in any component of aggregate demand creates a larger change in GDP.
national debt The accumulation of all annual budget deficits.
natural rate of unemployment The unemployment rate associated with full employment, somewhere between 4 to 6 percent in the United States.
net exports The value of a nation’s total exports minus total imports.
net export effect The process of how expansionary fiscal policy decreases net exports due to rising interest rates. Another form of crowding out.
nominal GDP The value of current production at the current prices.
nominal interest rate The interest rate unadjusted for inflation. The opportunity cost of holding money in the money market.
nonmarket transactions Household work or do-it-yourself jobs that are missed by GDP accounting.
nonrenewable resources Natural resources that cannot replenish themselves.
normal goods A good for which demand increases with an increase in consumer income.
official reserves account The Fed’s adjustment of a deficit or surplus in the current and capital account by the addition or subtraction of foreign currencies so that the balance of payments is zero.
open market operation (OMO) A tool of monetary policy, it involves the Fed’s buying (or selling) of Treasury bonds from (or to) commercial banks and the general public.
opportunity cost The value of the sacrifice made to pursue a course of action.
peak The top of the business cycle where an expansion has ended and is about to turn down.
present value If r is the current interest rate, the present value of $1 received one year from now is $1/(1 + r ).
price index A measure of the average level of prices in a market basket for a given year, when compared to the prices in a reference (or base) year.
producer surplus The difference between the price received and the marginal cost of producing the good.
production possibilities The different quantities of goods that an economy can produce with a given amount of scarce resources.
production possibility curve or frontier (PPC or PPF) A graphical device that shows the combination of two goods that a nation can efficiently produce with available resources and technology.
productivity The quantity of output that can be produced per worker in a given amount of time.
protective tariff An excise tax levied on an imported good that is produced in the domestic market so that it may be protected from foreign competition.
quantity theory of money The theory that an increase in the money supply will not affect real output and will only result in higher prices.
quota A maximum amount of a good that can be imported into the domestic market.
real GDP The value of current production, but using prices from a fixed point in time.
real rate of interest The cost of borrowing to fund an investment and equal to the nominal interest rate minus the expected rate of inflation.
recession Two or more consecutive quarters of falling real GDP.
recessionary gap The amount by which full employment GDP exceeds equilibrium real GDP.
relative prices The price of one unit of good X measured not in currency, but in the number of units of good Y that must be sacrificed to acquire good X.
renewable resources Natural resources that can replenish themselves if they are not overharvested.
required reserves The minimum amount of deposits that must be held at the bank for withdrawals.
reserve ratio The fraction of total deposits that must be kept on reserve.
resources Also called factors of production, these are commonly grouped into the four categories of labor, physical capital, land or natural resources, and entrepreneurial ability.
revenue tariff An excise tax levied on goods that are not produced in the domestic market.
saving function A positive relationship between disposable income and saving.
scarcity The imbalance between limited productive resources and unlimited human wants.
second-hand sales Final goods and services that are resold.
shortage A situation in which, at the going market price, the quantity demanded exceeds the quantity supplied.
specialization Production of goods, or performance of tasks, based upon comparative advantage.
spending multiplier The amount by which real GDP changes due to a change in spending.
stagflation A situation seen in the macroeconomy when inflation and the unemployment rate are both increasing. Also called cost-push inflation.
sticky prices The case when price levels do not change, especially downward, with changes in AD.
stock A certificate that represents a claim to, or share of, the ownership of a firm.
substitute goods Two goods are consumer substitutes if they provide essentially the same utility to the consumer.
substitution effect The change in quantity demanded resulting from a change in the price of one good relative to the price of other goods.
supply curve Shows the quantity of a good supplied at all prices.
supply schedule A table showing quantity supplied for a good at various prices.
supply shock An economy-wide phenomenon that affects the costs of firms and results in a shifting AS curve.
supply-side fiscal policy Fiscal policy centered on incentives to save and invest to prompt economic growth with very little inflation.
surplus A situation in which, at the going market price, the quantity supplied exceeds the quantity demanded.
tax multiplier The magnitude of the effect that a change in lump sum taxes has on real GDP.
technology A nation’s knowledge of how to produce goods in the best possible way.
theory of liquidity preference Keynes’ theory that the interest rate adjusts to bring the money market into equilibrium.
total welfare The sum of consumer surplus and producer surplus.
trade-offs The reality of scarce resources implies that individuals, firms, and governments are constantly faced with difficult choices that involve benefits and costs.
transaction demand The amount of money held in order to make transactions.
trough The bottom of the cycle where a contraction has stopped and is about to turn up.
underground economy The unreported or illegal activity, bartering, or informal exchange of cash for goods and services that are not reported in official tabulations of GDP.
velocity of money The average number of times that a dollar is spent in a year.
world price The global equilibrium price of a good when nations engage in trade.