.phoenix college > departments > Liberal Arts > economics > ECN111> Terms and Tools
These are the more important terms you will encounter in your
reading or class discussions. Additional terms can be found in
the glossary at the back of the textbook.
The terms below are approximately in the order in which you are
likely to encounter them. Notice that many of the terms below
describe people's behavior or imply a theory about behavior. However,
a tool is a conceptual creation that enables theories to
be applied to various situations. In other words, not all
of the terms are names of tools.
goods- things people want.
resources- things that are used to make goods. Sometimes called factors or inputs.
products- goods or services which have been produced. Sometimes called output.
scarcity- people cannot have everything they want; resources and goods are limited compared to desires.
marginal thinking-all decisions are made incrementally or a little at a time.
opportunity cost-the highest valued alternative given up; the relevant cost in every decision.
economization -people tend to pick the way of doing things that involves either the lowest cost or greatest benefit.
response to incentives-people change behavior based on perceived changes in the costs or the benefits of an option.
costly information- information is scarce and thus many decisions are made with limited information; information costs are the costs of obtaining information.
secondary effects- when actions alter the incentives (costs and benefits) involved in making other decisions (or taking other actions); these can include decisions made by other people or decisions made in the future.
subjective values- different people view costs and benefits differently.
scientific thinking- the approach we will take to economics; we try to predict a decision or its results rather than describe exactly how it is made or judge whether we agree with it.
(law of) diminishing returns- the observation that the benefit of an action tends to fall as it is repeated (in a particular span of time).
marginal opportunity cost (marginal cost)-the highest valued alternative given up to do a marginal (or incremental) amount of an activity; the margin is often specified. Usually rises as quantity of a particular activity rises.
marginal utility -the benefit (satisfaction) received or anticipated when an additional amount of an activity is undertaken; usually used with marginal opportunity cost. Usually falls as quantity of a particular activity rises, according to the Law of Diminishing Returns.
economic efficiency-obtaining a given result at minimum opportunity cost or gaining maximum benefit for a given cost. Based on economization. There are two specific kinds-- (1) productive efficiency-The situation in which no more output of one good can be produced without reducing output of some other good. (2) allocative (distribution) efficiency -The situation in which no person can be made better off without making another person worse off.
production possibilities curve (PPC)-a graphical depiction of all of the possible and (productive) efficient combinations of two goods which can be produced by an individual or group.
specialization- concentration on producing one kind of good or performing one kind of action rather than producing a variety of goods for oneself.
trade- voluntarily giving up goods to another person in exchange for goods which are more highly valued.
property rights-the recognized and enforced ability to trade and use goods
comparative advantage-the ability to produce at lowest opportunity cost; the basis for trade and specialization.
the law of comparative advantage says that people will specialize in production of goods for which they have the lowest marginal opportunity cost, and trade these goods for other goods that they desire.
absolute advantage-the ability to produce a greater amount with the same resources
transactions costs-costs associated with the action of trade, including information and transportation costs.
quantity demanded-the amount of a good that buyers wish to buy at a particular price.
demand-the relationship between the price and quantity demanded of a good, all else being held constant
law of demand-states that the demand relationship is an inverse or negative one (as price rises, quantity demanded falls, all else being held constant)
quantity supplied-the amount of a good that sellers wish to sell at a particular price.
supply-the relationship between the price and quantity supplied of a good, all else being held constant
demand and supply equilibrium-the unique price and quantity combination at which the quantity demanded equals the quantity supplied in a market; where the market is headed or will end up. Notice, there is actually no "law of supply and demand," but the equality implied by equilibrium is what people mean when they use this expression.
disequilibrium- the state when a market in not in equilibrium (generally due to price floors, price ceilings, or taxes)
price floor-price kept above equilibrium, resulting in a surplus
surplus- a greater quantity supplied than is demanded, indication of price above equilibrium; also called excess supply
price ceiling-price kept below equilibrium, resulting in a shortage
shortage-a greater quantity demanded than is supplied, indication of price below equilibrium; also called excess demand
consumer surplus-the total value buyers place on a good over the price they must pay for it; the gains to buyers from trade
producer surplus-the payment sellers receive for a good over the cost to them of selling it; the gains from sellers of trade
increase in demand (or supply)-a change in the relationship between price and quantity demanded (or supplied) so that a greater quantity of the good is demanded (supplied), at every possible price, than was true before. This is shown by moving the demand (supply) curve rightward.
decrease in demand (or supply)-a change in the relationship between price and quantity demanded (or supplied) so that a smaller quantity of the good is demanded (supplied), at every possible price, than was true before. This is shown by moving the demand (supply) curve to the left.
substitute- good used instead of another
complement- good used along with another
normal good- good which is purchased in greater quantity as the buyers' incomes rise.
inferior good- good which is purchased in smaller quantity as the buyers' incomes rise
excise tax- a tax on each unit of a good that is sold
invisible hand-the principle that individuals gain by satisfying the wants of others; markets cause individuals to promote the general welfare while promoting their own.
externality-when a decision imposes a cost (negative externality) or imparts a benefit (positive externality) to people not involved in the decision making.
public goods- goods for which the consumption by one person does not exhaust the amount available for others, and for which prevention of consumption is difficult.
materials- inputs which are altered in form or function to make goods.
labor- a person's time when used as an input in a productive process. Labor can be used to produce a service or to transform materials into goods.
capital- machines, tools, buildings, and other durable inputs that do not generally get used up as they are used to produce goods. Capital differs from labor and materials in this respect.
derived demand- the idea that resources are not desired for themselves, but rather for the value of what they can produce and how much they can produce.
productivity-the output produced by an input or resource. Generally, it is measured as the additional product that is produced by adding one more unit of input to the productive process (also called the "marginal product" of the resource).
human capital- skills, education, training and experience that enable a worker to become more productive. These are not used up as the worker works; the worker still has them even though she/he has used them on the job. The text also refers to these as "human resources."
compensating wage differentials- wage difference that are based on job characteristics such as unpleasantness or danger of a profession.
economic rent-the excess of salary paid to a worker over her/his opportunity cost; similar to producer surplus.
percentage change or percentage difference- this is not really an economic
tool, but it is a mathematical one. It is the change in some variable, divided
by the initial value of the variable. Often, it is calculated from one year
to the next. The shorthand used in class for this is .
rate of time preference- the rate at which a person desires to have things in the present rather than waiting to have them at some future time.
nominal- a numerical or monetary value
(nominal) interest rate-the percentage difference between the amount of money borrowed at one time and the amount repaid at another, on an annual basis.
inflation rate-the rate of change in prices over time, on an annual basis. Can be determined by finding the rate of change in a price index (see below).
anticipated inflation-the rate of change in prices (or in the price level) that is expected by decision-makers.
inflationary premium-the component of the nominal interest rate that is due to anticipated inflation.
real- a value which has been corrected for the effects of inflation; a value put in terms of goods and services rather than money.
real interest rate- the interest rate in terms of purchasing power, that is, when changes in prices have been accounted for. The real interest rate is approximately the nominal interest rate minus the inflationary premium (which is based on the anticipated inflation rate). One way to think of it is as the interest rate in terms of things rather than money. The real interest rate is based upon the rate of time preference as well as risks associated with the loan.
discounting -calculating the present value of a future payment. The present value will be inversely related to the interest rate and the amount of time that must pass before the payment is made.
present value formula- one of several mathematical formulas relating
the interest rate, the future amount (future value) and principal amount (present
value) from an investment or loan. Specifically, 
, where PV is the present value, FV is the future
value, i is the interest rate, and n is the number of years in which the future
value will be received.
loanable funds market, money market, capital market
- the market in which loans are made and interest rates are determined.
The "buyers" of loans (capital) are borrowers, the "sellers"
are lenders, and the "price" is the interest rate.
rate of return equalization principle- the tendency for
interest rates or investment returns to be equal in all investments
of equal risk, due to market forces.
income statistics- money received as wages, tips and interest for each household. Generally, gifts, benefits received, transfer payments, welfare, and other government programs are not counted in income statistics. Income is generally lower than a person's wealth, which includes accumulated savings and the value of property. A very wealthy person might have very little income (if she is retired, for example).
income quintiles - groupings of all the households in the country, according to income, into fifths. For example, those earning the highest 20% of incomes would go into the upper quintile, so that anyone in the top quintile is earning more income than at least 80% of the people in the country. Quintile groupings cannot logically be used to indicate income mobility, since the people in a particular quintile one year are not all going to be in that same quintile the next year. A more justifiable use of quintiles is in determining income equality, for which the incomes separating the quintiles should be used (not the average income in a quintile).
Gross Domestic Product (GDP) -the market value of all final goods and services produced domestically during the year. Final goods and services are those that are purchased by their ultimate users.
consumption (C)-household (consumer) spending on goods and services. It is the largest component of GDP expenditure in the United States economy.
investment (I)-business spending on goods and services.
government spending (G) - purchases by the government of goods and services; the second largest component of GDP.
net exports (X-M)- goods produced domestically but purchased
by foreigners minus goods purchased from foreigners.
GDP=C+I+G+(X-M) expresses that GDP is the sum of the spending
of consumers, businesses, government and foreigners on domestic
current output.
public sector-government
private sector- business and consumers
price index- a number which is calculated from the economy's price and output data, and which will allow estimation of the inflation rate over time. Generally, a price index is constructed by determining the sums of money that would be necessary to purchase the same combination of goods at two different time periods (and at two sets of prices), taking a ratio of these sums, and multiplying by 100. The percentage change in a price index over time can be used as a measure of inflation.
Consumer Price Index- a price index which is calculated using a combination of items which consumers are likely to buy. This index is one of those most commonly used by government and business to determine inflation at the retail level.
GDP deflator- a price index which is calculated using the goods comprising GDP.
nominal (current) GDP - GDP computed using current year's prices.
real (constant) GDP- GDP that has been adjusted for inflation by use of a price index or price ratio (ratio of price indices). Real GDP is also sometimes called "real output." Real GDP= (nominal GDP)/(price ratio)
growth rate- the percentage change or percentage difference in some variable, such as real GDP
price ratio -the ratio of price indices, this can also be a ratio of nominal to real GDP
net monetary debtor- a person who owes more money than he is owed by others. Such a person will gain from an unanticipated inflation.
net monetary creditor- a person who is owed more money by others than she owes to others. Such a person is harmed by an unanticipated inflation.
labor force- persons who are either employed or unemployed (see unemployment)
unemployment- the situation in which one is either actively looking for work or waiting to start work (such as during a temporary layoff) but does not have a job currently. A person in such a situation is unemployed.
unemployment rate - the percentage of persons in the labor force who are unemployed.
labor force participation rate- the percentage of the population that is in the labor force.
frictional unemployment- unemployment that is caused by the job search process and the costs involved in getting information on available jobs.
structural unemployment- unemployment caused by changes in the economy which will require some workers to get retrained before they can find a job. The longer it takes the worker to learn that he needs training and how it can be obtained, the longer the worker will be unemployed.
cyclical unemployment- unemployment resulting from cycles in the economy affecting the demand for or supply of labor; it takes buyers and sellers in the labor market to adjust to new realities concerning wages, especially if the labor market is frequently changing.
long run -a time period sufficient to enable decision-makers to adjust to market changes.
short run -a time period in which decision-makers have not yet adjusted to market changes.
aggregate demand-the inverse relationship between the price level and the quantity of goods and services desired by buyers (consumers, businesses, government, and foreigners) from the economy.
aggregate supply- the relationship between the price level and the quantity of goods and services produced in the economy. In the short run, the aggregate supply is thought to be a positive relationship. In the long run, aggregate supply is represented by a vertical line indicating that output does not depend on the price level.
short run macroeconomic equilibrium -the real GDP and price level at which the short-run aggregate supply and the aggregate demand curve are equal.
long run macroeconomic equilibrium -the real GDP and price level at which the short-run aggregate supply, the long run aggregate supply, and the aggregate demand curve are equal.
full employment equilibrium -the long run macroeconomic equilibrium, so called because all resources are being used to their full capacity.
natural rate of unemployment- the level of unemployment at full employment equilibrium; some unemployment (frictional unemployment) is considered unavoidable or natural.
exchange rate- the price of one country's money in terms of another country's money.
fiscal policy- government taxing and spending policy
countercyclical policy- a policy that attempts to stabilize the economy by offsetting whatever changes the economy is experiencing naturally.
self-correcting mechanism-the belief that when an economy is operating at less (more) than full employment, decreases (increases) in wages, resource prices, and interest rates will eventually restore long run equilibrium without government intervention.
balanced (government) budget-a situation in which the government is taking in exactly the same amount of taxes as it is spending
(government) budget deficit-a situation in which the government raises less in tax revenues than it spends.
government) budget surplus-a situation in which the government raises more in tax revenues than it spends.
national debt or government debt- the sum of the government budget surpluses and deficits; the total owed by the government
Keynesian model-the view of the economy as relationships between expenditure and income. These relationships are that consumption depends on income, while income depends on consumption, government spending, and investment.
autonomous spending- spending that occurs regardless of income
induced spending- spending (primarily on consumption) that depends on the level of income in the economy.
marginal propensity to consume - the change in consumption which is induced by each dollar's change in income.
saving- income that is neither taxed nor spent on consumption.
injections- spending that tends to generate income and thus raise GDP; these include consumption (C), investment (I), and government spending (G).
eakages- income disposal that tends to reduce future income; these include savings (S) and taxes T).
YG=C+I+G, YD=C+S+T the relationships for income generation or creation (YG) and income disposal (YD). In a Keynesian equilibrium, income generation is equal to income disposal.
Keynesian multiplier - the relationship between changes in equilibrium income and an initial change in autonomous spending. For each dollar change in autonomous spending, the Keynesian model predicts that the change in equilibrium income will be 1/(1-MPC) times as great.
expansionary fiscal policy- increase in government spending or reduction in taxes intended to increase the budget deficit and cause the economy to grow.
restrictive fiscal policy- reductions in government spending or increases in taxes to restrict the growth of the economy (often to avoid inflation).
automatic stabilizers-programs that will increase government spending during recessions and reduce government spending during growth periods in the economy, without special action by government officials.
crowding out effect- when reductions in private consumer and business spending occur because government deficits raise real interest rates.
rational expectations-the view that changes in government spending will affect private spending, as those in the private sector anticipate higher or lower future taxes. The implication is that fiscal policy will be largely ineffective.
adaptive expectations-the view that private sector decision makers will base decisions on the past, with the most recent past having the biggest influence on current decisions.
new classical economics- the school of thought that markets tend to long run equilibrium without government action. The implication is that fiscal policy will be largely ineffective.
marginal tax rate- the amount of additional tax that must be paid for each additional dollar of income.
average tax rate -the total tax liability of a person divided by her/his income.
progressive tax- a tax for which the average tax rate rises as income moves to higher levels.
regressive tax - a tax for which the average tax rate falls and income becomes higher.
proportional tax - a tax for which the average tax rate is the same regardless of income.
Laffer curve-a graphical representation of the relationship of tax rates to tax revenues. It shows that, as tax rates rise, tax revenues will rise and then fall.
money- anything commonly used and generally accepted as final payment of debts. in the United States, money includes demand deposits and currency.
monetary policy-affecting the economy by changing the amount of money in existence.
demand deposits- checking account money; money which can be transferred by check
currency- money in the form of cash and coin
fractional reserve banking system-a system in which banks keep only a portion of their deposits to back up those deposits.
Federal Reserve Bank-the central bank of the United States, it has control over banks and the money supply.
"The Fed" -nickname for the Federal Reserve Bank.
actual (bank) reserves- vault cash plus bank deposits at the Fed
vault cash- coins and cash held by banks. Vault cash is not money; instead, it is actual reserves.
required reserves- reserves which banks are must have to secure their deposits. They are equal to the demand deposits in the bank times the required reserve ratio.
required reserve ratio- the fraction of deposits that banks must hold in the form of actual reserves. The ratio is set by the Fed. If the Fed reduces the required reserve ratio, excess reserves will rise, thus enabling banks to lend more, create demand deposits and thus expand the money supply.
excess reserves- the amount by which actual reserves exceed required reserves. Excess reserves can safely be lent out, as they are not legally needed to secure deposits in the bank.
(re)discount rate- the interest rate that the Fed charges banks when they borrow reserves. This is the only interest rate that the Fed directly sets. if the Fed lowers the discount rate, it tends to encourage banks to borrow reserves, enabling them to extend more loans, increase demand deposits and thus increase the money supply.
open market operations- the most frequently used tool of the Fed, these are purchases or sales of bonds by the Fed. Purchase of bonds by the Fed will raise bank actual reserves and thus increase demand deposit creation and the money supply. Sale of bonds by the Fed will have the opposite effect.
bank expansion- the act by banks of creating money by making new loans of demand deposits.
bank expansion equation -the formula relating additional excess reserves in the banking system to the amount of money that can be eventually generated (in the form of new loans) by banks. Specifically, new loans= (new ER)/r , where ER is excess reserves and r is the required reserve ratio.
velocity of money- the number of times each dollar in existence changes hands in a year.
Equation of Exchange-the equation relating the money supply to other
economic variables. Specifically, MV=PQ, where M is the money supply, V is velocity,
P is the price level and Q is real output or real GDP. In terms of growth rates,
expansionary monetary policy- an increase in the growth rate of the money supply.
restrictive monetary policy- reductions in the growth rate of the money supply to restrict the growth of the economy (often to avoid inflation).
nonactivist - the view that the economy would be more stable is the monetary and fiscal policy makers followed consistent policy rules instead of changing policy as conditions change.
activist - the view that monetary and fiscal policy can be used to "fine tune" and stabilize the economy.
Phillips Curve-the theoretical inverse relationship between inflation and unemployment over time. Data suggests that the relationship does not actually exist, or that the theory must be modified to include changes in expected inflation.
tariff-a tax on imported goods.
quota- a restriction on the quantity of goods that can be imported.
exchange rate- the price of one country's money in terms of another country's money.
appreciation-becoming more valuable (higher value or price).
depreciation-becoming less valuable (lower value or price).
balance of payments- a way to measure imports and exports of goods, services and loans.
credit (in account balancing)- a positive bookkeeping entry, recording a payment of money received.
debit (in account balancing)- a bookkeeping entry, recording a payment of money going out.
current account- the flow of money used to pay for goods and services exchanged internationally.
current account deficit-money is leaving the country to pay for imported goods and services. Also called a "trade deficit."
current account surplus -money is entering the country as other countries pay for goods and services being shipped to them. Also called a "trade surplus."
merchandise trade- the international trade of goods (not services).
capital account- the flow of money lent internationally; the flow of international credit.
capital account deficit-money is leaving the country as it is lent internationally.
capital account surplus -money is entering the country
as other countries lend to people or governments in this country.
phoenix college > departments > Liberal Arts > eonomics > ECN111> Terms and Tools