Glossary of terms

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...
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/or a foreign debt crisis. The most recent financial crisis, also known...
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.
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...
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