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7/28/2019 Finance Vocab
Absolute Advantage: A situation where a producer is more productive at producing
every product, when compared to some other producer.
Adverse selection: A process that unintentionally leads to lower quality being selected
over higher quality because of asymmetric information.
Aggregate Demand: The total demand for goods and services in the economy during a
specific time period. Aggregate demand is equal to the sum of consumption, investment,
government purchases , and the net exports.
Aggregate Supply: The total supply of goods and services in the economy during a
specific time period.
Allocative Efficiency: For a firm, a state in which is neither producing too much nortoo little relative to the willingness of buyers to buy. When allocative inefficiency occurs,
as it does when the firm has market power and is earning a normal profit, the firm isproducing too little. In this state of allocative inefficiency, buys are willing to pay more
for the next unit of output than it costs the firm to produce it, but is not willing to produce
the next unit of output because to lure that buyer to the market the firm would have todecrease the price of its product to all buyers.
Asymmetric information: One party to a transaction has better information than the
Autonomous spending multiplier: A number that indicates just how much an additionaldollar of autonomous spending will be multiplied. Spending generates a multipliereffect because one persons spending is another persons income, which then is re-spent.
Autonomous spending is new spending, or that not generated from income caused by
other spending within the economy. An injection of this new or autonomous spendinginto an economy in an economic slump can be multiplied as new spending becomes new
income, which becomes additional spending, and this can help lift the economy out of the
Average (Total) Cost: Cost per unit of output produced. This can be calculated either
by dividing total cost by the quantity of output, or by adding average fixed cost and
average variable cost. Because average fixed cost decreases as output increase, whileaverage variable cost tends to increase as output increase, average (total) cost tends to
first decrease, reach a minimum, and then increase.
Average Fixed Cost: Fixed cost per unit of output produced. As production increases,
the firms fixed cost is spread across more units of output, implying a decrease in the
average fixed cost. The fact that average fixed cost decreases as output increases is what
can give a larger firm a cost advantage over a smaller firm.
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Average Product: The amount of output produced per unit of input employed.
Average Product of Labor: The average amount of output produced by labor (say per
worker or per hour)
Average Variable Cost: Variable cost per unit of output producer. As production
increase, variables costs increase, and the presence of diminishing returns will tend to
imply that they increase at an increasing rate. If variable cost increases at an increasingrate, then average variable cost increases, and this can give a smaller firm a cost
advantage over a larger firm.
Bad: A physical object that decreases a consumers level of satisfaction, rather thanincreasing it.
Bourgeoisie: The ruling class
Budget deficit: The amount money a government must borrow when it spends more
than the revenue it takes in.
Budget Set: The set containing all of consumption bundles a consumer can afford.
Budget surplus:The amount of public saving a government does when its revenueexceeds what it spends
Buyer: A trader who obtains ownership of a good or service
Capital: One of the three factors of production recognized by Adam Smith. Capital isanything that enhances the productivity of labor that is human made (unlike land) and isnot entirely used up in the process of production (unlike raw materials). It can also be
defined as accumulated investment.
Capitalist: A person who earns income by organizing and operating a business (or firm).
Capitalism: An economic system in which industry (the means of production) is ownedand controlled by private individuals who seek profit, rather than being owned and
controlled collectively by government.
Choice: A selection made from a set of alternatives
Circular Flow Diagram: The circular flow diagram divides the economy into two
sectors: The firm sector sells products and buys factors, while the household sector sellsfactors and buys products. Factors supplied by households are transformed by firms into
products. Products supplied by firms are consumed by households. Households pay
money (expenditures) to firms for products. Firms pay money (income) to householdsfor factors.
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Classical Theory of Income Distribution: An explanation for why some people earn
higher incomes than others that is derived from the assumption that producers hire laborin a way that maximizes the firms profits. The theory is that people are paid an income
equal to the value that the firm would lose if their labor time were taken away. Those
who earn more are those who produce more value for the firm (at the margin).
Command Economy: An economic system where a central authority (e.g., government)
determines how resources will be allocated.
Common Resource: A resource such that, the use of the resource by person does not
significantly diminish the ability of another to also use it, and the other person cannot be
easily excluded from using the resource. A common rival to some extent, but notexclusive.
Communism: A social system, typically not well defined, associated with the ideas of
Karl Marx and Fredrick Engels. As usually described, communism is equivalent tosocialism. However, socialism is characterized by government control of production
processes, and Marx and Engels talked about the withering away of the state undercommunism, so that there is no ruling class. Small tribal communities probably best fit
the Marxian notion of communism, where government decisions are made by consensus
and where the all for one and one for all attitude is typically implemented.
Communist Manifesto: An 1848 document written by Marx and Engel, an open
declaration that the common people (proletariate) should revolt and throw of the chains
of the ruling class (Bourgeoise)
Comparative Advantage: A situation where a producer can produce an item at a lower
opportunity cost than another producer. More intuitively, a producer has a comparativeadvantage in producing a good when the producer is either producing what he or she does
most best or least worst.
Compensating Wage Differential: An additional amount of money paid for a job to
compensate for features of the job that are less desirable relative to features of other jobs;
e.g. dirty conditions, longer training period, risk of injury
(Long run) Competitive Equilibrium: For an industry, a state in which entry and exit
have eliminated economic profits and losses.
Complements: Two goods are complements if one goods ability to provide utility to the
consumer diminishes when the consumption of the second good decreases.
Competition: In the marketplace, buyers vying with other buyers for attractive
purchases, and sellers vying with other sellers for attractive sales.
Composition of output: The distribution of output among the four expenditure
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components: Consumption, investment, government purchases, and net exports. The
composition of output changes when there is a shift in production from one expenditure
component (e.g., from consumption) to another component (e.g. investment).
Composition of resources: The existing mix of different types of resources that a
decision maker has to use.
Confounding Factor: When multiple factors influence can an outcome, it can be
difficult to understand how each factor influences the outcome, or even whether all of thefactors actually influence the outcome. A factor is said to be a confounding factor when
it can obscure the influence of another factor.
Constant returns to scale: In production, if ALL input factors are increased by someamount (e.g., doubled), and all output increases proportionately (e.g., doubles).
Consumer surplus: For an individual, it is the amount a consumer is willing to pay
above and beyond the market price. For the market, it is the sum over all of theconsumers of all of the individual consumer surplus amounts. In a supply-demand
diagram, this consumer surplus for the market is the area above the market price, butbelow the demand curve.
Consumption: Using a resource to satisfy a want.
Consumption Bundle: A set (or bundle) of goods and services that a consumer might or
might not be able to purchase.
Consumption-Saving Choice Problem: A problem solved by a consumer, where the
consumer chooses how much current income to spend and how much to save,
recognizing that income saved is bad because it cannot be consumed now but goodbecause it allows for more consumption later.
Contractionary policy: A government policy change that increases aggregate demand
Creative destruction: A term coined in 1942 by Joseph Schumpeter in his work,
Capitalism, Socialism and Democracy, to denote a process of industrial mutation that
incessantly revolutionizes the economic structure from within, incessantly destroying theold one, incessantly creating a new one.
Crowding out: The idea that addition spending by government will tend to reduceprivate sector consumption and investment spending because the added government
spending will tend in make the interest rate level in the economy higher than it would
Das Kapital: A four volume book written by Marx and Engels. The book presented a
theory explaining why capitalism will eventually dissolve.
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Demand: A measure of the willingness to buy either a product (i.e. an output of the
production process) or a factor (i.e., an input to the production process).
Demander: A buyer
Demand Curve: A graph showing the relationship between the price of a good or serviceand the quantity people want to buy.
Demand curve (shift in curve): When there is a change in demand caused bysomething other than price.
Demand curve (movement along): When there is a change in demand caused by a
change in price (as opposed to any other thing that might change demand).
Dialectical materialism: The idea that the social order of a society is determined by
how production is carried out. In particular, dialectical materialism indicates political
structure is determined by economic structure.
Diminishing Marginal Utility: The idea that the utility obtained from consuming agood will increase, but at a decreasing rate, as more of the good is consumed.
Diminishing Returns: In a production system, having fixed inputs and a variable input,and keeping the fixed inputs constant, as more of a variable input is applied, each
additional unit of input yields less and less additional output.
Discounting: Reducing the value associated with an event associated with a differentperiod of time, usually an event that would occur in the future. People tend to prefer
receiving goods in the present rather than in the future, so we say they discount the
Diseconomies of scale: In production, if ALL input factors are increased by some
amount (e.g., doubled), and production increases less than proportionally (e.g., less thandoubles), then there are diseconomies of scale.
Disequilibrium: A state in a market where supply does not equal demand, meaning
there is either a shortage or surplus.
Distribution of resources: The existing pattern of control different decision makers
have over a set of resources
Double Coincidence of Wants: In a trading situation, a state where one party has
something that the second party wants, and the second party has something that the firstparty wants.
Easterlin Hypothesis: The idea that economic development brings with it changes that
discourage childbearing, so that (in contrast to the Malthusian Principle of Population) a
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higher standard of living is associated with a lower population growth rate
Economic Profit: A profit level that will encourage new firms to enter the industry,which is defined to be a state in which the price received for the product is greater than
the average cost.
Economics: A field of study that seeks to explain how a social system works and how
individuals cope with the fact that resources are scarce. With regard to examining the
social system, a classic definition is that economics is the study of the production,consumption, and distribution of wealth. Adam Smith, who is often recognized as the
father of economics, sought to explain how the social system, and especially activities in
markets, impacted the well-being of individuals and social classes. With regard to
individual behavior, Alfred Marshall, a famous 19th century economist, describedeconomics as the study of man in the ordinary business of life. Gary Becker, a Nobel
Prize winning economist described economics as The art of getting the most out of life.
Economies of scale: In production, if ALL input factors are increased by some amount(e.g. doubled), and production increases more than proportionally (e.g., more than
doubles), there are economies of scale.
Economy: A system that determines how resources are allocated so as to satisfy the
wants of people within a society.
Efficiency Wage: A wages that is determined by more than simply supply and demand,
recognizing that a wage above the market-clearing wage may increase productivity (i.e.,
efficiency) The concept recognizes that paying a wage that is above average mayactually make the firm more profitable because it will tend to attract a worker of above
Elastic: Relatively responsive. When thinking of the responsiveness of y (dependent
variable) upon x (independent variable), an elastic response implies that the percentage
change in y is larger than the percentage change in x.
Elasticity: A measure of the responsiveness of some dependent variable as it depends
upon some independent variable. Specifically, if y is the dependent variable and x is the
independent variable, then the elasticity of y as it depends upon x is calculated as thepercentage change in y divided by the percentage change in x.
Engels, Fredrick: A contemporary and co-author of Karl Marx. Engels supportedMarx financially and philosophically. Engels observations of the poor living and
working conditions of working classes in Northern England in the mid 1800s were
fundamental to the development of what has become known as Marxian thought.
Entry: The addition of producers to the market in question, typically because there is
economic profit to be earned.
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Equilibrium Price: The price at which the quantity demanded in a market is equal to the
Equilibrium Quantity: The quantity that is bought and sold on the market at the
Exit: The reduction of producers in the market in question, typically because there an
economic loss is being earned.
Expansionary policy: A government policy change that decreases aggregate demand
Expenditure: A monetary payment made to a firm paid in exchange for a good orservice provided by the firm.
Exports: The expenditure of foreigners on domestically produced goods.
Externality: A side effect from one activity which has consequences for another activity
but is not reflected in market prices. Externalities can be either positive, when an externalbenefit is generated, or negative, when an external cost is generated.
Factors of Production: The inputs that flow into the production process. Adam Smithidentified Land, Labor, and Capital as three distinctive factors or categories of inputs.
Firm: An entity the produces, or transforms inputs received from households into
outputs (or products) that are consumed by households.
Fiscal Policy: The decisions made by government about the levels of government
purchases and net taxes.
Fixed Cost: The part of total cost which does not depend on the level of current
production. A fixed cost must be paid even if there is no production.
Flow: A quantity that can only be measured with the passage of time. (See stock for
the other significant quantity measure.)
Free-rider: A person who receives a benefit from some good or activity but does not
have to pay an associated cost.
Full employment: An economic state where there is no surplus of labor, or any other
factor of production. The economy is producing up to its potential and is supply
constrained in this full employment state.
GATT: (General Agreement on Tariffs and Trade) A trade agreement that promotes
international free trade, which was first discussed in 1945.
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GDP Deflator: A broad price index measuring the price changes of all goods and service
include in GDP (i.e. consumption goods, investment goods, government goods, and
Globalization: An extension of trade beyond the borders of nations, which also often
requires an extension of government controls beyond borders to some degree, and isaccompanied by increased interdependence, integration, and interaction between people
in different nations
Good: A physical object, as opposed to a service, that can provide satisfaction when
Government: An authority that controls the actions of members of a group of people.
Government purchases: The expenditures made by government on goods and services
produced by firms, including the wages and salaries of all government employees.
Gross Domestic Product (GDP): A measure of the size of an economy. Specifically,
the GDP of a country is defined as the market value of all final goods and servicesproduced within a country in a given period of time.
Growth: Pushing out the production possibilities frontier so that what previously couldnot be produced is now possible to produce
Growth Rate: The rate at which some economic measure is increasing, measured as a
percentage change from the previous period.
Hegelian philosophy: The idea that change is the rule of life, along with the idea that
any force for change tends to be met by a countervailing force, so that history can bedescribed as a process whereby countervailing forces for change resolve themselves into
Household: An entity that consumes the products produced by firms and supplies firms
with the factors of (or inputs to) production.
Human capital: Skills, knowledge, and training embodied in labor that improve laborsability to produce.
Imperfect Competition: A model of the supply side of a market in which producershave some market power, firms compete with other by more than just changing their
product price, and firms may not be able to freely enter or exit the industry. The standard
imperfectly competitive forms include monopoly, monopolistic competition, andoligopoly.
Imports: The level of domestic expenditure on foreign produced goods.
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Incentive: A manipulation of the environment that makes the marginal benefit of a
desired action greater than the marginal cost, so that it is in the self interest of the
decision maker to choose a course of action that is in the direction desired by themanipulator.
Income: A payment made by a firm in exchange for a factor of production (i.e. an inputto the production process). So, it is also a payment received by the owner of a factor of
production in exchange for providing the factor of production to a firm.
Income Effect: One explanation for why an increase in price leads the typical buy to
buy less, which is that a price increase has a similar impact to a decrease in income in
that the ability to buy the product has decreased
Income Elasticity of Demand: A measure of the responsiveness of the demand for a
good or service as it depends upon the buyers income. Specifically, it is the percentage
change in the quantity demanded divided by the percent change in income.
Increasing returns: The opposite of diminishing returns. A production situation where
successive increases in a variable input yield more and more additional output.
Indifferent: When comparing two things, not preferring one to the other.
Individual demand curve: A graph showing how a change in price will affect an
individuals willingness to buy a commodity.
Inelastic: Relatively unresponsive. When thinking of the responsiveness of y(dependent variable) upon x (independent variable), an elastic response implies that the
percentage change in y is smaller than the percentage change in x.
Inferior Good: A good such that less is purchased (rather than more) when the buyers
Input: A resource used in the production of an output
Insurance pool: A group of people who all pay premiums (i.e. money) into a fund from
which insurance claims can be made to those who qualify.
Institution: A rule (e.g. a law, a tradition) that governs behavior within a society
Interest: The payment received by the capitalist in the production process for
contributing capital .
Internalizing (an externality): An action, usually taken by government, designed to
make someone who generates a negative externality pay for the spillover costs, or an
action designed to see that someone who generates a positive externality gets
compensated for the spill over benefit that they create.
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Investment: An expenditure or an activity that increases the ability (of labor) to produce,
or equivalently, an addition to capital stock.
Keynes, John Maynard: A famous English economist, who wrote a 1936 book entitled
The General Theory of Employment, Interest, and Money. The ideas of Keynes haveshaped macroeconomics since that time. A fundamental Keynesian idea is the idea that
the economy is demand driven, meaning changes in aggregate demand can influence
the employment and output levels of the economy. In particular, Keynes believeddecreases in the demand for investment goods would be a common cause of recessions,
and Keynes argued that government should actively seek to stabilize employment and
output by replacing lost aggregate demand with expansionary fiscal policies (increases in
government purchases or tax cuts).
Labor: One of the three factors of production recognized by Adam Smith. It is the
measure of work done by humans.
Labor demand: A measure of a producers willingness to buy (i.e., hire) labor
Labor demand curve (Movements along curve): A curve that show how labor demand
depends upon the real wage. It is typically downward sloping because, as the real wage
increases, business become less profitable and it tends to be optimal for firms to respondby decreasing its willingness to hire labor.
Labor demand (Shifts in curve): The labor demand curve shifts when something other
than the real wage changes that affects the willingness of the producer to hire labor. Ingeneral, anything that impacts labor productivity will shift the labor demand curve.
Labor-Leisure Choice Problem: A problem solved by a consumer, where the consumerchooses how much time to allocate to labor and how much to allocate to leisure,
recognizing that leisure is good in itself and labor is good because it leads to income that
can be used to buy products.
Labor Productivity: The rate at which labor generates output. The two basic labor
productivity measures are the average product of labor and the marginal product of labor.
Labor Supply: A measure of the willingness of people to work. More precisely, the
number of labor units (e.g., hours) that people are willing to supply to the labor market.
Labor Theory of Value: An explanation for why the price of one good is higher or
lower than the prices of other goods. Specifically, the idea is that the value of a good or
service can be measured in terms of the amount of labor required to produce it, includingthe labor embodied in procuring the raw materials and machinery used in the process.
Land: One of the three factors of production recognized by Adam Smith. Land refers to
any naturally occurring resource whose supply is fixed.
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Landlord: A person who earns income by renting out a piece of property owned.
Law of Accumulation: The idea that a free market economy will naturally generate
people who earn more income than they will spend, meaning savings will tend to
accumulate and flow into capital, which will naturally increase the productivity of thesociety.
Law of Demand: The observation that when price rises, quantity demanded falls. This isnot necessary in theory, but it is very rarely violated in practice.
Law of Diminishing Marginal Utility: The that diminishing marginal utility is
Law of Diminishing Returns: The idea that diminishing returns is pervasively
Law of One Price: The idea that, in an efficient market, identical goods will sell at the
same prices because all sellers will flock to the highest prevailing price, and all buyers tothe lowest prevailing price.
Long Run: When speak of a production process, a period of time during which thelevels of some inputs to the production process are variable, meaning a firm can fully
adapt to an environmental change. When speaking of a market, a period of time that is
long enough so that the market can fully adjust to an environmental change. In general,
a period of time long enough that all possible adjustments to some environmental changecan take place.
Luxury Good: A good that people tend to buy when they become exceptionally rich buttend not to buy when they are exceptionally poor. The demand for a luxury tends to be
price elastic because it is not perceived to be required.
Macroeconomics: Study of the economy as a whole
Malthus, Thomas Robert: A Classical economist, long with Adam Smith and David
Ricardo. Known for his Principle of Population, which explained why the averagepersons in society would tend to be poor, unless the society finds a way to control
Malthusian Principle of Population: A theory that explains why the average person in
society will tend to be poor. Whenever the standard of living is above subsistence,
Malthus argued that the population will grow and tend to grow faster than the ability toproduce, so that the standard of living will be forced downward to subsistence.
Marginal benefit: The change in total benefit that arises when the quantity produced or
purchased changes by one unit.
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Marginal Cost: The change in total cost that arises when the quantity produced (or
purchased) changes by one unit.
Marginal Product: The change in the output level of the product that occurs when an
input is increased by one unit. Conversely, one can define the marginal product to be thechange in the output level of the product with an input is decreased by one unit.
Marginal Product of Labor: The increase in output that results from a one unitincrease in labor input, or the decrease in output that results from a one unit decrease in
Marginal Rate of Substitution: In general, the rate at which the consumer is willing to
trade one good for another, while remaining at the same level of satisfaction.
Specifically, when good B can be substituted for good A, the marginal rate of substitution
is the amount of good B that must be given to the consumer in order for the consumer tobe left at the same level of satisfaction, if at the same time one unit of good A is taken
Marginal Revenue Product: The change in a firms revenue that occurs when an input
is increased by one unit. Conversely, one can define the marginal revenue product to bethe change in the firms revenue level that occurs when an input is decreased by one unit.
Marginal Utility: How much extra utility, or satisfaction, a person gets from consuming
one extra unit of something
Market: Any medium through which buyers and sellers can meet and trade.
Market demand curve: A graph showing how a change in price will affect the total
quantity that all buyers in the market are willing to buy. (This can be obtained by
summing up individual demand curves.)
Market Equilibrium: A situation where quantity supplied for sale in a market is equal to
the quantity that demanders want to buy
Market Power: The ability of a seller to increase price and not lose buyers. More
market power implies a given price increase will cause less buyers to be lost. No market
power, which is the case for perfect competition, implies any increase in price causes allbuyers to be lost.
Market Economy: An economic system where markets determine how resources areallocated, as buyers and sellers seek mutually beneficial trades and prices adjust to
eliminate surpluses and shortages.
Marx, Karl: A thinker who took the ideas of the classical economists (Smith, Ricardo,
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Malthus) and combined them with Hegelian philosophy to produce ideas that explained
why capitalism would not survive, but rather would be replaced by a less individualist
and more communal social system.
Mercantilism: An economic system in which the policies of government are primarily
aimed at raising revenue for government based upon the trade of merchants. Historically,the policies included trade restrictions (tariffs and quotas) in an effort to accumulate gold
from trade surpluses and strict licensing to earn revenue from sponsored businesses.
Microeconomics: Study of individual component parts of an economy.
Minimum Average Cost: The lowest average cost at which the product in question can
be produced. This firm size is where the firm is productively efficient.
Mixed Economic System: An economic system that contains both command elements,
where government allocates resources, and market elements, where resources are
allocated through markets
Monopoly: A firm that is the single seller in a market
Monopolistic Competition: A model of the supply side of a market in which firms have
some market power, and firms are free to enter and exit the industry.
Monopsony: A market with a single buyer
Moral hazard: A situation where people may take greater risks because they know theiraction is insured.
Nash equilibrium: In game theory, it is a solution concept for a game involving two ormore players. In a Nash equilibrium, no player has anything to gain by changing only his
or her own strategy (or choice) unilaterally. (Watch "The Beautiful Mind"!)
Natural Monopoly: A situation where there is a single seller in the market because the
average cost of production decreases as the size of the firm gets larger, meaning the firm
becomes more productively efficient as it gets larger. Goods that are not rival (at least
not much so), but are exclusive resource (e.g. cable TV, electricity) are good candidatesfor being produced in a natural monopoly market.
Necessity: A good or service for which the demand tends to be price inelastic because itis perceived to be required.
Need: A want that at least some person would say is of high priority.
Negative Externality: A cost incurred for which an associated benefit has not been
received, and the cost was not self generated.
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Net exports: Exports minus imports. When net exports is positive, the economy is
running a trade surplus. When net exports is negative, the economy is running a trade
Net capital inflows: Foreign purchases of domestic assets minus domestic purchases of
foreign assets. Net capital inflows are positive when foreigners purchase more domesticassets than domestics purchase foreign assets.
Net capital outflows: Domestic purchases of foreign assets minus foreign purchases ofdomestic assets. Net capital inflows are positive when domestics purchase more foreignc
assets than foreigners purchase domestic assets.
Net taxes: Tax revenues received by government minus the transfer payments paid outby government.
Net Total Benefit: The difference between total benefit and total cost, or the net
satisfaction gained from a particular action.
Nominal GDP: A dollar value for gross domestic product that has not been adjusted toaccount for inflation
Nominal Wage: The wage of labor in units of currency, not adjusted for inflation, andthus not in terms of what the money will buy.
Non-exclusive: A good is non-exclusive if it is not possible to exclude someone from
consuming the good if they so desire.
Non-rival:A good is non-rival if its consumption by one individual does not reduce the
amount of the good available for consumption by others.
Normal Profit: A profit level that allows the firm to remain in the industry, but one thatneither encourages other firms to enter nor encourages the firm in question to exit.
Normative Analysis: An analysis that indicates how things should be, as opposed tohow they are.
Oligopoly: A model of the supply side of a market in which firms have substantial
market power, typically because the industry is dominated by a few large firms. The
distinguishing characteristic of oligopoly is that the actions of one firm determine theopportunities available for another firm, which implies the pricing of the product is a
game where each firm must think strategically.
Opportunity cost: A measure of the value of an activity or good, the level of which is
indicated by the next best alternative forgone.
Output: The result of a production process, obtained from the processing (or
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transformation) of inputs. Output is also called the product of the production process.
Per Capita Real GDP: A measure of the economys output level per person, which is astandard measure of the average standard of living. It is calculated by dividing a real
GPD value by the economys population.
Perfect Competition: A model of the supply side of a market in which no producer has
any market power, firms compete only changing their product price, and firms are free to
enter and exit the industry.
Physical Capital: Referring to any non-human asset made by humans and then used to
Pigouvian Tax: An excise (i.e per unit) tax levied so as to internalize a negative
externalities of some market activity. The level of the Pigouvian tax is set so that the tax
revenue collected would be sufficient to compensate all those people for the external
costs they incur from the activity.
Positive Analysis: An analysis that indicates how things are, as opposed to how theyshould be.
Positive Externality: A benefit received for which an associated cost has not beenincurred, and the benefit was not self generated.
Poverty: The state of being poor, which depends on how you define it. Officially, in the
U.S., you are in a state of poverty if you have an income level that is less than a certainthreshold. While some at that threshold today would have been considered relatively
rich 100 years ago, which is an indication that what it means to be poor is always a
relative concept, the poverty thresholds used in the U.S. for individuals, families, andhouseholds have been relatively stable over time in real terms, so that they are intended to
be absolute indicators of what it means to be poor.
Poverty Rate: The percentage of individuals, or families, or households that have an
income level less than the predetermined poverty income threshold.
Preference Relation: A way to represent the idea that a consumer can compare any twoalternatives and decide either which one is best or decide that neither is better.
Proletariat: The common class of working people
Price: What must be given up to purchase one unit of a good or service.
Price Elasticity of Demand: A measure of the responsiveness of the demand for a good
or service as it depends upon its price. Specifically, it is the percentage change in the
demanded divided by the percent change in price.
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Price Elasticity of Supply: A measure of the responsiveness of the supply of a good or
service as it depends upon its price. Specifically, it is the percentage change in thequantity supplied divided by the percent change in price.
Price Index: A series of numbers that measures the average level of prices in aneconomy. When the number in a price index doubles, it is an indication that prices in
the economy are twice as high. In general, an increase in the price index of x percent
indicates an x percent increase in the general level of prices in the economy.
Price System: A description used for the part of a market economy that consists of the
role changing prices play in allocating resources. Changes in prices send signals to
buyers and sellers, and these signals essentially decide, for the market economy, whoproduces what, where they produce, when, and how.
Price Theory: An explanation for how prices are determined in a market economy. The
standard explanation is that prices adjust so as to elimination surpluses and shortages,meaning the price observed is explained as the price such that there is not surplus and no
Prisoner's dilemma: It is a situation in which 2 decision makers can each choose to
cooperate with the other or defect. The payoffs are such that when one cooperates itis in the others self interest to defect, and when one defects it is in the others self
interest to also defect. Thus, if he only concern of each person is maximizing his or her
own payoff, it is in the self interest of each to defect. The dilemma arises because the
payoffs are also such that when both defect, each receives a lower payoff than when bothcooperate. Put differently, mutual defection is a Nash equilibrium, but is less preferred
by each decision maker to mutual cooperation.
Private Benefit: A benefit received by an individual that results from a choice made by
that individual. When a positive externality is present, the private benefit of an activity is
less than the social benefit.
Private Cost: A cost incurred by an individual that are the result of a choice made by that
individual. When a negative externality is present, the private cost of an activity is less
than the social costs.
Private Good: A good is rival and exclusive
Private Property: Property not owned by the government but by individuals.
Producer surplus: For an individual firm, it is the amount by which the market priceexceeds the cost of producing the particular unit of the good or service. For the market, it
is the sum over all of the producers of all of the individual producer surplus amounts. In
a supply-demand diagram, this producer surplus for the market is the area above the
supply curve, but below the market price.
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Product: The output of a production process
Product Market: The market in which the outputs of firms are bought and sold.
Production: A process by which a set of inputs (or factors) are transformed into a set ofoutputs (or products).
Production possibilities set: All the different outcomes that can be produced with givenresources and technology
Production possibilities frontier: The outer edge of the production possibilities set
which separates what can be produced from what cannot be produced.
Productive efficiency: For the economy as a whole, a state in which it is not possible to
produce more of one good without decreasing the output of some other good. For a firm,
a state in which the firm is producing the product at minimum average cost. A firm isproductively inefficient if the firms average cost of production is above its minimum
Productive inefficiency: A state in which it is possible to produce more of one good
without decreasing the output of some other good.
Profit: The income earned by the capitalist, equal to the revenues of the firm minus the
Public Good: A good that is non-rival and non-exclusive.
Public saving: The amount of money government makes available to private sectorcapital markets when government revenue exceeds government spending.
Real GDP: A dollar value for gross domestic product that has been adjusted to accountfor inflation
Real Wage: The wage after if has been adjusted for the effects of inflation, so that what
is measured is the buying power of one unit of labor time.
Recession: A decrease in economys output level. The official definition of a recession
for the U.S. economy is an instance where real GDP decreases for two or more successivequarters.
Related Market: A market that will tend to be affected by changes in the market inquestion, perhaps because the commodities are either substitutes or complements.
Relative price: The price of a good or service measured in terms of another good or
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Rent: The income earned by the landlord.
Resource: Anything that can provide satisfaction to some person (e.g. time, money, oil,
Ricardo, David: A famous Classical economist, along with Adam Smith and Thomas
Malthus. Given credit for the principle of comparative advantage. Known for explaining
why economic development would disproportionately benefit Landlords (i.e. the ownersof fixed factors of production), and not so much benefit either workers or capitalists.
Satiation: A situation where an individuals want is satisfied to such an extent that a
resource which would typically provide additional satisfaction to the individual cannot, atleast at that time, provide any additional satisfaction.
Satisfaction: The fulfillment of a want
Saving: Not spending; setting aside income for the future
Scarce Resource: A resource that is limited relative to the wants it can satisfy
Seller: A trader who relinquishes ownership of a good or service
Service: A commodity (or product) one can buy that involves buying or renting the time
of another person, rather buying a physical object.
Shortage: A situation in a market where buyers want to buy more than sellers want to
Short Run: When speak of a production process, a period of time during which the
levels of some inputs to the production process are fixed, meaning a firm may not be able
to adapt to an environmental change as effectively as it could over a longer period oftime. When speaking of a market, a period of time during which the market has not been
able to fully adjust to some environmental change. In general, a period of time during
which all possible adjustments to some environmental change have not yet taken place.
Smith, Adam: Often referred to as the father of economics. Published The Wealth of
Nations in 1776, which included a number of timeless economic ideas, including the
invisible hand idea that self-interest, when channeled through a market economy, canhave socially beneficial results.
Social Benefit: The total of all benefits associated with an economic activity. If socialbenefits are greater than private benefits, then a positive externality is present.
Social Costs: The total of all the costs associated with an economic activity. If social
costs are greater than private costs, then a negative externality is present.
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Socialism: An economic system in which industry (the means of production) is owned
collectively by government.
Specialization: Seeking to be a master of one trade, rather than a Jack of all, so as to
Stock: A quantity that can be measured at any point in time. (See flow for the other
significant quantity measure.)
Subsidy: Money paid, usually by government, as an incentive to make an activity
happened that that otherwise would not take place.
Subsistence Wage: A wage level that will allow workers to survive and reproduce, but
Substitutes: One good is a close substitute for a second good if a proportionate increasein the first good can effectively offset the utility lost when one unit of the first good is
Substitution Effect: One explanation for why an increase in price leads the buyer to buy
less, which is a price increase implies the product becomes more expensive relative toother products,
and this encourages people to shift their expenditure away from the more expensive
product toward the relatively less expensive substitutes.
Sunk Cost: A cost that has already been paid, one that is not irreversible. Because it
has already been paid, a sunk cost should not affect what is best to do next.
Superior Good: A good such that more is purchased (rather than less) when the buyers
Supply: The quantity that a seller is willing to put out on the market for sale
Supply Curve (movement along curve): A curve that shows the relationship between
the quantity the seller is willing to offer for sale on the market and the price that the sellerreceives.
Supply Curve (shift in the curve): The supply curve shifts when something other thanprice impacts the sellers willingness to sell.
Surplus: A situation in a market where sellers want to sell more than buyers want to buy.
System: A set of interdependent component parts that together accomplish some
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Tax: A levy imposed by a government, meaning an individual or business must transfer
money to a government.
Technology: The existing body of know-how about materials, techniques of production,
operation of equipment.
Terms of Trade: The rate at which one resource is trades for another
Total benefit: The total satisfaction obtained from an action
Total cost: The total satisfaction foregone when one action is chosen rather than the next
Trade: Relinquishing ownership of one resource in exchange for obtaining ownership of
some other resource
Trade barrier: Any regulation or policy that restricts international trade (e.g., tariffs,
Trade sanction: A trade penalty imposed by one nation or more nations one or more
other nations, usually an agreement to not trade with the sanctioned nation(s).
Trade surplus: A situation where a nation exports more products than it imports
(measured in terms of its own currency).
Trade-off: A situation where gaining one thing involves losing something else
Tragedy of the Commons: A situation in which a common resource is destroyedbecause the individual marginal benefit of using more of the common resource exceeds
the individual marginal cost for each individual, and individual use of the common
resource generates a negative externality that diminishes the quality of the commonresource.
Transactions Cost: The cost that must be incurred in order to make a trade or a transfer
(e.g. travel cost).
Unintended consequence: An unexpected undesirable event that results from a policy
action or provided incentive that was intended to do good, (and may have done good insome other way).
Unit-Elastic: Moderately responsive. When thinking of the responsiveness of y(dependent variable) upon x (independent variable), an elastic response implies that the
percentage change in y is equal to the percentage change in x.
Utility: The level of pleasure or satisfaction experienced by a consumer
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Variable Cost: The part of total cost that increases as the volume of production
Wage: The monetary payment received by the worker for one unit of labor time.
Want: Something that is desired
Worker: A person who earns income by selling their own labor time
WTO: (World Trade Organization) The governing body of international trade, which sets
enforces the rules of trade and punishing offenders.