Scarcity: Nothing is unlimited, this causes forces us to make choices.

Macroeconomics: Branch of economics that studies large-scale factors that influence entire economic systems.

Microeconomics: Branch of economics that studies small-scale factors that influence individual producers, consumers, and industries.

Factors of Production: Resources that are required to produce goods and services; entrepreneurship, capital, land, and labor.

Capital: Man-made tools that are used to produce goods and services.

Entrepreneurship: Combining factors of production to produce new goods and services (i.e. business leadership).

Labor: Workers

Land: Raw materials (natural resources).

Market: Anywhere that the voluntary exchange of goods and services between many buyers and sellers takes place.

Incentive: Something that causes a person to act; can be positive or negative.

Capitalism/Free Market/Free Enterprise: An economic system where the forces of supply and demand dictate what to make, how to make it, and who gets the things that are made.

Communism/Centrally Planned/Command: An economic system where government planners dictate what to make, how to make it, and who gets the things that are made.

Socialism/Mixed: An economic system where there is a mixture of government and private control of the factors of production.

Ceteris Paribus: Latin phrase that translates to "all else remains constant;" a simplifying assumption used by economists.

Efficient: When all resources are used in such a way that there are no missed opportunities in production (i.e. all resources are used, none are wasted).

Inefficient: When resources are used in such a way that there are missed opportunities in production (i.e. not all resources are fully utilized, some are wasted).

Opportunity Cost: The cost of decision making measured as the sacrificed value or utility of the next best option.

Equilibrium: A state of balance where things are equal. In a market, it is the price and quantity where supply and demand are the same.

Elasticity: Flexibility to change production or consumption decisions when the market price of a good or service changes.

Surplus: When the quantity supplied of a good or service is greater than the quantity demanded.

Shortage: When the quantity supplied of a good or service is less than the quantity demanded.

Producer Surplus: The total benefit that producers receive when they sell goods at the market price.

Consumer Surplus: The total benefit that consumers receive when they buy goods at the market price.

Deadweight Loss: Benefit that does not go to either producers or consumers and is therefore lost to society.

Total Welfare: The sum of producer and consumer surplus; represents the total benefit produced by the market that goes to all members of society.

Gross Domestic Product (GDP): The total dollar value of all final goods and services produced within a nation’s borders in a given period of time.

• Consumer Spending + Gross Private Investment + Government Spending + (Exports - Imports)

Aggregate: A whole that is combined of many separate parts (“Everything put together”)

Real: Measured in unchanging, fixed prices (i.e., “adjusted for inflation”)

• ex., Real Gross Domestic Product, Real wages

Nominal: Measured in current prices. (i.e., “not adjusted for inflation”)

• ex. Nominal Gross Domestic Product, Nominal wages

Real GDP Per Capita: A measurement of the level of production in a country divided by the number of individuals in the country’s population.

• rGDP/Population

• Indicator of a nation’s standard of living and level of individual productivity

Inflation: • A steady increase in prices of goods and services over time.

• Money becomes less valuable and the opportunity cost of holding cash increases.

  • Inflation Rate = ((Price 2 – Price 1) ÷ Price 1) x 100

Cost Push Inflation: Higher input costs cause businesses to increase prices of goods and services

Demand Pull Inflation: Higher demand for products causes businesses to increase prices (law of supply).

Disinflation: A slowing in the rate of inflation. (i.e., “Prices are still rising, just not as rapidly as before”)

• ex. last year, the rate of inflation was 5%, this year the rate of inflation is 3%

Deflation: A negative inflation rate. (i.e., “Prices are lower (in real terms) than they were before

• ex. this year, the rate of inflation is -2%

GDP Deflator: A measure of the level of prices of all new, domestically produced, final goods and services in an economy.

• Price index that measures price inflation of deflation, and is calculated using nominal GDP and real GDP.

Consumer Price Index (CPI): A measure of the level of prices of a fixed market basket of goods and services commonly purchased by households.

• Price index that measures price inflation or deflation, and is calculated using nominal market baskets and a base year market basket.

Spending Multiplier: Represents the multiple by which GDP increases or decreases in response to an increase and decrease in government expenditures and/or investment

• Spending Multiplier = 1/(1-MPC)

The Business Cycle: A graphic representation of changes in real GDP over time.

• Indicates how productivity changes over time.

Expansion/Recovery: A sustained increase in real GDP over time (positive GDP growth).

• Increasing economic output

• Decreasing unemployment

• Increasing inflation

Peak: The highest level of rGDP in the business cycle

• Positive rGDP growth stops

• Unemployment rate stops rising

• Inflation rate stops rising

• End of economic prosperity

Trough: The lowest level of rGDP in the business cycle

• Negative rGDP growth stops

• Unemployment rate stops rising

• Inflation rate stops falling

• Beginning of economic recovery

Contraction: Negative rGDP growth.

Recession: A contraction that lasts between 6 months (2 consecutive quarters) to 2 years (8 consecutive quarters).

Depression: A contraction that lasts longer than 2 years (8 consecutive quarters)

Unemployment: Members of the labor force who are not working but are actively seeking work (within the past 4 weeks).

• Unemployment Rate = (unemployed/labor force) x 100

Labor Force: Adult civilians who are either employed or unemployed.

• Must be:

  • Over 16

  • Not incarcerated

  • Not institutionalized

Underemployed Workers: People who are:

• Overqualified for their jobs

• Working part time when they wish to work full time

• Working in a job that pays less than they are accustomed to earning

• Ex. An accountant who has to work part time at Whataburger because she can’t find a full time accounting job.

Discouraged Workers: People who were unemployed so long that they decided to stop seeking work

• When they stop seeking work, they drop out of the labor force

• They are no longer considered unemployed statistically

Aggregate: A whole that is composed of many parts; everything put together.

Aggregate Price Level: The overall price level faced by households (Consumer Price Index).

Aggregate Output: The total amount of final goods and services produced in a country in a given period of time (real GDP).

Aggregate Demand (AD): A curve that shows the relationship between the aggregate price level (CPI) and the quantity for aggregate output demanded by households, firms, the government, and the rest of the world.

Wealth Effect (Real Balances Effect): A change in the aggregate price level influences the purchasing power of consumers. Prices go up, purchasing power goes down, and vice versa.

Interest Rate: The cost of borrowing money, expressed as a percentage of the total sum borrowed (known as the principal).

Interest Rate Effect: A rise in the aggregate price level causes interest rates to increase, which has a negative effect on business investment.

Fiscal Policy: Changes in government spending or taxes that are designed to affect overall (aggregate) spending.

Aggregate Supply: Shows the relationship between the aggregate price level (CPI) and aggregate output (real GDP) that producers are willing and able to supply.

Nominal Wage: The dollar amount earned by workers without adjusting for inflation.

Sticky Wages: Due to contracts and informal agreements, nominal wages are slow to adjust when the aggregate price level changes.

Short-Run: A period of time when input prices are not flexible (sticky) and do not adjust to the aggregate price level. Usually less than or equal to 2 years.

Long-Run: A period of time when input prices are completely flexible and can adjust to the aggregate price level. Usually greater than 2 years.

Short-Run Aggregate Supply (SRAS): Supply curve that slopes upward due to sticky resource prices.

Long-Run Aggregate Supply (LRAS): Supply curve that is perfectly inelastic at the level of full output; shows that the aggregate price level does not affect aggregate output in the long-run.

Potential Output: The normal level of output for the economy given the available factors of production. Shows the level of real GDP that the economy would produce if all input prices were completely flexible.

Short-Run Macroeconomic Equilibrium: Aggregate demand and short-run aggregate supply intersect to the left or right of the LRAS. The aggregate price level is above or below the expected price level, and output is above or below potential output (known as an Output Gap).

Long-Run Macroeconomic Equilibrium: Aggregate demand, short-run aggregate supply, and long-run aggregate supply intersect at one point on the graph. The aggregate price level matches the expected price level, and the actual output matches potential output. The economy is at full employment, and prices are stable.

Inflationary Gap: Output gap created when aggregate demand increases; prices rise above the expected price level (unexpected inflation), and unemployment falls below the natural rate. Happens when AD shifts rightward.

Recessionary Gap: Output gap that is created when aggregate demand decreases; prices fall below the expected price level (unexpected deflation or disinflation), and unemployment rises above the natural rate. Happens when AD shifts leftward.

Stagflation: A simultaneous increase in the rates of unemployment and inflation. This happens when the SRAS shifts leftward.

Self-Correcting: "Markets move toward equilibrium." If an output gap exists in the short run, the economy will gradually move back toward long-run equilibrium. If the output gap is negative, nominal wages will fall, SRAS will increase, and the economy will move back toward long-run equilibrium. If the output gap is positive, nominal wages will rise, and SRAS will decrease until the economy reaches long-run equilibrium.

Money: Item that can facilitate market transactions by serving as a medium of exchange, a unit of account, and a store of value.

Fiat Money: Money that has value because the government has decreed that it is an acceptable form of payment.

Commodity Money: Money that has intrinsic value; it has other uses besides serving as a medium of exchange, store of value, and unit of account.

Demand Deposits: A bank account that allows you to instantly access all your money. Considered as virtually equivalent to cash.

Liquidity: The ease with which an asset can be spent or turned into spendable cash at a fair market price. Cash and demand deposits are the most liquid assets.

Treasury Securities (Bonds): A formal debt obligation issued by the US Treasury. Essentially, it’s an I.O.U. from the US government. The government borrows money for a set period of time (anywhere from 6 months to 30 years) and makes annual interest payments to the bond holder until the period of time has ended (maturity date), at which point the government repays the face value of the bond.

The Federal Reserve (The Fed): The central bank of the United States. Established by congress in 1913, they are responsible for promoting full employment and price stability by changing the supply of money in circulation.

Federal Open Market Committee (FOMC): The group of 7 governors general and 5 district bank presidents that vote on the monetary policy actions of the Federal Reserve.

Open Market Operations: When the Federal Reserve Open Market Committee buys and sells US treasury securities (bonds) in order to influence the amount of money in circulation.

Interest Rate: The cost of borrowing money (also, the benefit gained from lending (or saving) money), expressed as a percentage of the principal.

Principal: The initial amount of money that is lent or borrowed.

Federal Funds Rate: The interest rate that commercial banks charge each other for short-term loans. Always 0.5% less than the Discount Rate.

Discount Rate: The interest rate that the Federal Reserve charges commercial banks for short-term loans. Always 0.5% higher than the Federal Funds Rate.

The Reserve Requirement Ratio (RRR): The fraction of demand deposits that banks are required to keep in reserve (cannot be loaned out). Established by the Federal Reserve for all US commercial banks.

Fractional Reserve Banking: Banks only keep a fraction of their deposits in reserve, the rest are loaned out to other customers.

Required Reserves: The fraction of demand deposits that banks are required to keep in reserve; established by the Fed’s reserve requirement ratio. Provide liquidity to banks and help protect against bank runs.

Excess Reserves: The fraction of demand deposits that banks are free to lend to other customers. Banks can only increase lending by an amount less than or equal to their excess reserves.

Deposit Expansion Multiplier (Money Multiplier): A formula that helps determine how much money the banking system can create with each dollar of reserves. =(1÷RRR)

Velocity of Money: The average number of times a dollar is used to purchase goods and services in a year. =(P*Y)÷M

Quantity Equation: Shows that the quantity of money in circulation has a direct, proportional relationship with the price level. Justification for the quantity theory of inflation and a key reason why the Federal Reserve can use Monetary policy to stabilize the economy. M*V = P*Y

Present Value of Money: The current value of X amount of dollars to be received in N number of years given the prevailing interest rate r% (AKA “discounting”). =X÷(1+r)^N

Future Value of Money: The value of money P to be received in N number of years at r% interest. =P(1+R)^N

Economic Growth: An increase in a society’s ability to meet the needs and wants of citizens utilizing the scarce factors of production available. Economists usually look to changes in real GDP per capita as the most important measure of economic growth.

Capital Deepening: Capital deepening is a situation where the capital per worker is increasing in the economy. This is also referred to as an increase in the capital intensity. (ex. Increasing construction of new factories = capital deepening)

Capital Flight: Capital flight, in economics, occurs when assets or money rapidly flow out of a country, due to an event of economic consequence or as the result of economic globalization.

Externality: A cost or benefit from production or consumption of a product that accrues to someone other than the immediate buyers and seller of the product being produced or consumed. (ex. Positive Externality = Public education; Negative Externality = Industrial pollution). Governments attempt to adjust the cost of externalities with taxes and subsidies.

Public Goods: A good or service that is characterized by nonrivalry and non-excludability. These characteristics imply that no private firm can break even when attempting to provide such products. As a result, they’re often produced by governments and paid for with tax revenues. (ex. Military defense)

Private Goods: A good or service that is individually consumed and can be profitably produced by privately owned firms because they can exclude nonpayers from receiving the benefits. (ex. A Smartphone)

Stagflation: The simultaneous increase in the rate of unemployment and the rate of inflation. Caused by a leftward shift of the SRAS curve.

Crowding-Out: When federal spending increases, the demand for loanable funds increases. This will cause interest rates to rise in the economy; as a result, business investment will decline.

Automatic Fiscal Policy: Fiscal policy actions that do not require a new act of congress to take effect. (ex. Progressive income taxes or unemployment insurance)

Discretionary Fiscal Policy: Fiscal policy actions that do require a new act of congress to take effect. (ex. Passing a new bill to cut corporate taxes during a recession)

Budget Deficit: When Federal spending exceeds tax revenue (gov’t expenditure > gov’t revenue). The national debt is the sum of all prior year’s budget deficits.

Budget Surplus: When Federal spending is less than tax revenue (gov’t expenditure < gov’t revenue). The extra money from a budget surplus can be used to pay down existing national debt.

Balanced Budget: When Federal spending is exactly equal to tax revenue (gov’t expenditure = gov’t revenue). This is quite rare on the national level and can be disrupted by automatic fiscal policy actions (ex. progressive taxes and social safety net programs).

Non-Accelerating Inflation Rate of Unemployment (NAIRU): The unemployment rate where the inflation rate is completely stable (neither increasing nor decreasing). This is equal to the natural rate of unemployment (4-6%). When the unemployment rate falls below 4%, the rate of inflation accelerates (in the short-run); when the unemployment rate rises above 6%, the rate of inflation decelerates (in the short-run).

Short-Run Phillips Curve: A downward sloping curve that illustrates an inverse relationship between unemployment and inflation in the short run.

Long-Run Phillips Curve: A perfectly inelastic curve (at the NAIRU) that illustrates that there is no trade-off between unemployment and inflation in the long-run.

Theory of Rational Expectations: People make choices based on their rational outlook, available information, and past experiences. This suggests that the current expectations in the economy are equivalent to what people think the future state of the economy will become. This can interfere with fiscal and monetary policy. (ex. If people believe that the economy is headed for a recession, they’ll save more money and spend less. This behavior will actually hasten the onset of a recession due to lower consumer spending. In this environment, even if Congress tried to stimulate the economy by cutting taxes, people are likely to save rather than spend the tax-cut. This means that the discretionary fiscal policy will be less effective due to people’s expectations)

Counter-Cyclical Policy: Using monetary and fiscal policy tools to boost economic performance or reduce the rate of inflation in the short-run.

Imports: Goods and services produced abroad and purchased domestically.

Exports: Goods and services produced domestically and sold abroad.

Globalization: The growth of international economic, social, and political linkages between many countries around the world.

Autarky: A situation where a country does not trade with others (aka self-sufficiency).

Interdependence: A situation where countries depend on each other.

Comparative advantage: The ability to produce a good or service for a lower opportunity cost than others given the same amount of time and resources.

Absolute advantage: The ability to produce more of a good or service than others given the same amount of time and resources.

Protectionism: Policies that limit imports, usually with the goal of protecting domestic producers in import competing industries from foreign competition.

Tariff: An excise tax on imported goods.

Import Quota: A limit on the quantity of a good that can be imported.

Outsourcing: The business practice of hiring someone in a foreign country to produce some part of a good or service that was once produced domestically (ex. Call centers in India).

Floating Currency: Exchange rates between countries change value due to supply and demand of their currencies on international currency exchange markets.

Appreciation: When a currency increases in value relative to other world currencies.

Depreciation: When a currency decreases in value relative to other world currencies.

Current Account: A measure of all the imports and export transactions between the US and the rest of the world. Records the exchange of goods and services (net exports) plus net foreign factor income and net foreign transfers.

Capital Account: A measure of all the purely financial transactions between the US and the rest of the world. Records the exchange of real estate, stocks, bonds, physical capital, and foreign investment.

Official Reserves: An offsetting account used to facilitate trade between the US and the rest of the world (essentially, it’s a store of foreign currency managed by the government).

Trade Deficit: A situation where a country imports more than they export.

Trade Surplus: A situation where a country exports more than it imports.

Balanced Trade: A situation where a country imports the same amount that it exports.