Inflation Is the persistent increase in the general level of prices. It can be seen as the devaluing worth of money.

. There are three main theories of the causes of inflation; The first is that it is caused by a supply shock which increases costs leading to cost push inflation e.g. a large rise in the price of an imported raw material i.e. OPEC oil price rise in the 70s. Excessive demands in the economy leading to demand pull inflation. This could result from easing of restrictions on credit. Monetarists believe that it is caused by an increase in the money supply. If the velocity of circulation is constant and in the short run output is constant, the according to the quantity theory of money where MV=PT, if M rises then P must rise and son an increase in the money supply leads to an increase in the price level (Inflation)

Real exchange rate An exchange rate adjusted to reflect the different inflation rates in the countries of the two currencies concerned. It measures the cost of foreign goods relative to domestic goods. It gives a measure of competitiveness, and is sometimes referred to as the terms of trade.

An appreciation of the real exchange rate indicates that the foreign price (in dollars) of a bundle of goods has risen relative to the domestic price. If the real exchange rate appreciates it means that the real value of the dollar has depreciated; that is, the purchasing power of the dollar has fallen in relative terms.

Balance of payments - it records the transactions between the government and the residents of a country with the rest of the world over a given period of time. It has 3 main components; capital account, current account, official financing account. Current Account (CA): it records a country's transactions in goods and services, investment incomes and transfers. Determinants of current account are: export, import and other items (government policies, pattern of international asset-holding, level of interest rate, profits and dividends at home and in the rest of the world). Capital Account (CA): it records all transactions involving the purchase and sale of financial assets between the domestic economy and the rest of the world (including lending to and borrowing from the rest of the world). Determinants of the capital account are: exchange rate, difference between the domestic and the international interest rate and the extent of capital mobility. Official Financing Account: it records the transactions of the Central Bank on behalf of the government. It includes changes in official reserves of gold and and foreign currencies, the government borrowings from foreign Central Banks and the transactions with the IMF.

The Multiplier is the ratio of the change in equilibrium output to the change in autonomous spending that caused that change. It comes about because injections of new demand for goods and services into the circular flow of income stimulate further rounds of spending. In other words one persons spending is another persons income. This can lead to a bigger eventual effect on output and employment.

The size of the multiplier depends on the marginal propensity to consume (MPC) or the marginal propensity to save (MPS).
The higher is the propensity to consume domestically produced goods and services, the greater is the multiplier effect. The government can influence the size of the multiplier through changes in direct taxes. For example, a cut in the rate of income tax will increase the amount of extra income that can be spent on further goods and services

The formula to calculate the multiplier is: 1/1-mpc or 1/mps. For example if consumers spend 0.8 and save 0.2 of every 1 of extra income, the multiplier will be; 1/1-0.8=1/0.2=5 Hence the multiplier will be 5 which means that every 1 of new income generates 5 of extra income.

The Liquidity Trap LT is a situation in the economy in which the demand for money has become infinitely elastic. This tends to occur at very low levels of interest rates, typically characterising a recessionary situation in the economy. In the context of LT, monetary policy as in increasing the money supply in the economy will not lower the interest rate as any increase of money circulating will be absorbed into these idle balances. The existence of a liquidity trap presumes a speculative motive for holding money and it reflects the acknowledgement that money can be a store of value and is not merely a means of exchange.

Phillips Curve: the Phillips curve proposes the existence of a stable, inverse, non-linear relationship between the change of the price level and the average level of unemployment. This relationship was empirically estimated by Phillips in 1958. It was interpreted as the existence of a trade-off between unemployment and inflation and used as a policy instrument in the late 60s and early 70s.

The Phillips curve was empirically disproved and theoretically challenged by Milton Friedman. The expectations-augmented Phillips Curve was developed by Milton Friedman to try and explain the breakdown of the Phillips Curve. Friedman argued that there is no such thing as a long run stable trade-off between inflation and unemployment and that and any attempt to reduce unemployment to below its natural rate would simply be inflationary.

Equilibrium there are different definitions of equilibrium that prevail in macroeconomics. It could be a state of rest so there are no incentives within the economy for change. For classical macroeconomics, it always corresponds to full employment whereas in Keynesian economics it is likely to be characterised by involuntary employment.

Steady-State Balanced Growth (SSBG): is a gowth path along which all variables capital, output and labour grow at constant and equal rates. It is the growth framework that was used in growth theory with the first contribution by Harrod & Domar.

On this growth path, the economy gets bigger, but its structural characteristics stay the same because of the fixed capital output ratio. Assuming a constant rate of change (as in SSBG) is the simplest way of conceiving a growth path and it can be considered the first step for the analysis of dynamic change (i.e., with changing rate of change).

Natural Rate of Unemployment (NRU): The lowest rate of unemployment that an economy can sustain over the long run. Keynesians believe that a government can lower the rate of unemployment (i.e. employ more people) if it were willing to accept a higher level of inflation (the idea behind the Phillips Curve).

However, critics of this say that the effect is temporary and that unemployment would bounce back up but inflation would stay high. Thus, the natural, or equilibrium, rate is the lowest level of unemployment at which inflation remains stable. Also known as the "non-accelerating inflation rate of unemployment" (NAIRU).

Mundell-Fleming Model A model conceived by Mundell and Flemming independently to understand the effects of fixed & flexible exchange rates in an open economy. It is seen as an extension of the IS-LM model by the addition of the BP (balance of payments) curve.
Micro

Law of diminishing returns: it states that if increasing quantities of variable input are applied to a given quantity of a fixed input, the marginal product and the average product of the variable input will eventually decrease.

It is also called the law of variable proportions, because it predicts the consequences of varying the proportions in which input types are used. The law of diminishing returns implies eventually increasing marginal and average variable costs. Cross price elasticity of demand; is used to see how sensitive the demand for a good is to a price change of another good. A high positive cross-price elasticity tells us that if the price of one good goes up, the demand for the other good goes up as well. A negative tells us just the opposite, that an increase in the price of one good causes a drop in the demand for the other good. A small value (either negative or positive) tells us that there is little relation between the two goods.

If CPEoD > 0 then the two goods are substitutes If CPEoD =0 then the two goods are independent (no relationship between the two goods If CPEoD < 0 then the two goods are complements

The common formula for the Cross-Price Elasticity of Demand (CPEoD) is given by: CPEoD = (% Change in Quantity Demand for Good X)/(% Change in Price for Good Y)

Price elasticity of demand; Measures the responsiveness of quantity demanded of a good to a change in the price. If consumers are relatively responsive to a price change, demand is said to be elastic. If consumers are relatively unresponsive to a price change, demand is said to be enelastic.

A very high price elasticity suggests that when the price of a good goes up, consumers will buy a great deal less of it and when the price of that good goes down, consumers will buy a great deal more. A very low price elasticity implies just the opposite, that changes in price have little influence on demand. The formula for the Price Elasticity of Demand (PEoD) is: PEoD = (% Change in Quantity Demanded)/(% Change in Price)

Often an assignment or a test will ask you a follow up question such as "Is the good price elastic or inelastic between $9 and $10". To answer that question, you use the following rule of thumb:

If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes) If PEoD = 1 then Demand is Unit Elastic

If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

Recall that we always ignore the negative sign when analyzing price elasticity, so PEoD is always positive. In the case of our good, we calculated the price elasticity of demand to be 2.4005, so our good is price elastic and thus demand is very sensitive to price changes.

Income elasticity of demand; used to see how sensitive the demand for a good is to an income change. The higher the income elasticity, the more sensitive demand for a good is to income changes. A very high income elasticity suggests that when a consumer's income goes up, consumers will buy a great deal more of that good. A very low price elasticity implies just the opposite, that changes in a consumer's income has little influence on demand.

The formula for the Income Elasticity of Demand (IEoD) is given by: IEoD = (% Change in Quantity Demanded)/(% Change in Income)

Unlike price elasticities, we do care about negative values, so do not drop the negative sign if you get one.

Often an assignment or a test will ask you the follow up question "Is the good a luxury good, a normal good, or an inferior good between the income range of $40,000 and $50,000?" To answer that use the following rule of thumb:

If IEoD > 1 then the good is a Luxury Good and Income Elastic If IEoD < 1 and IEOD > 0 then the good is a Normal Good and Income Inelastic If IEoD < 0 then the good is an Inferior Good and Negative Income Inelastic

In our case, we calculated the income elasticity of demand to be 0.8 so our good is income inelastic and a normal good and thus demand is not very sensitive to income changes.

Nash equilibrium A concept of game theory where the optimal outcome of a game is one where no player has an incentive to deviate from their chosen strategy after considering an opponent's choice. Game theory analysis is relevant in studying the conduct and behaviour of firms in an oligopolistic market. A game may have multiple Nash equilibria or none at all

To test for a Nash equilibrium, simply reveal each person's strategy to all players. The Nash equilibrium exists if no players change their strategy, despite knowing the actions of their opponents.

Price discrimination: occurs when a business charges a different price to different groups of consumers for the same goods or services, for reasons not associated with cost. Essentially there are two main conditions required for discriminatory pricing: a). There must be a different price elasticity of demand for each group of consumers. The firm is then able to charge a higher price to the group with a low PED and a lower price to the group with a more PED b). The firm must be able to prevent re-sale or consumer switching They could do so by imposing time limits on the good or service, use identification systems (photocards) or digital ways to protect usage.

Marginal rate of substitution; is the rate at which an individual must give up good A in order to obtain one more unit of good B while keeping their overall utility constant. The MRS is calculated between two goods placed on an indifference curve, which displays a frontier of equal utility of each combination of good A and good B.

It is the slope of the indifference curve, the formula for MRS= -dy/dx where d is the change in good and x and y are different goods, this calculation assumes utility remains constant. For example consider an indifference curve between hamburgers and hot dogs at a picnic. If the MRS of hamburgers for hot dogs is 2, then the individual would be willing to give up 2 hamburgers in order to obtain 1 extra hot dog.

Production function: it relates inputs to outputs, describing the technological relation between the inputs that a firm uses and the output that it produces. Its general form: Q = f (L, K) where Q is output (total product), and L (labour) and K (capital) are inputs. The production function relates flows of inputs to flows of outputs, so many units over a period of time. If output is below the maximum level allowed by the technology as specified in the production function, it is said to be technically inefficient.

Economic efficiency: A broad term that implies an economic state in which every resource is optimally allocated to serve each person in the best way while minimizing waste and inefficiency. When an economy is economically efficient, any changes made to assist one person would harm another. In terms of production, goods are produced at their lowest possible cost, as are the variable inputs of production.

Marginal utility The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important economic concept because economists use it to determine how much of an item a consumer will buy. Positive marginal utility is when the consumption of an additional item increases the total utility. Negative marginal utility is when the consumption of an additional item decreases the total utility.