Specially created for the UNILAG Economics Department students

1. When something unexpected happens that affects one economy (or
part of an economy) more than the rest. This can create big problems
for policymakers if they are trying to set a macroeconomic policy that
works for both the area affected by the shock and the unaffected
area. For instance, some economic areas may be oil exporters and thus
highly dependent on the price of oil, but other areas are not. If the oil
price plunges, the oil-dependent area would benefit from policies
designed to boost demand that might be unsuited to the needs of the
rest of the economy. This may be a constant problem for those
responsible for setting the interest rate for the euro given the big
differences--and different potential exposures to shocks--among the
economies within the euro zone.
ASYMMETRIC SHOCK

2. Boom and bust. The long-run pattern of economic growth
and recession. According to the Centre for International
Business Cycle Research at Columbia University, between
1854 and 1945 the average expansion lasted 29 months and
the average contraction 21 months. Since the second world
war, however, expansions have lasted almost twice as long,
an average of 50 months, and contractions have shortened
to an average of only 11 months.
BUSINESS CYCLE

3. An economy that does not take part in
international trade; the opposite of an
OPEN ECONOMY. At the turn of the
century about the only notable
example left of a closed economy is
North Korea.
CLOSED ECONOMY

4. Deflation is a persistent fall in the
general price level of goods and
SERVICES. It is not to be confused with a
decline in prices in one economic
sector or with a fall in the INFLATION
rate (which is known as DISINFLATION).
DEFLATION

5. People generally spend a smaller share of their BUDGET on
food as their INCOME rises. Ernst Engel, a Russian statistician,
first made this observation in 1857. The reason is that food is a
necessity, which poor people have to buy. As people get
richer they can afford better-quality food, so their food
spending may increase, but they can also afford LUXURIES
beyond the budgets of poor people. Hence the share of
food in total spending falls as incomes grow.
ENGEL'S LAW

6. One of the two instruments of macroeconomic policy; monetary
policy's side-kick. It comprises public spending and taxation, and any
other government income or assistance to the private sector (such as
tax breaks). It can be used to influence the level of demand in the
economy, usually with the twin goals of getting unemployment as low
as possible without triggering excessive inflation. At times it has been
deployed to manage short-term demand through fine tuning, although
since the end of the keynesian era it has more often been targeted on
long-term goals, with monetary policy more often used for shorter-term
adjustments.
FISCAL POLICY

7. Short for gross national product, another
measure of a country's economic performance.
It is calculated by adding to GDP the income
earned by residents from investments abroad,
less the corresponding income sent home by
foreigners who are living in the country.
GNP

8. Very, very bad. Although people debate when, precisely, very rapid INFLATION turns
into hyper-inflation (a 100% or more increase in PRICES a year, perhaps?) nobody
questions that it wreaks huge economic damage. After the first world war, German
prices at one point were rising at a rate of 23,000% a year before the country’s
economic system collapsed, creating a political opportunity grasped by the Nazis. In
former Yugoslavia in 1993, prices rose by around 20% a day. Typically, hyper-inflation
quickly leads to a complete loss of confidence in a country’s currency, and causes
people to search for other forms of MONEY that are a better store of value. These may
include physical ASSETS, GOLD and foreign currency. Hyper-inflation might be easier
to live with if it was stable, as people could plan on the basis that prices would rise at a
fast but predictable rate. However, there are no examples of stable hyper-inflation,
precisely because it occurs only when there is a crisis of confidence across the
economy, with all the behavioural unpredictability this implies.
HYPER-INFLATION

9. Investment from abroad; the
opposite of OUTWARD INVESTMENT.
INWARD INVESTMENT

10. The shape of the trend of a country’s trade balance following a
DEVALUATION. A lower EXCHANGE RATE initially means cheaper
EXPORTS and more expensive IMPORTS, making the current account
worse (a bigger DEFICIT or smaller surplus). After a while, though, the
volume of exports will start to rise because of their lower PRICE to foreign
buyers, and domestic consumers will buy fewer of the costlier imports.
Eventually, the trade balance will improve on what it was before the
devaluation. If there is a currency APPRECIATION there may be an
inverted J-curve.
J-curve

11. A branch of ECONOMICS, based, often loosely, on the ideas of KEYNES, characterised
by a belief in active GOVERNMENT and suspicion of market outcomes. It was
dominant in the 30 years following the second world war, and especially during the
1960s, when FISCAL POLICY became bigger-spending and looser in most developed
countries as policymakers tried to kill off the BUSINESS CYCLE. During the 1970s, widely
blamed for the rise in INFLATION, Keynesian policies gradually gave way to
monetarism and microeconomic policies that owed much to the NEO-CLASSICAL
ECONOMICS that Keynes had at times opposed. Even so, the idea that PUBLIC
SPENDING and TAXATION have a crucial role to play in managing DEMAND, in order
to move towards FULL EMPLOYMENT, remained at the heart of MACROECONOMIC
POLICY in most countries, even after the monetarist and supply-side revolution of the
1980s and 1990s. Recently, a school of new, more pro-market Keynesian economists
has emerged, believing that most markets work, but sometimes only slowly.
KEYNESIAN

12. Old news. Some economic statistics move
weeks or months after changes in the
BUSINESS CYCLE or INFLATION. They may
not be a reliable guide to the current state
of an economy or its future path. Contrast
with LEADING INDICATORS.
LAGGING
INDICATORS

13. The big picture: analysing economy-wide phenomena such as
GROWTH, INFLATION and UNEMPLOYMENT. Contrast with
MICROECONOMICS, the study of the behaviour of individual markets,
workers, households and FIRMS. Although economists generally
separate themselves into distinct macro and micro camps,
macroeconomic phenomena are the product of all the
microeconomic activity in an economy. The precise relationship
between macro and micro is not particularly well understood, which
has often made it difficult for a GOVERNMENT to deliver well-run
MACROECONOMIC POLICY.
MACROECONOMICS

14. The school of ECONOMICS that developed the free-market ideas of
CLASSICAL ECONOMICS into a full-scale model of how an economy
works. The best-known neo-classical economist was ALFRED MARSHALL,
the father of MARGINAL analysis. Neo-classical thinking, which mostly
assumes that markets tend towards EQUILIBRIUM, was attacked by
KEYNES and became unfashionable during the Keynesian-dominated
decades after the second world war. But, thanks to economists such as
MILTON FRIEDMAN, many neo-classical ideas have since become
widely accepted and uncontroversial.
NEO-CLASSICAL
ECONOMICS

15. How far an economy’s current OUTPUT is below what it would be at full
CAPACITY. On average, INFLATION rises when output is above potential
and falls when output is below potential. However, in the short run, the
relationship between inflation and the output gap can deviate from the
longer-term pattern and can thus be misleading. Alas for policymakers –
because nobody really knows what an economy’s potential output is,
the size and even the direction of the output gap can easily be
misdiagnosed, which can contribute to serious errors in
MACROECONOMIC POLICY.
OUTPUT GAP

16. A In 1958, an economist from New Zealand, A.W.H. Phillips (1914-75),
proposed that there was a trade-off between INFLATION and
UNEMPLOYMENT: the lower the unemployment rate, the higher was the
rate of inflation. Governments simply had to choose the right balance
between the two evils. He drew this conclusion by studying nominal
wage rates and jobless rates in the UK between 1861 and 1957, which
seemed to show the relationship of unemployment and inflation as a
smooth curve.
Economies did seem to work like this in the 1950s and 1960s, but then
the relationship broke down. Now economists prefer to talk about the
NAIRU, the lowest rate of unemployment at which inflation does not
accelerate.
PHILLIPS CURVE

17. The foundation stone of MONETARISM. The theory says that the quantity of MONEY
available in an economy determines the value of money. Increases in the MONEY
SUPPLY are the main cause of INFLATION. This is why Milton FRIEDMAN claimed that
'inflation is always and everywhere a monetary phenomenon'.
The theory is built on the Fisher equation, MV = PT, named after Irving Fisher (1867-
1947). M is the stock of money, V is the VELOCITY OF CIRCULATION, P is the average
PRICE level and T is the number of transactions in the economy. The equation says,
simply and obviously, that the quantity of money spent equals the quantity of money
used. The quantity theory, in its purest form, assumes that V and T are both constant, at
least in the short-run. Thus any change in M leads directly to a change in P. In other
words, increase the money supply and you simply cause inflation.
QUANTITY THEORY
OF MONEY

18. Policies to pump up DEMAND and
thus boost the level of economic
activity. Monetarists fear that such
policies may simply result in higher
INFLATION.
REFLATION

19. GOVERNMENT policies intended to smooth the economic cycle,
expanding DEMAND when UNEMPLOYMENT is high and reducing it
when INFLATION threatens to increase. Doing this by FINE TUNING has
mostly proved harder than KEYNESIAN policymakers expected, and it
has become unfashionable. However, the use of automatic stabilisers
remains widespread. For instance, social handouts from the state
usually increase during tough times, and taxes increase (FISCAL DRAG),
boosting government revenue, when the economy is growing.
STABILISATION

20. Payments that are made without any
good or service being received in return.
Much PUBLIC SPENDING goes on transfers,
such as pensions and WELFARE benefits.
Private-sector transfers include charitable
donations and prizes to lottery winners.
TRANSFERS

21. If you pay your cleaner or builder in cash, or for some reason neglect to
tell the taxman that you were paid for a service rendered, you
participate in the underground or black economy. Such transactions do
not normally show up in the figures for GDP, so the black economy may
mean that a country is much richer than the official data suggest. In the
United States and the UK, the black economy adds an estimated 5-10%
to GDP; in Italy, it may add 30%. As for Russia, in the late 1990s estimates
of the black economy ranged as high as 50% of GDP.
UNDERGROUND
ECONOMY

22. This usually refers to FIRMS, where it is defined as the value of the firm's OUTPUT minus
the value of all its inputs purchased from other firms. It is therefore a measure of the
PROFIT earned by a particular firm plus the wages it has paid. As a rule, the more
value a firm can add to a product, the more successful it will be. In many countries,
the main form of INDIRECT TAXATION is value-added tax, which is levied on the value
created at each stage of production. However, it is paid, ultimately, by whoever
consumes the finished product.
Another definition of value added refers to the change in the overall economic value
of a company. This takes into account changes in the combined value of its SHARES,
ASSETS, DEBT and other liabilities. Part of the pay of company bosses is often linked to
how much economic value is added to the company under their management.
VALUE ADDED

23. The difference between basic pay and total
earnings. Wage drift consists of things such as
overtime payments, bonuses, PROFIT share and
performance-related pay. It usually increases
during periods of strong GROWTH and declines
during an economic downturn.
WAGE DRIFT

24. Producing OUTPUT at the minimum possible cost. This is not
enough to ensure the best sort of economic EFFICIENCY,
which maximises society's total CONSUMER plus PRODUCER
SURPLUS, because the quantity of output produced may not
be ideal. For instance, a MONOPOLY can be an X-efficient
producer, but in order to maximise its PROFIT it may produce
a different quantity of output than there would be in a
surplus-maximising market with PERFECT COMPETITION.
X-efficiency

25. The annual income from a SECURITY, expressed
as a percentage of the current market PRICE of
the security. The yield on a SHARE is its DIVIDEND
divided by its price. A BOND yield is also known
as its INTEREST RATE: the annual coupon divided
by the market price.
YIELD

26. When the gains made by winners in an economic transaction
equal the losses suffered by the losers. It is identified as a
special case in GAME THEORY. Most economic transactions
are in some sense positive-sum games. But in popular
discussion of economic issues, there are often examples of a
mistaken zero-sum mentality, such as “PROFIT comes at the
expense of WAGES”, “higher PRODUCTIVITY means fewer
jobs”, and “IMPORTS mean fewer jobs here”.
ZERO-SUM GAME