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Economics, 5e

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45-degree line the line showing that expenditure equals aggregate income.


ability-to-pay principle the view that those with greater income should pay more in taxes than those with less income.

absolute advantage a situation in which a person or country is more efficient at producing a good in comparison with another person or country.

accounting profits total revenue minus total costs, where total costs exclude the implicit opportunity costs; this is the definition of profits usually reported by firms.

ad valorem tariff a tax on imports evaluated as a percentage of the value of the import.

aggregate demand the total demand for goods and services by consumers, businesses, government, and foreigners.

aggregate demand (AD) curve a line showing a negative relationship between inflation and the aggregate quantity of goods and services demanded at that inflation rate.

aggregate hours the total number of hours worked by all workers in the economy in a given period of time.

aggregate supply the total value of all goods and services produced in the economy by the available supply of capital, labor, and technology (also called potential GDP).

antidumping duty a tariff imposed on a country as a penalty for dumping goods.

Antitrust Division of the Justice Department the division of the Justice Department in the United States that enforces antitrust legislation, along with the Federal Trade Commission.

antitrust policy government actions designed to promote competition among firms in the economy; also called competition policy or antimonopoly policy.

Arrow impossibility theorem a theorem that says that no democratic voting scheme can avoid a voting paradox.

asset something of value owned by a person or a firm.

automatic stabilizers automatic tax and spending changes that occur over the course of the business cycle that tend to stabilize the fluctuations in real GDP.

average fixed cost (AFC) fixed costs divided by the quantity produced.

average product of labor the quantity produced divided by the amount of labor input.

average revenue total revenue divided by quantity.

average tax rate the total tax paid divided by the total taxable income.

average total cost (ATC) total costs of production divided by the quantity produced (also called cost per unit).

average total cost pricing a regulatory method that stipulates that the firm charge a price that equals average total cost.

average variable cost (AVC) variable costs divided by the quantity produced.






backward-bending labor supply curve the situation in which the income effect outweighs the substitution effect of an increase in the wage at higher levels of income, causing the labor supply curve to bend back and take on a negative slope.

balanced budget a budget in which tax revenues equal spending.

bank a firm that channels funds from savers to investors by accepting deposits and making loans.

barriers to entry anything that prevents firms from entering a market.

bilateral monopoly the situation in which there is one buyer and one seller in a market.

budget constraint an income limitation on a person's expenditure on goods and services.

budget deficit the amount by which government spending exceeds tax revenues.

budget surplus the amount by which tax revenues exceed government spending.






capital the factories, improvements to cultivated land, machinery and other tools, equipment, and structures used to produce goods and services.

capital abundant a higher level of capital per worker in one country relative to another.

capital gain the increase in the value of an asset through an increase in its price.

capital income the sum of profits, rental payments, and interest payments.

capital intensive production that uses a relatively high level of capital per worker.

capital loss the decrease in the value of an asset through a decrease in its price.

capitalism an economic system based on a market economy in which capital is individually owned, and production and employment decisions are decentralized.

capitalism an economic system based on a market economy in which capital is individually owned, and production and employment decisions are decentralized.

cartel a group of producers in the same industry who coordinate pricing and production decisions.

catch-up line the downward-sloping relation between the level of productivity and the growth of productivity predicted by growth theory.

central bank independence a description of the legal authority of central banks to make decisions on monetary policy with little interference by the government in power.

ceteris paribus "all other things being equal"; refers to holding all other variables constant or keeping all other things the same when one variable is changed.

checking deposit an account at a financial institution on which checks can be written; also called checkable deposit.

choice a selection among alternative goods, services, or actions.

circular flow diagram a diagram illustrating the flow of funds through the economy as people buy and sell in markets.

Clayton Antitrust Act a law passed in 1914 in the United States aimed at preventing monopolies from forming through mergers.

Coase theorem the idea that private negotiations between people will lead to an efficient resolution of externalities regardless of who has the property rights as long as the property rights are defined.

collectivized farm a farm in a planned economy that is in theory collectively owned by peasants, but is controlled by the government.

command and control the regulations and restrictions that the government uses to correct market imperfections.

command economy an economy in which the government determines prices and production; also called a centrally planned economy.

commerce clause the clause in the U.S. Constitution that prohibits restraint of trade between states.

communism an economic system in which all capital is collectively owned.

comparative advantage a situation in which a person or group can produce one good at a lower opportunity cost than another person or group.

comparative advantage a situation in which a person or country can produce one good at a lower opportunity cost than another person or country.

compensating wage differential a difference in wages for people with similar skills based on some characteristic of the job, such as riskiness, discomfort, or convenience of the time schedule.

competitive equilibrium model a model that assumes utility maximization on the part of consumers and profit maximization on the part of firms, along with competitive markets and freely determined prices.

competitive market a market in which no firm has the power to affect the market price of a good.

complement a good that is usually consumed or used together with another good.

constant returns to scale a situation in which long-run average total cost is constant as the output of a firm changes.

consumer price index (CPI) a price index equal to the current price of a fixed market basket of consumer goods and services relative to a base year.

consumer surplus the difference between what a person is willing to pay for an additional unit of a good—the marginal benefit—and the market price of the good; for the market as a whole, it is the sum of all the individual consumer surpluses, or the area below the market demand curve and above the market price.

consumer surplus the difference between what a person is willing to pay for an additional unit of a good - the marginal benefit - and the market price of the good.

consumption purchases of final goods and services by individuals.

consumption function the positive relationship between consumption and income.

consumption share the proportion of GDP that is used for consumption; equals consumption divided by GDP, or C/Y.

contestable market A market in which the threat of competition is enough to encourage firms to act like competitors.

contestable market a market in which the threat of competition is enough to encourage firms to act like competitors.

contingent valuation an estimation of the willingness to pay for a project on the part of consumers who may benefit from the project.

controlled experiments empirical tests of theories in a controlled setting in which particular effects can be isolated.

convergence of positions the concentration of the stances of political parties around the center of citizens' opinions.

cooperative outcome an equilibrium in a game where the players agree to cooperate.

corporate income tax a tax on the accounting profits of corporations.

cost-benefit analysis an appraisal of a project based on the costs and benefits derived from it.

Council of Economic Advisers a three-member group of economists appointed by the president of the United States to analyze the economy and make recommendations about economic policy.

countercyclical policy a policy designed to offset the fluctuations in the business cycle.

coupon the fixed amount that a borrower agrees to pay to the bondholder each year.

craft union a union organized to represent a single occupation, whose members come from a variety of industries.

cross-price elasticity of demand the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good.

crowding out the decline in private investment owing to an increase in government purchases.

currency money in its physical form: coin and paper money.

currency to deposit ratio the proportion of currency that people in the economy want to hold relative to their deposits; it equals currency divided by deposits.

Current Population Survey a monthly survey of a sample of U.S. households done by the U.S. Census Bureau; it measures employment, unemployment, the labor force, and other characteristics of the U.S. population.

Current Population Survey a monthly survey of a sample of U.S. households done by the U.S. Census Bureau; it measures employment, unemployment, the labor force, and other characteristics of the U.S. population.

customs union a free trade area with a common external tariff.

cyclical unemployment unemployment due to a recession, when the rate of unemployment is above the natural rate of unemployment.






deadweight loss the loss in producer and consumer surplus due to an inefficient level of production.

debt contract a contract in which a lender agrees to provide funds today in exchange for a promise from the borrower, who will repay that amount plus interest at some point in the future.

debt to GDP ratio the total amount of outstanding loans the federal government owes divided by nominal GDP.

deferred payment contract an agreement between a worker and an employer whereby the worker is paid less than the marginal revenue product when young, and subsequently paid more than the marginal revenue product when old.

deflation a decrease in the overall price level, or a negative inflation rate.

demand a relationship between price and quantity demanded.

demand curve a graph of demand showing the downward-sloping relationship between price and quantity demanded.

demand schedule a tabular presentation of demand showing the price and quantity demanded for a particular good, all else being equal.

demand shock a shift in one of the components of aggregate demand that leads to a shift in the aggregate demand curve.

depreciation the decrease in an asset's value over time; for capital, it is the amount by which physical capital wears out over a given period of time.

depreciation the decrease in an asset's value over time; for capital, it is the amount by which physical capital wears out over a given period of time.

deregulation movement begun in the late 1970s, the drive to reduce the government regulations controlling prices and entry in many industries.

derived demand demand for an input derived from the demand for the product produced with that input.

developing country a country that is poor by world standards in terms of real GDP per capita.

diffusion the spreading of an innovation throughout the economy.

diminishing returns a situation in which successive increases in the use of an input, holding other inputs constant, will eventually cause a decline in the additional production derived from one more unit of that input.

diminishing returns to labor a situation in which the increase in output due to a unit increase in labor declines with increasing labor input; a decreasing marginal product of labor.

discount rate the interest rate that the Fed charges commercial banks when they borrow from the Fed.

discretionary fiscal policy changes in tax or spending policy requiring legislative or administrative action by the president or Congress.

diseconomies of scale a situation in which long-run average total cost increases as the output of a firm increases.

disinflation a reduction in the inflation rate.

dividend yield the dividend stated as a percentage of the price of the stock.

division of labor the division of production into various parts in which different groups of workers specialize.

double-auction market a market in which several buyers and several sellers state prices at which they are willing to buy or sell a good.






earned income tax credit (EITC) a part of the personal income tax through which people with low income who work receive a payment from the government or a rebate on their taxes.

earnings the accounting profits of a firm.

economic development the process of growth by which countries raise incomes per capita and become industrialized; also refers to the branch of economics that studies this process.

economic fluctuations swings in real GDP that lead to deviations of the economy from its long-term growth trend.

economic growth an upward trend in real GDP, reflecting expansion in the economy over time.

economic interaction exchanges of goods and services between people.

economic model an explanation of how the economy or part of the economy works.

economic profits total revenue minus total costs, where total costs include opportunity costs, whether implicit or explicit.

economic rent the price of something that has a fixed supply.

economic variable any economic measure that can vary over a range of values.

economics the study of how people deal with scarcity.

economies of scale a situation in which long-run average total cost declines as the output of a firm increases.

economies of scale a situation in which long-run average total cost declines as the output of a firm increases.

efficiency wage a wage higher than that which would equate quantity supplied and quantity demanded, set by employers in order to increase worker efficiency—for example, by decreasing shirking by workers.

efficient market hypothesis the idea that markets adjust rapidly enough to eliminate profit opportunities immediately.

elastic demand demand for which the price elasticity is greater than 1.

emission tax a charge made to firms that pollute the environment based on the quantity of pollution they emit.

employment-to-population ratio the ratio (usually expressed as a percentage) of employed workers to the working-age population.

equilibrium interest rate the interest rate that equates the sum of the consumption, investment, and net exports shares to the share of GDP available for nongovernment use.

equilibrium price the price at which quantity supplied equals quantity demanded.

equilibrium price the price at which quantity supplied equals quantity demanded.

equilibrium quantity the quantity traded at the equilibrium price.

equilibrium risk-return relationship the positive relationship between the risk and the expected rate of return on an asset, derived from the fact that, on average, risk-averse investors who take on more risk must be compensated with a higher return.

equity contract shares of ownership in a firm; payments to the owners of the shares depend on the firm's profits.

excess capacity a situation in which a firm produces below the level that gives the minimum average total cost.

excess costs costs of production that are higher than the minimum average total cost.

exchange market intervention purchases and sales of foreign currency by a government in exchange markets with the intention to affect the exchange rate.

exchange rate the price of one currency in terms of another in the foreign exchange market. We express the exchange rate as the number of units of foreign currency that can be purchased with one unit of domestic currency.

exchange rate the price of one currency in terms of another in the foreign exchange market. We express the exchange rate as the number of units of foreign currency that can be purchased with one unit of domestic currency.

excise tax a tax paid on the value of goods at the time of purchase.

exclusive dealing a condition of a contract by which a manufacturer does not allow a retailer to sell goods made by a competing manufacturer.

exclusive territories the regions over which a manufacturer limits the distribution or selling of its products to one retailer or wholesaler.

expansion the period between the trough of a recession and the next peak, consisting of a general rise in output and employment.

expected return the return on an uncertain investment calculated by weighting the gains or losses by the probability that they will occur.

expenditure line the relation between the sum of the four components of spending (C + I + G + X) and aggregate income.

experimental economics a branch of economics that uses laboratory experiments to analyze economic behavior.

explicit collusion open cooperation of firms to make mutually beneficial pricing or production decisions.

exports the total value of the goods and services that people in one country sell to people in other countries.

external diseconomies of scale a situation in which growth in an industry causes average total cost for the individual firm to rise because of some factor external to the firm; it corresponds to an upward-sloping long-run industry supply curve.

external diseconomies of scale a situation in which growth in an industry causes average total cost for the individual firm to rise because of some factor external to the firm; it corresponds to an upward-sloping long-run industry supply curve.

externality the situation in which the costs of producing or the benefits of consuming a good spill over onto those who are not producing or consuming the good.






face value the principal that will be paid back when a bond matures.

factor-price equalization the equalization of the price of labor and the price of capital across countries when they are engaging in free trade.

family support programs transfer programs through which the federal government makes grants to states to give cash to certain low-income families.

federal budget a summary of the federal government's proposals for spending, taxes, and the deficit.

federal debt the total amount of outstanding loans owed by the federal government.

federal funds rate the interest rate on overnight loans between banks that the Federal Reserve influences by changing the supply of funds (bank reserves) in the market.

Federal Open Market Committee (FOMC) the committee, consisting of the seven members of the Board of Governors and the twelve presidents of the Fed district banks, that meets about eight times per year and makes decisions about the supply of money; only five of the presidents vote at any one time.

Federal Reserve System (the Fed) the central bank of the United States, which oversees the creation of money in the United States.

Federal Trade Commission (FTC) the government agency established to help enforce antitrust legislation in the United States; it shares this responsibility with the Antitrust Division of the Justice Department.

final good a new good that undergoes no further processing before it is sold to consumers.

firm an organization that produces goods or services.

first theorem of welfare economics the conclusion that a competitive market results in an efficient outcome; sometimes called the “invisible hand theorem”; the definition of efficiency used in the theorem is Pareto efficiency.

five-year plan a document that stated production goals for the entire Soviet economy for the succeeding five years.

fixed costs costs of production that do not depend on the quantity of production.

fixed costs costs of production that do not depend on the quantity of production.

fixed exchange rate policy a policy in which a country maintains a fixed value of its currency in terms of other currencies.

flat tax a tax system in which there is a constant marginal tax rate for all levels of taxable income.

flexible exchange rate policy a policy in which exchange rates are determined in foreign exchange markets and governments do not agree to fix them.

food stamp program a government program that provides people with low incomes with coupons (food stamps) that they can use to buy food.

foreign direct investment investment by a foreign entity of at least a 10 percent direct ownership share in a firm.

foreign exchange market a market in which one currency (such as Japanese yen) can be exchanged for another currency (such as U.S. dollars).

free entry and exit movement of firms into and out of an industry that is not blocked by regulation, other firms, or any other barriers.

free trade area (FTA) an area that has no trade barriers between the countries in the area.

freely determined price a price that is determined by the individuals and firms interacting in markets.

free-rider problem a problem arising in the case of public goods because those who do not contribute to the costs of providing the public good cannot be excluded from the benefits of the good.

frictional unemployment unemployment arising from normal turnover in the labor market, such as when people change occupations or locations, or are new entrants.

fringe benefits compensation that a worker receives excluding direct money payments for time worked insurance, retirement benefits, vacation time, and maternity and sick leave.






gains from trade improvements in income, production, or satisfaction owing to the exchange of goods or services.

gains from trade improvements in income, production, or satisfaction owing to the exchange of goods or services.

game theory a branch of applied mathematics with many uses in economics, including the analysis of the interaction of firms that take each other's actions into account.

GDP deflator nominal GDP divided by real GDP; it measures the level of prices of goods and services included in real GDP relative to a given base year.

Gini coefficient an index of income inequality ranging between 0 (for perfect equality) and 1 (for absolute inequality); it is defined as the ratio of the area between the Lorenz curve and the perfect equality line to the area between the lines of perfect equality and perfect inequality.

Gosplan the planning agency of the Soviet Union.

government failure a situation in which the government makes things worse than the market, even though there may be market failure.

government purchases purchases by federal, state, and local governments of new goods and services.

government purchases share the proportion of GDP that is used for government purchases; equals government purchases divided by GDP, or G/Y.

gradualism the slow phasing in of free market reforms.

gross domestic product (GDP) a measure of the value of all the goods and services newly produced in an economy during a specified period of time.

growth accounting formula an equation that states that the growth rate of productivity equals capital's share of income times the growth rate of capital per hour of work plus the growth rate of technology.

growth accounting formula Productivity growth rate = 1/3 (growth rate of capital per hour of work) + (growth rate of technology)






Head Start a government transfer program that provides day care and nursery school training for poor children.

Herfindahl-Hirschman index (HHI) an index ranging in value from 0 to 10,000 indicating the concentration in an industry; it is calculated by summing the squares of the market shares of all the firms in the industry.

horizontal merger a combining of two firms that sell the same good or the same type of good.

housing assistance programs government programs that provide subsidies either to low-income families to rent housing or to contractors to build low-income housing.

human capital a person's accumulated knowledge and skills.

human capital a person's accumulated knowledge and skills.






implicit rental price the cost of the funds used to buy the capital plus the depreciation of the capital over a given period of time.

imports the total value of the goods and services that people in one country buy from people in other countries.

incentive a device that motivates people to take action, usually so as to increase economic efficiency.

incentive regulation a regulatory method that sets prices for several years ahead and then allows the firm to keep any additional profits or suffer any losses over that period of time.

income effect the amount by which the quantity demanded falls because of the decline in real income from a price increase.

income elasticity of demand the percentage change in quantity demanded of a good divided by the percentage change in income.

income inequality disparity in levels of income among individuals in the economy.

increasing opportunity cost a situation in which producing more of one good requires giving up an increasing amount of production of another good.

individual demand curve a curve showing the relationship between quantity demanded of a good by an individual and the price of the good.

industrial union a union organized within a given industry, whose members come from a variety of occupations.

industry a group of firms producing a similar product.

inelastic demand demand for which the price elasticity is less than 1.

infant industry argument the view that a new industry may be helped by protectionist policies.

inferior good a good for which demand decreases when income rises and increases when income falls.

inflation adjustment (IA) line a flat line showing the level of inflation in the economy at a given point in time. It shifts up when real GDP is greater than potential GDP, and it shifts down when real GDP is less than potential GDP; it also shifts when expectations of inflation or raw materials prices change.

inflation rate the percentage increase in the overall price level over a given period of time, usually one year.

informal economy the portion of an economy characterized by illegal, unregulated businesses.

innovation application of new knowledge in a way that creates new products or significantly changes old ones.

insider a person who already works for a firm and has some influence over wage and hiring policy.

interest rate the amount received per dollar loaned per year, usually expressed as a percentage (e.g., 6 percent) of the loan.

interindustry trade trade between countries in goods from different industries.

interindustry trade trade between countries in goods from different industries.

intermediate good a good that undergoes further processing before it is sold to consumers.

internalize the process of providing incentives so that externalities are taken into account internally by firms or consumers.

International Monetary Fund (IMF) an international agency, established after World War II, designed to help countries with balance of payments problems and to ensure the smooth functioning of the international monetary system.

international trade the exchange of goods and services between people or firms in different nations.

international trade the exchange of goods and services between people or firms in different nations.

intraindustry trade trade between countries in goods from the same or similar industries.

intraindustry trade trade between countries in goods from the same or similar industries.

invention a discovery of new knowledge.

investment purchases of final goods by firms plus purchases of newly produced residences by households.

investment share the proportion of GDP that is used for investment; equals investment divided by GDP, or I/Y. Sometimes called investment rate.

invisible hand the idea that the free interaction of people in a market economy leads to a desirable social outcome; the term was coined by Adam Smith.






job rationing a reason for unemployment in which the quantity of labor supplied is greater than the quantity demanded because the real wage is too high.

job search a reason for unemployment in which uncertainty in the labor market and workers' limited information requires people to spend time searching for a job.

job vacancies positions that firms are trying to fill, but for which they have yet to find suitable workers.






labor the number of hours people are available to work in producing goods and services.

labor abundant a lower level of capital per worker in one country relative to another.

labor demand the relationship between the quantity of labor demanded by firms and the wage.

labor demand curve a downward-sloping relationship showing the quantity of labor firms are willing to hire at each wage.

labor force all those who are either employed or unemployed.

labor force participation rate the ratio (usually expressed as a percentage) of people in the labor force to the working-age population.

labor income the sum of wages, salaries, and fringe benefits paid to workers.

labor intensive production that uses a relatively low level of capital per worker.

labor market the market in which individuals supply their labor time to firms in exchange for wages and salaries.

labor market equilibrium the situation in which the quantity supplied of labor equals the quantity demanded of labor.

labor productivity output per hour of work.

labor supply the relationship between the quantity of labor supplied by individuals and the wage.

labor supply curve the relationship showing the quantity of labor workers are willing to supply at each wage.

labor union a coalition of workers, organized to improve the wages and working conditions of the members.

law of demand the tendency for the quantity demanded of a good in a market to decline as its price rises.

law of supply the tendency for the quantity supplied of a good in a market to increase as its price rises.

learning by doing a situation in which workers become more proficient by doing a particular task many times.

liability something of value that a person or a firm owes to someone else.

long run the minimum period of time during which all inputs to production can be changed.

long-run average total cost curve the curve that traces out the short-run average total cost curves, showing the lowest average total cost for each quantity produced as the firm expands in the long run.

long-run competitive equilibrium model a model of firms in an industry in which free entry and exit produce an equilibrium such that price equals the minimum of average total cost.

long-run equilibrium a situation in which entry into and exit from an industry are complete and economic profits are zero, with price (P) equal to average total cost (ATC).

long-run industry supply curve a curve traced out by the intersections of demand curves shifting to the right and the corresponding short-run supply curves.

long-run industry supply curve a curve traced out by the intersections of demand curves shifting to the right and the corresponding short-run supply curves.

Lorenz curve a curve showing the relation between the cumulative percentage of the population and the proportion of total income earned by each cumulative percentage. It measures income inequality.






macroeconomics the branch of economics that examines the workings and problems of the economy as a whole—GDP growth and unemployment.

mandated benefits benefits that a firm is required by law to provide to its employees.

marginal benefit the increase in the benefit from, or the willingness to pay for, one more unit of a good.

marginal cost the change in total costs due to a one-unit change in quantity produced.

marginal cost the change in total costs due to a one-unit change in quantity produced.

marginal cost pricing a regulatory method that stipulates that the firm charge a price that equals marginal cost.

marginal private benefit the marginal benefit from consumption of a good as viewed by a private individual.

marginal private cost the marginal cost of production as viewed by the private firm or individual.

marginal product of labor the change in production due to a one-unit increase in labor input.

marginal product of labor the change in production due to a one-unit increase in labor input.

marginal propensity to consume (MPC) the slope of the consumption function, showing the change in consumption that is due to a given change in income.

marginal revenue the change in total revenue due to a one-unit increase in quantity sold.

marginal revenue product of capital the change in total revenue due to a one-unit increase in capital.

marginal revenue product of labor the change in total revenue due to a one-unit increase in labor input.

marginal social benefit the marginal benefit from consumption of a good from the viewpoint of society as a whole.

marginal social cost the marginal cost of production as viewed by society as a whole.

marginal tax rate the change in total tax divided by the change in income.

market an arrangement by which economic exchanges between people take place.

market definition demarcation of a geographic region and a category of goods or services in which firms compete.

market demand curve the horizontal summation of all the individual demand curves for a good; also simply called the demand curve.

market economy an economy characterized by freely determined prices and the free exchange of goods and services in markets.

market equilibrium the situation in which the price is equal to the equilibrium price and the quantity traded equals the equilibrium quantity.

market failure any situation in which the market does not lead to an efficient economic outcome and in which there is a potential role for government.

market power a firm's power to set its price without losing its entire share of the market.

maturity date the date when the principal on a loan is to be paid back.

means-tested transfer a transfer payment that depends on the income of the recipient.

median voter theorem a theorem stating that the median or middle of political preferences will be reflected in government decisions.

Medicaid a health insurance program designed primarily for families with low incomes.

Medicare a government health insurance program for the elderly.

medium of exchange something that is generally accepted as a means of payment.

microeconomics the branch of economics that examines individual decision-making at firms and households and the way they interact in specific industries and markets.

minimum efficient scale the smallest scale of production for which long-run average total cost is at a minimum.

minimum wage a wage per hour below which it is illegal to pay workers.

minimum wage a wage per hour below which it is illegal to pay workers.

mixed economy a market economy in which the government plays a very large role.

monetary base currency plus reserves; the monetary base can be tightly controlled by the Fed.

monetary policy rule a description of how much the interest rate or other instruments of monetary policy respond to inflation or other measures of the state of the economy.

money that part of a person's wealth that can be readily used for transactions; money also serves as a store of value and a unit of account.

money demand a relationship between the nominal interest rate and the quantity of money that people are willing to hold at any given nominal interest rate.

money multiplier the multiple by which the money supply changes as a result of a change in the monetary base.

money supply the sum of currency (coin and paper money) and deposits at banks.

monopolistic competition a market structure characterized by many firms selling differentiated products in an industry in which there is free entry and exit.

monopoly one firm in an industry selling a product for which there are no close substitutes.

monopsony a situation in which there is a single buyer of a particular good or service in a given market.

multilateral negotiations simultaneous tariff reductions on the part of many countries.






Nash equilibrium a set of strategies from which no player would like to deviate unilaterally.

national saving aggregate income minus consumption minus government purchases.

national saving rate the proportion of GDP that is saved, neither consumed nor spent on government purchases; equals national saving (S) divided by GDP, or S/Y.

nationalization the taking over of private firms by the government.

natural monopoly a single firm in an industry in which average total cost is declining over the entire range of production and the minimum efficient scale is larger than the size of the market.

natural monopoly a single firm in an industry in which average total cost is declining over the entire range of production and the minimum efficient scale is larger than the size of the market.

natural unemployment rate the unemployment rate that exists when there is neither a recession nor a boom and real GDP is equal to potential GDP.

negative externality the situation in which costs spill over onto someone not involved in producing or consuming the good.

negatively related a situation in which an increase in one variable is associated with a decrease in another variable; also called inversely related.

net exports the value of exports minus the value of imports.

net exports share the proportion of GDP that is equal to net exports; equals net exports divided by GDP, or X/Y.

new economy a term used to describe the period of high productivity growth, attributed largely to better computer and information technology.

nominal GDP gross domestic product without any correction for inflation; the same as GDP; the value of all the goods and services newly produced in a country during some period of time, usually a year.

nominal interest rate the interest rate uncorrected for inflation.

noncooperative outcome an equilibrium in a game where the players cannot agree to cooperate and instead follow their individual incentives.

nonexcludability the situation in which no one can be excluded from consuming a good.

nonrivalry the situation in which increased consumption of a good by one person does not decrease the amount available for consumption by others.

nontariff barrier any government action other than a tariff that reduces imports, such as a quota or a standard.

normal good a good for which demand increases when income rises and decreases when income falls.

normal profits the amount of accounting profits when economic profits are equal to zero.

normative economics economic analysis that makes recommendations about economic policy.






oligopoly an industry characterized by few firms selling the same product with limited entry of other firms.

on-the-job training the building of the skills of a firm's employees while they work for the firm.

open market operation the buying or selling of bonds by the central bank.

opportunity cost the value of the next-best forgone alternative that was not chosen because something else was chosen.

opportunity cost the value of the next-best forgone alternative that was not chosen because something else was chosen.

outsider someone who is not working for a particular firm, making it difficult for him or her to get a job with that firm even though he or she is willing to work for a lower wage.






Pareto efficient a situation in which it is not possible to make someone better off without making someone else worse off.

payoff matrix a table containing strategies and payoffs for two players in a game.

payroll tax a tax on the wages and salaries of individuals.

peak the highest point in real GDP before a recession.

perestroika the restructuring of the Soviet economy by reforming the central planning process.

perfectly elastic demand demand for which the price elasticity is infinite, indicating an infinite response to a change in the price and therefore a horizontal demand curve.

perfectly elastic supply supply for which the price elasticity is infinite, indicating an infinite response of quantity supplied to a change in price and thereby a horizontal supply curve.

perfectly inelastic demand demand for which the price elasticity is zero, indicating no response to a change in price and therefore a vertical demand curve.

perfectly inelastic supply supply for which the price elasticity is zero, indicating no response of quantity supplied to a change in price and thereby a vertical supply curve.

personal income tax a tax on all forms of income an individual or household receives.

piece-rate system a system by which workers are paid a specific amount per unit they produce.

political business cycle a business cycle caused by politicians' use of economic policy to overstimulate the economy just before an election.

portfolio diversification spreading the collection of assets owned in order to limit exposure to risk.

portfolio investment investment by a foreign entity of less than a 10 percent ownership share in a firm.

positive economics eco-nomic analysis that explains what happens in the economy and why, without making recommendations about economic policy.

positive externality the situation in which benefits spill over onto someone not involved in

positively related a situation in which an increase in one variable is associated with an increase in another variable; also called directly related.

potential GDP the economy's long-term growth trend for real GDP, determined by the available supply of capital, labor, and technology. Real GDP fluctuates above and below potential GDP.

potential GDP the economy's long-term growth trend for real GDP determined by the available supply of capital, labor, and technology. Real GDP fluctuates above and below potential GDP.

poverty line an estimate of the minimum amount of annual income required for a family to avoid severe economic hardship.

poverty rate the percentage of people living below the poverty line.

predatory pricing action on the part of one firm to set a price below its shutdown point in order to drive its competitors out of business.

price the amount of money or other goods that one must pay to obtain a particular good.

price ceiling a government price control that sets the maximum allowable price for a good.

price control a government law or regulation that sets or limits the price to be charged for a particular good.

price discrimination a situation in which different groups of consumers are charged different prices for the same good.

price elasticity of demand the percentage change in the quantity demanded of a good divided by the percentage change in the price of that good.

price elasticity of supply the percentage change in quantity supplied divided by the percentage change in price.

price fixing the situation in which firms conspire to set prices for goods sold in the same market.

price floor a government price control that sets the minimum allowable price for a good.

price leader the price-setting firm in a collusive industry in which other firms follow the leader.

price level the average level of prices in the economy.

price shock a change in the price of a key commodity such as oil, usually because of a shortage, that causes a shift in the inflation adjustment line; also sometimes called a supply shock.

price-cost margin the difference between price and marginal cost divided by the price. This index is an indicator of market power, where an index of 0 indicates no market power and a higher price-cost margin indicates greater market power.

price-earnings ratio the price of a stock divided by its annual earnings per share.

price-maker a firm that has the power to set its price, rather than taking the price set by the market.

price-taker any firm that takes the market price as given; this firm cannot affect the market price because the market is competitive.

prisoner's dilemma a game in which individual incentives lead to a nonoptimal (noncooperative) outcome. If the players can credibly commit to cooperate, then they achieve the best (cooperative) outcome.

private remedy a procedure that eliminates or internalizes externalities without government action other than defining property rights.

privatization the process of converting a government enterprise into a privately owned enterprise.

producer surplus the difference between the price received by a firm for an additional item sold and the marginal cost of the item's production; for the market as a whole, it is the sum of all the individual firms' producer surpluses, or the area above the market supply curve and below the market price.

producer surplus the difference between the price received by a firm for an additional item sold and the marginal cost of the item's production.

product differentiation the effort by firms to produce goods that are slightly different from other types of goods.

production function a relationship that shows the quantity of output for any given amount of input.

production function a relationship that shows the quantity of output for any given amount of input.

production function the relationship that describes output as a function of labor, capital, and technology.

production possibilities alternative combinations of production of various goods that are possible, given the economy's resources.

production possibilities curve a curve showing the maximum combinations of production of two goods that are possible, given the economy's resources.

production target a goal set for the production of a good or service in a planned economy.

productivity output per hour of work.

profit maximization an assumption that firms try to achieve the highest possible level of profits—total revenue minus total costs—given their production function.

profits total revenue received from selling the product minus the total costs of producing the product.

progressive tax a tax for which the amount of an individual's taxes rises as a proportion of income as the person's income increases.

property rights rights over the use, sale, and proceeds from a good or resource.

property rights rights over the use, sale, and proceeds from a good or resource.

property tax a tax on the value of property owned.

proportional tax a tax for which the amount of an individual's taxes as a percentage of income is constant as the person's income rises.

public choice models models of government behavior that assume that those in government take actions to maximize their own well-being, such as getting reelected.

public good a good or service that has two characteristics nonrivalry in consumption and nonexcludability

purchasing power parity the theory that exchange rates are determined in such a way that the prices of goods in different countries are the same when measured in the same currency.






quantity demanded the quantity of a good that people want to buy at a given price during a specific time period.

quantity equation of money the equation relating the price level and real GDP to the quantity of money and the velocity of money The quantity of money times its velocity equals the price level times real GDP.

quantity supplied the quantity of a good that firms are willing to sell at a given price.

quintiles divisions or groupings of one-fifth of a population ordered by income, wealth, or some other statistic.

quota a governmental limit on the quantity of a good that may be imported or sold.






rate of return the return on an asset stated as a percentage of the price of the asset.

real business cycle theory a theory of macroeconomics that stresses that shifts in potential GDP are a primary cause of fluctuations in real GDP; the shifts in potential GDP are usually assumed to be caused by changes in technology.

real business cycle theory a theory of macroeconomics that stresses that shifts in potential GDP are a primary cause of fluctuations in real GDP; the shifts in potential GDP are usually assumed to be caused by changes in technology.

real gross domestic product (real GDP) a measure of the value of all the goods and services newly produced in a country during some period of time, adjusted for changes in prices over time.

real gross domestic product (real GDP) a measure of the value of all the goods and services newly produced in a country during some period of time, adjusted for changes in prices over time.

real interest rate the interest rate minus the expected rate of inflation; it adjusts the nominal interest rate for inflation.

real wage the wage or price of labor adjusted for inflation; in contrast, the nominal wage has not been adjusted for inflation.

real wage the wage or price of labor adjusted for inflation; in contrast, the nominal wage has not been adjusted for inflation.

recession a decline in real GDP that lasts for at least six months.

recovery the early part of an economic expansion, immediately after the trough of the recession.

regressive tax a tax for which the amount of an individual's taxes falls as a proportion of income as the person's income increases.

reinflation an increase in the inflation rate caused by a change in monetary policy.

relative price the price of a particular good compared to the price of other things.

rent control a government price control that sets the maximum allowable rent on a house or apartment.

rental price of capital the amount that a rental company charges for the use of capital equipment for a specified period of time.

required reserve ratio the fraction of a bank's deposits that it is required to hold at the Fed.

resale price maintenance the situation in which a producer sets a list price and does not allow the retailer to offer a discount to consumers.

reserves deposits that commercial banks hold at the Fed.

return the income received from the ownership of an asset; for a stock, the return is the dividend plus the capital gain.

revenue tariff an import tax whose main purpose is to provide revenue to the government.

rule of reason an evolving standard by which antitrust cases are decided, requiring not only the existence of monopoly power but also the intent to restrict trade.






sales tax a type of excise tax that applies to total expenditures on a broad group of goods.

scarcity the situation in which the quantity of resources is insufficient to meet all wants.

Sherman Antitrust Act a law passed in 1890 in the United States to reduce anticompetitive behavior; Section 1 makes price fixing illegal, and Section 2 makes attempts to monopolize illegal.

shock therapy the abrupt introduction of free markets in a formerly centrally planned economy.

short run the period of time during which it is not possible to change all inputs to production; only some inputs, such as labor, can be changed.

shortage (excess demand) the situation in which quantity demanded is greater than quantity supplied.

shortage (excess demand) the situation in which quantity demanded is greater than quantity supplied.

shutdown point the point at which price equals the minimum of average variable cost.

Smoot-Hawley tariff a set of tariffs imposed in 1930 that raised the average tariff level to 59 percent by 1932.

social insurance transfer a transfer payment, such as social security, that does not depend on the income of the recipient.

social security the system through which individuals make payments to the government when they work and receive payments from the government when they retire or become disabled.

socialism an economic system in which the government owns and controls all the capital and makes decisions about prices and quantities as part of a central plan.

socialism an economic system in which the government owns and controls all the capital and makes decisions about prices and quantities as part of a central plan.

specific tariff a tax on imports that is proportional to the number of units or items imported.

spending balance the level of income or real GDP at which the 45-degree line and the expenditure line cross; also called equilibrium income.

stagflation the situation in which high inflation and high unemployment occur

state enterprise an organization, analogous to a firm in a market economy, that is owned and controlled by the government.

store of value something that will allow purchasing power to be carried from one period to the next.

strategic behavior firm behavior that takes into account the market power and reactions of other firms in the industry.

structural surplus the level of the government budget surplus under the scenario where real GDP is equal to potential GDP; also called the full-employment surplus.

structural unemployment unemployment due to structural problems such as poor skills, longer-term changes in demand, or insufficient work incentives.

substitute a good that has many of the same characteristics as and can be used in place of another good.

substitution effect the amount by which quantity demanded falls when the price rises, exclusive of the income effect.

supplemental security income (SSI) a means-tested transfer program designed primarily to help the poor who are disabled or blind.

supply a relationship between price and quantity supplied.

supply curve a graph of supply showing the upward-sloping relationship between price and quantity supplied.

supply schedule a tabular presentation of supply showing the price and quantity supplied of a particular good, all else being equal.

surplus (excess supply) the situation in which quantity supplied is greater than quantity demanded.

surplus (excess supply) the situation in which quantity supplied is greater than quantity demanded.

systematic risk the level of risk in asset markets that investors cannot reduce by diversification.






tacit collusion implicit or unstated cooperation of firms to make mutually beneficial pricing or production decisions.

target inflation rate the central bank's goal for the average rate of inflation over the long run.

tariff a tax on imports.

tax bracket a range of taxable income that is taxed at the same rate.

tax incidence the allocation of the burden of the tax between buyer and seller.

tax revenue the tax rate times the amount subject to tax.

taxable income a household's income minus exemptions and deductions.

technological change improvement in technology over time.

technology anything that raises the amount of output that can be produced with a given amount of labor and capital.

technology anything that raises the amount of output that can be produced with a given amount of labor and capital.

time inconsistency the situation in which policymakers have the incentive to announce one economic policy but then change that policy after citizens have acted on the initial, stated policy.

total amount of saving a measure of the amount of resources a country has for investment, either in its own country or abroad.

total costs the sum of variable costs and fixed costs.

total costs the sum of variable costs and fixed costs.

total revenue the price per unit times the quantity the firm sells.

tradable permit a governmentally granted license to pollute that can be bought and sold.

trade balance the value of exports minus the value of imports.

trade creation the increase in trade due to a decrease in trade barriers.

trade diversion the shifting of trade away from the low-cost producer toward a higher-cost producer because of a reduction in trade barriers with the country of the higher-cost producer.

trade war a conflict among nations over trade policies caused by imposition of protectionist policies on the part of one country and subsequent retaliatory actions by other countries.

transaction cost the cost of buying or selling in a market, including search, bargaining, and writing contracts.

transfer payment a grant of funds from the government to an individual.

treble damages penalties awarded to the injured party equal to three times the value of the injury.

trough the lowest point of real GDP at the end of a recession.






unemployment insurance a program that makes payments to people who lose their jobs.

unemployment rate the percentage of the labor force that is unemployed.

unemployment rate the percentage of the labor force that is unemployed.

unit of account a standard unit in which prices can be quoted and values of goods can be compared.

unit-free measure a measure that does not depend on a unit of measurement.

Uruguay Round the most recent round of multilateral negotiations, completed in 1993.

user fee a fee charged for the use of a good normally provided by the government.

utility a numerical indicator of a person's preferences in which higher levels of utility indicate a greater preference.

utility maximization an assumption that people try to achieve the highest level of utility given their budget constraint.






value added the value of a firm's production minus the value of the intermediate goods used in production.

variable costs costs of production that vary with the quantity of production.

variable costs costs of production that vary with the quantity of production.

velocity a measure of how frequently money is turned over in the economy.

vertical merger a combining of two firms, one of which supplies goods to the other.

voluntary restraint agreement (VRA) a country's self-imposed government restriction on exports to a particular country.

voting paradox a situation where voting patterns will not consistently reflect citizens' preferences because of multiple issues on which people vote.






wage the price of labor defined over a period of time worked.

working-age population persons over 16 years of age who are not in an institution such as a jail or hospital.

World Bank an international agency, established after World War II, designed to promote the economic development of poorer countries through lending channeled from industrialized countries.

World Trade Organization (WTO) an international organization that can mediate trade disputes.






yield the annual rate of return on a bond if the bond were held to maturity.





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