Sunday, September 22, 2013

Economic Terms for the Impatient Learner: What is ...?

New York Stock Exchange on Wall Street in New ...Image via Wikipedia

The aggregate demand curve illustrates the relationship between economic goods demanded and the price level, assuming all else is held constant (that is, under a ceteris paribus assumption).


  is the New York Stock Exchange, the largest physical exchange in the U.S. Is in New York City.

An annuity 

is an asset that pays a constant amount each year to the holder until the annuity expires and/or the holder of the annuity passes away.

An arbitrage opportunity is the opportunity to buy an asset at a low price then immediately selling it on a different market for a higher price.

Autarky is the state of an individual who does not trade with anyone.

The average propensity to consume is the proportion of income the average family spends on goods and services.

The average propensity to save is the proportion of income the average family saves (does not spend on consumption).

Average total cost is the sum of all the production costs divided by the number of units produced.

A country's balance of payments is the quantity of its own currency flowing out of of the country (for purchases, for example, but also for gifts and intrafirm transfers) minus the amount flowing in.

A basis point is one-hundredth of a percentage point. Used in the context of interest rates.

A bear market occurs when almost all stock prices are falling. The term bear market comes from the image of a bear pawing something to the ground.

The Black-Scholes equation

is an equation for option securities prices on the basis of an assumed stochastic process for stock prices. The Black-Scholes algorithm can produce an estimate the value of a call on a stock, using as input:
• an estimate of the risk-free interest rate now and in the near future
• current price of the stock
• exercise price of the option (strike price)
• expiration date of the option

The term blue chip usually refers to a stock, but could in theory apply to any financial asset with potential risk. A blue chip stock is one that entails unusually small risk (risk being a subjective judgment). Stocks that are considered "blue chip" are issued by large stable corporations like IBM.

A bond is a fixed interest financial asset issued by governments, companies, banks, public utilities and other large entities. Bonds pay the bearer a fixed amount a specified end date. A discount bond pays the bearer only at the ending date, while a coupon bond pays the bearer a fixed amount over a specified interval (month, year, etc.) as well as paying a fixed amount at the end date.

The Bretton Woods system was a international monetary framework of fixed exchange rates after World War II. Drawn up by the U.S. and Britain in 1944. Keynes was one of the architects. The Bretton Woods system ended on August 15, 1971, when President Richard Nixon ended trading of gold at the fixed price of $35/ounce. At that point for the first time in history, formal links between the major world currencies and real commodities were severed.

A bull market occurs when almost all stock prices are on the rise. The term bull market comes from the image of a bull flinging things into the air with his horns.

The business cycle frequency is considered to be three to five years. Called the business cycle frequency by Burns and Mitchell (1946), and this became standard language.

A buyer's market is a market for a good (stocks, housing, etc.) where prices are falling and there are more parties interested in selling than in buying.

Cartels are agreements between most or all of the major producers of a good to either limit their production and/or fix prices. Cartels are generally illegal in the United States.

Coupon bonds. A bond can be resold into two parts that can be thought of as components: (1) a principal component that is the right to receive the principal at the end date, and (2) the right to receive the coupon payments. The components are called strips. The right to receive coupon payments is the coupon strip.

Ceteris Paribus means "assuming all else is held constant". The author using ceteris paribus is attempting to distinguish an effect of one kind of change from any others.

The Chicago School refers to an perspective on economics of the University of Chicago circa 1970. Variously interpreted to imply: 1) A preference for models in which information is perfect, and an associated search for empirical evidence that choices, not institutional limitations, are what result in outcomes for people. (E.g., that committing crime is a career choice; that smoking represents an informed tradeoff between health risk and immediate gratification.) 2) That antitrust law is rarely necessary, because potential competition will limit monopolist abuses.
A commodity is good that is generally a primary good used in manufacturing such as timber, cotton, wool and copper.

Comparative advantage requires at least two goods and at least two places where each good could be produced with scarce resources in each place. The example drawn here is from Ehrenberg and Smith (1997), page 136. Suppose the two goods are food and clothing, and that "the price of food within the United States is 0.50 units of clothing and the price of clothing is 2 units of food. [Suppose also that] the price of food in China is 1.67 units of clothing and the price of clothing is 0.60 units of food." Then we can say that "the United States has a comparative advantage in producing food and China has a comparative advantage in producing clothing. It follows that in a trading relationship the U.S. should allocate at least some of its scarce resources to producing food and China should allocate at least some of its scarce resources to producing clothing, because this is the most efficient allocation of the scarce resources and allows the price of food and clothing to be as low as possible.
Famous economist David Ricardo illustrated this in the 1800s using wool in Britain and wine from Portugal as examples. The comparative advantage concept seems to be one of the really challenging, novel, and useful abstractions in economics.

The consumer price index or CPI is a measure of the level of inflation. CPI measures how much the price of a basket of consumer goods has changed over a given time period.

A cost-of-living price index measures the changing cost of a constant standard of living. The index is a scalar measure for each time period. Usually it is a positive number which rises over time to indicate that there was inflation. Two incomes can be compared across time by seeing whether the incomes changed as much as the index did.

The CPI or Consumer Price Index is a measure of the cost of goods purchased by average U.S. household. It is calculated by the U.S. government's Bureau of Labor Statistics.
As a pure measure of inflation, the CPI has some flaws:
1) new product bias (new products are not counted for a while after the appear)
2) discount store bias (consumers who care won't pay full price)
3) substitution bias (variations in price can cause consumers to respond by substituting on the spot, but the basic measure holds their consumption of various goods constant)
4) quality bias (product improvements are under-counted)
5) formula bias (overweighting of sale items in sample rotation).

The current account balance is the difference between a country's savings and its investment. "[If the current account balance is] positive, it measures the portion of a country's saving invested abroad; if negative, the portion of domestic investment financed by foreigners' savings."

The current account balance is defined by the sum of the value of imports of goods and services plus net returns on investments abroad, minus the value of exports of goods and services, where all these elements are measured in the domestic currency.

Cyclical unemployment occurs when the unemployment rate moves in the opposite direction as the GDP growth rate. So when GDP growth is small (or negative) unemployment is high.

Dumping is an informal name for the practice of selling a product in a foreign country for less than either (a) the price in the domestic country, or (b) the cost of making the product. It is illegal in some countries to dump certain products into them, because they want to protect their own industries from such competition.

Depreciation is the decline in price of an asset over time attributable to deterioration, obsolescence, and impending retirement. It applies particularly to physical assets like equipment and structures.

Deflation occurs when prices are declining over time. This is the opposite of inflation; when the inflation rate (by some measure) is negative, the economy is in a deflationary period.

Derivatives are securities whose value is derived from the some other time-varying quantity. Usually that other quantity is the price of some other asset such as bonds, stocks, currencies, or commodities. It could also be an index, or the temperature. Derivatives were created to support an insurance market against fluctuations.

Discount rate has at least two meanings:
(1) The interest rate at which an agent discounts future events in preferences in a multi-period model. Often denoted r. A present-oriented agent discounts the future heavily and so has a HIGH discount rate. Contrast with discount factor. See also future-oriented.
In a discrete time model where agents discount the future by a factor of b, one finds r=(1-b)/b, following from b=1/(1+r).
(2) The Discount Rate is the name of the rate at which U.S. banks can borrow from the U.S. Federal Reserve

Economies of scale. The cost per unit made declines with the number of units produced. It is a descriptive, quantitative term. One measure of the economies of scale is the cost per unit made. There can be analogous economies of scale in marketing or distribution of a product or service too. The term may apply only to certain ranges of output quantity.

Ex ante is latin for "beforehand". In models where there is uncertainty that is resolved during the course of events, the ex antes values (e.g. of expected gain) are those that are calculated in advance of the resolution of uncertainty.

Ex Dividend Date: Firms pay dividends to those who are shareholders on a certain date. The next day is called the ex dividend date. People who own no shares until the ex dividend date do not receive the dividend. The price of the stocks is often adjusted downward before the start of trading on the ex dividend date because to compensate for this.

Ex post. Latin for "after the fact". In models where there is uncertainty that is resolved during the course of events, the ex post values (e.g. of expected gain) are those that are calculated after the uncertainty has been resolved.
A free trader is a holder of the political point of view that the best policy is to allow free trade into one's own country.

The Friedman Rule: In a cash-in-advance model of a monetary system, the Friedman rule for monetary policy is to deflate so that it is not costly to those who have money to continue to hold it. Then the cash-in-advance constraint isn't binding on them.

Glass-Steagall Act: The Glass-Steagall act was a 1933 United States national law separating investment banking and commercial banking firms. Also prohibited banks from owning corporate stock. It was designed to confront the problem that banks in the Great Depression collapsed because they held a lot of stock.

The Gross Domestic Product (GDP) represents the total value of the goods and services produced by an economy over some unit of time (a month, a season, a year etc.). The "Domestic" part of the name comes from the fact, unlike GNP, it does not consider imports or exports in the calculation.

The Gross National Product (GNP) is the value of all the goods and services produced in an economy, plus the value of the goods and services imported, less the goods and services exported.

International Monetary Fund: IMF stands for the International Monetary Fund -- an international organization with liquidity services to maintain financial stability.
Initial Public Offering: IPO stands for "initial public offering", the event of a firm's first sale of stock shares.

The Keynes Effect: As prices fall, a given nominal amount of money will be a larger real amount. Consequently the interest rate would fall and investment demanded rise. This Keynes effect disappears in the liquidity trap. Contrast the Keynes effect with the Pigou effect.

Labor Theory of Value: "Both Ricardo and Marx say that the value of every commodity is (in perfect equilibrium and perfect competition) proportionaly to the quantity of labor contained in the commodity, provided this labor is in accordance with the existing standard of efficiency of production (the 'socially necessary quantity of labor'). Both measure this quantity in hours of work and use the same method in order to reduce different qualities of work to a single standard." And neither accounts well for monopoly or imperfect competition. (Schumpeter, p 23)

Leveraged Buy-Out: LBO stands for leveraged buy-out. The act of taking a public company private by buying it with revenues from bonds, and using the revenues of the company to pay off the bonds.

The Liquidity trap is a Keynesian idea. When expected returns from investments in securities or real plant and equipment are low, investment falls, a recession begins, and cash holdings in banks rise. People and businesses then continue to hold cash because they expect spending and investment to be low. This is a self-fulfilling trap.

The Lorenz Curve is used to discuss concentration of suppliers (firms) in a market. The horizontal axis is divided into as many pieces as there are suppliers. Often it is given a percentage scale going from 0 to 100. The firms are in order of decreasing size. On the vertical axis are the market sales in percentage terms from 0 to 100. The Lorenz curve is a graph of the sales of all the firms to the right of each point on the horizontal axis.

Marginal revenue is the revenue a company gains in producing one additional unit of a good.
M2 is a measure of total money supply. M2 includes everything in M1 and also savings and other time deposits.

Money is a good that acts as a medium of exchange in transactions. Classically it is said that money acts as a unit of account, a store of value, and a medium of exchange. Most authors find that the first two are nonessential properties that follow from the third. In fact, other goods are often better than money at being intertemporal stores of value, since most monies degrade in value over time through inflation or the overthrow of governments.

The Modigliani-Miller Theorem is that the total value of the bonds and equities issued by a firm in a model is independent of the number of bonds outstanding or their interest rate.
The theorem was shown by Modigliani and Miller, 1958 in a particular context with no fixed costs, transactions costs, asymmetric information, and so forth. Analogous theorems are shown in various contexts. The assumptions made by such theorems offer a way of organizing what it would be that makes corporations choose to offer various levels of bonds. The choice of numbers and types of bonds and stocks a corporation offers is the choice of capital structure. Among the factors affecting the capital structure of a firm are taxes, bankruptcy costs, agency costs, signalling, bargaining position in litigation, and differences between firms and investors in access to capital markets.

Mutatis Mutandis: The necessary changes having been made; substituting new terms.
Oligopoly: A market for a good where a few major suppliers account for a large majority of sales.

An option is a contract that gives the holder the right, but not the duty, to make a specified transaction for a specified time.
The most common option contracts give the holder the right buy a specific number of shares of the underlying security (equity or index) at a fixed price (called the exercise price or strike price) for a given period of time. Other option contracts allow the holder to sell.

Pareto Optimal. In an endowment economy, an allocation of goods to agents is Pareto Optimal if no other allocation of the same goods would be preferred by every agent. Pareto optimal is sometimes abbreviated as PO. Optimal is the descriptive adjective, whereas optimum is a noun. A Pareto optimal allocation is one that is a Pareto optimum. There may be only one such optimum.

The Phillips curve is a relation between inflation and unemployment. Follows from William Phillips' 1958 "The relation between unemployment and the rate of change of money wage rates in the United Kingdom, 1861-1957" in Economica.

The Pigou effect is the wealth effect on consumption as prices fall. A lower price level leads to a greater existing private wealth of nominal value, leading to a rise in consumption.

Predatory Pricing. A company engages in predatory pricing when it sets the price of its goods very low in order to eliminate its competitors and prevent new companies from entering into the marketplace.

Price elasticity is a measure of responsiveness of some other variable to a change in price.

The prime rate of interest is a rate of interest that serves as a benchmark for most other loans in a country. The precise definition of prime rate differs from country to country. In the United States, the prime rate is the interest rate banks charge to large corporations for short-term loans.

Private sector companies are ones that are not owned by the government. This is opposed to the public sector that consists of industries such as education and unemployment insurance.

Productivity is a measure relating a quantity or quality of output to the inputs required to produce it. Often means labor productivity, which is can be measured by quantity of output per time spent or numbers employed. Could be measured in, for example, U.S. dollars per hour.

Progressive tax. A tax on income in which the proportion of tax paid relative to income increases as income increases.

A put option is a security which conveys the right to sell a specified quantity of an underlying asset at or before a fixed date.

Recession. A not very well defined term that indicates a slowdown in economic activity. A particularly long-lasting and painful recession is known as a depression.

Rational expectations is an assumption in a model: that the agent under study uses a forecasting mechanism that is as good as is possible given the stochastic processes and information available to the agent.
Often in essence the rational expectations assumption is that the agent knows the model, and fails to make absolutely correct forecasts only because of the inherent randomness in the economic environment.

Regressive tax. A tax on income in which the proportion of tax paid relative to income decreases as income increases.

Regulation Q is a U.S. Federal Reserve System rule limiting the interest rates that U.S. banks and savings and loan institutions could pay on deposits.

The Ricardian proposition is that tax financing and bond financing of a given stream of government expenditures lead to equivalent allocations. This is the Modigliani-Miller theorem applied to the government.

Risk. If outcomes will occur with known or estimable probability the decisionmaker faces a risk. Certainty is a special case of risk in which this probability is equal to zero or one.

The Robinson-Patman Act is U.S. legislation of 1936 which made rules against price discrimination by firms. Agitation by small grocers was a principal cause of the law. They were under competitive pressure and displaced by the arrival of chain stores. The Robinson-Patman Act is thought by many to have prevented reasonable price competition, since it made many pricing actions illegal per se. For many of its provisions, 'good faith' was not a permitted defense. So it can be argued that it was confusing, vague, unnecessarily restrictive, and designed to prevent some competitors in retailing from being driven out rather than to further social welfare generally, e.g. by allowing pricing decisions that would benefit consumers.

Treasury Bills are short-term bonds issued by the government used to pay to cover government spending.

Uncertainty. If outcomes will occur with a probability that cannot even be estimated, the decisionmaker faces uncertainty.
This meaning to uncertainty is attributed to Frank Knight, and is sometimes referred to as Knightian uncertainty.

The unemployment rate is the percentage of the population who are willing to work for the current market wage for someone of his or her skill level but cannot find employment.

Utilitarianism is a moral philosophy, generally operating on the principle that the utility (happiness or satisfaction) of different people can not only be measured but also meaningfully summed over people and that utility comparisons between people are meaningful. That makes it possible to achieve a well-defined societal optimum in allocations, production, and other decisions, and achieve the goal utilitarian British philosopher Jeremy Bentham described as "the greatest good for the greatest number."

A value added tax is a form of sales or consumption tax that is used in many countries around the world including Canada (GST) , Australia (GST) and all member countries of the European Union (EU VAT).

A Walrasian auctioneer is a hypothetical market-maker who matches suppliers and demanders to get a single price for a good. One imagines such a market-maker when modeling a market as having a single price at which all parties can trade.
Such an auctioneer makes the process of finding trading opportunities perfect and cost free; consider by contrast a "search problem" in which there is a stochastic cost of finding a partner to trade with and transactions costs when one does meet such a partner.

A wage curve is a graph of the relation between the local rate of unemployment, on the horizontal axis, and the local wage rate, on the vertical axis. Blanchflower and Oswald show that this relation is downward sloping. That is, locally high wages and locally low unemployment are correlated.
The World Bank is a collection of international organizations to aid countries in their process of economic development with loans, advice, and research. It was founded in the 1940s to aid Western European countries after World War II with capital

A zero-sum game is a game in which total winnings and total losings sum to zero for each possible outcome.
A yellow-dog contract is a requirement by a firm that the worker agree not to engage in collective labor action. Such contracts are not enforceable in the U.S.

How to Diversify

Debt Financing

Credit Scores

P/E Ratio, Crystal Ball

Fixed Index Annuities

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Current Liabilities

Adam Smith and Wealth

Personal Budgeting

Investing in Stocks

Professor Guerrero Laws for Wealth

Economic Terms for the Impatient: What is ...?

Senada Selmani, model

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