REA AP Macroeconomics Crash Course: Key Definitions

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Absolute Advantage
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When a country can produce the good using fewer resources than another country or individual.
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Aggregate Demand (AD)
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Shows the total quantity demand for all goods and services of a nation at various price levels at a given time.
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Aggregate Supply (AS)
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Shows the total amount of goods and services that all firms in the industry will produce at various price levels in a given period of time.
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Appreciation
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An increase in the value of one currency relative to another, resulting from an increase in demand for or a decrease in supply of the currency on the FOREX market.
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Balance of Payments
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Measures all the monetary exchanges between one nation and all other nations. Includes the current account and the capital account.
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Bonds
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A certificate of debt issued by a company or a government to an investor.
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Budget deficit
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When a government spends more than it collects in tax revenues in a given year.
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Business Cycle
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A model showing the short-run periods of contraction and expansion in output experienced by an economy over time.
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Capital
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Human-made resources (machinery and equipment) used to produce goods and services; goods that do not directly satisfy human wants. Sometimes separated into human capital (education, know-how) and physical capital (tools you can touch and operate).
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Capital Account (aka the Financial Account)
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Measures the flow of funds for investment in real assets (such as factories or office buildings) or financial assets (such as stocks and bonds) between a nation and the rest of the world.
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Ceteris Paribus
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“Other things being equal;” used as a reminder that all variables other than the ones being studied are assumed to be constant.
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Circular Flow Diagram
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A model of the macroeconomy that shows the interconnectedness of businesses, households, government, banks, and the foreign sectors. Money flows in a circular direction, and goods, services, and resources flow in the opposite direction.
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Classical Economic Theory
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The view that an economy will self-correct from periods of economic shock if left alone. Also known as “laissez-faire.”
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Comparative Advantage
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When an individual, a firm or a nation is able to produce a particular product at a lower-opportunity cost than another individual, firm, or nation. This is the basis on which nations trade with one another.
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Consumer Price Index (CPI)
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An index that measures the price of a fixed market basket of consumer goods bought by a typical consumer. This is used to calculate the inflation rate in a nation.
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Consumption
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A component of a nation’s aggregate demand; measures the total spending by domestic households on goods and services.
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Contractionary Fiscal Policy
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A demand-side policy whereby government increases taxes or decreases its expenditures in order to reduces the supply of money, increasing interest rates and reducing aggregate demand. Could be used to bring down high inflation rates.
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Contractionary Monetary Policy
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A demand-side policy whereby the central bank reduces the supply of money, increasing interest rates and reducing aggregate demand. Could be used to bring down high inflation rates.
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Cost-Push Inflation
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Inflation resulting from a decrease in AS (from higher wage rates and raw material prices, such as the price of oil) and accompanied by a decrease in real output and employment. Also referred to as “stagflation” or “adverse aggregate supply shock.”
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Crowding-Out Effect
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The rise in interest rates and the resulting decrease in investment spending in the economy caused by increased government borrowing in the loanable funds market. Seen as a disadvantageous side effect of expansionary fiscal policy.
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Current Account
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Measures the balance of trade in goods and services and the flow of income between one nation and all other nations. It also records monetary gifts or grants that flow into or out of a country. Equal to a country’s net exports.
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Cyclical Unemployment
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Unemployment caused by a fall in aggregate demand in a nation. Not included in the natural rate of unemployment. When a nation is in a recession, there will be cyclical unemployment.
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Deflation
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A decrease in the average price level of a nation’s output over time.
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Demand Deposit
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A deposit in a commercial bank against which checks may be written. Also known as a “checkable deposit.”
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Demand-Pull Inflation
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Inflation resulting from an increase in AD without a corresponding increase in AS.
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Depreciation
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A decrease in the value of one currency relative to another, resulting from a decrease in demand for or an increase in the supply of the currency on the FOREX market.
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Devaluation
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When a government intervenes in the market for its own currency to weaken it relative to another currency. Usually achieved through direct intervention in the FOREX market or through the use of monetary policy that affects interest rates, and thereby affects international demand for the currency.
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Discount Rate
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One of the three tools of monetary policy, it is the interest rate the the federal government charges on the loans it makes to commercial banks.
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Economic Growth
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An increase in the potential output of goods and services in a nation over time.
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Economic Resources
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Land, labor, capital, and entrepreneurial ability that are used in the production of goods and services. They are “economic” resources because they are scarce (limited in supply and desired). Also know “factors of production.”
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Excess Reserves
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The amount by which a bank’s actual reserves exceed its required reserves.
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Exchange Rate
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The price of one currency in terms of another currency, determined in the FOREX market.
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Exports
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The spending by foreigners on domestically produced goods and services. Counts as an injection into a nation’s circular flow of income.
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Federal Funds Rate (FFR)
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The interest rate banks charge one another on overnight loans made out of their excess reserves. The FFR is the interest rate targeted by the Fed through its open-market operations.
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Fiscal Policy
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Changes in government spending and tax collections implemented by government with the aim of either increasing or decreasing aggregate demand to achieve the macroeconomic objectives of full employment and price-level stability.
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Floating Exchange Rate System
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When a currency’s exchange rate is determined by the free interaction of supply and demand in international FOREX markets.
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FOREX Market
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The market in which international buyers and sellers exchange foreign currencies for one another to buy and sell goods, services, and assets from various countries. It is where a currency’s exchange rate relative to other currencies is determined.
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Fractional Reserve Banking
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A banking system in which banks hold only a fraction of deposits as required reserves and can lend some of the money deposited by their customers to other borrowers.
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Frictional unemployment
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Unemployment of workers who have employable skills, such as those who are voluntarily moving between jobs or recent graduates who are looking for their first job.
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Full employment
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When an economy is producing at a level of output at which almost the nation’s resources are employed. The unemployment rate when an economy is at full employment equals the natural rate, and includes only frictional and structural unemployment. This is also referred to as “potential output.”
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GDP (Gross Domestic Product)
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The total market value of all final goods and services produced during a given time period within a country’s borders. Equal to the total income of the nation’s households or the total expenditures on the nation’s output.
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GDP Deflator
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The price index for all final goods and services used to adjust the nominal GDP into real GDP.
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Human Capital
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The value skills integrated into labor through education, training, knowledge, and health. An important determinant of aggregate supply and the level of economic growth in a nation.
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Imports
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Spending on goods and services produced in foreign nations. Counts as a leakage from a nation’s circular flow of income.
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Inflation
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A rise in the average level of prices in the economy over time (% change in the CPI)
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Inflationary Gap
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The difference between a nation’s equilibrium level of output and its full employment level of output when the nation is overheating (producing beyond its full employment level).
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Inflationary spiral
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The rapid increase in average price level resulting from demand-pul inflation leading to higher wages, causing cost-push inflation.
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Interest Rate
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The opportunity cost of money. Either the cost of borrowing money or the cost of spending money. Conversely this is the price a lender is paid for allowing someone else to use money for a time.
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Investment
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A component of aggregate demand, it includes all spending on capital equipment, inventories, and technology by firms. This does not include financial investment, which is the purchase of financial assets (stocks/bonds). Also includes household purchasing of newly constructed residences.
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Law of Increasing Opportunity Cost
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As more of a particular product is produced, the opportunity cost, in terms of what must be given up of other goods to produce each unit of the product, increases. Explains the convex shape of a nation’s PPC.
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Loanable Funds Market
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The market in which the demand for private investment and the supply of household savings intersect to determine the equilibrium real interest rate.
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Long Run
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The period of time over which the wage rate and price level of inputs in a nation are flexible. In the long run, any changes in AD are cancelled out due to the flexibilty of wages and prices and an economy will return to its full employment level of output. Sometimes referred to as the “flexible wage period.”
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Long Run Aggregate Supply (LRAS)
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The level of output to which an economy will always return in the long run. This curve intersects the horizontal axis at the full employment or potential level of output.
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M1
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A component of the money supply including currency and checkable deposits.
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M2
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A more broadly defined componen of the money supply. Equal to M1 plus savings deposits, money-market deposits, mutual funds, and small-time deposits.
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M3
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The broadest component of the money supply. Equal to M2 plus large time deposits.
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Macroeconomics
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The study of entire nations’ economies and the interactions between households, firms, government, and foreigners.
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Macroeconomic Equilibrium
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The level of output at which a natioin is producing at any particular period of time. May be below its full employment level (if the economy is recession) or beyond its full employment (if the economy is overheating).
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Managed or Fixed Exchange Rate System
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When a government or central bank takes action to manage or fix the value of its currency relative to another currency on the FOREX market.
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Marginal Analysis
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Decision-making which involves a comparison of marginal (extra) benefits and marginal costs.
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Marginal Propensity to Consume (MPC)
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The fraction of any change in income spent on domestically produced goods and services; equal to the change in consumption divided by the change in disposable income.
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Marginal Propensity to Save (MPS)
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The fraction of any change in income that is saved; equal to the change in savings divided by the change in disposable income.
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Market Economic System
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A system of resource allocation in which buyers and sellers meet in markets to determine the price and quantity of goods, services, and productive resources.
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Microeconomics
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The study of the interactions etween consumers and producers in markets for individual products.
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Monetarism
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The view that the main cause of changes in aggregate output and the price level are fluctuations in the money supply.
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Monetary Policy
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The central bank’s manipulation of the supply of money aimed at raising or lowering interest rates to stimulate or contract the level of aggregate demand to promote the macroeconomic objectives of price-level stability and full employment.
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Money
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Any object that can be used to facilitate the exchange of goods and services in a market.
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Money Demand
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The sum of the transaction demand and the asset demand for money. Inversely related to the nominal interest rate.
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Money Market
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The market where the supply of money is set of the central bank; includes the downwards-sloping money demand curve and a vertical money-supply curve. The “price” of money is the nominal interest rate.
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Money Supply
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The vertical curve representing the total supply of excess reserves in a nation’s banking systems. Determined by the monetary policy actions of the central bank.
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Multiplier Effect
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The increase in total spending in an economiy resulting from an initial injection of new spending. The size of the multplier effect depends upon the spending multiplier.
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Natural Rate of Unemployment (NRU)
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The level of unemployment that prevails in an economy that is producing at its full employment level of output. Includes structural and frictional unemployment.
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Net exports
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A component of aggregated demand that equals the income earned from the sale of exports to the rest of the world, minus expenditures by domestic consumers on imports.
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Official reserves
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To balance the two accounts in the balance of payments (current and financial accounts), a country’s official foreign exchange reserves measures the net effect of all the money flows from the other accounts.
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Open-Market Operations
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The central bank’s buying/selling of bonds on the open market from commercial banks and the public. Aimed at increasing or decreasing the level of reserves in the banking system and thereby affects the interest rate and the level of aggregated demand.
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Opportunity Cost
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What must be given up to have anything else.. Opportunity costs are not necessarily monetary costs, but rather include what you COULD do with the resources you use to undertake any activity or exchange.
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Phillips Curve (long run)
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A curve vertical at the NRU, showing that in the long run there is no trade-off between the price level, and the level of unemployment in an economy.
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Phillips Curve (short run)
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A downward-sloping curve showing the short-run inverse relationship between the level of inflation and the level of unemployment.
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Production Possibilities Curve (PPC)
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A graph that shows the various combinations of output that the economy can produce given the available factors of production and the available production technology.
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Productivity
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The output per unit of input of a resource. An important determinant of the level of aggregate supply in a nation.
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Protectionism
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The use of tariffs, quotas, or subsidies to give domestic producers a competitive advantage over foreign producers. Meant to protect domestic production and employment from foreign competition.
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Rational Expectations Theory
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The hypothesis that business firms and households expect monetary and fiscal policies to have certain effects on the economy and take, in pursuit of their own self-interests, actions which make these policies ineffective at changing real output.
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Recession
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A contraction in total output of goods and services in a nation between two periods of time. Could be caused by a decrease in aggregate demand or in aggregate supply.
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Recessionary Gap
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The difference between an economy’s equilibrium level of output and its full employment level of output when an economy is in recession.
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Required Reserves
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The proportion of a bank’s total deposits it is required to keep in reserve with the central bank.
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Scarcity
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When something is both deserved and limited in supply. The basic economic problem.
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Self-correction
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The idea that an economy producing at an equilibrium level of output that is below or above its full employment will return on its own to full employment if left to its own devices. Requires flexible wages and prices, and is associated with classical economic views.
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Stagflation
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A macro situation in which both inflation and unemployment increase. Caused by negative supply shock.
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Sticky Wage and Price Model
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The SRAS is sometimes referred to this because workers’ wage demands take time to adjust to changes in the overall price level, and therefore, in the short run an economy may produce weel below or beyond its full employment level of output.
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Structural Unemployment
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Unemployment caused by changes in the structure of demand for goods and in technology; workers who are unemployed because they do not match what is in demand by producers in the economy or whose skills have been left behind by economic advancement.
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Supply Shock
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Anything that leads to a sudden, unexpected change in aggregate supply. Can be negative (decrease AS) or positive (increase AS). May include a change in energy prices, wages, or business taxes, or may result from a natural disaster or a new discovery of important resources.
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Trade Deficit
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When a country’s total spending on imported goods and services exceeds its total revenues from the sale of exports to the rest of the world. Synonymous with a deficit in the current account of the balance of payments and with a negative net export component of GDP.
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Trade Surplus
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When a country’s sale of exports exceeds its spending on imports. Synonymous with a surplus in the current account of the balance of payments.
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Wealth
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An important determinant of consumption. Wealth is the total value of a household’s assets minus all its liabilities.

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