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Glossary

accountability: The obligation of a decision-maker (or body) to be responsive to the needs and wishes of people affected by his, her or its decisions.
administratively feasible: Policies for which the government has sufficient information and staff for implementation.
adverse selection: The problem faced by parties to an exchange in which the terms offered by one party will cause some exchange partners to drop out. Example: The problem of asymmetric information in insurance. If the price is sufficiently high, the only people who will seek to purchase medical insurance are people who know they are ill (but the insurer does not). This will lead to further price increases to cover costs. Also referred to as the ‘hidden attributes’ problem (the state of already being ill is the hidden attribute), to distinguish it from the ‘hidden actions’ problem of moral hazard. See also: incomplete contract, moral hazard, asymmetric information.
allocation: A description of who does what, the consequences of their actions, and who gets what as a result (for example in a game, the strategies adopted by each player and their resulting payoffs).
altruism: The willingness to bear a cost in order to help another person. Altruism is a social preference. See also: social preferences.
antitrust policy: Government policy and laws to limit monopoly power and prevent cartels. Also known as: competition policy.
arbitrage: The practice of buying a good at a low price in one market to sell it at a higher price in another. Traders engaging in arbitrage take advantage of the price difference for the same good between two countries or regions. As long as the trade costs are lower than the price gap, they make a profit. See also: price gap.
artificially scarce good: A public good for which it is possible to exclude some people from enjoying. Also known as: club good. See also: public good.
asset: Anything of value that is owned. See also: balance sheet, liability.
asset price bubble: A sustained and significant rise in the price of an asset, fuelled by expectations of future price increases.
asymmetric information: Information that is relevant to all the parties in an economic interaction, but is known by some and not by others. See also: adverse selection, moral hazard.
average product: Total output divided by a particular input, for example per worker (divided by the number of workers) or per worker per hour (total output divided by the total number of hours of labour put in).
balance sheet: A record of the assets, liabilities, and net worth of an economic actor such as a household, bank, firm, or government.
bank: A firm that creates money in the form of bank deposits in the process of supplying credit.
bank money: Money in the form of bank deposits created by commercial banks when they extend credit to firms and households.
bank run: A situation in which depositors withdraw funds from a bank because they fear that it may go bankrupt and not honour its liabilities (that is, not repay the funds owed to depositors).
bargaining power: The extent of a person’s advantage in securing a larger share of the economic rents made possible by an interaction.
base money: Cash held by households, firms, and banks, and the balances held by commercial banks in their accounts at the central bank, known as reserves. Also known as: high-powered money.
behavioural experiment: An experiment designed to study some aspect of human behaviour.
best response: In game theory, the strategy that will give a player the highest payoff, given the strategies that the other players select.
biologically feasible: An allocation that is capable of sustaining the survival of those involved is biologically feasible.
budget constraint: An equation that represents all combinations of goods and services that one could acquire that exactly exhaust one’s budgetary resources.
capital goods: The durable and costly non-labour inputs used in production (machinery, buildings) not including some essential inputs, e.g. air, water, knowledge that are used in production at zero cost to the user.
capitalism: An economic system in which the main form of economic organization is the firm, in which the private owners of capital goods hire labour to produce goods and services for sale on markets with the intent of making a profit. The main economic institutions in a capitalist economic system, then, are private property, markets, and firms.
capitalist revolution: Rapid improvements in technology combined with the emergence of a new economic system.
cartel: A group of firms that collude in order to increase their joint profits.
causality: A direction from cause to effect, establishing that a change in one variable produces a change in another. While a correlation is simply an assessment that two things have moved together, causation implies a mechanism accounting for the association, and is therefore a more restrictive concept. See also: natural experiment, correlation.
central bank: The only bank that can create base money. Usually part of the government. Commercial banks have accounts at this bank, holding base money. See also: base money.
ceteris paribus: Economists often simplify analysis by setting aside things that are thought to be of less importance to the question of interest. The literal meaning of the expression is ‘other things equal’. In an economic model it means an analysis ‘holds other things constant’.
club good: See also: artificially scarce good, public good.
co-insurance: A means of pooling savings across households in order for a household to be able to maintain consumption when it experiences a temporary fall in income or the need for greater expenditure.
collateral: An asset that a borrower pledges to a lender as a security for a loan. If the borrower is not able to make the loan payments as promised, the lender becomes the owner of the asset.
commodities: Physical goods traded in a manner similar to shares. They include metals such as gold and silver, and agricultural products such as coffee and sugar, oil and gas. Sometimes more generally used to mean anything produced for sale. See also: share.
common-pool resource: A rival good that one cannot prevent others from enjoying. Also known as: common property resource. See also: rival good.
competition policy: Government policy and laws to limit monopoly power and prevent cartels. Also known as: antitrust policy.
competitive equilibrium: A market outcome in which all buyers and sellers are price-takers, and at the prevailing market price, the quantity supplied is equal to the quantity demanded.
complements: Two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the other. See also: substitutes.
conflict of interest: The situation which arises if in order for one party to gain more from the interaction, another party must do less well.
conspicuous consumption: The purchase of goods or services to publicly display one’s social and economic status.
constant prices: Prices corrected for increases in prices (inflation) or decreases in prices (deflation) so that a unit of currency represents the same buying power in different periods of time. See also: purchasing power parity, real GDP.
constant returns to scale: These occur when doubling all of the inputs to a production process doubles the output. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs. See also: increasing returns to scale, decreasing returns to scale.
constrained choice problem: This problem is about how we can do the best for ourselves, given our preferences and constraints, and when the things we value are scarce. See also: constrained optimization problem.
constrained optimization problem: Problems in which a decision-maker chooses the values of one or more variables to achieve an objective (such as maximizing profit) subject to a constraint that determines the feasible set (such as the demand curve).
consumer durables: Consumer goods with a life expectancy of more than three years such as home furniture, cars, and fridges.
consumer price index (CPI): A measure of the general level of prices that consumers have to pay for goods and services, including consumption taxes.
consumer surplus: The consumer’s willingness to pay for a good minus the price at which the consumer bought the good, summed across all units sold.
consumption (C): Expenditure on both short-lived goods and services and long-lived goods, which are called consumer durables. See also: consumer durables.
consumption good: A good or service that satisfies the needs of consumers over a short period.
consumption smoothing: Actions taken by an individual, family, or other group in order to sustain their customary level of consumption. Actions include borrowing or reducing savings to offset negative shocks, such as unemployment or illness; and increasing saving or reducing debt in response to positive shocks, such as promotion or inheritance.
contract: A legal document or understanding that specifies a set of actions that parties to the contract must undertake.
cooperation: Participating in a common project that is intended to produce mutual benefits.
cooperative firm: A firm that is mostly or entirely owned by its workers, who hire and fire the managers.
copyright: Ownership rights over the use and distribution of an original work.
correlation: A statistical association in which knowing the value of one variable provides information on the likely value of the other, for example high values of one variable being commonly observed along with high values of the other variable. It can be positive or negative (it is negative when high values of one variable are observed with low values of the other). It does not mean that there is a causal relationship between the variables. See also: causality, correlation coefficient.
correlation coefficient: A measure of how closely associated two variables are and whether they tend to take similar or dissimilar values, ranging from a value of 1 indicating that the variables take similar values (‘are positively correlated’) to –1 indicating that the variables take dissimilar variables (‘negative’ or ‘inverse’ correlation). A value of 1 or –1 indicates that knowing the value of one of the variables would allow you to perfectly predict the value of the other. A value of 0 indicates that knowing one of the variables provides no information about the value of the other. See also: correlation, causality.
creative destruction: Joseph Schumpeter’s name for the process by which old technologies and the firms that do not adapt are swept away by the new, because they cannot compete in the market. In his view, the failure of unprofitable firms is creative because it releases labour and capital goods for use in new combinations.
credit-constrained: A description of individuals who are able to borrow only on unfavourable terms. See also: credit-excluded.
credit-excluded: A description of individuals who are unable to borrow on any terms. See also: credit-constrained.
credit rationing: The process by which those with less wealth borrow on unfavourable terms, compared to those with more wealth.
crowding out: There are two quite distinct uses of the term. One is the observed negative effect when economic incentives displace people’s ethical or other-regarding motivations. In studies of individual behaviour, incentives may have a crowding-out effect on social preferences. A second use of the term is to refer to the effect of an increase in government spending in reducing private spending, as would be expected for example in an economy working at full capacity utilization, or when a fiscal expansion is associated with a rise in the interest rate.
cyclical unemployment: The increase in unemployment above equilibrium unemployment caused by a fall in aggregate demand associated with the business cycle. Also known as: demand-deficient unemployment. See also: equilibrium unemployment.
deadweight loss: A loss of total surplus relative to a Pareto-efficient allocation.
decile: A subset of observations, formed by ordering the full set of observations according to the values of a particular variable and then splitting the set into ten equally-sized groups. For example, the 1st decile refers to the smallest 10% of values in a set of observations. See also: percentile.
decreasing returns to scale: These occur when doubling all of the inputs to a production process less than doubles the output. Also known as: diseconomies of scale. See also: increasing returns to scale.
default risk: The risk that credit given as loans will not be repaid.
deflation: A decrease in the general price level. See also: inflation.
demand curve: The curve that gives the quantity consumers will buy at each possible price.
democracy: A political system, that ideally gives equal political power to all citizens, defined by individual rights such as freedom of speech, assembly, and the press; fair elections in which virtually all adults are eligible to vote; and in which the government leaves office if it loses.
depreciation: The loss in value of a form of wealth that occurs either through use (wear and tear) or the passage of time (obsolescence).
developmental state: A government that takes a leading role in promoting the process of economic development through its public investments, subsidies of particular industries, education and other public policies.
difference-in-difference: A method that applies an experimental research design to outcomes observed in a natural experiment. It involves comparing the difference in the average outcomes of two groups, a treatment and control group, both before and after the treatment took place.
differentiated product: A product produced by a single firm that has some unique characteristics compared to similar products of other firms.
diminishing marginal product: A property of some production functions according to which each additional unit of input results in a smaller increment in total output than did the previous unit.
diminishing marginal returns to consumption: The value to the individual of an additional unit of consumption declines, the more consumption the individual has. Also known as: diminishing marginal utility.
diminishing marginal utility: A property of some utility functions according to which each additional unit of a given variable results in a smaller increment to total utility than did the previous additional unit. Also known as: diminishing marginal returns to consumption.
discount rate: A measure of a person’s impatience: how much that person values an additional unit of consumption now relative to an additional unit of consumption later. It is the absolute value of the slope of a person’s indifference curve for consumption now and consumption later, minus one. Also known as: subjective discount rate.
diseconomies of scale: These occur when doubling all of the inputs to a production process less than doubles the output. Also known as: decreasing returns to scale. See also: economies of scale.
disequilibrium: A situation in which at least one of the actors can benefit by altering his or her actions and therefore changing the situation, given what everybody else is doing.
disinflation: A decrease in the rate of inflation. See also: inflation, deflation.
disposable income: Income available after paying taxes and receiving transfers from the government.
disutility of effort: The degree to which doing some task (effort) is unpleasant.
division of labour: The specialization of producers to carry out different tasks in the production process. Also known as: specialization.
dominant strategy: Strategy that yields the highest payoff for a player, no matter what the other players do.
dominant strategy equilibrium: An outcome of a game in which every player plays his or her dominant strategy.
earnings: Wages, salaries, and other income from labour.
economic accountability: Accountability achieved by economic processes, notably competition among firms or other entities in which failure to take account of those affected will result in losses in profits or in business failure. See also: accountability, political accountability.
economically feasible: Policies for which the desired outcomes are a Nash equilibrium, so that once implemented private economic actors will not undo the desired effects.
economic cost: The out-of-pocket cost of an action, plus the opportunity cost.
economic inequality: Differences among members of a society in some economic attribute such as wealth, income, or wages.
economic profit: A firm’s revenue minus its total costs (including the opportunity cost of capital).
economic rent: A payment or other benefit received above and beyond what the individual would have received in his or her next best alternative (or reservation option). See also: reservation option.
economics: The study of how people interact with each other and with their natural surroundings in providing their livelihoods, and how this changes over time.
economic system: A way of organizing the economy that is distinctive in its basic institutions. Economic systems of the past and present include: central economic planning (e.g. the Soviet Union in the 20th century), feudalism (e.g. much of Europe in the early Middle Ages), slave economy (e.g. the US South and the Caribbean plantation economies prior to the abolition of slavery in the 19th century), and capitalism (most of the world’s economies today).
economies of scale: These occur when doubling all of the inputs to a production process more than doubles the output. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs. Also known as: increasing returns to scale. See also: diseconomies of scale.
efficiency unit: A unit of effort is sometimes called an efficiency unit.
efficiency wages: The payment an employer makes that is higher than an employee’s reservation wage, so as to motivate the employee to provide more effort on the job than he or she would otherwise choose to make. See also: labour discipline model, employment rent.
employment rate: The ratio of the number of employed to the population of working age. See also: population of working age.
employment relationship: The interaction between an employee and an employer in which the employer sets the hours and other conditions of work and the wage, directs the employee’s activities and may terminate her employment, and the employee chooses how hard to work and whether to quit her job. The employee’s level of effort, or her decision to remain in the firm, are determined by the choices made by the two parties—and are affected by the exercise of power by the employer and the social norms of both parties.
employment rent: The economic rent a worker receives when the net value of her job exceeds the net value of her next best alternative (that is, being unemployed). Also known as: cost of job loss.
endogenous: Produced by the workings of a model rather than coming from outside the model. See also: exogenous
endowment: The facts about an individual that may affect his or her income, such as the physical wealth a person has, either land, housing, or a portfolio of shares (stocks). Also includes level and quality of schooling, special training, the computer languages in which the individual can work, work experience in internships, citizenship, whether the individual has a visa (or green card) allowing employment in a particular labour market, the nationality and gender of the individual, and even the person’s race or social class background. See also: human capital.
entrepreneur: A person who creates or is an early adopter of new technologies, organizational forms, and other opportunities.
equilibrium: A model outcome that does not change unless an outside or external force is introduced that alters the model’s description of the situation.
equilibrium unemployment: The number of people seeking work but without jobs, which is determined by the intersection of the wage-setting and price-setting curves. This is the Nash equilibrium of the labour market and product market where neither employers nor workers could do better by changing their behaviour. See also: involuntary unemployment, structural unemployment, wage-setting curve, price-setting curve, WS/PS model, inflation-stabilizing rate of unemployment.
equity: An individual’s own investment in a project. This is recorded in an individual’s or firm’s balance sheet as net worth. See also: net worth. An entirely different use of the term is synonymous with fairness.
excess demand: A situation in which the quantity of a good demanded is greater than the quantity supplied at the current price. See also: excess supply.
excess supply: A situation in which the quantity of a good supplied is greater than the quantity demanded at the current price. See also: excess demand.
exogenous: Coming from outside the model rather than being produced by the workings of the model itself. See also: endogenous.
exogenous shock: A sharp change in external conditions affecting a model.
external benefit: A positive external effect: that is, a positive effect of a production, consumption, or other economic decision on another person or people that is not specified as a benefit in a contract. Also known as: external economy. See also: external effect.
external cost: A negative external effect: that is, the negative effect of production, consumption, or other economic decisions on another person or party, which is not specified as a liability in a contract. Also known as: external diseconomy. See also: external effect.
external diseconomy: A negative effect of a production, consumption, or other economic decision, that is not specified as a liability in a contract. Also known as: external cost, negative externality. See also: external effect.
external economy: A positive effect of a production, consumption, or other economic decision, that is not specified as a benefit in a contract. Also known as: external benefit, positive externality. See also: external effect.
external effect: When a person’s action confers a benefit or cost on some other individual, and this effect is not taken account of by the person in deciding to take the action. It is external because it is not included in the decision-making process of the person taking the action. Positive effects refer to benefits, and negative effects to costs, that are experienced by others. A person breathing second-hand smoke from someone else’s cigarette is a negative external effect. Enjoying your neighbour’s beautiful garden is a positive external effect. Also known as: externality. See also: incomplete contract, market failure, external benefit, external cost.
fairness: A way to evaluate an allocation based on one’s conception of justice.
feasible frontier: The curve made of points that defines the maximum feasible quantity of one good for a given quantity of the other. See also: feasible set.
feasible set: All of the combinations of the things under consideration that a decision-maker could choose given the economic, physical or other constraints that he faces. See also: feasible frontier.
financial deregulation: Policies allowing banks and other financial institutions greater freedom in the types of financial assets they can sell, as well as other practices.
firms: Economic organizations in which private owners of capital goods hire and direct labour to produce goods and services for sale on markets to make a profit.
fiscal capacity: The ability of a government to impose and collect substantial taxes from a population at low administrative and other costs. One measure of this is the amount collected divided by the cost of administering the tax system.
Fisher equation: The relation that gives the real interest rate as the difference between the nominal interest rate and expected inflation: real interest rate = nominal interest rate – expected inflation.
fixed costs: Costs of production that do not vary with the number of units produced.
flow variable: A quantity measured per unit of time, such as annual income or hourly wage. See also: stock variable.
free ride: Benefiting from the contributions of others to some cooperative project without contributing oneself.
fundamental value of a share: The share price based on anticipated future earnings and the level of risk.
gains from exchange: The benefits that each party gains from a transaction compared to how they would have fared without the exchange. Also known as: gains from trade. See also: economic rent.
game: A model of strategic interaction that describes the players, the feasible strategies, the information that the players have, and their payoffs. See also: game theory.
game theory: A branch of mathematics that studies strategic interactions, meaning situations in which each actor knows that the benefits they receive depend on the actions taken by all. See also: game.
gender division of labour: The ways men and women differ in how they spend their work time.
gig economy: An economy made up of people performing services matched by means of a computer platform with those paying for the service. Workers are paid for each task they complete, and not per hour. They are not legally recognized as employees of the company that owns the platform, and typically receive few benefits from the owners, other than matching.
Gini coefficient: A measure of inequality of any quantity such as income or wealth, varying from a value of zero (if there is no inequality) to one (if a single individual receives all of it).
global financial crisis: This began in 2007 with the collapse of house prices in the US, leading to the fall in prices of assets based on subprime mortgages and to widespread uncertainty about the solvency of banks in the US and Europe, which had borrowed to purchase such assets. The ramifications were felt around the world, as global trade was cut back sharply. Goverments and central banks responded aggressively with stabilization policies.
governing elite: Top government officials such as the president, cabinet officials, and legislative leaders, unified by a common interest such as membership in a particular party.
government: Within a given territory, the only body that can dictate what people must do or not do, and can legitimately use force and restraints on an individual’s freedom to achieve that end. Also known as: state.
government bond: A financial instrument issued by governments that promises to pay flows of money at specific intervals.
government failure: A failure of political accountability. (This term is widely used in a variety of ways, none of them strictly analogous to market failure, for which the criterion is simply Pareto inefficiency). See also: political accountability.
gross domestic product (GDP): A measure of the market value of the output of final goods and services in the economy in a given period. Output of intermediate goods that are inputs to final production is excluded to prevent double counting.
gross domestic product (GDP) per capita: A measure of the market value of the output of the economy in a given period (GDP) divided by the population.
gross income: Income net of taxes paid. Includes depreciation. See also: income, net income.
hawk–dove game: A game in which there is conflict (when hawks meet), sharing (when doves meet), and taking (by a hawk when it meets a dove).
hedge finance: Financing used by firms to fulfil contractual payment obligations using cashflow. Term coined by Hyman Minsky in his Financial Instability Hypothesis. See also: speculative finance.
hidden actions (problem of): This occurs when some action taken by one party to an exchange is not known or cannot be verified by the other. For example, the employer cannot know (or cannot verify) how hard the worker she has employed is actually working. Also known as: moral hazard. See also: hidden attributes (problem of).
hidden attributes (problem of): This occurs when some attribute of the person engaging in an exchange (or the product or service being provided) is not known to the other parties. Example: an individual purchasing health insurance knows her own health status, but the insurance company does not. Also known as: adverse selection. See also: hidden actions (problem of).
homo economicus: Latin for ‘economic man’, referring to an actor assumed to adopt behaviours based on an amoral calculation of self-interest.
human capital: The stock of knowledge, skills, behavioural attributes, and personal characteristics that determine the labour productivity or labour earnings of an individual. It is part of an individual’s endowments. Investment in this through education, training, and socialization can increase the stock, and such investment is one of the sources of economic growth. See also: endowment, labour productivity.
impatience: Any preference to move consumption from the future to the present. This preference may be derived either from pure impatience or diminishing marginal returns to consumption.
inactive population: People in the population of working age who are neither employed nor actively looking for paid work. Those working in the home raising children, for example, are not considered as being in the labour force and therefore are classified this way.
incentive: Economic reward or punishment, which influences the benefits and costs of alternative courses of action.
income: The amount of labour earnings, dividends, interest, rent, and other payments (including transfers from the government) received by an economic actor, net of taxes paid, measured over a period of time, such as a year. The maximum amount that you could consume and leave your wealth unchanged. Also known as: disposable income. See also: gross income.
income effect: The effect, for example, on the choice of consumption of a good that a change in income would have if there were no change in the price or opportunity cost.
income elasticity of demand: The percentage change in demand that would occur in response to a 1% increase in the individual’s income.
income net of depreciation: Disposable income minus depreciation. See also: disposable income, gross income, depreciation.
incomplete contract: A contract that does not specify, in an enforceable way, every aspect of the exchange that affects the interests of parties to the exchange (or of any others affected by the exchange).
increasing returns to scale: These occur when doubling all of the inputs to a production process more than doubles the output. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs. Also known as: economies of scale. See also: decreasing returns to scale, constant returns to scale.
indifference curve: A curve of the points which indicate the combinations of goods that provide a given level of utility to the individual.
Industrial Revolution: A wave of technological advances and organizational changes starting in Britain in the eighteenth century, which transformed an agrarian and craft-based economy into a commercial and industrial economy.
inequality aversion: A dislike of outcomes in which some individuals receive more than others. It is considered a social preference. See also: social preferences
inferior good: A good whose consumption decreases when income increases (holding prices constant).
inflation: An increase in the general price level in the economy. Usually measured over a year. See also: deflation, disinflation.
inflation-stabilizing rate of unemployment: The unemployment rate (at labour market equilibrium) at which inflation is constant. Originally known as the ‘natural rate’ of unemployment. Also known as: non-accelerating rate of unemployment, stable inflation rate of unemployment. See also: equilibrium unemployment.
insolvent: An entity is this if the value of its assets is less than the value of its liabilities. See also: solvent.
institution: The laws and informal rules that regulate social interactions among people and between people and the biosphere, sometimes also termed the rules of the game.
interest rate: The price of bringing some spending power forward in time. See also: nominal interest rate, real interest rate.
interest rate (short-term): The price of borrowing base money. This is a nominal interest rate.
investment (I): Expenditure on newly produced capital goods (machinery and equipment) and buildings, including new housing.
invisible hand game: A game in which there is a single Nash equilibrium and where there is no other outcome in which both players would be better off or at least one better off and the other not worse off. See also: Nash equilibrium, Pareto efficient.
involuntary unemployment: A person who is seeking work, and willing to accept a job at the going wage for people of their level of skill and experience, but unable to secure employment is involuntarily unemployed.
irrational exuberance: A process by which assets become overvalued. The expression was first used by Alan Greenspan, then chairman of the US Federal Reserve Board, in 1996. It was popularized as an economic concept by the economist Robert Shiller.
isocost line: A line that represents all combinations that cost a given total amount.
isoprofit curve: A curve on which all points yield the same profit.
joint surplus: The sum of the economic rents of all involved in an interaction. Also known as: gains from exchange.
labour discipline model: A model that explains how employers set wages so that employees receive an economic rent (called employment rent), which provides workers an incentive to work hard in order to avoid job termination. See also: employment rent, efficiency wages.
labour force: The number of people in the population of working age who are, or wish to be, in work outside the household. They are either employed (including self-employed) or unemployed. See also: unemployment rate, employment rate, participation rate.
labour productivity: Total output divided by the number of hours or some other measure of labour input.
lending rate (bank): The average interest rate charged by commercial banks to firms and households. This rate will typically be above the policy interest rate: the difference is known as the markup or spread on commercial lending. This is a nominal interest rate. Also known as: market interest rate. See also: interest rate, policy (interest) rate.
leverage ratio (for banks or households): The value of assets divided by the equity stake in those assets.
liability: Anything of value that is owed. See also: balance sheet, asset.
liquidity: Ease of buying or selling a financial asset at a predictable price.
liquidity risk: The risk that an asset cannot be exchanged for cash rapidly enough to prevent a financial loss.
Lorenz curve: A graphical representation of inequality of some quantity such as wealth or income. Individuals are arranged in ascending order by how much of this quantity they have, and the cumulative share of the total is then plotted against the cumulative share of the population. For complete equality of income, for example, it would be a straight line with a slope of one. The extent to which the curve falls below this perfect equality line is a measure of inequality. See also: Gini coefficient.
marginal cost: The addition to total costs associated with producing one additional unit of output.
marginal external cost (MEC): The cost of producing an additional unit of a good that is incurred by anyone other than the producer of the good. See also: marginal private cost, marginal social cost.
marginal private benefit (MPB): The benefit (in terms of profit, or utility) of producing or consuming an additional unit of a good for the individual who decides to produce or consume it, not taking into account any benefit received by others.
marginal private cost (MPC): The cost for the producer of producing an additional unit of a good, not taking into account any costs its production imposes on others. See also: marginal external cost (MEC), marginal social cost (MSC).
marginal product: The additional amount of output that is produced if a particular input was increased by one unit, while holding all other inputs constant.
marginal rate of substitution (MRS): The trade-off that a person is willing to make between two goods. At any point, this is the slope of the indifference curve. See also: marginal rate of transformation.
marginal rate of transformation (MRT): A measure of the trade-offs a person faces in what is feasible. Given the constraints (feasible frontier) a person faces, the MRT is the quantity of some good that must be sacrificed to acquire one additional unit of another good. At any point, it is the slope of the feasible frontier. See also: feasible frontier, marginal rate of substitution.
marginal social benefit (MSB): The benefit (in terms of utility) of producing or consuming an additional unit of a good, taking into account both the benefit to the individual who decides to produce or consume it, and the benefit to anyone else affected by the decision.
marginal social cost (MSC): The cost of producing an additional unit of a good, taking into account both the cost for the producer and the costs incurred by others affected by the good’s production. Marginal social cost is the sum of the marginal private cost and the marginal external cost.
marginal utility: The additional utility resulting from a one-unit increase of a given variable.
market: A way that people exchange goods and services by means of directly reciprocated transfers (unlike gifts), voluntarily entered into for mutual benefit (unlike theft, taxation), that is often impersonal (unlike transfers among friends, family).
market-clearing price: At this price there is no excess supply or excess demand. See also: equilibrium.
market failure: When markets allocate resources in a Pareto-inefficient way.
market power: An attribute of a firm that can sell its product at a range of feasible prices, so that it can benefit by acting as a price-setter (rather than a price-taker).
maturity transformation: The practice of borrowing money short term and lending it long term. For example, a bank accepts deposits, which it promises to repay at short notice or no notice, and makes long-term loans (which can be repaid over many years). Also known as: liquidity transformation.
mean: A summary statistic for a set of observations, calculated by adding all values in the set and dividing by the number of observations.
median: The middle number in a set of values, such that half of the numbers are larger than the median and half are smaller. Also known as: 50th percentile.
merit goods: Goods and services that should be available to everyone, independently of their ability to pay.
minimum acceptable offer: In the ultimatum game, the smallest offer by the Proposer that will not be rejected by the Responder. Generally applied in bargaining situations to mean the least favourable offer that would be accepted.
missing market: A market in which there is some kind of exchange that, if implemented, would be mutually beneficial. This does not occur due to asymmetric or non-verifiable information.
money: Money is something that facilitates exchange (called a medium of exchange) consisting of bank notes and bank deposits, or anything else that can be used to purchase goods and services, and is generally accepted by others as payment because others can use it for the same purpose. The ‘because’ is important and it distinguishes exchange facilitated by money from barter exchange, in which goods are directly exchanged without money changing hands.
monopolistic competition: A market in which each seller has a unique product but there is competition among firms because firms sell products that are close substitutes for one another.
monopoly: A firm that is the only seller of a product without close substitutes. Also refers to a market with only one seller. See also: monopoly power, natural monopoly.
monopoly power: The power that a firm has to control its own price. The fewer close substitutes for the product are available, the greater the firm’s price-setting power. See also: monopoly.
monopoly rents: A form of profits, which arise due to restricted competition in selling a firm’s product.
moral hazard: This term originated in the insurance industry to express the problem that insurers face, namely, the person with home insurance may take less care to avoid fires or other damages to his home, thereby increasing the risk above what it would be in absence of insurance. This term now refers to any situation in which one party to an interaction is deciding on an action that affects the profits or wellbeing of the other but which the affected party cannot control by means of a contract, often because the affected party does not have adequate information on the action. It is also referred to as the ‘hidden actions’ problem. See also: hidden actions (problem of), incomplete contract, too big to fail.
mortgage (or mortgage loan): A loan contracted by households and businesses to purchase a property without paying the total value at one time. Over a period of many years, the borrower repays the loan, plus interest. The debt is secured by the property itself, referred to as collateral. See also: collateral.
mutual gains: An outcome of an interaction among two or more people, in which all parties are better off as a result than they would have been without the interaction (or at least some parties are better off and none are worse off).
Nash equilibrium: A set of strategies, one for each player in the game, such that each player’s strategy is a best response to the strategies chosen by everyone else.
natural experiment: An empirical study exploiting naturally occurring statistical controls in which researchers do not have the ability to assign participants to treatment and control groups, as is the case in conventional experiments. Instead, differences in law, policy, weather, or other events can offer the opportunity to analyse populations as if they had been part of an experiment. The validity of such studies depends on the premise that the assignment of subjects to the naturally occurring treatment and control groups can be plausibly argued to be random.
natural monopoly: A production process in which the long-run average cost curve is sufficiently downward-sloping to make it impossible to sustain competition among firms in this market.
negative feedback (process): A process whereby some initial change sets in motion a process that dampens the initial change. See also: positive feedback (process).
net income: Gross income minus depreciation. See also: income, gross income, depreciation.
net present value: The present value of a stream of future income minus the associated costs (whether the costs are in the present or the future). See also: present value.
network economies of scale: These exist when an increase in the number of users of an output of a firm implies an increase in the value of the output to each of them, because they are connected to each other.
net worth: Assets less liabilities. See also: balance sheet, equity.
nominal interest rate: The price of bringing some spending power (in dollars or other nominal terms) forward in time. The policy rate and the lending rate quoted by commercial banks are examples of nominal interest rates. See also: real interest rate, interest rate, Fisher equation.
nominal wage: The actual amount received in payment for work, in a particular currency. Also known as: money wage. See also: real wage.
non-excludable public good: A public good for which it is impossible to exclude anyone from having access. See also: artificially scarce good.
non-rival good: A good that, if available to anyone, is available to everyone at no additional cost. See also: rival good, non-excludable public good.
normal good: A good for which demand increases when a person’s income rises, holding prices unchanged.
oligopoly: A market with a small number of sellers of the same good, giving each seller some market power.
one-shot game: A game that is played once and not repeated.
opportunity cost: The opportunity cost of some action A is the foregone benefit that you would have enjoyed if instead you had taken some other action B. This is called an opportunity cost because by choosing A you give up the opportunity of choosing B. It is called a cost because the choice of A costs you the benefit you would have experienced had you chosen B.
Pareto criterion: According to the Pareto criterion, a desirable attribute of an allocation is that it be Pareto efficient. See also: Pareto dominant.
Pareto dominant: Allocation A Pareto dominates allocation B if at least one party would be better off with A than B, and nobody would be worse off. See also: Pareto efficient.
Pareto efficiency curve: The set of all allocations that are Pareto efficient. Often referred to as the contract curve, even in social interactions in which there is no contract, which is why we avoid the term. See also: Pareto efficient.
Pareto efficient: An allocation with the property that there is no alternative technically feasible allocation in which at least one person would be better off, and nobody worse off.
Pareto improvement: A change that benefits at least one person without making anyone else worse off. See also: Pareto dominant.
Pareto inefficient: An allocation with the property that there is some alternative technically feasible allocation in which at least one person would be better off, and nobody worse off.
participation rate: The ratio of the number of people in the labour force to the population of working age. See also: labour force, population of working age.
patent: A right of exclusive ownership of an idea or invention, which lasts for a specified length of time. During this time it effectively allows the owner to be a monopolist or exclusive user.
payment service: Any service provided by a financial institution to allow one person or organization to pay another for a product or service.
payoff: The benefit to each player associated with the joint actions of all the players.
payoff matrix: A table of the payoffs associated with every possible combination of strategies chosen by two or more players in a game.
percentile: A subset of observations, formed by ordering the full set of observations according to the values of a particular variable and then splitting the set into one hundred equally-sized groups. For example, the 1st percentile refers to the smallest 1% of values in a set of observations. See also: decile.
piece-rate work: A type of employment in which the worker is paid a fixed amount for each unit of the product that the worker produces.
Pigouvian subsidy: A government subsidy to encourage an economic activity that has positive external effects. Example: subsidizing basic research.
Pigouvian tax: A tax levied on activities that generate negative external effects so as to correct an inefficient market outcome. See also: external effect, Pigouvian subsidy.
policy (interest) rate: The interest rate set by the central bank, which applies to banks that borrow base money from each other, and from the central bank. Also known as: base rate, official rate. See also: real interest rate, nominal interest rate.
political accountability: Accountability achieved by political processes such as elections, oversight by an elected government, or consultation with affected citizens. See also: accountability, economic accountability.
political institution: The rules of the game that determine who has power and how it is exercised in a society.
politically feasible: Capable of being implemented given the existing political institutions.
political rent: A payment or other benefit in excess of the individual’s next best alternative (reservation position) that exists as a result of the individual’s political position. The reservation position in this case refers to the individual’s situation were they to lack a privileged political position. See also: economic rent.
political system: A set of principles, laws, and procedures that determine how governments will be selected, and how those governments will make and implement decisions that affect all or most members of a population.
polluter pays principle: A guide to environmental policy according to which those who impose negative environmental effects on others should be made to pay for the damages they impose, through taxation or other means. See also: external cost.
population of working age: A statistical convention, which in many countries is all people aged between 15 and 64 years.
positional good: A good—such as high status, conspicuous consumption, or power—which, if enjoyed by one member of a community is experienced negatively by others. The more one person benefits from this good, the more others are harmed.
positive feedback (process): A process whereby some initial change sets in motion a process that magnifies the initial change. See also: negative feedback (process).
power: The ability to do (and get) the things one wants in opposition to the intentions of others, ordinarily by imposing or threatening sanctions.
preference: Pro-and-con evaluations of the possible outcomes of the actions we may take that form the basis by which we decide on a course of action.
present value: The value today of a stream of future income or other benefits, when these are discounted using an interest rate or the person’s own discount rate. See also: net present value.
price discrimination: A selling strategy in which different prices for the same product are set for different buyers or groups of buyers, or per-unit prices vary depending on the number of units purchased.
price elasticity of demand: The percentage change in demand that would occur in response to a 1% increase in price. We express this as a positive number. Demand is elastic if this is greater than 1, and inelastic if less than 1.
price elasticity of supply: The percentage change in supply that would occur in response to a 1% increase in price. Supply is elastic if this is greater than 1, and inelastic if less than 1.
price gap: A difference in the price of a good in the exporting country and the importing country. It includes transportation costs and trade taxes. When global markets are in competitive equilibrium, these differences will be entirely due to trade costs. See also: arbitrage.
price markup: The price minus the marginal cost, divided by the price. It is inversely proportional to the elasticity of demand for this good.
price-setting (PS) curve: The curve—arising from the price-setting decisions of firms in markets for goods and services (the product market)—that gives the real wage paid when firms choose their profit-maximizing price.
price-taker: Characteristic of producers and consumers who cannot benefit by offering or asking any price other than the market price in the equilibrium of a competitive market. They have no power to influence the market price.
primary markets: See also: secondary and primary markets
principal–agent relationship: This is an asymmetrical relationship in which one party (the principal) benefits from some action or attribute of the other party (the agent) about which the principal’s information is not sufficient to enforce in a complete contract. See also: incomplete contract. Also known as: principal–agent problem.
prisoners’ dilemma: A game in which the payoffs in the dominant strategy equilibrium are lower for each player, and also lower in total, than if neither player played the dominant strategy.
private property: Something is private property if the person possessing it has the right to exclude others from it, to benefit from the use of it, and to exchange it with others.
procedural judgements of fairness: An evaluation of an outcome based on how the allocation came about, and not on the characteristics of the outcome itself, (for example, how unequal it is). See also: substantive judgements of fairness.
producer surplus: The price at which a firm sells a good minus the minimum price at which it would have been willing to sell the good, summed across all units sold.
production function: A graphical or mathematical expression describing the amount of output that can be produced by any given amount or combination of input(s). The function describes differing technologies capable of producing the same thing.
profit margin: The difference between the price and the marginal cost.
property rights: Legal protection of ownership, including the right to exclude others and to benefit from or sell the thing owned.
public bad: The negative equivalent of a public good. It is non-rival in the sense that a given individual’s consumption of the public bad does not diminish others’ consumption of it.
public good: A good for which use by one person does not reduce its availability to others. Also known as: non-rival good. See also: non-excludable public good, artificially scarce good.
public goods game: Similar to a prisoners’ dilemma game with more than two people; the dominant strategy is not to contribute to the public good.
public policy: A policy decided by the government. Also known as: government policy
purchasing power parity (PPP): A statistical correction allowing comparisons of the amount of goods people can buy in different countries that have different currencies. See also: constant prices.
pure impatience: In a situation in which a person’s endowment is the same amount of consumption this period and later, she would have this characteristic if she values an additional unit of consumption now over an additional unit later. It arises when a person is impatient to consume more now because she places less value on consumption in the future for reasons of myopia, weakness of will, or for other reasons. See also: weakness of will.
ratio scale: A scale that uses distances on a graph to represent ratios. For example, the ratio between 3 and 6, and between 6 and 12, is the same (the larger number is twice the smaller number). In a ratio scale chart, all changes by the same ratio are represented by the same vertical distance. This contrasts with a linear scale, where the distance between 3 and 6, and between 6 and 9, is the same (in this case, 3). Also known as a log scale (in for example, Microsoft Excel).
real GDP: An inflation-adjusted measure of the market value of the output of the economy in a given period. (GDP). See also: inflation, constant prices, gross domestic product.
real interest rate: The price of bringing some real spending power forward in time. See also: nominal interest rate.
real wage: The nominal wage, adjusted to take account of changes in prices between different time periods. It measures the amount of goods and services the worker can buy. See also: nominal wage.
reciprocity: A preference concerning one’s actions towards others that depends on an evaluation of the others’ actions or character, for example, a preference to help those who have helped you or in some other way acted well (in your opinion), and to harm those who have acted poorly. It is considered a social preference. See also: social preferences.
repeated game: A game in which the same interaction (same payoffs, players, feasible actions) may occur more than once.
repugnant market: Buying or selling something that people believe ought not to be exchanged on a market.
research and development: Expenditures by a private or public entity to create new methods of production, products, or other economically relevant new knowledge.
reservation indifference curve: A curve that indicates allocations (combinations) that are as highly valued as one’s reservation option. See also: reservation option.
reservation option: A person’s next best alternative among all options in a particular transaction. Also known as: fallback option. See also: reservation price.
reservation price: The lowest price at which someone is willing to sell a good (keeping the good is the potential seller’s reservation option). See also: reservation option.
reservation wage: What an employee would get in alternative employment, or from an unemployment benefit or other support, were he or she not employed in his or her current job.
residual claimant: The person who receives the income left over from a firm or project after the payment of all contractual costs (for example the cost of hiring workers and paying taxes).
risk aversion: A preference for certain over uncertain outcomes.
rival good: A good which, if consumed by one person, is not available to another. See also: non-rival good.
saving: When consumption expenditure is less than net income, saving takes place and wealth rises. See also: wealth.
scarcity: A good that is valued, and for which there is an opportunity cost of acquiring more.
secondary and primary markets: The primary market is where goods or financial assets are sold for the first time. For example, the initial sale of shares by a company to an investor (known as an initial public offering or IPO) is on the primary market. The subsequent trading of those shares on the stock exchange is on the secondary market. The terms are also used to describe the initial sale of tickets (primary market) and the secondary market in which they are traded.
separation of ownership and control: The attribute of some firms by which managers are a separate group from the owners.
sequential game: A game in which all players do not choose their strategies at the same time, and players that choose later can see the strategies already chosen by the other players, for example the ultimatum game. See also: simultaneous game.
share: A part of the assets of a firm that may be traded. It gives the holder a right to receive a proportion of a firm’s profit and to benefit when the firm’s assets become more valuable. Also known as: common stock.
shock: An exogenous change in some of the fundamental data or variables used in a model.
simultaneous game: A game in which players choose strategies simultaneously, for example the prisoners’ dilemma. See also: sequential game.
social dilemma: A situation in which actions, taken independently by individuals in pursuit of their own private objectives, may result in an outcome that is inferior to some other feasible outcome that could have occurred if people had acted together, rather than as individuals.
social insurance: Expenditure by the government, financed by taxation, which provides protection against various economic risks (for example, loss of income due to sickness, or unemployment) and enables people to smooth incomes throughout their lifetime. See also: co-insurance.
social interaction: A situation in which the actions taken by each person affect other people’s outcomes as well as their own.
social norm: An understanding that is common to most members of a society about what people should do in a given situation when their actions affect others.
social preferences: A person with social preferences cares not only about how her action affects her personally, but also about how it affects other people. Also known as: other-regarding preferences.
solvent: A firm or individual for which net worth is positive or zero. For example, a bank whose assets are more than its liabilities (what it owes). See also: insolvent.
specialization: This takes place when a country or some other entity produces a narrower range of goods and services than it consumes, acquiring the goods and services that it does not produce by trade.
speculative finance: A strategy used by firms to meet payment commitments on liabilities using cash flow, although the firm cannot repay the principal in this way. Firms in this position need to ‘roll over’ their liabilities, usually by issuing new debt to meet commitments on maturing debt. Term coined by Hyman Minsky in his Financial Instability Hypothesis. See also: hedge finance.
stock exchange: A financial marketplace where shares (also known as stocks) and other financial assets are traded. It has a list of companies whose shares are traded there. See also: share.
stock variable: A quantity measured at a point in time. Its units do not depend on time. See also: flow variable.
strategic interaction: A social interaction in which the participants are aware of the ways that their actions affect others (and the ways that the actions of others affect them).
strategy: An action (or a course of action) that a person may take when that person is aware of the mutual dependence of the results for herself and for others. The outcomes depend not only on that person’s actions, but also on the actions of others.
structural unemployment: The level of unemployment at the Nash equilibrium of the labour and product market model.
subprime borrower: An individual with a low credit rating and a high risk of default. See also: default risk, subprime mortgage.
subprime mortgage: A residential mortgage issued to a high-risk borrower, for example, a borrower with a history of bankruptcy and delayed repayments. See also: subprime borrower.
substantive judgements of fairness: Judgements based on the characteristics of the allocation itself, not how it was determined. See also: procedural judgements of fairness.
substitutes: Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other. See also: complements.
substitution effect: The effect for example, on the choice of consumption of a good that is only due to changes in the price or opportunity cost, given the new level of utility.
supply curve: The curve that shows the number of units of output that would be produced at any given price. For a market, it shows the total quantity that all firms together would produce at any given price.
tangency: When a line touches a curve, but does not cross it.
tax: A compulsory payment to the government levied, for example, on workers’ incomes (income taxes) and firms’ profits (profit taxes) or included in the price paid for goods and services (value added or sales taxes).
technically feasible: An allocation within the limits set by technology and biology.
technological progress: A change in technology that reduces the amount of resources (labour, machines, land, energy, time) required to produce a given amount of the output.
technology: A process taking a set of materials and other inputs, including the work of people and capital goods (such as machines), to produce an output.
too big to fail: Said to be a characteristic of large banks, whose central importance in the economy ensures they will be saved by the government if they are in financial difficulty. The bank thus does not bear all the costs of its activities and is therefore likely to take bigger risks. See also: moral hazard.
total surplus: The total gains from trade received by all parties involved in the exchange. It is measured as the sum of the consumer and producer surpluses. See: joint surplus.
trademark: A logo, a name, or a registered design typically associated with the right to exclude others from using it to identify their products.
trade union: An organization consisting predominantly of employees, the principal activities of which include the negotiation of rates of pay and conditions of employment for its members.
tragedy of the commons: A social dilemma in which self-interested individuals acting independently deplete a common resource, lowering the payoffs of all. See also: social dilemma.
transaction costs: Costs that impede the bargaining process or the agreement of a contract. They include costs of acquiring information about the good to be traded, and costs of enforcing a contract.
ultimatum game: An interaction in which the first player proposes a division of a ‘pie’ with the second player, who may either accept, in which case they each get the division proposed by the first person, or reject the offer, in which case both players receive nothing.
unemployment: A situation in which a person who is able and willing to work is not employed.
unemployment benefit: A government transfer received by an unemployed person. Also known as: unemployment insurance.
unemployment rate: The ratio of the number of the unemployed to the total labour force. (Note that the employment rate and unemployment rate do not sum to 100%, as they have different denominators.) See also: labour force, employment rate.
union voice effect: The positive effect on labour effort (and hence labour productivity) of trade union members’ sense that they have a say (a voice) in how the firm is run.
unit cost: Total cost divided by number of units produced.
utility: A numerical indicator of the value that one places on an outcome, such that higher-valued outcomes will be chosen over lower-valued ones when both are feasible.
Veblen effect: A negative external effect that arises from the consumption of a positional good. Examples include the negative external effects imposed on others by the consumption of luxury housing, clothing, or vehicles.
verifiable information: Information that can be used to enforce a contract.
wage labour: A system in which producers are paid for the time they work for their employers.
wage-setting (WS) curve: The curve—arising from the wage-setting decisions of firms in the labour market—that gives the real wage necessary at each level of economy-wide employment to provide workers with incentives to work hard and well.
wage subsidy: A government payment either to firms or employees, to raise the wage received by workers or lower the wage costs paid by firms, with the objective of increasing hiring and workers’ incomes.
weakness of will: The inability to commit to a course of action (dieting or foregoing some other present pleasure, for example) that one will regret later. It differs from impatience, which may also lead a person to favour pleasures in the present, but not necessarily act in a way that one regrets.
wealth: Stock of things owned or value of that stock. It includes the market value of a home, car, any land, buildings, machinery, or other capital goods that a person may own, and any financial assets, such as bank deposits, shares, bonds, or loans made to others. Debts to others are subtracted from wealth—for example, the mortgage owed to the bank.
willingness to accept (WTA): The reservation price of a potential seller, who will be willing to sell a unit only for a price at least this high. See also: reservation price, willingness to pay.
willingness to pay (WTP): An indicator of how much a person values a good, measured by the maximum amount he or she would pay to acquire a unit of the good. See also: willingness to accept.
worker-owned cooperative: A form of business in which a substantial fraction of the capital goods are owned by employees rather than being owned by those who are not involved in production in the firm; worker-owners typically elect a manager to make day-to-day decisions.
worker’s best response function (to wage): The amount of work that a worker chooses to perform as her best response to each wage that the employer may offer. Also known as: best response curve.
WS/PS model: Model of the aggregate economy that combines wage-setting (WS) and price-setting (PS) decisions. Where the WS and PS curves intersect is the Nash equilibrium and determines structural unemployment and the real wage. See also, wage-setting curve, price-setting curve, structural unemployment.
yield: The implied rate of return that the buyer gets on their money when they buy a bond at its market price.