Glossary
Aggregate Demand (AD)
The total demand for all goods and services produced in an economy at a given price level and in a given time period.
Example:
Increased government spending or consumer confidence can shift the Aggregate Demand curve to the right.
Contractionary Fiscal Policy
Government actions, such as decreasing government spending or increasing taxes, aimed at reducing aggregate demand to combat inflation.
Example:
To cool down an overheated economy, the government might implement contractionary fiscal policy by cutting public works projects.
Contractionary Monetary Policy
Actions taken by the central bank, such as increasing interest rates or selling bonds, to decrease the money supply and reduce aggregate demand.
Example:
The Fed might use contractionary monetary policy by raising the federal funds rate to curb high inflation.
Cost-Push Inflation
Inflation caused by a decrease in aggregate supply due to increased production costs, leading to higher prices and decreased real GDP.
Example:
A sharp increase in global oil prices can cause cost-push inflation as transportation and production costs rise for many businesses.
Deflation
A decrease in the general price level of goods and services, often associated with a contraction in the money supply and economic slowdown.
Example:
During periods of deflation, consumers might delay purchases, expecting prices to fall even further, which can hurt businesses.
Demand-Pull Inflation
Inflation caused by an increase in aggregate demand, leading to higher prices and increased real GDP.
Example:
A sudden surge in consumer confidence and spending after a tax cut could lead to demand-pull inflation as 'too much money chases too few goods'.
Discount Rate
The interest rate at which commercial banks can borrow money directly from the Federal Reserve.
Example:
A decrease in the discount rate makes it cheaper for banks to borrow, encouraging more lending and expanding the money supply.
Federal Reserve (the Fed)
The central bank of the United States, responsible for managing the nation's money supply and implementing monetary policy.
Example:
The Federal Reserve might raise interest rates to slow down an overheating economy and combat inflation.
Inflation
A sustained increase in the general price level of goods and services in an economy over a period of time.
Example:
If the price of a typical basket of groceries, including bread, milk, and eggs, consistently rises each month, the economy is experiencing inflation.
Inflationary Gap
A situation where the actual real GDP is greater than the potential real GDP, leading to upward pressure on prices.
Example:
When an economy is operating beyond its full employment level, it experiences an inflationary gap, indicating overheating.
Monetary Neutrality
The theory that changes in the money supply only affect nominal variables (like prices and wages) but have no long-run impact on real variables (like output and employment).
Example:
According to monetary neutrality, doubling the money supply would eventually just double all prices and wages, leaving real economic activity unchanged.
Money Supply
The total amount of currency and other liquid assets in an economy at a given time.
Example:
When the money supply increases, there's more cash available for people to spend, which can lead to higher prices.
Nominal Variables
Economic variables measured in monetary units, such as the price level, nominal GDP, or nominal wages.
Example:
Your paycheck amount in dollars is a nominal variable, as it doesn't account for changes in purchasing power.
Open Market Operations
The buying and selling of government securities by the Federal Reserve to control the money supply.
Example:
To increase the money supply, the Fed conducts open market operations by purchasing government bonds from commercial banks.
Quantity Theory of Money
A theory stating that the money supply multiplied by the velocity of money equals the price level multiplied by real output (M x V = P x Y).
Example:
The Quantity Theory of Money suggests that if the central bank rapidly expands the money supply while output and velocity are stable, inflation will result.
Real Variables
Economic variables measured in physical units or adjusted for inflation, such as real GDP, real wages, or employment.
Example:
The actual quantity of goods and services your paycheck can buy is a real variable, reflecting your true purchasing power.
Reserve Ratio
The fraction of deposits that banks are required to hold in reserve and not lend out.
Example:
If the Fed lowers the reserve ratio, banks can lend out a larger portion of their deposits, increasing the money supply.
Short-run Aggregate Supply (SRAS)
The total quantity of goods and services that firms are willing and able to produce at different price levels in the short run.
Example:
If wages for workers suddenly increase across the board, the Short-run Aggregate Supply curve will shift to the left.
Supply Shocks
Unexpected events that suddenly increase or decrease the supply of a commodity or service, often leading to significant price changes.
Example:
A major natural disaster destroying crops would be a negative supply shock, leading to higher food prices.
Velocity of Money
The average number of times a unit of money is spent on new goods and services in a specific period.
Example:
If people are quickly spending and re-spending their money, the velocity of money is high, indicating active economic transactions.
Wage-Price Spiral
A macroeconomic phenomenon where rising wages lead to higher production costs, which in turn lead to higher prices, prompting demands for even higher wages.
Example:
If workers demand higher pay due to rising living costs, and businesses raise prices to cover those wages, it can create a wage-price spiral.