Glossary

A

absolute advantage one person has an absolute advantage over another if he or she takes fewer hours to perform a task than the other person

accounting profit the difference between a firm’s total revenue and its explicit costs

adaptive rationality standard a variant of the rational-choice model that permits additional preferences to be added if they can be shown not to handicap resource acquisition in competitive environments

adverse selection the pattern in which insurance tends to be pur­chased disproportionately by those who are most costly for companies to insure

aggregate demand (AD) curve a curve that shows the relationship between short-run equilibrium output Y and the rate of inflation π, it thus shows the amount of output consumers, firms, govern­ment, and entities abroad want to purchase at each inflation rate, holding all other factors constant

aggregate expenditure the sum of consumer expenditures, firms’ investment, government purchases, and net exports

aggregate supply shock either an inflation shock or a shock to potential output; adverse aggregate supply shocks of both types reduce output and increase inflation

aggregation the adding up of individual economic variables to obtain economywide totals

allocative function of price changes in prices direct resources away from overcrowded markets and toward markets that are underserved

anchoring and adjustment an estimation technique that begins with an initial approximation (the anchor), which is then modified in accordance with additional available information (the adjustment)

appreciation an increase in the value of a currency relative to other currencies

assets anything of value that one owns

asymmetric information situations in which buyers and sellers are not equally well informed about the characteristics of goods and services for sale in the marketplace

attainable point any combination of goods that can be produced using currently available resources

autarky a situation in which a country is economically self-sufficient

automatic stabilizers provisions in the law that imply automatic increases in government spending or decreases in taxes when real output declines

autonomous consumption consumption spending that is not related to the level of disposable income

autonomous expenditure the portion of planned aggregate expendi­ture that is independent of output

availability heuristic a rule of thumb that estimates the frequency of an event by the ease with which it is possible to summon examples from memory

average benefit the total benefit of undertaking n units of an activ­ity divided by n

average cost the total cost of undertaking n units of an activity divided by n

average labor productivity output per employed worker

average total cost (ATC) total cost divided by total output

average variable cost (AVC) variable cost divided by total output

B

balance sheet a list of an economic unit’s assets and liabilities on a specific date

balance-of-payments deficit the net decline in a country’s stock of international reserves over a year

balance-of-payments surplus the net increase in a country’s stock of international reserves over a year

bank reserves cash or similar assets held by commercial banks for the purpose of meeting depositor withdrawals and payments

banking panic a situation in which news or rumors of the immi­nent bankruptcy of one or more banks leads bank depositors to rush to withdraw their funds

barrier to entry any force that prevents firms from entering a new market

barter the direct trade of goods or services for other goods or services

basic elements of a game the players, the strategies available to each player, and the payoffs each player receives for each possible combination of strategies

bequest saving saving done for the purpose of leaving an inheritance

better-than-fair gamble a gamble whose expected value is positive

Board of Governors the leadership of the Fed, consisting of seven governors appointed by the president to staggered 14-year terms

bond a legal promise to repay a debt, usually including both the principal amount and regular interest, or coupon, payments

boom a particularly strong and protracted expansion

business cycles (or cyclical fluctuations) short-term fluctuations in GDP and other indicators of economic activity

buyer’s reservation price the largest dollar amount the buyer would be willing to pay for a good

buyer’s surplus the difference between the buyer’s reservation price and the price he or she actually pays

C

capital gains increases in the value of existing assets

capital good a long-lived good that is used in the production of other goods and services

capital inflows purchases of domestic assets by foreign households and firms

capital losses decreases in the value of existing assets

capital outflows purchases of foreign assets by domestic house­holds and firms

cartel a coalition of firms that agree to restrict output for the purpose of earning an economic profit

cash on the table an economic metaphor for unexploited gains from exchange

change in aggregate demand a shift of the entire AD curve

change in demand a shift of the entire demand curve

change in supply a shift of the entire supply curve

change in the quantity demanded a movement along the demand curve that occurs in response to a change in price

change in the quantity supplied a movement along the supply curve that occurs in response to a change in price

closed economy an economy that does not trade with the rest of the world

Coase theorem if, at no cost, people can negotiate the purchase and sale of the right to perform activities that cause external­ities, they can always arrive at efficient solutions to the prob­lems caused by externalities

collective good a good or service that, to at least some degree, is nonrival but excludable

commitment device a way of changing incentives so as to make otherwise empty threats or promises credible

commitment problem a situation in which people cannot achieve their goals because of an inability to make credible threats or promises

comparative advantage one person has a comparative advantage over another if his or her opportunity cost of performing a task is lower than the other person’s opportunity cost

compensating wage differential a difference in the wage rate—negative or positive—that reflects the attractiveness of a job’s working conditions

complements two goods are complements in consumption if an increase in the price of one causes a leftward shift in the demand curve for the other (or if a decrease causes a right­ward shift)

compound interest the payment of interest not only on the original deposit, but on all previously accumulated interest

constant (or parameter) a quantity that is fixed in value

constant returns to scale a production process is said to have con­stant returns to scale if, when all inputs are changed by a given proportion, output changes by the same proportion

consumer price index (CPI) for any period, a measure of the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year

consumer surplus the difference between a buyer’s reservation price for a product and the price actually paid

consumption expenditure (or consumption) spending by house­holds on goods and services such as food, clothing, and entertainment

consumption function the relationship between consumption spend­ing and its determinants, in particular, disposable (after-tax) income

consumption possibilities the combinations of goods and services that a country’s citizens might feasibly consume

contractionary policies government policy actions designed to reduce planned spending and output

core rate of inflation the rate of increase of all prices except energy and food

cost-plus regulation a method of regulation under which the regu­lated firm is permitted to charge prices that cover explicit costs of production plus a markup to cover the opportunity cost of resources provided by the firm’s owners

costly-to-fake principle to communicate information credibly to a potential rival, a signal must be costly or difficult to fake

coupon payments regular interest payments made to the bondholder

coupon rate the interest rate promised when a bond is issued; the annual coupon payments are equal to the coupon rate times the principal amount of the bond

credible promise a promise to take an action that is in the prom­iser’s interest to keep

credible threat a threat to take an action that is in the threatener’s interest to carry out

cross-price elasticity of demand the percentage by which the quantity demanded of the first good changes in response to a 1 percent change in the price of the second

crowding out the tendency of increased government deficits to reduce investment spending

customer discrimination the willingness of consumers to pay more for a product produced by members of a favored group, even if the quality of the product is unaffected

cyclical fluctuations See business cycles

cyclical unemployment the extra unemployment that occurs during periods of recession

D

deadweight loss the loss of consumer and producer surplus caused by disparitiy between price and marginal cost

decision tree (or game tree) a diagram that describes the possible moves in a game in sequence and lists the payoffs that corre­spond to each possible combination of moves

deflating (a nominal quantity) the process of dividing a nominal quantity by a price index (such as the CPI) to express the quantity in real terms

deflation a situation in which the prices of most goods and ser­vices are falling over time so that inflation is negative

demand curve a schedule or graph showing the quantity of a good that buyers wish to buy at each price

demand for money the amount of wealth an individual or firm chooses to hold in the form of money

dependent variable a variable in an equation whose value is determined by the value taken by another variable in the equation

deposit insurance a system under which the government guaran­tees that depositors will not lose any money even if their bank goes bankrupt

depreciation a decrease in the value of a currency relative to other currencies

depression a particularly severe or protracted recession

devaluation a reduction in the official value of a currency (in a fixed exchange rate system)

diminishing returns to capital if the amount of labor and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production

diminishing returns to labor if the amount of capital and other inputs in use is held constant, then the greater the quantity of labor already employed, the less each additional worker adds to production

disappearing political discourse the theory that people who support a position may remain silent because speaking out would cre­ate a risk of being misunderstood

discount rate the interest rate that the Fed charges commercial banks to borrow reserves

discount window lending the lending of reserves by the Federal Reserve to commercial banks

discouraged workers people who say they would like to have a job but have not made an effort to find one in the past four weeks

disinflation a substantial reduction in the rate of inflation

disposable income the aftertax amount of income that people are able to spend

distributional effects changes in the distribution of income or wealth in the economy

diversification the practice of spreading one’s wealth over a variety of different financial investments to reduce overall risk

dividend a regular payment received by stockholders for each share that they own

dominant strategy one that yields a higher payoff no matter what the other players in a game choose

dominated strategy any other strategy available to a player who has a dominant strategy

durable goods goods that yield utility over time and are made to last for three years or more

duration the length of an unemployment spell

E

earned-income tax credit (EITC) a policy under which low-income workers receive credits on their federal income tax

economic loss an economic profit that is less than zero

economic profit (or excess profit) the difference between a firm’s total revenue and the sum of its explicit and implicit costs

economic rent that part of the payment for a factor of production that exceeds the owner’s reservation price, the price below which the owner would not supply the factor

economic surplus the benefit of taking an action minus its cost

economics the study of how people make choices under conditions of scarcity and of the results of those choices for society

economies of scale See increasing returns to scale

efficiency (or economic efficiency) a condition that occurs when all goods and services are produced and consumed at their respective socially optimal levels

efficient (or Pareto efficient) a situation is efficient if no change is possible that will help some people without harming others

efficient point any combination of goods for which currently available resources do not allow an increase in the produc­tion of one good without a reduction in the production of the other

elastic the demand for a good is elastic with respect to price if its price elasticity of demand is greater than 1

employer discrimination an arbitrary preference by an employer for one group of workers over another

entrepreneurs people who create new economic enterprises

equation a mathematical expression that describes the relationship between two or more variables

equilibrium a balanced or unchanging situation in which all forces at work within a system are canceled by others

equilibrium exchange rate See fundamental value of the exchange rate

equilibrium price and equilibrium quantity the price and quan­tity at the intersection of the supply and demand curves for the good

excess demand (or shortage) the amount by which quantity demanded exceeds quantity supplied when the price of a good lies below the equilibrium price

excess reserves bank reserves in excess of the reserve requirements set by the central bank

excess supply (or surplus) the amount by which quantity supplied exceeds quantity demanded when the price of the good exceeds the equilibrium price

expansion a period in which the economy is growing at a rate significantly above normal

expansionary gap a positive output gap, which occurs when actual output is higher than potential output (Y > Y*)

expansionary policies government policy actions intended to increase planned spending and output

expected value of a gamble the sum of the possible outcomes of the gamble multiplied by their respective probabilities

expenditure line a line showing the relationship between planned aggregate expenditure and output

explicit costs the actual payments a firm makes to its factors of production and other suppliers

external benefit (or positive externality) a benefit of an activ­ity received by people other than those who pursue the activity

external cost (or negative externality) a cost of an activity that falls on people other than those who pursue the activity

externality an external cost or benefit of an activity

F

factor of production an input used in the production of a good or service

fair gamble a gamble whose expected value is zero

federal funds rate the interest rate that commercial banks charge each other for very short-term (usually overnight) loans

Federal Open Market Committee (FOMC) the committee that makes decisions concerning monetary policy

Federal Reserve System (or the Fed) the central bank of the United States

final goods or services goods or services consumed by the ultimate user; because they are the end products of the production process, they are counted as part of GDP

financial intermediaries firms that extend credit to borrowers using funds raised from savers

first-dollar insurance coverage insurance that pays all expenses gen­erated by the insured activity

fiscal policy decisions that determine the government’s budget, including the amount and composition of government expen­ditures and government revenues

Fisher effect the tendency for nominal interest rates to be high when inflation is high and low when inflation is low

fixed cost the sum of all payments made to the firm’s fixed factors of production

fixed exchange rate an exchange rate whose value is set by official government policy

fixed factor of production an input whose quantity cannot be altered in the short run

flexible exchange rate an exchange rate whose value is not offi­cially fixed but varies according to the supply and demand for the currency in the foreign exchange market

flow a measure that is defined per unit of time

foreign exchange market the market on which currencies of various nations are traded for one another

forward guidance information that a central bank provides to the financial markets regarding its expected future monetary-policy path

fractional-reserve banking system a banking system in which bank reserves are less than deposits so that the reserve-deposit ratio is less than 100 percent

free-rider problem an incentive problem in which too little of a good or service is produced because nonpayers cannot be excluded from using it

frictional unemployment the short-term unemployment associated with the process of matching workers with jobs

fundamental value of the exchange rate (or equilibrium exchange rate) the exchange rate that equates the quantities of the cur­rency supplied and demanded in the foreign exchange market

fungibility the property of an entity whose individual units are interchangeable, as money in separate accounts

G

game tree See decision tree

government budget deficit the excess of government spending over tax collections (GT)

government budget surplus the excess of government tax collec­tions over government spending (TG); the government budget surplus equals public saving

government purchases purchases by federal, state, and local gov­ernments of final goods and services; government purchases do not include transfer payments, which are payments made by the government in return for which no current goods or services are received, nor do they include interest paid on the government debt

gross domestic product (GDP) the market value of the final goods and services produced in a country during a given period

H

head tax a tax that collects the same amount from every taxpayer

health maintenance organization (HMO) a group of physicians that provides health services to individuals and families for a fixed annual fee

homo economicus the narrowly self-interested, well-informed, highly disciplined, and cognitively formidable actor often assumed in traditional economic models

human capital an amalgam of factors such as education, training, experience, intelligence, energy, work habits, trustworthiness, and initiative that affects the value of a worker’s marginal product

human capital theory a theory of pay determination that says a worker’s wage will be proportional to his or her stock of human capital

hurdle method of price discrimination the practice by which a seller offers a discount to all buyers who overcome some obstacle

hyperinflation a situation in which the inflation rate is extremely high

I

imperfectly competitive firm (or price setter) a firm that has at least some control over the market price of its product

implicit costs the opportunity costs of the resources supplied by the firm’s owners

in-kind transfer a payment made not in the form of cash, but in the form of a good or service

income effect the change in the quantity demanded of a good that results because a change in the price of a good changes the buyer’s purchasing power

income elasticity of demand the percentage by which a good’s quantity demanded changes in response to a 1 percent change in income

income-expenditure multiplier (or multiplier) the effect of a one-unit increase in autonomous expenditure on short-run equilibrium output

increasing returns to scale (or economies of scale) a production process is said to have increasing returns to scale if, when all inputs are changed by a given proportion, output changes by more than that proportion

independent variable a variable in an equation whose value deter­mines the value taken by another variable in the equation

indexing the practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index; indexing prevents the purchasing power of the nominal quantity from being eroded by inflation

induced expenditure the portion of planned aggregate expenditure that depends on output Y

inefficient point any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other

inelastic the demand for a good is inelastic with respect to price if its price elasticity of demand is less than 1

inferior good a good whose demand curve shifts leftward when the incomes of buyers increase and rightward when the incomes of buyers decrease

inflation shock a sudden change in the normal behavior of infla­tion, unrelated to the nation’s output gap

inflation-protected bonds bonds that pay a nominal interest rate each year equal to a fixed real rate plus the actual rate of inflation during that year

intermediate goods or services goods or services used up in the production of final goods and services and therefore not counted as part of GDP

international capital flows purchases or sales of real and financial assets across international borders

international financial markets financial markets in which borrow­ers and lenders are residents of different countries

international reserves foreign currency assets held by a government for the purpose of purchasing the domestic currency in the foreign exchange market

investment spending by firms on final goods and services, primar­ily capital goods

invisible hand theory Adam Smith’s theory that the actions of inde­pendent, self-interested buyers and sellers will often result in the most efficient allocation of resources

involuntary part-time workers people who say they would like to work full-time but are able to find only part-time work

J

judgmental and decision heuristics rules of thumb that reduce com­putation costs

L

labor force the total number of employed and unemployed people in the economy

labor union a group of workers who bargain collectively with employers for better wages and working conditions

law of demand people do less of what they want to do as the cost of doing it rises

law of diminishing marginal utility the tendency for the addi­tional utility gained from consuming an additional unit of a good to diminish as consumption increases beyond some point

law of diminishing returns a property of the relationship between the amount of a good or service produced and the amount of a variable factor required to produce it; the law says that when some factors of production are fixed, increased produc­tion of the good eventually requires ever-larger increases in the variable factor

law of one price if transportation costs are relatively small, the price of an internationally traded commodity must be the same in all locations

lemons model George Akerlof’s explanation of how asymmetric information tends to reduce the average quality of goods offered for sale

liabilities the debts one owes

life-cycle saving saving to meet long-term objectives such as retire­ment, college attendance, or the purchase of a home

logrolling the practice whereby legislators support one another’s legislative proposals

long run a period of time of sufficient length that all the firm’s factors of production are variable

long-run aggregate supply (LRAS) line a vertical line showing the economy’s potential output Y*

long-run equilibrium a situation in which actual output equals potential output and the inflation rate is stable; graphically, long-run equilibrium occurs when the AD curve, the SRAS line, and the LRAS line all intersect at a single point

loss aversion the tendency to experience losses as more pain­ful than the pleasures that result from gains of the same magnitude

M

M1 the sum of currency outstanding and balances held in check­ing accounts

M2 all the assets in M1 plus some additional assets that are usable in making payments but at greater cost or inconvenience than currency or checks

macroeconomic policies government actions designed to affect the performance of the economy as a whole

macroeconomics the study of the performance of national econo­mies and the policies that governments use to try to improve that performance

marginal benefit the increase in total benefit that results from car­rying out one additional unit of an activity

marginal cost the increase in total cost that results from carrying out one additional unit of an activity

marginal product (MP) the additional output a firm gets by employ­ing one additional unit of labor

marginal propensity to consume (mpc) the amount by which con­sumption rises when disposable income rises by $1; We assume that 0 < mpc < 1

marginal revenue the change in a firm’s total revenue that results from a one-unit change in output

marginal utility the additional utility gained from consuming an additional unit of a good

market the market for any good consists of all buyers or sellers of that good

market equilibrium occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price

market interest rate See nominal interest rate

market power a firm’s ability to raise the price of a good without losing all its sales

market value the selling prices of goods and services in the open market

means-tested a benefit program whose benefit level declines as the recipient earns additional income

medium of exchange an asset used in purchasing goods and services

menu costs the costs of changing prices

microeconomics the study of individual choice under scarcity and its implications for the behavior of prices and quantities in individual markets

monetary policy determination of the nation’s money supply

money any asset that can be used in making purchases

money demand curve a curve that shows the relationship between the aggregate quantity of money demanded M and the nomi­nal interest rate i

monopolistic competition an industry structure in which a large number of firms produce slightly differentiated products that are reasonably close substitutes for one another

moral hazard the tendency of people to expend less effort protect­ing those goods that are insured against theft or damage

mutual fund a financial intermediary that sells shares in itself to the public and then uses the funds raised to buy a wide vari­ety of financial assets

N

Nash equilibrium any combination of strategy choices in which each player’s choice is his or her best choice, given the other players’ choices

national saving the saving of the entire economy, equal to GDP less consumption expenditures and government purchases of goods and services, or YCG

natural monopoly a monopoly that results from economies of scale (increasing returns to scale)

natural rate of unemployment, u* the part of the total unemploy­ment rate that is attributable to frictional and structural unemployment; equivalently, the unemployment rate that prevails when cyclical unemployment is zero, so that the economy has neither a recessionary nor an expansionary output gap

negative externality See external cost

negative income tax (NIT) a system under which the government would grant every citizen a cash payment each year, financed by an additional tax on earned income

net exports exports minus imports

net worth an economic unit’s wealth determined by subtracting liabilities from assets

nominal exchange rate the rate at which two currencies can be traded for each other

nominal GDP a measure of GDP in which the quantities produced are valued at current-year prices; nominal GDP measures the current dollar value of production

nominal interest rate (or market interest rate) the annual percent­age increase in the nominal value of a financial asset

nominal price the absolute price of a good in dollar terms

nominal quantity a quantity that is measured in terms of its current dollar value

nondurable goods goods that can be quickly consumed or imme­diately used, having a lifespan of less than three years

nonexcludable good a good that is difficult, or costly, to exclude nonpayers from consuming

nonrival good a good whose consumption by one person does not diminish its availability for others

normal good a good whose demand curve shifts rightward when the incomes of buyers increase and leftward when the incomes of buyers decrease

normal profit the opportunity cost of the resources supplied by the firm’s owners, equal to accounting profit minus economic profit

normative analysis addresses the question of whether a policy should be used; normative analysis inevitably involves the val­ues of the person doing the analysis

normative economic principle one that says how people should behave

O

Okun’s law each extra percentage point of cyclical unemploy­ment is associated with about a 2 percentage point increase in the output gap, measured in relation to poten­tial output

oligopoly an industry structure in which a small number of large firms produce products that are either close or perfect substitutes

100 percent reserve banking a situation in which banks’ reserves equal 100 percent of their deposits

open economy an economy that trades with other countries

open-market operations open-market purchases and open-market sales

open-market purchase the purchase of government bonds from the public by the Fed for the purpose of increasing the supply of bank reserves and the money supply

open-market sale the sale by the Fed of government bonds to the public for the purpose of reducing bank reserves and the money supply

opportunity cost the value of what must be forgone to undertake an activity

optimal combination of goods the affordable combination that yields the highest total utility

output gap, YY* the difference between the economy's actual output and its potential output at a point in time

outsourcing a term increasingly used to connote having services performed by low-wage workers overseas

overvalued exchange rate an exchange rate that has an officially fixed value greater than its fundamental value

P

parameter See constant

participation rate the percentage of the working-age population in the labor force (that is, the percentage that is either employed or looking for work)

payoff matrix a table that describes the payoffs in a game for each possible combination of strategies

peak the beginning of a recession; the high point of economic activity prior to a downturn

perfect hurdle a threshold that completely segregates buyers whose reservation prices lie above it from others whose reservation prices lie below it, imposing no cost on those who jump the hurdle

perfectly competitive market a market in which no individual sup­plier has significant influence on the market price of the product

perfectly discriminating monopolist a firm that charges each buyer exactly his or her reservation price

perfectly elastic demand demand is perfectly elastic with respect to price if price elasticity of demand is infinite

perfectly elastic supply supply is perfectly elastic with respect to price if elasticity of supply is infinite

perfectly inelastic demand demand is perfectly inelastic with respect to price if price elasticity of demand is zero

perfectly inelastic supply supply is perfectly inelastic with respect to price if elasticity is zero

Personal Responsibility Act the 1996 federal law that transferred responsibility for welfare programs from the federal level to the state level and placed a five-year lifetime limit on payment of AFDC benefits to any given recipient

physical capital equipment and tools (such as machines and facto­ries) needed to complete one’s work

planned aggregate expenditure (PAE) total planned spending on final goods and services

policy reaction function describes how the action a policy-maker takes depends on the state of the economy

pork barrel spending a public expenditure that is larger than the total benefit it creates but that is favored by a legislator because his or her constituents benefit from the expenditure by more than their share of the resulting extra taxes

portfolio allocation decision the decision about the forms in which to hold one’s wealth

positional arms control agreement an agreement in which contes­tants attempt to limit mutually offsetting investments in per­formance enhancement

positional arms race a series of mutually offsetting investments in performance enhancement that is stimulated by a positional externality

positional externality this occurs when an increase in one person’s performance reduces the expected reward of another’s in situations in which reward depends on rela­tive performance positive (or descriptive) economic principle one that predicts how people will behave

positive analysis addresses the economic consequences of a particular event or policy, not whether those consequences are desirable

positive externality See external benefit

potential output, Y* (or potential GDP or full-employment output) the amount of output (real GDP) that an economy can pro­duce when using its resources, such as capital and labor, at normal rates

poverty threshold the level of income below which the federal gov­ernment classifies a family as poor

precautionary saving saving for protection against unexpected set­backs such as the loss of a job or a medical emergency

present-aim standard of rationality a variant of the rational-choice model that permits greater flexibility in assumptions about preferences

price ceiling a maximum allowable price, specified by law

price discrimination the practice of charging different buyers dif­ferent prices for essentially the same good or service

price elasticity of demand the percentage change in the quantity demanded of a good or service that results from a 1 percent change in its price

price elasticity of supply the percentage change in quantity sup­plied that occurs in response to a 1 percent change in price

price index a measure of the average price of a given class of goods or services relative to the price of the same goods or services in a base year

price level a measure of the overall level of prices at a particular point in time as measured by a price index such as the CPI

price setter See imperfectly competitive firm

price taker a firm that has no influence over the price at which it sells its product

principal amount the amount originally lent

prisoner’s dilemma a game in which each player has a dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy

private saving the saving of the private sector of the economy is equal to the after-tax income of the private sector minus con­sumption expenditures (YTC); private saving can be further broken down into household saving and business saving

producer surplus the amount by which price exceeds the seller’s reservation price

production possibilities curve a graph that describes the maximum amount of one good that can be produced for every possible level of production of the other good

profit the total revenue a firm receives from the sale of its product minus all costs—explicit and implicit—incurred in producing it

profit-maximizing firm a firm whose primary goal is to maximize the difference between its total revenues and total costs

profitable firm a firm whose total revenue exceeds its total cost

progressive tax one in which the proportion of income paid in taxes rises as income rises

proportional income tax one under which all taxpayers pay the same porportion of their incomes in taxes

protectionism the view that free trade is injurious and should be restricted

public good a good or service that, to at least some degree, is both nonrival and nonexcludable

public saving the saving of the government sector is equal to net tax payments minus government purchases (TG)

purchasing power parity (PPP) the theory that nominal exchange rates are determined as necessary for the law of one price to hold

pure commons good one for which nonpayers cannot easily be excluded and for which each unit consumed by one person means one less unit available for others

pure monopoly the only supplier of a unique product with no close substitutes

pure private good one for which nonpayers can easily be excluded and for which each unit consumed by one person means one less unit available for others

pure public good a good or service that, to a high degree, is both nonrival and nonexcludable

Q

quantitative easing (QE) an expansionary monetary policy in which a central bank buys long-term financial assets, thereby lowering the yield or return of those assets while increasing the money supply

quantity equation money times velocity equals nominal GDP: M × V = P × Y

quota a legal limit on the quantity of a good that may be imported

R

rate of inflation the annual percentage rate of change in the price level, as measured, for example, by the CPI

rational person someone with well-defined goals who tries to fulfill those goals as best he or she can

rational spending rule spending should be allocated across goods so that the marginal utility per dollar is the same for each good

rationing function of price changes in prices distribute scarce goods to those consumers who value them most highly

real exchange rate the price of the average domestic good or service relative to the price of the average foreign good or service, when prices are expressed in terms of a common currency

real GDP a measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices; real GDP measures the actual physical volume of production

real interest rate the annual percentage increase in the purchasing power of a financial asset; the real interest rate on any asset equals the nominal interest rate on that asset minus the infla­tion rate

real price the dollar price of a good relative to the average dollar price of all other goods

real quantity a quantity that is measured in physical terms—for example, in terms of quantities of goods and services

real wage the wage paid to workers measured in terms of purchas­ing power; the real wage for any given period is calculated by dividing the nominal (dollar) wage by the CPI for that period

recession (or contraction) a period in which the economy is grow­ing at a rate significantly below normal

recessionary gap a negative output gap, which occurs when potential output exceeds actual output (Y* > Y)

regression to the mean the phenomenon that unusual events are likely to be followed by more nearly normal ones

regressive tax a tax under which the proportion of income paid in taxes declines as income rises

relative price the price of a specific good or service in comparison to the prices of other goods and services

rent-seeking the socially unproductive efforts of people or firms to win a prize

repeated prisoner’s dilemma a standard prisoner’s dilemma that confronts the same players repeatedly

representativeness heuristic a rule of thumb according to which the likelihood of something belonging to a given category increases with the extent to which it shares characteristics with stereotypical members of that category

reserve requirements set by the Fed, the minimum values of the ratio of bank reserves to bank deposits that commercial banks are allowed to maintain

reserve-deposit ratio bank reserves divided by deposits

revaluation an increase in the official value of a currency (in a fixed exchange rate system)

Rise See slope

risk premium the rate of return that financial investors require to hold risky assets minus the rate of return on safe assets

risk-averse person someone who would refuse any fair gamble

risk-neutral person someone who would accept any gamble that is fair or better

Run See slope

S

satisficing a decision-making strategy that aims for adequate results because optimal results may necessitate excessive expenditure of resources

saving current income minus spending on current needs

saving rate saving divided by income

seller’s reservation price the smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost

seller’s surplus the difference between the price received by the seller and his or her reservation price

short run a period of time sufficiently short that at least some of the firm’s factors of production are fixed

short-run aggregate supply (SRAS) line a horizontal line showing the current rate of inflation, as determined by past expecta­tions and pricing decisions

short-run equilibrium a situation in which inflation equals the value determined by past expectations and pricing decisions and output equals the level of short-run equilibrium output that is consistent with that inflation rate; graphically, short-run equilibrium occurs at the intersection of the AD curve and the SRAS line

short-run equilibrium output the level of output at which output Y equals planned aggregate expenditure PAE; the level of output that prevails during the period in which prices are predetermined

shortage See excess demand

skill-biased technological change technological change that affects the marginal products of higher-skilled workers differently from those of lower-skilled workers

slope in a straight line, the ratio of the vertical distance the straight line travels between any two points (rise) to the corresponding horizontal distance (run)

socially optimal quantity the quantity of a good that results in the maximum possible economic surplus from producing and consuming the good

speculative attack a massive selling of domestic currency assets by financial investors

stabilization policies government policies that are used to affect planned aggregate expenditure, with the objective of eliminat­ing output gaps

standard of living the degree to which people have access to goods and services that make their lives easier, healthier, safer, and more enjoyable

statistical discrimination the practice of making judgments about the quality of people, goods, or services based on the charac­teristics of the groups to which they belong

status quo bias the general resistance to change, often stemming from loss aversion

stock a measure that is defined at a point in time

stock (or equity) a claim to partial ownership of a firm

store of value an asset that serves as a means of holding wealth

structural policy government policies aimed at changing the under­lying structure, or institutions, of the nation’s economy

structural unemployment the long-term and chronic unemploy­ment that exists even when the economy is producing at a normal rate

substitutes two goods are substitutes in consumption if an increase in the price of one causes a rightward shift in the demand curve for the other (or if a decrease causes a leftward shift)

substitution effect the change in the quantity demanded of a good that results because buyers switch to or from substitutes when the price of the good changes

sunk cost a cost that is beyond recovery at the moment a decision must be made

supply curve a graph or schedule showing the quantity of a good that sellers wish to sell at each price

surplus See excess supply

T

tariff a tax imposed on an imported good

tit-for-tat a strategy for the repeated prisoner’s dilemma in which players cooperate on the first move and then mimic their partner’s last move on each successive move

total cost the sum of all payments made to the firm’s fixed and variable factors of production

total expenditure (total revenue) the dollar amount that consumers spend on a product (P × Q) is equal to the dollar amount that sellers receive

total surplus the difference between the buyer’s reservation price and the seller’s reservation price

trade balance (or net exports) the value of a country’s exports less the value of its imports in a particular period (quarter or year)

trade deficit when imports exceed exports, the difference between the value of a country’s imports and the value of its exports in a given period

trade surplus when exports exceed imports, the difference between the value of a country’s exports and the value of its imports in a given period

tragedy of the commons the tendency for a resource that has no price to be used until its marginal benefit falls to zero

transfer payments payments the government makes to the public for which it receives no current goods or services in return

trough the end of a recession; the low point of economic activity prior to a recovery

U

ultimatum bargaining game a game in which the first player has the power to confront the second player with a take-it-or-leave-it offer

unattainable point any combination of goods that cannot be pro­duced using currently available resources

undervalued exchange rate an exchange rate that has an officially fixed value less than its fundamental value

unemployment rate the number of unemployed people divided by the labor force

unemployment spell a period during which an individual is contin­uously unemployed

unit elastic the demand for a good is unit elastic with respect to price if its price elasticity of demand equals 1

unit of account a basic measure of economic value

V

value added for any firm, the market value of its product or service minus the cost of inputs purchased from other firms

value of marginal product of labor (VMP) the dollar value of the additional output a firm gets by employing one additional unit of labor

variable a quantity that is free to take a range of different values

variable cost the sum of all payments made to the firm’s variable factors of production

variable factor of production an input whose quantity can be altered in the short run

velocity a measure of the speed at which money circulates, that is, the speed at which money changes hands in transactions involv­ing final goods and services, or, equivalently, nominal GDP divided by the stock of money. Numerically, V = (P × Y)/M, where V is velocity, P × Y is nominal GDP, and M is the money supply whose velocity is being measured

vertical intercept in a straight line, the value taken by the depen­dent variable when the independent variable equals zero

W

wealth the value of assets minus liabilities

wealth effect the tendency of changes in asset prices to affect households’ wealth and thus their consumption spending

Weber-Fechner law the relationship according to which the per­ceived change in any stimulus varies according to the size of the change measured as a proportion of the original stimulus

winner-take-all labor market one in which small differences in human capital translate into large differences in pay

worker mobility the movement of workers between jobs, firms, and industries

Workers’ compensation A government insurance system that pro­vides benefits to workers who are injured on the job

world price the price at which a good or service is traded on inter­national markets

Z

zero lower bound a level, close to zero, below which the Fed can­not further reduce short-term interest rates

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