abatement policy
A policy designed to reduce environmental damages. See also: abatement.
Practices to limit or reverse environmental damages. See also: abatement policy.
absolute advantage
A person or country has this in the production of a good if the inputs it uses to produce this good are less than in some other person or country. See also: comparative advantage.
The obligation of a decision-maker (or body) to be responsive to the needs and wishes of people affected by his, her or its decisions.
No tendency to move either in the same or opposite direction to aggregate output and employment over the business cycle.
adjustment gap
The lag between some outside change in labour market conditions and the movement of the economy to the neighbourhood of the new equilibrium.
administratively feasible
Policies for which the government has sufficient information and staff for implementation.
adverse selection
The problem faced by parties to an exchange in which the terms offered by one party will cause some exchange partners to drop out. An example is the problem of asymmetric information in insurance: if the price is sufficiently high, the only people who will seek to purchase medical insurance are people who know they are ill (but the insurer does not). This will lead to further price increases to cover costs. Also referred to as the ‘hidden attributes’ problem (the state of already being ill is the hidden attribute), to distinguish it from the ‘hidden actions’ problem of moral hazard. See also: incomplete contract, moral hazard, asymmetric information.
aggregate demand
The total of the components of spending in the economy, added to get GDP: Y = C + I + G + XM. It is the total amount of demand for (or expenditure on) goods and services produced in the economy. See also: consumption, investment, government spending, exports, imports.
aggregate output
The total output in an economy, across all sectors and regions.
A description of who does what, the consequences of their actions, and who gets what as a result.
The willingness to bear a cost in order to benefit somebody else.
antitrust policy
Government policy and laws to limit monopoly power and prevent cartels. Also known as: competition policy.
The practice of buying a good at a low price in a market to sell it at a higher price in another. Traders engaging in arbitrage take advantage of the price difference for the same good between two countries or regions. As long as the trade costs are lower than the price gap, they make a profit. See also: price gap.
artificially scarce good
A public good that it is possible to exclude some people from enjoying. Also known as: club good.
asset price bubble
Sustained and significant rise in the price of an asset fuelled by expectations of future price increases.
Anything of value that is owned. See also: balance sheet, liability.
asymmetric information
Information that is relevant to the parties in an economic interaction, but is known by some but not by others. See also: adverse selection, moral hazard.
A policy where a government tries to improve its budgetary position in a recession by increasing its saving. See also: paradox of thrift.
automatic stabilizers
Characteristics of the tax and transfer system in an economy that have the effect of offsetting an expansion or contraction of the economy. An example is the unemployment benefits system.
The use of machines that are substitutes for labour.
autonomous consumption
Con­sumption that is independent of current income.
autonomous demand
Components of aggregate demand that are independent of current income.
average cost
The total cost of the firms’s output divided by the total number of units of output.
average product
Total output divided by a particular input, for example per worker (divided by the number of workers) or per worker per hour (total output divided by the total number of hours of labour put in).
balance of payments (BP)
This records the sources and uses of foreign exchange. This account records all payment transactions between the home country and the rest of the world, and is divided into two parts: the current account and the capital and financial account. Also known as: balance of payments account.
balance sheet
A record of the assets, liabilities, and net worth of an economic actor such as a household, bank, firm, or government.
bank bailout
The government buys an equity stake in a bank or some other intervention to prevent it from failing.
bank money
Money in the form of bank deposits created by commercial banks when they extend credit to firms and households.
bank run
A situation in which depositors withdraw funds from a bank because they fear that it may go bankrupt and not honour its liabilities (that is, not repay the funds owed to depositors).
A firm that creates money in the form of bank deposits in the process of supplying credit.
bargaining gap
The difference between the real wage that firms wish to offer in order to provide workers with incentives to work, and the real wage that allows firms the markup that maximizes profits given the degree of competition.
bargaining power
The extent of a person’s advantage in securing a larger share of the economic rents made possible by an interaction.
base money
Cash and the balances held by commercial banks in their accounts at the central bank, known as reserves. Also known as: legal tender, high-powered money.
best response
In game theory, the strategy that will give a player the highest payoff, given the strategies that the other players select.
Beveridge curve
The inverse relationship between the unemployment rate and the job vacancy rate (each expressed as a fraction of the labour force). Named after the British economist of the same name.
biodiversity loss (rate of)
Proportion of species that become extinct every year.
biological survival constraint
This shows all the points that are ‘biologically feasible’. See also: biologically feasibile.
biologically feasible
An allocation that is capable of sustaining the survival of those involved is biologically feasible.
A type of financial asset for which the issuer promises to pay a given amount over time to the holder. Also known as: corporate bonds.
Bretton Woods system
An international monetary system of fixed but adjustable exchange rates, established at the end of the Second World War. It replaced the gold standard that was abandoned during the Great Depression.
broad money
The stock of money in circulation, which is the sum of base money (excluding legal tender held by banks) and bank money. See also: legal tender, bank money.
budget constraint
An equation that represents all combinations of goods and services that one could acquire that exactly exhaust one’s budgetary resources.
business cycle
Alternating periods of faster and slower (or even negative) growth rates. The economy goes from boom to recession and back to boom. See also: short-run equilibrium.
cap and trade
A policy through which a limited number of permits to pollute are issued, and can be bought and sold on a market. It combines a quantity-based limit on emissions, and a price-based approach that places a cost on environmentally damaging decisions.
A situation in which a firm has more orders for its output than it can fill. See also: low capacity utilization.
capacity utilization rate
A measure of the extent to which a firm, industry, or entire economy is producing as much as the stock of its capital goods and current knowledge would allow.
capital goods
The equipment, buildings, raw materials, and other inputs used in producing goods and services, including where applicable any patents or other intellectual property that is used.
capital intensity (of production)
The amount of capital goods per worker.
Making greater use of capital goods (for example machinery and equipment) as compared with labour and other inputs. See also: labour-intensive.
capital productivity
Output per unit of capital good. See also: labour productivity.
An economic system in which private property, markets, and firms play an important role.
capitalist revolution
Rapid improvements in technology combined with the emergence of a new economic system.
A group of firms that collude in order to increase their joint profits.
catch-up growth
The process by which many (but far from all) economies in the world close the gap between the world leader and their own economy.
categorical inequality
Inequality between particular social groups (identified, for instance, by a category such as race, nation, caste, gender or religion). Also known as: group inequality.
A direction from cause to effect, establishing that a change in one variable produces a change in another. While a correlation is simply an assessment that two things have moved together, causation implies a mechanism accounting for the association, and is therefore a more restrictive concept. See also: natural experiment, correlation.
central bank
The only bank that can create a country’s legal tender. Usually part of the government. Commercial banks have accounts at this bank, holding legal tender.
ceteris paribus
Economists often simplify analysis by setting aside things that are thought to be of less importance to the question of interest. The literal meaning of the expression is ‘other things equal’. In an economic model it means an analysis ‘holds other things constant’.
club good
See: artificially scarce good, public good.
A means of pooling savings across households in order for a household to be able to maintain consumption when it experiences a temporary fall in income or the need for greater expenditure.
codified knowledge
Knowledge that can be written down in a form that would allow it to be understood by others and reproduced, such as the chemical formula for a drug. See also: tacit knowledge.
An asset that a borrower pledges to a lender as a security for a loan. If the borrower is not able to make the loan payments as promised, the lender becomes the owner of the asset.
collateralized debt obligation (CDO)
A structured financial instrument (a derivative) consisting of a bond or note backed by a pool of fixed-income assets. The collapse in the value of the instruments of this type that were backed by subprime mortgage loans was a major factor in the financial crisis of 2007–2008.
Physical goods traded in a manner similar to stocks. They include metals such as gold and silver, and agricultural products such as coffee and sugar, oil and gas. Sometimes more generally used to mean anything produced for sale.
common currency area
A group of countries that use the same currency. This means there is just one monetary policy for the group. Also known as: currency union.
common-pool resource
A rival good that one cannot prevent others from enjoying. Also known as: common property resource.
comparative advantage
A person or country has comparative advantage in the production of a particular good, if the cost of producing an additional unit of that good relative to the cost of producing another good is lower than another person or country’s cost to produce the same two goods. See also: absolute advantage.
competition policy
Government policy and laws to limit monopoly power and prevent cartels. Also known as: antitrust policy.
competitive equilibrium
A market outcome in which all buyers and sellers are price-takers, and at the prevailing market price, the quantity supplied is equal to the quantity demanded.
Two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the other. See also: substitutes.
concave function
A function of two variables for which the line segment between any two points on the function lies entirely below the curve representing the function (the function is convex when the line segment lies above the function).
conspicuous consumption
The purchase of goods or services to publicly display one’s social and economic status.
constant prices
Prices corrected for increases in prices (inflation) or decreases in prices (deflation) so that a unit of currency represents the same buying power in different periods of time. See also: purchasing power parity.
constant returns to scale
These occur when doubling all of the inputs to a production process doubles the output. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs. See also: increasing returns to scale, decreasing returns to scale.
constrained choice problem
This problem is about how we can do the best for ourselves, given our preferences and constraints, and when the things we value are scarce. See also: constrained optimization problem.
constrained optimization problem
Problems in which a decision-maker chooses the values of one or more variables to achieve an objective (such as maximizing profit) subject to a constraint that determines the feasible set (such as the demand curve).
consumer durables
Consumer goods with a life expectancy of more than three years such as home furniture, cars, and fridges.
consumer price index (CPI)
A measure of the general level of prices that consumers have to pay for goods and services, including consumption taxes.
consumer surplus
The consumer’s willingness to pay for a good minus the price at which the consumer bought the good, summed across all units sold.
consumption (C)
Expenditure on consumer goods including both short-lived goods and services and long-lived goods, which are called consumer durables.
consumption function (aggregate)
An equation that shows how consumption spending in the economy as a whole depends on other variables. For example, in the multiplier model, the other variables are current disposable income and autonomous consumption. See also: disposable income, autonomous consumption.
consumption good
A good or service that satisfies the needs of consumers over a short period.
contingent valuation
A survey-based technique used to assess the value of non-market resources. Also known as: stated-preference model.
A legal document or understanding that specifies a set of actions that parties to the contract must undertake.
Participating in a common project that is intended to produce mutual benefits.
cooperative firm
A firm that is mostly or entirely owned by its workers, who hire and fire the managers.
coordination game
A game in which there are two Nash equilibria, of which one may be Pareto superior to the other. Also known as: assurance game.
Ownership rights over the use and distribution of an original work.
correlation coefficient
A measure of how closely associated two variables are and whether they tend to take similar or dissimilar values, ranging from a value of 1 indicating that the variables take similar values (‘are positively correlated’) to –1 indicating that the variables take dissimilar variables (‘negative’ or ‘inverse’ correlation). A value of 1 or –1 indicates that knowing the value of one of the variables would allow you to perfectly predict the value of the other. A value of 0 indicates that knowing one of the variables provides no information about the value of the other. See also: correlation, causality.
A statistical association in which knowing the value of one variable provides information on the likely value of the other, for example high values of one variable being commonly observed along with high values of the other variable. It can be positive or negative (it is negative when high values of one variable are observed with low values of the other). It does not mean that there is a causal relationship between the variables. See also: causality, correlation coefficient.
costs of entry
Startup costs that would be incurred when a seller enters a market or an industry. These would usually include the cost of acquiring and equipping new premises, research and development, the necessary patents, and the cost of finding and hiring staff.
Tending to move in the opposite direction to aggregate output and employment over the business cycle.
creative destruction
Joseph Schumpeter’s name for the process by which old technologies and the firms that do not adapt are swept away by the new, because they cannot compete in the market. In his view, the failure of unprofitable firms is creative because it releases labour and capital goods for use in new combinations.
A description of individuals who are able to borrow only on unfavourable terms. See also: credit-excluded.
A description of individuals who are unable to borrow on any terms. See also: credit-constrained.
credit ratings agency
A firm which collects information to calculate the credit-worthiness of individuals or companies, and sells the resulting rating for a fee to interested parties.
credit rationing
The process by which those with less wealth borrow on unfavourable terms, compared to those with more wealth.
crowding out
There are two quite distinct uses of the term. One is the observed negative effect when economic incentives displace people’s ethical or other-regarding motivations. In studies of individual behaviour, incentives may have a crowding out effect on social preferences. A second use of the term is to refer to the effect of an increase in government spending in reducing private spending, as would be expected for example in an economy working at full capacity utilization, or when a fiscal expansion is associated with a rise in the interest rate.
current account (CA)
The sum of all payments made to a country minus all payments made by the country. See also: current account deficit, current account surplus.
current account deficit
The excess of the value of a country’s imports over the combined value of its exports plus its net earnings from assets abroad. See also: current account, current account surplus.
current account surplus
The excess of the combined value of its exports and net earnings from assets abroad over the value of its imports. See also: current account, current account deficit.
cyclical unemployment
The increase in unemployment above equilibrium unemployment caused by a fall in aggregate demand associated with the business cycle. Also known as: demand-deficient unemployment. See also: equilibrium unemployment.
deadweight loss
A loss of total surplus relative to a Pareto-efficient allocation.
decreasing returns to scale
These occur when doubling all of the inputs to a production process less than doubles the output. Also known as: diseconomies of scale. See also: increasing returns to scale.
default risk
The risk that credit given as loans will not be repaid.
A decrease in the general price level. See also: inflation.
demand curve
The curve that gives the quantity consumers will buy at each possible price.
demand shock
An unexpected change in aggregate demand, such as a rise or fall in autonomous consumption, investment, or exports. See also: supply shock.
demand side (aggregate economy)
How spending decisions generate demand for goods and services, and as a result, employment and output. It uses the multiplier model. See also: supply side (aggregate economy).
demand side
The side of a market on which those participating are offering money in return for some other good or service (for example, those purchasing bread). See also: supply side.
A political system, that ideally gives equal political power to all citizens, defined by individual rights such as freedom of speech, assembly, and the press; fair elections in which virtually all adults are eligible to vote; and in which the government leaves office if it loses.
democratic accountability
Political accountability by means of elections and other democratic processes. See also: accountability, political accountability.
demographic transition
A slowdown in population growth as a fall in death rate is more than balanced by a fall in birth rates.
The loss in value of a form of wealth that occurs either through use (wear and tear) or the passage of time (obsolescence).
A financial instrument in the form of a contract that can be traded, whose value is based on the performance of underlying assets such as shares, bonds or real estate. See also: collateralized debt obligation.
developmental state
A government that takes a leading role in promoting the process of economic development through its public investments, subsidies of particular industries, education and other public policies.
differentiated product
A product produced by a single firm that has some unique characteristics compared to similar products of other firms.
diffusion gap
The lag between the first introduction of an innovation and its general use. See also: diffusion.
The spread of the invention throughout the economy. See also: diffusion gap.
diminishing average product of labour
A situation in which, as more labour is used in a given production process, the average product of labour typically falls.
diminishing marginal product
A property of some production functions according to which each additional unit of input results in a smaller increment in total output than did the previous unit.
diminishing marginal returns to consumption
The value to the individual of an additional unit of consumption declines, the more consumption the individual has. Also known as: diminishing marginal utility.
diminishing marginal utility
A property of some utility functions according to which each additional unit of a given variable results in a smaller increment to total utility than did the previous additional unit. Also known as: diminishing marginal returns to consumption.
diminishing returns
A situation in which the use of an additional unit of a factor of production results in a smaller increase in output than the previous increase. Also known as: diminishing marginal returns in production
discount rate
A measure of the person’s impatience: how much the person values an additional unit of consumption now relative to an additional unit of consumption later. It is the slope of the person’s indifference curve for consumption now and consumption later, minus one. Also known as: subjective discount rate.
discounting future generations’ costs and benefits
A measure of how we currently value the costs and benefits experienced by people who will live in the future. Note that this is not a measure of individual impatience about one’s own future benefits and costs.
diseconomies of scale
These occur when doubling all of the inputs to a production process less than doubles the output. Also known as: decreasing returns to scale. See also: economies of scale.
disequilibrium process
An economic variable may change either because the things that determine the equilibrium value of that variable have changed (an equilibrium process), or because the system is not in equilibrium so that there exist forces for change that are internal to the model in question (a disequilibrium process). The latter process applies when the economy moves towards a stable equilibrium (which itself is not moving) or away from a tipping point (an unstable equilibrium).
disequilibrium rent
The economic rent that arises when a market is not in equilibrium, for example when there is excess demand or excess supply in a market for some good or service. In contrast, rents that arise in equilibrium are called equilibrium rents.
A decrease in the rate of inflation. See also: inflation, deflation.
disposable income
Income available after paying taxes and receiving transfers from the government.
distributionally neutral
A policy that is neither progressive or regressive so that it does not alter the distribution of income. See also: progressive (policy), regressive (policy).
division of labour
The specialization of producers to carry out different tasks in the production process. Also known as: specialization.
dominant strategy equilibrium
An outcome of a game in which every player plays his or her dominant strategy.
dominant strategy
Action that yields the highest payoff for a player, no matter what the other players do.
dominant technology
A technology that produces the same amount at lower cost than alternative technologies irrespective of the prices of inputs. It is capable of producing the same amount of output as the alternative technology with less of at least one input, and not more of any input.
We describe an outcome in this way if more of something that is positively valued can be attained without less of anything else that is positively valued. In short: an outcome is dominated if there is a win-win alternative.
Wages, salaries, and other income from labour.
economic accountability
Accountability achieved by economic processes, notably competition among firms or other entities in which failure to take account of those affected will result in losses in profits or in business failure. See also: accountability, political accountability.
economic cost
The out-of-pocket cost of an action, plus the opportunity cost.
economic profit
A firm’s revenue minus its total costs (including the opportunity cost of capital).
economic rent
A payment or other benefit received above and beyond what the individual would have received in his or her next best alternative (or reservation option). See also: reservation option.
economic system
The institutions that organize the production and distribution of goods and services in an entire economy.
economically feasible
Policies for which the desired outcomes are a Nash equilibrium, so that once implemented private economic actors will not undo the desired effects.
The study of how people interact with each other and with their natural surroundings in providing their livelihoods, and how this changes over time.
economies of agglomeration
The advantages that firms may enjoy when they are located close to other firms in the same or related industries. See also: economies of scale.
economies of scale
These occur when doubling all of the inputs to a production process more than doubles the output. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs. Also known as: increasing returns to scale. See also: diseconomies of scale.
economies of scope
Cost savings that occur when two or more products are produced jointly by a single firm, rather being produced in separate firms.
effective tax rate on profits
This is calculated by taking the before-tax profit rate, subtracting the after-tax profit rate, and dividing the result by the before-tax profit rate. This fraction is usually multiplied by 100 and reported as a percentage.
efficiency wages
The payment an employer makes that is higher than an employee’s reservation wage, so as to motivate the employee to provide more effort on the job than he or she would otherwise choose to make. See also: labour discipline model, employment rent.
employment protection legislation
Laws making job dismissal more costly (or impossible) for employers.
employment rate
The ratio of the number of employed to the population of working age. See also: population of working age.
employment rent
The economic rent a worker receives when the net value of her job exceeds the net value of her next best alternative (that is, being unemployed). Also known as: cost of job loss.
Produced by the workings of a model rather than coming from outside the model. See also: exogenous
The facts about an individual that may affect his or her income, such as the physical wealth a person has, either land, housing, or a portfolio of shares (stocks). Also includes level and quality of schooling, special training, the computer languages in which the individual can work, work experience in internships, citizenship, whether the individual has a visa (or green card) allowing employment in a particular labour market, the nationality and gender of the individual, and even the person’s race or social class background. See also: human capital.
A person who creates or is an early adopter of new technologies, organizational forms, and other opportunities.
environment-consumption indifference curve
A curve on which all points are combinations of environmental quality and consumption that are equally valued by an individual or policymaker. The slope of the indifference curve is the ratio of the marginal disutility of lost consumption due to the cost of abating and of the marginal utility of environmental quality (a public good shared by all).
equilibrium (of a market)
A state of a market in which there is no tendency for the quantities bought and sold, or the market price, to change, unless there is some change in the underlying costs, preferences, or other determinants of the behaviour of market actors.
equilibrium rent
Rent in a market that is in equilibrium. Also known as: stationary or persistent rents.
equilibrium unemployment
The number of people seeking work but without jobs, which is determined by the intersection of the wage-setting and price-setting curves. This is the Nash equilibrium of the labour market where neither employers nor workers could do better by changing their behaviour. See also: involuntary unemployment, cyclical unemployment, wage-setting curve, price-setting curve, inflation-stabilizing rate of unemployment.
A model outcome that is self-perpetuating. In this case, something of interest does not change unless an outside or external force is introduced that alters the model’s description of the situation.
An individual’s own investment in a project. This is recorded in an individual’s or firm’s balance sheet as net worth. See also: net worth. An entirely different use of the term is synonymous with fairness.
evolutionary economics
An approach that studies the process of economic change, including technological innovation, the diffusion of new social norms, and the development of novel institutions.
excess demand
A situation in which the quantity of a good demanded is greater than the quantity supplied at the current price. See also: excess supply.
excess supply
A situation in which the quantity of a good supplied is greater than the quantity demanded at the current price. See also: excess demand.
exchange rate
The number of units of home currency that can be exchanged for one unit of foreign currency. For example, the number of Australian dollars (AUD) needed to buy one US dollar (USD) is defined as number of AUD per USD. An increase in this rate is a depreciation of the AUD and a decrease is an appreciation of the AUD.
exogenous shock
A sharp change in external conditions affecting a model.
Coming from outside the model rather than being produced by the workings of the model itself. See also: endogenous.
expected inflation
The opinion that wage- and price-setters form about the level of inflation in the next period. See also: inflation.
exports (X)
Goods and services produced in a particular country and sold to households, firms and governments in other countries.
expropriation risk
The probability that an asset will be taken from its owner by the government or some other actor.
external benefit
A positive external effect: that is, a positive effect of a production, consumption, or other economic decision on another person or people that is not specified as a benefit in a contract. Also known as: external economy. See also: external effect.
external cost
A negative external effect: that is, the negative effect of production, consumption, or other economic decisions on another person or party, which is not specified as a liability in a contract. Also known as: external diseconomy. See also: external effect.
external diseconomy
A negative effect of a production, consumption, or other economic decision, that is not specified as a liability in a contract. Also known as: external cost, negative externality. See also: external effect.
external economy
A positive effect of a production, consumption, or other economic decision, that is not specified as a benefit in a contract. Also known as: external benefit, positive externality. See also: external effect.
external effect
A positive or negative effect of a production, consumption, or other economic decision on another person or people that is not specified as a benefit or liability in a contract. It is called an external effect because the effect in question is outside the contract. Also known as: externality. See also: incomplete contract, market failure, external benefit, external cost.
factors of production
The labour, machinery and equipment (usually referred to as capital), land, and other inputs to a production process.
A way to evaluate an allocation based on one’s conception of justice.
fallacy of composition
Mistaken inference that what is true of the parts (for example a household) must be true of the whole (in this case the economy as a whole). See also: paradox of thrift.
feasible frontier
The curve made of points that defines the maximum feasible quantity of one good for a given quantity of the other. See also: feasible set.
feasible set
All of the combinations of the things under consideration that a decision-maker could choose given the economic, physical or other constraints that he faces. See also: feasible frontier.
final income
A measure of the value of goods and services a household can consume from its disposable income. This is equal to disposable income minus VAT paid, plus the value of public services received.
financial accelerator
The mechanism through which firms’ and households’ ability to borrow increases when the value of the collateral they have pledged to the lender (often a bank) goes up.
financial deregulation
Policies allowing banks and other financial institutions greater freedom in the types of financial assets they can sell, as well as other practices.
fire sale
The sale of something at a very low price because of the seller’s urgent need for money.
firm-specific asset
Something that a person owns or can do that has more value in the individual’s current firm than in their next best alternative.
A business organization which pays wages and salaries to employ people, and purchases inputs, to produce and market goods and services with the intention of making a profit.
first copy costs
The fixed costs of the production of a knowledge-intensive good or service.
fiscal capacity
The ability of a government to impose and collect substantial taxes from a population at low administrative and other costs. One measure of this is the amount collected divided by the cost of administering the tax system.
fiscal multiplier
The total (direct and indirect) change in output caused by an initial change in government spending. See also: fiscal stimulus, fiscal policy, aggregate demand.
fiscal policy
Changes in taxes or government spending in order to stabilize the economy. See also: fiscal stimulus, fiscal multiplier, aggregate demand.
fiscal stimulus
The use by the government of fiscal policy (via a combination of tax cuts and spending increases) with the intention of increasing aggregate demand. See also: fiscal multiplier, fiscal, policy, aggregate demand.
Fisher equation
The relation that gives the real interest rate as the difference between the nominal interest rate and expected inflation: real interest rate = nominal interest rate – expected inflation.
fixed costs
Costs of production that do not vary with the number of units produced.
A quantity measured per unit of time, such as annual income or hourly wage.
foreign direct investment (FDI)
Ownership and substantial control over assets in a foreign country. See also: foreign portfolio investment.
foreign portfolio investment
The acquisition of bonds or shares in a foreign country where the holdings of the foreign assets are not sufficiently great to give the owner substantial control over the owned entity. Foreign direct investment (FDI), by contrast, entails ownership and substantial control over the owned assets. See also: foreign direct investment.
free ride
Benefiting from the contributions of others to some cooperative project without contributing oneself.
fundamental value of a share
The share price based on anticipated future earnings and the level of systematic risk, which can be interpreted as a measure of the benefit today of holding the asset now and in the future.
fundamental value
See: fundamental value of a share.
gains from exchange
The benefits that each party gains from a transaction compared to how they would have fared without the exchange. Also known as: gains from trade. See also: economic rent.
game theory
A branch of mathematics that studies strategic interactions, meaning situations in which each actor knows that the benefits they receive depend on the actions taken by all. See also: game.
A model of strategic interaction that describes the players, the feasible strategies, the information that the players have, and their payoffs. See also: game theory.
GDP deflator
A measure of the level of prices for domestically produced output. This is the ratio of nominal (or current price) GDP to real (or constant price) GDP.
general-purpose technologies
Technological advances that can be applied to many sectors, and spawn further innovations. Information and communications technology (ICT), and electricity are two common examples.
Gini coefficient
A measure of inequality of any quantity such as income or wealth, varying from a value of zero (if there is no inequality) to one (if a single individual receives all of it).
global financial crisis
This began in 2007 with the collapse of house prices in the US, leading to the fall in prices of assets based on subprime mortgages and to widespread uncertainty about the solvency of banks in the US and Europe, which had borrowed to purchase such assets. The ramifications were felt around the world, as global trade was cut back sharply. Goverments and central banks responded aggressively with stabilization policies.
global greenhouse gas abatement cost curve
This shows the total cost of abating greenhouse gas emissions using abatement policies ranked from the most cost-effective to the least. See also: abatement policy.
Globalization I and II
Two separate periods of increasing global economic integration: the first extended from before 1870 until the outbreak of the First World War in 1914, and the second extended from the end of the Second World War into the twenty-first century. See also: globalization.
A process by which the economies of the world become increasingly integrated by the freer flow across national boundaries of goods, investment, finance, and to a lesser extent, labour. The term is sometimes applied more broadly to include ideas, culture, and even the spread of epidemic diseases.
gold standard
The system of fixed exchange rates, abandoned in the Great Depression, by which the value of a currency was defined in terms of gold, for which the currency could be exchanged. See also: Great Depression.
golden age (of capitalism)
The period of high productivity growth, high employment, and low and stable inflation extending from the end of the Second World War to the early 1970s.
goods market equilibrium
The point at which output equals the aggregate demand for goods produced in the home economy. The economy will continue producing at this output level unless something changes spending behaviour. See also: aggregate demand.
governing elite
Top government officials such as the president, cabinet officials, and legislative leaders, unified by a common interest such as membership in a particular party.
government bond
A financial instrument issued by governments that promises to pay flows of money at specific intervals.
government budget balance
The difference between government tax revenue and government spending (including government purchases of goods and services, investment spending, and spending on transfers such as pensions and unemployment benefits). See also: government budget deficit, government budget surplus.
government budget deficit
When the government budget balance is negative. See also: government budget balance, government budget surplus.
government budget surplus
When the government budget balance is positive. See also: government budget balance, government budget deficit.
government debt
The sum of all the bonds the government has sold over the years to finance its deficits, minus the ones that have matured.
government failure
A failure of political accountability. (This term is widely used in a variety of ways, none of them strictly analogous to market failure, for which the criterion is simply Pareto inefficiency).
government spending (G)
Expend­iture by the government to purchase goods and services. When used as a component of aggregate demand, this does not include spending on transfers such as pensions and unemployment benefits. See also: government transfers
government transfers
Spending by the government in the form of payments to households or individuals. Unemployment benefits and pensions are examples. Transfers are not included in government spending (G) in the national accounts. See also: government spending (G)
Within a given territory, the only body that can dictate what people must do or not do, and can legitimately use force and restraints on an individual’s freedom to achieve that end. Also known as: state.
Great Depression
The period of a sharp fall in output and employment in many countries in the 1930s.
great moderation
Period of low volatility in aggregate output in advanced economies between the 1980s and the 2008 financial crisis. The name was suggested by James Stock and Mark Watson, the economists, and popularized by Ben Bernanke, then chairman of the Federal Reserve.
great recession
The prolonged recession that followed the global financial crisis of 2008.
green adjustment
Accounting adjustment made to conventional measures of national income to include the value of natural capital.
greenhouse gas
Gases—mainly water vapour, carbon dioxide, methane and ozone—released in the earth’s atmosphere that lead to increases in atmospheric temperature and changes in climate.
gross domestic product (GDP)
A measure of the market value of the output of the economy in a given period.
gross income
Income net of taxes paid. Includes depreciation. See also: income, net income.
gross unemployment benefit replacement rate
The proportion of a worker’s previous gross (pre-tax) wage that is received (gross of taxation) when unemployed.
hedge finance
Financing used by firms to fulfil contractual payment obligations using cashflow. Term coined by Hyman Minsky in his Financial Instability Hypothesis. See also: speculative finance.
hedonic pricing
A method used to infer the economic value of unpriced environmental or perceptual qualities that affect the price of a marketed good. It allows a researcher to put a price on hard-to-quantify characteristics. Estimations are based on people’s revealed preferences, that is, the price they pay for one thing compared to another.
hidden actions (problem of)
This occurs when some action taken by one party to an exchange is not known or cannot be verified by the other. For example, the employer cannot know (or cannot verify) how hard the worker she has employed is actually working. Also known as: moral hazard. See also: hidden attributes (problem of).
hidden attributes (problem of)
This occurs when some attribute of the person engaging in an exchange (or the product or service being provided) is not known to the other parties. An example is that the individual purchasing health insurance knows her own health status, but the insurance company does not. Also known as: adverse selection. See also: hidden actions (problem of).
human capital
The stock of knowledge, skills, behavioural attributes, and personal characteristics that determine the labour productivity or labour earnings of an individual. Investment in this through education, training, and socialization can increase the stock, and such investment is one of the sources of economic growth. Part of an individual’s endowments. See also: endowment.
An extreme (and so far hypothetical) type of globalization in which there is virtually no barrier to the free flows of goods, services, and capital. See also: globalization.
idiosyncratic risk
A risk that only affects a small number of assets at one time. Traders can almost eliminate their exposure to such risks by holding a diverse portfolio of assets affected by different risks.  Also known as: diversifiable risk.
Any preference to move consumption from the future to the present. This preference may be derived either from pure impatience or diminishing marginal returns to consumption.
imports (M)
Goods and services produced in other countries and purchased by domestic households, firms, and the government.
in-kind transfers
Public expenditure in the form of free or subsidized services for households rather than in the form of cash transfers.
inactive population
People in the population of working age who are neither employed nor actively looking for paid work. Those working in the home raising children, for example, are not considered as being in the labour force and therefore are classified this way.
Economic reward or punishment, which influences the benefits and costs of alternative courses of action.
inclusive trade union
A union, representing many firms and sectors, which takes into account the consequences of wage increases for job creation in the entire economy in the long run.
income effect
The effect that the additional income would have if there were no change in the price or opportunity cost.
income elasticity of demand
The percentage change in demand that would occur in response to a 1% increase in the individual’s income.
The amount of profit, interest, rent, labour earnings, and other payments (including transfers from the government) received, net of taxes paid, measured over a period of time such as a year. The maximum amount that you could consume and leave your wealth unchanged. Also known as: disposable income. See also: pre-tax income.
incomplete contract
A contract that does not specify, in an enforceable way, every aspect of the exchange that affects the interests of parties to the exchange (or of others).
increasing returns to scale
These occur when doubling all of the inputs to a production process more than doubles the output. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs. Also known as: economies of scale. See also: decreasing returns to scale, constant returns to scale.
incremental innovation
Innovation that improves an existing product or process cumulatively.
A measure of the amount of something in one period of time, compared to the amount of the same thing in a different period of time, called the reference period or base period. It is common to set its value at 100 in the reference period.
indifference curve
A curve of the points which indicate the combina­tions of goods that provide a given level of utility to the individual.
Industrial Revolution
A wave of technological advances and organizational changes starting in Britain in the eighteenth century, which transformed an agrarian and craft-based economy into a commercial and industrial economy.
Goods-producing business activity: agriculture, mining, manufacturing, and construction. Manufacturing is the most important component.
inequality aversion
A dislike of outcomes in which some individuals receive more than others.
infant industry
A relatively new industrial sector in a country that has relatively high costs, because its recent establishment means that it has few benefits from learning by doing, its small size deprives it of economies of scale, or a lack of similar firms means that it does not benefit from economies of agglomeration. Temporary tariff protection of this sector or other support may increase productivity in an economy in the long run.
inflation-adjusted price
Price that takes into account the change in the overall price level.
inflation-stabilizing rate of unemployment
The unemployment rate (at labour market equilibrium) at which inflation is constant. Originally known as the ‘natural rate’ of unemployment. Also known as: non-accelerating rate of unemployment, stable inflation rate of unemployment. See also: equilibrium unemployment.
inflation targeting
Monetary policy regime where the central bank changes interest rates to influence aggregate demand in order to keep the economy close to an inflation target, which is normally specified by the government.
An increase in the general price level in the economy. Usually measured over a year. See also: deflation, disinflation.
innovation rents
Profits in excess of the opportunity cost of capital that an innovator gets by introducing a new technology, organizational form, or marketing strategy. Also known as: Schumpeterian rents.
innovation system
The relationships among private firms, governments, educational institutions, individual scientists, and other actors involved in the invention, modification, and diffusion of new technologies, and the way that these social interac­tions are governed by a combination of laws, policies, know­ledge, and social norms in force.
The process of invention and diffusion considered as a whole.
An entity is this if the value of its assets is less than the value of its liabilities. See also: solvent.
The laws and social customs governing the way people interact in society.
intellectual property rights
Patents, trademarks, and copyrights. See also: patent, trademark, copyright.
interest rate (short-term)
The price of borrowing base money.
interest rate
The price of bringing some buying power forward in time. See also: nominal interest rate, real interest rate.
intergenerational elasticity
When comparing parents and grown offspring, the percentage difference in the second generation’s status that is associated with a 1% difference in the adult generation’s status. See also: intergenerational inequality, intergenerational mobility, intergenerational transmission of economic differences.
intergenerational inequality
The extent to which differences in parental generations are passed on to the next generation, as measured by the intergenerational elasticity or the intergenerational correlation. See also: intergenerational elasticity, intergenerational mobility, intergenerational transmission of economic differences.
intergenerational mobility
Changes in the relative economic or social status between parents and children. Upward mobility occurs when the status of a child surpasses that of the parents. Downward mobility is the converse. A widely used measure of intergenerational mobility is the correlation between the positions of parents and children (for example, in their years of schooling or income). Another is the intergenerational elasticity. See also: intergenerational elasticity, intergenerational transmission of economic differences.
intergenerational transmission of economic differences
The processes by which the economic status of the adult sons and daughters comes to resemble the economic status of the parents. See also: intergenerational elasticity, intergenerational mobility.
The development of new methods of production and new products.
Goods held by a firm prior to sale or use, including raw materials, and partially-finished or finished goods intended for sale.
investment function (aggregate)
An equation that shows how investment spending in the economy as a whole depends on other variables, namely, the interest rate and profit expectations. See also: interest rate, profit.
investment (I)
Expenditure on newly produced capital goods (machinery and equipment) and buildings, including new housing.
irrational exuberance
A process by which assets become overvalued. The expression was first used by Alan Greenspan, then chairman of the US Federal Reserve Board, in 1996. It was popularized as an economic concept by the economist Robert Shiller.
isocost line
A line that represents all combinations that cost a given total amount.
isoprofit curve
A curve on which all points yield the same profit.
isototal benefits curve
The combinations of the probability of innovation and the total benefits to society from a firm’s innovation that yield the same total benefits.
A unit of energy or work, originally defined as the amount of energy necessary to lift a small apple vertically 1 metre.
labour discipline model
A model that explains how employers set wages so that employees receive an economic rent (called employment rent), which provides workers an incentive to work hard in order to avoid job termination. See also: employment rent, efficiency wages.
labour force
The number of people in the population of working age who are, or wish to be, in work outside the household. They are either employed (including self-employed) or unemployed. See also: unemployment rate, employment rate, participation rate.
Making greater use of labour as an input in production as compared with machines and other inputs. See also: capital-intensive.
labour market equilibrium
The combination of the real wage and the level of employment determined by the intersection of the wage-setting and the price-setting curves. This is the Nash equilibrium of the labour market because neither employers nor workers could do better by changing their behaviour. See also: equilibrium unemployment, inflation-stabilizing rate of unemployment.
labour market matching
The way in which employers looking for additional employees (that is, with vacancies) meet people seeking a new job.
labour market
In this market, employers offer wages to individuals who may agree to work under their direction. Economists say that employers are on the demand side of this market, while employees are on the supply side. See also: labour force.
labour productivity
Total output divided by the number of hours or some other measure of labour input.
law of one price
Holds when a good is traded at the same price across all buyers and sellers. If a good were sold at different prices in different places, a trader could buy it cheaply in one place and sell it at a higher price in another. See also: arbitrage.
learning by doing
This occurs when the output per unit of inputs increases with greater experience in producing a good or service.
lending rate (bank)
The average interest rate charged by commercial banks to firms and households. This rate will typically be above the policy interest rate: the difference is the markup or spread on commercial lending. Also known as: market interest rate. See also: interest rate, policy rate.
Leontief paradox
The unexpected finding by Wassily Leontief that exports from the US were labour-intensive and its imports capital-intensive, a result that contradicts what the economic theories predicted: namely that a country abundant in capital (like the US) would export goods that used a large quantity of capital in their production.
leverage ratio (for banks or households)
The value of assets divided by the equity stake in those assets.
leverage ratio (for non-bank companies)
The value of total liabilities divided by total assets.
See: leverage ratio.
Anything of value that is owed. See also: balance sheet, asset.
limit order
An announced price and quantity combination for an asset, either to be sold or bought.
linear regression line
The best-fitting line through a set of data.
See: liquidity.
liquidity risk
The risk that an asset cannot be exchanged for cash rapidly enough to prevent a financial loss.
Ease of buying or selling a financial asset at a predictable price.
A consequence of the network external effects that create winner-take-all competition. The competitive process results in an outcome that is difficult to change, even if users of the technology consider an alternative innovation superior.
logarithmic scale
A way of measuring a quantity based on the logarithm function, f(x) = log(x). The logarithm function converts a ratio to a difference: log (a/b) = log a – log b. This is very useful for working with growth rates. For instance, if national income doubles from 50 to 100 in a poor country and from 1,000 to 2,000 in a rich country, the absolute difference in the first case is 50 and in the second 1,000, but log(100) – log(50) = 0.693, and log(2,000) – log(1,000) = 0.693. The ratio in each case is 2 and log(2) = 0.693.
long-run equilibrium
An equilibrium that is achieved when variables that were held constant in the short run (for example, the number of firms in a market) are allowed to adjust, as people have time to respond the situation.
long run (model)
The term does not refer to a period of time, but instead to what is exogenous. A long-run cost curve, for example, refers to costs when the firm can fully adjust all of the inputs including its capital goods; but technology and the economy’s institutions are exogenous. See also: technology, institutions, short run (model), medium run (model).
Lorenz curve
A graphical representation of inequality of some quantity such as wealth or income. Individuals are arranged in ascending order by how much of this quantity they have, and the cumulative share of the total is then plotted against the cumulative share of the population. For complete equality of income, for example, it would be a straight line with a slope of one. The extent to which the curve falls below this perfect equality line is a measure of inequality. See also: Gini coefficient.
low capacity utilization
When a firm or economy could increase output by increasing employment utilizing the existing capital goods.
marginal cost
The effect on total cost of producing one additional unit of output. It corresponds to the slope of the total cost function at each point.
marginal external cost (MEC)
The cost of producing an additional unit of a good that is incurred by anyone other than the producer of the good.   See also: marginal private cost, marginal social cost.
marginal private benefit (MPB)
The benefit (in terms of profit, or utility) of producing or consuming an additional unit of a good for the individual who decides to produce or consume it, not taking into account any benefit received by others. 
marginal private cost (MPC)
The cost for the producer of producing an additional unit of a good, not taking into account any costs its production imposes on others. See also: marginal external cost, marginal social cost.
marginal product
The additional amount of output that is produced if a particular input was increased by one unit, while holding all other inputs constant.
marginal productivity of abatement expenditures
The marginal rate of transformation (MRT) of abatement costs into improved environment. It is the slope of the feasible frontier. See also: marginal rate of transformation, feasible frontier.
marginal propensity to consume (MPC)
The change in consumption when disposable income changes by one unit.
marginal propensity to import
The change in total imports associated with a change in total income.
marginal rate of substitution (MRS)
The trade-off that a person is willing to make between two goods. At any point, this is the slope of the indifference curve. See also: marginal rate of transformation.
marginal rate of transformation (MRT)
The quantity of some good that must be sacrificed to acquire one additional unit of another good. At any point, it is the slope of the feasible frontier. See also: marginal rate of substitution.
marginal revenue
The increase in revenue obtained by increasing the quantity from Q to Q + 1.
marginal social benefit (MSB)
The benefit (in terms of utility) of producing or consuming an additional unit of a good, taking into account both the benefit to the individual who decides to produce or consume it, and the benefit to anyone else affected by the decision.
marginal social cost (MSC)
The cost of producing an additional unit of a good, taking into account both the cost for the producer and the costs incurred by others affected by the good’s production. Marginal social cost is the sum of the marginal private cost and the marginal external cost.
marginal utility
The additional utility resulting from a one-unit increase of a given variable.
market capitalization rate
The rate of return that is just high enough to induce investors to hold shares in a particular company. This will be high if the company is subject to a high level of systematic risk.
market-clearing price
At this price there is no excess supply or excess demand. See also: equilibrium.
market failure
When markets allocate resources in a Pareto-inefficient way.
market power
An attribute of a firm that can sell its product at a range of feasible prices, so that it can benefit by acting as a price-setter (rather than a price-taker).
A market is a way of connecting people who may mutually benefit by exchanging goods or services through a process of buying and selling.
matching market
A market that matches members of two distinct groups of people. Each person in the market would benefit from being connected to the right member of the other group. Also known as: two-sided market.
maturity transformation
The practice of borrowing money short-term and lending it long-term. For example, a bank accepts deposits, which it promises to repay at short notice or no notice, and makes long-term loans (which can be repaid over many years). Also known as: liquidity transformation
median voter model
An economic model of the location of businesses applied to the positions taken in electoral platforms when two parties compete that provides conditions under which, in order to maximize the number of votes they will receive, the parties will adopt positions that appeal to the median voter. See also: median voter.
median voter
If voters can be lined up along a single more-versus-less dimension (such as preferring higher or lower taxes, more or less environmental protection), the median voter is the one ‘in the middle’—that is (if there is an odd number of voters in total), with an equal number preferring more and preferring less than what he or she does. See also: median voter model.
medium run (model)
The term does not refer to a period of time, but instead to what is exogenous. In this case capital stock, technology, and institutions are exogenous. Output, employment, prices, and wages are endogenous. See also: capital, technology, institutions, short run (model), long run (model).
menu costs
The resources used in setting and changing prices.
merchandise trade
Trade in tangible products that are physically shipped across borders.
merit goods
Goods and services that should be available to everyone, independently of their ability to pay.
minimum acceptable offer
In the ultimatum game, the smallest offer by the Proposer that will not be rejected by the Responder. Generally applied in bargaining situations to mean the least favourable offer that would be accepted.
missing market
A market in which there is some kind of exchange that, if implemented, would be mutually beneficial. This does not occur due to asymmetric or non-verifiable information.
momentum trading
Share trading strategy based on the idea that new information is not incorporated into prices instantly, so that prices exhibit positive correlation over short periods.
monetary policy
Central bank (or government) actions aimed at influencing economic activity through changing interest rates or the prices of financial assets. See also: quantitative easing.
money wage
The amount of money an employer pays to a worker. Also known as: nominal wage.
A medium of exchange consisting of bank notes and bank deposits, or anything else that can be used to purchase goods and services, and is accepted as payment because others can use it for the same purpose.
monopolized market
Market in which a single firm produces all the goods that are sold.
monopoly power
The power that a firm has to control its own price. The fewer close substitutes for the product are available, the greater the firm’s price-setting power. See also: monopoly.
monopoly rents
A form of economic profits, which arise due to restricted competition in selling a firm’s product. See also: economic profits.
A firm that is the only seller of a product without close substitutes. Also refers to a market with only one seller. See also: monopoly power, natural monopoly.
moral hazard
This term originated in the insurance industry to express the problem that insurers face, namely, the person with home insurance may take less care to avoid fires or other damages to his home, thereby increasing the risk above what it would be in absence of insurance. This term now refers to any situation in which one party to an interaction is deciding on an action that affects the profits or wellbeing of the other but which the affected party cannot control by means of a contract, often because the affected party does not have adequate information on the action. It is also referred to as the ‘hidden actions’ problem. See also: hidden actions (problems of), incomplete contract, too big to fail.
mortgage-backed security (MBS)
A financial asset that uses mortgages as collateral. Investors receive payments derived from the interest and principal of the underlying mortgages. See also: collateral.
mortgage (or mortgage loan)
A loan contracted by households and businesses to purchase a property without paying the total value at one time. Over a period of many years, the borrower repays the loan, plus interest. The debt is secured by the property itself, referred to as collateral. See also: collateral.
multiplier model
A model of aggregate demand that includes the multiplier process. See also: fiscal multiplier, multiplier process.
multiplier process
A mechanism through which the direct and indirect effect of a change in autonomous spending affects aggregate output. See also: fiscal multiplier, multiplier model.
See: fiscal multiplier.
Nash equilibrium
A set of strategies, one for each player in the game, such that each player’s strategy is a best response to the strategies chosen by everyone else.
national accounts
The system used for measuring overall output and expenditure in a country.
natural experiment
An empirical study exploiting naturally occurring statistical controls in which researchers do not have the ability to assign participants to treatment and control groups, as is the case in conventional experiments. Instead, differences in law, policy, weather, or other events can offer the opportunity to analyse populations as if they had been part of an experiment. The validity of such studies depends on the premise that the assignment of subjects to the naturally occurring treatment and control groups can be plausibly argued to be random.
natural logarithm
See: logarithmic scale.
natural monopoly
A production process in which the long-run average cost curve is sufficiently downward-sloping to make it impossible to sustain competition among firms in this market.
negative feedback (process)
A process whereby some initial change sets in motion a process that dampens the initial change. See also: positive feedback (process).
net capital flows
The borrowing and lending tracked by the current account. See also: current account, current account deficit, current account surplus.
net income
Gross income minus depreciation. See also: income, gross income, depreciation.
net present value
The present value of a stream of future income minus the associated costs (whether the costs are in the present or the future). See also: present value.
net worth
Assets less liabilities. See also: balance sheet, equity.
network economies of scale
These exist when an increase in the number of users of an output of a firm implies an increase in the value of the output to each of them, because they are connected to each other.
network external effects
An external effect of one person’s action on another, occuring because the two are connected in a network. See also: external effect.
New Deal
US President Franklin Roosevelt’s program, begun in 1933, of emergency public works and relief programs to employ millions of people. It established the basic structures for modern state social welfare programs, labour policies, and regulation.
nominal interest rate
The interest rate uncorrected for inflation. It is the interest rate quoted by high-street banks. See also: real interest rate, interest rate.
nominal wage
The actual amount received in payment for work, in a particular currency. Also known as: money wage. See also: real wage.
non-compete contract
A contract of employment containing a provision or agreement by which the worker cannot leave to work for a competitor. This may reduce the reservation option of the worker, lowering the wage that the employer needs to pay.
non-excludable public good
A public good for which it is impossible to exclude anyone from having access. See also: artificially scarce good.
non-rival good
A good that, if available to anyone, is available to everyone at no additional cost. See also: rival good, non-excludable public good.
normal profits
Corresponds to zero economic profit and means that the rate of profit is equal to the opportunity cost of capital. See also: economic profit, opportunity cost of capital.
The relocation of part of a firm’s activities outside of the national boundaries in which it operates. It can take place within a multinational company or may involve outsourcing production to other firms.
Okun’s coefficient
The change in the unemployment rate in percentage points predicted to be associated with a 1% change in the growth rate of GDP. See also: Okun’s law.
Okun’s law
The empirical regularity that changes in the rate of growth of GDP are negatively correlated with the rate of unemployment. See also: Okun’s coefficient.
A market with a small number of sellers, giving each seller some market power.
opportunity cost of capital
The amount of income an investor could have received by investing the unit of capital elsewhere.
opportunity cost
When taking an action implies forgoing the next best alternative action, this is the net benefit of the foregone alternative.
order book
A record of limit orders placed by buyers and sellers, but not yet fulfilled.
The right to use and exclude others from the use of something, and the right to sell the thing that is owned.
paradox of thrift
If a single individual consumes less, her savings will increase; but if everyone consumes less, the result may be lower rather than higher savings overall. The attempt to increase saving is thwarted if an increase in the saving rate is unmatched by an increase in investment (or other source of aggregate demand such as government spending on goods and services). The outcome is a reduction in aggregate demand and lower output so that actual levels of saving do not increase.
Pareto criterion
According to the Pareto criterion, a desirable attribute of an allocation is that it be Pareto-efficient. See also: Pareto dominant.
Pareto dominant
Allocation A Pareto-dominates allocation B if at least one party would be better off with A than B, and nobody would be worse off. See also: Pareto efficient.
Pareto efficiency curve
The set of all allocations that are Pareto efficient. Often referred to as the contract curve, even in social interactions in which there is no contract, which is why we avoid the term. See also: Pareto efficient.
Pareto efficient
An allocation with the property that there is no alternative technically feasible allocation in which at least one person would be better off, and nobody worse off.
Pareto improvement
A change that benefits at least one person without making anyone else worse off. See also: Pareto dominant.
participation rate
The ratio of the number of people in the labour force to the population of working age. See also: labour force, population of working age.
A right of exclusive ownership of an idea or invention, which lasts for a specified length of time. During this time it effectively allows the owner to be a monopolist or exclusive user.
The benefit to each player associated with the joint actions of all the players.
perfectly competitive equilibrium
Such an equilibrium occurs in a model in which all buyers and sellers are price-takers. In this equilibrium, all transactions take place at a single price. This is known as the law of one price. At that price, the amount supplied equals the amount demanded: the market clears. No buyer or seller can benefit by altering the price they are demanding or offering. They are both price-takers. All potential gains from trade are realized. See also: law of one price.
A pay which varies, at least partially, with a worker’s performance. See also: piece-rate work.
Phillips curve
An inverse relationship between the rate of inflation and the rate of unemployment.
piece-rate work
A type of employment in which the worker is paid a fixed amount for each unit of the product made.
Pigouvian subsidy
A government subsidy to encourage an economic activity that has positive external effects. (For example, subsidizing basic research.)
Pigouvian tax
A tax levied on activities that generate negative external effects so as to correct an inefficient market outcome. See also: external effect, Pigouvian subsidy.
policy (interest) rate
The interest rate set by the central bank, which applies to banks that borrow base money from each other, and from the central bank. Also known as: base rate, official rate. See also: real interest rate, nominal interest rate.
political accountability
Accountability achieved by political processes such as elections, oversight by an elected government, or consultation with affected citizens. See also: accountability, economic accountability.
political institutions
The rules of the game that determine who has power and how it is exercised in a society.
political rent
A payment or other benefit in excess of the individual’s next best alternative (reservation position) that exists as a result of the individual’s political position. The reservation position in this case refers to the individual’s situation were he or she to lack a privileged political position. See also: economic rent.
political system
A political system determines how governments will be selected, and how those governments will make and implement decisions that affect all or most members of a population.
polluter pays principle
A guide to environmental policy according to which those who impose negative environmental effects on others should be made to pay for the damages they impose, through taxation or other means.
population of working age
A statistical convention, which in many countries is all people aged between 15 and 64 years.
positive feedback (process)
A process whereby some initial change sets in motion a process that magnifies the initial change. See also: negative feedback (process).
postwar accord
An informal agreement (taking different forms in different countries) among employers, governments, and trade unions that created the conditions for rapid economic growth in advanced economies from the late 1940s to the early 1970s. Trade unions accepted the basic institutions of the capitalist economy and did not resist technological change in return for low unemployment, tolerance of unions and other rights, and a rise in real incomes that matched rises in productivity.
The ability to do (and get) the things one wants in opposition to the intentions of others, ordinarily by imposing or threatening sanctions.
precautionary saving
An increase in saving to restore wealth to its target level. See also: target wealth.
predistribution policy
Government actions that affect the endowments people have and their value, including the distribution of market income and the distribution of privately held wealth. Examples include education, minimum wage, and anti-discrimination policies. See also: redistribution policy.
A description of the benefit or cost we associate with each possible outcome.
present value
The value today of a stream of future income or other benefits, when these are discounted using an interest rate or the person’s own discount rate. See also: net present value.
price-based environmental policy
A policy that uses a tax or subsidy to affect prices, with the goal of internalizing the external effects on the environment of an individual’s choices.
price discrimination
A selling strategy in which different prices are set for different buyers or groups of buyers, or prices vary depending on the number of units purchased.
price elasticity of demand
The percentage change in demand that would occur in response to a 1% increase in price. We express this as a positive number. Demand is elastic if this is greater than 1, and inelastic if less than 1.
price gap
A difference in the price of a good in the exporting country and the importing country. It includes transportation costs and trade taxes. When global markets are in competitive equilibrium, these differences will be entirely due to trade costs. See also: arbitrage.
price markup
The price minus the marginal cost divided by the price. It is inversely proportional to the elasticity of demand for this good.
price-setting curve
The curve that gives the real wage paid when firms choose their profit-maximizing price.
Characteristic of producers and consumers who cannot benefit by offering or asking any price other than the market price in the equilibrium of a competitive market. They have no power to influence the market price.
primary deficit
The government deficit (its revenue minus its expenditure) excluding interest payments on its debt. See also: government debt.
primary labour market
A market in which workers are typically represented by trade unions, and enjoy high wages and job security. See also: secondary labour market, segmented labour market.
principal-agent relationship
This relationship exists when one party (the principal) would like another party (the agent) to act in some way, or have some attribute that is in the interest of the principal, and that cannot be enforced or guaranteed in a binding contract. See also: incomplete contract. Also known as: principal-agent problem.
prisoners’ dilemma
A game in which the payoffs in the dominant strategy equilibrium are lower for each player, and also lower in total, than if neither player played the dominant strategy.
private good
A good that is both rival, and from which others can be excluded.
private property
The right and expectation that one can enjoy one’s possessions in ways of one’s own choosing, exclude others from their use, and dispose of them by gift or sale to others who then become their owners.
procedural judgements of fairness
An evaluation of an outcome based on how the allocation came about, and not on the characteristics of the outcome itself, (for example, how unequal it is). See also: substantive judgements of fairness.
process innovation
An innovation that allows a good or service to be produced at lower cost than its competitors.
Tending to move in the same direction as aggregate output and employment over the business cycle. See also: countercyclical.
producer surplus
The price at which a firm sells a good minus the minimum price at which it would have been willing to sell the good, summed across all units sold.
product innovation
An innovation that produces a new good or service at a cost that will attract buyers.
production function
A graphical or mathematical expression describing the amount of output that can be produced by any given amount or combination of input(s). The function describes differing technologies capable of producing the same thing.
profit margin
The difference between the price and the marginal cost.
progressive (policy)
An expenditure or transfer that increases the incomes of poorer households by more than richer households, in percentage terms. See also: regressive (policy).
property rights
Legal protection of ownership, including the right to exclude others and to benefit from or sell the thing owned.
protectionist policy
Measures taken by a government to limit trade; in particular, to reduce the amount of imports in the economy. These are designed to protect local industries from external competition. They can take different forms, such as taxes on imported goods or import quotas.
prudential policy
A policy that places a very high value on reducing the likelihood of a disastrous outcome, even if this is costly in terms of other objectives foregone. Such an approach is often advocated where there is great uncertainty about the conditions under which a disastrous outcome would occur.
public bad
The negative equivalent of a public good. It is non-rival in the sense that a given individual’s consumption of the public bad does not diminish others’ consumption of it.
public good
A good for which use by one person does not reduce its availability to others. Also known as: non-rival good. See also: non-excludable public good, artificially scarce good.
purchasing power parity (PPP)
A statistical correction allowing comparisons of the amount of goods people can buy in different countries that have different currencies. See also: constant prices.
pure impatience
This is a characteristic of a person who values an additional unit of consumption now over an additional unit later, when the amount of consumption is the same now and later. It arises when a person is impatient to consume more now because she places less value on consumption in the future for reasons of myopia, weakness of will, or for other reasons.
quantitative easing (QE)
Central bank purchases of financial assets aimed at reducing interest rates on those assets when conventional monetary policy is ineffective because the policy interest rate is at the zero lower bound. See also: zero lower bound.
quantity-based environmental policy
Policies that implement environmental objectives by using bans, caps, and regulations.
A limit imposed by the government on the volume of imports allowed to enter the economy during a specific period of time.
race to the bottom
Self-destructive competition between national or regional governments, resulting in lower wages and less regulation to attract foreign investment in a globalized economy.
radical innovation
Innovations based on a broad range of knowledge from different sectors, recombining this to create new and very different products.
rationed goods
Goods that are allocated to buyers by a process other than price (such as queueing, or a lottery).
real interest rate
The interest rate corrected for inflation (that is, the nominal interest rate minus the rate of inflation). It represents how many goods in the future one gets for the goods not consumed now. See also: nominal interest rate, interest rate.
real wage
The nominal wage, adjusted to take account of changes in prices between different time periods. It measures the amount of goods and services the worker can buy. See also: nominal wage.
The US National Bureau of Economic Research defines it as a period when output is declining. It is over once the economy begins to grow again. An alternative definition is a period when the level of output is below its normal level, even if the economy is growing. It is not over until output has grown enough to get back to normal. The latter definition has the problem that the ‘normal’ level is subjective.
A preference to be kind or to help others who are kind and helpful, and to withhold help and kindness from people who are not helpful or kind.
redistribution policy
Taxes, monetary, and in-kind transfers of the government that result in a distribution of final income that differs from the distribution of market income. See also: predistribution policy.
regressive (policy)
An expenditure or transfer that increases the incomes of richer households by more than poorer households, in percentage terms. See also: progressive (policy).
relative price
The price of one good or service compared to another (usually expressed as a ratio).
Money sent home by international migrant workers to their families or others in the migrants’ home country. In countries which either supply or receive large numbers of migrant workers, this is an important international capital flow.
rent ceiling
The maximum legal price a landlord can charge for a rent.
repeated game
A game in which the same interaction (same payoffs, players, feasible actions) may be occur more than once.
research and development
Expenditures by a private or public entity to create new methods of production, products, or other economically relevant new knowledge.
reservation indifference curve
A curve that indicates allocations (combinations) that are as highly valued as one’s reservation option.
reservation option
A person’s next best alternative among all options in a particular transaction. Also known as: fallback option. See also: reservation price.
reservation price
The lowest price at which someone is willing to sell a good (keeping the good is the potential seller’s reservation option). See also: reservation option.
reservation wage
What an employee would get in alternative employment, or from an unemployment benefit or other support, were he or she not employed in his or her current job.
reserves (natural resource)
The amount of a natural resource that is economically feasible to extract given existing technologies. See also: resources (natural).
residual claimant
The person who receives the income left over from a firm or other project after the payment of all contractual costs (for example the cost of hiring workers and paying taxes).
resources (natural)
The estimated total amount of a substance in the earth’s crust. See also: reserves (natural resource).
revealed preference
A way of studying preferences by reverse engineering the motives of an individual (her preferences) from observations about her or his actions.
reverse causality
A two-way causal relationship in which A affects B and B also affects A.
rival good
A good which, if consumed by one person, is not available to another. See also: non-rival good.
When consumption expenditure is less than net income, saving takes place and wealth rises. See also: wealth.
A good that is valued, and for which there is an opportunity cost of acquiring more.
Schumpeterian rents
Profits in excess of the opportunity cost of capital that an innovator gets by introducing a new technology, organizational form or marketing strategy. Also known as: innovation rents.
secondary labour market
Workers typically on short-term contracts with limited wages and job security. This might be due to their age, or because they are discriminated against by race or ethnic group. See also: primary labour market, segmented labour market.
segmented labour market
A labour market whose distinct segments function as separate labour markets with limited mobility of workers from one segment to the other (including for reasons of racial, language, or other forms of discrimination). See also: primary labour market, secondary labour market.
Saving by a household in order to be able to maintain its consumption when there is a temporary fall in income or need for greater expenditure.
separation of ownership and control
The attribute of some firms by which managers are a separate group from the owners.
sequential game
A game in which all players do not choose their strategies at the same time, and players that choose later can see the strategies already chosen by the other players, for example the ultimatum game. See also: simultaneous game.
A part of the assets of a firm that may be traded. It gives the holder a right to receive a proportion of a firm’s profit and to benefit when the firm’s assets become more valuable. Also known as: common stock.
An exogenous change in some of the fundamental data used in a model.
short-run equilibrium
An equilibrium that will prevail while certain variables (for example, the number of firms in a market) remain constant, but where we expect these variables to change when people have time to respond to the situation.
short run (model)
The term does not refer to a period of time, but instead to what is exogenous: prices, wages, the capital stock, technology, institutions. See also: price, wages, capital, technology, institutions, medium run (model), long run (model).
short selling
The sale of an asset borrowed by the seller, with the intention of buying it back at a lower price. This strategy is adopted by investors expecting the value of an asset to decrease. Also known as: shorting.
short side (of a market)
The side (either supply or demand) on which the number of desired transactions is least (for example, employers are on the short side of the labour market, because typically there are more workers seeking work than there are jobs being offered). The opposite of short side is the long side. See also: supply side, demand side.
This subjective term refers to the case when the person making a judgement places too much weight on costs, benefits, and other things occurring in the near future than would be appropriate.
simultaneous game
A game in which players choose strategies simultaneously, for example the prisoners’ dilemma. See also: sequential game.
social dilemma
A situation in which actions taken independently by individuals in pursuit of their own private objectives result in an outcome which is inferior to some other feasible outcome that could have occurred if people had acted together, rather than as individuals.
social insurance
Expenditure by the government, financed by taxation, which provides protection against various economic risks (for example, loss of income due to sickness, or unemployment) and enables people to smooth incomes throughout their lifetime. See also: co-insurance.
social interactions
Situations in which the actions taken by each person affect other people’s outcomes as well as their own.
social norm
An understanding that is common to most members of a society about what people should do in a given situation when their actions affect others.
social preferences
Preferences that place a value on what happens to other people, and on acting morally, even if it results in lower payoffs for the individual.
A firm or individual for which net worth is positive or zero. For example, a bank for this assets are more than its liabilities (what it owes). See also: insolvent.
sovereign debt crisis
A situation in which government bonds come to be considered so risky that the government may not be able to continue to borrow. If so, the government cannot spend more than the tax revenue they receive.
This takes place when a country or some other entity produces a more narrow range of goods and services than it consumes, acquiring the goods and services that it does not produce by trade.
Buying and selling assets in order to profit from an anticipated change in their price.
speculative finance
A strategy used by firms to meet payment commitments on liabilities using cash flow, although the firm cannot repay the principal in this way. Firms in this position need to ‘roll over’ their liabilities, usually by issuing new debt to meet commitments on maturing debt. Term coined by Hyman Minsky in his Financial Instability Hypothesis. See also: hedge finance.
stable equilibrium
An equilibrium in which there is a tendency for the equilibrium to be restored after it is disturbed by a small shock.
Persistent high inflation combined with high unemployment in a country’s economy.
stationary state
In the absence of technological progress, the marginal contribution of additional capital goods to increased production would eventually become so small that the process of growth could cease. John Stuart Mill welcomed this prospect as ‘a very considerable improvement on our present condition’.
statutory minimum wage
A minimum level of pay laid down by law, for workers in general or of some specified type. The intention of a minimum wage is to guarantee living standards for the low-paid. Many countries, including the UK and the US, enforce this with legislation. Also known as: minimum wage.
stock exchange
A financial marketplace where shares (or stocks) and other financial assets are traded. It has a list of companies whose shares are traded there.
A quantity measured at a point in time. It’s units do not depend on time. See also: flow.
strategic complements
For two activities A and B: the more that A is performed, the greater the benefits of performing B, and the more that B is performed the greater the benefits of performing A.
strategic interaction
A social interaction in which the participants are aware of the ways that their actions affect others (and the ways that the actions of others affect them).
strategic substitutes
For two activities A and B: the more that A is performed, the less the benefits of performing B, and the more that B is performed the less the benefits of perfoming A.
An action (or a course of action) that a person may take when that person is aware of the mutual dependence of the results for herself and for others. The outcomes depend not only on that person’s actions, but also on the actions of others.
subprime borrower
An individual with a low credit rating and a high risk of default. See also: subprime mortgage.
subprime mortgage
A residential mortgage issued to a high-risk borrower, for example, a borrower with a history of bankruptcy and delayed repayments. See also: subprime borrower.
subsistence level
The level of living standards (measured by consumption or income) such that the population will not grow or decline.
substantive judgements of fairness
Judgements based on the characteristics of the allocation itself, not how it was determined. See also: procedural judgements of fairness.
Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other. See also: complements.
substitution effect
The effect that is only due to changes in the price or opportunity cost, given the new level of utility.
supply curve
The curve that shows the number of units of output that would be produced at any given price. For a market, it shows the total quantity that all firms together would produce at any given price.
supply shock
An unexpected change on the supply side of the economy, such as a rise or fall in oil prices or an improvement in technology. See also: wage-setting curve, price-setting curve, Phillips curve.
supply side (aggregate economy)
How labour and capital are used to produce goods and services. It uses the labour market model (also referred to as the wage-setting curve and price-setting curve model). See also: demand side (aggregate economy).
supply-side policies
A set of economic policies designed to improve the functioning of the economy by increasing productivity and international competitiveness, and by reducing profits after taxes and costs of production. Policies include cutting taxes on profits, tightening conditions for the receipt of unemployment benefits, changing legislation to make it easier to fire workers, and the reform of competition policy to reduce monopoly power. Also known as: supply-side reforms.
supply-side problem
See: supply side.
supply side
The side of a market on which those participating are offering something in return for money (for example, those selling bread). See also: demand side.
surplus, joint
The sum of the economic rents of all involved in an interaction. Also known as: total gains from exchange or trade.
systematic risk
A risk that affects all assets in the market, so that it is not possible for investors to reduce their exposure to the risk by holding a combination of different assets. Also known as: undiversifiable risk.
systemic risk
A risk that threatens the financial system itself.
tacit knowledge
Knowledge made up of the judgments, know-how, and other skills of those participating in the innovation process. The type of knowledge that cannot be accurately written down. See also: codified knowledge.
When two curves share one point in common but do not cross. The tangent to a curve at a given point is a straight line that touches the curve at that point but does not cross it.
target wealth
The level of wealth that a household aims to hold, based on its economic goals (or preferences) and expectations. We assume that households try to maintain this level of wealth in the face of changes in their economic situation, as long as it is possible to do so.
A tax on a good imported into a country.
tax incidence
The effect of a tax on the welfare of buyers, sellers, or both.
Innovation in management that seeks to reduce labour costs, for example by dividing skilled jobs into separate less-skilled tasks so as to lower wages.
technically feasible
An allocation within the limits set by technology and biology.
technological progress
A change in technology that reduces the amount of resources (labour, machines, land, energy, time) required to produce a given amount of the output.
A process taking a set of materials and other inputs, including the work of people and machines, to produce an output.
tipping point (environmental)
A state of the environment beyond which some process (typically a degradation) becomes self-reinforcing, because of positive feedback processes. On one side, processes of environmental degradation are self-limiting. On the other side, positive feedbacks lead to self-reinforcing, runaway environmental degradation. See also: positive feedback (process).
tipping point
An unstable equilibrium at the boundary between two regions characterized by distinct movements in some variable. If the variable takes a value on one side, the variable moves in one direction; on the other, it moves in the other direction. See also: asset price bubble.
too big to fail
Said to be a characteristic of large banks, whose central importance in the economy ensures they will be saved by the government if they are in financial difficulty. The bank thus does not bear all the costs of its activities and is therefore likely to take bigger risks. See also: moral hazard.
total surplus
The total gains from trade received by all parties involved in the exchange. It is measured as the sum of the consumer and producer surpluses.
trade balance
Value of exports minus the value of imports. Also known as: net exports. See also: trade deficit, trade surplus.
trade costs
The transport costs, tariffs or other factors incurred in trading between markets in two countries that mean that, for affected goods, the law of one price will not hold across each market. See also: law of one price.
trade deficit
A country’s negative trade balance (it imports more than it exports). See also: trade surplus, trade balance.
trade surplus
A country’s positive trade balance (it exports more than it imports). See also: trade deficit, trade balance.
trade union
An organization consisting predominantly of employees, the principal activities of which include the negotiation of rates of pay and conditions of employment for its members.
A logo, a name, or a registered design typically associated with the right to exclude others from using it to identify their products.
tragedy of the commons
A social dilemma in which self-interested individuals acting independently deplete a common resource, lowering the payoffs of all. See also: social dilemma.
transaction costs
Costs that impede the bargaining process or the agreement of a contract. They include costs of acquiring information about the good to be traded, and costs of enforcing a contract.
trilemma of the world economy
The likely impossibility that any country, in a globalized world, can simultaneously maintain deep market integration (across borders), national sovereignty, and democratic governance. First suggested by Dani Rodrik, an economist.
unemployment benefit
A government transfer received by an unemployed person. Also known as: unemployment insurance
unemployment, involuntary
The state of being out of work, but pre­ferring to have a job at the wages and working conditions that other­wise identical employed workers have. See also: unemployment.
unemployment rate
The ratio of the number of the unemployed to the total labour force. (Note that the employment rate and unemployment rate do not sum to 100%, as they have different denominators.) See also: labour force, employment rate.
A situation in which a person who is able and willing to work is not employed.
unstable equilibrium
An equilibrium such that, if a shock disturbs the equilibrium, there is a subsequent tendency to move even further away from the equilibrium. 
A numerical indicator of the value that one places on an outcome, such that higher valued outcomes will be chosen over lower valued ones when both are feasible.
value added
For a production process this is the value of output minus the value of all inputs (called intermediate goods). The capital goods and labour used in production are not intermediate goods. The value added is equal to profits before taxes plus wages.
verifiable information
Information that can be used to enforce a contract.
wage inflation
An increase in the nominal wage. Usually measured over a year. See also: nominal wage.
wage labour contract
See: wage labour, contract.
wage labour
A system in which producers are paid for the time they work for their employers.
wage-price spiral
This occurs if an initial increase in wages in the economy is followed by an increase in the price level, which is followed by an increase in wages and so on. It can also begin with an initial increase in the price level.
wage-setting curve
The curve that gives the real wage necessary at each level of economy-wide employment to provide workers with incentives to work hard and well.
weakness of will
The inability to commit to a course of action (dieting or foregoing some other present pleasure, for example) that one will regret later. It differs from impatience, which may also lead a person to favour pleasures in the present, but not necessarily act in a way that one regrets.
Stock of things owned or value of that stock. It includes the market value of a home, car, any land, buildings, machinery or other capital goods that a person may own, and any financial assets such as shares or bonds. Debts are subtracted—for example, the mortgage owed to the bank. Debts owed to the person are added.
welfare state
A set of government policies designed to provide improvements in the welfare of citizens by assisting with income smoothing (for example, unemployment benefits and pensions).
willingness to accept (WTA)
The reservation price of a potential seller, who will be willing to sell a unit only for a price at least this high. See also: willingness to pay.
willingness to pay (WTP)
An indicator of how much a person values a good, measured by the maximum amount he or she would pay to acquire a unit of the good. See also: willingness to accept.
winner-take-all competition
Firms entering a market first can often dominate the entire market, at least temporarily.
worker’s best response function (to wage)
The optimal amount of work that a worker chooses to perform for each wage that the employer may offer.
The implied rate of return that the buyer gets on their money when they buy a bond at its market price.
zero economic profit
A rate of profit equal to the opportunity cost of capital. See also: normal profits, opportunity cost of capital.
zero lower bound
This refers to the fact that the nominal interest rate cannot be negative, thus setting a floor on the nominal interest rate that can be set by the central bank at zero. See also: quantitative easing.
zero sum game
A game in which the payoff gains and losses of the individuals sum to zero, for all combinations of strategies they might pursue.