IB Economics 교재

Summer 2018

TABLE OF CONTENTS
Introduction
Foundations of Economics

Section 1: Microeconomics
1. Competitive Markets: Demand and Supply
2. Elasticity
3. Government Intervention
4. Market Failure

Section 2: Macroeconomics
1. The Level of Overall Economic Activity
2. Aggregate Demand and Aggregate Supply
3. Macroeconomic Objectives I: Low Unemployment, Low Inflation
4. Macroeconomic Objectives II: Economic Growth, Distribution of
Income
5. Demand-side and Supply-side Policies

Section 3: International Economics

1. International Trade
2. Exchange Rates and the Balance of Payments
3. Economic Integration and the Terms of Trade

Section 4: Development Economics

1. Understanding Economic Development
2. Topics in Economic Development
3. Foreign Sources of Finance and Foreign Debt
4. Consequences of Economic Growth; Balance between Markets and
Intervention

Appendix:

List of Definitions

Introduction: Foundations of Economics

Scarcity, Choice, Opportunity Cost

Definitions:

SCARCITY exists when human wants exceed the amount that available
resources can produce.

OPPORTUNITY COST is the cost of any economic activity measured in

terms of the best alternative that is foregone. When the best alternative is
chosen from a range of alternatives, the second best choice is the opportunity
cost.

FACTORS OF PRODUCTION refer to scarce resources –land, labor,

capital, and enterprise—used to produce economic goods and services.

RESOURCE ALLOCATION is the assignment of scarce resources to

specific uses. That is, deciding the questions of what will be produced, how
and when?

DISTRIBUTION OF INCOME refers to the way in which income is

distributed among the population.

PRODUCTION POSSIBILITY CURVE (PPC) refers to the boundary

between attainable and unattainable levels of production.

GOODS refer to physical objects people need and want (eg, food, clothing,
houses, books etc)

SERVICES refer to the non-physical activities that people need and want (eg
education, health care, travel, insurance etc)

Scarcity exists because factors of production are finite and wants are infinite.
Because of scarcity, we are forced to make choices.

Every economy is forced to answer three questions:

1. What to produce.
2. How to produce.
3. For whom to produce.
Questions 1 and 2 are about Resource Allocation.
Question 3 is about Distribution of Output and Income

Factors of Production: Land, Labor, Capital, Enterprise

LAND is one of the four factors of production. Refers to all natural

resources. It includes all agricultural, non-agricultural land, as well as
everything above the land (such as minerals, oil, water, forests, etc)

LABOUR is one of the four factors of production. Refers to human

resources involved in productive contributions to the economy. It includes
both physical and mental efforts that people contribute to the production of
goods and services.

CAPITAL is one of the four factors of production. It refers to man-made

items. (eg, machines, robots, factories) It is also known as physical capital,
or investment good, or capital good.

ENTERPRISE is a key factor of production and is the reward derived from

combining the other three factors - land, labor and capital - to produce goods
and services. It is a human skill possessed by some people, involving the
ability to innovate, take business risks, and run and manage businesses.

*Capital can mean different things in different contexts of economics.

i.e. Physical capital, human capital, natural capital, financial capital.
What is defined above is physical capital.

Production Possibility Curve (PPC)

Points A, B, C, D, E, and the PPC show the points that an economy can be
producing given that all resources are fully employed, and all resources are
used efficiently. In the real world, no economy produces at full employment
and perfect efficiency.
If not, then you would lie within the PPC—like Point F.
Point G cannot be attained because of resource scarcity. Because of scarcity,
the economy is forced to make choices on which products to produce at
which quantity.
Scarcity means that choices involve opportunity cost—if you increase
production of one good, you are foregoing the production of another.

In Figure 1.2(a), the PPC’s shape is

similar to that of Figure 1.1 while in
Figure 1.2(b) it is a straight line. When the PPC bends outward and to the
right, as in Figure 1.2(a), opportunity costs change as the economy moves
from one point on the PPC to another. In part (a), for each additional unit of
computers that is produced, the opportunity cost, consisting of microwave
ovens sacrificed, gets larger and larger as computer production increases. By
contrast, when the PPC is a straight line (as in Figure 1.2(b)), opportunity
costs are constant.

The PPC can also shift inwards or outwards. Outward shift of PPC occurs
when FOP or efficiency increases. Inward shift of PPC occurs when FOP
decreases or efficiency decreases.
Economics as a Social Science

Economists often use two key assumptions when developing economic

models: Ceteris Paribus, and the assumption of Rational Economic Decision
Making.
Ceteris paribus is a Latin expression that means ‘other things equal’.
Another way of saying this is that all other things are assumed to be constant
or unchanging.
Economic theories and assumptions are also based on the assumption of
rational economic decision-making. This means that individuals and firms
are assumed to act in their best self-interest, trying to maximize the
satisfaction they expect to receive from their economic decisions.

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Positive vs Normative Economics

POSITIVE STATEMENT is an expression that can be verified by

observation and/or fact.
NORMATIVE STATEMENT is an expression of opinion that cannot be
verified by observation or statistical fact.
Economists use positive statements to describe economic events and to
construct theories and models that try to explain these events. Positive
statements are also used in stating laws of economics.
Normative statements are important in normative economics, where they
form the basis of economic policy-making. Economic policies are
government actions that try to solve economic problems.
Positive and normative economics, while distinct, often work together.

MICROECONOMICS is the study of the behavior of households and firms

and how the prices of goods and services are determined.
MACROECONOMICS is the study of the whole economy, using
aggregates, which are wholes or collections of many individual sums.

Central Themes in Economics

Distinction between economic growth and economic development (To be

covered further in Section 4)

ECONOMIC GROWTH is an increase in a country’s Real GDP per capita.

It is one of the five major macroeconomic objectives.
ECONOMIC DEVELOPMENT occurs in a country when there is an
increase in Real GDP per capita plus an improvement in the standard of
living. It is one of the five major macroeconomic objectives.

Current patterns of Resource Allocation as a threat to Sustainability

SUSTAINABILITY involves using resources in ways that do not reduce

their quantity or quality over time.
SUSTAINABLE DEVELOPMENT refers to the use of the factors of
production by the current generation that result in the resources being
available for future generations.

MARKET ECONOMIC SYSTEM refers to a system where individuals,

rather than governments, own the factors of production and decide what,
how and when to produce.
COMMAND ECONOMY is the economic system in which the government
controls all or the majority of the factors of production, makes decisions
about the allocation of scarce resources and the distribution of income.

Real-world economies combine and market and command systems.

Economies may lean towards one type of structure over the other, but
characteristics of both exist in all economies. This mixed structure is called
mixed market economies.
In mixed market economies, the command methods of making allocation
and distribution decisions are referred to as government intervention,
because the government intervenes (or interferes) in the workings of
markets. Examples of government intervention include provision of public
education, public health care, public parks, road systems, national defense,
flood control, minimum wage legislation, restrictions on imports, anti-
monopoly legislation, tax collection, income redistribution, and many more.
We will compare these systems in Section 2 and 3.

Finally, there is the concept of economic efficiency and equity.

ECONOMIC EFFICIENCY occurs when society is producing the goods and

services most valued by society. Occurs outside firms.

EQUITY refers to the idea of being fair or just. Equity is not the same as
‘equality’. Equality is one possible interpretation of equity, but there are also
other possible interpretations. For example, in many countries in the world,
it is considered equitable that people with higher incomes and wealth pay
higher taxes than people with lower incomes and wealth.

Section 1: Microeconomics
Chapter 1: Competitive Markets: Supply and Demand

1.1 Introduction to competitive markets

The market may be in a specific place (such as a vegetable market), or it

may involve many different places (such as the oil market). Buyers and
sellers may meet (say, in a shop), or they may never meet, communicating
by fax, phone, internet, classified ads, or any other method which allows
them to convey information about price, quantity and quality. A market can
be local, where the buyers and sellers originate from a local area; it may be
national, in which case the buyers and sellers are from anywhere within a
country; or it may be international, with buyers and sellers from anywhere in
the world. For example, small neighborhood bakeries produce and sell bread
and other baked goods for the local community – this is a local market.
Local takeaway restaurants also produce for the local market. The labor
market, on the other hand, tends to be mostly a national market. By contrast,
the world oil market includes oil producers in different countries, and buyers
of oil virtually everywhere in the world, as well as wholesalers, retailers and
other intermediaries involved in buying and selling oil around the world.
Goods and services are sold in product markets, while resources (factors of
production) are sold in resource markets (factor markets).

COMPETITION is rivalry among buyers and sellers of the inputs and

outputs of the factors of production.

Supply and Demand

DEMAND is the relationship between the quantity demanded of a good or

service and its price.
QUANTITY DEMANDED is the amount of a good or service that
consumers plan to buy at each price in a given period of time.

DEMAND SCHEDULE lists the quantities of a good or service and its

price, holding all else constant.
According to the Law of Demand, there is a negative causal relationship
between price and quantity demanded.

Law of Demand—negative causal relationship between price and quantity

demanded
The main reason why the demand curve is downward sloping is the marginal
utility theory.
Firstly, utility is the benefit gained from the consumption of a good or
service. Marginal utility refers to the change in utility, yielded from the next
unit of good or service consumed. Each successive unit of the good or
service you consume yields less and less utility (benefit). Therefore, as a
consumer, you will be willing to buy each extra unit only if it has a lower
price. In other words, the quantity demanded only increases as price
decreases.

The market demand for a certain good or service is simply the sum of all the
individual demands for that good or service.

There are many determinants of demand—all of which can shift the demand
curve. The demand curve can shift outward (rightward) if more quantity is
demanded at the same price point. The demand curve can also shift inward
(leftward) if the quantity demanded is less at the same price point.

The determinants of demand:

 Income (Y)
o Income (Normal goods): A good is a normal good when
demand for it increases in response to an increase in consumer
income (demand for the good varies directly with income).
 Therefore, an increase in income leads to a rightward shift in
the demand curve, and a decrease in income leads to a leftward
shift.
o Income in the case of inferior goods: There are some goods
where the demand falls as consumer income increases; the good
is then an inferior good (the demand for the good varies
inversely with income). Examples of inferior goods are second-
hand clothes, used cars and bus tickets. As income increases,
consumers switch to more expensive alternatives, and so the
demand for the inferior goods falls. Veblen goods (with snob
appeal) are also inferior goods.
 Preferences/Taste (t)
o If preferences and tastes change in favor of a product (the good
becomes more popular), demand increases and the demand
curve shifts to the right; if tastes change against the product (it
becomes less popular), demand decreases and the demand curve
shifts to the left.
 Price of Substitutes (Ps)
o Two goods are substitutes (substitute goods) if they satisfy a
similar need. An example of substitute goods is Coca-Cola®
and Pepsi ®. A fall in the price of one (say, Coca-Cola) results
in a fall in the demand for the other (Pepsi).
 Price of Complements (Pc)
o Two goods are complements (complementary goods) if they
tend to be used together. In this case, a fall in the price of one
leads to an increase in the demand for the other. This is because
the fall in the price of DVD players results in a bigger quantity
of DVD players being purchased, and the demand for DVDs.
increases.
 Advertisement (Ad)
o In many cases, advertisements for a good or service will
stimulate consumption. For example, if McDonalds wanted to
sell more burgers, they may put out an advertisement, which
gets people’s attention and may lead to more consumption.
 Population (Pop)
o If there is an increase in the number of buyers (demanders),
demand increases and therefore the market demand curve shifts
to the right. This follows simply from the fact that market
demand is the sum of all individual demands.
  Future Expectations (Fx)
o If there is an expectation that consumers have about the
economy, consumption patterns may change. For example, if
people predicted that the economy was going to be worse off
next year, people may consume less and decide to save their
money.
Movement along the demand curve; Shift in Demand curve

Any change in price produces

a change in quantity
demanded, shown as a
movement on the demand
curve (first graph).

Any change in a
determinant of demand leads
to a change in demand,
represented by a shift of the
entire demand curve.
Supply

SUPPLY is the relationship between the quantity supplied and its price.

QUANTITY SUPPLIED is the amount of a good or service that producers

plan to sell at each price in a given period of time.

SUPPLY SCHEDULE is a list of quantity supplied at different prices,

holding everything constant.

The Law of Supply states that there is a positive causal relationship between
quantity supplied of a good or service over a period of time and its price.
Reason why there is a positive relationship is because higher prices, more
incentive to produce more output. This ultimately leads to higher profits.

Like demand, market supply is the sum of individual supply curves.

The vertical supply curve

Under certain special circumstances, the supply curve is vertical at some

particular fixed quantity. A vertical supply curve tells us that even as price
increases, the quantity supplied cannot increase; it remains constant. The
quantity supplied is independent of price. There are two reasons why this
may occur:

1. There is a fixed quantity of the good supplied because there is no time to

produce more of it.
2. There is a fixed quantity of the good because there is no possibility of
ever producing more of it.

The only determinant for Quantity Supplied is Price.

However, there are many determinants of supply.

Determinants of Supply:
 Costs of FOPs
o The firm buys various factors of production that it uses to
produce its product. Prices of factors of production (such as
wages, which are the price of labor) are important in
determining the firm’s costs of production. If a factor price
rises, production costs increase, production becomes less
profitable and the firm produces less; the supply curve shifts to
the left.
 Technology
o A new improved technology lowers costs of production, thus
making production more profitable. Supply increases and the
supply curve shifts to the right. In the (less likely) event that a
firm uses a less productive technology, costs of production
increase and the supply curve shifts leftward.
 Tax (Indirect tax or tax on profits)
o Firms treat taxes as if they were costs of production. Therefore,
the imposition of a new tax or the increase of an existing tax
represents an increase in production costs, so supply will fall
and the supply curve shifts to the left. The elimination of a tax
or a decrease in an existing tax represents a fall in production
costs; supply increases and the supply curve shifts to the right.
We will study the effects of taxes in more detail in Chapter 4.
 Subsidy

o A subsidy is a payment made to the firm by the government,

and so has the opposite effect of a tax. The introduction of a
subsidy or an increase in an existing subsidy is equivalent to a
fall in production costs, and gives rise to a rightward shift in the
supply curve, while the elimination of a subsidy or a decrease
in a subsidy leads to a leftward shift in the supply curve.
 Unexpected Events
o Sudden, unpredictable events, called ‘shocks’, can affect
supply, such as weather conditions in the case of agricultural
products, war, or natural/man-made catastrophes.
 Future Expectations
o If firms expect the price of their product to rise, they may
withhold some of their current supply from the market (not
offer it for sale), with the expectation that they will be able to
sell it at the higher price in the future; in this case, a fall in
 supply in the present results, and hence a leftward shift in the
supply curve.
 Competitive Supply
o Competitive supply of two or more products refers to
production of one or the other by a firm; the goods compete for
the use of the same resources, and producing more of one
means producing less of the other. For example, a farmer, who
can grow wheat or corn, chooses to grow wheat. If the price of
corn increases, the farmer may switch to corn production as this
is now more profitable, resulting in a fall in wheat supply and a
leftward shift of the supply curve.
 Joint Supply
o Joint supply of two or more products refers to production of
goods that are derived from a single product, so that it is not
possible to produce more of one without producing more of the
other. For example, butter and skimmed milk are both produced
from whole milk; petrol (gasoline), diesel oil and heating oil are
all produced from crude oil. This means that an increase in the
price of one leads to an increase in its quantity supplied and
also to an increase in supply of the other joint product(s)
 Number of Competitors
o An increase in the number of firms producing the good
increases supply and gives rise to a rightward shift in the supply
curve; a decrease in the number of firms decreases supply and
produces a leftward shift. This follows from the fact that market
supply is the sum of all individual supplies.

Movement along the supply curve; shift in the supply curve:

If price changes, then the supply curve does not shift. There is movement
along the curve. If there is a change in a determinant of supply, there is a
shift in curve (outward or inward)

Market Equilibrium
Once we put the demand curve and supply curve together, we get something
like Figure 2.9.
EQUILIBRIUM is a situation where demand equals supply at a given price
and the market clears.

If quantity demanded of a good is smaller than quantity supplied, the

difference between the two is called a surplus, where there is excess supply;
if quantity demanded of a good is larger than quantity supplied, the
difference is called a shortage, where there is excess demand. The existence
of a surplus or a shortage in a free market will cause the price to change so
that the quantity demanded will be made equal to quantity supplied. In the
event of a shortage, price will rise; in the event of a surplus, price will fall.

If there is a change in demand, the market equilibrium will shift.

Likewise, if there is a change in supply, the market equilibrium will shift.

CONSUMER SURPLUS is the difference between the amount a consumer

is willing to pay for a commodity and the amount that is actually paid.
PRODUCER SURPLUS is the difference between a producer’s total
revenue and the opportunity cost of production.

ALLOCATIVE EFFICIENCY occurs when no resources are wasted; when

no one can be made better off without making someone else worse off.

PRODUCTIVE EFFICIENCY occurs within a firm. It exists when they are

producing output with the minimum amount of inputs. The incentive for a
firm to achieve this is the profit motive. Also known as technical efficiency.

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1.2 Elasticity

PRICE ELASTICITY OF DEMAND (PED) is the responsiveness of

quantity demanded of a good or service to a change in its price.

PED=%Change in QD/ % Change in Price

“PED is greater” means abs value is greater

0<PED<1→inelastic
PED=1 (unit elastic)
1<PED<∞ →Elastic
PED=0 (Perfectly inelastic)
PED=∞  (Perfectly elastic)

*PED varies along a straight line demand curve (NOT EQUAL TO SLOPE)

Determinants of PED
 Number and closeness of substitutes (more substitutes, more elastic)
 Necessities or Luxuries
 Length of time in purchasing decision (more time → more elastic)
 Proportion of Income (higher of proportion of income → more elastic)

PED vs Revenue
If PED is inelastic, then increase in price → increase in TR
If PED is elastic, then increase in price → decrease in TR
If PED is unit elastic, then increase in price → no change in TR

PED falls as price falls (along a downward sloping straight line demand
curve)
When price is high, Demand is ELASTIC (so lowering price increases TR)
When price is low, Demand is INELASTIC (so higher price increases TR)
Max TR is when PED=1

If PED is inelastic, tax burden is pushed towards consumers

CROSS-PRICE ELASTICITY OF DEMAND (CPED) is a measure of the
responsiveness in quantity demanded of one good/service to the change in
price of a related good/service.

CPED=% Change in Quantity Demanded of Good A/% Change in Price of

Good B

IF XED is positive → Substitute Goods

IF XED is negative → Complementary Goods

If absolute value of XED is larger, than greater substitutes or stronger

complements

INCOME ELASTICITY OF DEMAND (YED) is the responsiveness of the

quantity demanded of a good or service to a change in income. Important
tool used by businesses and governments in their decision making process.
YED=% Change in Quantity Demanded/% Change in Income

If YED is positive, then normal good

If YED is negative, then inferior good
If YED>1, then luxury good

PRICE ELASTICITY OF SUPPLY (PES) is the responsiveness of quantity

supplied of a good or service to a change in its price.

PES=% Change in Quantity Supplied/% Change in Price

PES<1, Inelastic Supply
PES>1, Elastic Supply
PES=1 UNIT ELASTIC Supply
PES=0, Perfectly inelastic
PES=∞, Perfectly Elastic

Determinants of PES
 Length of Time
 Mobility of FOP
 Spare Capacity of Firms
 Ability to Store

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1.3 Government Intervention

INDIRECT TAX is a tax imposed by government directly on spending.

Examples include: GST, payroll tax, sales tax, land tax, stamp duty paid on
the purchase of a property.

WHY EXCISE TAX (PIGOUVIAN TAX)

 Source of Government Revenue
 Discourage consumption of demerit goods (goods with negative
externalities)
 Redistribute income
 Correcting negative externalities (internalize the costs)
 Improve allocation of resources

CONSEQUENCES
 Consumers (worsen off)
o Price goes up, and
quantity decreases
 Producers (Firms)
WORSE OFF
o Fall in price they
receive, and quantity
falls (fall in
revenue)
 Government (better
off)
o Gains revenue
 Workers (worse off)
o Lower output means
lower employment

SPECIFIC TAX is a tax set at a

fixed amount per unit on a good
or service.

AD VALOREM TAX is an
indirect tax on a good or service
imposed by a government whose amount of tax depends on the value of the
item or service.
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SUBSIDY is a government payment to producers of a good or service.

WHY SUBSIDY
 Increase producer revenues
 Make goods more affordable to low-income groups
 Encourage production and consumption of goods (positive externality,
or merit goods)
 Support growth of an industry
 Encourage exports of goods

CONSEQUENCES
 Consumers (better off)
o Price goes down,
quantity
increases
 Producers (Better
off)
o Higher price
received, and
quantity is
increased →
increase in
revenue
  Government (worse off)
o Government must pay subsidy (Opportunity Cost, potential
budget deficit)
 Workers (better off)
o Higher output ➔ more employment

PRICE CEILING is a price imposed below the market equilibrium price.

CONSEQUENCES
 SHORTAGE
 Rationing
o First come first
served
o Favoritism
 Parallel
Markets (Ticket
scalping)

Auction/Bidding
 RIOTS

MINIMUM or FLOOR PRICE is a price imposed above the market

equilibrium price. It is designed to assist producers.

CONSEQUENCES
 SURPLUS
 Government
must buy it
 Store it
 Export it
 Send it as aid
  Convert it to something else
 Destroy it

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1.4 Market Failure

MARKET FAILURE occurs where markets do not work at all or do not

work well. It refers to the failure of the price mechanism to achieve an
optimum allocation of resources. (MB=MC)

NEGATIVE EXTERNALITY is a market activity that negatively affects

other people. It is a form of market failure.

MARKET SOLUTIONS
 Tax
 Price Floor
NON-MARKET SOLUTIONS
 Advertisement
 Education
 Legislation

Negative Production Externality

Negative Consumption Externality

POSITIVE EXTERNALITIES refer to activities external to the market that
affect other people in a positive way.

MARKET SOLUTIONS
 Subsidy
 Price Ceiling
NON-MARKET SOLUTIONS
 Research and Development
 Human Capital

Positive Production Externality

Positive Consumption Externality

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PUBLIC GOOD is a good or service that is non-excludable and non-

rivalrous. (Common Access Resources)
Excludable ➔ possible to exclude people from the good
Rivalrous ➔ Consumption reduces availability for others

Quasi-public goods are non-rivalrous, but excludable (with entrance fees).

SUSTAINABLE DEVELOPMENT refers to the use of the factors of

production by the current generation that result in the resources being
available for future generations.

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Section 2: Macroeconomics

2.1 The level of overall Economic Activity

MEASURES OF ECONOMIC ACTIVITY

GROSS DOMESTIC PRODUCT (GDP) is the value of a country’s total

output of goods and services before depreciation.

GDP Calculation Methods

 Expenditure Approach
o GDP=AD=C+I+G+(x-m)
o INVESTMENT DOES NOT INCLUDE HUMAN or
NATURAL CAPITAL
 Income Approach
o National Income (GNI)= wages + rent + interest + profit
 Output Approach
o GDP=AS=value of goods in primary sector + value of goods in
secondary sector+ value of goods in tertiary sector

Difference between GDP and GNI/GNP--Domestic versus national

Domestic is within a country (regardless of who owns the FOPs)

National is → income measured of the country’s residents, regardless of
where the income comes from
GNI= GDP + Net property income earned abroad

Nominal versus Real Values:

-Nominal measures in terms of current prices
-Real eliminates the influence of change in price
Real GDP=nominal GDP/Price deflator*100

GDP versus GDP per capita (per capita means you divide by the total
population)

Is GDP a good indicator for the economy

 GDP/GNI does not include parallel markets
 Does not account for negative externalities (HDI)
 Does not account for distribution of income
 GDP versus GDP per capita
 Nominal versus real
 Net remittances (GNI)

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BUSINESS CYCLE refers to the fluctuations in economic activity over a
period of time. Usually measured by Real GDP and other macroeconomic
variables.

Real GDP vs time

BOOM DOWNTURN RECESSION RECOVERY

Long-term growth trend=potential output

BOOM → actual GDP>Potential GDP (outside the PPC)
→unemployment<natural rate

Recession → actual GDP< Potential GDP (inside PPC)

→Unemployment>natural rate

Increasing steepness is economic growth

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2.2 Aggregate Demand and Aggregate Supply

AGGREGATE DEMAND (AD) is the relationship between the aggregate

quantity of goods and services demanded - or Real GDP - and the price level
–   the GDP deflator holding everything else constant. AD = C+ I+ G + X -
M.

REASOSN WHY ITS DOWNWARD SLOPING

 Wealth Effect (If PL goes up, real value of wealth goes down)
 Interest Rate Effect (If PL goes up, interest rates go up→C goes
down)
 International Trade Effect (Foreign purchases effect)

Determinants of Aggregate Demand:

 Changes in Consumption:
o Changes in consumer confidence. Consumer confidence is a
measure of how optimistic consumers are about their future
income and the future of the economy.
o Changes in interest rates. Some consumer spending is financed
by borrowing, and so is influenced by interest rate changes.
o Changes in wealth. An increase in consumer wealth (for
example, an increase in stock market values, or an increase in
the value of homes) makes people feel wealthier
o Changes in personal income taxes. If the government increases
personal income taxes (taxes paid by households on their
incomes), then consumer disposable income, which is the
income left over after personal income taxes have been paid,
falls
 Changes in Investment
o Changes in business confidence. This is a measure of how
optimistic businesses are about their future profits and the
future of the economy.
o Changes in interest rates.
o Changes in technology
o Changes in corporate taxes
 Changes in Government Spending
o Political and economic reasons (to be discussed later)
  Changes in export, imports
o Changes in exchange rate (to be discussed in International
Economics)
o Changes in National income abroad
o Changes in the level of trade protection

AGGREGATE SUPPLY (AS) is the sum total of planned production for the
whole economy.

SHORT-RUN AGGREGATE SUPPLY (SRAS) is the relationship between

Real GDP and the price level, holding everything else constant.
LONG-RUN AGGREGATE SUPPLY (LRAS) is the relationship between
Real GDP and the Price Level at full employment. Unemployment is at its
natural rate.

LRAS is vertical because wages (and other FOP prices) change in the LR,
firms’ costs of production remain constant even with PL changes because
they change to match output and price. Also, LRAS is another way to show
the PPC.
Hence, no incentive to increase or decrease output levels

LRAS is at Yf because it represents the trend-line of the business cycle

Wage and price flexibility in the LR has made it come to Yf in LR

Determinants of SRAS
 Changes in wages (costs of production rise)
 Changes in price of FOPs (costs of production rise)
 Changes in business tax
  Changes in business subsidies
 Supply-side shocks

LRAS Shift
 Increase in quantity of FOPs
 Increase in quality of FOPs
 Improvement in technology
 Improvement in efficiency
 Reduction in natural rate of unemployment
Deflationary gaps and inflationary gaps are eliminated in the long run.

Keynesian Model (very short run) (Keynes questioned the classical,

monetarists/new classical economists)

 Getting stuck in the short run. (Wage and price are sticky
downwardthey don’t change that easily)
 Hence, the economy is unable to move into the long run (fixed prices)
The Keynesian AS curve has three sections.

Section 1: In section I, real GDP is low, and the price level remains constant
as real GDP increases. In this range of real GDP, there is a lot of
unemployment of resources and spare capacity. Firms can easily increase
their output by employing the unemployed capital and other unemployed
resources, without having to bid up wages and other resource prices.

Section 2: In section II, real GDP increases are accompanied by increases in

the price level. The reason is that as output increases, so does employment of
resources, and eventually bottlenecks in resource supplies begin to appear as
there is no longer spare capacity in the economy. Wages and other resource
prices begin to rise, which means that costs of production increase. The only
way that firms will be induced to increase their output is if they can sell it at
higher prices.
Section 3: In section III, the AS curve becomes vertical at Ymax, indicating
that real GDP reaches a level beyond which it cannot increase anymore; at
this point, the price level rises very rapidly. Real GDP can no longer
increase because firms are using the maximum amount of labor and all other
resources in the economy. Since real GDP cannot increase further, any
efforts on the part of firms to increase their output only result in greater
increases in the price level.

Key features of Keynesian Model:

 Recessionary gaps can persist for extended periods of time (because

Keynesian analysis is short-run)
 Increase in AD need not increase price levels (as done in the new
classical method)

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2.3 Macroeconomic Objectives

MACROECONOMIC OBJECTIVES refers to the five key macroeconomic

issues that are of concern to governments: economic growth, economic
development, full employment, price stability, and external equilibrium.

a) Low Unemployment

According to the ILO, the unemployed are people who are registered as able,
available and willing to work at the going wage rate but who cannot find
work despite an active search for work.

NATURAL RATE OF UNEMPLOYMENT is the unemployment rate when

the economy is at full employment and the labor market clears. It includes
any frictional, seasonal and structural unemployment.
 Structural
 Frictional
 Seasonal

UNNATURAL RATE OF UNEMPLOYMENT

 Cyclical Unemployment (Demand-Deficient, Keynesian)
 Real Wage Unemployment (neo-classical)
 Hidden unemployment

Graph of the Labor Market

W1
PL1
W2
PL2
 Y2 Y1 E2 E1

CONSEQUENCES OF UNEMPLOYMENT
 A loss of real GDP
 A loss of income for unemployed
 A loss of tax revenue
 Costs to the government (social costs with public goods, or food
stamps)
 Income inequality
 Hysteresis Effect
 Social consequences such as higher crime rate, increased stress,
increased indebtedness, homelessness

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b) Low Inflation
INFLATION is a sustained increase in the general price level. Measured by
the Consumer/Retail Price Index.

Disinflation is inflation occurring at a lower rate

DEFLATION is a sustained decrease in the general price level. Often

accompanied by a fall in total output and an increase in unemployment.

CONSUMER PRICE INDEX (CPI) is an index of the average household’s

purchase of goods and services most commonly used in western countries to
measure inflation (excludes housing costs, see RPI).

PROBLEMS with CPI

 Different rates of inflation for different income earners
 Regional or cultural factors
 Discount stores and sales
 Changes in consumption pattern due to introduction of new products
 Improvement in product quality

CORE RATE OF INFLATION (excludes food and energy products with

highly volatile prices)

PRODUCER PRICE INDEX (PPI)Several indices of price received by

producers of goods at various stages in the production process (primary,
intermediate, tertiary goods)

INFLATION GOOD OR BAD?

 Fixed income or wages lose
o People who pay, gain
o People who earn, lose
 Holders of cash/Savers/Lenders ALL LOSE
 Borrowers WIN
 Uncertainty
 Menu Costs/ Shoe leather costs
 Foreign Purchases effect
 Food price inflation
DEFLATION GOOD OR BAD?
 Wages of workers are sticky downward (Ratchet effect)
 Large oligopolistic firms fear price wars
 Uncertainty
 Menu Costs
 Risk of bankruptcy and financial crisis

Price Index for Year A=Value of basket in year A/value of basket in base
year

Inflation is always equal to price index-100

Types of Inflation:
DEMAND-PULL INFLATION is a sustained increase in the general price
level resulting from an increase in aggregate demand.
COST-PUSH INFLATION refers to the sustained increase in the general
price level resulting from increased cost in the inputs of the factors of
production.

PHILLIPS CURVE
PHILLIPS CURVE shows the trade-off between unemployment and
inflation.

SHORT-RUN PHILLIPS CURVE shows the relationship between

unemployment and inflation, holding the expected rate of inflation and the
natural rate of unemployment constant. (STAGFLATION)

LONG-RUN PHILLIPS CURVE shows the relationship between inflation

and unemployment when the actual rate of inflation equals the expected rate
of inflation.

1. Short Run
Phillips
curve
shifts Up
(as AD shifts
out)
 2. Inflation is higher and unemployment reduced
3. Wage meets price levels in LR, so wage goes up
4. SRAS shifts in, and meets LRAS
5. LRPC

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c) Economic Growth

ECONOMIC GROWTH is an increase in a country’s Real GDP per capita.

It is one of the five major macroeconomic objectives.

Actual economic growth is point shift in PPC

Potential economic growth is PPC shift

d) EQUITY in the Distribution of Income

Equity is fairness
Equality is equal-ness

LORENZ CURVE measures income inequality within the population.

Gini Coefficient=0, Income equality
Gini Coefficient=1, income inequality

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e) Poverty

ABSOLUTE POVERTY exists when only the minimum level of basic needs
– such as food, shelter and clothing - can be met (compare with Relative
Poverty).
Living on less than $1.25extreme poverty
Living on less than $2 a day, moderate poverty

RELATIVE POVERTY exists where a proportion of the population in a

country cannot enjoy the standard of living normal to their society. This type
of poverty will always exist where there is any substantial degree of income
and asset inequality within a given society.
CAUSES OF POVERTY
 Low income
 Unemployment
 Low human capital
 POVERTY
CONSEQUENCES OF POVERTY
 Low living standards
 Lack of health care/education
 Higher mortality rates

Means to redistribute wealth:

TRANSFER PAYMENTS refer to payments made by the government to

redistribute income. Examples include pensions, travel and health
concessions for the elderly, the provision of government low cost housing,
and child and family benefits. They are common in MDCs, but not in LDCs.
1. SUBSIDY on goods for low income groups
2. Taxation
a. DIRECT TAX is a tax imposed by governments directly on an
individual or organization. Most commonly applied on personal
income and company profits.
b. Proportional (constant tax rate)
c. Regressive (decreasing tax rate as increase in income)
d. Progressive (increasing tax rate as increase in income)

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2.4 Fiscal Policy (Demand-side)
There are four types of demand-side policies: fiscal, monetary,
expansionary, contractionary.

FISCAL POLICY refers to the government’s policy on taxation (direct and

indirect), government expenditure and transfer payments and their affect on
aggregate demand and aggregate supply.

 Taxes (direct and indirect)

 Government Expenditure
 Transfer Payments

If revenue equals expenditure, BALANCED BUDGET

If revenue greater than expenditure, BUDGET SURPLUS
If revenue less than expenditure, BUDGET DEFICIT (Debt)

AUTOMATIC STABLIZER is a mechanism that decreases the size of

fluctuations in aggregate expenditure.
 Progressive Income tax
o As real GDP increases, government tax revenues increase (so C
and G balance out)
o As real GDP decreases, government tax revenue decreases (so
C and G balance out)
 Unemployment Benefit
o As real GDP falls, unemployment increases, unemployment
benefits increases (spending increases)
o As real GDP increases, unemployment decreases,
unemployment benefits decreases (spending decreases)

FISCAL POLICY GOOD OR BAD?

 Effective in pulling an economy out of recession
 Effective in reducing inflation
 Good Ability to target parts of the economy
 Time Lag
 Opportunity Cost
 Crowding out the private sector
 If Supply-side does not move with it, instability)
  Future expectations and pessimism in a recession means tax cuts does
not mean increase in spending
 Can create a better economyeconomic growth in the long run.

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2.5 Monetary Policy

MONETARY POLICY refers to changes in the money supply and interest

rates to affect aggregate demand and aggregate supply. In most countries,
these policy decisions are made by the Central Bank.

MONEY SUPPLY versus RATE OF INTEREST?

*interest rate is like price of currency

INTEREST RATE TRANSMISSION MECHANISM

 Expansionary (increases consumption, and investment)
o Increase supply of money
o Lower interest rate
 Contractionary (decreases consumption, investment)
o Decreases supply of money, increase interest rates)

MONETARY POLICY GOOD OR BAD?

 No time lag
 No opportunity cost
 No crowding out the private sector
 May be ineffective in recession
 Inability to deal with stagflation
 Central Bank is no longer independent from the government

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2.6 Supply-side Policies

SUPPLY-SIDE POLICIES refer to government policies designed to increase

output. Examples include tax reductions and concessions.
 Interventionist
 Market-based
 Incentive-related

Interventionist
 Improve health care/education (Human Capital)
 Invest in technology
 Invest in infrastructure
 Support infant industries
Market-based
 Encouraging competition
o Privatization
o Deregulation (breaking up monopolies, and reducing demerit
goods)
 Trade liberalization
 Outsourcing
 Labor market reforms (abolishing minimum wages, reducing
unemployment benefits)
Incentive-related
 Lowering personal income tax
 Lowering tax on interests income
 Lowering business tax

SUPPLY-SIDE POLICY GOOD OR BAD?

 Time lag!!!!!
 Potential economic growth
 Increases employment
 May reduce inflationary pressure
 Huge opportunity costs
 Does not leave market forces be
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SECTION 3: International Economics

3.1 International Trade

FREE TRADE is the movement of goods and services without protectionist

barriers.

FREE TRADE GOOD OR BAD?

 Increases in domestic consumption
 Increase in domestic production (specialization)
 Economies of scale in production
 More choice for consumers
 Greater efficiency (due to competition)
 Lower prices
 Efficient allocation of resources
 Engine for growth
 International relations

ABSOLUTE ADVANTAGE exists when one country can produce a good or

service with less resources or factors of production compared to another
country.

COMPARATIVE ADVANTAGE exists where a country can produce a

good or service at a lower opportunity cost compared with another country.
 France has absolute advantage in both cheese and wine
Poland has comparative advantage in cheese (opportunity cost is less)

If countries export goods with absolute advantage, output increases

(Specialization)

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TRADE PROTECTIONISM is the restriction of international free trade by
governments. Measures include quotas, tariffs, embargoes and import duties.

TARIFFS are taxes imposed by the government of an importing country.

They are a major form of protectionism, particularly of agricultural
protectionism by the USA, EU and Japan against agricultural imports from
LDCs.

QUOTAS are restrictions on the quantity of a good or service that a firm is

permitted to sell or that a country is permitted to import.
SUBSIDY is a government payment to producers of a good or service. It is
an indirect measure of trade protectionism.

TRADE PROTECTIONISM GOOD OR BAD?

 Infant Industry Argument
 Local employment
 National food security
 Tariff as a source of government revenue
 Anti-dumping
 Protect Culture
 Maintain External equilibrium

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 3.2 Exchange Rates

FREELY FLOATING EXCHANGE RATE is one where the price of one

currency against another is determined by market forces on the foreign
exchange market.

APPRECIATION is an increase in the value of a domestic currency in terms

of other currencies. Occurs as a result of market forces.
DEPRECIATION OF CURRENCY is the reduction in the value of a
domestic currency against foreign currencies under a regime of floating
exchange rates.
CAUSES OF EXCHANGE RATE CHANGE
 Net Exports
o If exports increases, currency appreciates
o If imports increases, currency depreciates
 If interest rates go up, currency appreciates
 Inflation in a country leads to currency depreciation
 Investment from abroadappreciation

EFFECTS OF EXCHANGE RATE CHANGE

 Inflation changes
o Cost-push because if import heavy and currency depreciates,
costs go up
o Demand-pull because currency deprecation could make exports
cheaper and shift out AD

FIXED EXCHANGE RATE exists where the price of one currency against
another is fixed on the foreign exchange market.

DEVALUATION is a fall in the value of a currency operating under a fixed

exchange rate system. Results from government action.
REVALUATION is government action to increase the price of its currency
relative to other currencies.

DIRTY OR MANAGED FLOAT exists when a government intervenes in

the managed float of its currency. It creates an artificial value or price of the
currency, and is generally unsustainable in the long term.

Governments buy and sell official cash reserves to appreciate or depreciate

currency

OVERVALUED CURRENCIES
 Imports are cheaper (raw materials, capital goods)
 Exports are more expensive (worsening current account balance)
UNDERVALUED CURRENCIES
  Imports are more expensive
 Exports are cheaper (can use that to increase employment, and expand
economies)

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3.3 The Balance of Payments

BALANCE OF PAYMENTS (BoP) is an account of a country’s transactions

with the rest of the world.

CURRENT ACCOUNT is that part of the balance of payments which

records the transactions of goods/visible items and services/invisible items.
Used as a measure to determine how healthy a country’s external account is.
 Balance of trades in goods
 Balance of trades in services
 Income (inflows minus outflows)
 Current transfers
CAPITAL ACCOUNT is the part of BOP that records the capital transfers
and transactions in non-produced, non-financial assets.
 Capital transfers
 Transactions in non-produced, non-financial assets

FINANCIAL ACCOUNT is the part of BOP that records investment and

reserve assets.
 Direct Investment (FDI)
 Portfolio Investment
 Reserve Assets

Current Account Balance=Capital Account + Financial account balance

Current account + Capital account + Financial Account +

Errors/Omissions=0

CURRENT ACCOUNT AND FINANCIAL ACCOUNT are interdependent

Trade deficit (consumes outside PPC)

imports>exports
financial account must be in surplus to pay for the excess of imports

Trade Surplus (consumes inside PPC)

Exports>imports
Country buys from foreigners, so it accumulates foreign currencies (used
to buy assets, or invest)

DEFICIT in the CURRENT ACCOUNT may result in depreciationmore

exports (balance)
SURPLUS in the CURRENT ACCOUNT may result in appreciationmore
imports (balance)

FIXED EXCHANGE RATE GOOD OR BAD?

 Certainty
 Foreign currency reserves (managed float)Opportunity Cost
 Market failure (distortion of PSM)
 No inflationary pressure
 May lead to capital flight
PERSISTENT CURRENT ACCOUNT DEFICIT
 Higher interest rates to attract foreign financial investments (but
discourages consumption)
 High indebtedness
 Depreciating exchange rate
 Lower economic growth

MARSHALL-LERNER CONDITION states that if the PEDx + PEDm > 1,

then a depreciation of the exchange rate will improve the balance of
payments. If the PEDx + PEDm = 1, then the BOP will remain unchanged.
If the PEDx + PEDm <1, then a depreciation will worsen the BOP.

J-CURVE EFFECT refers to the way and the time frame in which the trade
balance may initially worsen before it improves, after a depreciation of the
exchange rate.
 At first, current account worsens due to inelasticity of imports and
exports
Combined PED=1 is turning point
Later, consumers and producers adjust to changes in prices, and PED
increases. Then Current account improves.

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3.4 Economic Integration

TRADING BLOCS

AEB represents trade creation (welfare gained)

BCF represents Trade diversion (potential welfare gained, if free trade)

MONETARY UNION refers to the replacement of the currencies of the

majority members of the EU with a single currency, the Euro.
 Eliminates exchange rate risk (uncertainty)
 Eliminates transactions costs
 Can’t use monetary policy

TERMS OF TRADE is the rate at which exports will trade for imports. It
expresses a price relationship and measured through the Terms of Trade
Index.

TERMS OF TRADE INDEX is the ratio of export prices to import prices

expressed as an index.
Terms of Trade=Average price value of exports/Average price value of
imports x 100

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CHAPTER 4: Development Economics

4.1 Economic Development

ECONOMIC DEVELOPMENT occurs in a country when there is an

increase in Real GDP per capita plus an improvement in the standard of
living. It is one of the five major macroeconomic objectives.

For LEDCs, most important source of economic growth:

 Increase in physical and human capital
 New technologies
 Institutional changes
Developing countries characteristics
 Low levels of GDP per capita
 High levels of poverty
 Large agricultural sector
  High birth rates
o Families have low income…
o More people, less money
 Low levels of health/educationLow productivity

POVERTY
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Millennium Development Goals

The Millennium Development Goals (MDGs) are eight international
development goals that were established in 2000 by the United Nations. The
goals to achieve by 2015 are:
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 4.2 Measuring Development

There are two types of indicators economists use: single indicators, and
composite indicators.

Single indicators are indicators that measure only one aspect of

development.
For example, you can have GDP per capita or GNI per capita. Health-related
indicators, and education-related indicators are often used as well.

Composite indicators, such as the HDI are summary indicators that measure
multiple aspects of development.

HUMAN DEVELOPMENT INDEX (HDI) (a UN measure) measures the

average achievement of a country in three dimensions of human
development - life expectancy at birth, adult literacy rate, and purchasing
power through GDP per capita (PPP US$). The maximum level is 1.

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4.3 The Role of Domestic Factors (Think externalities!!!)

There are many domestic factors that play a part in determining if a country
will develop economically:
 Education
 Health
 Appropriate Technology
 Credit, micro-credit
 Empowerment of women
 Income distribution

MICROCREDIT refers to the provision of a credit facility or lending of very

small amount of money to private small businesses. It has the potential to be
an important source of funding in LDCs.
o Tackles poverty
o Growth of the informal sector
o Highly unskilled people may be harmed by microcredit
o Interest rates are too high

4.4 -4.8 The role of International Trade, FDI, Foreign Aid,

International Debt, Market Intervention
BARRIERS TO DEVELOPMENT:
o Overspecialization on a narrow range of products
o Dependency on commodity exports
o Missing out n diversification
o Price volatility
o Tariff barriers/Non-tariff barriers

WAYS TO DEVELOP
Outward means interact with outside

1. IMPORT SUBSTITUTION (INWARD DEVELOPMENT) is increasing

domestic production of goods and services to replace imports. Process
adopted by many LDCs in an attempt to industrialize.
o Independence from imports
o Not relying on exports
o Infant Industry argument
CONSEQUENCES
o High levels of protection of domestic firms
o Inefficiency (misallocation of resources)
o Too much government intervention

2. EXPORT PROMOTION (OUTWARD DEVELOPMENT)

o Targeting specific industries
o Large public investment
o Expansion into foreign markets
o Benefits of diversification
o Major investment in human capital
o Increase in employment

3. SUPPLY SIDE POLICIES (INWARD)

4. Subsidy (INWARD)

5. Price Floor (INWARD)

 6. TRADE LIBERALIZATION (OUTWARD DEVELOPMENT) is the
freeing-up of trade by a country and between countries. It is a major
objective of the current WTO Doha Trade negotiations.
o Eliminating protectionism
o Privatization
o Free float exchange rates

7. DIVERSIFICATION (INWARD if no trade)

a. Sustained increase in exports
b. Development of technological capabilities and skills

GLOBALIZATION GOOD OR BAD?

GLOBALIZATION is a process of breaking the down barriers between

countries resulting in greater integration and interdependence. Since the
1980s, largely brought about through massive technological changes in
communications and information.
MULTINATIONAL COMPANIES/CORPORATIONS (MNC) refers to
companies that have production units in more than one foreign country (also
known as TNCs).
o GOOD
o Can create jobs/decrease unemployment)
o Global economies of scale
o Tax revenue for local government
o Development of infrastructure
o Creation of capital in countries with large savings gap
o Promotes trade
o Improves international relations
o Allows LEDCs to utilize their own resources
o MNCs profit can be used for R/D
o MNCs can lead to economic growth
o BAD
o Exploitation of workers
o Crowd out local firms
o Aggravate income inequality
o Loss of culture
o Detrimental to environment
 o Dependency culture
o Some companies hide taxes
o Capital flight!!!

AID GOOD OR BAD?

o GOOD
o Shifts out PPC (increases efficiency)
o Reduce savings gap
o Capital deepening
o Targeted aid (can improve income inequality)
o HUMANITARIAN AID
o Helps break poverty cycle
o BAD
o Correlated with corruption
o Aggravates income inequality
o Distortion of PSM
o Dependency culture
o Delays government reforms
o Tied Aid
o Crowds out local firms
o Trade is better than aid!

DEBT RELIEF

o Debt Rescheduling (restructure debt on better terms with commercial

banks)
o IMF lending and stabilization policies
o OPPORTUNITY COST
o Lower private investment (crowding out)
o Lower economic growth

Debt Cancellation (HIPC)

Heavily Indebted Poor Countries Initiative (HIPC)
Multilateral Debt Relief Initiative (MDRI)
Together, they considered the levels of debt reduction.
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APPENDIX: List of Definitions

A
ABOVE FULL EMPLOYMENT EQUILIBRIUM exists when macroeconomic equilibrium
occurs at a level of Real GDP above long-run aggregate supply (LRAS).
ABSOLUTE ADVANTAGE exists when one country can produce a good or service with
less resources or factors of production compared to another country.
ABSOLUTE POVERTY exists when only the minimum level of basic needs – such as
food, shelter and clothing - can be met (compare with Relative Poverty).
ABUNDANCE occurs when a person can obtain as much of something as they want. It is
the opposite of scarcity.
ACCELERATOR refers to a larger percentage change in investment as a result of a
percentage change in demand.
ACCOUNTING PROFIT is the difference between total revenues and total explicit costs
(TR – TC. If TC > TR, AP is negative. If TC < TR, AP is positive. If TC = TR, then it is
break even).
AD VALOREM TAX is an indirect tax on a good or service imposed by a government
whose amount of tax depends on the value of the item or service.
AGGREGATE DEMAND (AD) is the relationship between the aggregate quantity of
goods and services demanded - or Real GDP - and the price level – the GDP deflator
holding everything else constant. AD = C+ I+ G + X - M.
AGGREGATE DEMAND SHOCK is any shock, such as 9/11 or a war, which causes the
aggregate demand curve to shift to the left or right.
AGGREGATE SUPPLY CURVE is the relationship between planned rates of total
production for the whole economy and the price level.
AGGREGATE SUPPLY (AS) is the sum total of planned production for the whole
economy.
AGGREGATE SUPPLY SHOCK is any shock, such as 9/11 or a dramatic change in the
weather, which causes the aggregate supply curve to shift to the left or right.
AGRICULTURAL PROTECTIONISM is the restriction of agricultural international trade
by governments. Of major concern to LDCs. It is a major reason for the failure of the
WTO Doha Round of negotiations.
AID is money and/or goods and services provided to a country. It can be tied - that is,
certain conditions are imposed by the donor - or untied. It can come from private
investment and or Overseas Development Assistance.
ALLOCATIVE EFFICIENCY occurs when no resources are wasted; when no one can be
made better off without making someone else worse off.
ANTICIPATED INFLATION is an inflation rate that has been correctly forecast.
ANTI-DUMPING measures are imposed by governments against exports of goods and
services, which are sold into their country below the cost of production.
APPRECIATION is an increase in the value of a domestic currency in terms of other
currencies. Occurs as a result of market forces.
ASEAN refers to the free trade area of The Association of South East Asian Nations.
ASEAN PLUS 3 refers to ASEAN plus the possible inclusion of China, Japan and South
Korea.
ASSET is anything of value that is owned; such as a house, shares and furniture.
AUTOMATIC STABLIZER is a mechanism that decreases the size of fluctuations in
aggregate expenditure.
AUTONOMOUS CONSUMPTION is that part of consumption which is independent of the
level of disposable income.
AVERAGE ANNUAL GROWTH IN GDP refers to the average percentage growth in GDP
over a period of time.
AVERAGE ANNUAL GROWTH IN GDP PER CAPITA refers to the average percentage
growth in GDP per capita over a period of time.
AVERAGE ANNUAL POPULATION GROWTH refers to the average percentage growth in
population over a period of time.
AVERAGE FIXED COSTS (AFC) are total fixed costs divided by the number of units
produced.
AVERAGE PROPENSITY TO CONSUME (APC) is consumption divided by disposable
income at any given level of income. It is the proportion of total disposable income
that is consumed.
AVERAGE PROPENSITY TO SAVE (APS) is savings divided by disposable income at any
given level of income. It is the proportion of total disposable income that is saved.
AVERAGE TAX RATE is the total direct tax payment divided by total income. Or the
proportion of total income paid in direct tax.
AVERAGE TOTAL COSTS (ATC) are total costs divided by the number of units
produced.
AVERAGE VARIABLE COSTS (AVC) are total variable costs divided by the number of
units produced.
B
BALANCE OF PAYMENTS (BoP) is an account of a country’s transactions with the rest
of the world.
BALANCE OF TRADE is the difference between the value of visible exports and the
value of visible imports.
BALANCE OF TRADE DEFICIT refers to a situation where a country’s visible imports
exceed its visible exports.
BALANCE OF TRADE SURPLUS refers to a situation where a country’s visible exports
exceed its visible imports.
BILATERIAL FREE TRADE AGREEMENT refers to a free trade agreement between two
countries.
BRAND NAME is a name given by an organization to a product or service with the aim
to distinguish from other goods and services on the market, thereby enhancing its
value and resulting in consumer loyalty.
BALANCING ITEM refers to the estimated net value of omissions from all other items
recorded in the balance of payments accounts.
BANKRUPTCY is a situation where an entity is unable to pay its debts.
BARRIERS TO ENTRY refers to obstacles placed to make it difficult for firms to enter
an industry and provide competition to existing suppliers of a good or service. A form
of protectionism; often imposed by governments to protect their domestic industries.
BARTER is a system of exchange where goods and services are exchanged without the
use of money. Still used by some countries, such as Myanmar.
BASE YEAR is the year selected as the point of reference for comparison.
BIRTH RATE is the number of births per 1,000 people in the population per year.
BLACK MARKET ECONOMY refers to the unofficial economic activity in an economy. It
cannot be precisely measured because the value of the activities is not officially
recorded in a country’s accounts (‘Parallel Markets’ is the appropriate IB term).
BUDGET is the annual statement of accounts of a government for a forthcoming
period, usually the next twelve months. The surplus or deficit reflects the internal
health of a country or state.
BUDGET SURPLUS occurs where the government’s income exceeds its expenditure.
BUDGET DEFICIT occurs where the government’s income is less than its expenditure.
Persistent deficits reflect poor management of a country’s internal accounts/affairs.
BUFFER STOCK SCHEME refers to attempts, by producers and/or governments, to
smooth out fluctuations in prices in goods and hence producer incomes.
BUSINESS CYCLE refers to the fluctuations in economic activity over a period of time.
Usually measured by Real GDP and other macroeconomic variables.
C
CAPITAL is one of the four factors of production. It refers to man-made items. For
example, machines, robots, factories.
CAPITAL CONSUMPTION refers to the reduction in the value of capital goods over a
one-year period due to obsolescence and physical wear and tear.
CAPITAL COSTS are the cost incurred in providing capital goods.
CAPITAL DEEPENING refers to improvements in the quality of capital. Examples
include new ideas and inventions that find their way into the productive process via
new, or improvements to existing, capital goods.
CAPITAL FLIGHT is the movement of domestic financial capital across international
boundaries. It usually is a result of domestic problems-such as a war or insurgency- and
results in problems of capital deepening, particularly for LDCs leading to increased
international debt.
CAPITAL GOODS consist of one of the four factors of production produced by people.
For example, machines, robots, factories.
CAPITAL INVESTMENT is the investment in capital or capital goods.
CAPITAL MOVEMENTS is the flow of funds across international boundaries for
investment in capital goods and/or in response to, or anticipation of, obtaining a
higher interest rate.
CAPITAL WIDENING refers to an increase in the quantity of capital.
CAPITALISM refers to an economic system in which the productive resources are
owned by individuals/corporations.
CARTEL exists when a group of producers enter into a collusive agreement to limit
output and control supply in order to raise prices and profits. Results in increased
producer sovereignty. OPEC is a good example.
CENTRAL BANK refers to the official institution in a country, which controls the
money supply, and also sets interest rates. It controls monetary policy. In the majority
of countries, it operates independently of the government.
CETERIS PARIBUS is the assumption that all other variables are kept constant, except
those variables under study.
CHILD MALNUTRITION refers to situations where a child does not have sufficient
sustenance for a healthy life.
CLASSICAL UNEMPLOYMENT is caused when labour unions or minimum wage
legislation hold the real wage above the equilibrium level, not allowing the market to
clear. It is one of the two types of disequilibrium unemployment.
COLLUSION is a situation where a group of individuals or firms join together, either
officially or usually unofficially, to exercise greater producer sovereignty.
COLLUSIVE OLIGOPOLY refers to the price setting by oligopolists to prevent a price
war from occurring.
COMMAND ECONOMY is the economic system in which the government controls all or
the majority of the factors of production, makes decisions about the allocation of
scarce resources and the distribution of income.
COMMODITY AGREEMENTS are arrangements between producers to control supply
onto the market, aimed at stabilising and/or raising commodity prices. They create a
buffer stock.
COMPARATIVE ADVANTAGE exists where a country can produce a good or service at a
lower opportunity cost compared with another country.
COMPETITION is rivalry among buyers and sellers of the inputs and outputs of the
factors of production.
COMPLEMENTARY GOOD OR SERVICE exists when the change in price of one good or
service causes an opposite shift in the demand for another good or service.
CONCENTRATION RATIO refers to the percentage of all sales contributed by a small
number of the largest firms in an industry.
CONSTANT PRICES is the currency expressed in terms of real purchasing power, using
a base year as a comparison.
CONSTANT RETURNS TO SCALE exists when the percentage change in a firm’s output
equals the percentage change in its inputs.
CONSUMER EXPENDITURE is expenditure on durable and non-durable goods and
services by consumers.
CONSUMER GOODS refer to durable and non-durable goods and services.
CONSUMER PRICE INDEX (CPI) is an index of the average household’s purchase of
goods and services most commonly used in western countries to measure inflation
(excludes housing costs, see RPI).
CONSUMER SOVEREIGNTY exist where consumers, by their spending, ultimately
determines which goods and services will be produced in an economy.
CONSUMER SURPLUS is the difference between the amount a consumer is willing to
pay for a commodity and the amount that is actually paid.
CONSUMPTION is the process of using up goods and services.
CONSUMPTION FUNCTION expresses the relationship between the amount consumed
and disposable income.
CONSUMPTION GOODS are goods bought by households to use up.
CONTESTABLE MARKETS refers to markets where entry and exit is free, thereby
allowing greater competition in an industry.
COST-BENEFIT ANALYSIS refers to the process of putting a monetary value on the
total costs and total benefits of an economic activity, and then weighing them up to
make a decision. A major problem in economics is “how do you place a monetary value
on the social or external costs and benefits of an economic activity?”
COST-PUSH INFLATION refers to the sustained increase in the general price level
resulting from increased cost in the inputs of the factors of production.
COUNTER-CYCLICAL POLICY is the use of expansionary and contractionary monetary
and fiscal policies to offset wide fluctuations in economic activity.
COUNTER-PRODUCTIVE ECONOMIC ADVICE refers to advice, or terms, imposed on a
country by an international financial institution that the government of the country
believes is not in the country best economic interest. Often used in relation to IMF
loans granted to LDCs.
CREEPING INFLATION refers to a sustained low rate of increase in the general price
level. Considered not only acceptable but also good for an economy.
CROSS-PRICE ELASTICITY OF DEMAND (CPED) is a measure of the responsiveness in
quantity demanded of one good/service to the change in price of a related
good/service.
CROWDING IN refers to the likelihood of a decrease in a government’s expenditure on
goods and services will result in a reduction in interest rates, thereby crowding in
private investment because firm’s borrowing costs are lower.
CROWDING OUT refers to the likelihood of an increase in a government’s expenditure
on goods and services will result in an increase in interest rates, thereby crowding out
private investment because firm’s borrowing costs are higher.
CRUDE BIRTH RATE is the number of births per year per 1,000 population.
CRUDE DEATH RATE is the number of deaths per year per 1,000 population.
CURRENCY TRADER is a person or organization which deals/trades in one or more
currencies. They are engaged in speculative foreign exchange transactions, which
account for the majority of all currency dealings.
CURRENT ACCOUNT is that part of the balance of payments which records the
transactions of goods/visible items and services/invisible items. Used as a measure to
determine how healthy a country’s external account is.
CURRENT ACCOUNT BALANCE refers to whether the current account is in surplus or
deficit.
CURRENT ACCOUNT BALANCE TO GDP (%) expresses the relationship in percentage
terms between the current account balance and GDP. It is a measure of both the
importance and health of a country’s external account.
CURRENT ACCOUNT DEFICIT exists where imports of goods and services exceed their
exports. Persistent deficits are a major problem for a country - particularly LDCs -
because they indicate that the country is living beyond its means. To overcome this, a
country has to increase its borrowings on its BOP capital account.
CURRENT ACCOUNT SURPLUS exists where exports of goods and services exceed their
imports. Indicates a healthy external account, and a healthy economy.
CUSTOMS UNION is a unification of two or more countries of their customs and trade
policies.
CYCLICAL UNEPLOYMENT is unemployment resulting from a downturn in the business
cycle resulting in a recession. Occurs when total demand is insufficient to create full
employment.
D
DEATH-RATE is the number of deaths per 1,000 population.
DEBT-SERVICING refers to the ability of an organization and/or country to meet
interest and principal payments on its debts/borrowings as and when they fall due.
Often represents a major external account problem for LDCs.
DECREASING RETURN TO SCALE occurs when an increase in a firms’ inputs results in a
less than proportional increase in its output.
DEFAULT ON LOANS exists when an organization or country fails to repay its
borrowings on the due date.
DEFICIT SPENDING exists when a government’s spending exceeds its tax revenues.
DEFLATE refers to government action to reduce aggregate demand through fiscal
and/or monetary measures.
DEFLATION is a sustained decrease in the general price level. Often accompanied by a
fall in total output and an increase in unemployment.
DEMAND is the relationship between the quantity demanded of a good or service and
its price.
DEMAND-DEFICIENT (CYCLICAL) UNEMPLOYMENT occurs as a result of a fall in
aggregate demand for goods and services. This leads to a decline in the demand for
labour. It is one of the two types of disequilibrium unemployment.
DEMAND CURVE shows the relationship between the quantity of a good or service and
its price, holding all else constant. Shown on a graph/diagram.
DEMAND SCHEDULE lists the quantities of a good or service and its price, holding all
else constant.
DEMAND-PULL INFLATION is a sustained increase in the general price level resulting
from an increase in aggregate demand.
DEMERIT GOOD is a good or service that is socially undesirable. It is the opposite of a
merit good.
DEPENDENCY RATIO is the percentage of the population under aged 15 years and 65
plus years. Refers to the fact that these people generally do not pay tax and are
dependent upon the economic activity of others.
DEPRECIATION OF CAPITAL is the reduction in the value of capital goods over a year
due to obsolescence and wear and tear.
DEPRECIATION OF CURRENCY is the reduction in the value of a domestic currency
against foreign currencies under a regime of floating exchange rates.
DERVIVED DEMAND is when the demand for the final product produced results in an
increase in the demand for inputs of the factors of production.
DEVALUATION is a fall in the value of a currency operating under a fixed exchange
rate system. Results from government action.
DEVALUE is to lower the value of a currency operating under a fixed exchange rate
system. Results from government action.
DEVELOPMENT is a process that improves the lives, or standard of living, of all people
in a country. Includes both tangible and intangible factors.
DEVELOPMENT INDICATORS are measures - such as literacy, malnutrition and the
poverty level - that indicate a country’s level of economic development.
DIMINISHING OR MARGINAL RETURNS occurs at the point when continual increases in
a variable factor of production applied to a fixed factor of production results in a less
than proportional increase in output.
DIRECT TAX is a tax imposed by governments directly on an individual or organization.
Most commonly applied on personal income and company profits.
DIRTY OR MANAGED FLOAT exists when a government intervenes in the managed float
of its currency. It creates an artificial value or price of the currency, and is generally
unsustainable in the long term.
DISECONOMIES OF SCALE exists when an increases in output leads to increases in
long-run average costs.
DISGUISED UNEMPLOYMENT exists in the workplace where labour produces very little
output, their marginal product is very low and inefficiency is high. In short, too many
workers are employed for a given task. Examples exist in many of China’s State Owned
Enterprises.
DISTRIBUTION OF INCOME refers to the way in which income is distributed among the
population.
DIVISION OF LABOUR is the segregation of the factor of production – labour – into
different tasks. Occurs in most organizations.
DOHA ROUND OF TRADE NEGOTIATIONS refers to the WTO round of negotiations of
members aimed at reductions in trade restrictions. It began in 2001 and was due to be
completed in 2004, but has been extended.
DOMINANT PRICE LEADER refers to the market leader in an industry that is usually the
first to change prices.
DOUBLE COUNTING exists when expenditure is counted on both intermediate and final
goods and services. It is avoided in the preparation of national accounts.
DUAL ECONOMY is the existence of two distinct types of economies, operating side-
by-side.
DUMPING is when the price of a country’s exports is below the true costs of
production.
DUOPOLY is a market structure where there are only two sellers in a market and
interdependence plays a major role in price determination.
DURABLE CONSUMER GOODS are goods used by consumers that have a life span of
more than one year.
DUTIES are a form of protectionism. They are levies imposed by governments on
imports. Result in increased consumer prices and less competition in the marketplace.
E
ECONOMIC DEVELOPMENT occurs in a country when there is an increase in Real GDP
per capita plus an improvement in the standard of living. It is one of the five major
macroeconomic objectives.
ECONOMIC EFFICIENCY occurs when society is producing the goods and services most
valued by society. Occurs outside firms.
ECONOMIC GOOD is any good or service that is scarce.
ECONOMIC GROWTH is an increase in a country’s Real GDP per capita. It is one of the
five major macroeconomic objectives.
ECONOMIC PROBLEM is one of relative scarcity of resources relative to unlimited
human wants.
ECONOMIC PROFIT is the extra profit a firm earns over the combination of accounting
profit and normal profit. Also referred to a supernormal profit.
ECONOMIC REFORMS refers to changes - usually resulting in improvements - to a
country’s economic systems.
ECONOMIC STRUCTURE refers to the classification of a country’s output produced by
sectors of the economy-usually, primary, secondary and tertiary sectors.
ECONOMIC SYSTEM refers to the system that guides the use of resources to satisfy
human wants.
ECONOMIC THEORY is a principle or rule that allows us to understand and predict
economic choices.
ECONOMICS is the study of how people/societies use their scarce resources to satisfy
unlimited wants.
ECONOMIES OF SCALE occurs when increasing the scale of production leads to a lower
cost per unit of output.
EFFICIENCY is concerned with how well scarce resources are allocated to solve the
three problems of what to produce, how to produce, and for whom production should
take place.
ELASTICITY is a measure of the responsiveness of one variable to the change in
another variable.
EMBARGO is a total ban on trade. It is one of the forms of protectionism. It may be
imposed by a domestic government or from outside the country. An example of the
former is an embargo on drugs.
EMPLOYMENT refers to the paid utilisation of the factor of production-labour.
EMU refers to the European Monetary Union, a group of countries that use the single
currency -the Euro.
ENERGY CONSUMPTION PER CAPITA is the amount of energy consumed divided by the
total population.
ENTERPRISE is a key factor of production and is the reward derived from combining
the other three factors - land, labour and capital - to produce goods and services.
ENVIRONMENTAL DEGRADATION is a deterioration in the environment through, for
example, pollution and deforestation. Major problem largely ignored by many world
leaders.
EQUATION OF EXCHANGE is expressed as formula M x V = P X Q.
EQUILIBRIUM is a situation where demand equals supply at a given price and the
market clears.
EU refers to the European Union, a group of countries that have formed a trading bloc.
EURO is the official currency of the majority - but not all - of members of the EU.
EUROCURRENCY is the official currency of the majority - but not all - of members of
the EU.
EUROPEAN MONETARY SYSTEM (EMS) refers to the agreement whereby EU members
promoted exchange rate stability within the EU before the introduction of the Euro.
EXCHANGE is the act of trading goods and services between countries for their mutual
economic benefit.
EXCHANGE RATE is the price of a currency expressed against another, or group of
currencies, on the foreign exchange market.
EXCHANGE RATE THEORY refers to the economic theory of managing an exchange
rate.
EXPANDING DOWNSTREAM refers to a situation where a company expands its
operations away from the market towards the original source of raw materials.
EXPENDITURE-REDUCING POLICIES are contractionary macroeconomic policies
designed to reduce incomes and thus expenditure.
EXPENDITURE-SWITCHING POLICIES are policies which a designed to reduce spending
on imports and lead to an increase in spending on domestically produced goods and
services and exports.
EXPORTS are goods and services sold by one country to another.
EXPORTS AS % OF GDP expresses the relationship, in percentage terms, between
exports and GDP.
EXTERNAL BALANCE refers to a country’s balance of payments on current account.
That is, whether it is in surplus or deficit. Related to the key macroeconomic
objective of external equilibrium.
EXTERNAL DEBT is the amount of money owed by a country to the rest of the world.
EXTERNAL EQUILIBRIUM is concerned with the balance of payments on current
account of a country. That is, whether it is in balance, surplus or deficit. It is one of
the five major macroeconomic objectives. The attainment of balance over a period of
time is an indication that a country can pay its way in the world. Persistent deficits – a
major problem for many LDCs - obviously indicates that a country is living beyond its
means.
EXTERNAL SHOCK relates to an unexpected shift in aggregate demand and/or
aggregate supply.
EXTERNALITY is an effect of production or consumption that is not taken into account
by producers or consumers that affects the utility or costs of other producers or
consumers.
F
FACTORS OF PRODUCTION refers to the scarce resources - land, labour, capital and
enterprise - used to produce economic goods and services.
FARM SUBSIDIES are payments by governments to agricultural producers. These
subsidies by the USA, EU and Japan are a major reason for the failure of the Doha
Round of Free Trade negotiations.
FEMALE ILLITERACY is the percentage of females in a population who cannot read and
write.
FERTILITY RATE is the average number of children born to each female in a country.
FINANCIAL MARKETS are markets which savings pass through to firms and
governments for investment purposes.
FIRM is an organization that utilises the factors of production to produce and sell
goods and services.
FISCAL DEFICIT AS % OF GDP expresses the relationship in percentage terms
between the budget deficit and GDP. It is an indicator of the internal health of an
economy - the higher the %, the “sicker” the economy.
FISCAL DEFICIT exists where government expenditure exceeds its tax revenues.
FISCAL POLICY refers to the government’s policy on taxation (direct and indirect),
government expenditure and transfer payments and their affect on aggregate demand
and aggregate supply.
FISCAL SURPLUS exists where government tax revenues exceed its expenditure.
FIXED COSTS (FC) refer to those costs that do not vary with output in the short run. In
the long run, all costs are variable.
FIXED EXCHANGE RATE exists where the price of one currency against another is fixed
on the foreign exchange market. Currently, this is the situation with the Chinese Yuan
to the US$.
FIXED INVESTMENT refers to purchases of capital goods.
FLOATING EXCHANGE RATE is one where the price of one currency against another is
determined by market forces on the foreign exchange market.
FLOOR PRICE, or minimum price, is a price imposed above the market equilibrium
price. It is designed to assist producers.
FOREIGN AID refers to assistance to a country from private sources or public bodies
from outside a country. For LDCs, it is a major source of financing BOP current account
deficits.
FOREIGN DIRECT INVESTMENT (FDI) refers to the investment by overseas firms in
another country. Majority is undertaken by MNCs.
FOREIGN EXCHANGE MARKET refers to the institutions through which currencies are
traded on the open market.
FREE ENTERPRISE is the system that allows individuals and firms to obtain scarce
resources, organise them, and sell goods and services without major government
interference.
FREE GOOD is any good or service that is abundant.
FREE RIDER is someone that consumes a good or service without paying for it.
FREE TRADE is the movement of goods and services without protectionist barriers.
FREE TRADE AGREEMENT is an agreement that allows the movement of goods and
services without protectionist barriers between two or more countries.
FREE TRADE AREA refers to a group of countries (two or more) that engage in the
movement of goods and services without protectionist barriers.
FREELY FLOATING EXCHANGE RATE is one where the price of one currency against
another is determined by market forces on the foreign exchange market.
FRICTIONAL UNEMPLOYMENT refers to unemployment caused by new entrants into
the market, technological change and geographic movement of workers.
FULL EMPLOYMENT exists when the labour market clears allowing for structural,
seasonal and frictional unemployment. Also known as the natural rate of
unemployment. It is one of the five major macroeconomic objectives.
G
GDP IMPLICIT PRICE DEFLATOR is an index that measures the changes in prices of all
goods and services produced by an economy.
GDP PER CAPITA is the gross domestic product divided by the total population.
GIFFEN GOODS refers to goods where the income effect of a price change of inferior
goods is greater than the substitution effect. Many economists dispute this claim.
GINI COEFFICIENT is a way of showing income inequality by converting the Lorenz
curve into a single statistic.
GLOBALISATION is a process of breaking the down barriers between countries
resulting in greater integration and interdependence. Since the 1980s, largely brought
about through massive technological changes in communications and information.
GLOBALISED ECONOMY is the movement, through globalisation, to a borderless world
economy.
GLUT is an excess of supply of a good or service over demand at the equilibrium price.
GNI (GROSS NATIONAL INCOME) is the sum of all the incomes within a country
allowing for net property income from abroad.
GNI PER CAPITA is gross national income divided by the total population.
GROSS DOMESTIC PRODUCT (GDP) is the value of a country’s total output of goods
and services before depreciation.
GROSS NATIONAL SAVINGS AS A % OF GDP expresses the relationship in percentage
terms between gross national savings and GDP. For investment to occur, savings must
first take place. Therefore, the higher the % of gross national savings to GDP the
greater will be future total output.
GROWTH IN INVESTMENT refers to the increase - usually expressed in percentage
terms - in investment that is a precursor to increased total output and employment.
GROWTH IN OUTPUT refers to the increase-usually expressed in percentage terms-in
the value of a country’s total output in goods and services.
H
HARD LOAN is a loan with commercial rates of interest and terms of repayment.
HARROD-DOMAR GROWTH MODEL refers to a model of growth, which focuses on the
constraint in growth caused by shortage of capital in LDCs.
HIDDEN UNEMPLOYMENT exists in a firm where too many people are employed
resulting in many employees producing very little. Inefficiency is high. Also known as
disguised unemployment.
HUMAN CAPITAL is the investment that takes place in the factor of production –
labour - aimed to increase productivity, well-being and job satisfaction. Occurs
through the investment in education and training of people.
HUMAN DEVELOPMENT INDEX (HDI) (a UN measure) measures the average
achievement of a country in three dimensions of human development - life expectancy
at birth, adult literacy rate, and purchasing power through GDP per capita (PPP US$).
The maximum level is 1.
HUMAN SUFFERING INDEX (HSI) is an index of ten indicators of human well-being.
Used to rank countries and make comparisons.
HYPER-INFLATION is an excessive sustained increase in the general price level. Very
damaging to an economy as it results, for example, in domestic goods and services
being non-competitive in international markets.
I
ILLITERACY is the percentage of the population who cannot read and write.
IMPERFECT COMPETITION refers to the many market structures that fall between the
two extremes of perfect competition and pure monopoly.
IMPORT SUBSTITUTION is increasing domestic production of goods and services to
replace imports. Process adopted by many LDCs in an attempt to industrialise.
IMPORTS are the purchase of goods and services from another country.
INCOME ELASTICITY OF DEMAND (YED) is the responsiveness of the quantity
demanded of a good or service to a change in income. Important tool used by
businesses and governments in their decision making process.
INCOME INEQUALITIES refers to the gap in incomes between high, middle and low
income-earners. Statistics indicate that the gap is widening, rather than narrowing, in
most countries.
INCREASING RETURNS TO SCALE occurs when output increases more than
proportionally to the increase in inputs.
INDIRECT TAX is a tax imposed by government directly on spending. Examples include:
GST, payroll tax, sales tax, land tax, stamp duty paid on the purchase of a property.
INFANT INDUSTRY ARGUMENT refers to the argument for governments to protect
newly established industries from foreign competition, to enable them to grow
domestically and internationally.
INFANT MORTALITY RATE is the number of live-born infants who die before one year
old per 1,000 of the population.
INFERIOR GOOD is a good for which consumption falls as income rises.
INFLATION is a sustained increase in the general price level. Measured by the
Consumer/Retail Price Index.
INFRASTRUCTURE is the basic physical systems of a country's or community's
population, including roads, utilities, water, sewage. These systems are considered
essential for enabling productivity in the economy. Developing infrastructure often
requires large initial investment, but the economies of scale tend to be significant.
INTEREST is the cost of borrowing money or return received for money lent. Also, the
return paid to the owners of capital.
INTEREST RATE is the price paid or received for borrowing or lending money.
INTEREST RATE DIFFERENTIAL refers to the difference in Central Bank interest rates
between countries.
INTERNAL BALANCE refers to the state of the government’s fiscal budget.
INTERNATIONAL INDEBTEDNESS is the amount of borrowings a country has obtained
from overseas. Major problem for LDCs.
INTERNATIONAL MONETARY FUND (IMF) is now primarily involved in arranging credit
and providing mainly macroeconomic advice to LDCs. Often accused by LDCs as being
interfering in their internal affairs as credit provided often comes with stringent
conditions which have political and social consequences for borrowing governments.
INVESTMENT is expenditure on investment in goods and services or capital creation.
INVESTMENT LOANS refer to World Bank loans that are long term, 5 to 10 years, and
are used to finance specific projects involving goods, services and works in poor
countries.
INVISIBLE BALANCE refers to the balance of all items on the balance of payments of
current account, except for the exports and imports of goods.
J
J-CURVE EFFECT refers to the way and the time frame in which the trade balance
may initially worsen before it improves, after a depreciation of the exchange rate.
K
KEYNESIAN THEORY advocates government intervention due to the inherently
unstable nature of the economy. Favours fiscal policy measures rather than monetary
policy measures to correct macroeconomic problems in the economy.
KINKED DEMAND CURVE is a pricing model in an oligopolistic market structure. Rivals
follows one firm’s decision to decrease their price, but not to increase their price, of a
good or service.
KUZNETS RATIO refers to the percentage of income earned by the bottom 40%
expressed as a ratio of income earned by the top 20%.

L
LABOUR is one of the four factors of production. Refers to human resources involved
in productive contributions to the economy.
LABOUR FORCE is the number of people who have jobs plus those who are
unemployed.
LABOUR PRODUCTIVITY is the output per unit of labour input.
LAFFER CURVE refers to a graphical representation of the relationship between tax
rates and total revenues raised by taxation. The curve illustrates that higher tax rates
will generate a lower tax revenue for government but the supply side incentive of
lower tax rates will incentivize entrepreneurs to earn more, and also to create jobs for
others who will also pay more tax to the treasury.
LAISSEZ-FAIRE is a viewpoint that advocates non-government intervention in an
economy.
LAND is one of the four factors of production. Refers to all natural resources.
LAW OF DIMISHING OR MARGINAL RETURNS advocates that, at some point, continual
increases in a variable factor of production applied to a fixed factor of production will
result in a less than proportional increase in output.
LESS DEVELOPED COUNTRY (LDC) refers to countries with a low standard of living,
such that many people do not have the basic necessities of life such as adequate food,
water, clothing, heath and education.
LIFE EXPECTANCY is the average number of years a person is expected to live. It is
one indicator of the level of economic development of a country.
LIVING BELOW THE POVERTY LINE refers to the percentage of the population living
on less than US$1 per day. This is the World Bank definition. It is one indicator of the
level of economic development of a country.
LONG RUN is the time period when all factors of production are variable.
LONG-RUN AGGREGATE SUPPLY (LRAS) is the relationship between Real GDP and the
Price Level at full employment. Unemployment is at its natural rate.
LONG-RUN AVERAGE COST CURVE represents the cheapest way to produce goods and
services. It is derived by joining the minimum point of the various SRAC curves.
LONG-RUN PHILLIPS CURVE shows the relationship between inflation and
unemployment when the actual rate of inflation equals the expected rate of inflation.
LONG-RUN SUPPLY CURVE describes the response of the quantity supplied to a change
in price after all technology adjustments have been made.
LORENZ CURVE measures income inequality within the population.
LOW-INCOME HOUSEHOLDS refers to households where the basic necessities of life
cannot be met. Covers approximately 3 billion of the world’s population.
M
MACROECONOMIC EQUILIBRIUM occurs where the quantity of Real GDP demanded and
supplied meet. It is where AD = SRAS.
MACROECONOMIC OBJECTIVES refers to the five key macroeconomic issues that are
of concern to governments: economic growth, economic development, full
employment, price stability, and external equilibrium.
MACROECONOMICS is the study of the whole economy.
MALE ILLITERACY refers to the number or percentage of males who cannot read or
write.
MANAGED EXCHANGE RATES is a system of exchange rates where governments
intervene to influence the price of their currency.
MARGINAL COST (MC) is the change in total cost for the last unit increase in the
variable input.
MARGINAL COST PRICING is a system of pricing in which the price charged is equal to
the opportunity cost to society of producing one more unit of good or service.
MARGINAL PRIVATE COST (MPC) is the marginal cost directly incurred by producers.
MARGINAL PROPENSITY TO CONSUME (MPC) is the ratio of the change in consumption
to the change in disposable income.
MARGINAL PROPENSITY TO CONSUME DOMESTIC (MPCd) is the proportion of an
increase in disposable income that is spent on domestic goods and services.
MARGINAL PROPENSITY TO IMPORT (MPM) is the proportion of an increase in
disposable income that is spent on imports.
MARGINAL PROPENSITY TO SAVE (MPS) is the ratio of the change in savings to the
change in disposable income.
MARGINAL REVENUE (MR) is the change in total revenue resulting from selling one
more unit.
MARGINAL SOCIAL BENEFIT (MSB) is the total value of the benefit from one additional
unit of consumption. It includes benefits to the buyer plus any indirect benefits to
society.
MARGINAL SOCIAL COST (MSC) is the total cost of producing one additional unit of
output. This includes costs borne by the producer plus any indirect costs borne by
society.
MARGINAL TAX RATE is applied to the last tax bracket of taxable income. It is the
percentage of extra income that must be paid in taxes.
MARKET ECONOMIC SYSTEM refers to a system where individuals, rather than
governments, own the factors of production and decide what, how and when to
produce.
MARKET ECONOMY refers to an economy where individuals, rather than governments,
own the factors of production and decide what, how and when to produce.
MARKET EQUILIBRIUM PRICE is the clearing price where the demand curve and supply
curve intersect.
MARKET EXCHANGE RATE refers to the price of a currency determined by the market
forces of demand and supply of a currency.
MARKET FAILURE occurs where markets do not work at all or do not work well. It
refers to the failure of the price mechanism to achieve an optimum allocation of
resources.
MARKET POWER refers to a market structure where a high degree of producer
sovereignty exists.
MARKET SHARE is the percentage of the total market or market segment captured by
a producer.
MARKET STRUCTURE is primarily classified by the degree of competition that exists in
the market. Structures range from perfect competition through to monopoly.
MARSHALL-LERNER CONDITION states that if the PEDx + PEDm > 1, then a
depreciation of the exchange rate will improve the balance of payments. If the PEDx +
PEDm = 1, then the BOP will remain unchanged. If the PEDx + PEDm <1, then a
depreciation will worsen the BOP.
MAXIMUM or CEILING PRICE is a price imposed below the market equilibrium price. It
is designed to help consumers by making the price cheaper.
MERCANTILISM is increasing a nation's wealth by government regulation of all of the
nation's commercial interests.
MERCHANDISE EXPORTS are the visible goods one country sells to another.
MERCOSUR refers to a free trade area formed by major South American countries,
such as Brazil and Argentina.
MERGER is the joining of two entities.
MERIT GOOD is a good that is socially desirable. It has positive externalities and will
often be underprovided in a free market.
MICRO-LENDING refers to the lending of very small amount of money to private small
businesses. It is has the potential to be an important source of funding in LDCs.
MICROCREDIT refers to the provision of a credit facility or lending of very small
amount of money to private small businesses. It has the potential to be an important
source of funding in LDCs.
MICROECONOMICS is the study of the behaviour of households and firms and how the
prices of goods and services are determined.
MIDDLE-INCOME DEVELOPING COUNTRIES have a higher standard of living compared
with low-income countries, but still there are many people who still cannot meet their
basic needs.
MINIMUM BASIC LIVING STANDARD refers to being able to satisfy the basic necessities
of life, such a food, clothing, water, shelter, education and health care.
MINIMUM or FLOOR PRICE is a price imposed above the market equilibrium price. It is
designed to assist producers.
MINIMUM WAGE LAW is a regulation that makes it illegal to hire labour below a
specified wage.
MIXED ECONOMY refers to an economic system in which the economic decisions
regarding the allocation of scarce resources is partly determined by the private sector
and partly by the government.
MODELS or THEORIES are simplified representations of the real world.
MONETARIST is an economist who assigns a high degree of importance to variations in
the money supply as the main determinant of aggregate demand.
MONETARY POLICY refers to changes in the money supply and interest rates to affect
aggregate demand and aggregate supply. In most countries, these policy decisions are
made by the Central Bank. In some countries, such as China, Myanmar and North Korea
these policy decisions are made by the government; consequently, monetary policy
and fiscal policy are controlled by governments - not at good situation.
MONETARY UNION refers to the replacement of the currencies of the majority
members of the EU with a single currency, the Euro.
MONEY is a medium of exchange.
MONOPOLIST is a single supplier that supplies the whole industry.
MONOPOLISTIC COMPETITION is a type of market structure in which a large number of
firms compete with similar items.
MONOPOLY is a type of market structure where there is a single supplier that supplies
the whole industry.
MONOPOLY POWER exists where producer sovereignty is maximized.
MONOPSONY refers to a single buyer of a good or service. Such an entity exerts very
significant market power.
MOST DEVELOPED COUNTRY (MDC) refers to a country where its people have the
basic necessities of life, plus the majority of people have money for luxuries. A
country that has a high level of economic development - Real GDP per capital plus a
high standard of living.
MULTILATERAL FREE TRADE AGREEMENT is a free trade agreement entered into by
three or more countries.
MULTINATIONAL COMPANIES/CORPORATIONS (MNC) refers to companies that have
production units in more than one foreign country (also known as TNCs).
MULTIPLIER is the change in equilibrium Real GDP divided by the change in
autonomous expenditure, which causes Real GDP to change. K = how much the AD
shifts left or right in response to a change in income or spending.
N
NAFTA refers to North American Free Trade Agreement. Member countries include the
USA, Canada and Mexico.
NATIONAL DEBT is the central government debt.
NATIONAL INCOME is the value of the goods and services available to a country during
a year.
NATIONALISATION is the government act of placing a privately owned company under
public ownership.
NATURAL MONOPOLY occurs when a monopoly can supply the entire market at a
lower price than two or more smaller firms.
NATURAL RATE OF UNEMPLOYMENT is the unemployment rate when the economy is
at full employment and the labour market clears. It includes any frictional, seasonal
and structural unemployment.
NATURAL RESOURCES refer to the factors of production that are not man-made.
NEGATIVE EXTERNALITY is a market activity that negatively affects other people. It is
a form of market failure.
NEGATIVE TAX is effectively a subsidy paid by the government.
NET IMPORTER OF FOREIGN DIRECT INVESTMENT refers to a country that imports
more investment than it exports.
NET INVESTMENT is the net additions to the capital stock-gross investment minus
depreciation.
NET NATIONAL PRODUCT (NNP) is GNP minus depreciation.
NEWLY INDUSTRIALISED COUNTRIES (NICS) refers to a small group of countries with
advanced industrial, financial and services sectors in their economy. Examples include:
Hong Kong, Singapore, South Korea, Greece and Mexico.
NOMINAL GDP is the output of final goods and services valued at current prices.
NOMINAL INTEREST RATE is the price or borrowing or lending money at current
prices.
NOMINAL VALUES refer to the value of variables expressed in current prices.
NON-GOVERNMENT ORGANISATIONS (NGO) refers to organizations that are not
government bodies. They are involved in unofficial aid programmes in LDCs - e.g. the
Red Cross and Oxfam.
NON-PRICE COMPETITION generally refers to the branding and advertising of
products/services to increase sales, market share and profits by firms, without having
to engage in price competition.
NON-RENEWABLE NATURAL RESOURCES refers to natural resources that can only be
used once.
NORMAL GOOD is a good or services for which demand increases when income
increases.
NORMAL PROFIT refers to the opportunity cost of capital.
NORMATIVE STATEMENT is an expression of opinion that cannot be verified by
observation or statistical fact.
O
OECD is the Organization for Economic Co-operation and Development.
OFFICIAL DEVELOPMENT ASSISTANCE (ODA) is aid transferred by public bodies.
Divided into bilateral aid and multilateral aid.
OFFICIAL RESERVES refers to governments’ holdings, in the vaults of their Central
Bank, of gold, securities and foreign currencies.
OLIGOPOLY is a type of market structure in which a small number of producers
compete with each other.
OPEC is the Organization of Petroleum Exporting Countries. It is an oil cartel. Sets
production quotas.
OPEN ECONOMY is an economy that has economic links with other economies.
OPPORTUNITY COST is the cost of any economic activity measured in terms of the
best alternative that is foregone. When the best alternative is chosen from a range of
alternatives, the second best choice is the opportunity cost. It is one of the most
important economic principles.
OUTSOURCING refers to the transfer of the manufacturing of a good or performing of
a service from within the firm to outside the firm. For example, many IT services are
being transferred from firms in Western countries to India, because of India’s
comparative advantage and it can perform these functions at a substantially lower
cost.
OVER-CONSUMPTION exists where consumption of a good or service exceeds its
available long-term supply. Clean water, a very scarce resource in the 21st Century,
used for drinking, cooking and sanitation is a good example in LDCs.
OVER-VALUED CURRENCY refers to any currency whose price is set by a government
above the free market equilibrium rate. The Myanmar Kyat is a good example. The
Argentina Peso until its devaluation in January 2002 is another example.
P
PARADOX OF THRIFT refers to an increased desire to save-an increase in MPS that
leads to a reduction in the equilibrium level of saving.
PEGGED CURRENCY exists where the price of one currency is fixed to another.
PERFECT COMPETITION is a market structure in which the decisions of buyers and
sellers have no effect on the market price. It is a structure where consumer
sovereignty is maximised.
PERFECTLY ELASTIC DEMAND is demand with an elasticity of infinity.
PERFECTLY ELASTIC SUPPLY is supply with an elasticity of infinity.
PERFECTLY INELASTIC DEMAND is demand with an elasticity of zero.
PERFECTLY INELASTIC SUPPLY is supply with an elasticity of zero.
PERSISTENT BOP CURRENT ACCOUNT DEFICITS refers to a country that has sustained
deficits on its current account. It is indicative of poor financial health of its external
account, and failure to achieve one of the five key macroeconomic objectives. Has an
impact on the other four macroeconomic objectives.
PHILLIPS CURVE shows the trade-off between unemployment and inflation.
POPULATION DOUBLING TIME is the number of years it will take for a population to
double, assuming a constant rate of increase.
POPULATION GROWTH RATE is the percentage increase in population in a year.
POPULATION--RATE OF NATURAL INCREASE is the birth rate minus the death rate
expressed as a percentage, ignoring net migration.
POSITIVE EXTERNALITIES refer to activities external to the market that affect other
people in a positive way.
POSITIVE STATEMENT is an expression that can be verified by observation and/or
fact.
POVERTY refers to those members of society who cannot enjoy the basic necessities
of life. There are two types of poverty: absolute and relative.
PRESENT VALUE OF DEBT/EXPORTS expresses the ratio of the present value of a
country’s debt to its exports. As exports are the means without borrowing to repay
external debt, this ratio indicates a country’s ability to meet its external debt
commitments.
PRICE CEILING is a price imposed below the market equilibrium price.
PRICE CONTROL refers to a government regulation of free market prices.
PRICE DIFFERENTIATION is a situation in which price differences for similar products
reflect only the marginal cost in providing those goods and services to different groups
of buyers.
PRICE DISCRIMINATION is the practice of charging a higher price to some customers
and not others for an identical good or service when there is no difference in cost.
PRICE ELASTICITY OF DEMAND (PED) is the responsiveness of quantity demanded of a
good or service to a change in its price.
PRICE ELASTICITY OF SUPPLY (PES) is the responsiveness of quantity supplied of a
good or service to a change in its price.
PRICE FIXING occurs when individuals or firms collude to set the price of a good or
service above the market price. It is illegal in most countries.
PRICE INDEX is a measure of the level of prices in one period expressed as a
percentage of their level in another period.
PRICE LEVEL is the average level of prices as measured by a price index.
PRICE STABILITY is one the five key macroeconomic objectives. It is used as an
indicator of the economic health of an economy. Price stability impacts on the other
four macroeconomic objectives.
PRICE TAKER is a firm that cannot influence the price of its output. Exists for firms,
for example, that operate in a perfectly competitive market structure.
PRICES AND INCOME POLICY is government policies that restrict the increase of prices
and incomes in order to achieve price stability.
PRIMARY HEALTH CARE refers to the provision of health services based upon
preventing, rather than curing, diseases. For example, providing clean water and
immunization.
PRIMARY PRODUCTION is that sector of the economy engaged in producing goods that
can be found in, or depend upon, nature.
PRIMARY SCHOOL ENROLEMENT RATE is the percentage of children of primary school
age that attend primary school.
PRIVATE DEBT refers to the external debt of a country provided by private
sources/firms.
PRIVATE GOOD is a good or service consumed by only one person.
PRIVATE INVESTMENT is investment by firms/individuals.
PRIVATIZATION is the process of selling a public corporation to private shareholders.
PRODUCER SURPLUS is the difference between a producer’s total revenue and the
opportunity cost of production.
PRODUCT DIFFERENTIATION refers to real and/or perceived slight differences in a
good or service.
PRODUCTION involves the conversion of natural, human and capital resources into
goods and services.
PRODUCTION FUNCTION shows the relationship between how output varies when the
employment of inputs changes.
PRODUCTION POSSIBILITY CURVE (PPC) refers to the boundary between attainable
and unattainable levels of production.
PRODUCTION POSSIBILITY FRONTIER (PPF) refers to the boundary between attainable
and unattainable levels of production.
PRODUCTION QUOTAS are restrictions on the amount of production. A topical
example is the OPEC production quotas.
PRODUCTIVE EFFICIENCY occurs within a firm. It exists when they are producing
output with the minimum amount of inputs. The incentive for a firm to achieve this is
the profit motive. Also known as technical efficiency.
PRODUCTIVTY is the increase in output per unit of input.
PROGRESSIVE INCOME TAX is where the marginal rate of tax applied is greater than
the average tax rate as incomes increase.
PROPORTIONAL INCOME TAX is where the average and marginal tax rates are the
same, regardless of income levels.
PROTECTIONISM is the restriction of international free trade by governments.
Measures include quotas, tariffs, embargoes and import duties.
PROTECTIONIST BARRIERS refers to the government establishing any form of
restriction on the free trade of goods and services. They can include measure such as
tariffs through to administrative and health constraints.
PUBLIC GOOD is a good or service that is non-excludable and non-rivalrous.
PURCHASING POWER PARITY (PPP) exists where money has equal value across
countries.
Q
QUANTITY DEMANDED is the amount of a good or service that consumers plan to buy
at each price in a given period of time.
QUANTITY OF LABOUR DEMANDED is the number of labour hours hired by all firms in
an economy.
QUANTITY OF LABOUR SUPPLIED is the number of hours of labour services that
households supply to firms.
QUANTITY SUPPLIED is the amount of a good or service that producers plan to sell at
each price in a given period of time.
QUANTITY THEORY OF MONEY states that an increase in the quantity of money will
lead to an equal percentage increase in the price level.
QUOTAS are restrictions on the quantity of a good or service that a firm is permitted
to sell or that a country is permitted to import.
R
REAL EXCHANGE RATE refers to the price of a currency against another after
discounting for inflation.
REAL GDP is the nominal value of output of final goods and services discounted by the
increase in the price level.
REAL INCOME is nominal income discounted by the increase in the price level
(inflation).
REAL INTEREST RATE is nominal interest rate discounted by the increase in the price
level (inflation).
RECESSION is a decline in Real GDP in two or more successive quarters.
REFLATION refers to the use of tax cuts, increased government expenditure and
easier monetary policy to increase aggregate demand, aggregate supply and
employment.
REGIONAL TRADING BLOC refers to regionally-based economies forming a free trade
area. For example, ASEAN and NAFTA.
REGRESSIVE INCOME TAX is where the marginal rate of tax is lower than the average
tax rate as income increases.
RELATIVE POVERTY exists where a proportion of the population in a country cannot
enjoy the standard of living normal to their society. This type of poverty will always
exist where there is any substantial degree of income and asset inequality within a
given society.
RELATIVE SCARSITY refers to a situation where there is not enough of one scarce
resource compared to another. For example, Singapore has a relative scarcity of land
compared to capital.
RESOURCE ALLOCATION is the assignment of scarce resources to specific uses. That
is, deciding the questions of what will be produced, how and when?
RESOURCES are the factors of production.
RETAIL PRICE INDEX (RPI) measures the average level of the prices of a basket of
goods and services consumed by the typical household (includes housing costs, see
CPI).
RETURNS TO SCALE refers to increases in output that result from increasing all inputs
by the same percentage.
REVALUATION is government action to increase the price of its currency relative to
other currencies.
RURAL-URBAN MIGRATION refers to the movement of labour from the countryside to
the cities. The best example today exists in China where tens of millions per year are
migrating each year; and will continue to do so for the foreseeable future.
S
SAVINGS is disposable income minus consumption. S = Yd – C.
SAVINGS FUNCTION is the relationship between savings and disposable income.
SCARSE RESOURCE is not enough of a factor of production.
SCARSITY exist when human wants exceed the amount that available resources can
produce.
SEASONAL UNEMPLOYMENT refers to unemployment caused by seasonality in demand
or supply of a good or service.
SECONDARY SCHOOL ENROLEMENT RATE is the percentage of secondary school age
children that are enrolled at school.
SELF-SUFFICIENCY exists where each individual consumes only what they produce.
SERVICES refer to purchases that do not have physical characteristics - e.g. teaching,
shipping and financial advice.
SHORTAGE is an excess of demand over supply of a good or service at the equilibrium
price.
SHORT RUN is the period of time in which at least one factor of production is fixed.
SHORT TERM DEBT is borrowings that must be paid back within one to three years.
SHORT-RUN AGGREGATE SUPPLY (SRAS) is the relationship between Real GDP and the
price level, holding everything else constant.
SHORT-RUN AGGREGATE SUPPLY CURVE is a curve showing the relationship between
Real GDP and the price level, holding everything else constant.
SHORT-RUN PHILLIPS CURVE shows the relationship between unemployment and
inflation, holding the expected rate of inflation and the natural rate of unemployment
constant.
SHUTDOWN POINT is where the firm is just covering its total variable costs.
SOCIAL COSTS refers to those costs of a good or service that are not borne by the
producer but by society as a whole. They include the cost of negative externalities.
SOCIAL COST-BENEFIT ANALYSIS attempts to identity and quantify in monetary terms
the social costs and benefits of an economic activity. Examples include the effects
from pollution and environmental degradation.
SOFT LOAN is a loan on more favourable terms compared with market terms.
SPECIFIC TAX is a tax set at a fixed amount per unit on a good or service.
STAGFLATION refers to the combination of very high rates of inflation and very high
rates of unemployment.
STANDARD OF LIVING covers range of tangible and intangible goods, services and
benefits that people enjoy in a society. Items include health care, education, free
speech, employment, and freedom from oppression.
STRUCTURAL ADJUSTMENT LOANS refers to loans made the World Bank that are short
term, 1 to 3 years, and help finance institutional reform in poor countries.
STRUCTURAL UNEMPLOYMENT refers to the type of unemployment that results from a
fundamental change in the structure of the economy.
SUBSIDY is a government payment to producers of a good or service.
SUBSISTENCE AGRICULTURE is the production of farm output mainly for own
consumption.
SUBSISTENCE FARMING is the production of farm output mainly for one’s own
consumption.
SUBSITUTION EFFECT is the tendency of people to substitute away from more
expensive commodities to cheaper commodities.
SUBSTANTIAL DEBT WRITE-OFF refers to a situation where a lender forgives a
borrower a major part of the borrower’s debt.
SUBSTITUTES are goods or services that may be used in place of another.
SUPERNORMAL PROFIT refers to the extra profit over normal profit. If the AC curve is
below the AR (demand) curve then a firm can earn supernormal profit.
SUPPLY is the relationship between the quantity supplied and its price.
SUPPLY CURVE is graph or diagram showing the relationship between the quantity
supplied and the price of a good or service, holding everything else constant.
SUPPLY SCHEDULE is a list of quantity supplied at different prices, holding everything
constant.
SUPPLY-SIDE POLICIES refer to government policies designed to increase output.
Examples include tax reductions and concessions.
SUSBSISTENCE FARMERS refers to farmers that produce just enough for their own
consumption. They are common in most LDCs.
SUSTAINABLE DEVELOPMENT refers to the use of the factors of production by the
current generation that result in the resources being available for future generations.
T
TARIFFS are taxes imposed by the government of an importing country. They are a
major form of protectionism, particularly of agricultural protectionism by the USA, EU
and Japan against agricultural imports from LDCs.
TAX INCIDENCE refers to the distribution of the tax burden among various groups in
society.
TAX RATE is the percentage rate of tax levied on a particular activity.
TECHNOLOGICAL UNEMPLOYMENT is unemployment caused by technological changes
in an economy that leads to a reduction in the demand for labour.
TECHNICAL EFFICIENCY occurs within a firm. It exists when they are producing output
with the minimum amount of inputs. The incentive for a firm to achieve this is the
profit motive. Also known as productive efficiency.
TECHNOLOGY refers to the method of converting resources into goods and services.
TECHNOLOGY DEFLATION is a sustained decrease in the price of goods and services
that result from improvements and application of technology.
TERMS OF TRADE is the rate at which exports will trade for imports. It expresses a
price relationship and measured through the Terms of Trade Index.
TERMS OF TRADE INDEX is the ratio of export prices to import prices expressed as an
index.
THEORY OF DEMAND states that the quantity demanded and price are inversely
related, other things being equal.
THIRD WORLD DEBT is the total external deficits of LDCs.
TOKEN INTEREST RATE refers to a very low price of borrowing money or paid on
money lent. Exists under conditions of deflation. For example, in Japan in the early
years of 2000.
TOTAL COST (TC) is the sum of the costs of all the inputs used in production. TC = TFC
+ TVC.
TOTAL DEBT SERVICE AS A % OF EXPORTS expresses the relationship, in percentage
terms, between a country’s total interest payments on external borrowings and the
value of their exports. The higher the figure, the less export income a country has to
fund future economic growth and development.
TOTAL DEBT SERVICE AS A % OF GDP expresses the relationship, in percentage terms,
between a country’s total interest payments on external borrowings and the value of
their GDP. The higher the figure, the less export income a country has to fund future
economic growth and development.
TOTAL FIXED COST (TFC) is the cost of all the fixed inputs.
TOTAL REVENUE (TR) is the price of goods or services multiplier by quantity sold. TR
= P X Q.
TOTAL VARIABLE COST (TVC) is the cost of all variable inputs.
TRADEABLE PERMITS refers to an international scheme that allows “pollution
permits” to be bought and sold between countries. The scheme is designed to control
worldwide pollution and its effects on the environment.
TRADE CYCLE refers to is the long term fluctuation of national income.
TRADE LIBERALIZATION is the freeing-up of trade by a country and between
countries. It is a major objective of the current WTO Doha Trade negotiations.
TRADE UNION is an organization formed to represent the interest of the factor of
production, labour.
TRADING BLOC is a group of countries that have joined together to benefit from free
trade and economic integration.
TRANSFER PAYMENTS refer to payments made by the government to redistribute
income. Examples include pensions, travel and health concessions for the elderly, the
provision of government low cost housing, and child and family benefits. They are
common in MDCs, but not in LDCs.
TRANSFER PRICING is the process, undertaken by MNCs, of minimizing their tax bills
by setting their internal prices so that the highest value added work appear to be done
in the countries with the lowest tax rates. Transfer pricing problems present a loss of
tax revenue for governments. Can be major problem for a country, particularly LDCs.
TRANSNATIONAL CORPORATIONS (TNCS) are companies that have production units in
one or more foreign countries.
U
UNANTICIPATED INFLATION is inflation that it not expected or planned for.
UNDEREMPLOYMENT refers to situations where a person desires to work more hours
than is currently available to them.
UNDER-VALUED CURRENCY refers to the price of a currency that is below is the free
market rate. Currently, this is a criticism by the USA, Japan and other countries
levelled against the Chinese Yuan.
UNEMPLOYMENT EQUILIBRIUM exists where macroeconomic equilibrium at Real GDP
is below long run aggregate supply.
UNEMPLOYMENT is the number of adult workers who are not employed but are
seeking jobs. The figure includes frictional, seasonal and structural unemployment.
UNEMPLOYMENT RATE is the number of unemployed expressed as a percentage of the
total labour force. The figure includes frictional, seasonal and structural
unemployment.
UNIT ELASTIC DEMAND is an elasticity of demand of 1. The quantity demanded and
price change in equal proportions.
UNPRODUCTIVE FARMLAND refers to agricultural land that cannot be used or provide
adequate food, whether used to grow crops or graze animals.
URBAN POPULATION is the percentage of the total population living in towns or cities.
V
VALUE ADDED is the value of a firm’s output minus the value of inputs brought in from
other firms.
VARIABLE COST (VC) is a cost that varies with the output level.
VARIABLE INPUTS are inputs whose quantity can be varied in the short run.
VEBLEN GOODS are goods that have snob value and are bought to display wealth.
Their demand curve slopes upwards from left to right, as the higher the price the
greater the quantity demanded.
VELOCITY OF CIRCULATION refers to the average number of time a unit of money is
used annually to buy the goods and services that make up GDP.
VIRTUAL MONOPOLY refers to a firm that has monopoly power because of its
dominance of an industry, but it is not the only supplier of a good or service.
VISIBLE BALANCE is the difference between the value of exports and imports of goods.
VISIBLE TRADE is the value of exports and imports of goods.
VOLUNTARY EXPORT RESTRAINT (VER) is a self-imposed restriction by an exporting
country on the volume of its exports.
W
WANTS refer to the unlimited desires of people for a good or service.
WEALTH is the total assets of an individual, firm or government minus its total
liabilities.
WORLD BANK is an international financial institution owned by its members
responsible for providing technical assistance and funding to poor countries.
WORLD TRADE ORGANISATION (WTO) is an international agreement of member
nations committed in principle to free multinational trade through the reduction of
trade barriers. In reality, as the Doha Round demonstrates, this key principle does not
always work in practice to the detriment of LDCs

Some graphs and content are taken from “Economics for the IB Diploma” by Ellie Tragakes