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glossary

Accelerator model: The model according to which investment depends on the change in output.

Accommodating policy: A policy that yields to the effect of a shock and thereby prevents the shock from being disruptive; for example, a policy that raises aggregate demand in response to an adverse supply shock, sustaining the effect of the shock on prices and keeping output at the natural level.

Accounting profit: The amount of revenue remaining for the owners of a firm after all the factors of production except capital have been compensated. (Cf. economic profit, profit.)

Acyclical: Moving in no consistent direction over the business cycle. (Cf. countercyclical, procyclical.)

Adaptive expectations: An approach that assumes that people form their expectation of a variable based on recently observed values of the variable. (Cf. rational expectations.)

Adverse selection: An unfavourable sorting of individuals by their own choices; for example, in efficiency-wage theory, when a wage cut induces good workers to quit and bad workers to remain with the firm.

Aggregate: Total for the whole economy.

Aggregate demand curve: The negative relationship between the price level and the aggregate quantity of output demanded that arises from the interaction between the goods market and the money market.

Aggregate-demand externality: The macroeconomic impact of one firm’s price adjustment on the demand for all other firms’ products.

Aggregate supply curve: The relationship between the price level and the aggregate quantity of output firms produce.

Animal spirits: Exogenous and perhaps self-fulfilling waves of optimism and pessimism about the state of the economy that, according to some economists, influence the level of investment.

Appreciation: A rise in the value of a currency relative to other currencies in the market for foreign exchange. (Cf. depreciation.)

Arbitrage: The act of buying an item in one market and selling it at a higher price in another market in order to profit from the price differential in the two markets.

Asymmetric information: A situation in which one party in an economic transaction has some relevant information not available to the other party.

Automatic stabilizer: A policy that reduces the amplitude of economic fluctuations without regular and deliberate changes in economic policy; for example, an income tax system that automatically reduces taxes when income falls.

Average propensity to consume (APC): The ratio of consumption to income (C/Y).


Balance sheet: An accounting statement that shows assets and liabilities.

Balanced budget: A budget in which receipts equal expenditures.

Balanced trade: A situation in which the value of imports equals the value of exports, so net exports equal zero.

Bank capital: The resources the bank owners have put into the institution.

Bank of Canada: The central bank of Canada.

Bank Rate: The interest rate that the Bank of Canada charges if it makes loans to chartered banks.

Baumol–Tobin model: A model of money demand positing that people choose optimal money holdings by comparing the opportunity cost of the forgone interest from holding money and the benefit of making less frequent trips to the bank.

Bond: A document representing an interest-bearing debt of the issuer, usually a corporation or the government.

Borrowing constraint: A restriction on the amount a person can borrow from financial institutions, limiting that person’s ability to spend his or her future income today; also called a liquidity constraint.

Budget constraint: The limit that income places on expenditure. (Cf. intertemporal budget constraint.)

Budget deficit: A shortfall of receipts from expenditure.

Budget surplus: An excess of receipts over expenditure.

Business cycle: Economy-wide fluctuations in output, incomes, and employment.

Business fixed investment: Equipment and structures that businesses buy for use in future production.


Capital: 1. The stock of equipment and structures used in production. 2. The funds to finance the accumulation of equipment and structures.

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Capital budgeting: An accounting procedure that measures both assets and liabilities.

Capital requirement: A minimum amount of bank capital mandated by regulators.

Central bank: The institution responsible for the conduct of monetary policy, such as the Bank of Canada in Canada.

Classical dichotomy: The theoretical separation of real and nominal variables in the classical model, which implies that nominal variables do not influence real variables. (Cf. neutrality of money.)

Classical model: A model of the economy derived from the ideas of the classical, or pre-Keynesian, economists; a model based on the assumptions that wages and prices adjust to clear markets and that monetary policy does not influence real variables. (Cf. Keynesian model.)

Closed economy: An economy that does not engage in international trade. (Cf. open economy.)

Cobb–Douglas production function: A production function of the form F(K, L) = AKαL1–α, where K is capital, L is labour, and A and α are parameters.

Commodity money: Money that is intrinsically useful and would be valued even if it did not serve as money. (Cf. fiat money, money.)

Competition: A situation in which there are many individuals or firms so that the actions of any one of them do not influence market prices.

Constant returns to scale: A property of a production function whereby a proportionate increase in all factors of production leads to an increase in output of the same proportion.

Consumer price index (CPI): A measure of the overall level of prices that shows the cost of a fixed basket of consumer goods relative to the cost of the same basket in a base year.

Consumption: Goods and services purchased by consumers.

Consumption function: A relationship showing the determinants of consumption; for example, a relationship between consumption and disposable income, C = C(YT).

Contractionary policy: Policy that reduces aggregate demand, real income, and employment. (Cf. expansionary policy.)

Coordination failure: A situation in which decisionmakers reach an outcome that is inferior for all of them because of their inability to jointly choose strategies that would result in a preferred outcome.

Corporate profit tax: The tax levied on the accounting profit of corporations.

Cost of capital: The amount forgone by holding a unit of capital for one period, including interest, depreciation, and the gain or loss from the change in the price of capital.

Cost-push inflation: Inflation resulting from shocks to aggregate supply. (Cf. demand-pull inflation.)

CPI: See consumer price index.

Crowding out: The reduction in investment that results when expansionary fiscal policy raises the interest rate.

Currency: The sum of outstanding paper money and coins.

Cyclical unemployment: The unemployment associated with short-run economic fluctuations; the deviation of the unemployment rate from the natural rate.

Cyclically adjusted budget deficit: The budget deficit adjusted for the influence of the business cycle on government spending and tax revenue; the budget deficit that would occur if the economy’s production and employment were at their natural rates.


Debt-deflation theory: A theory according to which an unexpected fall in the price level redistributes real wealth from debtors to creditors and, therefore, reduces total spending in the economy.

Debt finance: Obtaining funds for a business by borrowing, such as through the bond market.

Deflation: A decrease in the overall level of prices. (Cf. disinflation, inflation.)

Deflator: See GDP deflator.

Demand deposits: Assets that are held in banks and can be used on demand to make transactions, such as chequing accounts.

Demand-pull inflation: Inflation resulting from shocks to aggregate demand. (Cf. cost-push inflation.)

Demand shocks: Exogenous events that shift the aggregate demand curve.

Deposit insurance: Insurance provided by the Canada Deposit Insurance Corporation (CDIC) to individuals and firms that deposited funds in a bank or trust company that has gone bankrupt.

Deposit switching: The switching of federal government deposits between the Bank of Canada and the chartered banks for the purposes of regulating the money supply.

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Depreciation: 1. The reduction in the capital stock that occurs over time because of aging and use. 2. A fall in the value of a currency relative to other currencies in the market for foreign exchange. (Cf. appreciation.)

Depreciation allowances: Deductions permitted in the calculation of corporate taxes to allow for the wearing out of capital equipment.

Depression: A very severe recession.

Devaluation: An action by the central bank to decrease the value of a currency under a system of fixed exchange rates. (Cf. revaluation.)

Diminishing marginal product: A characteristic of a production function whereby the marginal product of a factor falls as the amount of the factor increases while all other factors are held constant.

Discounting: The reduction in value of future expenditure and receipts, compared to current expenditure and receipts, resulting from the presence of a positive interest rate.

Discouraged workers: Individuals who have left the labour force because they believe that there is little hope of finding a job.

Disinflation: A reduction in the rate at which prices are rising. (Cf. deflation, inflation.)

Disposable income: Income remaining after the payment of taxes.

Diversification: Reduction of risk by holding assets with imperfectly correlated returns.

Dominated asset: An asset that offers an inferior return compared to another asset in all possible realizations of future uncertainty.

Double coincidence of wants: A situation in which each of two individuals has precisely the good that the other wants.


Economic profit: The amount of revenue remaining for the owners of a firm after all the factors of production have been compensated. (Cf. accounting profit, profit.)

Efficient markets hypothesis: The theory that asset prices reflect all publicly available information about the value of an asset.

Efficiency of labour: A variable in the Solow growth model that measures the health, education, skills, and knowledge of the labour force.

Efficiency units of labour: A measure of the labour force that incorporates both the number of workers and the efficiency of each worker.

Efficiency-wage theories: Theories of real-wage rigidity and unemployment according to which firms raise labour productivity and profits by keeping real wages above the equilibrium level.

Elasticity: The percentage change in a variable caused by a 1 percent change in another variable.

Employment insurance (EI): A government program under which unemployed workers can collect benefits for a certain period after losing their jobs.

Endogenous growth theory: Models of economic growth that try to explain the rate of technological change.

Endogenous variable: A variable that is explained by a particular model; a variable whose value is determined by the model’s solution. (Cf. exogenous variable.)

Equilibrium: A state of balance between opposing forces, such as the balance of supply and demand in a market.

Equity finance: Obtaining funds for a business by issuing ownership shares, such as through the stock market.

Euler’s theorem: The mathematical result economists use to show that economic profit must be zero if the production function has constant returns to scale and if factors are paid their marginal products.

Ex ante real interest rate: The real interest rate anticipated when a loan is made; the nominal interest rate minus expected inflation. (Cf. ex post real interest rate.)

Ex post real interest rate: The real interest rate actually realized; the nominal interest rate minus actual inflation. (Cf. ex ante real interest rate.)

Exchange rate: The rate at which a country makes exchanges in world markets. (Cf. nominal exchange rate, real exchange rate.)

Exogenous variable: A variable that a particular model takes as given; a variable whose value is independent of the model’s solution. (Cf. endogenous variable.)

Expansionary policy: Policy that raises aggregate demand, real income, and employment. (Cf. contractionary policy.)

Exports: Goods and services sold to other countries.


Factor of production: An input used to produce goods and services; for example, capital or labour.

Factor price: The amount paid for one unit of a factor of production.

Factor share: The proportion of total income being paid to a factor of production.

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Federal Reserve (the Fed): The central bank of the United States.

Fiat money: Money that is not intrinsically useful and is valued only because it is used as money. (Cf. commodity money, money.)

Financial crisis: A major disruption in the financial system that impedes the economy’s ability to intermediate between those who want to save and those who want to borrow and invest.

Financial intermediaries: Institutions that facilitate the matching of savers and borrowers, such as banks.

Financial intermediation: The process by which resources are allocated from those individuals who wish to save some of their income for future consumption to those individuals and firms who wish to borrow to buy investment goods for future production.

Financial markets: Markets through which savers can directly provide resources to borrowers, such as the stock market and bond market.

Financial system: The set of institutions through which the resources of those who want to save are allocated to those who want to borrow.

Financing constraint: A limit on the quantity of funds a firm can raise—such as through borrowing—in order to buy capital.

Fire sale: The precipitous fall in the price of assets that takes place when financial institutions must sell their assets quickly in the midst of a crisis.

Fiscal dividend: The new room in the budget that is created by decreased interest payment obligations on the national debt.

Fiscal policy: The government’s choice regarding levels of spending and taxation.

Fisher effect: The one-for-one influence of expected inflation on the nominal interest rate.

Fisher equation: The equation stating that the nominal interest rate is the sum of the real interest rate and expected inflation (i = r + πe).

Fixed exchange rate: An exchange rate that is set by the central bank’s willingness to buy and sell the domestic currency for foreign currencies at a predetermined price. (Cf. floating exchange rate.)

Flexible prices: Prices that adjust quickly to equilibrate supply and demand. (Cf. sticky prices.)

Floating exchange rate: An exchange rate that the central bank allows to change in response to changing economic conditions and economic policies. (Cf. fixed exchange rate.)

Flow: A variable measured as a quantity per unit of time. (Cf. stock.)

Foreign debt: The debt accumulated by domestic households, firms, and governments that must be financed by sending interest payments to foreigners each year.

Fractional-reserve banking: A system in which banks keep only some of their deposits on reserve. (Cf. 100-percent-reserve banking.)

Frictional unemployment: The unemployment that results because it takes time for workers to search for the jobs that best suit their skills and tastes. (Cf. wait unemployment.)

Full-employment budget deficit: See cyclically adjusted budget deficit.


GDP: See gross domestic product.

GDP deflator: The ratio of nominal GDP to real GDP; a measure of the overall level of prices that shows the cost of the currently produced basket of goods relative to the cost of that basket in a base year.

General equilibrium: The simultaneous equilibrium of all the markets in the economy.

GNP: See gross national product.

Gold standard: A monetary system in which gold serves as money or in which all money is convertible into gold.

Golden rule level of capital: The saving rate in the Solow growth model that leads to the steady state in which consumption per worker (or consumption per efficiency unit of labour) is maximized.

Government purchases: Goods and services bought by the government. (Cf. transfer payments.)

Government-purchases multiplier: The change in aggregate income resulting from a one-dollar change in government purchases.

Gross domestic product (GDP): The total income earned domestically, including the income earned by foreign-owned factors of production; the total expenditure on domestically produced goods and services.

Gross national product (GNP): The total income of all residents of a nation, including the income from factors of production used abroad; the total expenditure on the nation’s output of goods and services.


High-powered money: The sum of currency and bank reserves; also called the monetary base.

Hyperinflation: Extremely high inflation.

Hysteresis: The long-lasting influence of history, such as on the natural rate of unemployment.


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Identification problem: The difficulty of isolating a particular relationship in data when two or more variables are related in more than one way.

Imperfect-information model: The model of aggregate supply emphasizing that individuals do not always know the overall price level because they cannot observe the prices of all goods and services in the economy.

Import quota: A legal limit on the amount of a good that can be imported.

Imports: Goods and services bought from other countries.

Imputed value: An estimate of the value of a good or service that is not sold in the marketplace and therefore does not have a market price.

Income effect: The change in consumption of a good resulting from a movement to a higher or lower indifference curve, holding the relative price constant. (Cf. substitution effect.)

Index of leading indicators: See leading indicators.

Indexed bonds and taxes: Bonds with interest each year equal to a specified real return plus whatever the previous year’s inflation had been; a tax system in which all exemptions and tax-bracket boundaries are adjusted each year by the rate of inflation.

Indifference curves: A graphical representation of preferences that shows different combinations of goods producing the same level of satisfaction.

Inflation: An increase in the overall level of prices. (Cf. deflation, disinflation.)

Inflation–Real Output Volatility Trade-off: The proposition that a central bank—when responding to supply shocks—must choose between minimizing the effect of the shocks on how much real output varies around its natural value and the effect of the shocks on how much inflation varies around its target value.

Inflation targeting: A monetary policy under which the central bank announces a specific target, or target range, for the inflation rate.

Inflation tax: The revenue raised by the government through the creation of money; also called seigniorage.

Inside lag: The time between a shock hitting the economy and the policy action taken to respond to the shock. (Cf. outside lag.)

Insiders: Workers who are already employed and therefore have an influence on wage bargaining. (Cf. outsiders.)

Interest rate: The market price at which resources are transferred between the present and the future; the return to saving and the cost of borrowing.

Intermediation: See financial intermediation.

Intertemporal budget constraint: The budget constraint applying to expenditure and income in more than one period of time. (Cf. budget constraint.)

Intertemporal substitution of labour: The willingness of people to trade off working in one period for working in future periods.

Inventory investment: The change in the quantity of goods that firms hold in storage, including materials and supplies, work in process, and finished goods.

Investment: Goods purchased by individuals and firms to add to their stock of capital.

Investment tax credit: A provision of the corporate income tax that reduces a firm’s tax when it buys new capital goods.

IS curve: The negative relationship between the interest rate and the level of income that arises in the market for goods and services. (Cf. IS–LM model, LM curve.)

IS–LM model: A model of aggregate demand that shows what determines aggregate income for a given price level by analyzing the interaction between the goods market and the money market. (Cf. IS curve, LM curve.)


Keynesian cross: A simple model of income determination, based on the ideas in Keynes’s General Theory, which shows how changes in spending can have a multiplied effect on aggregate income.

Keynesian model: A model derived from the ideas of Keynes’s General Theory; a model based on the assumptions that wages and prices do not adjust to clear markets and that aggregate demand determines the economy’s output and employment. (Cf. classical model.)


Labour-augmenting technological progress: Advances in productive capability that raise the efficiency of labour.

Labour force: Those in the population who have a job or are looking for a job.

Labour-force participation rate: The percentage of the adult population in the labour force.

Large open economy: An open economy that can influence its domestic interest rate; an economy that, by virtue of its size, can have a substantial impact on world markets and, in particular, on the world interest rate. (Cf. small open economy.)

Laspeyres price index: A measure of the level of prices based on a fixed basket of goods. (Cf. Paasche price index.)

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Leading indicators: Economic variables that fluctuate in advance of the economy’s output and thus signal the direction of economic fluctuations.

Lender of last resort: The role a central bank plays when it lends to financial institutions in the midst of a liquidity crisis.

Leverage: The use of borrowed money to supplement existing funds for purposes of investment.

Life-cycle hypothesis: The theory of consumption that emphasizes the role of saving and borrowing as transferring resources from those times in life when income is high to those times in life when income is low, such as from working years to retirement.

Liquid: Readily convertible into the medium of exchange; easily used to make transactions.

Liquidity constraint: A restriction on the amount a person can borrow from a financial institution, which limits the person’s ability to spend his future income today; also called a borrowing constraint.

Liquidity crisis: A situation in which a solvent bank does not have sufficient cash on hand to satisfy the withdrawal demands of depositors.

Liquidity-preference theory: A simple model of the interest rate, based on the ideas in Keynes’s General Theory, which says that the interest rate adjusts to equilibrate the supply and demand for real money balances.

LM curve: The positive relationship between the interest rate and the level of income (while holding the price level fixed) that arises in the market for real money balances. (Cf. IS–LM model, IS curve.)

Loanable funds: The flow of resources available to finance capital accumulation.

Lucas critique: The argument that traditional policy analysis does not adequately take into account the impact of policy changes on people’s expectations.


M1, M2, M2+, M3: Various measures of the stock of money, where larger numbers signify a broader definition of money.

Macroeconometric model: A model that uses data and statistical techniques to describe the economy quantitatively, rather than just qualitatively.

Macroeconomics: The study of the economy as a whole. (Cf. microeconomics.)

Marginal product of capital (MPK): The amount of extra output produced when the capital input is increased by one unit.

Marginal product of labour (MPL): The amount of extra output produced when the labour input is increased by one unit.

Marginal propensity to consume (MPC): The increase in consumption resulting from a one-dollar increase in disposable income.

Marginal rate of substitution (MRS): The rate at which a consumer is willing to give up some of one good in exchange for more of another; the slope of the indifference curve.

Market-clearing model: A model that assumes that prices freely adjust to equilibrate supply and demand.

Medium of exchange: The item widely accepted in transactions for goods and services; one of the functions of money. (Cf. store of value, unit of account.)

Menu cost: The cost of changing a price.

Microeconomics: The study of individual markets and decisionmakers. (Cf. macroeconomics.)

Model: A simplified representation of reality, often using diagrams or equations, that shows how variables interact.

Monetarism: The doctrine according to which changes in the money supply are the primary cause of economic fluctuations, implying that a stable money supply would lead to a stable economy.

Monetary base: The sum of currency and bank reserves; also called high-powered money.

Monetary neutrality: See neutrality of money.

Monetary policy: The central bank’s choice regarding the supply of money.

Monetary transmission mechanism: The pro-cess by which changes in the money supply influence the amount that households and firms wish to spend on goods and services.

Monetary union: A group of economies that have decided to share a common currency and thus a common monetary policy.

Money: The stock of assets used for transactions. (Cf. commodity money, fiat money.)

Money demand function: A function showing the determinants of the demand for real money balances; for example, (M/P)d = L(i, Y).

Money multiplier: The increase in the money supply resulting from a one-dollar increase in the monetary base.

Moral hazard: The possibility of dishonest behaviour in situations in which behaviour is imperfectly monitored; for example, in efficiency-wage theory, the possibility that low-wage workers may shirk their responsibilities and risk getting caught and fired.

Multiplier: See government-purchases multiplier, money multiplier, or tax multiplier.

Mundell–Fleming model: The IS–LM model for a small open economy.

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Mundell–Tobin effect: The fall in the real interest rate that results when an increase in expected inflation raises the nominal interest rate, lowers real money balances and real wealth, and thereby reduces consumption and raises saving.

Mutual fund: A financial intermediary that holds a diversified portfolio of stock or bonds.


National income accounting: The accounting system that measures GDP and many other related statistics.

National income accounts identity: The equation showing that GDP is the sum of consumption, investment, government purchases, and net exports.

National saving: A nation’s income minus consumption and government purchases; the sum of private and public saving.

Natural-rate hypothesis: The premise that fluctuations in aggregate demand influence output, employment, and unemployment only in the short run, and that in the long run these variables return to the levels implied by the classical model.

Natural rate of unemployment: The steady-state rate of unemployment; the rate of unemployment toward which the economy gravitates in the long run.

Near money: Assets that are almost as useful as money for engaging in transactions and, therefore, are close substitutes for money.

Neoclassical model of investment: The theory according to which investment depends on the deviation of the marginal product of capital from the cost of capital.

Net capital outflow: The net flow of funds being invested abroad; domestic saving minus domestic investment; also called net foreign investment.

Net exports: Exports minus imports.

Net foreign investment: See net capital inflow.

Net investment: The amount of investment after the replacement of depreciated capital; the change in the capital stock.

Neutrality of money: The property that a change in the money supply does not influence real variables. (Cf. classical dichotomy.)

New classical theory: The theory according to which economic fluctuations can be explained by real changes in the economy (such as changes in technology) and without any role for nominal variables (such as the money supply). (Cf. real business cycle theory.)

New Keynesian theory: The school of thought according to which economic fluctuations can be explained only by admitting a role for some microeconomic imperfection, such as sticky wages or prices. (Cf. new classical theory.)

Nominal: Measured in current dollars; not adjusted for inflation. (Cf. real.)

Nominal exchange rate: The rate at which one country’s currency trades for another country’s currency. (Cf. exchange rate, real exchange rate.)

Nominal interest rate: The return to saving and the cost of borrowing without adjustment for inflation. (Cf. real interest rate.)

Normal good: A good that a consumer demands in greater quantity when his or her income rises.


Okun’s law: The negative relationship between unemployment and real GDP, according to which a decrease in unemployment of 1 percentage point is associated with additional growth in real GDP of approximately 2 percent.

100-percent-reserve banking: A system in which banks keep all deposits on reserve. (Cf. fractional-reserve banking.)

Open economy: An economy in which people can freely engage in international trade in goods and capital. (Cf. closed economy.)

Open-market operations: The purchase or sale of government bonds by the central bank for the purpose of increasing or decreasing the money supply.

Outside lag: The time between a policy action and its influence on the economy. (Cf. inside lag.)

Outsiders: Workers who are not employed and therefore have no influence on wage bargaining. (Cf. insiders.)


Paasche price index: A measure of the level of prices based on a changing basket of goods. (Cf. Laspeyres price index.)

Payroll taxes: Taxes levied on employees and employers that, up to a specified maximum, are proportional to the worker’s wage income.

Permanent income: Income that people expect to persist into the future; normal income. (Cf. transitory income.)

Permanent-income hypothesis: The theory of consumption according to which people choose consumption based on their permanent income, and use saving and borrowing to smooth consumption in response to transitory variations in income.

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Phillips curve: A negative relationship between inflation and unemployment; in its modern form, a relationship among inflation, cyclical unemployment, expected inflation, and supply shocks, derived from the short-run aggregate supply curve.

Pigou effect: The increase in consumer spending that results when a fall in the price level raises real money balances and, thereby, consumers’ wealth.

Political business cycle: The fluctuations in output and employment resulting from the manipulation of the economy for electoral gain.

Portfolio theories of money demand: Theories that explain how much money people choose to hold and that stress the role of money as a store of value. (Cf. transactions theories of money demand.)

Precautionary saving: The extra saving that results from uncertainty regarding, for example, longevity or future income.

Present value: The amount today that is equivalent to an amount to be received in the future, taking into account the interest that could be earned over the interval of time.

Private saving: Disposable income minus consumption.

Production function: The mathematical relationship showing how the quantities of the factors of production determine the quantity of goods and services produced; for example,Y = F(K, L).

Production smoothing: The motive for holding inventories according to which a firm can reduce its costs by keeping the amount of output it produces steady and allowing its stock of inventories to respond to fluctuating sales.

Profit: The income of firm owners; firm revenue minus firm costs. (Cf. accounting profit, economic profit.)

Public saving: Government receipts minus government spending; the budget surplus.

Purchasing-power parity: The doctrine according to which goods must sell for the same price in every country, implying that the nominal exchange rate reflects differences in price levels.


q theory of investment: The theory according to which expenditure on capital goods depends on the ratio of the market value of installed capital to its replacement cost.

Quantity equation: The identity stating that the product of the money supply and the velocity of money equals nominal expenditure (MV = PY); coupled with the assumption of stable velocity, an explanation of nominal expenditure called the quantity theory of money.

Quantity theory of money: The doctrine emphasizing that changes in the quantity of money lead to changes in nominal expenditure.

Quota: See import quota.


Random walk: The path of a variable whose changes over time are unpredictable.

Rational expectations: An approach that assumes that people optimally use all available information—including information about current and prospective policies—to forecast the future. (Cf. adaptive expectations.)

Real: Measured in constant dollars; adjusted for inflation. (Cf. nominal.)

Real business cycle theory: The theory according to which economic fluctuations can be explained by real changes in the economy (such as changes in technology) and without any role for nominal variables (such as the money supply). (Cf. new classical theory.)

Real exchange rate: The rate at which one country’s goods trade for another country’s goods. (Cf. exchange rate, nominal exchange rate.)

Real interest rate: The return to saving and the cost of borrowing after adjustment for inflation. (Cf. nominal interest rate.)

Real money balances: The quantity of money expressed in terms of the quantity of goods and services it can buy; the quantity of money divided by the price level (M/P).

Real rental price of capital: The amount paid to rent one unit of capital.

Recession: A sustained period of falling real income.

Reserves: The money that banks have received from depositors but have not used to make loans.

Residential investment: New housing bought by people to live in and by landlords to rent out.

Revaluation: An action undertaken by the central bank to raise the value of a currency under a system of fixed exchange rates. (Cf. devaluation.)

Ricardian equivalence: The theory according to which forward-looking consumers fully anticipate the future taxes implied by government debt, so that government borrowing today coupled with a tax increase in the future to repay the debt has the same effect on the economy as a tax increase today.

Risk averse: A dislike of uncertainty.


G-9

Sacrifice ratio: The number of percentage points of a year’s real GDP that must be forgone to reduce inflation by 1 percentage point.

Saving: See national saving, private saving, and public saving.

Seasonal adjustment: The removal of the regular fluctuations in an economic variable that occur as a function of the time of year.

Sectoral shift: A change in the composition of demand among industries or regions.

Seigniorage: The revenue raised by the government through the creation of money; also called the inflation tax.

Shadow banks: Financial institutions that (like banks) are at the centre of financial intermediation but (unlike banks) do not take in deposits insured by the CDIC.

Shock: An exogenous change in an economic relationship, such as the aggregate demand or aggregate supply curve.

Shoeleather cost: The cost of inflation from reducing real money balances, such as the inconvenience of needing to make more frequent trips to the bank.

Small open economy: An open economy that takes its interest rate as given by world financial markets; an economy that, by virtue of its size, has a negligible impact on world markets and, in particular, on the world interest rate. (Cf. large open economy.)

Solow growth model: A model showing how saving, population growth, and technological progress determine the level of and growth in the standard of living.

Solow residual: The growth in total factor productivity, measured as the percentage change in output minus the percentage change in inputs, where the inputs are weighted by their factor shares. (Cf. total factor productivity.)

Speculative bubble: A rise in the price of an asset above its fundamental value.

Stabilization policy: Public policy aimed at reducing the severity of short-run economic fluctuations.

Stagflation: A situation of falling output and rising prices; combination of stagnation and inflation.

Steady state: A condition in which key variables are not changing.

Sticky-price model: The model of aggregate supply emphasizing the slow adjustment of the prices of goods and services.

Sticky prices: Prices that adjust sluggishly and, therefore, do not always equilibrate supply and demand. (Cf. flexible prices.)

Stock: 1. A variable measured as a quantity at a point in time. (Cf. flow.) 2. Shares of ownership in a corporation.

Stock market: A market in which shares of ownership in corporations are bought and sold.

Stock-out avoidance: The motive for holding inventories according to which firms keep extra goods on hand to prevent running out if sales are unexpectedly high.

Store of value: A way of transferring purchasing power from the present to the future; one of the functions of money. (Cf. medium of exchange, unit of account.)

Structural unemployment: The unemployment resulting from wage rigidity and job rationing. (Cf. frictional unemployment.)

Substitution effect: The change in consumption of a good resulting from a movement along an indifference curve because of a change in the relative price. (Cf. income effect.)

Supply shocks: Exogenous events that shift the aggregate supply curve.


Tariff: A tax on imported goods.

Taylor Principle: The proposition that the central bank should increase (decrease) the nominal interest rate by more than one percentage point when the inflation rate is one percentage point above (below) its target value.

Taylor Rule: A summary of central bank behaviour which involves the bank raising (lowering) the nominal interest rate above (below) its long-run average value whenever inflation is above (below) its target value and whenever real GDP is above (below) its natural-rate value.

Tax multiplier: The change in aggregate income resulting from a one-dollar change in taxes.

Technology shocks: Variations in the level of technological ability that result in more or less output being produced from any given combination of labour and capital.

Time inconsistency: The tendency of policy-makers to announce policies in advance in order to influence the expectations of private decisionmakers, and then to follow different policies after those expectations have been formed and acted upon.

Tobin’s q: The ratio of the market value of installed capital to its replacement cost.

G-10

Total factor productivity: A measure of the level of technology; the amount of output per unit of input, where different inputs are combined on the basis of their factor shares. (Cf. Solow residual.)

Trade balance: The receipts from exports minus the payments for imports.

Transactions theories of money demand: Theories that explain how much money people choose to hold and that stress the role of money as a medium of exchange. (Cf. portfolio theories of money demand.)

Transfer payments: Payments from the government to individuals that are not in exchange for goods and services, such as public pension and employment insurance receipts. (Cf. government purchases.)

Transitory income: Income that people do not expect to persist into the future; current income minus normal income. (Cf. permanent income.)

Trickle-down economics: The school of thought according to which tax breaks for the rich indirectly provide benefits for those further down the income scale. The opposite approach, which emphasizes the indirect benefits for the rich that accompany policies aimed at those on lower incomes, is known as percolate-up economics.


Underground economy: Economic transactions that are hidden in order to evade taxes or conceal illegal activity.

Unemployment rate: The percentage of those in the labour force who do not have jobs.

Unit of account: The measure in which prices and other accounting records are recorded; one of the functions of money. (Cf. medium of exchange, store of value.)


Value added: The value of a firm’s output minus the value of the intermediate goods the firm purchased.

Velocity of money: The ratio of nominal expenditure to the money supply; the rate at which money changes hands.


Wage: The amount paid for one unit of labour.

Wage rigidity: The failure of wages to adjust to equilibrate labour supply and labour demand.

Work in process: Goods in inventory that are in the process of being completed.

Worker-misperception model: The model of aggregate supply emphasizing that workers sometimes perceive incorrectly the overall level of prices.

World interest rate: The interest rate prevailing in world financial markets.