AS Macroeconomics – Key Definitions

Chapter 4A – Explaining Trade

Absolute advantage A country has ____________ in producing a product if it

can produce more of a product with the same quantity of
resources than another country.

Comparative ____________ is where a country can produce at a lower

advantage opportunity cost than another country.
Opportunity cost in When a country (or business) uses its resources to produce
production one good/service, it can’t use those resources to produce
anything else.
Mutually beneficial A rate of trade that results in both economies being better
exchange rate off than they were when not trading.
Self-sufficient (autarky) A country that does not trade with the outside world.
Competitive advantage A country has ____________ in producing a product if it
can produce at a lower average cost of production than
another country.
Factor endowment The most important factor in determining international
theory trade is the quantity and quality of factors of production in
each country.
Specialisation in An economy concentrates in producing goods and services
production where they have an advantage over other economies.

Terms of trade The relative price of imports in terms of exports. Equal to

Index of export prices/Index of Import prices x 100.
Free trade Countries allow goods and services to be traded in and out
of the country without any government interference. No
protectionist policies are used (e.g. tariffs, quotas, etc.).

Protectionism Any policy that interferes with market forces in order to

give an advantage to domestic industry faced with foreign
competition.
Quota A restriction on the maximum quantity of imports.
Exchange Control Governments limit the buying of foreign currency by its
citizens and businesses with the goal of limiting imports.
Export Subsidies Government gives money to domestic companies that
export, reducing their costs and resulting in higher exports.

Embargo A ban on the import or export of a product or on trading

with another country.
Red tape and long _____________ can slow up the import process and
customs procedures increase prices.

Quality standards Governments set high and complicated criteria on

imported products which raises costs for potential
importers.

Standard of Living The level of wealth, comfort, material goods and

necessities available to a certain person or group of
people. Often measured in Real GDP/head.

WTO (World Trade Set up with the intention of promoting free trade. Used as
Organisation) a “third party” to settle trade disputes and organise trade
negotiations

Infant industry/Sunrise One which consists of mainly small firms that have not yet
Industry developed economies of scale. As a result, average costs of
production are higher.

Sunset Industry One which is in decline.

Dumping The process of selling goods in a overseas market below

the cost of production (i.e. at a very low price).

Globalisation The process through which an increasingly free flow of

ideas, people, goods, services and capital leads to the
integration of economies and societies
Brain drain Higher skilled workers may leave the country (emigrate).
Economic integration Regional trading blocs.

North American Free Includes the USA, Canada and Mexico.

Trade Agreement
(NAFTA)
The Association of 10 members including Singapore, Malaysia, Indonesia and
Southeast Asian Thailand.
Nations (ASEAN)
Free Trade Area Removal of all or some trade restrictions (e.g. – tariffs and
quotas) between members. Members are given freedom to
set their own barriers (restrictions) to non-members.

Customs Union Removal of all trade restrictions between members.

Members agree to a common external tariff on trade with
non-members.
Economic Union Removal of all trade restrictions between members,
common external tariff, and the free movement of factors
of production between members.
Monetary Union A type of economic union where all of the countries use
the same currency.

Economies of scale The average cost of production for a business falls as it

increases in size.

Trade diversion The shift in production by a trading bloc from a less

expensive nonmember country to a more expensive
member country.

Trade creation _________ is where high-cost domestic production is

replaced by more efficiently produced imports from within
a customs union.
Chapter 4B – Aggregate Demand, Aggregate Supply & Inflation

Aggregate demand The total spending in an economy on goods and services

(AD) in a period of time.

Components of Consumption, Investment, Government Spending and

aggregate demand Net Exports (AD = C + I + G + (X-M)).
Consumption The total spending by households on goods and services
in an economy.
Influences of Real disposable income, wealth, confidence, interest
consumption rates, taxes, and population.
Disposable income Income after direct taxes have been paid to the
government.
‘Real’ (income, wages, Adjusted for inflation.
interest rates etc.)
Aggregate demand Shows the level of output demanded at different price
curve levels.

Purchasing power The financial ability to buy goods and services.

The wealth effect The purchasing power of savings held in bank accounts
and other financial assets (e.g. houses, government
bonds) will increase. Consumers feel as though their
assets are worth more so they consume more, increasing
aggregate demand.
The international effect Lower prices will increase demand for exports because
they are more price competitive. Net exports increase.
Lower prices induce consumers to save, driving down the
The interest rate effect interest rate (supply of money increases), increasing the
demand for investment due to the cheaper cost of
borrowing. Therefore AD increases.
Interest rates The cost of borrowing and the reward for saving.

Investment The total spending by firms on capital goods.

Influences of Business confidence, profits tax/corporation tax,

investment advances in technology, interest rates.
Net exports The total value of exports minus the total value of
imports.
Aggregate supply (AS) The total output that firms in an economy are willing and
able to supply at different price levels in a given period
of time.

Short-run aggregate The total output of an economy that will be supplied

supply when there has not been enough time for the price of
factors of production to change.
Long-run aggregate Shows the relationship between real GDP and changes in
supply the price level when there has been time for input prices
(i.e. FoP prices) to adjust to changes in aggregate
demand.

The profit effect As the price level (of G/S) rises, the prices of FoP (e.g.
wage rates, rent) do not change. So this increases profit,
meaning firms are willing to supply more as the price
level increases.

The cost effect Although the FoP costs remain unchanged in the short-
run, average costs may rise as output increases (e.g.
overtime payments).
Misinterpretation Firms think demand for their products has increased
effect because the price they receive has increased i.e. their
product is more popular. So they supply more.

Causes of a shift of Change in the price of FoP, changes in taxes on firms,

SRAS and changes in the quality/quantity of FoP.
Causes of a shift of Change in the quantity/quality of FoP.
LRAS
Keynesian LRAS curve At low levels of output (and thus employment), the LRAS
curve is perfectly elastic.

Neo classical LRAS Perfectly inelastic at all levels of demand.

curve
Inflation A sustained increase in an economy’s general price level.
General price level The cost of living for people within an economy. The
average price of goods and services sold.
Creeping inflation A low but continuous rate of inflation.
Hyperinflation A very high rate of inflation (monthly inflation exceeds
50%).
Consumer Price Index Shows the average change in prices of a basket of goods
(CPI) and services purchased by households.
Base year The starting date for measuring inflation. Given a value
of 100 (i.e. in this year prices were 100%).
Nominal price/value Prices that relate to the selling price (price you see in the
shop). Same as Money price.
Real value (calculation) = Nominal value x (Price index in base year / Price index
in current year)
Index linked wages The salary of an employee increases each year at the
same rate as inflation. Real wages remain unchanged.
Cost-push inflation The price level is pushed up by increasing costs of
production.
Wage-price spiral Where increased wages cause costs of production to
increase, resulting in firms increasing prices. Price
increases lead to workers asking for higher wages,
further increasing production costs.
Demand-pull inflation Prices are pulled up by increases in aggregate demand
when the economy is close to/at full employment.
Full capacity The economy is already using most/all of its resources.
Monetarists A group of economists who believe that a rise in the
money supply is the main cause of inflation.
Monetary inflation The rate of growth of the money supply is greater than
the increase in the level of output in the economy.
International A measure of a country's advantage or disadvantage in
competitiveness selling its products in international markets.

Shoe leather costs The time and energy spent attempting to avoid the
negative impacts of inflation (e.g. searching for lowest
prices, making trips to the bank).
Menu costs These are the extra costs (time and money) for
businesses having to change their prices (e.g. catalogues,
 prices, bar codes), which happens frequently when there
is high inflation.

Inflationary What economic agents think the level of inflation will be

expectations in the future.
Inflationary noise Consumers and producers make inefficient decisions due
to the distorted signalling function of the price
mechanism during times of high inflation.
Inflation target Helps with planning and expectations of economic
agents.
Economic agent A decision maker in the economy (e.g. government,
consumer, firm, worker).
Deflation A sustained decrease in the price level.
Disinflation A fall in the rate of inflation (prices are still rising, but at
a slower rate than before).
Mortgage Where a person borrows money to buy property (e.g. a
house) and pays back the money over a period of time.
Fixed rate mortgage A mortgage that has a fixed interest rate for the entire
length of the loan repayment.
Variable rate mortgage A type of home loan in which the interest rate is not
fixed (the rate is often index linked i.e. moves up or
down with the inflation rate).
Deflationary spiral As firms make less profits, this leads to lower investment
and laying off of workers, reducing aggregate demand.
To lay off/make To stop employing somebody because there is not
redundant enough work to be done or they are no longer needed.
Chapter 4C – The Balance of Payments and Exchange Rates

The Balance of A record of all the economic transactions between the

Payments (BoP) residents of a country and the rest of the world.

Credit on the BoP An inflow of domestic currency into the country.

Debit on the BoP An outflow of domestic currency out of the country.
Deficit Outflows are more than inflows (Debits>Credits).
Surplus Inflows are more than outflows (Credits>Debits).
Current Account Records the trade in goods, trade in services, investment
income and current transfers.
Trade in goods The value of all of the goods imported minus all of the
goods exported. Also known as ‘Visibles’. e.g. Car, laptop
etc.
Trade in services The value of all the services exported minus the value of
the services imports. These “services” are invisible, i.e.
they cannot be touched, weighed or counted. e.g.
banking services, tourism, buying an airline ticket from a
foreign airline, insurance.
Income The money earnt by domestic businesses/citizens on
assets held abroad minus the money earnt by foreign
businesses/citizens that own assets in that country e.g.
dividends, rent, interest, profit.
Current transfers Payments made (or receipts received) for which there is
no corresponding exchange of an actual good or service.
E.g. foreign aid, gifts, workers remittances (payments
sent home by workers).
Current account deficit The combined debit items on the four sections of the
current account exceed the combined credit items on
the four parts.
Improvement in Either a current account surplus increases or a current
current account account deficit decreases.
Worsening of the Either a current account surplus reduces or a current
current account account deficit increases.
Capital Account Government debt forgiveness, money brought into/out
of country by migrants, sales/purchases of copyrights,
patents, and trademarks.
Financial Account A record of the transfer of financial assets (e.g.
ownership of a firm, purchase/sales of government
bonds and shares, hot money flows, net changes in
reserves) between one country and the rest of the
world. Net investment plus changes in reserves.
Net direct investment The buying or creation of productive assets by foreign
firms minus the buying or creation of productive assets
by domestic firms overseas (e.g. domestic company
builds a factory in foreign country or the takeover of a
foreign company).
Net portfolio Purchase and sale of government bonds and shares.
investment
Government bonds An amount of money borrowed by the government, to
be paid back in the future with interest. Also known as a
‘debt security’.
Hot money flows The flow of funds from one country to another to earn a
short-term profit on interest and exchange rate
differences.
Net changes in Includes the government’s holdings of gold and foreign
reserves currency. Additions to gold/foreign currency are debit
items and decreases are credit items.
Net errors and Sometimes known as the ‘balancing item’. This section of
omissions the BoP compensates for mistakes made in recording all
of the transactions.
Balance of payments When either the current or financial account is running a
disequilibrium surplus or deficit.
Causes of a current Growing domestic economy, declining economic activity
account deficit of trading partners, overvalued exchange rate, relatively
high inflation rate, low labour and capital productivity.
Cyclical current Due to a recession in the country of a trading partner,
account deficit import expenditures from the trading partner may fall.
Likely to be self-correcting/short term.
Overvalued The price is higher than the value.
Persistent Continues over a long time period. Opposite of
temporary.
Exchange rate Shows the value of one currency in terms of another
(e.g. $1 = €0.9)
Foreign exchange The place where currencies are bought and sold. Market
market is online/electronic.
Trade-weighted The price of one currency against a basket of currency.
exchange rates The weighting of the currencies in the basket depend on
the importance of the country’s trade.
Real effective exchange A currency value in terms of its purchasing power after
rate being adjusted for inflation (= nominal exchange rate x
(domestic price index / foreign price index)).
Appreciation A rise in the value of a currency, caused by an increase in
demand or fall in supply of a currency.
Revaluation A rise in the value of a currency, caused by government
intervention (e.g. buying domestic currency on foreign
exchange market or increasing interest rates).
Depreciation A decrease in the value of a currency, caused by a fall in
demand or increase in the supply of a currency.
Devaluation A decrease in the value of a currency, caused by a
government decision (e.g. selling domestic currency on
foreign exchange market or lowering interest rates).
Floating exchange rate Where the value of a currency is determined by the
market forces of supply and demand only. No
government intervention.
Managed exchange The value of the currency is determined by changes in
rate supply and demand in the free market but the
government will also “intervene” in some way to
influence the value. Normally between an upper/lower
limit.

Fixed exchange rate The government declares a central value for its currency
and then maintains this value.
Automatic adjustment If the value of a currency is determined by market forces,
mechanism when a country runs a current account deficit the
exchange rate should weaken. P(X) should fall and P (M)
 rises. Current account should improve automatically.
Speculation Trying to make a profit by guessing the future value of an
asset.
Export elasticity The extent to which an appreciation/depreciation will
change the demand for exports.
Import elasticity The extent to which an appreciation/depreciation will
change the demand for imports.
Inelastic PED of exports A decrease in the value of the currency will cause
quantity demanded of exports to increase at a smaller
percentage than the reduction in the price of the
currency.
Elastic PED of exports A decrease in the value of the currency will cause
quantity demanded of exports to increase at a greater
percentage than the reduction in the price of the
currency. Export revenue will rise following a
devaluation.
Inelastic PED of A decrease in the value of the currency will cause
imports quantity demanded of imports to decrease at a smaller
percentage than the reduction in the price of the
currency. Import expenditure will rise following a
devaluation.
Elastic PED of imports A decrease in the value of the currency will cause
quantity demanded of imports to decrease at a larger
percentage than the reduction in the price of the
currency. Import expenditure will decrease following a
devaluation.
The Marshall-Lerner A devaluation of the exchange rate will improve a BoP
condition deficit when the combined price elasticities of demand
for exports and imports are greater than one.

The J-curve effect A fall in the value of the exchange rate will worsen the
current account balance before it improves it.
Purchasing power A way of comparing international living standards by
parity (PPP) using an exchange rate based on the amount of each
currency needed to purchase the same basket of goods
and services.
Chapter 5 – Government Macroeconomic Intervention

Government Low and stable inflation, balance of payments equilibrium,

macroeconomic full employment, steady and sustainable economic growth,
objectives avoiding exchange rate fluctuations.
Sustainable Able to be maintained over a long period of time.
Economic growth An increase in real GDP. Shown on a PPC by a movement
(not a shift) outward from the origin.
Central Bank A bank that does business with other banks and the
government (but not firms/consumers) and controls a
country’s money supply and interest rates. e.g. Bank of
England, European Central Bank, The People’s Bank of
China.
Commercial Bank A bank that offers services to firms/consumers such as
deposit accounts, loans, and other financial services. E.g.
Standard Chartered Bank, Lloyds TSB, Agricultural Bank of
China.
Fluctuations An irregular rising and falling.
Labour force All people who are of working age that are willing and able
to work. Includes both employed and unemployed.
Fiscal policy The use of taxation and government spending to manage
aggregate demand in order to achieve the government’s
macroeconomic aims.

Reflationary/ Policy designed to increase AD. Can be achieved by lower

expansionary fiscal taxes or higher government spending.
policy
Deflationary/ Policy designed to reduce AD. Can be achieved by higher
contractionary fiscal taxes or lower government spending.
policy
Discretionary fiscal These are deliberate changes in government spending and
policy taxation (as opposed to spending/taxation changes that
happen automatically).
Automatic These are changes in government spending and taxation
stabilisers that occur during economic booms and recessions to
reduce fluctuations in aggregate demand without any
changes in government policy.

Economic boom A period of rapid economic expansion, resulting in higher

GDP, lower unemployment and rising asset prices.
Recession A slowdown in economic activity, accompanied by a fall in
Real GDP, investment spending, capacity utilisation,
household income and business profits. A fall in GDP for
two successive quarters of the year.
Government budget The budget is an annual statement in which the
government outlines plans for its spending and tax revenue
for the year ahead.
Budget surplus Tax revenue exceeds government spending.
Budget deficit When government spending exceeds tax revenue.
Balanced budget When government spending matches tax revenue.
Type of budget Deficit.
associated with
expansionary fiscal
policy
Type of budget Surplus.
associated with
contractionary fiscal
policy
Cyclical budget Occurs naturally when GDP falls, as governments will spend
deficit more money (through higher benefit payments) and receive
less tax revenues.

Structural budget This occurs when a government is committed to too much

deficit spending relative to its tax revenue. In this case the deficit
will not disappear when GDP increases. A government may
be concerned about this.

Monetary policy Any policy measures or instruments used to influence the

price or quantity of money. e.g. interest rates, money
supply, exchange rates.
Reflationary/ Policy designed to increase AD. Can be achieved by a cut in
expansionary interest rates, an increase in the money supply, or a
monetary policy reduction in the exchange rate.
Deflationary/ Policy designed to decrease AD. Can be achieved by an
contractionary increase in interest rates, an increase in the money supply,
monetary policy or a rise in the exchange rate.
Supply side policy Policies designed to increase the productive capacity of the
economy.
Incentive Something that motivates an individual to perform an
action.
Productivity A measure of the efficiency of production. Can be
expressed as a ratio of output to inputs in the production
process e.g. output per worker.
Labour mobility The extent to which workers are willing and able to move
between different jobs, occupations, and geographical
areas.
Labour market The ability of firms to make changes to their workforce in
flexibility terms of the number of workers they hire/fire, numbers of
hours worked and pay. Fewer rules/less union power
increases this ability.
Trade union An group of workers who join together to achieve common
goals (e.g. higher safety standards at work, higher pay).
Infrastructure the basic equipment and structures (e.g. roads, bridges,
airports, railways, subway, water/sewage systems) that are
needed for a country, region, or organization to function
properly
Privatisation The transfer of a business, industry or service from public to
private ownership.
Deregulation Concerns a government reducing the rules required for
firms to compete in an industry. This reduces barriers to
entry, increases competition and, hopefully, increases
efficiency.

Expenditure- This is any action taken by a government which is designed

switching policies to increase the buying of their country’s goods, and reduce
 the buying of other countries’ goods.

Expenditure This is any action taken by a government that is designed to

dampening/ reduce the total level of spending in an economy with the
reducing policies objective of improving the current account balance.

Marginal propensity This measures how spending on imports will change when
to import (MPM) there is a change in consumers’ disposable income (note: it
is similar to “income elasticity of demand”).

Time lag A delay between the action of one variable (e.g. interest
rate change) and the impact (e.g. change in aggregate
demand).