Sample Di

Lipsey & Chrystal: Economics 13e
Glossary
45° line
Used in macroeconomics to indicate points where planned spending and actual output are equal, so
that what firms produce is just equal to what agents wish to buy.
Absolute advantage
The advantage that one region is said to have over another in the production of some commodity
when an equal quantity of resources can produce more of that commodity in the first region than in
the second. Compare comparative advantage.
Absolute price
The price of a good or a service expressed in monetary units. Also called a money price.
Accelerator theory of investment

The theory that the level of investment depends on the rate of change of output.
Accommodation
An accommodation of inflation is said to occur when the monetary authorities increase the nominal
money supply at the same rate as the price level is rising so holding the real money supply constant,
which in turn prevents the LM and the AD curves from shifting left to lower equilibrium GDP.
Actual GDP
The level of GDP actually produced over a given period.
AD curve
See Aggregate Demand Curve: A curve that plots all combinations of the price level and GDP that
yield equilibrium in the goods and the asset markets—i.e. that yield IS–LM equilibrium.
AD* curve
A version of the aggregate demand curve showing a negative relationship between real GDP and an
unexpected increase in the rate of inflation drawn for a specific expected rate of inflation
AD-AS multiplier
The multiplier when the interest rate and the price level are both endogenous variables. See also
multipler.
Ad valorem tax
A tax levied as a percentage of the value of some transaction.
Adaptive expectations
The expectation of the future value of a variable formed on the basis of an adjustment that is some
proportion of the error in expectations made last period. The error is the difference between what
was expected last period and what actually happened.
© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Administered price
A price that is set by the decisions of the sellers of products rather than by impersonal market
forces.
Adverse selection
The tendency for people most at risk to insure, while people least at risk do not, so that the insurers
get an unrepresentative sample of clients within any one fee category.
Agents
All decision-makers, including consumers, workers, firms, and government bodies.
Aggregate (desired) expenditure (AE)

The total volume of purchases of currently produced goods and services that all of the nation‘s
spending units wish to make.
Aggregate demand (AD)

The total desired purchases of final output by all the nation’s buyers.
Aggregate demand curve

A curve that plots all combinations of the price level and GDP that yield equilibrium in the goods and
the asset markets—i.e. that yield IS–LM equilibrium.
Aggregate demand shock

A shift in the aggregate demand curve. This may result from an autonomous change in either
exogenous expenditures or the demand for money or a policy induced change in interest rates.
Aggregate production function

The technical relation that expresses the maximum national output that can be produced with each
possible combination of capital, labour, and other resource inputs. See also production function.
Aggregate spending
See aggregate expenditure: The total volume of purchases of currently produced goods and services
that all of the nation‘s spending units wish to make.
Aggregate supply (AS)

The total desired output of all the nation’s producers.
Aggregate supply curve

A curve relating the economy’s producers’ total desired output, GDP, to the price level, P.
Aggregate supply shock

A shift in the aggregate supply curve. This may result from an exogenous change in input prices or
from technical change.
Allocate efficiency
Situation in which total production cannot be reallocated in order to make someone made better off
without at the same time making someone else worse off.

Allocative inefficiency
Situation in which production can be reallocated to make someone better off while making no one
else worse off.
Appreciation
When a change in the free market exchange rate raises the value of one currency relative to others.
Arbitrage
Trading activity based on buying where a product is cheap and selling where it has a higher price
(from the French word arbitrer: to referee or arbitrate). Arbitrage activity helps to bring prices closer
in different segments of the market.
Arc elasticity
A measure of the average responsiveness of quantity to price over an interval of the demand curve:
(Δq/q) × (p/Δp). See also point elasticity.
AS curve
See aggregate supply curve: A curve relating the economy’s producers’ total desired output, GDP, to
the price level, P.
AS* curve
A version of the aggregate supply curve that relates desired output of firms to the inflation rate. Its
horizontal portion shows that GDP can vary over a wide range while the inflation rate stays close to
the rate that is targeted by the Bank and fully expected by the public.
Asset equilibrium
The demands for both money and bonds equals their supplies, which is true at any point on the LM
curve.
Asymmetric information
A situation in which some economic agents have more relevant information than others and this
affects the outcome of a bargain between them.
Auction prices
Prices that are set by the bidding of buyers, often against each other.
Autarky
Situation existing when a country does no foreign trade. Automatic fiscal stabilizers Forces that tend
to stabilise GDP and that arise because the values of some tax revenues and benefits change with
the level of economic activity. For example, income tax revenue rises as personal incomes rise,
corporation tax revenue rises as company profits rise, and unemployment benefits fall as
employment rises.
Autonomous expenditures
Expenditures that are determined outside of the model. In the simplest macro model with only
consumers and producers, these are expenditures that are independent of the current level of GDP.
In the IS-LM and ADAS models these are expenditures that are independent of the current levels of
the GDP and the interest rate.

Autonomous variable
See exogenous variable: A variable that influences other variables within a theory but is itself
determined by factors outside the theory. Also called an autonomous variable.
Average fixed costs (AFC)

Total fixed costs divided by the number of units produced.
Average product (AP)

Total output divided by the number of units of the variable factor used in its production.
Average propensity to consume (APC)

Total consumption expenditure divided by disposable income, C/Yd.
Average propensity to import

Total imports divided by GDP, IM/Y.
Average propensity to save (APS)

Total saving divided by total disposable income, S/Yd. Also known as the savings ratio.
Average revenue (AR)

Total revenue divided by the number of units sold.
Average total cost (ATC)

The total cost of producing any given output divided by the number of units produced, i.e. the cost
per unit.
Average variable cost (AVC)

Total variable cost divided by the number of units produced. Also called unit cost.
Balance of payments accounts

A summary record of a country’s transactions that involve payments and receipts of foreign
exchange.
Balance of trade
The difference between the value of imports and exports of goods and services.
Balanced budget
A situation in which current revenue is exactly equal to current expenditure (usually applied to the
finances of the government).
Balanced budget multiplier

The change in GDP divided by the increase in government spending that brought it about when taxes
are raised sufficiently to keep the budget balanced (ΔT = ΔG).
Balanced growth
In macroeconomics this occurs when all of the model’s endogenous variables grow at the same rate.

Bank rate
The rate of interest that the Bank of England pays on commercial banks’ reserve balances held at the
Bank of England. It is set by the Monetary Policy Committee (MPC) and changes in it are one of the
main ways in which monetary policy is implemented.
Barriers to entry
Anything that prevents new firms from entering an industry.
Barter
The trading of goods directly for other goods rather than for money.
Base period
A time period chosen for comparison purposes in order to express or compute index numbers.
Values in all other periods are expressed as percentages of the base-period value.
Base rate
The interest rate quoted by UK banks as the reference rate for much of their loan business. For
example, a company may be given a loan at ‘base plus 2 per cent’. The base rate changes periodically
when the Monetary Policy Committee changes the bank rate signalling that it wants changes in
money market rates in general. The equivalent term used by US banks is ‘prime rate’.
Base year
A base period that is a year.
Basic prices
Used in National Accounts to refer to prices received by producers that exclude taxes on products, as
in ‘gross value added at basic prices’.
Beta
The relationship between the price of a share and the prices in the share market in general. A beta
of 1 implies a perfect correlation between the price of the share in question and the general level of
prices in the market as a whole.
Bill
A tradable security, usually with an initial maturity of up to six months, which pays no explicit
interest and so trades at a discount to its maturity value.
Black market
A market in which goods are sold at prices that violate some legally imposed pricing or trading
restriction.
Bond
In economic theory, any evidence of a debt carrying a legal obligation to pay interest and repay the
principal at some stated future time. This term is used in this book to cover the many different types
of debt instrument that exist in practice.
Boom
Period of high output and high employment usually associated with a positive GDP gap. See also
slump.

Break-even price
The price at which a firm is just able to cover all of its costs, including the opportunity cost of capital.
See also shutdown price.
Budget balance
The difference between the government’s revenues and its expenditures. See also balanced budget.
Budget deficit
The shortfall of current revenue below current expenditure, usually with reference to the
government.
Budget line
Line showing all those combinations of commodities that are just obtainable, given a household’s
income and the prices of all commodities.
Budget surplus
The excess of current revenue over current expenditure, usually with reference to the government.
Built-in stabilizer
Anything that reduces the economy’s cyclical fluctuations and is activated without a conscious
government decision. See also automatic fiscal stabilizers.
Business cycles
Fluctuations in the general level of activity in an economy that affect many sectors at roughly the
same time, though not necessarily to the same extent. In recent times, the period from the peak of
one cycle to the peak of the next has varied in the range of five to ten years. Formerly known as
trade cycles.
Buyout
When an investor or group of investors buys up a controlling interest in a firm.
Capacity output
This output is also called normal capacity output. In micro economics it refers to output at which
short-run average total cost reaches a minimum. In macroeconomics it refers to the level of output
at which firms plan to produce under normal conditions. Where firms have horizontal short run unit
cost curves, it occurs a bit below the output at which the curves begin to take on a positive slope.
See also Yc
Capital
All those man-made aids to further production, such as tools, machinery, and factories, which are
used in the process of making other goods and services rather than being consumed for their own
sake.
Capital and financial account

Part of the balance of payments accounts that records international transactions in assets and
liabilities.

Capital consumption allowance

An estimate of the amount by which the capital stock is depleted through wear and tear. Also called
depreciation.
Capital deepening
Increases in the amount of capital per unit of labour (and other inputs) that can occur, for example,
in response to a fall in the rate of interest.
Capital goods
See investment goods: Goods produced not for present consumption, i.e. capital goods, inventories,
and residential housing.
Capital inflow
This arises when overseas residents buy assets denominated in the domestic currency or domestic
residents sell assets denominated in some foreign currency.
Capital outflow
This arises when overseas residents sell assets denominated in the domestic currency or domestic
residents buy assets denominated in some foreign currency.
Capital stock
The total quantity of physical capital in existence.
Capital widening
Investment in additional capacity that uses the same ratio of capital to labour as does existing
capacity.
Capital–labour ratio
The ratio of the amount of capital to the amount of labour used in production.
Cartel
A group of firms that agree among themselves to act as if they were a single seller.
Cash base
See high-powered money and M0: The monetary magnitude that is under the direct control of the
central bank. In the UK, it is composed of cash in the hands of the public, commercial bank reserves
of currency, and deposit balances held by the commercial banks with the Bank of England. Formerly
called M0.
Central authorities
See government: In economics, all public agencies, government bodies, and other organizations
belonging to, or under the control of, the government; sometimes called the central authorities.
Central bank
A bank that acts as banker to the commercial banking system and often to the government as well.
In the modern world it is usually a government-owned institution that is the sole money-issuing
authority and has a key role in the setting and implementation of monetary policy. In the UK the
central bank is the Bank of England. See also monetary authorities

Centrally planned economy

See command economy: An economy in which the decisions of the government (as distinct from
households and firms) exert the major influence over the allocation of resources and the distribution
of income. Also called a centrally planned economy.
Ceteris paribus
‘Other things being equal’: commonly used to describe a situation in which all but one of the
independent variables are held constant in order to study the effects of changes in the remaining
independent variable on the dependent variables.
Change in demand
A shift in the whole demand curve, i.e. a change in the amount that will be bought at each price.
Change in the quantity demanded

An increase or decrease in the specific quantity bought at a specified price, represented by a
movement along a demand curve in response to a change in price.
Circular flow of income

The flow of domestic spending on output and factor services passing between domestic (as opposed
to foreign) firms and domestic households.
Classical dichotomy
Concept in classical economics that monetary forces influence the general price level but have no
effect on any real variable. Related to the concept of neutrality of money.
Classical economics
A term often loosely used to refer to all mainline economics up to the 1950s. More precisely, it
refers to the economics that existed up to the late-1800s before the introduction of marginal theory
(often called the marginal revolution). From that time on, the main stream of economics is called
Neo-Classical. This body of theory was criticized by Keynes, although he called it Classical.
Neoclassical economics still exists today and in some ways is an alternative to Keynesian theory and
in other way compliments it.
Closed economy
An economy that does not engage in international trade (autarky).
Closed shop
A firm in which only union members can be employed. Closed shops may be either ‘pre-entry’,
where the worker must be a member of the union before being employed, or ‘post-entry’, where
the worker must join the union on becoming employed.
Coase theorem
The proposition that if those creating an externality and those affected by it can bargain together
with zero transaction costs, the externality will be internalized independently of whether it is the
creators of or the sufferers from the externality who have the related property rights.
Collective consumption goods

See public goods: Goods and services that, once produced, can be consumed by everyone in the
society such as police protection and parks. Also called collective consumption goods.

Command economy
An economy in which the decisions of the government (as distinct from households and firms) exert
the major influence over the allocation of resources and the distribution of income. Also called a
centrally planned economy.
Commercial policy
The government’s policy towards international trade, international investment flow, and related
international matters.
Commodities
A term often used to refer to basic goods, such as wheat and iron ore, that are produced by the
primary sector of the economy. Also often used by economists to refer to all goods and services.
Common market
An agreement among a group of countries to have free trade among themselves, a common set of
barriers to trade with other countries, and free movement of labour and capital among themselves.
Common property resource

A resource that is owned by no one and may be used by anyone.
Comparative advantage
The ability of one nation (or region or individual) to produce a commodity at a lower opportunity
cost in terms of other products forgone than another nation (or region or individual). Compare
absolute advantage.
Comparative statics
Short for ‘comparative-static equilibrium analysis’: studying the effect of a change in some variable
by comparing the positions of static equilibrium before and after the change.
Compensating variation
The amount of income that has to be taken away from a consumer following a price fall in one good
in order to return the consumer to the original indifference curve and thereby leave the consumer
feeling equally well off.
Competition policy
Policy designed to prohibit the acquisition and exercise of excessive market power by business firms.
It is designed to prevent monopolies from arising, or abusing their power where they do exist, and
also to prohibit non-competitive behaviour by oligopolistic firms.
Complements
Two goods for which the quantity demanded of one is negatively related to the price of the other.
Concentration ratio
The fraction of total market sales (or some other measure of market occupancy) accounted for by a
specific number of the industry’s largest firms, four-firm and eight-firm concentration ratios being
the most frequently used.

Constant returns to scale

When all of a firm’s inputs and its outputs increase at the same rate. For example, when a doubling
of all inputs leads to a doubling of all outputs.
Consumer
An agent who purchases goods or services for his or her own use.
Consumers’ surplus
The difference between the total value that consumers place on all units consumed of a commodity
and the payment they must make to purchase that amount of the commodity.
Consumption
The act of using goods and services to satisfy wants.
Consumption function
The relationship between personal planned consumption spending and the variables that affect it,
such as disposable income and wealth.
Consumption spending (or expenditure)

The amount that individuals spend on purchasing goods and services for consumption within a
specific period of time.
Contestable market
A market in which there are no sunk costs of entry or exit, so that potential entry, even with no
actual entry, may hold the profits of existing firms to low levels—zero in the case of perfect
contestability.
Cooperative solution
A situation in which existing agents cooperate to maximize their joint profits.
Core inflation
The inflation rate as measured by the CPI after removing some of the volatile prices that are beyond
the control of the Bank‘s monetary policy, particularly those for energy and agricultural
commodities.
Corporation
See joint stock company: A firm regarded in law as having an identity of its own. Its owners, who are
its shareholders, are not personally responsible for anything that is done in the name of the firm.
Called a corporation in North America.
Cost minimization
An implication of profit maximization that the firm will choose the method that produces any
specific output at the lowest attainable cost.
Creative destruction
Schumpeter’s theory that high profits and wages earned by monopolistic or oligopolistic firms and
unions are the spur for others to invent cheaper or better substitute products and techniques that
allow their suppliers to gain some of these profits thus eroding the previously existing market power.

Credibility
The extent to which actors in the private sector of the economy believe that the government will
carry out the policy it promises in the future. Important in policy analysis in macro models that
assume rational expectations, since expectations of future policy action influence current behaviour.
Cross-elasticity of demand
The responsiveness of demand for one commodity to changes in the price of another, defined as the
percentage change in quantity demanded of one commodity divided by the percentage change in
the price of another commodity that brought it about.
Cross-sectional data
A number of observations on the same variable, such as individuals’ savings or the price of eggs, all
taken at the same time but in different places or for different agents.
Current account
An account recording all international transactions between one country and the rest of the world
related to goods and services and income payments and receipts.
Customs union
A group of countries that agree to have free trade among themselves and a common set of barriers
against imports from the rest of the world.
Cyclical unemployment
See demand-deficient unemployment.
Debt
Anything that is owed by one agent to another. In the context of corporate finance this applies to
bonds or bank loans, but not equity.
Debt instruments
Any written documents that record the terms of a debt, often providing legal proof of the conditions
under which interest will be paid and the principal repaid.
Decision lag
The time it takes to assess a situation and decide what corrective action should be taken.
Decreasing returns to scale

A situation in which output increases less than proportionately to inputs as the scale of production
increases in the long run.
Deflation
A decrease in the general price level.
Degree of risk
A measurement of the amount of risk associated with some action such as lending money or
innovating. When the nature of the risk is known, the degree can be measured by the variance (or
standard deviation) of the probability distribution describing the possible outcomes.

Demand
The entire relationship between the quantity of a commodity that buyers would like to purchase per
period of time and the price of that commodity, other things being equal.
Demand curve
A graphical relation showing the quantity of some commodity that households would like to buy at
each possible price.
Demand for money

The amount of wealth that agents in the economy wish to hold in the form of money balances.
Demand for money function

The relation between the quantity of money demanded and its principle determinants such as
income, wealth, and interest rates. [run on] [run on]In the IS-LM model the term is also used to
describe just the relation between the quantity of money demanded and the interest rate.
Demand management
Policies that seek to shift the aggregate demand (AD) curve by shifting either the IS curve (fiscal
policy) or the LM curve (monetary policy).
Demand schedule
A numerical tabulation showing the quantities that are demanded at selected prices.
Demand shock
See aggregate demand shock: A shift in the aggregate demand curve. This may result from an
autonomous change in either exogenous expenditures or the demand for money or a policy induced
change in interest rates.
Demand-deficient unemployment
Unemployment that occurs because aggregate desired expenditure is insufficient to purchase all of
the output when firms at operating at normal capacity Also called cyclical unemployment.
Dependent variable
The variable that is determined by the independent variables; e.g., in the simple consumption
function, consumption is the dependent variable and disposable income is the independent variable.
Depreciation (1)
The loss in value of an asset over a period of time owing to physical wear and tear and obsolescence.
(2) A fall in the free-market value of domestic currency in terms of foreign currencies. See also
capital consumption allowance.
Depression
A prolonged period of a large positive GDP gap with high unemployment.
Derived demand
The demand for an input (factor of production) that results from the demand for the products that it
helps to make.

Developed countries
Usually refers to the rich industrial countries of North America, Western Europe, Japan, and
Australasia.
Developing countries
See less-developed countries: The lower-income countries of the world, most of which are in Asia,
Africa, and South and Central America. Also called underdeveloped countries and developing
countries.
development gap
The per capita income gap between less-developed countries and developed countries.
Differentiated product
A product that is produced in several distinct varieties, or brands, all of which are sufficiently similar
to distinguish them, as a group, from other products (e.g. cars and cell phones).
Diminishing marginal rate of substitution

The hypothesis that the less of one commodity is presently being consumed, the less willing the
consumer will be to give up a unit of that commodity to obtain an additional unit of a second
commodity; its geometrical expression is the decreasing absolute slope of an indifference curve as
one moves along it to the right. See foreign direct investment.
Direct taxes
Taxes levied on persons that can vary with the person’s situation such as income or marital status.
Discount rate
The difference between the current price of a bill and its maturity value expressed as an annualized
interest rate.
Discouraged worker
Someone of working age who has ceased looking for employment and hence has withdrawn from
the labour force because of the poor prospects of employment.
Diseconomies of scale
See decreasing returns to scale: A situation in which output increases less than proportionately to
inputs as the scale of production increases in the long run.
Disembodied technical change

Technical change that is the result of changes in the organization of production that are not
embodied in specific capital goods, e.g. improved management techniques.
Disequilibrium
A state of imbalance between opposing forces so that there is a tendency to change, as when
quantity demanded does not equal quantity supplied at the prevailing price.
Disposable income
The after-tax income that households have at their disposal to spend or to save. It is usually indicted
by the symbol Yd.

Distortions
Anything that creates a deviation from some optimality condition, and thereby induces some
inefficiency.
Distribution of income
The division of total GDP among various groups. See also functional and size distribution of income.
Distribution theory
The theory of what determines how the nation’s total GDP is divided among various groups. See also
functional and size distribution of income.
Dividends
Profits that are paid out to shareholders.
Division of labour
The breaking-up of a production process into a series of repetitive tasks, each done by a different
worker.
Dominant strategy
A strategy that offers the best choices for one player independent of what the other players do.
Double counting
In national income accounting, adding up the total outputs of all the sectors in the economy so that
the value of intermediate goods is counted both in the sector that produces them and in the sector
that purchases them.
Dumping
The selling of a commodity in a foreign country at a price below its domestic sale price, for reasons
not related to costs.
Duopoly
An industry containing exactly two firms.
Economic growth
The positive trend in the nation’s total real GDP over the long term.
Economic models
A term used in several related ways: sometimes as a synonym for theory, sometimes for a specific
quantification of a general theory, sometimes for the application of a general theory to a specific
context, and sometimes for an abstraction designed to illustrate some point but not meant as a full
theory on its own.
Economic profits
The difference between the revenues received from the sale of an output and the full opportunity
cost of the inputs used to make the output. The cost includes the opportunity cost of the owners’
capital. Also called pure profits or simply profits.
Economic rent
Any excess that a factor is paid above what is needed to keep it in its present use.

Economic union
A group of countries that have a customs union and a common market and common policies on
product regulation, plus freedom of movement of goods, services, capital and labour.
Economies of scale
See increasing returns to scale: A situation in which long-run average total cost falls as output
increases, enabling large firms to produce at lower unit cost than small firms. Arises when output
rises more than in proportion to the change in all inputs.
Economies of scope
Economies achieved by a multi-product firm owing to its overall size rather than its amount of
production of any one product; typically associated with large-scale distribution, advertising, and
purchasing and lower cost of borrowing money. With modern multipurpose machinery, scope
economies can also be achieved when such machines are used to produce a range of commodities
the demand for no one of which could keep the machine occupied full time.
Economy
Any specified collection of interrelated marketed and non-marketed productive activities.
Effective exchange rate

An index number of the value of a nation’s currency relative to a weighted basket of other
currencies. Whereas an exchange rate measures the rate of exchange of one currency for another
specific currency, changes in the effective exchange rate indicate movements in a single currency’s
value against other currencies in general.
Efficiency wage
A wage rate above the market-clearing level that enables employers to attract and keep the best
workers as well as to provide their employees with an incentive to perform well so as to avoid being
sacked.
Elastic
A percentage change in quantity that is greater than the percentage change in price (elasticity is
greater than 1 in absolute value).
Elasticity of demand
See price elasticity of demand: The percentage change in quantity demanded divided by the
percentage change in price that brought it about. Usually just called elasticity of demand.
Elasticity of supply
See price elasticity of supply: The percentage change in quantity supplied divided by the percentage
change in price that brought it about. Usually just called elasticity of supply.
Embodied technical change

A technical change that is the result of new or improved tangible things such as machines and
equipment
Endogenous variable
A variable that is explained within a theory. Also called an induced variable.

Entrepreneur
One who innovates, i.e. takes risks by introducing new products and/or new ways of making old
products.
Entrepreneurship
The skill required to be an entrepreneur.
Entry barrier
Barriers to the entry of new firms into an industry. These can be natural, such as occurs with
economies of large scale production, or created, such as when firms engage in excessive advertising
to make it difficult for a new firm to enter the industry.
Envelope curve
Any curve that encloses, by being tangent to, a series of other curves. In particular, the envelope
cost curve is the LRAC curve, which encloses the SRAC curves by being tangent to each without
cutting any of them.
Equation of exchange
MV = PT, where M is the money stock, V is the velocity of circulation, P is the average price of
transactions, and T is the number of transactions. As usually defined, it is an identity that says that
the value of money spent is equal to the value of goods and services sold. However, with additional
assumptions it provides a basis for the quantity theory of money.
Equilibrium
A state of balance between opposing forces so that there is no tendency to change.
Equilibrium differentials
Differentials in the prices of factors that persist in equilibrium without generating forces to eliminate
them.
Equilibrium employment
The level of employment achieved when GDP is at its potential level. Traditionally referred to as full
employment.
Equilibrium price
The price at which quantity demanded equals quantity supplied.
Equilibrium quantity
The amount that is bought and sold at the equilibrium price.
Equilibrium unemployment
The level of unemployment achieved when GDP is at its potential level. It is composed of frictional
and structural unemployment.
Equities
Certificates indicating part ownership of a joint-stock company.

Equivalent variation
The change in income that leaves a consumer just as well off as some specific change in the price of
a good.
Excess demand
The amount by which quantity demanded exceeds quantity supplied at some price; negative excess
supply.
Excess supply
The amount by which quantity supplied exceeds quantity demanded at some price; negative excess
demand.
Excess-capacity theorem
The prediction that each firm in a monopolistically competitive industry will be producing below its
minimum efficient scale and hence at an average cost that is higher than it could achieve by
producing its capacity output.
Exchange rate
The price at which two national currencies exchange for each other. Often expressed as the amount
of domestic currency needed to buy one unit of foreign currency.
Excludable good
Goods whose owners can prevent others from consuming it or its services.
Execution lag
The time it takes, once as policy has been decided on, to initiate it and for its full effects to be felt.
Exhaustible resource
See non-renewable resource ; Any productive resource that exists as a fixed stock that cannot be
replaced once it is used, such as natural petroleum.
Exhaustive expenditures
Government purchases of currently produced goods and services. Also called government direct
expenditures.
Exogenous variable
A variable that influences other variables within a theory but is itself determined by factors outside
the theory. Also called an autonomous variable.
Expectations-augmented
Phillips curve A curve created by adding a variable for the expected inflation rate as a second cause
to the curve that shows wage changes related to the level of unemployment. The higher the
expected rate of inflation, the higher will wage changes be for any given level of unemployment. It
follows that there is a separate short-run Phillips curve for each expected inflation rate, the higher
the expected rate, the higher the Phillips curve relating wage inflation to unemployment. See also
the short-run Phillips curve and the long-run Phillips curve.

Expected value
The most likely outcome of some procedure that is repeated over and over again; the mean of the
probability distribution expressing the possible outcomes.
Explicit collusion
This occurs when firms explicitly agree to cooperate rather than compete. See also tacit collusion.
Extensive form game

Game in which players make moves in some order over time.
External economies
Economies of scale that arise from sources outside the firm.
Externalities
Costs or benefits of a transaction that fall on agents not involved in that transaction.
Extrapolative expectations
Expectation formation based on the assumption that a past trend will continue into the future. The
simplest form of extrapolation would be to assume that the next period’s value of a variable will be
the same as this period’s.
Factor markets
Markets where factor services are bought and sold. Markets for inputs into the productive process.
Factor price theory

The theory of the determination of the prices of factors of production (inputs).
Factors of production
Resources used to produce goods and services; frequently divided into the basic categories of land,
labour, and capital. Sometimes entrepreneurship is distinguished as a fourth factor; sometimes it is
included in the category of labour.
Fair game
Any game, or other activity, for which the expected value of the outcome is zero, neither gain nor
loss. For example, betting a given sum of money on a head in a series tosses of a fair coin.
Fiat money
Inconvertible paper money that is issued by government order (or fiat).
Final demand
Demand for the final goods and services produced in the economy.
Final goods and services

The outputs of the economy after eliminating all double counting, i.e. excluding all intermediate
goods.
Financial capital
The funds used to finance a firm, including both equity capital and debt. Also called money capital,
as opposed to plant and machinery that is physical capital.

Financial innovation
Occurs when new products are introduced into the financial system, or when existing suppliers
behave in new ways. Changes are often a complex interaction of regulatory changes, changing
technology, and competitive pressures.
Financial intermediaries
Financial institutions that borrow from one lot of agents (often taking deposits of money) and make
loans to others.
Fine-tuning
The attempt to maintain GDP at, or near, its full employment level by means of frequent changes in
fiscal and/ or monetary policy. Compare gross-tuning.
Firm
A business unit that employs factors of production (inputs) to produce goods or services that it sells
to other firms, to households, or to the government.
Fiscal consolidation
A situation in which governments that have been running substantial budget deficits decide to aim
for a sustainable budgetary position, usually by getting their spending under control or raising taxes.
Fiscal policy
Policies designed to influence aggregate demand by altering government spending and/or taxes,
thereby shifting the IS curve, and the AD curves.
Fixed capital formation

See fixed investment: Investment in plant and equipment.
Fixed cost
A cost that does not change with output. Also called overhead cost, unavoidable cost, or indirect
cost.
Fixed exchange rate

An exchange rate that is held within a narrow band around some pre-announced par value by
intervention of the country’s central bank in the foreign-exchange market.
Fixed factors
Inputs whose available amount is fixed in the short run.
Fixed investment
Investment in plant and equipment.
Fixed prices
See administered prices: A price that is set by the decisions of the sellers of products rather than by
impersonal market forces.
Flexible prices
See auction prices: Prices that are set by the bidding of buyers, often against each other.

Floating exchange rate

An exchange rate that is left free to be determined on the foreign-exchange market by the forces of
demand and supply. flow variable A variable expressing a rate per period of time and whose value
will thus change when it is measured over different time periods. For example, a typical consumer’s
whose rate of spending was £10 per day is also spending at the rate of £70 per week or £7,300 per
year See stock variable.
Foreign direct investment (FDI)

Non-resident investment in the form of a takeover or capital investment in a domestic branch, plant,
or subsidiary corporation in which the investor has voting control. See also portfolio investment.
Foreign exchange
Foreign currencies and claims to them in such forms as bank deposits, cheques, and promissory
notes payable in that currency.
Foreign-exchange market
The market where foreign exchange is traded—at a price that is expressed by the exchange rate.
Free trade
An absence of any form of government interference with the free flow of international trade.
Free-market economy
An economy in which the decisions of individuals and firms (as distinct from the central authorities)
exert the major influence over the allocation of resources.
Free-rider problem
The problem that arises because people have a self-interest in not revealing the strength of their
own preferences for a public good in the hope that others will pay for it.
Free-trade area (FTA)

An agreement between two or more countries to abolish trade restrictions such as tariffs and import
quotas on all, or most, of the trade among themselves, while each remains free to set its own trade
restrictions against other countries.
Frictional unemployment
Unemployment that is associated with the normal turnover of labour in a dynamic economy.
Function
Loosely, an expression of a relationship between two or more variables. Precisely, Y is a function of
the variables X1, . . . , Xn if, for every set of values of the variables X1, . . . , Xn, there is associated a
unique value of the variable Y. Also referred to as a functional relation.
Functional distribution of income

The distribution of income among major classes of factors of production such as between owners of
land, owners of capital and owners of labour.

Functional relation
see function: Loosely, an expression of a relationship between two or more variables. Precisely, Y is a
function of the variables X1, . . . , Xn if, for every set of values of the variables X1, . . . , Xn, there is
associated a unique value of the variable Y. Also referred to as a functional relation.
Gains from trade

Advantages realized as a result of specialization made possible by trade.
Game theory
The study of the strategic choices between agents, applicable when the outcome for one agent
depends on the behaviour of the others.
GDP
See gross domestic product: The value of total output actually produced in the whole economy over
some period, usually a year (although quarterly data are also available). Money GDP is in current
money terms while real GDP is a volume measure that removes the effects of inflation relative to
some base period or reference year. GDP is often referred to as national income and is usually given
the symbol Y.
GDP gap
See output gap: The difference between actual output and potential output (Y − Y*); negative output
gaps are sometimes called recessionary gaps; positive output gaps are sometimes called inflationary
gaps. Also called the GDP gap.
General price level

Average level of the prices of all goods and services produced in the economy. Usually just called the
price level.
Giffen good
A good with a positively sloped demand curve.
Gilt-edged securities
UK government bonds; so called because they are considered to carry lower risk than private sector
debt.
Given period
Any particular period that is being compared with a base period by an index number.
Globalization
The increased world-wide interdependence of most economies. Integrated financial markets, the
sourcing of the production of components throughout the world, the growing importance of
transnational firms, and the linking of many service activities through the new information and
communications technologies are some of its many manifestations.
GNI
See gross national income: A measure of what a nation earns from all its economic activity
throughout the world. It differs from gross domestic product, which measures only what is produced
in the domestic economy (some of which may generate income for non-residents). Used to be
known as gross national product.

GNP
See gross national product: A National Accounts concept equivalent to gross national income used
prior to 1998. It measures income earned by domestic residents in return for contributions to
current production, whether production is located at home or abroad, and is equal to GDP plus net
property income from abroad.
Gold standard
Currency standard whereby a country’s money is convertible into gold, usually at a fixed price.
Goodhart’s law
The view that many statistical relations (particularly those established by monetarists) cannot be
used for policy purposes because they do not depend on causal relations and are, therefore,
unstable.
Goods
Tangible production, such as cars or shoes. Sometimes all goods and services are loosely referred to
as goods.
Goods markets
Markets where goods and services are bought and sold.
Government
In economics, all public agencies, government bodies, and other organizations belonging to, or
under the control of, the government; sometimes called the central authorities.
Government direct expenditures

See exhaustive expenditures: Government purchases of currently produced goods and services. Also
called government direct expenditures.
Government failure
Where government intervention imposes costs that would not have been accrued if it had acted
differently.
Gresham’s law
That bad money (i.e. money whose intrinsic value is less than its face value) drives good money (i.e.
money whose intrinsic value exceeds its face value) out of circulation.
Gross capital formation

See gross investment: The total value of all investment goods produced in the economy during a
stated period of time.
Gross domestic product (GDP)

The value of total output actually produced in the whole economy over some period, usually a year
(although quarterly data are also available). Money GDP is in current money terms while real GDP is
a volume measure that removes the effects of inflation relative to some base period or reference
year. GDP is often referred to as national income and is usually given the symbol Y.

Gross investment
The total value of all investment goods produced in the economy during a stated period of time.
Gross national income (GNI)

A measure of what a nation earns from all its economic activity throughout the world. It differs from
gross domestic product, which measures only what is produced in the domestic economy (some of
which may generate income for non-residents). Used to be known as gross national product.
Gross national product (GNP)

A National Accounts concept equivalent to gross national income used prior to 1998. It measures
income earned by domestic residents in return for contributions to current production, whether
production is located at home or abroad, and is equal to GDP plus net property income from abroad.
Gross return on capital

The market value of output minus all non-capital costs: made up of depreciation, the pure return on
capital, any risk premium, and the residual, which is pure profit.
Gross-tuning
Use of monetary and fiscal policies to attempt to correct only large deviations from potential GDP. It
is contrasted with fine-tuning, which aims to adjust aggregate demand frequently in order to keep
GDP close to its potential level at all times.
High-powered money
The monetary magnitude that is under the direct control of the central bank. In the UK, it is
composed of cash in the hands of the public, commercial bank reserves of currency, and deposit
balances held by the commercial banks with the Bank of England. Formerly called M0.
Homogeneous product
A product for which, as far as purchasers are concerned, every unit is identical to every other unit.
horizontal equity Treating similar groups equitably, which usually means treating them similarly.
Compare vertical equity.
Household
All people living under one roof and taking, or subject to others taking for them, joint financial
decisions.
Human capital
The capitalized value of productive investments in persons. Usually refers to value derived from
expenditures on education, training, and health improvements.
Hyperinflation
Episodes of very rapid inflation.
Hysteresis
Literally the lagging of effects behind their causes. In economics the term has come to relate to
persistence or irreversibility of behaviour when an economy is moving from one equilibrium to
another Its existence implies path-dependency, so that the ultimate equilibrium is not independent
of how the economy gets there (i.e. the equilibrium is not unique). For example, if the duration of a
period of unemployment affects the amount of the loss of the unemployed’s human capital, the

magnitude of equilibrium employment will be affected by the duration of any period of positive GDP
gap.
Identification problem
The problem, for example, of how to estimate both demand and supply curves from observed
market data on prices and quantities actually traded.
Import quota
A maximum amount set by the government of some product that may be imported each time
period.
Imputed costs
The costs of using factors of production (inputs) already owned by the firm, measured by the
earnings they could have received in their best alternative employment.
Incentives
Motivational influences that drive the behaviour of economic agents. Workers are motivated by the
wage rate and working conditions, firms by the profits that can earn by producing and selling goods
and services, consumers by the prices that they face for the goods and services they wish to
purchase.
Incidence
In tax theory, where the burden of a tax finally falls.
Income effect
The effect on quantity demanded of a change in real income, relative prices held constant.
Income elasticity of demand

The responsiveness of quantity demanded to a change in income as measured by the percentage
change in quantity demanded divided by the percentage change in income that brought it about.
Income–consumption line
On an indifference-curve diagram, a line showing how consumption bundles change as income
changes, with prices held constant.
Income-elastic
The percentage change in quantity demanded exceeds the percentage change in income that
brought it about.
Income-inelastic
The percentage change in quantity demanded is smaller than the percentage change in income that
brought it about.
Increasing returns industry

One in which all firms operate under increasing returns to scale.

Increasing returns to scale

A situation in which long-run average total cost falls as output increases, enabling large firms to
produce at lower unit cost than small firms. Arises when output rises more than in proportion to the
change in all inputs.
Incremental ratio
When Y is a function of X, the incremental ratio is the change in Y divided by the change in X that
brought it about, ΔY/ΔX. The limit of this ratio as ΔX approaches 0 is the derivative of Y with respect
to X, dY/dX.
Independent variable
A variable that can take on any value in some specified range; it influences the value of the
dependent variable(s), but is not itself affected by changes in the dependent variable(s) so causation
runs from the independent to the dependent variable(s).
Index number
An observation in a given time period expressed as a ratio to the observation in a base period and
then multiplied by 100.
Index of retail prices

See retail price index: An index of the general price level based on the consumption pattern of
typical consumers.
Indexation
Generally, the term applies to any contingent contract tied to an index number. When the contract’s
value changes with changes in an index of the price level, the contract is then specified in real terms.
Indicators
Variables that policymakers monitor for the information they yield about the state of the economy.
Indifference curve
A curve showing all combinations of two specific products that yield equal satisfaction to the
consumer and hence among which the consumer is indifferent.
Indifference map
A set of indifference curves in which curves further away from the origin indicate higher levels of
satisfaction than curves closer to the origin. The map represents a continuous surface analogous to
the contour map of a mountain in geography.
Indirect tax
A tax levied on a transaction that is paid by an agent by virtue of the agent’s association with some
activity and that does not vary with the circumstances of the agent who pays it, e.g. the VAT.
Induced
Anything that is determined from within a theory. The opposite of autonomous or exogenous; also
called endogenous.
Induced spending (expenditure)

Any spending flow that is related to GDP or to any other endogenous variable.

Induced variable
See endogenous variable: A variable that is explained within a theory. Also called an induced
variable.
Industrial union
A single union representing all workers in a given industry, whatever their trade.
Industry
A group of firms that sell a well-defined product or closely related set of products.
Inefficient exclusion
Situation in which sellers with excess capacity set positive prices, which exclude potential users who
put a value on the product or activity that is positive but less than the price.
Inelastic
The percentage change in quantity is less than the percentage change in price that brought it about
(elasticity is less than 1 in absolute value).
Infant-industry argument
The argument that new domestic industries with potential economies of scale need to be protected
from competition from established low-cost foreign producers so that they can grow large enough
to achieve costs as low as those of foreign producers.
Inferior good
A commodity with a negative income elasticity; demand for it diminishes when income increases.
Inflation
A positive rate of increase of the general price level.
Inflationary gap
A positive GDP gap, i.e. when actual GDP exceeds potential GDP.
Information lag
The time between an event happening and policymakers learning about it. For example, National
Accounts data for any quarter do not arrive until six weeks or so after that quarter ends and are
revised several times subsequently.
Infrastructure
The basic facilities (especially transportation and communications systems) on which the commerce
of an economy depends. Often used to refer to all publicly created physical capital.
Injections
Exogenous spending flows into the circular flow of income between domestic households and firms.
In the simple macro model the injections are government spending, exports, and investment (the
latter when the interest rate is exogenous but not when it becomes endogenous as in the |IS-LM
model).

Innovation
The commercialisation of something new, a new product, a new way of making an old product or of
organising the production process. See also entrepreneur and invention.
Innovators
Those who introduce innovations. Also called entrepreneurs.
Inputs
The materials and factor services used in the process of production, such as land, labour, capital and
raw materials.
Insider-outsider model
An analysis that gives more influence over labour market outcomes to those already in employment
(usually via trade-union representation) than to the unemployed.
Instruments
In macro theory the variables that policymakers can control directly. (In econometrics, instruments
are proxy variables used in regression equations because of their desirable statistical properties—
usually independence from the equation error.)
Interest
The amount paid each year on a loan, usually expressed as a percentage (e.g. 5 per cent per annum)
or as a ratio (e.g. 0.05) of the principal of the loan.
Interest-constant multiplier
The multiplier when the interest rate, and hence investment, are exogenous variables. Also called
the simple multiplier. See also multiplier.
Interest variable multiplier

See IS-LM multiplier: The multiplier when the interest rate and thus investment is an endogenous
variable (but the price level is exogenous). Also called the interest-variable multiplier.
Intermediate goods and services

All goods and services used as inputs into a further stage of production.
Internal economies
Economies of scale that arise from sources within the firm.
Internal labour market

The market inside the firm in which employees compete against each other, particularly for
promotion.
Internalizing an externality
Doing something that makes an externality enter into the firm’s own calculations of its private costs
and benefits such as putting a price on carbon emissions.

Invention
The discovery and/or development of something new. In economics this is a new product, process or
form of organisation. Distinguished from innovation, which is the commercialisation of new
inventions.
Inventories
Goods and materials that are held during the production or distribution process. See also stocks.
Investment
The act of producing or purchasing goods that are not for immediate consumption. These are
durable goods that will form part of the physical capital stock, housing and additions to inventories
of goods.
Investment demand function

A negative relationship between the quantity of investment per period and the interest rate, holding
other things constant. Sometimes called the marginal efficiency of investment.
Investment goods
Goods produced not for present consumption, i.e. capital goods, inventories, and residential
housing.
Investment spending
Spending on investment goods.
Invisibles
Services, especially in the context of the balance of payments accounts, that we cannot see
physically, such as insurance, freight haulage, and tourist expenditures.
Involuntary unemployment
Unemployment that occurs when a person is willing to accept a job at the going wage rate but
cannot find such a job.
IS curve
The locus of combinations of the interest rate and the level of real GDP for which desired aggregate
expenditure equals actual national output, GDP. So-called because, in a closed economy with no
government, it also reflects the combinations of the interest rate and GDP for which investment
equals saving, I = S. In general, it reflects combinations for which injections equal withdrawals.
IS-LM model
A diagrammatic representation of a model of aggregate demand determination based upon the
locus of equilibrium points in the aggregate expenditure sector (IS) and the monetary sector (LM). It
is incomplete as a model of GDP determination because in it the price level is exogenous.
IS-LM multiplier
The multiplier when the interest rate and thus investment is an endogenous variable (but the price
level is exogenous). Also called the interest-variable multiplier.
Isocost line
A line showing all combinations of inputs that have the same total cost to the firm.

Isoquant
A curve showing all efficient factor combinations for producing a given level of output.
Isoquant map
A series of isoquants from the same production function, each isoquant relating to a specific level of
output.
J-curve
Pattern usually followed by the balance of trade after a devaluation of the domestic currency.
Initially the trade balance deteriorates, and then after a lag it improves.
Joint-stock company
A firm regarded in law as having an identity of its own. Its owners, who are its shareholders, are not
personally responsible for anything that is done in the name of the firm. Called a corporation in
North America.
Keynesian economics
Economic theories based on AE, IS, LM, AD, and AS curves and assuming enough short-run price
inflexibility that AD and AS shocks cause substantial deviations of real GDP from its potential level.
Keynesian revolution
Adoption of the idea that government could use monetary and fiscal policy to control aggregate
demand and thereby influence the level of GDP and unemployment. For a while it was believed that
Keynesian economics had found ways in which policymakers could smooth business cycles and
eliminate unemployment.
Kondratieff cycles
Long cycles in economic activity of around fifty years’ duration. Sometimes referred to as long
waves.
Labour
All productive human resources, mental and physical, both inherited and acquired.
Labour force
See working population.
Labour force participation rate

The percentage of the population of working age that is actually in the labour force (i.e. either
working or seeking work).
Labour productivity
Total output divided by the labour used in producing it, i.e. output per unit of labour.
Laffer curve
A curve relating total tax revenue to the tax rate, showing zero tax revenue when the tax rate is
either zero or 100 percent and a single maximum tax yield somewhere between these extreme
points.

Land
All free gifts of nature, such as land, forests, minerals, etc. Sometimes called natural resources.
Law of demand
A prediction consistent with much evidence that (with rare exceptions) a reduction in a product’s
price will increase the quantity demanded and vice versa; that is, demand curves have a negative
slope.
Law of diminishing returns

Law stating that, if increasing quantities of a variable input are applied to a given quantity of a fixed
input, the marginal product, and the average product, of the variable input will eventually decrease.
Law of price adjustment

Law stating that, if there is an excess demand in a competitive market, price will rise, and if there is
an excess supply, price will fall.
Leakages
See withdrawals: Spending that leaves the domestic economy and does not create further incomes
for domestic residents. Import spending, for example, creates incomes overseas. Also called
leakages. The main withdrawals from the circular flow between households and firms are savings,
taxes, and imports.
Learning by doing
The increase in output per worker that often results as workers learn on the job through repeatedly
performing the same tasks. In the case of a newly introduced product, it causes a downward shift
over time in that product’s average variable cost curve.
Legal tender
Currency that is recognized in law as the acceptable medium for any transaction such as a
repayment of a debt or the purchase of a good. Bank of England notes became legal tender in
England and Wales in 1833. Euro notes became legal tender for members of the Eurozone in 2002.
Less-developed countries (LDCs)

The lower-income countries of the world, most of which are in Asia, Africa, and South and Central
America. Also called underdeveloped countries and developing countries.
Life-cycle theory
A theory that relates a household’s current consumption spending to its expected lifetime income or
wealth.
Limited partnership
A form of business organization in which the firm has two classes of owner: general partners, who
take part in managing the firm and who are personally liable for all of the firm’s actions and debts;
and limited partners, who take no part in the management of the firm and who risk only the money
that they have invested.
Liquidity
The ease with which an asset can be converted into money. liquidity preference The demand to hold
wealth as money rather than as interest-earning assets. Also called the demand for money.

Liquidity trap
A situation that may arise when interest rates are so low that further reductions either are not
possible or do not stimulate spending. In such situations the monetary authorities cannot stimulate
aggregate demand by interest-rate changes alone. In a liquidity trap, money and bonds become
perfect substitutes.
LM curve
The locus of combinations of the interest rate and real GDP for which money demand equals money
supply and hence, in a two-asset model, where the demand for bonds equals their supply. So-called
because when it was developed, liquidity preference then referred to the demand for money and M
(as it does now) to the money supply.
Logarithmic scale
A scale on which equal proportional changes are shown as equal absolute distances (e.g. 1 cm may
always represent doubling of a variable, whether from 3 to 6 or 50 to 100). Also called log scale or
ratio scale.
Long run
A period of time in which all inputs may be varied but the basic technology of production is
unchanged.
Long wave
See Kondratieff cycles.
Long-run aggregate supply (LRAS) curve

A curve that relates the price level to equilibrium real GDP after all input costs, including wage rates,
have been fully adjusted to eliminate any excess demand or supply.
Long-run average cost (LRAC) curve

Curve showing the least-cost method of producing each level of output when all inputs can be
varied. Also sometimes called the long-run average total cost curve.
Long-run industry supply (LRS) curve

Curve showing the relation between equilibrium price and the output that the firms in an industry
will be willing to supply after all desired entry or exit has occurred.
Long-run Phillips curve (LRPC)

Curve showing the relation between unemployment and the rate of change of money wage rates
when all markets are in equilibrium and the actual and expected rates of inflation are equal (no one
is surprised by the existing inflation rate). In many macro theories this curve is vertical at the natural
rate of unemployment or NAIRU. The curve is often shown as plotting the inflation rate against GDP
on the assumption of stable relations between (i) unemployment and the GDP and (ii) wage and
price level changes. See also the expectations-augmented Phillips curve and the short run Phillips
curve
Lorenz curve
A curve showing the extent of departure from equality in the distribution of income. It graphs the
proportion of total income earned by all people up to each stated point in the income distribution,

such as the proportion earned by the bottom quarter, the bottom half, and the bottom three-
quarters.
Lucas aggregate supply curve

An aggregate supply curve that is positively sloped for unexpected increases in the price level but
vertical for anticipated increases in the price level. Also known as the ‘surprises only’ aggregate
supply curve.
Lucas critique
The proposition that empirical macro models will be inaccurate when used to predict the effects of
changes in policy because the behaviour of agents will be different under different policy regimes.
M0
Currency held by the non-bank public plus commercial banks’ deposits with the central bank. Also
known as the monetary base, the cash base, or high-powered money. No longer widely used as an
indicator in the UK.
M1
A measure of the money stock that includes currency plus current account bank deposits. This
measure is no longer reported by the Bank of England.
M2
Currency held by the public plus retail current and savings accounts in banks and building societies.
Also known as ‘retail M4’, but no longer reported as M2.
M3
Measure of broad money no longer used as an indicator in the UK. It was equal to M1 plus all savings
deposits in banks. A harmonized measure of M3, M3H, is in use in the euro area as a monetary
indicator; however, this has a different definition, as it is equal to M4 plus foreign currency and
some other deposits.
M4
Currency in circulation plus all sterling deposits in banks and building societies. This is the standard
measure of the money stock in current use in the UK.
Macroeconomic equilibrium
Aggregate demand equals aggregate supply, which implies that desired expenditure equals the
actual output which is willingly supplied by producers and that the demand for money and bonds
also equal their supplies.
Macroeconomic policy
Any measure directed at influencing such macroeconomic variables as the overall levels of
employment, unemployment, GDP, and the price level.
Macroeconomics
The study of the determination of economic aggregates and averages, such as total output, total
employment, the general price level, and the rate of economic growth.

Marginal cost (MC)

The increase in total cost resulting from raising the rate of production by one unit. Technically this is
incremental cost, ΔC/ΔP (where where P indicates production), while marginal cost is the derivative
of cost with respect to production dC/dP
Marginal cost pricing

A policy of setting the price of a product equal to its marginal cost.
Marginal efficiency of capital

The rate at which the value of the stream of output of a marginal unit of capital must be discounted
to make it equal to ￡1. In effect, it is the interest rate at which one more unit of capital would be
just worth buying.
Marginal efficiency of capital schedule

A schedule that relates the marginal efficiency of each additional ￡1 worth of capital to the size of
the capital stock. It represents the demand curve for capital and is negatively sloped with respect to
the interest rate.
Marginal efficiency of investment

The relation between desired investment and the rate of interest, assuming all other things are
equal.
Marginal physical product (MPP)

See marginal product: The change in total product resulting from using one more (or less) unit of the
variable factor. Also called marginal physical product. Technically this is incremental product, ΔP/ΔF,
where P denotes product and F the variable factor, while marginal product is the partial derivative of
total product with respect to the variable input ∂P/∂F.
Marginal product (MP)

The change in total product resulting from using one more (or less) unit of the variable factor. Also
called marginal physical product. Technically this is incremental product, ΔP/ΔF, where P denotes
product and F the variable factor, while marginal product is the partial derivative of total product
with respect to the variable input ∂P/∂F.
Marginal productivity theory

The demand half of the neoclassical theory of income distribution, in which the demand for any
variable input is determined by the value of that input’s marginal revenue product.
Marginal propensity not to spend

The proportion of any new increment of disposable income that is not passed on in spending, and
instead leaks out of (i.e. is withdrawn from) the circular flow of income. Also called the marginal
propensity to withdraw and the marginal propensity to leak. Technically this can be expressed as an
incremental ratio ΔW/ΔYd, or as the derivative of not spending (withdrawing) with respect to
disposable income, dW/dYd. This can also be expressed in either form as a relation between
withdrawals and total GDP rather than disposable income.

Marginal propensity to consume (MPC)

The proportion of any new increment of disposable income that is spent on consumption, ΔC/ΔYd.
Technically this is incremental ratio while marginal propensity is the derivative of consumption with
respect to disposable income dC/Yd.
Marginal propensity to import

The proportion of any new increment of GDP that is spent on imports, ΔIM/ΔY. Technically this is the
incremental propensity while the marginal propensity is the derivative of imports with respect to
GDP, dC/Y.
Marginal propensity to leak

See marginal propensity not to spend.
Marginal propensity to save (MPS)

The proportion of any new increment of disposable income that is saved, ΔS/ΔYd. Technically this is
the incremental ratio, while the marginal propensity is the derivative of savings with respect to
disposable income dS/dYd.
Marginal propensity to spend

The ratio of any increment of aggregate induced expenditure (E) to the increment in total GDP (Y)
that brought it about. Technically this can be expressed as an incremental ratio ΔE/ΔY, or as the
derivative of expenditure with respect to GDP, dC/Y.
Marginal propensity to tax

The proportion of any increment in GDP that is taxed away by the government, ΔT/ΔY. Technically
this can be expressed as an incremental ratio ΔT/ΔY, or as the derivative of tax revenue with respect
to GDP, dT/Y.
Marginal propensity to withdraw

See marginal propensity not to spend.
Marginal rate of substitution (MRS)

The rate at which one input is substituted for another with output held constant. Graphically, the
slope of the isoquant.
Marginal rate of transformation

The slope of the production possibility boundary, indicating the rate of substitution of production of
one good for that of another.
Marginal revenue
The change in total revenue (R) resulting from a unit change in the sales (S) per period of time.
Technically this can be expressed as an incremental ratio ΔR/ΔS, or as the derivative of revenue with
respect to sales, dR/dS.
Marginal revenue product (MRP)

The addition to a firm’s revenue (R) resulting from the sale of the output produced by an additional
unit of the variable input (V). Technically this can be expressed as an incremental ratio ΔR/ΔV, or as
the derivative of revenue with respect to the variable input, dR/dV.

Marginal utility
The change in satisfaction resulting from consuming one unit more or one unit less of a good or
service. Technically this can be expressed as an incremental ratio ΔS/ΔG, where S is satisfaction and
G is a good being consumed or as the derivative of satisfaction with respect to the good consumed,
dS/dG.
Market
An area in either geographical or cyber space over which buyers and sellers negotiate the exchange
of a well-defined product.
Market economy
A society in which agents specialize in productive activities and meet most of their material wants
through exchanges voluntarily agreed upon by the contracting parties.
Market failure
Any market performance that is less than the most efficient possible (the optimal) performance.
Market for corporate control

Where potential buyers and sellers (both willing and unwilling) bargain about buying or selling the
ownership of firms.
Market prices
In National Accounts, refers to the fact that spending is measured in the prices actually paid by
consumers and so include taxes on products. See also basic prices.
Market sector
That portion of an economy in which producers must cover their costs by selling their output to
consumers in exchange for money. Non-market sectors include those where goods or services are
provided free of charge, such as parts of health and education and the activities of such non-
government organisations (NGOs) as Doctors Without Borders and Greenpeace.
Market structure
The characteristics of a market that influence the behaviour and performance of firms that sell in the
market. The four main market structures are perfect competition, monopolistic competition,
oligopoly, and monopoly.
Maturity
The length of time until the redemption date of a security such as a bond.
Medium of exchange
A commodity or token that is widely accepted in payment for goods and services.
Menu costs
Costs associated with changing prices, such as the costs of reprinting catalogues or menus. These
costs make it rational for producers to keep output prices fixed until input prices have changed
significantly, or to respond to such price changes only periodically.

Mercantilism
The doctrine that the gains from trade depend on the balance of trade, in contrast with the accepted
theory, in which the gains from trade are associated with the volume of trade.
Merchandise account
The part of the balance of payments accounts relating to trade in goods (but not services).
Merchandise trade
Trade in physical products. Same as visible trade.
Merger
The uniting of two or more formerly independent firms.
Merit goods
Goods that the government decides have sufficient merit that more should be produced and
consumed than people would choose to do if left to themselves.
Microeconomics
The study of the allocation of resources to the production of specific goods and services and the
distribution of income as they are affected by the working of the price system and by the policies of
the central authorities.
Minimum efficient scale (MES)

The smallest level of output at which long-run average cost is at a minimum; the smallest output
required to achieve all economies of scale in production.
Mismatch
See structural unemployment: Unemployment that exists because of a mismatch between the
characteristics of the unemployed and the characteristics of the available jobs in terms of region,
occupation, or industry.
Mixed economy
An economy in which a significant number of decisions about the allocation of resources are made
by firms and households and others by the government.
Monetarism
The doctrine that monetary aggregates (the money supply) exert powerful influences in the
economy and that control of these magnitudes is a potent means of affecting the economy’s
macroeconomic behaviour.
Monetary authorities
A general term that covers all those who are responsible for the setting and execution of monetary
policy, including the generation of high powered money and the setting of interest rates. In the UK,
these authorizers are the Band of England and the Monetary Policy Committee.
Monetary base
See high-powered money and M0: The monetary magnitude that is under the direct control of the
central bank. In the UK, it is composed of cash in the hands of the public, commercial bank reserves

of currency, and deposit balances held by the commercial banks with the Bank of England. Formerly
called M0.
Monetary equilibrium
A situation in which there is no excess demand for or supply of money. In two-asset model this also
implies equilibrium between the demand for and the supply of bonds.
Monetary policy
Policy of seeking to control aggregate demand, and ultimately the GDP and the inflation rate, by
setting short-term interest rates, and more recently, by quantitative easing which means buying
large amounts of government debt (and some other assets) in order to inject liquidity into the
system. Monetary Policy Committee In May 1997 the overall power to determine monetary policy
was given to the newly formed Monetary Policy Committee (MPC), chaired by the Governor of the
Bank and composed of five senior officials of the Bank and four outsiders appointed by the
government. The MPC sets monetary policy, while the Bank carries it out
Monetary transmission mechanism

The mechanism that turns a monetary shock induced by a change in either the private or the
government sector into a real spending shock (as shift of the IS, AD and AD* curves) and thus links
the monetary and the real sides of the economy.
Money
Any generally accepted medium of exchange, i.e. anything that will be accepted in exchange for
goods and services.
Money illusion
Refers to behaviour that responds to purely nominal changes in money prices and incomes in either
direction, even though real incomes or relative prices have not changed.
Money income
Income measured in terms of some monetary unit such as current pounds or dollars, but not taking
account of inflation. See also real income.
Money multiplier
The ratio of changes in the money stock to changes in the monetary base (i.e. in high-powered
money).
Money price
See absolute price: The price of a good or a service expressed in monetary units. Also called a money
price.
Money rate of interest

The rate of interest as measured in monetary units. See real rate of interest: The return on any
investment measured in real terms. It is approximated by the money rate of interest minus the
inflation rate (or expected inflation rate) and measured precisely by the equation (1+ nominal rate of
interest)/(rate of inflation) = (1 + real rate of interest). See also nominal interest rate.

Money stock
See supply of money: The total amount of money circulating in the economy. Also called the money
supply or the money stock.
Money supply
See supply of money: The total amount of money circulating in the economy. Also called the money
supply or the money stock.
Money-demand function
The function that determines the demand to hold money balances in relation to other variables such
as income, wealth and interest rates.
Monopolist
The sole seller of a product.
Monopolistic competition
A market structure in which there are many sellers and freedom of entry but in which each firm sells
a differentiated version of some generic product and, as a result, faces a negatively sloped demand
curve for its own product.
Monopoly
A market structure in which the industry contains only one firm.
Monopolist
The sole purchaser of a product.
Moral hazard
Any change in behaviour resulting from the fact that a contract has been agreed. Examples are
motorists who drive more recklessly because they have accident insurance and householders who
are careless about home security because they have theft insurance.
Multinational enterprises (MNEs)

See transnational corporations: Firms that have operations in more than one country. Also called
transnationals or multinational enterprises (MNEs).
Multiplier
The ratio of the change in GDP (or some other endogenous variable) to the change in autonomous
spending (or other exogenous variable) that brought it about. Several different multipliers are
distinguished: the simple or interest-constant multiplier; the interest-variable or IS-LM multiplier,
when the interest rate and hence investment becomes exogenous, and the AD-AS multiplier when
the price level becomes endogenous. encounter a rating-inflation rate of unemployment’ – the level
of unemployment compatible with a constant rate of inflation – one that neither accelerates nor
decelerates. In the long run, when the economy is in competitive equilibrium, the NAIRU is
equivalent to the natural rate of unemployment.
Nash equilibrium
An equilibrium that results when each player in a game (it might be a firm in an industry) is currently
doing the best that it can, given the current behaviour of all other players (who might be the other
firms in that industry).

Nash theorem
That every game with a finite number of players and a finite number of strategies has at least one
Nash equilibrium (so long as some random element to strategies is possible).
National asset formation

Positive net exports (X –IM) (which causes the net acquisition of foreign assets) plus domestic
investment, I.
National debt
The debt of the central government.
National income
A generic term for the value of the nation’s total output, and the value of the income generated by
the production of that output. Measured in practice by gross national product, GDP, which is equal
to the GNI in a closed economy.
National product
A generic term for the nation’s total output, typically measured by GDP. See gross national product.
Natural monopoly
An industry whose market demand is insufficient to allow two firms to cover their total costs at any
positive level of output.
Natural rate of unemployment

The level of unemployment in a competitive economy that exists when GDP is at its potential. For
most purposes it is equivalent to the NAIRU, but the latter may differ when the economy is adjusting
slowly back to full equilibrium following some large shock.
Natural scale
A scale on which equal absolute amounts are represented by equal distances. Compare logarithmic
scale.
Negatively related
Refers to the relationship where an increase in one variable is associated with a decrease in another.
Neoclassical theory
In general, a theory based on the maximizing choices of well-informed agents pursuing their own
self-interest in competitive markets. In distribution it is a theory that factor incomes are determined
by demand and supply, where demand depends on the value of the factor’s marginal product and
supply depends on the maximizing decisions of those who own the factors.
Net exports
Total exports minus total imports of goods and services (X − IM).
Net investment
Gross investment minus replacement investment, which is new capital that represents net additions
to the capital stock.

Net present value

The difference between the present value of revenues and the present value of costs.
Net taxes
Total tax receipts net of transfer payments.
Neutrality of money
This theory takes several forms: (1) a change in the money supply that instantaneously changes all
monetary values in the same proportion, such as when a monetary reform takes several zeros off all
forms of money and money contracts, will have no real effects; (2) there will be no perceptible
differences between the real behaviour of an economy that operates with a fully expected zero
inflation rate and a fully expected (and fully accommodated) small positive inflation rate, say 2
percent. (3) changes in the money stock as they occur in reality – taking a significant amount of time
to occur and to have their full effects felt – do not have real effects in long run (4) such changes do
not have real effects in the short run. Version (1) is accepted by virtually all economists; version (2) is
shown to be probably correct by the behaviour of those economies that have adapted the regime of
successful inflation targeting over the last 20 or so years, Version (3) is accepted by many
economists and is a property of many economic models, however, if there are transitional effects
that have long-lasting consequences (hysteresis effects), it may not hold. Version (4) is a property of
a few models but is not accepted by the majority of economists as being true in reality.
New Classical theory

A theory that assumes that the economy behaves as if it were perfectly competitive, with all markets
always clearing; where deviations from full employment can occur only if people make mistakes and
where, given rational expectations, these mistakes will not be systematic.
New Keynesian economics

Recent research agenda that has focused on explaining why prices do not adjust to clear markets,
especially the labour market. It differs from the traditional Keynesian approach in its concern for
equilibrium unemployment as well as demand-deficient unemployment.
Newly industrialized countries (NICs)

Formerly less-developed countries that have become major industrial producers and exporters in
recent times. Sometimes called newly industrialized economies (NIEs).
Nominal interest rate

Actual interest rate in money terms. It is contrasted with the real rate of interest
Nominal money supply

The money supply measured in monetary units.
Nominal national product

Total output valued at current prices and usually measured by ‘money GDP’.
Non-cooperative equilibrium
The equilibrium reached when firms calculate their own best policy without considering
competitors’ reactions and without explicit collusion.

Non-excludable
A good or service is non-excludable if its owners cannot dictate who will consume it.
Non-market sector
That portion of an economy in which producers must cover their costs from some source other than
sales revenue.
Non-renewable (or exhaustible) resource

Any productive resource that exists as a fixed stock that cannot be replaced once it is used, such as
natural petroleum.
Non-rivalrous
A good or a service is non-rivalrous if a given unit of it can be consumed by everyone. Thus, one
person’s consumption of it does not reduce the ability of another person to consume it—as with
knowledge, national defence, police protection, and navigational aids.
Non-strategic behaviour
Behaviour that does not take account of the reactions of others, as when a firm acts in perfect or
monopolistic competition.
Non-tariff barriers
Devices other than tariffs that are designed to reduce the flow of imports.
Non-tradables
Goods and services that are produced and sold domestically but do not enter into international
trade.
Normal form game

Players make choices based on expected payoffs simultaneously.
Normal good
A commodity whose demand increases when income increases. Compare inferior good.
Normative
Things that concern what ought to be and thus depend on value judgements. Compare positive.
Oligopoly
An industry that contains only a few firms that interact strategically. The outcome for each is
affected by what the others do.
OPEC
Organisation of Petroleum Exporting Countries a permanent, intergovernmental Organization to
regulate petroleum production, which was created in 1960, by Iran, Iraq, Kuwait, Saudi Arabia and
Venezuela, later joined by nine other Members: Qatar, Indonesia, Libya, United Arab Emirates,
Algeria, Nigeria, Ecuador, Angola, and Gabon, some of which have subsequently dropped out.
Open economy
An economy that engages in international trade.

Open shop
A place of employment in which a union represents its members but does not necessarily have
bargaining jurisdiction for all workers, and where membership of the union is not a condition of
getting or keeping a job.
Open-market operations
Sales or purchases of securities by the central bank aimed at influencing monetary conditions.
Opportunity cost
Measurement of cost by reference to the alternatives forgone.
Optimum output
See profit-maximizing output: The level of output that maximizes a firm’s profits. Sometimes also
called the optimum output.
Option
Options come in two varieties. A call option is the right (but not the obligation) to buy some
commodity or security in the future at a specific price called the exercise price that is set now. A put
option is the right (but not the obligation) to sell some commodity or security in the future at a
specific price that is set now.
Ordinary partnership
An enterprise composed of a group of individuals who are all jointly liable for the debts and other
obligations of that enterprise.
Output
The goods and services that result from the process of production.
Output gap
The difference between actual output and potential output (Y − Y*); negative output gaps are
sometimes called recessionary gaps; positive output gaps are sometimes called inflationary gaps.
Also called the GDP gap.
Overshooting
Occurs when the impact effect of a shock takes a variable beyond its ultimate equilibrium level.
Most widely applied to the exchange rate. A characteristic of a wide class of exchange-rate models
under rational expectations is that when monetary policy is, say, tightened, the exchange rate
initially appreciates to a point from which it will later depreciate towards its long-run equilibrium
level.
Paradox of value
The observation that the necessities of life, such as water, often have low prices while dispensable
luxuries, such as diamonds, often have high prices. This seemed a paradox to early economists but
was explained later by the observation that a product‘s price is related to its marginal utility not its
total utility.
Pareto optimality
A situation in which it is impossible to reallocate production activities to produce more of one good
without producing less of some other good, and in which it is impossible to reallocate consumption

activities to make at least one person better off without making anyone worse off. Also called Pareto
efficiency.
Participation rate
This is the proportion of the population of working age that is economically active and so working or
actively seeking work.
Partnership
An enterprise with two or more joint owners, each of whom is personally responsible for all of the
partnership’s debts and other obligations.
Paternalism
The belief that the individual is not the best judge of his or her own self-interest; i.e. the belief that
someone else knows better, such as a government official or a politician.
Path-dependence
The final outcome of a process depends on the path taken to reach that outcome. If a market has
path dependence, the nature of the final equilibrium reached after any disturbance will depend on
the path taken to reach equilibrium, thus the equilibrium is not unique. In Macroeconomics, one
important case of path dependence that is believed to exist is that a long period of positive GDP gap
and its resulting unemployment typically affects the stock of physical and human capital for a long
time after the gap has been eliminated. This case is sometimes referred to as showing hysteresis.
Per capita economic growth

The growth of per capita GDP or GNI divided by the population.
Perfect competition
A market structure in which the large number of firms in an industry are price takers and in which
there is freedom of entry into, and exit from, the industry.
Permanent income
The maximum amount that a person can consume per year into the indefinite future without
reducing his or her wealth.
Permanent income theory

A theory that relates actual consumption to permanent income.
Perpetuity
A bond that pays a fixed sum of money each year for ever and has no redemption date. Sometimes
called a consol in the UK.
Personal disposable income (PDI)

The gross income of the personal sector less all direct taxes and national insurance contributions.
Also called household disposable income and indicated by the symbol Yd.
Personal income
Income earned by or paid to individuals before personal income taxes are deducted.

Per-unit tax
See specific tax: A tax expressed as so much per unit, independent of its price. Also called a per-unit
tax.
Phillips curve
Curve that relates the percentage rate of change of money wages (measured at an annual rate) to
the level of unemployment (measured as the percentage of the working population unemployed).
The curve is often amended to relate the percentage change in money prices (the inflation rate) to
the level of the GDP on the assumption of stable relations between (i) unemployment and the GDP
and (ii) changes in money wages and changes in the price level. When the two curves are both in
use, they are often distinguished by naming them the wage-Phillips curve and the price-Phillips
curve. See short-run Phillips curve, long-run Phillips curve, and expectations- augmented Phillips
curve
Point elasticity of demand

Measures demand elasticity by using the derivative of quantity demanded with respect to price, (dq/
dp) × (p/q), as opposed to the arc elasticity that uses the ratio Δq/Δp taken over a small range.
Point elasticity of supply

Measures supply elasticity by using the derivative of quantity supplied (s) with respect to price,
(ds/dp) × (p/s), as opposed to the arc elasticity that uses the ratio Δs/Δp taken over a small range.
Poll tax
A tax that takes the same lump sum from everyone.
Portfolio investment
Investment in bonds and other debt instruments that do not imply ownership, and in minority
holdings of shares that do not establish legal control.
Positive
Statements concerning what is, was, or will be; they assert alleged facts about the universe in which
we live. Compare normative.
Positively related
An increase in one variable is associated with an increase in another.
Potential GDP
The level of output at which there is no demand deficient unemployment and firms are producing at
their normal rates of output. This is usually indicated by the symbol Y*
Precautionary balances
The amount of money people wish to hold because of the possibility of having to make unexpected
future payments. e Because both these and speculative balances respond to changes in the interest
rate, they are often lumped together treated as a single set of balances that change in response to
the interest rate.
Precautionary motive
The motive for holding money balances to meet unexpected future payments.

Predatory pricing
A pricing strategy that is intended to drive a competitor out of business.
Present value
The value now of a sum to be received in the future. Also called discounted present value.
Price control
Anything that influences prices by law rather than by market forces.
Price discrimination
Situation arising when firms sell different units of their output at different prices for reasons not
associated with differences in costs.
Price elasticity of demand

The percentage change in quantity demanded divided by the percentage change in price that
brought it about. Usually just called elasticity of demand.
Price elasticity of supply

The percentage change in quantity supplied divided by the percentage change in price that brought
it about. Usually just called elasticity of supply.
Price index
A statistical measure of the average level some group of prices relative to some base period. The
value in the base period is set to 100. price level See general price level.
Price system
An economic system in which market-determined prices play a key role in determining the allocation
of resources to various productive activities and the distribution of the GDP among various groups.
Price taker
A firm that can alter its rate of production and sales within any feasible range without having any
effect on the prices of its products that are determined by impersonal market forces.
Price–consumption line
A line on an indifference curve diagram showing how consumption changes as the price of one
commodity changes, ceteris paribus.
Price-makers
Firms that administer their prices. See administered price.
Principal
(1) The amount of a loan, (2) the agents who employ others to work on their behalf.
Principal–agent problem
The problem of resource allocation that arises because contracts that will induce agents to act in
their principals’ best interests are often impossible to write or too costly to monitor.

Principle of substitution
The prediction that methods of production will change if the relative prices of inputs change.
Relatively more of the cheaper input and relatively less of the more expensive input will be used.
Prisoner’s dilemma
A term in game theory for a game in which the Nash equilibrium leaves both players less well off
than if they cooperated with each other.
Private benefits
The benefits of some activity that accrue to the parties in that activity.
Private consumption spending

Spending on the goods consumed by private individuals, even where payment for the goods may
have been made by some other organisation such as the government, as with health services.
Private cost
The value of the best alternative use of the resources used in production as valued by the producer.
private sector That portion of an economy in which the organizations that produce goods and
services are owned and operated by private units such as households and firms. Compare public
sector.
Pro-cyclical
Anything that is p positively correlated with the business cycle. For example, employment increases
when GDP increases.
Producer
Any unit that makes goods or services.
Producers’ surplus
Total revenue minus total variable cost; the market value that the firm creates by producing goods,
net of the value of the resources currently used to create these goods but not counting any
contribution to fixed (sunk) costs. production The act of making goods and services.
Production function
A mathematical relation showing the maximum output that can be produced by each and every
combination of inputs.
Production possibility boundary

A curve that shows the alternative combinations of commodities that can just be attained if all
available productive resources are fully employed and used efficiently; the boundary between
attainable and unattainable output combinations.
Productive efficiency
Production of any output at the lowest attainable cost for that level of output, so that it is impossible
to reallocate resources and produce more of one output without simultaneously producing less of
some other output.

Productivity
Output per unit of input employed. Can be expressed in many alternates by dividing output by
different inputs such as labour or capital.
Products
A general term referring to all goods and services. Sometimes also referred to as commodities.
Profit
(1) In ordinary usage, the difference between the value of outputs and the value of inputs. (2) In
microeconomics, the difference between revenues received from the sale of goods and the value of
inputs, which includes all imputed costs for the services of inputs owned by the firm, the most
important of which is the opportunity cost of capital. Also called pure profit or economic profit. (3) In
macroeconomics, a component of factor incomes (and thus income-based measures of national
product) which is measured as trading surpluses plus a component of mixed incomes.
Profit-maximizing output
The level of output that maximizes a firm’s profits. Sometimes also called the optimum output.
Progressive tax
A tax that takes a larger percentage of people’s income the larger their income is. Compare
regressive tax and proportional tax.
Progressivity
The general term for the relation between income and the percentage of income paid in taxes.
Proportional tax
A tax that takes the same percentage of people’s income whatever the level of their income.
Protectionism
Any departure from free trade designed to give some protection to domestic industries from foreign
competition.
Public corporation
A body set up to run a nationalized industry. It is owned by the state but is usually under the
direction of a more or less independent, state-appointed board.
Public goods
Goods and services that, once produced, can be consumed by everyone in the society such as police
protection and parks. Also called collective consumption goods.
Public sector
That portion of an economy in which production is owned and operated by the government or by
bodies created and controlled by it, such as nationalized industries. Compare private sector.
Purchasing power parity theory

Theory that the equilibrium exchange rate between two national currencies will be the one that
equates their purchasing powers.

Purchasing power parity (PPP) exchange rate

The exchange rate between two currencies that equates their purchasing powers and hence adjusts
over time for relative inflation rates.
Pure market economy

An economy in which all decisions, without exception, are made by individuals and firms acting
through unhindered markets.
Pure profit
Any excess of a firm’s revenue over all opportunity costs including those of capital. Also called
economic profit.
Pure rate of interest

See pure return on capital: The amount that capital can earn in a riskless investment. Also called the
pure rate of interest. quantitative easing The purchase of government and corporate bonds by the
central bank on a large scale intended to raise the money supply, influence assets prices and affect
long term interest rates. Used by the Bank of England in 2009–10 when it wanted to stimulate
aggregate demand but could not lower bank rate any further.
Pure return on capital

The amount that capital can earn in a riskless investment. Also called the pure rate of interest.
quantitative easing The purchase of government and corporate bonds by the central bank on a large
scale intended to raise the money supply, influence assets prices and affect long term interest rates.
Used by the Bank of England in 2009–10 when it wanted to stimulate aggregate demand but could
not lower bank rate any further.
Quantity actually bought and sold

The amount of a commodity that consumers and firms actually succeed in purchasing and selling.
Quantity actually purchased

See quantity actually bought and sold: The amount of a commodity that consumers and firms
actually succeed in purchasing and selling.
Quantity demanded
The amount of a commodity that households wish to purchase in some time period.
Quantity supplied
The amount of a commodity that firms offer for sale in some time period.
Quantity theory of money

Theory predicting that the price level and the quantity of money vary in exact proportion to each
other; e.g., changing M by X per cent changes P by X per cent.
Ratio scale
See logarithmic scale: A scale on which equal proportional changes are shown as equal absolute
distances (e.g. 1 cm may always represent doubling of a variable, whether from 3 to 6 or 50 to 100).
Also called log scale or ratio scale.

Rational expectations
The theory that people fully understand how the economy works and learn quickly from their
mistakes, so that, while random errors may be made, systematic and persistent errors are not made.
Rational ignorance
This occurs when agents have no rational incentive to inform themselves about some government
action because the costs of so doing greatly exceed the potential benefits of any action the agent
could take as a result of having the correct information.
Real business cycles

An approach to the explanation of business cycles that uses dynamic equilibrium market-clearing
models and relies on productivity and taste shocks as a trigger. In such models all cycles are an
optimal response to the real shock and there are no deviations from potential output: rather, it is
the full equilibrium that fluctuates over time.
Real capital
Physical assets, including factories, machinery, and stocks of material and finished goods. Also called
physical capital.
Real exchange rate

An index of the relative prices of domestic and foreign goods.
Real income
The purchasing power of money income, measured by deflating nominal income by an index of the
price level.
Real money supply

The money supply measured in purchasing power units, measured as the nominal money supply
divided by an index of the price index.
Real national product

Total output valued at base-year or reference year prices, measured for example by GDP at 1999
prices. A volume measure of real activity that removes the effects of inflation.
Real product wage

The proportion of the sale value of each unit of output that is accounted for by labour costs
(including the pre-tax nominal wage rate, benefits, and the firm’s national insurance contributions).
Real interest rate

The return on any investment measured in real terms. It is approximated by the money rate of
interest minus the inflation rate (or expected inflation rate) and measured precisely by the equation
(1+ nominal rate of interest)/(rate of inflation) = (1 + real rate of interest). See also nominal interest
rate.
Real wage
The money wage deflated by a price index to measure the wage’s purchasing power.
Reallocation of resources
Some change in the uses to which the economy’s resources are put.

Recession
A sustained drop in the level of aggregate economic activity officially defined to occur when the GDP
drops for two successive periods.
Recessionary gap
A negative output gap, when actual GDP falls short of potential GDP.
redemption date
The time at which the principal of a loan is to be repaid.
Regressive tax
A tax that takes a smaller percentage of people’s incomes the larger their income is. Compare
progressive tax.
Relative price
Any price expressed as a ratio of another price or of all prices as measured by a price index.
Renewable resources
Productive resources that can be replaced as they are used up, as with real capital or forests;
distinguished from non-renewable resources, which are available in a fixed stock that when depleted
cannot be replaced, such as natural oil and coal.
Replacement investment
Investment that replaces capital as it wears out but does not increase the capital stock.
Replacement ratio
Benefits received by those out of work as a proportion of the wage of those in employment.
Repo
Short for a ‘sale and repurchase agreement’, whereby a firm sells a security (such as a gilt) to a bank
and agrees to buy it back at some future time. The difference in price between sale and repurchase
reflects the ruling rate of interest. The deal is a loan (usually short-term) secured on the security
involved. Central banks typically set the rate of interest in repo transactions for a specific term. In
the UK the Bank of England sets the two- week repo rate.
Reservation price
The price below which some action will not be taken, such as selling a commodity or accepting a job.
Resource allocation
The allocation of the economy’s scarce resources among alternative uses.
Retail price index (RPI)

An index of the general price level based on the consumption pattern of typical consumers.
Reverse repo
Similar to a repo, but here the bank sells the security to the firm and agrees to buy it back at some
future date.

Ricardo Effect
The theory that foresighted agents will understand that an increases in current government
spending financed by new public debt will require new taxes in the future to service that debt and so
will have little current expansionary effect because agents will increase their savings to cover their
future tax liabilities by an amount that will just offset the effect of the increase in government
spending.
Risk premium
The return on capital necessary to compensate owners of capital for the risk of loss of their capital.
Risk-averse
Description of agents who wish to avoid risks and so will play only those games that are sufficiently
biased in their favour to overcome their aversion to risk; they will be unwilling to play
mathematically fair games, let alone games those that are biased against them.
Risk-loving
Description of agents who are willing to play some games that are biased against them, the extent of
the love of risk being measured by the degree of bias that they are willing to accept.
Risk-neutral
Description of agents who are indifferent about playing a mathematically fair game and are willing to
play games that are biased in their favour but not games that are biased against them.
Rivalrous
A good or service is rivalrous if, when one person consumes a unit of it, no other person can also
consume that unit, as with all ordinary goods and services, such as apples or haircuts.
Saving
Income received by individuals that they do not spend through consumption expenditure.
Savings ratio
See average propensity to save: Total saving divided by total disposable income, S/Yd. Also known as
the savings ratio.
Scatter diagram
Plots of a series of observations each made on two variables, e.g. the price and quantity of eggs sold
in 20 different cities.
Seigniorage
The revenue that accrues to the issuer of money.
Self-employed
Those people who work for themselves.
Sellers’ preferences
Allocation of a commodity by the decisions of sellers when the commodity is in excess demand.

Services
Intangible production that does not generate a physical product, such as haircuts and medical
services.
Share option
See option: Options come in two varieties. A call option is the right (but not the obligation) to buy
some commodity or security in the future at a specific price called the exercise price that is set now.
A put option is the right (but not the obligation) to sell some commodity or security in the future at a
specific price that is set now.
Shares
See equities: Certificates indicating part ownership of a joint-stock company.
Shifting
The passing of tax incidence from the person who initially pays it to someone else.
Short run
The period of time over which some inputs, such as physical capital, cannot be varied.
Short-run aggregate supply (SRAS) curve

The total amount that will be produced and offered for sale at each price level on the assumption
that all input prices and technology are fixed.
Short-run equilibrium
Generally, equilibrium subject to fixed inputs or other things that cannot change over the time
period being considered.
Short-run Phillips curve

Any particular Phillips curve drawn for a given expected rate of inflation. See also the expectations-
augmented Phillips curve and the long-run Phillips curve.
Short-run supply curve

A curve showing the relation of quantity supplied to price when one or more factors is fixed; under
perfect competition, the horizontal sum of marginal cost curves (above the level of average variable
costs) of all firms in an industry.
Shutdown price
The price that is equal to a firm’s average variable costs, below which a profit-maximising firm will
produce no output. See also break-even price.
Simple multiplier
Usually applies to the value of the multiplier in the aggregate expenditure (AE) system when the
interest rate is an exogenous variable and firm are willing to supply all that is demanded at existing
prices (the aggregate supply curve is horizontal). Also called the interest-constant multiplier
Single proprietorship
An enterprise with one owner who is personally responsible for everything that is done. More
commonly called a sole trader.

Size distribution of income

A classification of the amount of income received by income earners who fall within each of a series
of income ranges, irrespective of the sources of that income. For example, the amount of income
received by those in the bottom 10 percent of the income distribution, the amount received by
those in the second 10 percent, right up to amount received by those in the top 10 percent of all
income earners.
Slump
A large and long-lasting positive GDP gap and thus a period of low output and low employment. See
also boom.
Small open economy (SOE)

An economy that is a price taker for both its imports and its exports. It must buy and sell at world
prices, irrespective of the quantities that it buys and sells.
Social benefits
The value of an activity to the whole society, which includes the internal effects on those who are
involved in deciding on it and the external effects on those who are not involved in the activity.
Social cost
The value to the whole society rather than to a specific individual or firm.
Sole trader
A non-incorporated business operated by a single owner. Modern UK terminology for a single
proprietorship.
Specialization
When applied to countries, it refers to producing at home products for which the country has
comparative advantage and importing those for which it has a comparative disadvantage. When
applied to labour within a country, it refers to specialisation in particular tasks rather than producing
a wider range of things, and in the extreme case producing everything that a person consumes. It is a
continuous variable so that one can speak of ‘increasing amounts of specialisation’ as for example
when one labourer produces everything she consumes, as might have happened in the days of
hunter gatherers; producing the whole of just one product, as happens under craft production; or
producing a small part of one product, as is typical today. See also division of labour.
Specific tax
A tax expressed as so much per unit, independent of its price. Also called a per-unit tax.
Speculation
Taking a financial position based on expectations of the future that will yield gain if things turn out
as, or better than, expected or losses if expectations are not fulfilled.
Speculative balances
Money held to take advantage of unexpected changes in asset prices (these are only bonds in the
simple two-asset macro model). Because both these and precautionary balances respond to changes
in the interest rate, they are often lumped together and treated as a single set of balances that
change in response to the interest rate.

Speculative motive
The motive that leads agents to hold money in response to the risks inherent in fluctuating asset
prices (these are only bonds in the simple two-asset macro model). spread The difference between
the prices or interest rates on specific assets or loans, such as the spread between deposit and loan
rates offered by banks.
SRAS curve
See short-run aggregate supply curve: The total amount that will be produced and offered for sale at
each price level on the assumption that all input prices and technology are fixed.
Stabilization policy
The attempt to reduce fluctuations in GDP, employment, and the price level by use of monetary and
fiscal policies.
Stagflation
The simultaneous occurrence of a positive GDP gap (with its accompanying high unemployment) and
rising inflation.
Stock
See equities: Certificates indicating part ownership of a joint-stock company.
Stock variable
A variable that does not have a time dimension. It is contrasted with a flow variable, which does.
Stockbuilding
The process of building stocks or inventories more commonly called inventory accumulation.
Stocks
Accumulation of inputs and outputs held by firms to facilitate a smooth flow of production in spite of
variations in delivery of inputs and sales of outputs. Now called inventories in National Accounts. In
US terminology, stocks are ordinary company shares or equities.
Strategic
Behaviour that takes into account the reactions of others to one’s own actions, as when an
oligopolistic firm makes decisions that take account of its competitors’ reactions. strategic form
game See normal form game.
Structural unemployment
Unemployment that exists because of a mismatch between the characteristics of the unemployed
and the characteristics of the available jobs in terms of region, occupation, or industry.
Substitutes
Two goods are substitutes if the quantity demanded of one is positively related to the price of the
other.
Substitution effect
The change in quantity demanded of a good resulting from a change in the commodity’s relative
price, eliminating the effect of the price change on real income.

Sunk costs of entry

Those costs that must be incurred for a firm to enter a market and cannot be recouped when the
firm leaves.
Supergame
A game that is repeated an infinite number of times.
Supply
The whole relation between the quantity supplied of some commodity and its own price.
Supply curve
The graphical representation of the relation between the quantity of some commodity that
producers wish to make and sell per period of time and the price of that commodity, ceteris paribus.
Supply function
A mathematical relation between the quantity supplied and all the variables that influence it.
Supply of effort
The total number of hours people in the labour force are willing to work. Also called supply of
labour.
Supply of labour
See supply of effort: The total number of hours people in the labour force are willing to work. Also
called supply of labour.
Supply of money
The total amount of money circulating in the economy. Also called the money supply or the money
stock.
Supply schedule
A numerical tabulation showing the quantity supplied at a number of alternative prices.
Supply shock
See aggregate supply shock: A shift in the aggregate supply curve. This may result from an
exogenous change in input prices or from technical change.
Supply-side policies
Policies that seek to shift either the shortrun or the long-run aggregate supply curve.
Surprise aggregate supply curve

See Lucas aggregate supply curve.
Sustainable growth
A concept introduced by the UN‘s Bruntland Commission and referring to growth that can continue
without causing side effects such as deforestation and climate warming that will slow or stop future
growth.

Tacit collusion
Occurs when firms arrive at the cooperative solution (which maximizes their joint profit) even
though they may not have formed an explicit agreement to cooperate.
Takeover
When one firm buys another firm.
Targets
The variables in the economy that policymakers wish to influence. Typical policy targets might be
inflation, unemployment, or real growth.
Tariffs
Taxes on imported goods.
Term
The amount of time between a bond’s issue date and its redemption date.
Terms of trade
The ratio of the average price of a country’s exports to the average price of its imports.
Theory of games
The study of rational decision-making in situations in which each player must anticipate the
reactions of competitors to the moves that she makes. It can be applied to analysis of the strategic
interaction of firms in oligopolistic markets.
Third-party effects
See externalities: Costs or benefits of a transaction that fall on agents not involved in that
transaction.
Time-inconsistency
Problem that arises in rational expectations models when policymakers have an incentive to
abandon their commitments at a later time. The existence of this incentive is generally understood
by private sector agents, and it may influence their current behaviour.
Time-series data
Data on some variable taken at different, usually regularly spaced, points in time, such as consumer
spending in each quarter for the last 10 years.
Total cost (TC)

The total of all costs of producing a firm’s output, usually divided into fixed and variable costs.
Total final expenditure

The total expenditure required to purchase all the goods and services that are produced
domestically when these are valued at market prices.
Total fixed costs

The total of a firm’s costs that do not vary in the short run.

Total product (TP)

Total amount produced by a firm during some time period.
Total revenue (TR)

Total amount of money that a firm receives from the sale of its output over some period of time.
Total utility
The total satisfaction derived from consuming some amount of a commodity.
Total variable costs

The total of those of the firm’s costs that vary in the short run.
Tradables
Goods and services that enter into international trade.
Trade account
The part of the balance of payments accounts relating to trade in goods and services. Merchandise
trade relates only to goods.
Trade creation
The increase in trade between the members of a customs union or free-trade area where previously
protected industries had served only their own home markets.
Trade cycles
See business cycles: Fluctuations in the general level of activity in an economy that affect many
sectors at roughly the same time, though not necessarily to the same extent. In recent times, the
period from the peak of one cycle to the peak of the next has varied in the range of five to ten years.
Formerly known as trade cycles.
Trade diversion
The diversion of a member country’s imports or exports from other countries to union members as a
result of the preferential removal of tariffs following the formation of a customs union or a free-
trade area.
Trade or craft union

A union covering workers with a common set of skills, no matter where, or for whom, they work.
Trade-weighted exchange rate

An index of the average of the exchange rates between a particular country’s currency and those of
its major trading partners, with each rate being weighted by the amount of trade with the country in
question. Also called the effective exchange rate.
Traditional economic system

Economic system in which behaviour is based primarily on tradition, custom, and habit.
Transaction costs
Costs involved in making a trade in addition to the price of the product itself, such as the time
involved or the cost of transport.

Transactions balances
Money balances held because of the non-synchronisation of every day payments and receipts. For
example, wages may be paid weekly while spending occurs daily.
Transactions motive
The motive for holding cash because purchases occur regularly while income is received only
periodically– the non-synchronisation of payments and receipts. transfer earnings The amount that a
factor or input must earn in its present use to prevent it from moving (i.e. transferring) to another
use.
Transfer payments
Payments not made in return for any contribution to current output, such as unemployment
benefits. Unrelated to retransfer earnings transmission mechanism See monetary transmission
mechanism.
Transnational corporations (TNCs)

Firms that have operations in more than one country. Also called transnationals or multinational
enterprises (MNEs).
Underdeveloped countries
See less-developed countries: The lower-income countries of the world, most of which are in Asia,
Africa, and South and Central America. Also called underdeveloped countries and developing
countries.
Unit cost
See average variable cost: Total variable cost divided by the number of units produced. Also called
unit cost.
Unit elasticity
An elasticity with a numerical measure of 1, indicating that the percentage change in quantity is
equal to the percentage change in price (so that total expenditure remains constant).
Utility
See marginal utility and total utility: The change in satisfaction resulting from consuming one unit
more or one unit less of a good or service. Technically this can be expressed as an incremental ratio
ΔS/ΔG, where S is satisfaction and G is a good being consumed or as the derivative of satisfaction
with respect to the good consumed, dS/dG; The total satisfaction derived from consuming some
amount of a commodity.
Utils
An imaginary measure of utility used in the exposition of marginal utility theory, which assumes that
utility is cardinally measurable.
Validation
When the authorities sustain an ongoing inflation by increasing the money supply at the same rate
as the price level is rising.
Value added
The value of a firm’s output minus the value of the inputs that it purchases from other firms.

Value added tax (VAT)

Tax charged as a proportion of a firm’s value added.
Value of money
See purchasing power of money.
Variable
Any well-defined item, such as the price of a commodity or its quantity, that can take on various
specific values. Endogenous variables are determined from with the theory while exogenous
variables are determined from without.
Variable cost
A cost that varies directly with changes in output. Also called direct cost or avoidable cost.
Variable factors
Inputs whose amount can be varied over the time period being considered, usually the short run.
Velocity of circulation
The number of times an average unit of money is used in transactions within a specific period.
Defined as the ratio of nominal GDP to the money stock.
Vertical equity
Equitable treatment of people in different income brackets. Compare horizontal equity.
Very long run

A period of time over which the technological possibilities open to a firm or the economy as a whole
are subject to change.
Visible account
The part of the balance of payments accounts relating to trade in goods.
Visible trade
Trade in physical products. Same as merchandise trade: Trade in physical products. Same as visible
trade.
Visibles
Tangible goods such as cars, aluminium, coffee, and iron ore, which we can see when they cross
international borders.
Voluntary export restriction (VER)

Restriction whereby an exporting country agrees to limit the amount it sells to a second country.
Voluntary unemployment
Unemployment that occurs when there is a job available but the unemployed person is not willing
to accept it at the existing wage rate.

Winner’s curse
The possibility that the agent who wins the bidding on a contested takeover may pay more than the
target firm is really worth because the winner is the one with the highest valuation of all bidders.
Withdrawals
Also called leakages. Spending that leaves the domestic economy and does not create further
incomes for domestic residents. Import spending, for example, creates incomes overseas. Also called
leakages. The main withdrawals from the circular flow between households and firms are savings,
taxes, and imports.
Working population
The total of the employed, the self-employed, and the unemployed, i.e. those of working age who
have a job plus those who are looking for work.
X-inefficiency
Failure to use resources efficiently within the firm so that firms are producing above their relevant
cost curves and the economy is inside its production possibility boundary.
Yc
The level of GDP at which the inflation rate starts to rise above the expected rate. This is a little
above potential or normal capacity GDP, Y*, because firms like to hold a bit of capacity in reserve to
meet unexpected temporary increases in demand without having to raise prices.
Yield curve
A line on a graph plotting the yield on securities against the term to maturity. It illustrates, for
example, the differences between three month, six month, one year, five year and twenty years
interest rates being quoted at the same point in time.

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Lipsey & Chrystal: Economics 13e

Accelerator theory of investment

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Aggregate (desired) expenditure (AE)

Aggregate demand (AD)

Aggregate demand curve

Aggregate demand shock

Aggregate production function

Aggregate supply (AS)

Aggregate supply curve

Aggregate supply shock

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Average fixed costs (AFC)

Average product (AP)

Average propensity to consume (APC)

Average propensity to import

Average propensity to save (APS)

Average revenue (AR)

Average total cost (ATC)

Average variable cost (AVC)

Balance of payments accounts

Balanced budget multiplier

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Capital and financial account

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Capital consumption allowance

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Centrally planned economy

Change in the quantity demanded

Circular flow of income

Collective consumption goods

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Common property resource

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Constant returns to scale

Consumption spending (or expenditure)

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Decreasing returns to scale

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Demand for money

Demand for money function

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Diminishing marginal rate of substitution

Disembodied technical change

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Effective exchange rate

Embodied technical change

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Extensive form game

Factor price theory

Final goods and services

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Fixed capital formation

Fixed exchange rate

© Richard Lipsey and Alec Chrystal, 2015. All rights reserved.

Floating exchange rate

Foreign direct investment (FDI)

Free-trade area (FTA)