Economic Glossary


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Absolute Advantage

The advantage in the production of a product enjoyed by one country over another when it uses fewer resources to produce that product than the other country does.

Accelerator Effect

The tendency for investment to increase when aggregate output increases and decrease when aggregate output decreases, accelerating the growth or decline of output.

Actual Investment

The actual amount of investment that takes place; it includes items such as unplanned changes in inventories.

Adjustment Costs

The costs that a firm incurs when it changes its production level—for example, the administration costs of laying off employees or the training costs of hiring new workers.

Adverse Selection

Can occur when a buyer or seller enters into an exchange with another party who has more information.

Aggregate Behavior

The behavior of all households and firms together.

Aggregate Demand

The total demand for goods and services in the economy.

Aggregate Demand (AD) Curve

A curve that shows the negative relationship between aggregate output (income) and the price level. Each point on the AD curve is a point at which both the goods market and the money market are in equilibrium.

Aggregate Income

The total income received by all factors of production in a given period.

Aggregate Output

The total quantity of goods and services produced (or supplied) in an economy in a given period.

Aggregate Output (Income) (Y)

A combined term used to remind you of the exact equality between aggregate output and aggregate income.

Aggregate Production Function

The mathematical representation of the relationship between inputs and national output, or gross domestic product.

Aggregate Supply

The total supply of all goods and services in an economy.

Aggregate Supply (AS) Curve

A graph that shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level.

Animal Spirits of Entrepreneurs

A phrase coined by Keynes to describe investors’ feelings.

Antitrust Division (of the Department of Justice)

One of two federal agencies empowered to act against those in violation of antitrust laws. It initiates action against those who violate antitrust laws and decides which cases to prosecute and against whom to bring criminal charges.

Appreciation of a Currency

The rise in value of one currency relative to another.

Automatic Destabilizers

Revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to destabilize GDP.

Automatic Stabilizers

Revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP.

Autonomous Variable

A variable that is assumed not to depend on the state of the economy—that is, it does not change when the economy does.

Average Fixed Cost (AFC)

Total fixed cost divided by the number of units of output; a per-unit measure of fixed costs.

Average Product

The average amount produced by each unit of a variable factor of production.

Average Propensity to Consume (APC)

The proportion of income households spend on consumption. Determined by dividing consumption (C) by income (Y).

Average Total Cost (ATC)

Total cost divided by the number of units of output.

Average Variable Cost (AVC)

Total variable cost divided by the number of units of output.

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Balance of Payments

The record of a country’s transactions in goods, services, and assets with the rest of the world; also the record of a country’s sources (supply) and uses (demand) of foreign exchange.

Balance of Trade

A country’s exports of goods and services minus its imports of goods and services.

Balance on Capital Account

In the United States, the sum of the following (measured in a given period): the change in private U.S. assets abroad, the change in foreign private assets in the United States, the change in U.S. government assets abroad, and the change in foreign government assets in the United States.

Balance on Current Account

Net exports of goods, plus net exports of services, plus net investment income, plus net transfer payments.

Balanced-Budget Multiplier

The ratio of change in the equilibrium level of output to a change in government spending where the change in government spending is balanced by a change in taxes so as not to create any deficit. The balanced-budget multiplier is equal to one: The change in Y resulting from the change in G and the equal change in T is exactly the same size as the initial change in G or T itself.

Barriers to Entry

Something that prevents new firms from entering and competing in imperfectly competitive industries.


The direct exchange of goods and services for other goods and services.


The year chosen for the weights in a fixed-weight procedure.

Black Market

A market in which illegal trading takes place at market-determined prices.


A contract between a borrower and a lender, in which the borrower agrees to pay the loan at some time in the future, along with interest payments along the way.

Brain Drain

The tendency for talented people from developing countries to become educated in a developed country and remain there after graduation.

Breaking Even

The situation in which a firm is earning exactly a normal rate of return.

Budget Constraint

The limits imposed on household choices by income, wealth, and product prices.

Budget Deficit

The difference between what a government spends and what it collects in taxes in a given period: G2T.

Business Cycle

The cycle of short-term ups and downs in the economy.

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Those goods produced by the economic system that are used as inputs to produce other goods and services in the future.

Capital Flight

The tendency for both human capital and financial capital to leave developing countries in search of higher rates of return elsewhere.

Capital Income

Income earned on savings that have been put to use through financial capital markets.

Capital Market

The input/factor market in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.

Capital Stock

For a single firm, the current market value of the firm’s plant, equipment, inventories, and intangible assets.

Capital-Intensive Technology

A production technique that uses a large amount of capital relative to labor.

Capitalist Economy

An economy in which most capital is privately owned.


A group of firms that gets together and makes joint price and output decisions to maximize joint profits.

Celler-Kefauver Act (1950)

Extended the government’s authority to ban vertical and conglomerate mergers.

Ceteris Paribus (i.e. Everything Else Equal)

A device used to analyze the relationship between two variables while the values of other variables are held unchanged.

Change In Business Inventories

The amount by which firms’ inventories change during a period. Inventories are the goods that firms produce now but intend to sell later.

Change In Inventory

Production minus sales.

Choice Set or Opportunity Set

The set of options that is defined and limited by a budget constraint.

Circular Flow

A diagram showing the income received and payments made by each sector of the economy.

Clayton Act

Passed by Congress in 1914 to strengthen the Sherman Act and clarify the rule of reason, the act outlawed specific monopolistic behaviors such as tying contracts, price discrimination, and unlimited mergers.

Coase Theorem

Under certain conditions, when externalities are present, private parties can arrive at the efficient solution without government involvement.


The act of working with other producers in an effort to limit competition and increase joint profits.

Command Economy

An economy in which a central government either directly or indirectly sets output targets, incomes, and prices.

Commodity Monies

Items used as money that also have intrinsic value in some other use.


An economic system in which the people control the means of production (capital and land) directly, without the intervention of a government or state.

Comparative Advantage

The advantage in the production of a product enjoyed by one country over another when that product can be produced at lower cost in terms of other goods than it could be in the other country.

Compensating Differentials

Differences in wages that result from differences in working conditions. Risky jobs usually pay higher wages; highly desirable jobs usually pay lower wages.

Compensation of Employees

Includes wages, salaries, and various supplements—employer contributions to social insurance and pension funds, for example—paid to households by firms and by the government.

Complements, Complementary Goods

Goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

Consent Decrees

Formal agreements on remedies between all the parties to an antitrust case that must be approved by the courts. Consent decrees can be signed before, during, or after a trial.

Constant Returns to Scale

An increase in a firm’s scale of production has no effect on average costs per unit produced.

Constrained Supply of Labor

The amount a household actually works in a given period at the current wage rate.

Consumer Goods

Goods produced for present consumption.

Consumer Price Index (CPI)

A price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer.

Consumer Sovereignty

The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

Consumer Surplus

The difference between the maximum amount a person is willing to pay for a good and its current market price.

Consumption Function

The relationship between consumption and income.

Contraction, Recession, or Slump

The period in the business cycle from a peak down to a trough, during which output and employment fall.

Contractionary Fiscal Policy

A decrease in government spending or an increase in net taxes aimed at decreasing aggregate output (income) (Y).

Contractionary Monetary Policy

A decrease in the money supply aimed at decreasing aggregate output (income) (Y).

Corn Laws

The tariffs, subsidies, and restrictions enacted by the British Parliament in the early nineteenth century to discourage imports and encourage exports of grain.

Corporate Bonds

Promissory notes issued by corporations when they borrow money.

Cost Shock, or Supply Shock

A change in costs that shifts the aggregate supply (AS) curve.

Cost-Benefit Analysis

The formal technique by which the benefits of a public project are weighed against its costs.

Cost-of-Living Adjustments (COLAs)

Contract provisions that tie wages to changes in the cost of living. The greater the inflation rate, the more wages are raised.

Cost-Push, or Supply-Side, Inflation

Inflation caused by an increase in costs.

Cournot Model

A model of a two-firm industry (duopoly) in which a series of output–adjustment decisions leads to a final level of output between the output that would prevail if the market were organized competitively and the output that would be set by a monopoly.

Cross-Price Elasticity of Demand

A measure of the response of the quantity of one good demanded to a change in the price of another good.

Crowding-Out Effect

The tendency for increases in government spending to crowd out investment

Currency Debasement

The decrease in value of money that occurs when its supply is increased rapidly.

Current Dollars

The current (i.e. "today's") prices that one pays for goods and services.

Cyclical Deficit

The deficit that occurs because of a downturn in the business cycle.

Cyclical Unemployment

The increase in unemployment that occurs during recessions and depressions.

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Debt Rescheduling

An agreement between banks and borrowers through which a new schedule of repayments of the debt is negotiated; often some of the debt is written off and the repayment period is extended.

Decreasing Returns to Scale, or Diseconomies of Scale

An increase in a firm’s scale of production leads to higher average costs per unit produced.

Deficit Response Index (DRI)

The amount by which the deficit changes with a $1 change in GDP.


A decrease in the overall price level.

Demand Curve

A graph illustrating how much of a given product a household would be willing to buy at different prices.

Demand Determined Price

The price of a good that is in fixed supply; it is determined exclusively by what firms and households are willing to pay for the good.

Demand Schedule

A table showing how much of a given product a household would be willing to buy at different prices.

Demand-Pull Inflation

Inflation that is initiated by an increase in aggregate demand.


The amount by which an asset’s value falls in a given period.

Depreciation of a Currency

The fall in value of one currency relative to another.


A prolonged and deep recession. The precise definitions of prolonged and deep are debatable.

Derived Demand

The demand for resources (inputs) that is dependent on the demand for the outputs those resources can be used to produce.

Descriptive Economics

The compilation of data that describe phenomena and facts.

Desired, or Optimal, Level of Inventories

The level of inventory at which the extra cost (in lost sales) from lowering inventories by a small amount is just equal to the extra gain (in interest revenue and decreased storage costs).

Desired, or Planned, Investment

Those additions to capital stock and inventory that are planned by firms.

Diamond/Water Paradox

A paradox stating that (1) the things with the greatest value in use frequently have little or no value in exchange, and (2) the things with the greatest value in exchange frequently have little or no value in use.

Discount Rate

Interest rate that banks pay to the Fed to borrow from it.

Discouraged-Worker Effect

The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force.

Discretionary Fiscal Policy

Changes in taxes or spending that are the result of deliberate changes in government

Discretionary Fiscal Policy

Changes in taxes or spending that are the result of deliberate changes in government

Disposable Personal Income or After-Tax Income

Personal income minus personal income taxes. The amount that households have to spend or save.

Disposable, or After-Tax, Income (Yd)

Total income minus net taxes: Y2T.


The portion of a corporation’s profits that the firm pays out each period to its shareholders.

Dominant Strategy

In game theory, a strategy that is best no matter what the opposition does.

Drop-In-the-Bucket Problem

A problem intrinsic to public goods: The good or service is usually so costly that its provision generally does not depend on whether or not any single person pays.


A firm or industry sells products on the world market at prices below the cost of production.

Durable Goods

Goods that last a relatively long time, such as cars and household appliances.

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Easy Monetary Policy

Fed policies that expand the money supply in an effort to stimulate the economy.

Economic Growth

An increase in the total output of an economy. It occurs when a society acquires new resources or when it learns to produce more using existing resources.

Economic Income

The amount of money a household can spend during a given period without increasing or decreasing its net assets. Wages, salaries, dividends, interest income, transfer payments, rents, and so forth are sources of economic income.

Economic Integration

Occurs when two or more nations join to form a free-trade zone.

Economic Problem

Given scarce resources, how exactly do large, complex societies go about answering the three basic economic questions?

Economic Theory

A statement or set of related statements about cause and effect, action and reaction.


The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.


In economics, allocative efficiency. An efficient economy is one that produces what people want at the least possible cost.

Efficiency Wage Theory

An explanation for unemployment that holds that the productivity of workers increases with the wage rate. If this is so, firms may have an incentive to pay wages above the market-clearing rate.

Efficient Market

A market in which profit opportunities are eliminated almost instantaneously.

Elastic Demand

A demand relationship in which the percentage change in quantity demanded is larger in absolute value than the percentage change in price (a demand elasticity with an absolute value greater than 1).


A general concept used to quantify the response in one variable when another variable changes.

Elasticity of Labor Supply

A measure of the response of labor supplied to a change in the price of labor.

Elasticity of Supply

A measure of the response of quantity of a good supplied to a change in price of that good. Likely to be positive in output markets.

Empirical Economics

The collection and use of data to test economic theories.


Any person 16 years old or older (1) who works for pay, either for someone else or in his or her own business for 1 or more hours per week, (2) who works without pay for 15 or more hours per week in a family enterprise, or (3) who has a job but has been temporarily absent, with or without pay.


A person who organizes, manages, and assumes risk, in order to combine the factors of production into a product/service


Occurs when there is no tendency for change. In the macroeconomic goods market, equilibrium occurs when planned aggregate expenditure is equal to aggregate output.

Equilibrium Price Level

The point at which the aggregate demand and aggregate supply curves intersect.



European Union (EU)

The European trading bloc composed of Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom

Excess Demand or Shortage

The condition that exists when quantity de-manded exceeds quantity supplied at the current price.

Excess Labor, Excess Capital

Labor and capital that are not needed to produce the firm’s current level of output.

Excess Reserves

The difference between a bank’s actual reserves and its required reserves.

Excess Supply or Surplus

The condition that exists when quantity supplied exceeds quantity demanded at the current price.

Exchange Rate

The price of one country’s currency in terms of another country’s currency; the ratio at which two currencies are traded for each other.

Expansion or Boom

The period in the business cycle from a trough up to a peak, during which output and employment rise.

Expansionary Fiscal Policy

An increase in government spending or a reduction in net taxes aimed at increasing aggregate output (income) (Y).

Expansionary Monetary Policy

An increase in the money supply aimed at increasing aggregate output (income) (Y).

Expected Rate of Return

The annual rate of return that a firm expects to obtain through a capital investment.

Expenditure Approach

A method of computing GDP that measures the amount spent on all final goods during a given period.

Explicit Contracts

Employment contracts that stipulate workers’ wages, usually for a period of 1 to 3 years.

Export Promotion

A trade policy designed to encourage exports.

Export Subsidies

Government payments made to domestic firms to encourage exports.


A cost or benefit resulting from some activity or transaction that is imposed or bestowed on parties outside the activity or transaction. Sometimes called spillovers or neighborhood effects.

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Factor Endowments

The quantity and quality of labor, land, and natural resources of a country.

Factor Market (See Input Market)

Factor Substitution Effect

The tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen.

Factors of Production

The inputs into the production process. Land, labor, and capital are the three key factors of production.

Fallacy of Composition

The erroneous belief that what is true for a part is necessarily true for the whole.

Favored Customers

Those who receive special treatment from dealers during situations of excess demand.

Federal Budget

The budget of the federal government.

Federal Debt

The total amount owed by the federal government.

Federal Open Market Committee (FOMC)

A group composed of the seven members of the Fed’s Board of Governors, the president of the New York Federal Reserve Bank, and 4 of the other 11 district bank presidents on a rotating basis; it sets goals concerning the money supply and interest rates and directs the operation of the Open Market Desk in New York.

Federal Reserve System (the Fed)

The central bank of the United States.

Federal Surplus (1) or Deficit (2)

Federal government receipts minus expenditures.

Federal Trade Commission (FTC)

A federal regulatory group created by Congress in 1914 to investigate the structure and behavior of firms engaging in interstate commerce, to determine what constitutes unlawful “unfair” behavior, and to issue cease-and-desist orders to those found in violation of antitrust law.

Fertility Rate

The birth rate. This rate is equal to (the number of births per year divided by the population) x 100.

Fiat, or Token, Money

Items designated as money that are intrinsically worthless.

Final Goods and services

Goods and services produced for final use.

Financial Capital Market

The complex set of institutions in which suppliers of capital (households that save) and the demand for capital (business firms wanting to invest) interact.

Financial Intermediaries

Banks and other institutions that act as a link between those who have money to lend and those who want to borrow money.


The phrase used by Walter Heller to refer to the government’s role in regulating inflation and unemployment.


An organization that comes into being when a person or a group of people decides to produce a good or service to meet a perceived demand. Most firms exist to make a profit.

Fiscal Drag

The negative effect on the economy that occurs when average tax rates increase because taxpayers have moved into higher income brackets during an expansion.

Fiscal Policy

Government policies concerning taxes and expenditures.

Fixed Cost

Any cost that does not depend on the firm’s level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run.

Fixed-Weight Procedure

A procedure that uses weights from a given base year.

Floating, or Market-Determined, Exchange Rates

Exchange rates that are determined by the unregulated forces of supply and demand.

Food Stamps

Vouchers that have a face value greater than their cost and that can be used to purchase food at grocery stores.

Foreign Exchange

All currencies other than the domestic currency of a given country.

Free-Rider Problem

A problem intrinsic to public goods: Because people can enjoy the benefits of public goods whether they pay for them or not, they are usually unwilling to pay for them.

Frictional Unemployment

The portion of unemployment that is due to the normal working of the labor market; used to denote short-run job/skill matching problems.

Full-Employment Budget

What the federal budget would be if the economy were producing at a full-employment level of output.

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Game Theory

Analyzes oligopolistic behavior as a complex series of strategic moves and reactive countermoves among rival firms. In game theory, firms are assumed to anticipate rival reactions.

General Agreement on Tariffs and Trade (GATT)

An international agreement signed by the United States and 22 other countries in 1947 to promote the liberalization of foreign trade.

General Equilibrium

The condition that exists when all markets in an economy are in simultaneous equilibrium.

Gini Coefficient

A commonly used measure of inequality of income derived from a Lorenz curve. It can range from 0 to a maximum of 1.

Goods Market

The market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined.

Government Consumption and Gross Investment (G)

Expenditures by federal, state, and local governments for final goods and services.

Government Failure

Occurs when the government becomes the tool of the rent seeker and the allocation of resources is made even less efficient by the intervention of government.

Government Franchise

A monopoly by virtue of government directive.

Government Spending Multiplier

The ratio of the change in the equilibrium level of output to a change in government spending.

Great Depression

The period of severe economic contraction and high unemployment that began in 1929 and continued throughout the 1930s.

Gross Domestic Product (GDP)

The total market value of all final goods and services produced within a given period by factors of production located within a country.

Gross Investment

The total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period.

Gross National Product (GNP)

The total market value of all final goods and services produced within a given period by factors of production owned by a country’s citizens, regardless of where the output is produced.

Gross Private Domestic Investment (I)

Total investment in capital—that is, the purchase of new housing, plants, equipment, and inventory by the private (or nongovernment) sector.

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Heckscher-Ohlin Theorem

A theory that explains the existence of a country’s comparative advantage by its factor endowments: A country has a comparative advantage in the production of a product if that country is relatively well endowed with inputs used intensively in the production of that product.

Herfindahl-Hirschman Index (HHI)

A mathematical calculation that uses market share figures to determine whether or not a proposed merger will be challenged by the government.

Homogeneous Products

Undifferentiated outputs; products that are identical to, or indistinguishable from, one another.


The consuming units in an economy.

Human Capital

A form of intangible capital that includes the skills and other knowledge that workers have or acquire through education and training and that yields valuable services to a firm over time.


A period of very rapid increases in the overall price level.

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Something that is always true.

Imperfect Competition

An industry in which single firms have some control over price and competition. Imperfectly competitive industries give rise to an inefficient allocation of resources.

Imperfect Information

The absence of full knowledge concerning product characteristics, available prices, and so forth.

Imperfectly Competitive Industry

An industry in which single firms have some control over the price of their output.

Implementation Lag

The time it takes to put the desired policy into effect once economists and policy makers recognize that the economy is in a boom or a slump.

Import Substitution

An industrial trade strategy that favors developing local industries that can manufacture goods to replace imports.

Impossibility Theorem

A proposition demonstrated by Kenneth Arrow showing that no system of aggregating individual preferences into social decisions will always yield consistent, nonarbitrary results.

Income Approach

A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods.

Income Elasticity of Demand

Measures the responsiveness of demand to changes in income.

Increasing Returns to Scale, or Economies of Scale

An increase in a firm’s scale of production leads to lower average costs per unit produced.

Indirect Taxes

Taxes like sales taxes, customs duties, and license fees.

Industrial Policy

Government involvement in the allocation of capital across manufacturing sectors.

Industrial Revolution

The period in England during the late eighteenth and early nineteenth centuries in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities.

Inelastic Demand

Demand that responds somewhat, but not a great deal, to changes in price. Inelastic demand always has an absolute value between zero and one.

Infant Industry

A young industry that may need temporary protection from competition from the established industries of other countries to develop an acquired comparative advantage.

Inferior Goods

Goods for which demand tends to fall when income rises.


An increase in the overall price level.

Inflation Rate

The percentage change in the price level.


A court order forbidding the continuation of behavior that leads to damages.


The use of new knowledge to produce a new product or to produce an existing product more efficiently.

Input or Factor Markets

The markets in which the resources used to produce products are exchanged.


The goods and services that firms purchase and turn into output.

Intangible Capital

Nonmaterial things that contribute to the output of future goods and services.


The fee that borrowers pay to lenders for the use of their funds.

Interest Rate

The annual interest payment on a loan expressed as a percentage of the loan. Equal to the amount of interest received per year divided by the amount of the loan.

Interest Sensitivity or Insensitivity of Planned Investment

The responsiveness of planned investment spending to changes in the interest rate. Interest sensitivity means that planned investment spending changes a great deal in response to changes in the interest rate; interest insensitivity means little or no change in planned investment as a result of changes in the interest rate.

Intermediate Goods

Goods that are produced by one firm for use in further processing by another firm.

International Monetary Fund (IMF)

An international agency whose primary goals are to stabilize international exchange rates and to lend money to countries that have problems financing their international transactions.

Interstate Commerce Commission (ICC)

A federal regulatory group created by Congress in 1887 to oversee and correct abuses in the railroad industry.


An advance in knowledge.

Inventory Investment

Occurs when a firm produces more output than it sells within a given period.


New capital additions to a firm’s capital stock. Although capital is measured at a given point in time (a stock), investment is measured over a period of time (a flow). The flow of investment increases the capital stock.

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J-Curve Effect

Following a currency depreciation, a country’s balance of trade may get worse before it gets better. The graph showing this effect is shaped like the letter J, hence the name “J-curve effect.”

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Kinked Demand Curve Model

A model of oligopoly in which the demand curve facing each individual firm has a “kink” in it. The kink follows from the assumption that competitive firms will follow if a single firm cuts price but will not follow if a single firm raises price.

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Labor Demand Curve

A graph that illustrates the amount of labor that firms want to employ at the particular wage rate.

Labor Force

The number of people employed plus the number of unemployed.

Labor Market

The input/factor market in which households supply work for wages to firms that demand labor.

Labor Productivity

Output per worker hour; the amount of output produced by an average worker in 1 hour.

Labor Supply Curve

A diagram that shows the quantity of labor supplied at different wage rates. Its shape depends on how households react to changes in the wage rate.

Labor Theory of Value

Stated most simply, the theory that the value of a commodity depends only on the amount of labor required to produce it.

Labor-Force Participation Rate

The ratio of the labor force to the total population 16 years old or older.

Labor-Intensive Technology

A production technique that uses a large amount of labor relative to capital.

Laffer Curve

With the tax rate measured on the vertical axis and tax revenue measured on the horizontal axis, the Laffer curve shows there is some tax rate beyond which the supply response is large enough to lead to a decrease in tax revenue for further increases in the tax rate

Laissez-Faire Economy

Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interests without any central direction or regulation.

Land Market

The input/factor market in which households supply land or other real property in exchange for rent.

Law of Demand

The negative relationship between price and quantity demanded: As price rises, quantity demanded decreases. As price falls, quantity demanded increases.

Law of Diminishing Marginal Utility

The more of any one good consumed in a given period, the less satisfaction (utility) generated by consuming each additional (marginal) unit of the same good.

Law of Diminishing Returns

When additional units of a variable input are added to fixed inputs after a certain point, the marginal product of the variable input declines.

Law of One Price

If the costs of transportation are small, the price of the same good in different countries should be roughly the same.

Law of Supply

The positive relationship between price and quantity of a good supplied: An increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied.

Legal Tender

Money that a government has required to be accepted in settlement of debts.

Lender of Last Resort

One of the functions of the Fed: It provides funds to troubled banks that cannot find any other sources of funds.

Liability Rules

Laws that require A to compensate B for damages imposed.

Life-Cycle Theory of Consumption

A theory of household consumption: Households make lifetime consumption decisions based on their expectations of lifetime income.

Liquidity Property of Money

The property of money that makes it a good medium of exchange as well as a store of value: It is portable and readily accepted and thus easily exchanged for goods.


Occurs when congressional representatives trade votes, agreeing to help each other get certain pieces of legislation passed.

Long Run

That period of time for which there are no fixed factors of production. Firms can increase or decrease scale of operation, and new firms can enter and existing firms can exit the industry.

Long-Run Average Cost Curve (LRAC)

A graph that shows the different scales on which a firm can choose to operate in the long run.

Long-Run Competitive Equilibrium

When P = SRMC = SRAC = LRAC and profits are zero.

Lorenz Curve

A widely used graph of the distribution of income, with cumulative percentage of families plotted along the horizontal axis and cumulative percentage of income plotted along the vertical axis.

Lucas Supply Function

The supply function embodies the idea that output (Y) depends on the difference between the actual price level and the expected price level.

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M1, or Transactions Money

Money that can be directly used for transactions.

M2, or Broad Money

M1 plus savings accounts, money market accounts, and other near monies.


The branch of economics that examines the economic behavior of aggregates—income, employment, output, and so on—on a national scale.

Marginal Cost (MC)

The increase in total cost that results from producing one more unit of output. Marginal costs reflect changes in variable costs.

Marginal Damage Cost (MDC)

The additional harm done by increasing the level of an externality-producing activity by one unit. If producing product X pollutes the water in a river, MDC is the additional cost imposed by the added pollution that results from increasing output by one unit of X per period.

Marginal Private Cost (MPC)

The amount that a consumer pays to consume an additional unit of a particular good.

Marginal Product

The additional output that can be produced by adding one more unit of a specific input, ceteris paribus.

Marginal Product of Labor (MPL)

The additional output produced by one additional unit of labor.

Marginal Productivity Theory of Income Distribution

At equilibrium, all factors of production end up receiving rewards determined by their productivity as measured by marginal revenue product.

Marginal Propensity to Consume (MPC)

That fraction of a change in income that is consumed, or spent.

Marginal Propensity to Import (MPM)

The change in imports caused by a $1 change in income.

Marginal Propensity to Save (MPS)

That fraction of a change in income that is saved.

Marginal Rate of Transformation (MRT)

The slope of the production possibility frontier (ppf).

Marginal Revenue (MR)

The additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, P=MR.

Marginal Revenue Product (MRP)

The additional revenue a firm earns by employing one additional unit of input, ceteris paribus.

Marginal Social Cost (MSC)

The total cost to society of producing an additional unit of a good or service. MSC is equal to the sum of the marginal costs of producing the product and the correctly measured damage costs involved in the process of production.

Marginal Utility (MU)

The additional satisfaction gained by the consumption or use of one more unit of something.


The institution through which buyers and sellers interact and engage in exchange.

Market Demand

The sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

Market Failure

Occurs when resources are misallocated, or allocated inefficiently. The result is waste or lost value.

Market Power

An imperfectly competitive firm’s ability to raise price without losing all demand for its product.

Market Supply

The sum of all that is supplied each period by all producers of a single product.

Market–Socialist Economy

An economy that combines government ownership with market allocation.

Maximin Strategy

In game theory, a strategy chosen to maximize the minimum gain that can be earned.

Medicaid and Medicare

In-kind government transfer programs that provide health and hospitalization benefits: Medicare to the aged and their survivors and to certain of the disabled, regardless of income, and Medicaid to people with low incomes.


The branch of economics that examines the functioning of individual industries and the behavior of individuals.

Midpoint Formula

A more precise way of calculating percentages using the value halfway between P1 and P2 for the base in calculating the percentage change in price, and the value halfway between Q1 and Q2 as the base for calculating the percentage change in quantity demanded.

Minimum Wage Laws

Laws that set a floor for wage rates—that is, a minimum hourly rate for any kind of labor.


A formal statement of a theory, usually a mathematical statement of a presumed relationship between two or more variables.

Modern Economic Growth

The period of rapid and sustained increase in real output per capita that began in the Western World with the Industrial Revolution.

Monetary Policy

The behavior of the Federal Reserve concerning the nation’s money supply.

Money Income

The measure of income used by the Census Bureau. Because it excludes noncash transfer payments and capital gains income, it is less inclusive than “economic income.”

Money Market

The market in which financial instruments are exchanged and in which the equilibrium level of the interest rate is determined.

Money Multiplier

The multiple by which deposits can increase for every dollar increase in reserves; equal to one divided by the required reserve ratio.

Monopolistic Competition

A common form of industry (market) structure in the United States, characterized by a large number of firms, none of which can influence market price by virtue of size alone. Some degree of market power is achieved by firms producing differentiated products. New firms can enter and established firms can exit such an industry with relative ease.


An industry composed of only one firm that produces a product for which there are no close substitutes and in which significant barriers exist to prevent new firms from entering the industry.

Moral Hazard

Arises when one party to a contract passes the cost of its behavior on to the other party to the contract.

Moral Suasion

The pressure exerted by the Fed on member banks to discourage them from borrowing heavily from the Fed.

Mortality Rate

The death rate. Equal to (the number of deaths per year divided by the population) X 100.

Movement Along a Demand Curve

The change in quantity demanded brought about by a change in price.


The ratio of the change in the equilibrium level of output to a change in some autonomous variable.

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