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appreciate when exchange rates change
budget deficit instead. (p. 303) tion function shows the relationship be-
so that a unit of its currency can buy more
tween total consumer expenditures and
units of foreign currency. (pp. 362, 381) Capital A nation™s capital is its available
total disposable income in the economy,
supply of plant, equipment, and soft-
Asset An asset of an individual or busi- holding all other determinants of con-
ware. It is the result of past decisions to
ness firm is an item of value that the indi- sumer spending constant. (p. 160)
make investments in these items. (pp. 138)
vidual or firm owns. (p. 251)
Convergence hypothesis The conver-
Capital account The capital account bal-
Automatic stabilizer An automatic sta- gence hypothesis holds that nations with
ance includes purchases and sales of fi-
low levels of productivity tend to have
bilizer is a feature of the economy that re-
nancial assets to and from citizens and
high productivity growth rates, so that
duces its sensitivity to shocks, such as
companies of other countries. (p. 370)
international productivity differences
sharp increases or decreases in spending.
shrink over time. (p. 137)
(p. 225) Capital formation Capital formation is
synonymous with investment. It refers to
Coordination failure A coordination fail-
Autonomous increase in consumption
the process of building up the capital
ure occurs when party A would like to
An autonomous increase in consumption
stock. (p. 138)
change his behavior if party B would
is an increase in consumer spending
405

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Glossary
406



change hers, and vice versa, and yet the Demand-side inflation Demand-side in- aspect of the economy. Economic models
two changes do not take place because flation is a rise in the price level caused are often expressed in equations, by
the decisions of A and B are not coordi- by rapid growth of aggregate demand. graphs, or in words. (p. 10)
nated. (p. 184) (p. 318)
Efficiency A set of outputs is said to be
Correlated Two variables are said to be Deposit creation Deposit creation refers produced efficiently if, given current tech-
correlated if they tend to go up or down to the process by which a fractional re- nological knowledge, there is no way one
together. Correlation need not imply cau- serve banking system turns $1 of bank can produce larger amounts of any out-
sation. (p. 10) reserves into several dollars of bank de- put without using larger input amounts
posits. (p. 252) or giving up some quantity of another
Cost disease of the personal services
output. (p. 47)
The cost disease of the personal services Deposit insurance Deposit insurance is
is the tendency of the costs and prices of a system that guarantees that depositors Equation of exchange The equation of
these services to rise persistently faster will not lose money even if their bank exchange states that the money value of
than those of the average output in the goes bankrupt. (p. 250) GDP transactions must be equal to the
economy. (p. 146) product of the average stock of money
Depreciate A nation™s currency is said to times velocity. That is: M 3 V 5 P 3 Y
Crowding in Crowding in occurs when depreciate when exchange rates change (p. 278)
government spending, by raising real so that a unit of its currency can buy
GDP, induces increases in private invest- fewer units of foreign currency. (p. 362) Equilibrium An equilibrium is a situa-
ment spending. (p. 311) tion in which there are no inherent forces
Depreciation Depreciation is the value that produce change. Changes away from
Crowding out Crowding out occurs when of the portion of the nation™s capital an equilibrium position will occur only
deficit spending by the government forces equipment that is used up within the as a result of “outside events” that dis-
private investment spending to contract. year. It tells us how much output is turb the status quo. (pp. 65, 176)
(p. 310) needed just to maintain the economy™s
capital stock. (pp. 171, 381) Excess reserves Excess reserves are any
Current account The current account
reserves held in excess of the legal mini-
balance includes international purchases Devaluation A devaluation is a reduc- mum. (p. 252)
and sales of goods and services, crossbor- tion in the official value of a currency.
der interest and dividend payments, and Exchange rate The exchange rate states
(p. 363)
cross-border gifts to and from both pri- the price, in terms of one currency, at
Development assistance Development
vate individuals and governments. It is which another currency can be bought.
assistance (“foreign aid”) refers to out-
approximately the same as net exports. (pp. 362, 381)
right grants and low-interest loans to
(p. 370)
Expenditure schedule An expenditure
poor countries from both rich countries
Cyclical unemployment Cyclical unem- schedule shows the relationship between
and multinational institutions like the
ployment is the portion of unemploy- national income (GDP) and total spend-
World Bank. The purpose is to spur eco-
ment that is attributable to a decline ing. (p. 179)
nomic development. (p. 147)
in the economy™s total production. Cycli-
Export subsidy An export subsidy is a
Discount rate The discount rate is the in-
cal unemploymentrises during reces-
payment by the government to exporters
terest rate the Fed charges on loans that it
sions and falls as prosperity is restored.
to permit them to reduce the selling prices
makes to banks. (p. 270)
(p. 114)
of their goods so they can compete more
Discouraged worker A discouraged
Deflating Deflating is the process of effectively in foreign markets. (p. 349)
worker is an unemployed person who
finding the real value of some monetary
Factors of production Inputs or factors
gives up looking for work and is therefore
magnitude by dividing by some appro-
of production are the labor, machinery,
no longer counted as part of the labor force.
priate price index. (p. 129)
buildings, and natural resources used to
(p. 114)
Deflation Deflation refers to a sustained make outputs. (p. 22)
Disposable income Disposable income
decrease in the general price level. (p. 93)
Federal funds rate The federal funds
(DI) is the sum of the incomes of all indi-
Demand curve A demand curve is a rate is the interest rates that banks pay
viduals in the economy after all taxes
graphical depiction of a demand schedule. and receive when they borrow reserves
have been deducted and all transfer pay-
It shows how the quantity demanded of from one another. (p. 266)
ments have been added. (p. 155)
some product will change as the price of
Fiat money Fiat money is money that is
Division of labor Division of labor means
that product changes during a specified pe-
decreed as such by the government. It is
breaking up a task into a number of
riod of time, holding all other determinants
smaller, more specialized tasks so that each of little value as a commodity, but it
of quantity demanded constant. (p. 58)
maintains its value as a medium of ex-
worker can become more adept at a partic-
Demand schedule A demand schedule change because people have faith that the
ular job. (p. 48)
is a table showing how the quantity de- issuer will stand behind the pieces of
Dumping Dumping means selling goods
manded of some product during a speci- printed paper and limit their production.
in a foreign market at lower prices than
fied period of time changes as the price of (p. 246)
those charged in the home market. (p. 353)
that product changes, holding all other
Final goods and services Final goods
determinants of quantity demanded con- Economic model An economic model is and services are those that are purchased
stant. (p. 58) a simplified, small-scale version of some by their ultimate users. (p. 89)


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Glossary 407



Fiscal policy The government™s fiscal each participating currency in terms of period, which is simply the year used as
policy is its plan for spending and taxa- gold and allowing holders of each partic- a basis of comparison. (p. 127)
tion. It can be used to steer aggregate de- ipating currency to convert that currency
Index number problem When relative
mand in the desired direction. (pp. 95, into gold. (p. 371)
prices are changing, there is no such
221, 301)
Government purchases Government pur- thing as a “perfect price index” that is
Fixed exchange rates Fixed exchange chases (G) refer to the goods (such as air- correct for every consumer. Any statisti-
rates are rates set by government deci- planes and paper clips) and services (such cal index will understate the increase in
sions and maintained by government ac- as school teaching and police protection) the cost of living for some families and
tions. (p. 369) purchased by all levels of government. overstate it for others. At best, the index
(p. 155) can represent the situation of an “aver-
Fixed taxes Fixed taxes are taxes that do
age” family. (p. 127)
not vary with the level of GDP. (p. 235) Gross domestic product (GDP) Gross
domestic product (GDP) is the sum of the Induced increase in consumption An
Floating exchange rates Floating ex- money values of all final goods and serv- induced increase in consumption is an in-
change rates are rates determined in free ices produced in the domestic economy crease in consumer spending that stems
markets by the law of supply and de- and sold on organized markets during a from an increase in consumer incomes.
mand. (p. 363) specified period of time, usually a year. It is represented on a graph as a move-
(pp. 23, 88, 168) ment along a fixed consumption func-
Foreign direct investment Foreign di-
tion. (p. 189)
rect investment is the purchase or con- Gross national product (GNP) Gross na-
struction of real business assets”such as tional product (GNP) is a measure of all Induced investment Induced invest-
factories, offices, and machinery”in a final production, making no adjustment ment is the part of investment spending
foreign country. (p. 147) for the fact that some capital is used up that rises when GDP rises and falls when
each year and thus needs to be replaced. GDP falls. (p. 179)
45° line Rays through the origin with a
(p. 171)
slope of 1 are called 45° lines because
Infant-industry argument The infant-
they form an angle of 45° with the hori-
industry argument for trade protection
Gross private domestic investment (I)
zontal axis. A 45° line marks off points Gross private domestic investment in- holds that new industries need to be pro-
where the variables measured on each cludes business investment in plant, tected from foreign competition until they
axis have equal values. (p. 17) equipment, and software; residential con- develop and flourish. (p. 352)
struction; and inventory investment.
45° line diagram An income-expendi-
Inflation Inflation refers to a sustained
(p. 169)
ture diagram, or 45° line diagram, plots
increase in the general price level. Infla-
total real expenditure (on the vertical Growth policy Growth policy refers to tion occurs when prices in an economy
axis) against real income (on the horizon- government policies intended to make rise rapidly. The rate of inflation is calcu-
tal axis). The 45° line marks off points the economy grow faster in the long run. lated by averaging the percentage growth
where income and expenditure are equal. (p. 106) rate of the prices of a selected sample of
(p. 180)
commodities. (p. 87)
Human capital Human capital is the
Fractional reserve banking Fractional amount of skill embodied in the work- Inflationary gap The inflationary gap is
reserve banking is a system under which force. It is most commonly measured by the amount by which equilibrium real
bankers keep as reserves only a fraction the amount of education and training. GDP exceeds the full-employment level
of the funds they hold on deposit. (p. 248) (p. 136) of GDP. (pp. 183, 205)
Frictional unemployment Frictional un- Income-expenditure diagram An income- Innovation Innovation is the process
employment is unemployment that is expenditure diagram, or 45° line dia- that begins with invention and includes
due to normal turnover in the labor mar- gram, plots total real expenditure (on the improvement to prepare the invention
ket. It includes people who are temporar- vertical axis) against real income (on the for practical use and marketing of the
ily between jobs because they are moving horizontal axis). The 45° line marks off invention or its products. (p. 142)
or changing occupations, or are unem- points where income and expenditure are
ployed for similar reasons. (p. 114) Inputs Inputs or factors of production
equal. (p. 180)
are the labor, machinery, buildings, and
Full employment Full employment is a Indexing Indexing refers to provisions natural resources used to make outputs.
situation in which everyone who is will- in a law or a contract whereby monetary (pp. 22, 42, 105)
ing and able to work can find a job. At payments are automatically adjusted
full employment, the measured unem- Intermediate good An intermediate good
whenever a specified price index changes.
ployment rate is still positive. (p. 115) is a good purchased for resale or for use in
Wage rates, pensions, interest payments
producing another good. (p. 89)
on bonds, income taxes, and many other
GDP deflator The price index used to
things can be indexed in this way, and International capital flows International
deflate nominal GDP is called the GDP
have been. Sometimes such contractual capital flows are purchases and sales of
deflator. It is a broad measure of econo-
provisions are called escalator clauses. financial assets across national borders.
mywide inflation; it includes the prices of
(p. 332) (p. 384)
all goods and services in the economy.
(p. 129) Index number An index number ex- Invention Invention is the act of discov-
presses the cost of a market basket of ering new products or new ways of mak-
Gold standard The gold standard is a
goods relative to its cost in some “base” ing products. (p. 142)
way to fix exchange rates by defining


Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:
Glossary
408



Investment Investment is the flow of re- consumption. On a graph, it appears as by the original change in spending that
sources into the production of new capi- the slope of the consumption function. causes the change in GDP. (p. 185)
tal. It is the labor, steel, and other inputs (p. 160)
National debt The national debt is the
devoted to the construction of factories,
Market system A market system is a federal government™s total indebtedness
warehouses, railroads, and other pieces
form of economic organization in which at a moment in time. It is the result of
of capital during some period of time.
resource allocation decisions are left to previous budget deficits. (p. 303)
(p. 138)
individual producers and consumers act-
National income National income is the
Investment spending Investment spend- ing in their own best interests without
sum of the incomes that all individuals in

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