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absolute advantage

the ability to produce something more efficiently


productive equipment or machinery

comparative advantage

the ability to produce something with a lower opportunity cost


a social science that studies how resources are used and is often concerned with how resources can be used to their fullest potential


using resources to their maximum potential


all human activity that is productive


all natural resources

law of Increasing costs

law that states that when more of a product is initially being produced, the higher the opportunity cost will be to produce still more


economic problems encountered by the nation as a whole


economic problems faced by individual units within the overall company

opportunity cost

the amount of one good that must be sacrificed to obtain an alternative good

positive economics

economic analysis that draws conclusions based on logical deduction or induction (value judgements are avoided)

production possibilities frontier

the combinations of two goods that can be produced if the economy uses all of its resources fully and efficiently

normative economies

economies involving value judgement


anything that can be used to produce a good or service

allocative efficiency

term for resources being deployed to produce just the right amount of each product to satisfy society's wants


an economic system where supply and demand determine prices

circular flow diagram

diagram that shows how households and firms are related by the exchange of resources and products

command economy

economy in which the central government dictates what will or will not be produced and who gets what

the law of demand

law that states that when the price of a product increases, the quantity demanded decreases, ceteris paribus

law of supply

law that states that when the price of a product increases, the quantity supplied increases, ceterus paribus

mixed economy

a blend of government commands and capitalism

consumption expenditures

all the goods and services sold to households

disposable personal income (DPI)

the income of households after taxes have been paid

government expenditures

goods and services sold to governments

gross domestic product (GDP)

dollar value of production within a nation's borders

gross national product (GNP)

dollar value of production by a country's citizens

intermediate sales

sales to firms that will incorporate the item into their final product

investment sales

sales to firms that will incorporate the item into their final product

investment expenditures

expenditures by businesses on plants and equipment plus the change in business inventories

national income (NI)

the income earned by households and profits earned by firms after subtracting depreciation and indirect business taxes

national income and product accounts (NIPA)

a comprehensive group of statistics that measures various aspects of the economy's performance

net exports

exports minus imports

personal income (PI)

income received by households

real GDP

GDP adjusted for the price changes

underground economy

all the illegal production of goods and services and legal production that does not pass through markets



GDP per capita


consumer price index (CPI)

measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services

cyclical unemployment

loss of jobs by individuals during a recession and the corresponding slowdown in production

fisher's hypothesis

Nominal Interest Rate= Real Interest Rate + Expected Inflation

frictional unemployment

state of being out of work because the person is in between jobs

GDP deflator

measure of the level of prices in the economy

hidden unemployment

describing those who are able to work but who are not actively seeking employment because they are discouraged about their prospects for finding employment


a sustained rise in most prices in the economy

menu cost

the misallocation of resources because of inflation

nonaccelerating inflation rate of unemployment

the full employment rate of unemployment; when employment falls below this rate, inflation accelerates

seasonal unemployment

state of being out of work because of the time of year

structural unemployment

state of being out of work because the economy is structured, or set up, to a person's disadvantage

unemployment rate

the number of unemployed persons divided by the labor force


(Total Cost this Period/Total Cost Base Period) x 100

Inflation rate

[(this period CPI-previous period CPI)/previous period CPI] x 100

GDP deflator

(GDP/Real GPD) x 100

Real GDP

(GDP/GDP deflator) x 100

Nominal Interest Rate

Real Interest Rate + Expected Inflation

Unemployment Rate

Number of unemployed/civilian labor force

aggregate demand

the demand for all goods and services by all households, business, governments, and foreigners

aggregate supply

the supply of all goods and services by all producers in the economy

break-even point

point where the consumption function crosses the 45 degree line and income equals spending so that saving is zero

business cycle

a wave of economic activity comprised of an expansion and a recession

classical economic theory

the predominant paradigm in economic analysis from about 1800 until 1930, based on Say's Law

consumption theory

the relationship between consumer spending and income

equilibrium price level

the price level that equates aggregate supply and aggregate demand, the average level of prices in the economy

equilibrium quantity

the amount of output that results in no shortage or surplus, the amount of goods and service bought and sold in the economy


a sustained improvement in economic activity

Keynesian theory

theory that opposes Classical theory by emphasizing the short run and focusing on economies that are operating below full capacity

marginal propensity to consume (MPC)

idea that given an extra dollar, how much is spent?


an initial change in spending in the economy that will have a magnified, or multiplied, effect on income


a sustained decline in economic activity

Say's Law

theory that supply creates its own demand


change in spending / change in income



total change in income

Initial Change in Spending x Multiplier

automatic stabilizers

government policies already in place that promote deficit spending during recessions and surplus budgets during expansions

crowding out

the increase in interest rates and subsequent decline in spending that occurs when the government borrows money to finance a deficit


situation that exists when government spending exceeds tax revenues

fiscal policy

changes in government spending and taxes to fight recessions or inflations

inflationary gap

what occurs when the equilibrium quantity of output is above potential output

Phillips tradeoff

the inverse relationship between inflation and unemployment

rational expectations

the idea that households and businesses will use all the information available to them when making economic decision

recessionary gap

what occurs when the equilibrium quantity of output is below potential output


term used to describe the situation when the economy experiences inflation and a recession simultaneously


spending by the government that is less than tax revenues

change in real GDP

Initial Change in Spending x Multiplier

certificate of deposit

debt instrument that is similar to a savings account except the interest rate is slightly greater and the deposit cannot be drawn on without penalty


coins and paper money

discount rate

the rate of interest the FED charges when it makes loans to depository institutions

excess reserves

the amount of any deposit that does not have to be held aside and may be used to make loans and buy investments

federal reserves

the central bank of the United The United States

fiat money

money that is not backed by any precious commodity

government securities

IOUs that the government issues when it borrows money


the ability to turn an asset into cash rapidly and without loss


currency, transaction accounts, and travelers' checks


M1 plus savings accounts, certificates of deposit, and other liquid assets


anything that society generally accepts in payment for a good or service

money multiplier

1/reserve requirement, the multiple by which the money supply will change because of a change in bank reserves

open market operations

activities in which the FED buys and sells government securities in the secondary market

required reserves

the amount of any deposit that must be held aside and not used to make loans or buy investment

reserve requirement

the percentage of any deposit that must be held aside and not used to amke loans or buy investments

savings account

an account at a depository institution that earns interest while the funds are readily available but cannot be withdrawn with checks

secondary market

place where government securities that have already been issued may be bought or sold

transaction account

a checking account at a bank or a similar account at some other depository institution

money multiplier

1/ Reserve Requirement

change in money supply

Money Multiplier x Change in Bank Reserves

board of governors

executive board of the FED that makes major monetary policy decisions

demand management policy

monetary and fiscal policy

equation of exchange

M x V = P x Q; the money supply times its velocity equals the price level times output

federal open market committee (FOMC)

a committee within the FED that designs and executes the particular of monetary policy


one who believes that changes in the money supply have a profound effect on the economy

monetary neutrality

policy in which a change in the money supply would result in a proportional change in prices while real variables, such as the unemployment rate, would be unaffected

monetary policy

changes in the money supply to fight recessions or inflations

money demand

the amount that households and firms want to hold in currency and deposits

velocity of money

describing the number of times the typical dollar of M1 or M2 is used to make purchases during a year

equation of exchange

M x V = P x Q

capital productivity

the amount of output per unit of plant and equipment

economic growth

growth of output usually measured by the percentage change in real GDP or real GDP per capita

human capital

the skill and knowledge embodied in the labor force

labor productivity

the amount of output per unit of labor

potential GDP

the amount that can be produced using resources fully and efficiently


output per unit of input

total productivity

the amount of all inputs

Rule of 70

years it takes a variable to double =70/the annual growth rate of the variable


the increase of the value of a currency in terms of another currency

balance of payments

an accounting of the funds that flow in and out of a country comprised of the capital account and the current account

balance of trade

a nation's exports minus its imports

capital account

a portion of the balance of payments comprised of foreign purchases of US assets minus US purchases of foreign assets, plus the change in official reserves

closed economy

a hypothetical economy with no foreign trade

current account

a portion of the balance of payments comprised of the trade balance, net investment income, and net transfers


the decrease of the value of a currency in terms of another currency


the practice or foreign producers selling a product in the domestic market for less than it cost to produce it

exchange rate

the value of one country's currency in terms of another's

gold standard

a unit of one currency that is equivalent to a stated amount of gold

import quota

a limit on the amount of a product that can be imported

import tariff

a tax on a specified import product

infant industries

those industries that are just getting started, perhaps requiring trade restrictions


situation in which a nation or group of nations uses their official reserves to supply or demand a currency in order to alter the exchange rate

managed float

an exchange rate regime where supply and demand determine exchange rates with occasional intervention when warranted

net investment income

amount US citizens earned as interest and dividends from abroad minus how much was paid to foreigners in interest and dividends

net transfers

money our government and citizens send as gifts or aid to foreigners minus how much foreigners send to us in gifts and aid

official reserves

government's holdings of foreign currencies

open economy

an economy with foreign trade

trade deficit

excess of a nation's imports over its exports

trade surplus

excess of a nation's exports of over its imports

balance of payments

current account +capital account

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