Equity The property of distributing output fairly among society's members. Market failure A situation in which the market fails to allocate resources efficiently. Scarcity Limited resources and unlimited wants. Productivity The amount of goods and services produced per hour by a worker. Monopoly The case in which there is only one seller in the market. Invisible hand The principle that self-interested market participants may unknowingly maximize the welfare of society as a whole. Efficiency The property of society getting the most from its scarce resources. Market economy An economic system where interaction of households and firms in markets determine the allocation of resources. Business cycle Fluctuations in economic activity. Externality When one person's actions have an impact on a bystander. Inflation An increase in the overall level of prices. Marginal changes Incremental adjustments to an existing plan. Economics Study of how society manages its scarce resources. Opportunity cost Whatever is given up to get something else. Market power The ability of an individual or group to substantially influence market prices. Phillips curve The short-run tradeoff between inflation and unemployment. Factors of production Inputs such as land, labor, and capital. Macroeconomics The study of economy-wide phenomena. Scientific method Objective development and testing of theories. Opportunity cost Whatever is given up to get something else. Normative Statements Prescription for how the world ought to be. Efficiency Getting maximum output from the resources available. Positive Statements Descriptions of the world as it is. Economic models Simplifications of reality based on assumptions. Production possibilities frontier A graph that shows the combinations of output the economy can possibly produce given the available factors of production and the available production technology. Microeconomics The study of how households and firms make decisions and how they interact in markets. Circular-flow diagram A diagram of the economy that shows the flow of goods and services, factors of production, and monetary payments between households and firms. Equilibrium quantity The quantity supplied and the quantity demanded at the equilibrium price. Demand schedule A table that shows the relationship between the price of a good and the quantity demanded. Supply schedule A table that shows the relationship between the price of a good and the quantity supplied. Monopolistically competitive Market with sellers offering slightly different products. Market A group of buyers and sellers of a particular good or service. Monopoly Market with only one seller. Inferior good A good for which, other things equal, an increase in income leads to a decrease in demand. Shortage A situation in which quantity demanded is greater than quantity supplied. Surplus A situation in which quantity supplied is greater than quantity demanded. Quantity demanded The amount of a good that buyers are willing and able to purchase. Equilibrium A situation in which the price has reached the level where quantity supplied equals quantity demanded. Competitive market A market in which there are many buyers and sellers so that each has a negligible impact on the market price. Law of demand The claim that, other things equal, the quantity demanded of a good falls when the price of the good rises. Oligopoly Market with only a few sellers. Equilibrium price The price that balances quantity supplied and quantity demanded. Quantity supplied The amount of a good that sellers are willing and able to sell. Law of supply The claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. The law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance. Complements Two goods for which an increase in the price of one leads to a decrease in the demand for the other. Normal good A good for which, other things equal, an increase in income leads to an increase in demand. Tax incidence The manner in which the burden of a tax is shared among participants in a market. Price ceiling A legal maximum on the price at which a good can be sold. Tax wedge The difference between what the buyer pays and the seller receives after a tax has been imposed. Price floor A legal minimum on the price at which a good can be sold. Nominal GDP The production of goods and services valued at current year prices Consumption Spending by households on goods and services, excluding new housing. Net exports Spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports). Recession Period of decline in GDP. Gross Domestic Product Market value of all final goods and services produced within a country in a given period of time. Total income Wages, rent, and profit. Inflation The rate at which prices are rising. Gross National Product Market value of all final goods and services produced by a nation's residents in a given period of time. Investment Spending on capital equipment, inventories, and structures, including household purchases of new housing. Government purchases Spending on goods and services by all levels of government. GDP deflator A measure of the price level calculated as the ratio of nominal GDP to real GDP, then multiplied by 100. Transfer payment Expenditures by government for which they receive no goods or services. Unemployment Percent of the labor force that is out of work. Microeconomics The study of how households and firms make decisions and how they interact in markets. Intermediate production Goods that are produced by one firm to be further processed by another firm. Macroeconomics The study of economy-wide phenomena. Real GDP The production of goods and services valued at base year prices. Final production Finished products sold to the end user. Total expenditure Consumption, investment, government purchases, and net exports. Base year The year from which prices are used to measure real GDP. Depreciation Value of worn out equipment and structures. cost of living The income necessary to maintain a constant standard of living. indexed contract A contract that requires that a dollar amount be automatically corrected for inflation. consumer price index The ratio of the value of the fixed basket purchased by the typical consumer to the basket's value in the base year, multiplied by 100. basket (of goods and services) The quantities of each item purchased by the typical consumer. producer price index The ratio of the value of a fixed basket of goods and services purchased by firms to the basket's value in the base year, multiplied by 100. inflation rate The percent change in a price index. real interest rate The interest rate corrected for the effects of inflation. cost-of-living-adjustment (COLA) An automatic increase in income in order to maintain a constant standard of living. substitution bias The inability of the CPI to account for consumers' substitution toward relatively cheaper goods and services. standard of living Material well-being. real GDP Output valued at base year prices. nominal GDP Output valued at current prices. GDP deflator The ratio of nominal GDP to real GDP, multiplied by 100. nominal interest rate The interest rate uncorrected for the effects of inflation. base year The benchmark year against which other years are compared. Bureau of Labor Statistics The government agency responsible for tracking prices. Human capital The knowledge and skills that workers acquire through education, training, and experience. Foreign direct investment Capital investment owned and operated by foreigners. Production function The relationship between inputs and output from production. Public good A good that we may all use at the same time without diminishing another's benefits. Property rights The ability of people to exercise control over their resources. Real GDP per person The quantity of goods and services available for the average individual in the economy. Physical capital The stock of equipment and structures used to produce output. Diminishing returns When the incremental increase in output declines as equal increments of an input are added to production. Constant returns to scale A production process where doubling all of the inputs doubles the output. Renewable resource Natural resource that can be reproduced. Infant-industry argument Restricting international trade to protect fledgling domestic industry from foreign competition. Outward-oriented policies Policies that decrease international trade restrictions. Catch-up effect The property that poorer countries tend to grow more rapidly than richer countries. Growth rate The annual percentage change in output. Factors of production Inputs used in production, such as labor, capital, and natural resources. Nonrenewable resource Natural resource that is limited in supply. Externality When the actions of one person affect the well-being of a bystander. Inward-oriented policies Policies that increase international trade restrictions. Technological Knowledge A society's understanding about the best ways to produce goods and services. Productivity The quantity of goods and services that a worker can produce per hour. Natural resources Inputs into production provided by nature. Foreign portfolio investment Capital investment financed with foreign money but operated by domestic residents. Discouraged workers Workers who stop looking for work due to an unsuccessful search. Cyclical unemployment The deviation of the unemployment rate from its natural rate. Efficiency wages Wages voluntarily paid in excess of the competitive equilibrium wage to increase worker productivity. Sectoral shifts Changes in the composition of demand across industries or regions. Reservation wage The lowest wage a worker will accept. Frictional unemployment Unemployment due to the time it takes for workers to search for the jobs that best suit their tastes and skills. Natural rate of unemployment Normal rate of unemployment about which the unemployment rate fluctuates. Labor-force participation rate Percentage of the adult population in the labor force. Right-to-work laws Legislation that makes it illegal to require union membership for employment. Strike An organized withdrawal of labor from the firm. Union Worker association that bargains with employers over wages and working conditions. Insiders Those employed in union jobs. Unemployment insurance A government program that pays laid off workers a portion of their original salaries. Labor force The total number of workers, which is the sum of the unemployed and the employed. Structural unemployment Unemployment that results because the number of jobs available in some labor market is insufficient for everyone who wants a job to get one. Unemployment rate Percentage of the labor force that is unemployed. Collective bargaining The process by which unions and firms agree on labor contracts. Outsiders Those not employed in union jobs. Medium of exchange Spendable asset such as a checking deposit. Budget deficit A shortfall of tax revenue relative to government spending causing public saving to be negative. Closed economy An economy with no international transactions. Financial intermediaries Financial institutions through which savers can indirectly lend to borrowers. Financial system The group of institutions in the economy that help match borrowers and lenders. Demand for loanable funds The amount of borrowing for investment desired at each real interest rate. Private saving The income that remains after consumption expenditures and taxes. Government debt The accumulation of past budget deficits. Supply of loanable funds The amount of saving made available for lending at each real interest rate. Bank Institution that collects deposits and makes loans. Mutual fund Institution that sells shares and uses the proceeds to buy a diversified portfolio. Financial markets Financial institutions through which savers can directly lend to borrowers. Stock Certificate of ownership of a small portion of a large firm. Budget surplus An excess of tax revenue over government spending causing public saving to be positive. National saving (saving) The income that remains after consumption expenditures and government purchases. Crowding out A decrease in investment as a result of government borrowing. Investment Expenditures on capital equipment and structures. Bond Certificate of indebtedness or IOU. Fractional-reserve banking A banking system in which banks hold only a fraction of deposits as reserves. Currency Paper bills and coins in the hands of the public. Store of value The function of money when used to transfer purchasing power to the future. Discount rate The interest rate the Fed charges on loans to banks. Barter Trading goods and services directly for goods and services. Unit of account The function of money when used as a yardstick to post prices and record debts. Commodity money Money in the form of a commodity with intrinsic value. Federal Reserve (Fed) The central bank of the United States. Money The set of assets generally accepted in trade for goods and services. Reserve ratio The fraction of deposits held as reserves. Excess reserves Reserves held beyond the minimum reserve requirement. Money supply The quantity of money in the economy. Fiat money Money without intrinsic value. Medium of exchange The function of money when used to purchase goods and services. Open-market operations The purchase and sale of U.S. government bonds by the Fed. Double coincidence of wants The accident that two people bartering have what the other wants. Reserve requirements The minimum legal percent of deposits that banks must hold as reserves. Monetary policy Decisions by the central bank concerning the money supply. Demand deposits Balances in bank accounts that can be accessed on demand by check. Money multiplier The amount of money the banking system generates from each dollar of reserves. Federal Open Market Committee The monetary policy committee within the Federal Reserve. Central bank An institution designed to regulate the banking system and money supply. Liquidity The ease with which an asset can be converted into the economy's medium of exchange. Reserves Deposits that banks have received but have not lent out. Shoeleather cost Resources wasted when inflation causes people to economize on money holdings. Inflation tax The practice of a government raising revenue by printing money. Quantity theory of money The theory that the quantity of money determines prices and the growth rate of money determines inflation. Real variables Variables measured in physical units. Menu cost The costs associated with changing prices. Nominal interest rate Interest rate uncorrected for inflation. Capital gains Profits made from selling an asset for greater than the purchase price. Fisher effect The one-to-one adjustment of the nominal interest rate to inflation. Inflation An increase in the overall level of prices. Hyperinflation Extraordinarily high inflation. Quantity equation M x V = P x Y Classical dichotomy The theoretical separation of nominal and real variables. Real interest rate Interest rate corrected for inflation. Nominal variables Variables measured in monetary units. Velocity of money Rate at which money circulates. Deflation A decrease in the overall level of prices. Menu costs Costs associated with changing prices. The business cycle Short-run economic fluctuations. Accommodative policy A policy of increasing aggregate demand in response to a decrease in short-run aggregate supply. Recession A period of mildly falling incomes and rising unemployment. Aggregate-demand curve The quantity of goods and services that households, firms, and the government want to buy at each price level. Natural rate of output The amount of output produced when unemployment is at its natural rate, sometimes called potential output or full-employment output. Stagflation A period of falling output and rising prices. Depression A period of unusually severe falling incomes and rising unemployment. Aggregate-supply curve The quantity of goods and services that firms are willing to produce at each price level. Model of aggregate supply and demand The model most economists use to explain short-run fluctuations in the economy around its long-run trend. Crowding-out effect The dampening of the shift in aggregate demand from expansionary fiscal policy, which raises the interest rate and reduces investment spending. Federal funds rate The interest rate banks charge one another for short-term loans. Investment accelerator The amplification of the shift in aggregate demand from expansionary fiscal policy, which raises investment expenditures. Theory of liquidity preference Keynes's theory that the interest rate is determined by the supply and demand for money in the short run. Automatic stabilizers Changes in fiscal policy that do not require deliberate action on the part of policymakers. Stabilization policy The use of fiscal and monetary policies to reduce fluctuations in the economy. Multiplier effect The amplification of the shift in aggregate demand from expansionary fiscal policy, which raises incomes and further increases consumption expenditures. Liquidity The ease with which an asset is converted into a medium of exchange. Marginal propensity to consume, or MPC The fraction of extra income that a household spends on consumption. Disinflation A reduction in the rate of inflation. Natural rate of unemployment The normal rate of unemployment toward which the economy gravitates. Rational expectations The theory that suggests that people optimally use all available information, including about government policies, when forecasting the future. Misery index The sum of inflation and unemployment. Natural rate hypothesis The theory that unemployment returns to its natural rate, regardless of inflation. Phillips curve The short-run tradeoff between inflation and unemployment. Sacrifice ratio The number of percentage points of annual output that is lost in order to reduce inflation one percentage point. Supply shock An event that directly alters firms' costs and prices, shifting the economy's aggregate-supply curve and, thus, the Phillips curve. Political business cycle Economic fluctuations caused by policymakers allying themselves with elected politicians. Destabilizing policy Policy which moves output away from the long-run natural rate. Leaning against the wind Engaging in a policy that stabilizes aggregate demand. Time inconsistency of policy The discrepancy between policy announcements and policy actions. Discretionary policy A policy chosen by policymakers who have few guidelines. Opportunity cost Whatever is given up to obtain some item. Comparative advantage The comparison among producers of a good based on their opportunity cost. Exports Goods produced domestically and sold abroad. Imports Goods produced abroad and sold domestically. Import quota A limit on the quantity of a good that can be produced abroad and sold domestically. Price takers Market participants that cannot influence the price so they view the price as given. World price The price of a good that prevails in the world market for that good. Tariff A tax on goods produced abroad and sold domestically. Trade surplus The amount by which exports exceed imports. Exports Goods and services produced domestically and sold abroad. Real exchange rate The rate at which people can trade the goods and services of one country for those of another country. Arbitrage Taking advantage of two prices for the same commodity by buying where it is cheap and selling where it is expensive. Nominal exchange rate The rate at which people can trade one currency for another currency. Depreciation A decrease in the value of a currency measured in terms of other currencies. Closed economy An economy that does not interact with other economies. Net exports The value of exports minus the value of imports or the trade balance. Purchasing-power parity The theory that a unit of a country's currency should buy the same quantity of goods in all countries. Appreciation An increase in the value of a currency measured in terms of other currencies. Open economy An economy that interacts with other economies. Trade deficit The amount by which imports exceed exports. Imports Goods and services produced in foreign countries and sold domestically. Net capital outflow The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. Import quota A limit on the quantity of a good which is produced abroad that can be sold domestically. Trade policy A government policy that directly affects the quantity of country's imports or exports. Capital flight A sudden reduction in the demand for domestic assets coupled with a sudden increase in the demand for foreign assets. Twin deficits The government budget deficit and the trade deficit. Tariff A tax on imported goods.