Economics

Economic Basics

1 + 1 = 2
2 + 2 = 4
Absolute Advantage – Ability of a country or party to produce a good or service more efficiently than its competitors
Adverse Selection – Situation where asymmetric information before a transaction leads to a market dominated by low-quality products
Barrier to Entry – Obstacle that makes it difficult for a new company to enter a market and compete
Buy Low, Sell High – Foundational strategy of purchasing assets at a low price & selling at a high price
Capital Gains – Profit earned from the sale of an asset or investment when its selling price exceeds its purchase price
Circular Flow Model – Diagram that illustrates the continuous movement of money & resources in an economy
Comparative Advantage – Ability to produce a good at a lower opportunity cost than a trading partner
Compound Interest – Earning interest on previous interest to accelerate growth over time
Cost-Benefit Analysis – Systematic process for calculating and comparing strengths and weaknesses of alternative courses of action
Crowding Out – Situation where increased government spending leads to a reduction in private sector spending
Deadweight Loss – Loss of economic efficiency that can occur when the equilibrium for a good or service is not achieved
Diminishing Marginal Utility – Principle that the additional satisfaction from consuming one more unit of a good declines with each additional unit consumed
Diversification – Risk management strategy of spreading investments across various assets to reduce exposure
Economic Rent – Extra payment made to a factor of production above the amount needed to keep it in its current use
Economies of Scale – Cost advantage that arises with increased output of a product, as fixed costs are spread over more units
Efficient Market Hypothesis – Theory that asset prices fully reflect all available information, making it impossible to consistently achieve higher returns
Elasticity of Demand – Measure of how much the quantity demanded of a good changes when its price changes
Externality – Cost or benefit imposed on a third party who did not agree to incur that cost or benefit
Fiat Money – Currency that is not backed by a physical commodity but rather by the government that issued it
Game Theory – Study of mathematical models of strategic interaction among rational decision-makers
Gains from Trade – Net benefits that agents achieve when they engage in voluntary exchange with one another
Gini Coefficient – Statistical measure of economic inequality in a population, represented as a ratio between 0 and 1
Human Capital – Skills, knowledge, and experience possessed by an individual or population, viewed in terms of their value or cost
Inflation – Rate at which the general level of prices for goods & services is rising
Law of Diminishing Returns – Principle that adding more of one input will eventually yield lower incremental returns
Law of Unintended Consequences – Concept that actions always have effects that are unanticipated or unplanned
Leverage – Use of borrowed capital to increase the potential return of an investment
Liquidity – Ease with which an asset or security can be converted into ready cash without affecting its market price
Marginal Analysis – Process of comparing the additional benefits of an action to its additional costs
Marginal Propensity to Consume – Proportion of an aggregate raise in pay that a consumer spends on goods and services rather than saving it
Monetary Policy – Process by which a central bank manages the money supply and interest rates to influence a nation’s economy
Monopoly – Market structure characterized by a single seller selling a unique product in the market with no close substitutes
Moral Hazard – Situation where one party is willing to take more risks because the costs of those risks will be borne by another party
Multiplier Effect – Proportionate amount of increase in final income that results from an injection of spending
Nominal vs. Real Value – Distinction between value measured in current money terms and value adjusted for inflation
Opportunity Cost – Real cost of any decision measured by the value of the next best alternative forgone
Pareto Efficiency – State of allocation of resources in which it is impossible to make any one individual better off without making another worse off
Phillips Curve – Historical inverse relationship between rates of unemployment and corresponding rates of inflation in an economy
Present Value – Current worth of a future sum of money or stream of cash flows given a specified rate of return
Price Elasticity of Supply – Measure of how much the quantity supplied of a good changes when its price changes
Principal-Agent Problem – Conflict in priorities between the owner of an asset and the person to whom control of the asset has been delegated
Production Possibility Frontier – Curve depicting the maximum output possibilities for two goods, given a set of limited resources
Purchasing Power Parity – Theory that states exchange rates between currencies are in equilibrium when purchasing power is the same
Quantity Theory of Money – Framework that states the general price level of goods and services is proportional to the amount of money in circulation
Quota – Government-imposed trade restriction that limits the number or monetary value of goods that a country can import or export
Rational Expectations – Hypothesis that agents make predictions based on all available information and learning from past trends
Regressive Tax – Tax that takes a larger percentage of income from low-income earners than from high-income earners
Return on Investment – Performance measure used to evaluate efficiency of an investment, calculated as (Net Profit / Cost of Investment) x 100
Risk-Return Tradeoff – Principle that potential return rises with an increase in risk
Rule of 72 – Formula to estimate number of years required to double an investment (72 / Annual Rate of Return)
Stagflation – Condition of slow economic growth and relatively high unemployment accompanied by a rise in prices
Sticky Prices – Resistance of market prices to change quickly despite shifts in the broad economy suggesting a different optimal price
Sunk Cost Fallacy – Cognitive bias of making decisions based on costs that have already been incurred & cannot be recovered
Supply & Demand – Core market model where price is determined by the interaction of availability & consumer desire
Systemic Risk – Risk of collapse of an entire financial system or market, as opposed to risk associated with any one entity
The 4% Rule – Retirement planning guideline suggesting a safe annual withdrawal rate of 4% from a portfolio
Time Value of Money – Principle that a dollar today is worth more than a dollar in the future due to its earning potential
Transaction Cost – Cost incurred in making an economic exchange, such as fees paid to a broker or time spent negotiating
Velocity of Money – Frequency at which one unit of currency is used to purchase domestically-produced goods and services
Yield Curve – Line that plots the interest rates of bonds having equal credit quality but differing maturity dates

Glossary

Abundance – Principle of Unlimited Potential & Resources
Accelerator Principle – Idea That Investment Spending Is Driven by Changes in Consumer Demand
Amortization – Process of Spreading Out a Loan into Series of Fixed Payments Over Time
Arbitrage – Simultaneous Buying & Selling of Same Asset in Different Markets to Profit from Price Differences
Asset – Anything Owned That Holds Value & Generates Cash Flow
Asset Allocation – Strategy of Dividing Investment Portfolio Among Different Asset Categories
Austrian School – Economic Philosophy Emphasizing Individual Action & Free Markets
Balance of Payments – Record of All Economic Transactions Between Residents of a Country & the Rest of the World
Balance Sheet – Snapshot of Financial Position at a Point in Time
Bear Market – Sustained Period of Falling Asset Prices
Behavioral Economics – Study of Psychological Factors in Economic Decision-Making
Black Swan – Unpredictable Event That Has Severe Consequences & Is Often Inappropriately Rationalized After Fact
Bond – Fixed Income Instrument Representing a Loan Made by Investor to Borrower
Bull Market – Sustained Period of Rising Asset Prices
Capital – Fuel & Tools for Wealth Creation & Production
Capital Gains – Profit from Sale of Property or Investment
Cash Flow – Movement of Money In & Out of Business or Investment
Collateral – Asset That Borrower Offers to Lender to Secure Loan
Comparative Advantage – Ability to Produce Goods at Lower Opportunity Cost Than Competitors
Compound Interest – Earning Interest on Previous Interest, Accelerating Growth
Consumer Price Index (CPI) – Measure of Average Change Over Time in Prices Paid by Consumers
Credit – Ability to Borrow Money or Access Goods with Promise of Future Payment
Cryptocurrency – Digital Currency Using Cryptography for Security & Operating Independently of Central Bank
Currency – Generally Accepted Medium of Exchange for Transactions
Debt – Money Borrowed That Must Be Repaid, Often with Interest
Default – Failure to Repay Loan According to Terms Agreed Upon
Deficit – Amount by Which Spending Exceeds Income Over Period
Deflation – General Decrease in Price Level of Goods & Services
Depression – Severe & Protracted Economic Downturn with High Unemployment
Derivative – Financial Contract Whose Value Is Derived from Underlying Asset
Dividend – Portion of Company’s Profits Paid Out to Its Shareholders
Dollar-Cost Averaging – Investing Fixed Amounts at Regular Intervals Regardless of Price
Economics – Study of How Societies Allocate Scarce Resources
Economies of Scale – Cost Advantages When Production Becomes Efficient
Elasticity – Measure of How Much Quantity Demanded or Supplied Changes in Response to Price Change
Equity – Ownership Value in Asset After All Debts Are Paid
ETF (Exchange-Traded Fund) – Basket of Securities Traded on Exchange Like Stock
Fiat Currency – Government-Issued Money Not Backed by Physical Commodity
Financial Intelligence – Knowledge Required to Make Prudent Monetary Decisions
Fiscal Policy – Government Use of Taxing & Spending to Influence Economy
Fixed Cost – Business Expense That Doesn’t Change Regardless of Production Volume
Foreclosure – Legal Process Where Lender Takes Possession of Property Due to Loan Default
Futures Contract – Agreement to Buy or Sell Asset at Predetermined Price at Specified Time
GDP (Gross Domestic Product) – Total Monetary Value of All Finished Goods & Services Produced in Country
Gig Economy – Labor Market Characterized by Short-Term Contracts or Freelance Work
Gold Standard – Monetary System Where Currency’s Value Is Directly Linked to Gold
Hedge Fund – Aggressive Investment Partnership Using Advanced Strategies to Generate High Returns
Hyperinflation – Extremely Rapid & Out-of-Control Price Increases in Economy
Illiquid Asset – Asset That Cannot Be Quickly Converted to Cash Without Loss
Inflation – General Increase in Price Level of Goods & Services
Infrastructure – Basic Physical Systems of Business or Nation
Interest Rate – Cost of Borrowing Money or Reward for Saving It
Investment – Allocating Resources with Expectation of Generating Future Profit
Keynesian Economics – Theory Advocating for Government Intervention to Manage Demand
Leverage – Use of Borrowed Money to Increase Potential Return of Investment
Liability – Financial Debt or Obligation That Must Be Settled
Liquidity – Ease with Which Asset Can Be Converted to Cash
Macroeconomics – Study of Behavior & Performance of Entire Economy
Margin – Borrowing Money from Broker to Purchase Securities
Market Economy – Economic System Where Supply & Demand Drive Production
Maturity – Date When Principal Amount of Debt Instrument Must Be Repaid
Microeconomics – Study of Economic Behavior of Individuals & Firms
Monetary Policy – Central Bank Actions to Manage Money Supply & Interest Rates
Money Supply – Total Amount of Monetary Assets Available in Economy
Monopoly – Market Structure with Single Seller Dominating Industry
Moral Hazard – Situation Where One Party Takes Risks Because Another Party Bears Cost
Mortgage – Loan Specifically for Purchase of Real Estate
Mutual Fund – Investment Vehicle Pooling Money from Many Investors to Purchase Securities
Narrative Economics – Study of How Popular Stories Influence Economic Behavior
Negative Equity – Situation Where Value of Asset Falls Below Outstanding Loan Balance
Net Worth – Total Assets Minus Total Liabilities of Individual or Company
Oligopoly – Market Structure Dominated by Small Number of Large Firms
Opportunity Cost – Value of Next Best Alternative Forgone by Decision
Option – Financial Derivative That Gives Right But Not Obligation to Buy or Sell Asset
Portfolio – Collection of Financial Investments Like Stocks, Bonds, & Cash
Price Elasticity – Measure of How Responsive Quantity Demanded Is to Price Change
Principal – Original Sum of Money Borrowed in Loan or Put Into Investment
Quantitative Easing – Central Bank Purchasing Securities to Increase Money Supply
Recession – Significant Decline in Economic Activity Lasting More Than Few Months
Return On Investment (ROI) – Measure of Profitability of Investment
Risk – Potential for Loss or Unfavorable Outcome on Investment
Securities – Tradable Financial Assets Such as Stocks, Bonds, or Options
Short Selling – Selling Borrowed Securities in Anticipation of Price Decline
Stagflation – Period of High Inflation Combined with High Unemployment & Stagnant Demand
Stock – Type of Security That Signifies Ownership in Corporation
Supply & Demand – Core Model Determining Price in Market
Sustainability – Meeting Present Needs Without Compromising Future Generations
Tariff – Tax Imposed on Imported Goods & Services
Transaction – Instance of Buying or Selling Something
Underwriting – Process of Evaluating Risk & Determining Terms for Insurance or Loan
Unsecured Loan – Debt Not Backed by Collateral
Variable Cost – Corporate Expense That Changes in Proportion to Production Output
Velocity of Money – Rate at Which Money Is Exchanged in Economy
Venture Capital – Financing Provided to Startup Companies with Long-Term Growth Potential
Wealth – Abundance of Valuable Financial Assets or Physical Possessions
Yield – Income Returned on Investment, Such as Interest or Dividends
Zero-Sum Game – Situation Where One Participant’s Gain Equals Another’s Loss
Zero-Based Budgeting – Budgeting Method Where All Expenses Must Be Justified for Each New Period