Terms

Definition

Scarcity

A situation in which wants and needs are in excess of the

resources available.

Production

The process of creating goods and services in an economy.

Opportunity Cost
Specialisation

Division of labour
Primary sector
Secondary sector
Tertiary sector
Quarternary sector

The next best alternative foregone.

The process of which individuals,firms and economies
concentrate on producing those g&s where they have
an advantage over others resulting in higher output
levels.
Specialisation of labour on specific tasks.
Extractive industries ( Agriculture, forestry, fishing,
mining )
Converts raw materials into goods (manufacturing )
Service sector ( banking, tourism, education, retailing and
transport )
The knowledge-based part of the economy ( ICT,
scientific research )

Free market

Decisions on how resources are allocated are based on the

interaction of demand and supply ( the price mechanism
).

Public goods

Goods which are non-excludable, non-rival, nonrejectable.

( street lighting )

Merit goods

Goods which have positive externalities associated with

it.
( education , healthcare )

Demerit goods
Sin tax
Private goods
Quasi- Public goods
Planned economy
Mixed economy

Goods which have negative externalities associated

with it.
(cigarettes )
Tax imposed on cigarettes and alcohols.
Goods bought and consumed by individuals for their own
benefit. (chocolate bar ) excludable, rival, rejectable
Goods that have some but not all characteristics of a
public good.
(Roads with toll gate )
The government has a central role in all decisions that
are made.
Involves both private and public sectors in the process
of resource allocation.

Production Possibility
Curve ( PPC )

Money
Medium of exchange
Unit of account

Standard of deferred
payment

Demand

Shows the maximum number of goods and services

that an economy can produce given the existing quantity
and quality of resources and the current state of
technology. Shows resources are not homogenous ( OC )

Refers to anything which is regularly used to buy g&s.

Sell products and use money to purchase instead of
barter system.
Unit by which prices are established for current and
projected transactions. Allows different values to be
added, measured and compare. ( link with divisible into
small units )
Money ability allows people to lend and borrow.

Refers to the quantities of product that purchasers are

willing and able to buy at various prices per period of
time.

Notional demand

Demand that is not always backed up by the ability to

buy.

Effective demand

Demand backed by purchasing power.

The law of demand

Demand curve

A higher quantity will be demanded at a lower price,

assuming all factors remain constant.
Represents the relationship between QD and P of a
product.

The law of
diminishing marginal
utility

Every extra unit of a g&s consumed will give less

satisfaction per unit and therefore consumers will only be
willing to pay less for additional units.

Joint demand

Where two goods are consumed together ( complements

)
Market demand curve

Reflects the total amount demanded by consumers.

Veblen goods

Luxury, expensive goods.

Giffen goods

Inferior goods.

Supply
The law of supply
Market supply curve

Refers to the Q of a product that suppliers are willing and

able to sell at various prices per period of time.
A higher Q will be supplied at higher prices as higher
prices usually result in higher profits.
The horizontal summation of individual supply curves.

Elasticity

A numerical measure of responsiveness of one

variable following a change in another variable, ceteris
paribus.

PED

Measures the sensitivity of demand to a change in

price.
PED = Percentage change in QD / Percentage change in
price
-

YED

Perfectly elastic ( infinity )

Perfectly inelastic 0
Elastic >1
Inelastic <1
Unitary elastic =1

Measures the sensitivity of demand to a change in

income.
YED = Percentage change in QD / Percentage change in
income
-

XED

Normal good ( +ve YED )

Inferior good ( -ve YED )

Measures the sensitivity of demand for one good to a

change in price of another good.
XED = Percentage change in QD of good A / Percentage
change in price B
-

PES

Substitutes ( +ve XED )

Complements ( -ve XED )

Measures the responsiveness of supply to a change in

price.
PES = Percentage change in QS / Percentage change in

price
Equilibrium
Equilibrium price
Equilibrium quantity
Disequilibrium
Excess demand
Excess supply
Consumer surplus
Producer surplus

Taxes
Direct tax

Refers to a state of balance where there is no tendency

for change to occur. QD = QS
The price where D & S are equal, where the market clears.
The amount that is traded at equilibrium price.
A situation where D & S are not equal.
QD > QS
QD < QS
The difference between the price that a consumer is
prepared to pay and the actual price paid.
The difference between the price a producer is willing
to accept and what is actually paid.

Charges imposed by government on incomes, profits

and some types of consumer goods and services.
Taxes on the income of individuals and firms. ( income tax
)

Indirect tax

Taxes levied on g&s . (VAT, GST )

Ad-valorem

A propotional tax which is a percentage of the price

charged by the retailer. ( VAT )

Specific tax

Taxes in the form of a fixed amount per unit purchased.

(excise taxes on petrol, tobacco, alcohol )

Subsidies

Payments made by government to producers to reduce

market prices.

Maximum price
control

A legal maximum price at which a good can be sold.

Minimum price
control

A legal minimum price at which a good can be sold.

Direct provision

Where governments supply public and merit goods to the

public for free.

Transfer Payments

A hand-out payment made by the government to certain

members of the community without the exchange of g&s.
Aimed to create a more equitable distribution of
income.

Nationalisation

When governments take over a private sector businesses.

Privatisation

Involves the transferring of assets from the public sector to

the private sector.

Aggregate Demand
(AD)

The total planned expenditure on final g&s in an

economy over a given time period.
AD = C + I + G + ( X M )

Aggregate Supply
(AS)

Total output that firms in an economy are willing and

able to supply at a given price level over a given time
period.

Inflation

Refers to a situation in economy where there is general

and sustained increase in price over a period of
time.

Creeping inflation

Inflation which increases gradually, but continually, over

time.

Hyperinflation
Money values
( nominal value )
Real values

Extremely high rates of inflation, e.g. thousand of %

( Zimbabwe)
Refers to a value expressed in monetary terms for a
specific year or years, without adjusting for inflation.
Nominal values adjusted for inflation.

Monetary inflation

Occurs where money supply > increase in the level of

output.

Cost-push inflation

Caused by an increase in costs of production.

Wage price spiral

Higher wage demands without any increase in

productivity leads to higher costs and hence price ;
higher prices lead to higher wage demands.

Demand-pull inflation

Occurs when there is an increase in the total demand

for g&s in an economy when the economy is at or close to
its maximum capacity.

Menu costs

Expenses involved when changing the prices again and

again when experiencing high rate of inflation.

Shoe leather costs

Used to refer to those people who prefer to hold only a

small amount of money at any one time. They rather put
money in financial institutions to gain high rate of
interest.

Inflationary noise

Makes it more difficult to assess what is happening to

the price of g&s, i.e. whether a rise in price reflects an
increase in relative price or an adjustment in line
with inflation.

Deflation
Disinflation
Good deflation

A general and sustained fall in price level, e.g. inflation

is -5% (-ve)
A fall in the inflation rate, e.g. 10% --> 5 %
Occurs as a result of increase in AS due to advance in
technology, resulting in a rise in output, employment and
international competitiveness.

Bad deflation

Balance of payments

Occurs as a result of decrease in AD due to a decrease in

consumption.

A record of a countrys transaction with the rest of the

world over a year.

Credit item

Money coming into the country. Recorded with +ve sign.

Debit item

Money going out of the country. Recorded with ve sign.

Current account

The overall balance of the trade in goods, services,

income and current transfer.

Capital account

Records transactions which involve the transfer of

ownership of fixed assets.

Financial account
Net errors and
omissions

Records the flow of investment.

A figure included to ensure the balance of payments
balances.

Deficits

Outflow of currency > inflow

Surplus

Inflow > outflow

Exchange rate
Floating ER system

The price of one currency in terms of another currency.

ER is determined by demand and supply of the currency
in the foreign exchange market. No government
intervention.

Depreciation of
currency

More units are needed to buy a single unit of other

currency.

Appreciation of
currency

Fewer units are needed to buy a single unit of other

currency.

Fixed ER system

An exchange rate set by the government and

maintained by the central bank.

Devaluation

Decision by the government to lower the international

price of the currency.

Revaluation

Decision by the government to raise the international price

of its currency.

Pegged ER system

The government declares a central value for its

currency and then intervenes in the foreign exchange
market to maintain its value.

Managed float

Value of currency is broadly decided by market forces but

government intervenes if there are significant
fluctuations ( ) in the countrys exchange rate. It
combines features of floating ER and the fixed ER.

Marshall Lerner
Condition

The BOP will improve following a devaluation of the

ER,provided the sum of the price elasticities of demand for
exports and imports are greater than 1 (elastic).

J-Curve Effect

A fall in ER causes an increase in a current account

deficit before it reduces due to the times it takes for
demand to respond. (describe short run-demand
inelastic ; long run price elastic, find cheaper suppliers )

Term of trade

Absolute advantage

Comparative
advantage

A numerical measure of the relationship between export

and import prices.

A country has absolute advantage over another country in

the production of a good if it can produce more of the
good given an equal quantity of resources.
Refers to the ability of a country to produce a good at a
lower OC than another country.

Free trade

Occurs when there are no barriers to importing and

exporting, i.e. No protectionism.

Free trade area

Removal of tariffs and quotas on internal trade.

Members are free to determine their own external
trade policies towards non-members. ( ASEAN)

Customs Union

Removal of tariffs and quotas ; with common

external tariffs on trade with non-members.

Economic Union

A number of economic policies, rules and regulations

are established, which affect all the member countries.
May have single currency, but not necessary for all
member countries agree to use that currency.
(EU where most members have adopted the euro and the
European Central Bank operates a single interest rate. )

Monetary Union

A group of countries or states that adopt a single

currency.

Globalisation

The opening up of world trade. It involves fewer

barriers to trade and less protectionism.

Protectionism

Refers to governments use of embargoes, tariffs,

quotas and other restrictions to protect domestic
producers from foreign competition.

Tariffs

Tax on imports and exports.

Quotas

Restrictions on the maximum quantity or value of

imports.

Embargoes

A law that bars imports from or trade with another

country, done with political reasons. USA has imposed
embargo on North Korea.

Fiscal Policy

Involves changes in taxation and government

spending to influence AD.

Reflationary /
Expansionary Fiscal
Policy

Increase AD Increase government spending, cut tax

rates.

Deflationary /
Contractionary Fiscal
Policy

Decrease AD Increase tax rates and cut government

spending.

Discretionary Fiscal
Policy
Automatic Stabilisers

Monetary Policy
Open market
operations
Quantitative easing

Supply side policy

A deliberate change in government expenditure and

taxation. Government actions in response to economic
situation.
Forms of government spending and taxation which change
without deliberate government action to offset
fluctuations in GDP.
Involves the change in money supply, interest rates
and the exchange rate to influence AD.
Where central bank buys and sells bond on the open
market in order to expand or contract the amount of
money in the banking system.
When the central bank stimulates the economy by buying
government securities or bonds, thereby lowering IR and
raising money supply. Allowed increased lending and
liquidity.
Policies designed to increase AS by improving the
workings of product and factor markets.

Free market approach

Tries to raise productive potential by increasing work and

investment incentives, removing restrictions on firms and
increasing competitive pressures.

The interventionist
approach

Seeks to increase AS through government intervention

in markets.

Expenditure
switching policies

Expenditure
dampening policies

Attempts to make imports relatively expensive

compared to exports.

Government policies to reduce spending throughout the

economy.