Glossary

A

absolute advantage

The ability to do a task using fewer inputs.

absolute poverty

Judges the adequacy of resources relative to an absolute standard of living.

accounting profit

The total revenue a business receives, less its explicit financial costs; Accounting profit = Total revenue − Explicit financial costs.

actively managed

When a fund is managed by stock pickers.

actuarially fair

An insurance policy that, on average, is expected to pay out as much in compensation as it receives in premiums.

adverse selection of buyers

The tendency for the mix of buyers to be skewed toward more high-cost buyers when sellers don’t know buyers’ type.

adverse selection of sellers

The tendency for the mix of goods to be skewed toward more low-quality goods when buyers can’t observe quality.

aggregate demand curve

Shows the relationship between the price level and the total quantity of output that buyers collectively plan to purchase.

aggregate expenditure

The total amount of goods and services that people want to buy across the whole economy = Consumption + Planned investment + Government purchases + Net exports.

aggregate supply curve

Shows the relationship between the price level and the total quantity of output that suppliers collectively produce.

anchoring bias

The tendency to begin with an anchor, or starting point, and insufficiently adjust from there.

annualized rate

Data converted to the rate that would occur if the same growth rate had occurred throughout the year.

anti-coordination game

When your best response is to take a different (but complementary) action to the other player.

appreciation

When the price of a currency rises.

automatic stabilizers

Spending and tax programs that adjust as the economy expands and contracts, without policy makers taking any deliberate action.

availability bias

The tendency to overestimate the frequency of events that are easily recalled, and to underestimate the frequency of less memorable events.

average cost

Cost per unit, calculated as your firm’s total costs (including fixed and variable costs) divided by the quantity produced.

average revenue

Revenue per unit, calculated as total revenue divided by the quantity supplied. Average revenue is equal to the price, if you charge everyone the same price.

B

bank run

When many bank customers try to withdraw their savings at the same time.

bargaining power

Your ability to negotiate a better deal.

barriers to entry

Obstacles that make it difficult for new firms to enter a market.

behavioral economics

Economic analysis that includes psychological factors in assessing how people make economic decisions.

best response

The choice that yields the highest payoff for you given the other player’s choice.

bilateral trade balance

How much we buy from a specific country compared to how much they buy from us.

binding price ceiling

A price ceiling that prevents the market from reaching the market equilibrium price, meaning that the highest price sellers can charge is set below the equilibrium price.

binding price floor

A price floor that prevents the market from reaching the equilibrium price, meaning that the lowest price that sellers can charge is above the equilibrium price.

bond

An IOU. Specifically, a promise to pay back a loan with interest.

budget deficit

The difference between spending and revenue in a year in which spending exceeds revenue.

budget surplus

The difference between spending and revenue in a year in which revenue exceeds spending.

bundling

Selling different goods together as a package.

business cycle

Short-term fluctuations in economic activity.

business investment

Spending by businesses on new capital assets.

C

cap and trade

A quantity regulation implemented by allocating a fixed number of permits, which can then be traded.

capital stock

The total quantity of physical capital used in the production of goods and services at a point of time.

catch-up growth

The rapid growth that occurs when a relatively poor country invests in its physical capital.

change in the quantity demanded

The change in quantity associated with movement along a fixed demand curve.

change in the quantity supplied

The change in quantity associated with movement along a fixed supply curve.

check mark method

If you put a check mark next to each player’s best response, then an outcome with a check mark from each player is a Nash equilibrium.

classical dichotomy

A purely nominal change—like a change in the average price level—won’t have any effect on real variables in the long run.

club good

A good that is excludable, but nonrival in consumption.

Coase Theorem

If bargaining is costless and property rights are clearly established and enforced, then externality problems can be solved by private bargains.

collusion

An agreement to limit competition; typically, an agreement by rivals to not compete with each other, but to all charge high prices instead.

common resource

A good that is rival and also nonexcludable.

comparative advantage

The ability to do a task at a lower opportunity cost.

compensating differential

The differences in wages required to offset the desirable or undesirable aspects of a job.

complementary goods

Goods that go together. Your demand for a good will decrease if the price of a complementary good rises.

complements-in-production

Goods that are made together. Your supply of a good will increase if the price of a complement-in-production rises.

compounding formula

Future value in t years = Present value × (1 + r)t.

congestion effect

When a good becomes less valuable because other people use it. If more people buy such a product, your demand for it will decrease.

constant returns to scale

Increasing all inputs by some proportion will cause output to rise by the same proportion.

consumer price index (CPI)

An index that tracks the average price consumers pay over time for a representative “basket” of goods and services.

consumer surplus

The economic surplus you get from buying something; Consumer surplus = Marginal benefit − Price.

consumption

Household spending on final goods and services.

consumption function

A curve plotting the level of consumption associated with each level of income.

consumption smoothing

Maintaining a steady or smooth path for your consumption spending over time.

coordination game

When all players have a common interest in coordinating their choices.

corrective subsidy

A subsidy designed to induce people to take account of the positive externalities they cause.

corrective tax

A tax designed to induce people to take account of the negative externalities they cause.

cost-benefit principle

Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice, and only pursue those whose benefits are at least as large as their costs.

cost-push inflation

Inflation that results from an unexpected rise in production costs.

credit constraints

Limits on how much you can borrow.

cross-price elasticity of demand

A measure of how responsive the demand of one good is to price changes of another. It measures the percent change in quantity demanded that follows from a 1% change in the price of another good; Cross-price elasticity of demand=% change in quantity demanded% change in price of another good.

crowding out

The decline in private investment—and particularly investment—that follows from a rise in government borrowing.

current account balance

Measures the difference between the income that Americans receive from abroad and the income that Americans pay to people abroad.

cyclical unemployment

Unemployment that is due to a temporary downturn in the economy.

D

deadweight loss

How far economic surplus falls below the efficient outcome; Deadweight loss = Economic surplus at the efficient quantity − Actual economic surplus.

decrease in demand

A shift of the demand curve to the left.

decrease in supply

A shift of the supply curve to the left.

default risk

The risk that your loan won’t be repaid.

deflation

A generalized decrease in the overall level of prices.

demand-pull inflation

Inflation resulting from excess demand.

deposit insurance

A guarantee that you won’t lose the money you deposit in the bank.

depreciation (capital)

The decline in capital due to wear and tear, obsolescence, accidental damage, and aging.

depreciation (currency)

When the price of a currency falls.

depreciation rate

The proportion of an investment’s remaining productive capacity you lose each year due to depreciation.

derived demand

The demand for an input derives from the demand for the stuff that input produces.

diminishing marginal benefit

Each additional item yields a smaller marginal benefit than the previous item.

diminishing marginal product

The marginal product of an input declines as you use more of that input.

diminishing marginal utility

Each additional dollar yields a smaller boost to your utility—that is, less marginal utility—than the previous dollar.

discount rate

The interest rate on loans that the Fed offers to banks through the discount window.

discounting

Converting future values into their equivalent present values.

discounting formula

Present value=Future value in t years×1(1+r)t.

discretionary fiscal policy

Policy that temporarily increases spending or cuts taxes to boost the economy.

discretionary spending

Spending that Congress appropriates annually.

discrimination

Treating people differently based on characteristics such as their gender, race, ethnicity, sexual orientation, religion, disability, social class, or other factors.

disposable income

Your after-tax income.

dissaving

The excess amount you consume above your income in a given period that you therefore must pay for by either withdrawing money from your savings or borrowing money.

distributional consequences

Who gets what.

diversification

Reducing risk by combining a large number of small risks whose outcomes are not closely related.

dividends

A share of profits that a company pays to its shareholders.

domestic demand curve

Shows the quantity of a good that all domestic consumers added together plan to buy, at each price.

domestic supply curve

Shows the quantity of a good that all domestic suppliers added together plan to sell, at each price.

dual mandate

The Fed’s two goals of low and stable prices and maximum sustainable employment.

E

earned income

Wages from an employer, or net earnings from self-employment.

economic burden

The burden created by the change in after-tax prices faced by buyers and sellers.

economic efficiency

An outcome is more economically efficient if it yields more economic surplus.

economic profit

The total revenue a firm receives, less both explicit financial costs and the entrepreneur’s implicit opportunity costs; Economic profit = Total revenue − Explicit financial costs − Entrepreneur’s implicit opportunity costs.

economic surplus

The total benefits minus total costs flowing from a decision. It measures how much a decision has improved your well-being.

effective marginal tax rate

The amount of each extra dollar you earn that you lose to higher taxes and lower government benefits.

efficiency wage

A higher wage paid to encourage greater worker productivity.

efficient allocation

Allocating goods to create the largest economic surplus, which requires that each good goes to the person who’ll get the highest marginal benefit from it.

efficient markets hypothesis

The theory that at any point in time, stock prices reflect all publicly available information.

efficient outcome

The efficient outcome yields the largest possible economic surplus.

efficient production

Producing a given quantity of output at the lowest possible cost, which requires producing each good at the lowest marginal cost.

efficient quantity

The quantity that produces the largest possible economic surplus.

elastic

When the absolute value of the percent change in quantity is larger than the absolute value of the percent change in price, which means that the absolute value of the price elasticity is greater than 1.

employed

Working-age people who are working.

equilibrium

The point at which there is no tendency for change. A market is in equilibrium when the quantity supplied equals the quantity demanded.

equilibrium price

The price at which the market is in equilibrium.

equilibrium quantity

The quantity demanded and supplied in equilibrium.

equilibrium unemployment rate

The long-run unemployment rate to which the economy tends to return.

equity

An outcome yields greater equity if it results in a fairer distribution of economic benefits.

excess demand

When the quantity demanded at the prevailing price exceeds the quantity supplied.

excise tax

A tax on a specific product.

expansion

A period of increasing economic activity.

expected utility

What your utility will be, on average, if you make a particular choice.

export

To sell goods or services to foreign buyers.

exports

Goods or services produced domestically and purchased by foreign buyers.

external benefit

A benefit accruing to bystanders.

external cost

A cost imposed on bystanders.

externality

A side effect of an activity that affects bystanders whose interests aren’t taken into account.

extrinsic motivation

The desire to do something for its external rewards such as higher pay.

F

fair bet

A gamble that, on average, will leave you with the same amount of money.

Fed model

The framework that uses the IS curve, the MP curve, and the Phillips curve to link interest rates, the output gap, and inflation.

Fed rule-of-thumb

The recipe that describes how the Fed often sets the interest rate: Federal funds rate −Inflation=Neutral real interest rate+½× (Inflation −2%)+Output gap.

federal funds rate

The interest rate that the Fed uses as its policy tool, which is the nominal interest rate that banks pay to borrow from each other overnight in the federal funds market.

Federal Open Market Committee (FOMC)

The Federal Reserve committee that decides on U.S. interest rates. It consists of the Fed governors and district Fed bank presidents.

final goods and services

Finished goods or services.

financial account balance

The difference between financial inflows and financial outflows.

financial inflows

Investments by foreigners in the United States.

financial outflows

Investments by Americans in foreign countries.

financial shocks

Any change in borrowing conditions that changes the real interest rate at which people can borrow. Financial shocks shift the MP curve.

finitely repeated game

When you face the same strategic interaction a fixed number of times.

firm demand curve

An individual firm’s demand curve, summarizes the quantity that buyers demand from an individual firm as it changes its price.

first-mover advantage

The strategic gain from an anticipatory action that can force a rival to respond less aggressively.

fiscal policy

The government’s use of spending and tax policies to influence economic conditions in order to stabilize the economy.

Five Forces framework

The structure of competition in your market can be described in terms of five forces: 1. Competition from existing competitors; 2. Threat of potential entrants; 3. Threat of substitute products; 4. Bargaining power of suppliers; 5. Bargaining power of customers.

fixed cost

Those costs that don’t vary when you change the quantity of output you produce.

floor framework

The Fed’s approach of setting other interest rates to put a lower bound on how low the federal funds rate will go.

focal point

A cue from outside a game that helps you coordinate on a specific equilibrium.

focusing illusion

The tendency to mis-predict your utility by focusing on a few factors at the expense of others.

foreign exchange market

The market in which currencies are bought and sold.

foreign saving

Funding that comes from foreigners lending to Americans.

forward guidance

Providing information about the future course of monetary policy in order to influence market expectations of future interest rates.

framing effect

When a decision is affected by how a choice is described, or framed. You should avoid framing effects altering your own decisions.

free entry

When there are no factors making it particularly difficult or costly for a business to enter or exit an industry.

free-rider problem

When someone can enjoy the benefits of a good without bearing the costs.

frictional unemployment

Unemployment due to the time it takes for employers to search for workers and for workers to search for jobs.

fundamental analysis

A framework for assessing an asset’s fundamental value.

fundamental value

The present value of the future profits that a company will earn.

future value

The amount that your money will grow into by a future date, as a result of earning interest.

G

gains from trade

The benefits that come from reallocating resources, goods, and services to better uses.

game tree

Shows how a game plays out over time, with the first move forming the trunk, and then each subsequent choice branching out, so the final leaves show all possible outcomes.

GDP deflator

A price index that tracks the price of all goods and services produced domestically.

GDP per person

Total GDP divided by the population.

general skills

Skills useful to many employers.

globalization

The increasing economic, political, and cultural integration of different countries.

government failure

When government policies lead to worse outcomes.

government purchases

Government purchases of goods and services.

government saving

Saving by the government.

“greater fool” theory

The idea that people buy an investment because they expect other people to buy it from them at a higher price.

Grim Trigger strategy

If the other players have cooperated in all previous rounds, you will cooperate. But if any player has defected in the past, you will defect.

gross domestic product (GDP)

The market value of all final goods and services produced within a country in a year.

gross government debt

The total accumulated amount of money the government owes.

group pricing

Price discrimination by charging different prices to different groups of people.

H

hedge

Acquire an offsetting risk.

“holding other things constant”

A commonly used qualifier noting your conclusions may change if some factor that you haven’t analyzed changes. (In Latin, it’s ceteris paribus.)

hold-up problem

Once you have made a relationship-specific investment, the other side may try to renegotiate so that they get a better deal (and you get a worse one).

housing investment

Spending on building or improving houses or apartments.

human capital

The accumulated knowledge and skills that make a worker more productive; the skills that workers bring to the job.

hurdle method

Offer lower prices only to those buyers who are willing to overcome some hurdle, or obstacle.

hyperinflation

Extremely high rates of inflation.

hysteresis

When a period of high unemployment leads to a higher equilibrium unemployment rate.

I

imperfect competition

When you face at least some competitors and/or you sell products that differ at least a little from your competitors. Monopolistic competition and oligopoly are examples.

implicit bias

Judgments shaped by the unconscious attribution of particular qualities to specific groups.

import

To buy goods or services from foreign sellers.

imports

Goods or services produced in a foreign country and purchased by domestic buyers.

import quota

A limit on the quantity of a good that can be imported.

income

The money you receive in a period of time, such as a year.

income effect

Measures how people’s choices change when they have more income. A higher wage increases your income, leading you to choose more leisure and hence less work.

income elasticity of demand

A measure of how responsive the demand for a good is to changes in income. It measures the percent change in quantity demanded that follows from a 1% change in income; Income elasticity of demand=% change in quantity demanded% change in income.

income taxes

Taxes collected on all income, regardless of its source.

increase in demand

A shift of the demand curve to the right.

increase in supply

A shift of the supply curve to the right.

indefinitely repeated game

When you face the same strategic interaction an unknown number of times.

index fund

A mutual fund that consists of a broad market index; an investment that automatically invests in a predefined portfolio of stocks.

indexation

Automatically adjusting wages, benefits, tax brackets, and the like to compensate for inflation.

individual demand curve

A graph, plotting the quantity of an item that someone plans to buy, at each price.

individual supply curve

A graph plotting the quantity of an item that a business plans to sell at each price.

inelastic

When the absolute value of the percent change in quantity is smaller than absolute value of the percent change in price, which means that the absolute value of the price elasticity is less than 1.

inferior good

A good for which higher income causes a decrease in demand.

inflation

A generalized rise in the overall level of prices.

inflation expectations

The rate at which average prices are anticipated to rise next year.

inflation fallacy

The (mistaken) belief that inflation destroys purchasing power.

inflation rate

The annual percentage increase in the average price level.

inflation target

A publicly stated goal for the inflation rate.

informative advertising

Advertising that provides information about a product and its attributes.

initial public offering

When a company first sells stock directly to the public.

insufficient demand

When the quantity demanded at the prevailing price is below what’s supplied.

insurance

A promise of compensation if a specified bad thing happens.

interdependence principle

Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of these factors changes, your best choice might change.

interest rate on excess reserves

The interest rate the Fed pays to banks on reserves that are in excess of required reserves.

intergenerational mobility

The extent to which the economic status of children is independent of the economic status of their parents.

intermediate goods and services

Goods or services used as inputs in the production of other products.

internal markets

Markets within a company to buy and sell scarce resources.

intrinsic motivation

The desire to do something for the enjoyment of the activity itself.

investment

Spending on new capital assets that increase the economy’s productive capacity.

investment line

The line that shows how the quantity of investment increases as the real interest rate falls.

involuntarily part time

Someone who wants full-time work and is working part time because they haven’t found a full-time job.

IS curve

Illustrates how lower real interest rates raise spending and hence GDP, leading to a more positive output gap.

J

job-specific skills

Skills that are only useful in a job with one particular employer.

K

knowledge problem

When knowledge needed to make a good decision is not available to the decision maker.

L

labor force

The employed plus the unemployed.

labor force participation rate

The percentage of the working-age population that is either employed or unemployed.

labor market Phillips curve

A Phillips curve linking unexpected inflation to the unemployment rate.

labor productivity

The quantity of goods and services that each person produces per hour of work.

labor supply

The time you spend working in the market.

lagging indicators

Variables that follow the business cycle with a delay.

law of demand

The tendency for quantity demanded to be higher when the price is lower.

law of diminishing returns

When one input is held constant, increases in the other inputs will, at some point, begin to yield smaller and smaller increases in output.

law of supply

The tendency for the quantity supplied to be higher when the price is higher.

leading indicators

Variables that tends to predict the future path of the economy.

lender of last resort

The Fed’s role as the lender that financial institutions turn to when they’re having trouble getting loans.

liquidity

The ability to quickly and easily convert your investments into cash, with little or no loss in value.

liquidity risk

The risk that if you need to sell an asset quickly, you may not be able to get a good price for it.

long run

The horizon over which you, or your rivals, may expand or contract production capacity, and new rivals may enter the market or existing firms may exit.

long-run aggregate supply curve

The aggregate supply curve that applies to the long run when prices have fully adjusted. Because the economy will return to producing its potential output, this curve is vertical.

long-term unemployed

People who have been unemployed for six consecutive months or longer.

look forward

In games that play out over time, you should look forward to anticipate the likely consequences of your choices.

loss aversion

Being more sensitive to losses than to gains.

M

macroeconomic equilibrium

Occurs when the quantity of output that buyers collectively want to purchase is equal to the quantity of output that suppliers collectively produce.

macroeconomics

The study of the economy as a whole.

mandate

A requirement to buy or sell a minimum amount of a good.

mandatory spending

Spending on programs that does not get determined annually; instead, it is set in law.

marginal benefit

The extra benefit from one extra unit (of goods purchased, hours studied, etc.).

marginal cost

The extra cost from one extra unit.

marginal external benefit

The extra external benefit accruing to bystanders from one extra unit.

marginal external cost

The extra external cost imposed on bystanders from one extra unit.

marginal principle

Decisions about quantities are best made incrementally. You should break “how many” questions into a series of smaller, or marginal decisions, weighing marginal benefits and marginal costs.

marginal private benefit

The extra benefit enjoyed by the buyer from one extra unit.

marginal private cost

The extra cost paid by the seller from one extra unit.

marginal product

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

marginal product of labor

The extra production that occurs from hiring an extra worker.

marginal propensity to consume

The fraction of each extra dollar of income that households spend on consumption.

marginal revenue

The addition to total revenue you get from selling one more unit.

marginal revenue product

Measures the marginal revenue from hiring an additional worker. The marginal revenue product is equal to the marginal product of labor multiplied by the price of that product. MRP_L = MP_L × P.

marginal social benefit

All marginal benefits, no matter who gets them; Marginal social benefit = Marginal private benefit + Marginal external benefit.

marginal social cost

All marginal costs, no matter who pays them; Marginal social benefit = Marginal private cost + Marginal external cost.

marginal tax rate

The tax rate you pay if you earn another dollar.

marginal utility

The additional utility you get from one more dollar.

marginally attached

Someone who wants a job, and who has looked for a job within the past year, but who isn’t counted as unemployed because they aren’t currently searching for work.

market

A setting bringing together potential buyers and sellers.

market demand curve

A graph plotting the total quantity of an item demanded by the entire market, at each price.

market economy

Each individual makes their own production and consumption decisions, buying and selling in markets.

market failure

When the forces of supply and demand lead to an inefficient outcome.

market for loanable funds

The market for the funds used to buy, rent, or build capital.

market power

The extent to which a seller can charge a higher price without losing many sales to competing businesses.

market supply curve

A graph plotting the total quantity of an item supplied by the entire market, at each price.

maturity transformation

Using short-term loans to make long-term loans.

means-tested

Eligibility is based on income and sometimes wealth.

menu costs

The marginal cost of adjusting prices.

monetary policy

The process of setting interest rates in an effort to influence economic conditions.

money

Any asset regularly used in transactions.

money illusion

The (mistaken) tendency to focus on nominal dollar amounts instead of inflation-adjusted amounts.

monopolistic competition

A market with many small businesses competing, each selling differentiated products.

monopoly

When there is only one seller in the market.

monopsony power

A business using its bargaining power as a major buyer of labor to pay lower prices, including lower wages.

moral hazard

The actions you take because they are not fully observable and you are partially insulated from their consequences.

movement along the demand curve

A price change causes movement from one point on a fixed demand curve to another point on the same curve.

movement along the supply curve

A price change causes movement from one point on a fixed supply curve to another point on the same curve.

MP curve

Illustrates the current real interest rate, which is shaped by monetary policy and the risk premium.

multiple equilibria

When there is more than one equilibrium.

multiplier

A measure of how much GDP changes as a result of both the direct and indirect effects flowing from each extra dollar of spending.

mutual fund

A fund that buys a portfolio of stocks (and sometimes bonds) on your behalf.

N

Nash equilibrium

An equilibrium in which the choice that each player makes is a best response to the choices other players are making.

natural monopoly

A market in which it is cheapest for a single business to service the market.

negative externality

An activity whose side effects harm bystanders.

net exports

Spending on exports minus spending on imports; also referred to as the trade balance.

net government debt

The debt that the government owes to individuals, businesses, and other governments both here and abroad.

net wealth

The amount by which your assets exceed your debts.

network effect

When a good becomes more useful because other people use it. If more people buy such a good, your demand for it will also increase.

neutral real interest rate

The interest rate that operates when the economy is in neutral—producing neither above nor below its potential.

next best alternative

The value of your best option, outside of this deal.

nominal exchange rate

The price of a country’s currency (in terms of another country’s currency).

nominal exchange rate formula

Nominal exchange rate=Number of units of a foreign currencyNumber of dollars.

nominal GDP

GDP measured in today’s prices.

nominal interest rate

The stated interest rate without a correction for the effects of inflation.

nominal variable

A variable measured in dollars (whose value may fluctuate over time).

nominal wage rigidity

Reluctance to cut nominal wages.

nonexcludable

When someone cannot be easily excluded from using something.

non-price competition

Competing to win customers by differentiating your product.

nonrival good

A good for which one person’s use doesn’t subtract from another’s.

normal good

A good for which higher income causes an increase in demand.

normative analysis

Prescribes what should happen, which involves value judgments.

not in the labor force

Those in the working-age population who are neither employed nor unemployed.

O

Okun’s rule of thumb

For every percentage point that actual output falls below potential output, the unemployment rate is around half a percentage point higher.

oligopoly

A market with only a handful of large sellers.

one-shot game

A strategic interaction that occurs only once.

open market operations

The Federal Reserve’s buying and selling of government bonds to influence the federal funds rate.

Open Market Trading Desk (the Desk)

A trading desk at the New York Federal Reserve Bank where the Fed buys and sells government bonds.

opportunity cost

The true cost of something is the next best alternative you have to give up to get it.

output gap

The difference between actual and potential output, measured as a percentage of potential output.

overconfidence

The tendency to overrate the accuracy of your forecasts.

overnight reverse repurchase agreements

When the Desk sells a government bond to a financial institution, with an agreement to buy it back the next day at a higher price.

P

pay-for-performance

Linking the income your workers earn to measures of their performance. Examples include commissions, piece rates, bonuses, or promotions.

payoff table

A table that lists your choices in each row, the other player’s choices in each column, and so shows all possible outcomes, listing the payoffs in each cell.

payroll taxes

Taxes on earned income.

peak

A high point in economic activity.

perfect competition

Markets in which 1) all firms in an industry sell an identical good; and 2) there are many buyers and sellers, each of whom is small relative to the size of the market.

perfect price discrimination

Charging each customer their reservation price.

perfectly elastic

When any change in price leads to an infinitely large change in quantity.

perfectly inelastic

When quantity does not respond at all to a price change.

permanent income

Your average lifetime income; your best estimate of your long-term average income.

permanent income hypothesis

The idea that consumption is driven by permanent income rather than current income.

personal saving

Saving by households of whatever money they don’t either spend or pay as taxes.

persuasive advertising

Advertising that tries to persuade or manipulate you into believing that you’ll enjoy a particular product.

Phillips curve

A curve illustrating the link between the output gap and unexpected inflation.

physical capital

Tools, machinery, and structures.

planned economy

Centralized decisions are made about what is produced, how, by whom, and who gets what.

planned investment

Spending on machinery, software, and buildings used to produce goods and services. Unlike total investment, it excludes changes in inventories.

positive analysis

Describes what is happening, explaining why, or predicting what will happen.

positive externality

An activity whose side effects benefit bystanders.

potential output

The level of output that occurs when all resources are fully employed.

poverty line

An income level, below which a family is defined to be in poverty.

poverty rate

The percentage of people whose family income is below the poverty line.

precautionary saving

Saving to be prepared for a financial emergency.

prediction markets

Markets whose payoffs are linked to whether an uncertain event occurs.

prejudice

A preconceived bias against a group that’s not based on reason or experience.

premium

The price of insurance.

present value

The amount of money that you would need to invest today in order to produce an equivalent benefit in the future.

price ceiling

A maximum price that sellers can charge.

price competition

Competing to win customers by offering lower prices.

price discrimination

Selling the same good at different prices.

price elasticity of demand

A measure of how responsive buyers are to price changes. It measures the percent change in quantity demanded that follows from a 1% price change; Price elasticity of demand=% change in quantity demanded% change in price.

price elasticity of supply

A measure of how responsive sellers are to price changes. It measures the percent change in quantity supplied that follows from a 1% price change; Price elasticity of supply=% change in quantity supplied% change in price.

price floor

A minimum price that sellers can charge.

price-taker

Someone who decides to charge the prevailing price and whose actions do not affect the prevailing price.

principal-agent problem

The problems that arise when a principal hires an agent to do something on their behalf, but the principal cannot perfectly observe the agent’s actions.

private information

When one party to a transaction knows something the other doesn’t.

producer price index (PPI)

A price index that tracks the prices of inputs into the production process.

producer surplus

The economic surplus you get from selling something; Producer surplus = Price − Marginal cost.

product differentiation

Efforts by sellers to make their products differ from those of their competitors.

production function

The methods by which inputs are transformed into output which determines the total production that’s possible with a given set of ingredients.

production possibility frontier

Shows the different sets of output that are attainable with your scarce resources.

profit margin

Profits per unit sold; Profit margin = Average revenue − Average cost.

progressive tax

A tax where those with more income tend to pay a higher share of their income in taxes.

property rights

Control over a tangible or intangible resource.

property tax

A tax on the value of property, usually real estate.

prune the tree method

A method for solving game trees: Start by looking forward to the final period and highlighting out your rival’s best responses, then prune the options the rival would never choose—the “dead leaves”—off your game tree.

public good

A nonrival good that is nonexcludable and hence subject to the free-rider problem.

Q

quantitative easing

Purchasing large quantities of longer-term government bonds and other securities in an effort to lower long-term interest rates.

quantity discount

When the per-unit price is lower when you buy a larger quantity.

quantity regulation

A minimum or maximum quantity that can be sold.

quota

A limit on the maximum quantity of a good that can be sold.

R

random walk

When a price follows an unpredictable path.

Rational Rule

If something is worth doing, keep doing it until your marginal benefits equal your marginal costs.

Rational Rule for Buyers

Buy more of an item if the marginal benefit of one more is greater than (or equal to) the price.

Rational Rule for Consumers

Consume more today if the marginal benefit of a dollar of consumption today is greater than (or equal to) the marginal benefit of spending a dollar plus interest in the future.

Rational Rule for Employers

Hire more workers if the marginal revenue product is greater than (or equal to) the wage.

Rational Rule for Entry

You should enter a market if you expect to earn a positive economic profit, which occurs when the price exceeds your average cost.

Rational Rule for Exit

Exit the market if you expect to earn a negative economic profit, which occurs if the price is less than your average costs.

Rational Rule for Investors

Pursue an investment opportunity if the present value of future revenues exceeds the up-front cost.

Rational Rule for Markets

Produce more of a good if its marginal benefit is greater than (or equal to) the marginal cost.

Rational Rule for Sellers

Sell one more item if the marginal revenue is greater than (or equal to) marginal cost.

Rational Rule for Sellers in Competitive Markets

Sell one more item if the price is greater than (or is equal to) the marginal cost.

Rational Rule for Society

Produce more of an item if its marginal social benefit is greater than (or equal to) the marginal social cost.

Rational Rule for Workers

Work one more hour as long as the wage is at least as large as the marginal benefit of another hour of leisure.

real exchange rate

The domestic price divided by the foreign price, expressed in the domestic currency. Calculated as: Domestic priceForeign price/Nominal exchange rate.

real GDP

GDP measured in constant prices.

real interest rate

The interest rate in terms of changes in your purchasing power; ≈ Nominal interest rate − Inflation rate

real variable

A variable that has been adjusted to account for inflation.

reason backward

Start by analyzing the last period of the game. Use this to figure what will happen in the second-to-last period, and keep reasoning backward until you can see all the consequences that follow from today’s decision.

recession

A period of declining economic activity.

refundable tax credit

A tax credit for which receiving the credit doesn’t depend on owing income taxes.

regressive tax

A tax where those with less income tend to pay a higher share of their income on the tax.

relationship-specific investment

An investment that is more valuable if the current business relationship continues.

relative poverty

Judges poverty relative to the material living standards of your contemporary society.

relative valuation

An assessment of the value of an asset by comparing it to similar assets.

repeated game

When you face the same strategic interaction with the same rivals and the same payoffs in successive periods.

representativeness bias

The tendency to assess the likelihood that something belongs in a category by judging how similar they are to that category.

reservation price

The maximum price a customer will pay for a product. It is equal to their marginal benefit.

reserve requirements

A minimum amount of reserves that each bank must hold.

reserves

The cash that banks need to keep on hand to make payments.

retained earnings

The profits that a company chooses not to give as dividends to shareholders.

revisions

Updates to earlier estimates.

risk averse

Disliking uncertainty.

risk loving

Liking uncertainty.

risk neutral

Indifferent to uncertainty.

risk premium

The extra interest that lenders charge to account for the risk of loaning money.

risk spreading

Breaking a big risk into many smaller risks so that it can be spread over many people.

risk-free interest rate

The interest rate on a loan that involves no risk.

rival good

A good for which your use of it comes at someone else’s expense.

Rule of 70

Divide 70 by the annual growth rate to get the number of years until the original amount doubles.

S

sales tax

A tax on purchases that’s typically a percentage of the purchase price of goods and services.

saving

The portion of income that you set aside, rather than spending on consumption.

scarcity

The problem that resources are limited.

search good

A good that you can easily evaluate before buying it.

seasonally adjusted

Data stripped of predictable seasonal patterns.

second-mover advantage

The strategic advantage that can follow from taking an action that adapts to your rival’s choice.

shadow banks

Financial firms that are similar to banks, but are not regulated like banks.

shift in the demand curve

A movement of the demand curve itself.

shift in the supply curve

A movement of the supply curve itself.

shoe-leather costs

The costs incurred trying to avoid holding cash.

short run

The horizon over which the production capacity, and the number and type of competitors you face, cannot change.

short-run aggregate supply curve

The aggregate supply curve that applies over a period when prices are neither fully fixed nor fully flexible. As a result, the short-run aggregate supply curve is upward-sloping.

shortage

When the quantity demanded exceeds the quantity supplied.

signal

An action taken to credibly convey private information, or information that is hard for someone else to verify.

social insurance

Government provided insurance against bad outcomes such as unemployment, illness, disability, or outliving your savings.

social safety net

The cash assistance, goods, and services provided by the government to better the lives of those at the bottom of the income distribution.

socially optimal

The outcome that is most efficient for society as a whole, including the interests of buyers, sellers, and bystanders.

someone else’s shoes technique

By mentally “trading places” with someone so that you understand their objectives and constraints, you can forecast the decisions they will make.

specialization

Focusing on specific tasks.

speculative bubble

When the price of an asset rises above what appears to be its fundamental value.

spending shocks

Any change in aggregate expenditure at a given real interest rate and level of income. Spending shocks shift the IS curve.

stagflation

A combination of economic stagnation—or falling output—combined with high inflation.

statistical discrimination

Using observations about the average characteristics of a group to make inferences about an individual.

statutory burden

The burden of being assigned by the government to send a tax payment.

sticky prices

Prices that adjust sporadically and sluggishly to changes in market conditions.

stock market

The market where people buy and sell existing stocks.

strategic interaction

When your best choice may depend on what others choose, and their best choice may depend on what you choose.

strategic plan

A list of instructions that describes exactly how to respond in any possible situation.

structural unemployment

Unemployment that occurs because wages don’t fall to bring labor demand and supply into equilibrium.

subsidy

A payment made by the government to those who make a specific choice.

substitute goods

Goods that replace each other. Your demand for a good will increase if the price of a substitute good rises.

substitutes-in-production

Alternative uses of your resources. Your supply of a good will decrease if the price of a substitute-in-production rises.

substitution bias

The overstating of inflation that occurs because people substitute toward goods whose prices rise by less.

substitution effect

Measures how people respond to a change in relative prices. A higher wage increases the returns to work relative to leisure, leading you to work more.

sunk cost

A cost that has been incurred and cannot be reversed. A sunk cost exists whatever choice you make, and hence it is not an opportunity cost. Good decisions ignore sunk costs.

supply shocks

Any change in production costs that leads suppliers to change the prices they charge at any given level of output. Supply shocks shift the Phillips curve.

surplus

When the quantity demanded is less than the quantity supplied.

switching costs

An impediment that makes it costly for customers to switch to buying from another business.

systematic risk

Risks that are common across the whole economy.

T

tariff

A tax on imported products.

tax expenditures

Special deductions, exemptions, or credits that lower your tax obligations, to encourage you to engage in certain kinds of activities.

tax incidence

The division of the economic burden of a tax between buyers and sellers.

taxable income

The amount of your income that you pay taxes on.

technological progress

New methods for using existing resources.

term risk

The risk that arises from uncertainty about future interest rates.

total revenue

The total amount you receive from buyers, which is calculated as price × quantity.

trade costs

The extra costs incurred as a result of buying or selling internationally, rather than domestically.

tragedy of the commons

The tendency to overconsume a common resource.

transfer payments

Payments that transfer income from one person to another.

trough

A low point in economic activity.

U

underemployed

Someone who has some work but wants more hours, or whose job isn’t adequately using their skills.

unemployed

Working-age people without jobs who are trying to get jobs.

unemployment rate

The percentage of the labor force that is unemployed.

unexpected inflation

The difference between inflation and inflation expectations = Inflation – Inflation expectations.

unfunded liability

A commitment to incur expenses in the future without a plan to pay for those expenses.

user cost of capital

The extra cost associated with using one more machine next year = (r + d) × C.

utilitarianism

The political philosophy that government should try to maximize total utility in society.

utility

Your level of well-being.

V

valuation formula

Present value of an ongoing stream of payments=Next year’s revenuer+d.

value added

The amount by which the value of an item is increased at each stage of production. Value added = Total sales − Cost of intermediate inputs.

variable costs

Those costs—like labor and raw materials—that vary with the quantity of output you produce.

vertical integration

When two (or more) companies along a production chain combine to form a single company.

very-short-run aggregate supply curve

The aggregate supply curve that applies to the very short run, in which no prices have changed. Because prices are effectively fixed, this curve is horizontal.

voluntary exchange

Buyers and sellers exchange money for goods only if they both want to.

W

wage-price spiral

A cycle where higher prices lead to higher nominal wages, which leads to higher prices.

wealth

All the assets—including savings, cars, a home—that you currently have.

willingness to pay

In order to convert nonfinancial costs or benefits into their monetary equivalent, ask yourself: “What is the most I am willing to pay to get this benefit (or avoid that cost)?”

working-age population

Those age 16 or older who are not in the military or institutionalized.

world price

The price that a product sells for in the global market.

Z

zero lower bound

The constraint that nominal interest rates cannot be effectively set below zero.