Glossary of terms

Absolute Advantage
The ability of a nation's residents to produce a good or service at a lower cost, measured in resources required to produce the good or service, or the ability to produce more output than other nations from given inputs of resources. For example suppose there was an...
Absolute Quota
A quantitative restriction that limits the amount of a product that can enter a country during a specific time period. For example the United States has a limit on different goods that could enter from other countries. In particular, the U.S. allows 847,690 cotton dresses to...
Arbitrage
Buying an item in one market to sell in another market for a higher price. An example would be an American resident who can buy many oranges in Mexico city for US $0.25 per orange and drive them a short distance to Los Angeles to sell each for US$0.50 for a profit of...
Autarky
A non-trade situation. Today, complete economic autarkies are rare. A possible example of a current autarky is North Korea. However, even North Korea has extensive trade with the Russian Federation, the People's Republic of China, Syria, Iran, Vietnam, and many countries in...
Balance of Payments
A system of accounts that measures transaction of goods, services, income, and financial assets between domestic residents, businesses, and governments and the rest of the world during a specific time period.The balance of payments is divided into three main categories: the...
Beggar-Thy-Neighbor Policy
A policy action that benefits one nation's economy but worsens economic performance in another nation. When a large country applies a tariff, a part of the tariff is shifted backwards resulting in a gain for the country that applied the tariff because the domestic...
Capacity Output
The real output that the economy could produce if all resources were used to their maximum. Typically the capacity output level is higher than the output level that a nation's economy tends to produce in the long-run, because all resources are not always utilized. For...
Capital
The physical equipment and buildings used to produce goods and services. For example the capital of a shoe making factory consists of all footwear making machines and the building in which the factory resides.
Capital Account
A tabulation of the flows of financial assets between domestic private residents and businesses and foreign private residents and businesses. The following investment flows would be recorded in the capital account: Purchase of foreign securities by domestic residents and...
Combination Tariff
A tariff that combines an ad valorem tariff and a specific tariff. Suppose Japan exports 100,000 Toyota Corollas to the United States. If the ad valorem tax imposed by the United States is 2% of the value of the good that is being imported and the specific tariff is US$5.00...
Common Market
A trading arrangement under which member nations remove all barriers to trade among their group, erect common barriers to trade with other countries outside the group, and permit unhindered movements of factors of production within the group. For example, in 1969 the...
Comparative Advantage
The ability to produce an additional unit of a good or service at a lower opportunity cost relative to other nations. For example suppose there was an economics professor and a maid. Suppose the economics professor worked her way through school by cooking at diners and...
Consumer Price Index (CPI)
A weighted sum of prices of goods and services that a typical consumer purchases each year. To illustrate a CPI, let's make up a simple example. Let's call our example the "young professional consumer price index." Suppose that a "typical" young professional spends one...
Consumer Surplus
The benefit that consumers receive from the existence of a market price. Consumer surplus is measured as the difference between what consumers are willing and able to pay for a good or services and the market price of the good. Supposed a college student is willing to pay...
Convertibility
The ability to freely exchange a currency for a reserve commodity or reserve currency. For example if the US dollar can be converted to gold, or a British pound, or Bulgarian lev, then the US currency is convertable.
Countervailing Duty (CVD)
A tax on imported goods and services designed to offset the domestic price effect of foreign export policies. Countervailing duties are generally imposed by the International Trade Commission (ITC). These taxes are imposed because a subsidized product can be sold for less...
Crawling Peg
An exchange rate system in which a country pegs its currency to the currency of another nation but allows the parity value to change at regular time intervals. For example Nicaragua has had a crawling-peg system since 1998. In order to promote exchange-rate stability and...
Currency-basket Peg
An exchange-rate system in which a country pegs its currency to the weighted average value of a basket, or selected number of currencies. For example, Kuwait shifted the peg of the Kuwaiti dinar to a currency basket from the U.S. dollar in 2007 because the dollar was weak...
Currency Board
An independent monetary authority that substitutes for a central bank. The currency board pegs the value of the domestic currency, and changes in the foreign reserve holdings of the currency board determine the level of the domestic monetary stock. For example, Bulgaria...
Current Account
Measures the flow of goods, services, income, and transfers or gifts between domestic residents, businesses, and governments and the rest of the world. Examples of activities that are included in the current account are the following: The expenditures on items such as...
Customs Union
A trading arrangement that entails the elimination of barriers to trade among participating nations and common barriers to trade with other countries outside the group. The South African Customs Union (SACU), renewed in 2002, is the worlds' oldest custom union, first formed...
Deadweight Loss
A loss of consumer or producer surplus that is not transferred to any other party and that represents a decline in economic efficiency. For example, consider a market for t-shirts where the cost of each t-shirt is US$1 and the demand will decrease linearly from a high...
Demand
The relationship between the prices that consumers are willing and able to pay for various quantities of a good or service for a given time period, all other things constant. For example to see how much Coke consumers want to drink depends on the price of Coke. When the...
Devalue
A situation in which a nation with a fixed exchange rate regime changes the fixed exchange rate, or parity, value of its currency so that it takes a greater number of domestic currency units to purchase one unit of the foreign currency. For example, suppose a foreign...
Discount Rate
The interest rate that the Federal Reserve charges on discount window loans that it gives to depository institutions. Discount rates vary from country to country. For example, in 2012 the discount rate in the U.S. was 0.50%; in Oman it was 0.05%; in China it was 3.25%; and...
Discretionary Policymaking
The act of responding to economic events as they occur, rather than in ways it might previously have been planned in the absence of those events. For example, the U.S. central banking system, the Federal Reserve (the Fed), in partnership with central banks around the world,...
Dollarization
A system in which the currency of another nation circulates as the sole legal tender. Some countries that are dollarized are British Virgin Islands,Caribbean Netherlands, Ecuador, El Salvador, Marshall Islands, Federated States of Micronesia, Palau, Turks and Caicos...
Dollar-standard Exchange-rate System
An exchange rate system in which a country pegs the value of its currency to the U.S. dollar and freely exchanges the domestic currency for the dollar at the pegged rate. For example, in 2012 the Hong Kong dollar is pegged to the U.S. dollar at a rate of 7.8 to 1. In the...
Domestic Credit
Total domestic securities and loans held as assets by a central bank. In the case of the United States, the Federal Reserve offers domestic credit to the United States government through government bonds. When necessary, short-term loans are also issued to local banks.
Dumping
A situation in which a firm sells its output to foreign consumers at a price that is less than what the firm charges its domestic consumers, or when a foreign firm prices its exports below their cost of production. Dumping can force established domestic producers out of a...
Economic Efficiency
A condition when scarce resources are allocated in the most productive activities. A state of economic efficiency is essentially just a theoretical one; a limit that can be approached but never reached. Instead, economists look at the amount of waste (or loss) between pure...
Economic Growth
An increase in the capacity of an economy to produce goods and services, compared from one period of time to another. Economic growth can be measured in nominal terms, which includes inflation, or in real terms, which are adjusted for inflation. For comparing one country's...
Economic Integration
The extent and strength of real-sector and financial-sector linkages among national economies. There are varying levels of economic integration, including preferential trade agreements (PTA), free trade areas (FTA), customs unions, common markets and economic and monetary...
Economic Profit
Total revenue minus explicit and implicit opportunity costs. This should not be confused with 'accounting profit', which does not take into account opportunity costs. For example, say you invest $100,000 to start a business, and in that year you earn $120,000 in profits....
Economic Union
A trading arrangement that commits participating nations to remove all barriers to trade among their group, to abide by common restrictions on trade with other countries outside the group, to allow unhindered movements of factors of production within the group, and to closely...
Economies of Scale
A reduction in log-run average cost induced by an increase in a firm's output. There are two types of economies of scale: -External economies - the cost per unit depends on the size of the industry, not the firm. -Internal economies - the cost per unit depends on size of...
Effective Exchange Rate
First, we need to explain that a bilateral exchange rate is the exchange rate between only two currencies: the dollar against the euro, the British pound against the Japanese yen, etc. Looking at the bilateral exchange rates gives us useful information but we may want to...
Efficient-market Hypothesis
A theory which states that equilibrium prices of and returns to bonds/stocks should reflect all past and current information plus traders' understanding of how market prices and returns are determined. As such it is impossible to "beat the market". According to the...
Ex Ante Conditionality
The imposition of International Monetary Fund (IMF) lending conditions before the IMF grants the loan. Since the 1980s, as the IMF has extended lending and funding programmes in the Third World and the post-communist states, the focus of conditionality has been on the...
Excess Quantity Demanded
The amount by which quantity demanded exceeds quantity supplied at a given price. Suppose for a given price of U.S. $2 the amount of Coke that is demanded in an economy is 100. If the Coca Cola company is only willing to produce and sell 50 cans of Coke at the price of U.S....
Excess Quantity Supplied
The amount by which quantity supplied exceeds quantity demanded at a given price. Suppose for a given price of U.S. $5 the amount of burgers that is demanded in an economy is 20. If the fast food restaurant is willing to produce and sell 100 burgers at the price of U.S. $5,...
Exchange Rate
Provides the value of one currency relative to another currency as the number of units of one currency required to purchase one unit of the other currency. In most financial papers, currencies are expressed in terms of U.S. dollars, while the dollar is commonly compared to...
Exchange-rate System
A set of rules that determine the international value of a currency. An exchange-rate system is the way an authority manages its currency in relation to other currencies and the foreign exchange market. There are three major categories of exchange rate systems. A floating...
Export Subsidy
A payment made by the government to a domestic firm for exporting its goods or services. For example, the Korean car maker Hyundai receives a payment from the Korean government for all the cars it exports. This induces Hyundai makers to increase the amount they export,...
Externality
A spillover effect influencing the welfare of third parties not involved in transactions within a market place. A prevalent negative externality is talking on cellphones and driving. The risk posed by driving while talking isn't just a risk to the driver; it's also a safety...
Factors of Production
The resources firms utilize to produce goods and services. Land, labor, capital and entrepreneurship encompass all of the inputs needed to produce a good or service. Land represents all natural resources, such as timber and gold, used in the production of a good. Labor is all...
Financial Crisis
A situation that arises when financial instability becomes so severe that the nation's financial system is unable to function. A financial crisis usually involves a banking crisis, a currency crisis, and a foreign debt crisis. The most recent financial crisis, also known as...
Financial Sector
A designation for the portion of the economy in which people trade financial assets. The financial sector includes a broad range of organizations that manage money, including credit unions, banks, credit card companies, insurance companies, consumer finance companies, stock...
Fiscal Agent
A term describing a central bank's role as an agent of its government's finance ministry or treasury department, in which the central bank issues, services, and redeems debts on the government's behalf. In the U.S. the treasury department issues securities at auctions. In...
Flexible Exchange-rate System
An exchange rate system whereby a nation allows market forces to determine the international value of its currency. In today's world, the majority of the world's currencies have some flexibility but central banks often participate in the markets to attempt to influence...
Foreign Direct Investment (FDI)
The acquisition of assets that involve a long-term relationship and controlling interest of at least 10 % in an enterprise located in another economy. An example of foreign direct investment would be an American company taking a majority stake in a company in China....
Foreign Exchange Market
A system of private banks, foreign exchange brokers, and central banks through which households, firms, and governments buy and sell national currencies. The foreign exchange market is the most liquid financial market in the world. The foreign exchange market assists...
Foreign Exchange Risk
The risk that the value of a future receipt or obligation will change due to variations in foreign exchange rates. For example, you might find that after agreeing to a price for exported or imported goods the exchange rate changes before delivery. Clearly, this can work...
Free-rider Problem
The potential for an individual to try to avoid contributing funds to pay for provision of a public good because he or she presumes that others will do so. A common example of a free rider problem is found in national defense. All citizens of a country benefit from being...
Free Trade Area
A trading arrangement that removes all barriers to trade among participating nations but that allows each nation to retain its own restrictions on trade with countries outside the free trade area. One of the most well known free trade areas was created because of the...
Gains from Trade
Additional goods and services that a nation's residents can consume, over and above the amounts that they could have produced within their own borders, due to trade with residents of other nations. Suppose we have two countries, X and Y. Suppose country X could produce 100...
GDP Price Deflator
A flexible-weight measure of the overall price level. It is equal to nominal Gross Domestic Product (GDP) divided by real GDP. For instance, suppose that nominal GDP is equal to U.S. $10 trillion and that the real GDP is U.S. $5 trillion. Then the GDP price deflator can be...
Globalization
The interdependences of economies, governments, and environments as well as the interconnectedness of peoples and societies. The advantages and disadvantages of globalization have been heavily scrutinized and debated in recent years. Proponents of globalization say that it...
Gross Domestic Product (GDP)
The market price value of all final goods and services produced within a country during a given period. The GDP includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. GDP = C + G + I +...
Heckscher-Ohlin Theorem
A theorem stating that a relatively labor-abundant nation will export a relatively labor-intensive good, while a relatively capital-abundant nation will export a relatively capital-intensive good. For example if one country has many machines (capital) but few workers, while...
Human Capital
The knowledge and skills that workers possess. Human capital could be invested in through education, training and enhanced benefits that will lead to an improvement in the quality of such capital. For example, a doctor can gain human capital through education and training....
Import Quota
A policy that restricts the quantity of imports. Nearly every country restricts the imports of foreign goods. For example, in 1996 Vietnam restricted the amount of cement, fertilizer, and fuel as well as the number of automobiles and motorcycles it would import. The import...
Inflation Bias
The tendency for the economy to experience continuing inflation as a result of discretionary monetary policy that takes place because of the time inconsistency problem of monetary policy. Because of the dangers of inflationary bias, several measures have been suggested to...
Law of Demand
An economic law that states that there is an inverse, or negative, relationship between the price that consumers are willing and able to pay and the quantities that they desire to purchase. According to the law of demand a higher price for a good or service leads people to...
Law of Diminishing Marginal Returns
An economic law stating that when more and more units of a factor of production (i.e. labor, capital) are added to fixed amounts of other productive factors, the additional output for each new unit employed eventually declines. Consider a factory that employs laborers to...
Law of Supply
An economic law that states that there is a positive or direct relationship between the prices producers receive and the quantities that they are willing to supply to the market. Suppose that the price of lattes rises from U.S. $3 to U.S. $3.25, then the quantity of lattes...
Leaning Against the Wind
Central bank interventions to halt or reverse the current trend in the market exchange value of its nation's currency. Leaning against the wind policy is exemplified by a central bank selling its own currency (increase in money supply) in order to depreciate its currency...
Leaning With the Wind
Central bank interventions to support or speed along the current trend in the market exchange value of its nation's currency. Leaning with the wind policy is exemplified by a central bank selling its own currency (increase in money supply) in order to depreciate its...
Lender of Last Resort
A central banking function in which the central bank stands willing to lend to any temporarily illiquid but otherwise solvent banking institution to prevent its illiquid position from leading to a general loss of confidence in that institution. For instance, in the U.S. the...
Locomotive Effect
A stimulus to economic activity in one nation generated by an increase in economic activity in another country. For example when there is an economic growth in the U.S. then residents of the U.S. will demand more exports causing countries that export to the U.S., such as...
Lombard Rate
The name given to the interest rate on central bank loans to commercial banks. Previously, the Lombard rate could be raised or lowered in keeping with Germany's monetary policy. However, since the euro came into being, Germany no longer controls its own monetary policy. As...
Long-run Average Cost
The ratio of a firm's total production cost to its output when the firm has sufficient time to vary the quantities of all factors of production. Let's suppose that Martha's Gourmet Cupcake is facing a sudden surge in demand for her cupcakes. In order to meet such a demand,...
M1
Currency plus transaction deposits. M1 includes demand deposits, which are checking accounts, and a category of the money supply that includes all physical money such as coins and currency; it also includes demand deposits, which are checking accounts, and Negotiable Order...
M2
A category within the money supply that includes M1 plus savings and small time deposits, and balances of individual and broker-dealer money market mutual funds, as well as repurchase agreements. M2 is a broader classification of money than M1. M2 can indicate the amount of...
Managed (dirty) Float
An exchange rate system in which a nation allows the international value of its currency to be primarily determined by market forces but intervenes from time to time to stabilize its currency. In most instances, the intervention aspect of a managed float system is meant to act...
Marginal Cost
The additional cost that the firm incurs from producing an additional unit of output. For example, suppose Bob owns a restaurant where his specialty is burgers. If it costs him U.S. $1000 to produce 100 burgers and U.S. $1020 to produce 101 burgers, then the marginal cost...
Marginal Product of Capital
The additional output generated by using an additional unit of capital. Suppose Juan owns a shipping company. He owns 10 ships and he can ship 1000 containers with these ships. He recently purchased one more ship and now his total shipping has increased to 1080. The...
Marginal Product of Labor
The additional output generated by employing an additional unit of labor. Suppose a car manufacturing firm has 100,000 employees and produces 100 cars per day. Then the firm hires 1000 more employees and now with 101,000 employees it produces 110 cars per day. All else...
Marginal Revenue
The additional revenue a firm earns from selling an additional unit of output. For example, a bakery producing cakes has a total revenue of U.S. $0, when it doesn't produce any output. The revenue it sees from producing its first cake is U.S. $15, bringing marginal revenue...
Market Clearing (equilibrium) Price
The price at which quantity supplied equals quantity demanded. The equilibrium price is referred to as a market-clearing price, because at this price there is no excess quantity demanded nor excess quantity supplied. Suppose at a price of U.S.$30 consumers are willing to...
Market Failure
Situation where resources cannot be efficiently allocated due to the breakdown of the price mechanism caused by factors such as the establishment of monopolies or externalities. In instances where there is a monopoly, the monopolist can determine the market price. The...
Market Price
The price determined by the interactions of all consumers and producers in the marketplace. For example, suppose that the market price for a burger has been U.S. $10 for a number of years. Suddenly, the market price shifts to U.S. $20 when it is announced that only half of...
Market Wage Rate
The wage rate at which the quantity of labor supplied by all workers in a labor market is equal to the total quantity of labor demanded by firms in that market. Suppose 80 high school math teachers are willing to work for the weekly wage of U.S. $400. And suppose Grady...
Mercantilism
An economic doctrine which states that a primary determinant of a nation's wealth is international trade and commerce. In particular it demands that polices that spur exports be enacted while limiting imports. Mercantilism dominated Western European economic policy and...
Monetary Aggregate
A grouping of assets sufficiently liquid to be defined as a measure of money. In the United States, the standardized monetary aggregates and their measured contents are known as: M1 – Physical cash and coins plus demand deposits, traveler’s checks M2 – All of M1...
Monetary Base
The sum of the currency in circulation and the reserves of commercial banks at the central bank. For example, suppose country A has 500 million currency units circulating in the public and its central bank has 20 billion currency units in reserve as part of deposits from...
Monopolistic Competition
An industry structure with a relatively few large firms, each with some market power to set prices. Monopolistic competition falls somewhere in-between perfect competition and monopoly. With perfect competition, all firms are small relative to the size of the market and are...
Monopoloy
A situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition, monopoly is characterized by an absence of competition, which often results in high prices and inferior products. Some firms get...
Moral Hazard
A situation where individuals, firms, or governments take too much risk because they expect to receive help if they get into trouble. The U.S. government bailed out several banks during the global financial crisis. Other banks could draw the conclusion that they would...
Nominal Exchange Rate
A bilateral exchange rate that is unadjusted for changes in the two nations' price levels. Consider the bilateral exchange relationship between the United States and the member countries of the European Monetary Union (EMU) between April 2000 and April 2002. During this...
Nominal Gross Domestic Product (nominal GDP)
The current value of all goods and services produced in the economy with no adjustment for the effect of inflation. Suppose during the year 2012 country X produced only two goods. It produced 100 cars priced at $100 each and 200 breads priced at $10 per loaf. Then the...
Nominal Interest Rate
A rate of return in current-dollar terms that does not reflect expected changes in the price levels. For example, if you borrow U.S. $100,000 and you are given an interest rate of 10%, then when the loan is paid back you will be paying U.S. $110,000. Note that the nominal...
Non-tariff Barriers
Instruments other than import tariffs that restrict international trade. Some examples of non-tariff barriers are quotas, import bans, packaging conditions, occupational safety and health regulations,rules of origin, and restrictive licensing. For example, New Zealand's...
Official Settlements Balance
A balance of payments account that tabulates transactions of reserve assets by official government agencies. The official settlement balance reflects transactions involving gold, foreign exchange reserves, bank deposits and special drawing rights (SDRs). If, for example,...
Oligopoly
A situation in which a particular market is controlled by a small group of firms and their pricing and production decision are interdependent. The retail gas market is a good example of an oligopoly because a small number of firms control a large majority of the market.
Open-market Operations
Central bank purchases or sales of government or private securities. In the U.S. open-market operations result when the Federal Reserve Bank (the Fed) buys and sells government debt. The Fed owns a significant amount of the national debt, and it sells a portion of that...
Opportunity Cost
The highest-valued, next-best alternative that must be sacrificed to obtain an item. For example, suppose it costs U.S. $100,000 to go to college. The opportunity cost of going to college is the next best thing you could have bought with the U.S. $100,000 as well as the...
Optimal Currency Area
The geographic area in which a single currency would create the greatest economic benefit. In particular, countries which share strong economic ties may benefit from a common currency. This allows for closer integration of capital markets and facilitates trade. The theory of...
Outsourcing
A practice used by different companies to reduce costs by transferring portions of work to outside suppliers rather than completing it internally. An example of a manufacturing company outsourcing would be Apple producing its products in China in order to save on...
Overvalued currency
The situation of a currency whose value on the exchange market is higher than is believed to be sustainable. For example, before the 1994 devaluation in Mexico, prices in Mexico were increasing quite rapidly compared to international prices. That created a situation where...
Pegged Exchange-rate System
An exchange rate system in which a country pegs the international value of the domestic currency to the currency of another nation. During the 2000's, an example of a country that fixes its exchange rate is Bulgaria. The Bulgarian lev was pegged to the euro.
Policy Rule
A commitment to a fixed strategy no matter what happens to other economic variables. Rules can directly limit the actions taken by a monetary authority. For example, one simple possible rule would be that the monetary authority hold the monetary base constant. This clearly...
Portfolio Investment
The acquisition of foreign financial assets that results in less than a 10% ownership share in the entity. Portfolio investment is investment made by investors who are not particularly interested in involvement in the management of a company. Portfolio investment can be...
Predatory Pricing
A situation in which a firm sets artificially low prices intended to induce competitor to leave the industry and to dissuade potential rivals from entering the industry. To utilize a predatory pricing strategy, a company must be large enough relative to its competition that...
Preferential Trade Arrangement
A trade agreement in which a nation grants partial trade preferences to one or more trading partners. For example, preferential trade agreements signed between Chile and Venezuela give the Chilean exporters considerable advantage over U.S. fruit suppliers.
Price Discrimination
A pricing strategy that charges customers different prices for the same product or service. For example, movie theaters usually charge three different prices for a show. The prices target various age groups, including youth, adults and seniors. The prices fluctuate with the...
Producer Surplus
The difference between the price that producers are willing to accept to supply a particular quantity of a good and the market price. Suppose you know how to make beaded necklesses which you are willing to sell for $2 per neckless. However, your friends are willing to pay...
Production Possibilities
The maximum output that can be produced in a nation given the available technology and resources. Suppose a country X does not engage in any international trade. Furthermore, let's suppose that country X's residents currently produce and consume only food and cars. Given...
Public Good
A product that one individual can consume without reducing its availability to another individual and from which no one is excluded. A public good is "non-rivalrous" and "non-excludable". For example, even if Sam doesn’t pay his taxes, he still benefits from the...
Purchasing Power Parity (PPP)
An economic theory which states that the price of a good or service in one nation should be the same as the exchange-rate-adjusted price of the same good or service in another nation. For example, a pack of gum that sells for CD$1.50 in a Canadian city should cost U.S.$1.00...
Quota Rent
A portion of the loss of consumer surplus caused by an import quota that is transferred to the foreign supplier as additional profits. Suppose a quota is placed on women's blouses that are imported in the U.S. from Singapore. Before the quota was placed, the domestic price...
Rational Expectations Hypothesis
The idea that individuals form expectations based on all available past and current information. A basic example of rational expectations theory is a situation in which a consumer delays buying a certain good because, based on his/her observations and experiences, he/she...
Real Exchange Rate
A bilateral exchange rate that has been adjusted for price changes in the two nations. Consider an example with the U.S. dollar and the euro between April 2000 and April 2002. During this period the euro declined relative to the dollar. In April 2000, the euro-dollar...
Real Gross Domestic Product (real GDP)
An inflation-adjusted measure that reflects the value of all goods and services produced in a given year, expressed in base-year prices. It is calculated as nominal GDP divided by the GDP price deflator. Say in 2004, nominal GDP is $200 billion. However, due to an...
Real Interest Rate
An interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower, and the real yield to the lender. The real interest rate can be calculated as follows: Real Interest Rate = Nominal Interest Rate - Inflation...
Regionalism
Establishment of trading agreements among geographic groupings of nations. The North American Free Trade Agreement (NAFTA) is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America.The goal of NAFTA...
Reserve Currency
A foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate. In 2011, the U.S. dollar was the primary reserve currency used by other countries. As a...
Reserve Requirements
Central bank regulations requiring private banks to hold specific fractions of transactions and term deposits either as vault cash or as funds on deposit at the central bank. For example, a bank receives a deposit of U.S. $100,000, and the reserve requirement is 20%. The...
Revalue
A situation in which a nation with a pegged exchange-rate regime changes the pegged value of its currency so that it takes a smaller number of domestic currency units to purchase one unit of the foreign currency. For example, suppose that the government of country X has set...
Specific Tariff
A tariff specified as an amount of money per unit of good sold. Governments may impose tariffs to raise revenue or to protect domestic industries from foreign competition, since consumers will generally purchase cheaper foreign produced goods. Tariffs can lead to trade wars as...
Speculative Attack
A concerted effort by financial-market speculators to profit from a sharp change in currency values. For example, the massive sale of the UK pound by currency traders in 1992 caused the value of the pound to collapse. Then, these same speculators could repurchase the pounds...
Sterilization
Intervention in the currency markets that leaves domestic money supply unchanged. For example, to weaken the Mexican peso, the Mexican central bank buys dollars and sells pesos in the financial market. That policy increases the supply of pesos and leads to lower interest...
Supply
The relationship between the prices of a good or service and the quantities supplied to the market by producers within a given time period, all other things constant. For example to see how much Coke producers want to sell depends on the price of the Coke. When the price...
Tariff
A tax on imported goods and services. Tariffs are used to restrict trade, as they increase the price of imported goods and services, making them more expensive to consumers. There are generally two types of tariffs. Ad valorem tariffs are calculated as a fixed percentage...
Tax Base
The value of goods, services, incomes, or wealth subject to taxation. For example, the property tax base of a house is its value. Hence, if Bob decides to build a house that is worth $200,000 in Atlanta, Bob's new house will add $200,000 to the property tax base of Atlanta.
Tax Competition
Reducing tax rates below those of other regions in an effort to induce individuals and businesses to engage in taxable activities in that region. For instance, in the European Union some countries such as the Republic of Ireland utilized their low levels of corporate tax to...
Tax Rate
A fraction of a tax base an individual or company is legally required to transmit to the government. For example, consider an individual with an income tax rate of 20%. For every $100,000 that individual makes, $20,000 must be paid as tax to the government.
Time Inconsistency Problem
Policy problem that can result if a policymaker has the ability, in the future, to alter its strategy in a way that is inconsistent both with its own initial announced intentions as well as the desires and strategies of private individuals. Greg Mankiw demonstrates the...
Trade Concentration Ratio
A measure of the degree of diversification of the international trade of a country. If the country trades with only a few other countries (North Korea) its trade concentration ration is high. If it trades with many countries (Germany), the trade concentration ratio is low....
Trade Deflection
The movement of goods or components of goods from outside a trading arrangement to a country within such an arrangement in order for the seller to benefit from trading preferences. For example Italy and France are part of a regional trade agreement, namely the European...
Trade Diversion
A shift in international trade caused by one nation giving trade preferences to another, resulting in a decline in trade with a third country. The United Kingdom's (U.K.) import of lamb is a good example of trade diversion. Before the U.K. joined the European Union (EU),...
Trade Share
A nation's flow of international trade as a percentage of regional or global trade total. Suppose country X's exports and imports are $1 million and the world's trade total is $5 million. Then country X's trade share is 20% ($ 1 million/ $5 million).
Translation Exposure
The risk that a company's equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets, liabilities or income in a foreign currency. For instance, assume the...
Undervalued Currency
The situation of a currency whose value on the exchange market is lower than is believed to be sustainable. For example, the Chinese currency the Renminbi is undervalued by approximately 30%. This is a source of friction in the US, with firms claiming they lose out to a...
Value Added
The market value of a good or service less the value of the resources used to produce it. The value added can be positive or negative, i.e. the producer could be destroying value. For example, during the transition from communism many government-owned Russian firms...
Value-added Taxes (VAT)
Taxes applied to each stage of production in which value is added to a good or service. For example when a radio is built by a company in Europe the manufacturer is charged a value-added tax on all of the supplies they purchase for producing the radio. Once the radio...
Voluntary Export Restraint (VER)
An agreement between policymakers and producers in two nations to restrict the exports of a good from one nation to the other. The most notable example of VERs was during the 1980s. When the automobile industry in the U.S. was threatened by the popularity of cheaper more...
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