Economics Final Exam Practice Vocabulary

Vocabulary terms and definitions derived from the Final Exam practice questions covering unemployment, monetary systems, exchange rates, and macroeconomic theories.

Cyclical unemployment

The portion of unemployment created by short-run fluctuations around the natural rate of unemployment.

Liquidity

The ease with which an asset can be converted into the economy’s medium of exchange.

Double coincidence of wants

A requirement in a barter economy where two parties each have a good or service the other wants; it serves as a hindrance to the allocation of resources when required for trade.

Demand deposits

Balances in bank accounts that are included in both the M1 and M2 measures of the money supply.

Reserve ratio

The fraction of deposits that a bank holds as reserves; calculated as $\text{Required Reserves} / \text{Deposits}$, such as a $10\%$ ratio on $5,000 requiring $500$ in reserves.

Discount rate

The interest rate that the Federal Reserve charges banks for loans.

Value of money

The reciprocal of the price level; when the price level falls, the number of dollars needed to buy a representative basket of goods decreases, and this value rises.

Velocity of money

The rate at which money changes hands, calculated using the equation $V = \frac{P \times Y}{M}$, where $M$ is the money supply, $P$ is the price level, and $Y$ is real GDP.

Quantity theory of money

A theory suggesting that if the money supply increases by a certain percentage (e.g., $5\%$), nominal GDP will rise by that same percentage while real GDP remains unchanged.

Trade deficit

An economic situation where a country's imports exceed its exports, meaning it buys more from overseas than it sells overseas.

Net capital outflow (NCO)

The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.

Real exchange rate

The nominal exchange rate (defined as foreign currency per dollar) multiplied by the ratio of domestic prices divided by foreign prices.

Purchasing-power parity

A theory of exchange rates stating that a unit of any given currency should be able to buy the same quantity of goods in all countries; the nominal exchange rate is determined by the ratio of the prices of a basket of goods in two countries.

Marginal propensity to consume (MPC)

The fraction of extra income that a household consumes rather than saves.

Classical dichotomy

The theoretical separation of nominal variables and real variables, suggesting that monetary policy affects nominal variables such as nominal wages, the price level, and nominal GDP.

Interest-rate effect

One reason for the downward slope of the aggregate-demand curve, depending on the idea that decreases in interest rates increase the quantity of goods and services demanded.

Multiplier effect

The additional shifts in aggregate demand that result when an original increase in government spending increases income and thereby increases consumer spending.

Theory of liquidity preference

Keynes's theory that the interest rate adjusts to bring the quantity of money people want to hold into balance with the quantity of money created by the Fed; the demand for money is represented as a downward-sloping line.