Key Concepts

Note: You need not memorize specific definitions for tests. Instead, be able to use the essential concepts skilfully.

• peak : A high point in the business cycle, where economic activity is at its maximum, relative to long-run potential.
• trough : A low point in the business cycle, where economic activity is at its minimum, relative to long-run potential.
• expansion : The phase in the business cycle that starts at a trough and ends at a peak.
• contraction : The phase in the business cycle that starts at a peak and ends at a trough.
• recession : A significant economic downturn, occuring during the contraction phase of the business cycle. Often recession is interpreted as 6 months or more of decline in real GDP.
• disequilibrium : A situation in markets where there is either a shortage or surplus.
• labor surplus : A situation where the quantity of labor supplied exceeds the quantity of labor demanded, causing increased unemployment.
• sticky wages : A situation where wages fail to adjust and the labor market falls into disequilibrium.
• sticky prices : A situation where prices fail to adjust and the goods market falls into disequilibrium.
• Keynesian macroeconomic view : That markets can work poorly, due in part to sticky wages and prices, causing the economy to be stuck at low levels of prosperity.
• natural unemployment rate: The level of the unemployment rate when the labor market is at full employment and economic output has reached its long-run potential.
• real business cycle theory: A theory in which changes in productivity and resource supply cause short-term economic fluctuations.
• fiscal policy: For a government, fiscal policy represents the choice of how much to spend, and how to finance the spending. Macroeconomic intervention, via fiscal policy, involves changes in spending, taxes, and/or borrowing, over the course of the business cycle.
• monetary policy: Monetary policy represents the central bank's choice concerning several variables, including the required reserve ratio, the federal funds rate, and purchase or sale in the market for government bonds. Macroeconomic intervention, via monetary policy, involves changes in these variables, over the course of the business cycle.
• pro-cyclical: A macroeconomic variable is pro-cylical if its value moves up and down over time, with timing similar to that of the ups and downs of the business cycle.
• counter-cyclical: A macroeconomic variable is counter-cylical if its value moves up and down over time, with timing opposite to that of the ups and downs of the business cycle.
• international business cycle: A tendency for business cycles to be similar, across countries, such that recessions happen at the same time, and expansions happen at the same time.

• long-run economy: The overall trend in the economy's direction over time, ignoring temporary issues such as recession, shortage, and surplus.
• Adam Smith: An economist that stressed the importance of markets as an automatic mechanism ("invisible hand") for achieving high living standards and economic growth.
• general equilbrium : A situation where all markets are in equilibrium.
• Say's law : The statement that the nation's income is just sufficient to purchase all the goods which have been produced. In a simple circular flow diagram, Say's law is illustrated by the existence of a circular and equal flow of money in the goods and factor markets.
• production function: A list of output levels for each level of labor, graphed as a line or curve.
• potential level of output: The level of output that results from full employment.
• productivity : The ratio of output to labor.
• equilibrium in labor market : The situation where quantity of labor supplied equals quantity of labor demanded, at the equilibrium wage.
• financial capital: funds used for economic investment in physical and human capital.
• saving : Income earned by households which is not spent, source of investment funds.
• interest rate : The reward to saving, also the price of investment funds.
• supply of investment funds : The quantity of savings provided by households, at each interest rate.
• demand for investment funds: The quantity of funds desired by firms and the goverment, at each interest rate.
• equilibrium in investment fund market : The situation where quantity of funds supplied equals quantity of funds demanded, at the equilibrium interest rate.
• crowding out: The reduction in private investment that arises from government borrowing.
• economic growth rate: The percentage change in output, from one period to the next.
• less-developed country: A country with a relatively low standard of living.
• World Bank: An institution that provides economic assistance to less-developed countries.
• closed economy: An economy with no foreign trade.
• open economy: An economy with foreign trade.
• M1 : A measure of money supply, equal to the sum of cash + balances on checking accounts.
• money: Plays three roles: unit of account, medium of exchange, store of value.
• financial intermediary: In the market for loanable funds, financial intermediaries connect household saving supply to firms' demand for investment funds.
• preferential trade agreement: An aggreement among select countries, permitting trade with relatively few restrictions. Examples are NAFTA and CAFTA.
• outsourcing: The situation where domestic firms hiring foreign labor, for production.
• absolute advantage: For two countrys A and B, A has an absolute advantage in producing a good if it uses fewer resources.
• comparative advantage : For two countries A and B, and two goods 1 and 2, A has a comparative advantage in producing good 1 if it's opportunity cost is lower, with opportunity cost measured by the ratio of resource quantities used in producing good 1 versus good 2.
• tariff: A tax on imports.
• quota: In international trade, a quota is an upper limit on the amount of imports.
• exchange rate: Price of foreign currency.
• fixed exchange rate: The situation where a government intervenes in foreign currency markets, so as to make the domestic currency trade at a fixed, constant rate over time.
• floating exchange rate: The situation where a government does not intervenes in foreign currency markets, in which case the domestic currency trades at the equilibrium exchang rate. The equilbrium rate tends to change, or "float", over time.
• Federal Reserve: The nation's central bank, also responsible for bank regulation and money supply.
• required reserve ratio: Lower bound on the fraction of a bank's deposits that must be held in the bank.
• equilibrium in foreign currency market : The quantity of foreign currency demanded equals the quantity of foreign currency supplied, at the equilibrium exchange rate.

• prosperity : A situation of abundance, concerning the material needs and wants of society.
• poverty : A situation where material needs, for some of society's members, are not satified.
• progress : Improvements in the ability to satisfy the material needs and wants of society.
• macroeconomics : The science of prosperity, macroeconomics studies the economy as a "whole".
• goods : Things provided for the improvement of our quality of life.
• services : Activities provided for the improvement of our quality of life.
• households : All persons who occupy a housing unit.
• firms : Sellers of goods and services.
• government policy-makers : Government officials that decide on the course of government action. In economics, such policy can affect the production and distribution of goods and services, and can alter the amount activity in the marketplace.
• rational behavior : Economic agents, including households and firms, are rational if they make choices by picking the outcome they identify as best. In making rational choices, economic agents use all available resources, without waste or loss.
• land : The physical territory required to produce goods and services.
• labor : The human effort required in the process of producing goods and services.
• capital : Tools of production.
• physical capital : Physical tools of production, such as tractors.
• human capital : Education and training that makes laborers more productive.
• technology : Scientific discoveries that lead to new and improved goods and services.
• entrepreneurship : The skill of acquiring and directing the other three factors of production (land, labor, capital).
• market economy : A macroeconomic system in which the allocation and distribution of resources, goods and services is determined primarily by private individuals and entities such as households and firms.
• socialism : A macroeconomic system in which the allocation and distribution of resources, goods and services is determined primarily by the government.
• financial system : An economic institution that provides opportunities for borrowing, lending, saving, investment, payment, and finance.
• Production: The process of creating goods and services.
• Resources: The inputs to production.
• economic policy : A plan of action, for achieving prosperity and progress, made by government leaders.
• macroeconomic dynamics : In terms of the macroeconomy, dynamics are changes in economic outcomes, over time.
• macroeconomic trend : The overall direction of the level of prosperity.
• factors of production: The main input categories, including land, labor, capital and entrepreneurship.
• productivity: The amount of output produced, from a unit of input.
• business cycle : Variations, or fluctuations, in the level of propsperity, relative to the macroeconomic trend.
• markets: Environments in which buyers and sellers gather to trade.
• price: The amount of money (or other tradeable) that is traded for a given good or service.
• quantity: The amount of a good or service which is sold, at a given price.
• demand: The buyer's willingness and ability to buy goods and services.
• supply: The seller's willingness and ability to sell goods and services.
• quantity demanded: The amount of a good that buyers will purchase, at a given price.
• quantity supplied: The amount of a good that sellers will provide, at a given price.
• goods: Things provided for the improvement of our quality of life.
• services: Activities provided for the improvement of our quality of life.
• Perfect Competition : A market with many buyers and sellers.
• equilibrium: The market condition where price is at the level that makes quantity demanded equal quantity supplied.
• surplus: A situation where price is above equilibrium, causing quantity supplied to exceed quantity demanded.
• shortage: A situation where price is below equilibrium, causing quantity demanded to exceed quantity supplied.
• market Diagram : A diagram illustrating possible behaviors of economic agents in markets.
• demand Curve : For a perfectly competitive market, the demand curve depicts quantities demanded, at each possible price. Typically, demand curves are downward sloping.
• supply Curve : For a perfectly competitive market, the supply curve depicts quantities supplied, at each possible price. Typically, supply curves are upward sloping.
• equilibrium point : In a market diagram, the equilibrium point represents a price-quantity combination, such that quantity supplied = quantity demanded. In perfectly competitive markets, the equilibrium point lies at the crossing of supply and demand curves.
• shortage, diagrammed : In a market diagram, shortage is represented by a price lower than equilibrium, such that quantity demanded > quantity supplied.
• surplus, diagrammed : In a market diagram, surplus is represented by a price higher than equilibrium, such that quantity demanded < quantity supplied.
• law of demand : The law of demand states that, in perfectly competitive markets, as prices rise the quantity demanded falls. In a market diagram, the law of demand takes the form of a downward-sloping demand curve. Also, the downward-sloping demand curve is associated with diminishing marginal utility of consumption.
• law of supply : The law of supply states that, in perfectly competitive markets, as prices rise the quantity supplied rises. In a market diagram, the law of supply takes the form of an upward-sloping supply curve. Also, the upward-sloping supply curve is associated with increasing marginal cost of production.
• Macroeconomic goals: These include rapid economic growth, low unemployment, and stable prices.
• Standard of living: The average level of material wellbeing of a nation's people.
• Economic growth: Improvements in living standards, over time.
• Employment: People at work.
• Price level: The average level of prices in the economy.
• Cost of living: The expense of achieving a standard of living.
• Inflation: The percentage change in the price level, from one period to the next.
• National output: The amount of goods and services produced by a nation, over a period of time.
• National income:The amount of income recieved by a nation people, over a period of time.
• Gross domestic product: A measure of national output, given by the total value of final goods and services produced within a nation, over a period of time.
• GDP per capita A measure of output per person, equal to GDP/population.
• Expenditure approach to measuring GDP: The measurement approach based on the equation GDP = C + I + G + NX, with C = consumption, I = investment, G = government purchases, NX = net exports.
• Consumption: The value of consumer goods and services purchased in a nation, over a period of time.
• Investment: The value of investment goods and services purchased in a nation, over a period of time.
• Government Purchases: The value of goods and services purchased by a nation's government, over a period of time.
• Exports: The value of goods and services a nation produces and sells abroad, over a period of time.
• Imports: The value of goods and services a nation purchases from abroad, over a period of time.
• Next Exports: Exports - Imports.
• Nominal GDP: Ordinary GDP, not corrected for inflation.
• GDP deflator: A measure of the average level of the prices of all final goods.
• Real GDP: An inflation-adjusted form of GDP.
• Human Development Index: A statistic that measures a nation's prosperity in terms of income and also education, health, and longevity.
• Index of Economic Freedom : A statistic that measures the extent of economic opportunity, and freedom, in a nation.
• Employment: The status of being employed, at work.
• Labor force: The total number of people in a nation who are willing and able to work.
• Unemployment rate: The percentage of people who are willing and able to work but can not find a job.
• Full employment: The level of employment that results from equilibrium in the labor market.
• Cyclical unemployment: The process of falling out of work due to the temporary, seasonal nature of some jobs. Example: working at a ski resort.
• Structural unemployment: Joblessness due to a fundamental mismatch between a worker's qualifications and the firms' needs.
• Frictional unemployment: Temporary unemployment due to the difficulty of prospective workers and firms finding each other.
• Inflation rate: The percentage change in the price level, over time.
• Consumer price index: A measure of the average level of consumer prices.
• Costs of inflation: Deteriorating buying power for people on a fixed income.
• Interest rate: The cost of borrowing, measured by the additional percentage of a loan's principal that must be repayed.
• Nominal interest rate: The ordinary rate of interest on a loan.
• Real interest rate: The rate of interest on a loan, adjusted for inflation.
• trade surplus: A situation where exports exceed imports.
• trade shortage : A situation where imports exceed exports.
• Foreign Direct Investment : Investment by firms, directly into their business operations in foreign countries.
• current account: An account of transactions between countries, in markets for goods and for factors of production. The current account balance is the difference between total purchases and total sales, for these markets.
• capital account : An account of transactions between countries, in markets for investment opportunities. The capital account balance is the difference between total purchases and total sales, in these markets.