41- 88 Economics and Fixed Income Fundamentals

Comprehensive vocabulary flashcards covering microeconomics, macroeconomics, international trade, and fixed income concepts based on the lecture transcript.

Inferior good

A good for which demand falls as income rises, characterized by a negative income elasticity. Examples include instant noodles and bus travel.

Normal good

A good for which demand rises as income rises, characterized by a positive income elasticity.

Necessity

A type of normal good with an income elasticity between $0$ and $1$, where demand rises slowly with income.

Luxury good (lyxvara)

A normal good with an income elasticity $> 1$, where demand rises faster than income.

Substitutes

Goods with positive cross-price elasticity, where a price increase in one leads to an increase in demand for the other (e.g., tea and coffee).

Complements

Goods with negative cross-price elasticity, where a price increase in one leads to a decrease in demand for the other (e.g., cars and petrol).

Price elasticity of demand

$\frac{\% \text{ change in quantity}}{\% \text{ change in price}}$. If inelastic ($< 1$), a price cut lowers total revenue; if elastic ($> 1$), a price cut raises revenue.

Demand-pull inflation

Inflation resulting from rising aggregate demand (AD shifts right), leading to increased prices and output. Triggers include spending, confidence, and money supply.

Cost-push inflation

Inflation resulting from rising input costs (SRAS shifts left), leading to increased prices but decreased output (stagflation). Triggers include oil and wages.

Perfect competition

A market structure with many firms, identical products, price takers, and free entry. It results in zero economic profit in the long-run and production at minimum efficient scale.

Monopolistic competition

A market structure with many firms, differentiated products, and low barriers. In the long-run, it results in zero economic profit and excess capacity (producing at less than minimum-cost output).

Oligopoly

A market structure with few firms, high barriers, and interdependent pricing; firms can earn long-run profit.

Monopoly

A single firm with high barriers acting as a price maker. It achieves long-run profit and produces where $MR = MC$.

Minimum efficient scale

The output level that minimizes long-run average total cost, representing the "optimal firm size" under perfect competition.

Herfindahl-Hirschman Index (HHI)

The sum of squared market shares used to measure concentration. Unlike the concentration ratio, it is sensitive to mergers among top firms.

Concentration ratio

The combined market share of the top $N$ firms; it is simple to calculate but its weakness is being unaffected by mergers among leading firms.

Leading indicators

Economic indicators that turn before the economy, such as building permits, stock prices, and new orders, used to predict the cycle.

Coincident indicators

Economic indicators that turn with the economy, such as industrial production and employment.

Lagging indicators

Economic indicators that turn after the economy, such as unemployment duration, prime rate, and CPI for services, used to confirm the cycle.

Fiscal policy

The government's use of spending and taxes to affect aggregate demand. Expansionary policy involves more spending or lower taxes, leading to a bigger deficit.

Monetary policy

The central bank's use of money supply and interest rates (via open market ops, reserve requirements, and the policy rate) to affect the economy.

Money neutrality

The principle that in the long run, money supply affects only nominal variables (price level) and not real variables like output or real rates.

Neutral policy rate

The rate calculated as $\text{trend real growth} + \text{inflation target}$, which neither stimulates nor slows the economy.

Monetary transmission mechanism

The channels through which a rate change flows (bank lending rates, asset prices, expectations, exchange rates). Inflation is the result, not a channel.

Fiscal multiplier

The ratio that determines how much GDP rises per unit of spending, calculated as $\frac{1}{1 - MPC}$ (assuming no taxes).

Automatic stabilizers

Taxes and transfers (like unemployment benefits) that adjust automatically to smooth the economic cycle.

Crowding out

A phenomenon where government borrowing raises interest rates, which reduces private investment and limits the impact of fiscal expansion.

Real exchange rate

An index of purchasing power that cannot be quoted in FX markets and must be constructed by analysts.

Nominal exchange rate

The actual quoted rate used to trade one currency for another.

Forward premium/discount

A condition where the base currency trades at a premium if forward $>$ spot; the higher-yielding currency will trade at a forward discount.

Covered interest rate parity

A no-arbitrage relationship that uses interest rate differentials to set the fair forward exchange rate.

Tariff

A tax on imports that raises government revenue, reduces the budget deficit, and protects domestic producers.

Quota

A limit on the quantity of imports. Unlike a tariff, it generates no government revenue unless the quotas are auctioned.

Export subsidy

Payments made to domestic exporters, which result in an increase in the budget deficit.

Managed float

An exchange rate system that is mostly market-determined but subject to occasional central bank intervention.

Comparative advantage

The ability to produce at a lower opportunity cost; it is the fundamental basis for beneficial trade rather than absolute advantage.

Absolute advantage

The ability to produce more with fewer resources; this is NOT the basis for specialization in trade.

Par value (face value)

The principal amount repaid at maturity; serves as the reference point for determining if a bond is at a premium or discount.

Coupon rate

The fixed percentage of par value paid as interest, set at issue and unchanging for fixed-rate bonds.

Yield-to-maturity (YTM)

The internal rate of return (IRR) of a bond if held to maturity; it acts as the market discount rate.

Current yield

$\frac{\text{annual coupon}}{\text{price}}$. It is a rough measure of income that ignores capital gains or losses.

Premium bond

A bond priced above par where the coupon $>$ yield. Its price drifts down to par as it approaches maturity.

Discount bond

A bond priced below par where the coupon $<$ yield. Its price drifts up to par as it approaches maturity.

Pull to par

The convergence of a bond's price toward its par value as maturity approaches, regardless of whether it started at a premium or discount.

Duration

A measure of the sensitivity of a bond's price to a $1\%$ change in yield; higher duration implies more interest-rate risk.

Macaulay duration

The weighted-average time to receive cash flows, measured in years. For a zero-coupon bond, it equals the maturity.

Modified duration

$\frac{\text{Macaulay duration}}{1 + \text{yield per period}}$. It represents the percentage price change per $1\%$ yield change for option-free bonds.

Effective duration

Price sensitivity to a shift in the benchmark yield curve; primarily used for bonds with embedded options (e.g., callable bonds, MBS).