Macroeconomics: Key Concepts and Theories
Closed economy An economy that does not interact with other economies.
Open economy An economy that interacts with other economies.
Exports Goods and services produced domestically and sold abroad.
Imports Goods and services produced in foreign countries and sold domestically.
Net exports The value of exports minus the value of imports, or the trade balance.
Trade surplus The amount by which exports exceed imports.
Trade deficit The amount by which imports exceed exports.
Balanced trade A situation in which exports equal imports.
Net capital outflow The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.
Nominal exchange rate The rate at which people can trade one currency for another currency.
Appreciation An increase in the value of a currency measured in terms of other currencies.
Depreciation A decrease in the value of a currency measured in terms of other currencies.
Real exchange rate The rate at which people can trade the goods and services of one country for those of another country.
Purchasing power parity The theory that a unit of a country’s currency should buy the same quantity of goods in all countries.
Arbitrage Taking advantage of two prices for the same commodity by buying where it is cheap and selling where it is expensive.
Twin deficits The government budget deficit and the trade deficit.
Trade policy A government policy that directly affects the quantity of a country’s imports or exports.
Tariff A tax on imported goods.
Import quota A limit on the quantity of a good that is produced abroad that can be sold domestically.
Capital flight A sudden reduction in the demand for domestic assets coupled with a sudden increase in the demand for foreign assets.
Recession A period of decreasing aggregate demand in response to a decrease in short-run aggregate supply.
Depression A period of unusually severe falling incomes and rising unemployment.
The business cycle
Short-run economic fluctuations model of aggregate demand and aggregate supply
The model most economists use to explain short-run fluctuations in the economy around its long-run trend.
Aggregate supply curve A curve that shows the quantity of goods and services that firms are willing to produce at each price level.
Aggregate demand curve A curve that shows the quantity of goods and services that households, firms, the government, and customers abroad are willing to buy at each price level.
Natural rate of output The production of goods and services that an economy achieves in the long run when unemployment is at its natural or normal rate.
Menu costs Costs associated with changing prices.
Stagflation A period of falling output and rising prices.
Accommodative policy A policy of increasing aggregate demand in response to a decrease in short-run aggregate supply.
Theory of liquidity preference Keynes’s theory that the interest rate is determined by the supply and demand for money in the short run.
Liquidity The ease with which an asset is converted into a medium of exchange.
Federal funds rate The interest rate banks charge one another for short-run loans.
Fiscal policy The setting of the level of government spending and taxation by government policymakers.
Multiplier effect The amplification of the shift in aggregate demand from expansionary fiscal policy, which raises incomes and further increases consumption expenditures.
Investment accelerator The amplification of the shift in aggregate demand from expansionary fiscal policy, which raises investment expenditures.
Marginal propensity to consume (MPC) The fraction of extra income that a household spends on consumption.
Crowding out effect The dampening of the shift in aggregate demand from expansionary fiscal policy, which raises the interest rate and reduces investment spending.
Stabilization policy The use of fiscal and monetary policies to reduce fluctuations in the economy.
Automatic stabilizers Changes in fiscal policy that do not require deliberate action on the part of policymakers.
Misery index The sum of inflation and unemployment.
Natural rate of unemployment The normal rate of unemployment toward which the economy gravitates.
Phillips curve The short-run trade-off between inflation and unemployment.
Natural rate hypothesis The theory that unemployment returns to its natural rate, regardless of inflation.
Disinflation A reduction in the rate of inflation.
Supply shock An event that directly alters firms’ costs and prices, shifting the economy’s aggregate supply curve and, thus, the Phillips curve.
Sacrifice ratio The number of percentage points of annual output that is lost in order to reduce inflation one percentage point.
Rational expectations The theory that suggests that people optimally use all available information, including about government policies, when forecasting the future.