Glossary

absolute advantage: A person or a country has an absolute advantage in the production of a particular good if, given a set of available inputs, they can produce more of it than another person or country.
asymmetric information: Information that is relevant to the parties in an economic interaction, but is known by some but not by others.
audit study: A type of experiment in which trained individuals called auditors pretend to apply for a service or enter a marketplace to test for discrimination. To do this they pretend to have matching characteristics, except for the one being tested.
autocracy: A political system in which one person, typically together with a small inner circle of elites, makes governmental decisions with few or no limitations. A dictatorship is a form of autocracy.
average product of labor: The total amount produced divided by the units of labor.
average total cost: Average total costs are the total cost of producing the firm’s output divided by the total number of units of output produced.
bargaining power: The extent of a person or firm’s advantage in securing a larger share of the economic rents made possible by an interaction.
best response: Given an action by another person, the action selected by doing the best you can is called the best response to the other’s action.
capital goods, capital: Capital goods (sometimes shortened to “capital”) are the durable and costly non-labor inputs used in production, such as machinery, equipment, and buildings. Capital does not include some essential inputs (such as air, water, and knowledge) that are used in production at zero cost to the user.
capital-intensive technology: A technology that requires a comparatively large amount of capital goods, such as equipment, machinery, and buildings.
capitalism: An economic system in which the main form of economic organization is the firm, where the private owners of capital goods hire labor to produce goods and services to be sold in markets with the intent of making a profit. The main economic institutions in a capitalist economic system are private property, markets, and firms.
causal, causality, causation: We say that a relationship between two variables is causal if we can establish that a change in one variable produces a change in the other. While a correlation is simply an assessment that two variables have moved together, causation implies a mechanism accounting for the association.
centrally planned economic system: In a centrally planned economy, decisions about what and how to produce are made by the government, rather than by firms responding to market prices.
comparative advantage: A person or a country has a comparative advantage in the production of a particular good if their cost of producing it, relative to the cost of another good, is lower than for another person or a country.
complete contract: A contract is complete if it (a) covers all aspects of the exchange in which any party to the exchange has an interest, and (b) is enforceable (by the courts) at close to zero cost to the parties.
conflict of interest: People have a conflict of interest when they disagree about the outcome of a decision or an allocation. Conflicts of interest over gains from cooperation exist because people disagree about who should get a larger share of the gains.
constant returns to scale: When production exhibits constant returns to scale, increasing all of the inputs to a production process by the same proportion increases output by the same proportion.
consumer surplus: Each consumer who buys a good receives a surplus equal to their willingness to pay minus the price. The term “consumer surplus” normally refers to the sum of these surpluses across all consumers.
cooperation: Cooperation means participating in a common project that is intended to produce mutual benefits.
correlation: A statistical association observed between two variables in a sample of data. If high values of one variable (such as people’s earnings) commonly occur along with high values of another variable (such as years of education), then the variables are positively correlated. When high values of one variable (such as air pollution) are associated with low values of the other variable (such as life expectancy), then the variables are negatively correlated. Correlation doesn’t mean that there is a causal relationship between the variables. For example, air pollution may not have caused the lower life expectancy we observed.
correspondence study: A type of experiment in which experimenters send out fictitious applications submitted online or via the mail. The experimenters randomly vary the specific characteristics they are interested in studying.
deadweight loss: Deadweight loss is a measure of the total loss of surplus (that is, potential gains from trade) relative to the maximum available in the market.
decile: A decile is a group containing 10% of the population.
decreasing returns to scale: When production exhibits decreasing returns to scale, increasing all of the inputs to a production process by the same proportion increases output by a lower proportion.
demand: Demand refers to the relationship between a product’s price and how much buyers are willing and able to buy at each possible price. See also demand curve (firm) and quantity demanded.
demand curve (firm): A firm’s demand curve is a graph that shows how much of the firm’s product people want to buy at different prices. See also demand and quantity demanded.
democracy: A political system that ideally gives equal political power to all citizens; it is defined by individual rights such as freedom of speech, assembly, and the press, and by fair elections in which virtually all adults are eligible to vote and the government leaves office if it loses.
developmental state: A government that takes a leading role in promoting the process of economic development through its public investments, subsidies of particular industries, education, and other public policies.
differentiated product: A differentiated product is a product with some unique characteristics compared to similar products produced by other firms.
disaggregated data: Data that have been broken down or separated into smaller groups or categories, such as region, age, income, education, gender, or race.
discrimination: The practice of treating people differently based on their membership, or perceived membership, in a group or category, such as race, gender, class, age, disability, religion, or national origin.
division of labor: The specialization of producers to carry out different tasks in the production process.
doing the best you can: Doing the best you can means that, from the set of actions available to them, people will choose the action that they believe will result in the outcome that they value the most, taking into account what they believe the other player will do in response to their choice.
economic rent: Economic rent is the difference between the net benefit (monetary or otherwise) that an individual receives from a chosen action, and the net benefit from the next-best alternative (or reservation option).
economic rent: Economic rent is the difference between the net benefit (monetary or otherwise) that an individual receives from a chosen action, and the net benefit from the next-best alternative (or reservation option).
economic rent: Economic rent is the difference between the net benefit (monetary or otherwise) that an individual receives from a chosen action, and the net benefit from the next-best alternative (or reservation option).
economic rent: Economic rent is the difference between the net benefit (monetary or otherwise) that an individual receives from a chosen action, and the net benefit from the next-best alternative (or reservation option).
economics: Economics is the study of how people interact with each other and with their natural environment in producing and acquiring their livelihoods, and how this changes over time and differs across societies.
economic system: A way of organizing the economy that is distinctive in its basic institutions. Economic systems of the past and present include central economic planning (the Soviet Union in the twentieth century), feudalism (much of Europe in the early Middle Ages), slave economy (the U.S. South and the Caribbean plantation economies prior to the abolition of slavery in the nineteenth century), and capitalism (most of the world’s economies today).
economies of scale: When production exhibits increasing returns to scale, increasing all of the inputs to a production process by the same proportion increases the output by a higher proportion.
elastic demand: Demand is relatively elastic when buyers are very responsive to price changes.
employer: A person who, alone or with others, employs people. The employer is either the firm’s owner(s) or a corporation’s board of directors.
employment contract: A system in which producers are paid for the time they work for their employers.
employment rent: The economic rent a worker receives when the net value of their job exceeds the net value of their next-best alternative (that is, being unemployed or their next-best alternative job). Also known as the cost of job loss.
endowment: A person’s endowments are the things they have that enable them to receive income. They include physical wealth (for example: land, housing, machinery); financial wealth (for example: savings, stocks/shares, bonds); intellectual property (for example: patents, copyrights); knowledge, skills, abilities, and experience that affect labor income; citizenship and rights to work. They can include characteristics such as nationality, gender, race, and social class, if these affect their income.
entrepreneur: A person or firm who creates or is an early adopter of new technologies, organizational forms, and other opportunities.
extreme poverty: Extreme poverty is defined as living below the International Poverty Line of $3 per day in 2021 international dollars. The World Bank defines the International Poverty Line (IPL).
factors of production: Any input into a production process is called a factor of production. Factors of production may include labor, machinery, and equipment (usually referred to as capital), land, energy, and raw materials.
firm: An economic organization in which private owners of capital goods hire and direct labor to produce goods and services for sale on markets to make a profit.
firm-specific assets: Any knowledge, skills, or networks that are only valuable to a person while that person remains employed in a particular firm.
fixed cost: Fixed costs are costs that do not change with the level of output.
gains to cooperation: In a strategic interaction, payoffs in excess of outside options are called the gains to cooperation. Gains to cooperation are also sometimes called rents.
game: A game (in game theory) is a model of a strategic interaction including a list of players, the order of play, the actions (or strategies) available to each player, and the payoffs resulting from each possible combination of players’ payoffs.
game tree: A game tree shows the players, the actions, the sequence of moves, and the payoffs resulting from each possible pathway through the game that results from the actions the players take.
Gross Domestic Product (GDP): A measure of the total output of goods and services produced in an economy in a given period. GDP combines in a single number all the output (or production) carried out by the firms, nonprofit institutions, and government bodies within a country. Household production is part of GDP if it is sold.
gross domestic product (GDP): A measure of the total output of goods and services produced in an economy in a given period. GDP combines in a single number all the output (or production) carried out by the firms, nonprofit institutions, and government bodies within a country. Household production is part of GDP if it is sold.
gross domestic product (GDP) per capita: A measure of the market value of the output of the economy in a given period (GDP) divided by the population.
group or categorical inequality: Inequality between particular social groups (identified, for instance, by a category such as race, nation, caste, gender, or religion). Also known as group inequality.
growth: We say that a country’s economy grows when its GDP per capita increases over time (positive growth rate). If the GDP per capita decreases over time, then the economy shrinks (negative growth rate). A growth rate is a percentage change. The formula to calculate a percentage change is: $\frac{(\text{new number} ‐ \text{old number})}{\text{old number}}$. For example, if Country A had GDP per capita of 10,000 in Year 1 and GDP per capita of 10,200 in Year 2, then Country A experienced economic growth of 2% $\frac{(10,200 ‐ 10,000)}{10,000} = 0.02$, or 2% growth in per capita GDP.
hidden action problem or moral hazards: If there is a conflict of interest between a principal and an agent over the agent taking some action that cannot be observed or cannot be verified by a court, then the principal faces a problem of hidden actions. Because the agent’s behavior is hidden, the agent might act in their own interest instead of doing what’s best for the principal, a situation also known as moral hazard.
incentive-compatibility constraint: The incentive-compatibility constraint (ICC) describes the limits on the outcomes that a first mover in a sequential game may achieve by showing how a second mover will respond to each of the choices that the first mover might make.
Industrial Revolution: A wave of technological advances and organizational changes that began in Britain in the eighteenth century; it transformed an agricultural and craft-based economy into a commercial and industrial economy.
inefficient: Consider two technologies: A and B. If A uses at least the same amount of one or more input(s) and more of another input to produce the same amount of output compared to B, then A is inefficient.
inelastic demand: Demand is relatively inelastic when buyers are not very responsive to price changes.
inequality: Inequality refers to the degree to which income, wealth, or other economic resources are distributed unevenly among people or groups in a society. It can be measured using statistical tools such as income percentiles, the Gini coefficient, or income shares held by different segments of the population (for example, the top 10% vs. the bottom 10%, called the Rich/Poor ratio).
infeasible outcome: An infeasible outcome is one that will not occur, either because it is technically impossible or because one of the two players would never agree to it.
innovation rent: Profits in excess of the opportunity cost of capital that an innovator gets by introducing a new technology, organizational form, or marketing strategy.
institution: An institution is a set of laws and informal rules that regulate social interactions among people, and between people and the biosphere; sometimes also termed ‘the rules of the game.’
institutions: An institution is a set of laws and informal rules that regulate social interactions among people, and between people and the biosphere; sometimes also termed “the rules of the game”.
interdependence principle, principle of interdepence: The outcomes people obtain in economic interactions depend on the actions that they and others take in response to each other and on what they believe about the future.
interdependence principle, principle of interdependence: The outcomes people obtain in economic interactions depend on the actions that they and others take in response to each other and on what they believe about the future.
involuntary unemployment: A person is involuntarily unemployed if they are seeking work, and willing to accept a job at the going wage for people of their level of skill and experience, but unable to secure employment.
isocost line: A line that represents all combinations of inputs that cost a given total amount.
labor discipline model: Employers face a labor discipline problem when they need to give workers an incentive to ensure that they work hard and well. In the labor discipline model, they do this by setting wages that include an economic rent (employment rent), which will be lost if the job is terminated.
labor force: The number of people in the working-age population who are, or wish to be, working outside the household. They are either employed (including self-employed) or unemployed.
labor force participation rate: The ratio of the number of people in the labor force to the population of working age.
labor-intensive technology: A technology that requires a comparatively large amount of human labor.
labor market: The market in which employers offer wages to individuals who may agree to work under their direction. Employers are on the demand side of this market, while workers are on the supply side.
labor market: The market in which employers offer wages to individuals who may agree to work under their direction. Employers are on the demand side of this market, while employees are on the supply side.
labor market: The market in which employers offer wages to individuals who may agree to work under their direction. Employers are on the demand side of this market, while workers are on the supply side.
labor market: The market in which employers offer wages to individuals who may agree to work under their direction. Employers are on the demand side of this market, while employees are on the supply side.
law of demand: According to the law of demand, a decrease in the price of a good will result in an increase in the quantity of the good demanded.
learning by doing: People learn better (less costly) ways of working by developing individual skills and discovering better ways to organize production among members of a team.
long run: The term does not refer to a specific length of time, but instead to what is held constant and what can vary within a model. The short run refers to what happens while some variables (such as prices, wages, or capital stock) are held constant (taken to be exogenous). The long run refers to what happens when these variables are allowed to vary and be determined by the model (they become endogenous). A long-run cost curve, for example, refers to costs when the firm can fully adjust all of the inputs including its capital goods.
marginal cost: A firm’s marginal costs are the increase in total costs when one additional unit of output is produced.
marginal product of labor: The marginal product of an input to production (for example, the marginal product of labor) is the additional amount of output produced in response to a 1-unit increase in the input.
marginal revenue: Marginal revenue is the change in revenue obtained by increasing the quantity sold by one unit.
market: A market enables people to exchange goods and services by means of directly reciprocated transfers (unlike gifts), voluntarily entered into for mutual benefit (unlike theft, taxation), in a way that is often impersonal (unlike transfers among friends, family).
market power: A firm has market power if it can sell its product at a range of feasible prices without losing many potential buyers to competing firms.
market share: Market share is a firm’s proportion of the market in which its product is sold. It can be measured as its share of the total revenue in the market, or of the total quantity sold in the market.
matching market: A market for interactions in which participants in the market have different characteristics from others and will benefit from matching with particular participants in the market. Two examples are: (1) firms and workers in the labor market, and (2) people in what is sometimes called the marriage market.
model: An economic model is a simplified representation of reality used to explain and predict behavior or outcomes.
moral hazard: If there is a conflict of interest between a principal and an agent over the agent taking some action that cannot be observed or cannot be verified by a court, then the principal faces a problem of hidden actions. Because the agent’s behavior is hidden, the agent might act in their own interest instead of doing what’s best for the principal, a situation also known as moral hazard.
natural experiments: An empirical study that exploits a difference in the conditions affecting two populations (or two economies), that has occurred for external reasons: for example, differences in laws, policies, or weather. Comparing outcomes for the two populations gives us useful information about the effect of the conditions, provided that the difference in conditions was caused by a random event. But it would not help, for example, in the case of a difference in policy that occurred as a response to something else that might affect the outcome.
network: A network is a structure composed of interconnected people (or objects) and the connections among them.
network economies of scale: These exist when an increase in the number of users of an output of a firm implies an increase in the value of the output to each of them, because they are connected to each other.
non-verifiable information: Information is non-verifiable if it cannot be verified by a court and therefore cannot be used to enforce a contract.
no-shirking wage: The wage that is just sufficient to motivate a worker to provide effort at the level specified by their employer.
occupational segregation: The uneven distribution of workers across jobs based on characteristics such as gender, race, or ethnicity. It includes both horizontal segregation (different groups in different types of jobs) and vertical segregation (some groups more likely to be in lower-paid or lower-status positions within the same field).
opportunity cost: The opportunity cost is the net benefit of the next-best alternative—what you give up when you make a choice.
outside option: The payoff a player will receive if they do not engage in the particular interaction being modeled. The outside option is also sometimes called the player’s reservation position or reservation option (it is “held in reserve”). Sometimes it is called the next-best alternative because it is the alternative to the agreement that is “next-best” in terms of how good it is.
participation constraint: Each member of an interaction must receive at least their outside option in order to participate in the interaction.
payoff: The players’ payoffs are a list of numbers identifying how much the players value each combination of actions that they can take in the game.
personal cost of working: The net physical and psychological costs of doing the work an employer asks of a worker.
piece rate: Under a piece rate contract, a worker is paid a fixed amount (the “rate”) for each unit (“piece”) of the product made.
political system: A political system determines how governments will be selected and how those governments will make and implement decisions that affect all or most members of a population.
population of working age: A statistical convention, which in many countries is all people aged between 15 and 64 years.
power: The ability to do and get the things we want in opposition to the intentions of others.
predatory pricing: Predatory pricing occurs when an incumbent firm charges a price lower than its marginal costs, seeking to drive its competitors out of business.
price discrimination: A selling strategy in which different prices are set for different buyers or groups of buyers based on the buyers’ differing willingness to pay.
price elasticity of demand: The price elasticity of demand is a measure of buyers’ responsiveness to a price change.
price markup: The price markup is the price a firm charges per unit minus the unit costs.
principle-agent problem or principle-agent relationship: A principal-agent relationship or principal-agent problem exists when one party (the principal) would like another party (the agent) to act in some way, or have some attribute, that is in the interest of the principal, and that action or attribute cannot be enforced or guaranteed in a binding contract.
principle of individual and societal interests: Individuals doing the best they can often does not lead to the best outcomes for all people or for the environment.
principle of mutual gains: People mutually benefit by interacting with others, but there are typically conflicts over the distribution of these gains.
principle of mutual gains and conflicts from exchange: People mutually benefit by interacting with others but there are typically conflicts over the distribution of these gains.
principle of trade-offs and opportunity cost: The gains you make by choosing some action typically come at the cost of gains that would have been possible had you acted differently.
private property: Something is private property if the person possessing it has the right to exclude others from it, to benefit from the use of it, and to exchange it with others.
producer surplus: The producer of a good receives a surplus on each unit, equal to the price minus the marginal cost of producing it. The term “producer surplus” normally refers to the sum of these surpluses across all units sold.
production function: A production function is a graphical or mathematical description of the relationship between the quantities of the inputs to a production process and the amount of output produced.
product market: The markets where goods or services are sold to households, other firms, and governments.
profit claimant: The person or persons who receive a firm’s remaining income after the payment of all contractual costs (for example, the cost of hiring workers and paying taxes). Also known as residual claimant because the profit is “the residual” after contractual costs have been paid.
profits: A firm’s profits are the difference between its total revenue and total costs, including opportunity costs.
purchasing power parity (PPP): Purchasing power parity is a price index that measures how much it costs to purchase a basket of goods and services in a specific country compared to how much it costs to purchase the same basket in a reference country in a particular year, such as the United States in 2011.
quantity demanded: Quantity demanded is the amount of a product people are willing to buy at a particular price. It refers to a specific point on the demand curve where price is fixed at a given level. See also demand and demand curve (firm).
quit rate: The quit rate is the number of quits—people voluntarily leaving their job—during the entire month as a percent of the total level of employment.
real wages: The wage expressed in terms of the amount of goods and services the worker can buy with it.
recession: The US National Bureau of Economic Research defines a recession as a period when output is declining. It is over once the economy begins to grow again.
relative prices: The price of one good or service compared to another (usually expressed as a ratio of the two prices).
rent: A player’s rent is the benefit they receive in excess of their outside option.
reservation wage: The reservation wage is the lowest wage a worker is willing to accept to take up a new job. It is the wage available in the worker’s next-best job option (the outside option). For workers whose next-best option is unemployment, the reservation wage takes into account the wages they expect to receive when they find a new job as well as any income received while unemployed.
rich/poor ratio: The rich/poor ratio is the ratio of the average income of the richest 10% of the population to the average income of the poorest 10% of the population within a country. It is a measure of inequality in a country.
rule of law: There is rule of law when all people and institutions in a country are subject to the same laws: “All are equal in the eyes of the law.”
rules of the game principle: The rules of the game affect how the players play the game, the size of the gains from cooperation available to the players, and how the gains are divided among the players.
rules of the game principle: The rules of the game affect how the players play the game, the size of the gains from cooperation available to the players, and how the gains are divided among the players.
rules of the game principle: The rules of the game affect how the players play the game, the size of the gains from cooperation available to the players, and how the gains are divided among the players.
rules of the game principle: The rules of the game affect how the players play the game, the size of the gains from cooperation available to the players, and how the gains are divided among the players.
search unemployment: Since workers differ from each other, and so do jobs, unemployed workers and firms with vacancies spend time searching for an employment match that suits them both. Unemployment caused by the search and matching process is called search unemployment.
separation of ownership and control: The attribute of some firms by which top managers are a separate group from the profit claimants.
shares: Shares (also known as stocks) are financial assets that can be bought and sold, giving their owners (the shareholders) a right to vote on certain matters, such as who is on the Board of Directors, and a right to receive a corresponding share of the firm’s profit should any of that profit be paid out to the shareholders.
shirking: Occurs when a worker does not exert the effort that the employer demands.
slope: Slope is a measure of a line’s steepness, often represented by the letter ‘m’ and calculated as the ratio of the vertical change (rise) to the horizontal change (run) between any two points, such as $(x_1, y_1)$ and $(x_2, y_2)$, on the line. The formula for slope is $m = (y_2 ‐ y_1) / (x_2 ‐ x_1)$. A larger slope indicates a steeper line, while a slope of zero means a horizontal line. A line that slopes upwards has a positive slope, whereas a line that slopes downwards has a negative slope.
social preferences: A person is said to have social preferences if their goal depends on what happens to other people, as well as on their own payoffs.
specialization: Specialization exists when workers, organizations, or countries concentrate on producing a limited set of goods or performing specific tasks. This often happens through the division of labor—a system where production is broken into smaller tasks and different people or groups take on different parts of production.
strategic asymmetry: Strategic asymmetry exists when one side of a strategic interaction has more power to make offers, set the rules of the game, or move first in the interaction. Because of this advantage, they can shape the outcome in their favor.
strategic interaction: A strategic interaction is an interaction in which each actor knows that what they get from the interaction depends on what they do and on what other people do, including how others respond to each person’s action.
structural power: The extent of a person or firm’s advantage in a bargain that is determined by the relative value of their next-best alternative to the bargain.
substitutes: Two goods (or services) are substitutes when buyers will readily replace one with the other if the prices are similar. If the price of one of the goods increases, buyers will be more likely to choose the other (so demand for it will increase).
technically feasible and infeasible outcomes: An outcome is technically feasible when the available technologies and resources make it possible to be achieved. An outcome is technically infeasible when the available technologies and resources make it not possible to be achieved.
technological innovation: A change in technology that reduces the amount of resources (labor, machines, land, energy, time) required to produce a given amount of the output.
technological progress: A change in technology that reduces the amount of resources (labor, machines, land, energy, time) required to produce a given amount of the output.
technological progress: A change in technology that reduces the amount of resources (labor, machines, land, energy, time) required to produce a given amount of the output.
technological progress: A change in technology that reduces the amount of resources (labor, machines, land, energy, time) required to produce a given amount of the output.
technological progress: A change in technology that reduces the amount of resources (labor, machines, land, energy, time) required to produce a given amount of the output.
technology: A process that uses a set of materials and other inputs, including the work of people and machines, to produce an output.
the distribution of income: The distribution of income describes how income in a society is divided among its people or groups, such as between individuals, households, or social classes.
the principle of doing the best you can: Doing the best you can means that, from the set of actions available to them, people will choose the action that they believe will result in the outcome that they value the most, taking into account what they believe the other player will do in response to their choice.
total cost: A firm’s total costs are the sum of all the costs it incurs to produce its total output, including opportunity costs.
total revenue: A firm’s total revenue is the number of units sold times the price per unit.
trade or labor union: An organization consisting predominantly of workers, the main activities of which include the negotiation of wages and conditions of employment for its members, for example, work hours and safety conditions.
unemployed worker: A worker who is not currently employed but is able to work and is currently looking for a job.
unemployment benefits: A government transfer that is paid to an unemployed person while they are unemployed (or for part of the unemployment period). In the United States, the government calls unemployment benefits “unemployment insurance” or UI, and amounts, eligibility, and other rules vary by state.
unemployment rate: The unemployment rate is the fraction of the labor force that is seeking work but is not currently employed.
variable cost: Variable costs are costs that change with the level of output.
willingness to pay: Willingness to pay is an indicator of how much a buyer values a good, measured by the maximum amount they will pay to acquire a unit of that good.