Paper 2 (Macro) definitions

Term Definition
Macroeconomy The economy in aggregate – the sum of all of the individual markets that
make up the economy.
Macroeconomic The four aims of government when managing the macroeconomy are usually:
objectives Strong and sustained economic growth (higher GDP), low unemployment,
low and stable inflation, a satisfactory trade position. Other objectives, such
as an acceptable distribution of income and environmental protection are
also possible.
GDP (Y) The value of all of the output (= income) generated in the domestic economy
over a given time period.
GNP The income flowing to the residents of an economy over a given period. GDP
+ net property income from abroad.
Property income Income derived from ownership of assets in other countries, such as
from abroad property, shares in foreign companies or the bonds of foreign governments.
Economic growth The increase in GDP over a given time period.
Inflation The sustained increase in the general price level of an economy. The
reduction in the purchasing power of money.
Unemployment Unemployment consists of all those of a working age who are actively seeking
work at going wage rates but do not have a job.
Current account A record of the international income and expenditure for economic agents in
of B of P an economy over a given period of time.
‘Visibles’ Entries into the current account relating to trade in goods.
Primary income Interest, profit and dividends generated by investments abroad.
Secondary International transfers, such as remittances made by migrant workers.
income
‘Invisibles’ Entries into the current account relating to trade in services and primary and
secondary income.
Real GDP The value of GDP adjusted to remove the effects of inflation. Real GDP is
measured ‘at constant prices.’ An increase in real GDP represents an increase
in the volume of output generated in the economy.
Nominal GDP The value of GDP without adjustment for inflation. Nominal GDP is measured
‘at current prices.’ An increase in nominal GDP could be cause either by an
increase in the volume of output or by inflation.
Real GDP/capita Real GDP divided by population.
Index An index represents all values relative to a base, which is given the value 100.
Index numbers have no units. Index number = (Value/base value) x 100.
Weighted index A composite index adjusted to take account of the relative importance of its
components. For example, a price index such as the RPI may be constructed
from the prices of many products and weights attached to each product to
reflect the proportion of consumer expenditure accounted for by the
product.
CPI The Consumer Price Index is a weighted price index and is used to calculate
the official inflation rate.
RPI The Retail Price Index is an alternative weighted price index that differs from
the Consumer Price Index mainly in the goods and services that are used to
calculate it and the mathematical method for calculating the index. The RPI
tends to rise less quickly than the CPI
RPIX The RPI but excluding mortgage interest payments.

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 Paper 2 (Macro) definitions
Core inflation Core inflation is the inflation rate calculated on the basis of excluding sectors
where prices are particularly volatile, such as food and energy.
Claimant Count The claimant count is a measure of unemployment based on all those
claiming Job Seeker’s Allowance, the main benefit received by those who are
unemployed.
ILO measure The International Labour Organisation’s measure of unemployment, which is
based on survey data. It is designed to give a more accurate measure of
unemployment than the claimant count.
Living standards Living standards are usually measured using real GDP/capita. More
accurately this may be said to be a measure of material standards of living,
while living standards are also affected by a range of non-material factors,
such as the value of human relationships and political freedoms.
PPP exchange Purchasing power parity exchange rates are those which give equal spending
rates power when a given sum of one currency is converted into another. They
adjust for differences in the general price level between economies. When
real GDP/capita figures are converted into a common currency for
comparison, PPP exchange rates should be used to provide a better basis for
comparison of living standards.
The circular flow A model of the economy in which households supply factors of production to
of income firms in return for factor incomes (wages, interest, rent and profits), while
firms provide goods and services to households in return for consumer
expenditure (c). Consumer expenditure is returned to households as factor
income, setting up a circular flow.
Injections (J) Injections into the circular flow are sources of expenditure from outside of
the flow, namely investment (I), government expenditure (G) and exports (X).
Withdrawals (W) Withdrawals from the circular flow occur when income received by
(= leakages) households is not returned to firms as consumer expenditure. Withdrawals
are caused by saving (S), taxes (T) and import (M).
The national Income is identical to output is identical to expenditure. This is because
income identity income, output and expenditure are the same flow measured at three
different points.
Aggregate The total demand for the goods and services produced in an economy over a
demand given period of time. AD = C + I + G + X – M.
Consumption (C) Expenditure by households on goods and services. That part of disposable
income that is not saved.
Disposable Income after tax and benefits.
income
Discretionary Income left after providing for basic needs and meeting ongoing
income commitments such as mortgage and utility payments.
The marginal The proportion of each additional £ of income which is consumed.
propensity to
consume (MPC)
Life-cycle The theory that consumers use borrowing and saving to smooth the path of
hypothesis consumption over their lifetimes, typically borrowing when young, saving in
middle-age and running down these savings in retirement. The life cycle
hypothesis may weaken the link between disposable income and
consumption.
Permanent Milton Friedman’s hypothesis that increases in income will only be spent if
income they are believed to be permanent. This may mean that tax cuts will fail to
hypothesis stimulate consumption, if it is believed that the cut is only a temporary

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 Paper 2 (Macro) definitions
measure.
Determinants of These include: disposable income, discretionary income, the interest rate
consumption (lower interest rates discourage saving and encourage borrowing to finance
consumption – the interest rate is the opportunity cost of consumption),
consumer confidence, house prices.
Wealth effect The effect on consumption as wealth increases. For example, when house
prices increase, home owners may engage in mortgage equity withdrawal to
finance consumption.
Equity withdrawal Equity is the difference between the current price of a house and the
outstanding mortgage debt of its owner. It is thus the money that the
homeowner would have if they sold the house and repaid the mortgage.
Homeowners can withdraw equity by increasing their mortgage and using the
funds borrowed to finance consumption.
Saving (S) That part of disposable income that is not consumed.
Saving ratio The proportion of national income that is saved: (S/Y) x 100
Determinants of These include: Interest rates, income, income distribution (those with low
saving incomes have a lower propensity to save), age distribution (see life-cycle
hypothesis), inflation (high levels of inflation may discourage saving),
confidence (the precautionary motive for saving is stronger when confidence
in future economic prospects is low).
Investment (I) Expenditure by firms on additional to the capital stock. This consists of fixed
capital such as buildings and machinery and circulating capital such as
unfinished products.
Determinants of These include: levels of retained profits, the interest rate (as investment is
investment often funded by borrowing), the growth of output (see accelerator) and
business confidence.
Government Expenditure by the government, divided into current spending (for example,
spending the wages of teachers), capital spending (for example, the building of a
school) and transfer payments (for example, Job Seeker’s Allowance).
Transfer Payments for which no corresponding output is generated, such as
payments government benefits. Such benefits are part of the personal income of the
recipient but not part of national income (by circular flow definition, national
income = national output, so transfer payments cannot be included).
Net exports Exports minus imports.
The multiplier (K) The process by which an injection into the circular flow results in a large
increase in national income. The value of the multiplier = 1/(1-MPC) where
MPC is the marginal propensity to consume, the proportion of each
additional £ of income which is consumed.
The accelerator The process by which investment grows or falls at a higher rate than national
income.
Short run Short run aggregate supply is the total output that domestic firms are willing
aggregate supply and able so supply at a given general price level over a given period of time.
Short run aggregate supply is based on a constant cost of production, so if
production costs change, the SRAS curve will shift.
Long run The relationship between the general price level of the economy and output
aggregate supply in the long run. Neo-classical economists argue the level of output to be
independent of the price level in the long run, so that the LRAS curve is
vertical at the capacity (potential output of the economy)
Potential output The maximum output that can be generated with currently available factors
= economic of production (land, labour, capital and enterprise). Potential output is a

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capacity = full function of the quantity and quality of factors of production available.
employment
output.
Productivity Output per resource per time period. For example output per hour worked
or output per worker.
Factor mobility The ability of factors to move from one use to another, for example the
ability of a worker to move between jobs (occupational mobility) or between
regions (geographical mobility). Factor mobility is an important determinant
of potential output.
Economic Factors that encourage economic behaviours, for example wages as an
incentives incentive to work. Rational economic agents respond to incentives.
Incentives are an important determinant of potential output.
Institutional The structure of the organisations that support the functioning of the
structure of the economy such as banks and government. This is an important determinant of
economy potential output. For example, well-functioning banks facilitate lending to
firms for investment purposes.
Keynesian Keynesian economists believe that the economy can be in equilibrium with
aggregate supply mass unemployment. In contrast, neo-classical economists believe that mass
curve unemployment will put downward pressure on wages, which in turn would
lower the costs of firms and encourage a return to full employment and the
economy operating at full potential. For this reason, the Keynesian AS curve
is a backwards L-shape while the neo-classical LRAS curve is vertical.
The economic The path of GDP over time which typically follows a sequence of peak,
cycle = business followed by recession, followed by trough, followed by recovery. Sustained
cycle periods of above trend growth are known as booms.
Trend growth The average growth rate over an extended period of time, at least the
duration of one complete economic cycle.
Negative output Current output (GDP) is below potential output. Negative output gaps result
gap from below trend growth and are accompanied by unemployment.
Positive output Current output (GDP) is above potential output, for example through factors
gap of production working overtime hours. Positive output gaps emerge
following long periods of above trend growth.
Costs of growth Negative factors associated with growth, such as environmental damage.
Benefits of Positive factors associated with growth, such as reductions in poverty.
growth
Demand side An economic event that impacts sharply on aggregate demand. Examples
shock would include recession in a major trading partner, reducing demand for
exports, or the financial crisis of 2007-2009. Covid also constitutes a demand
side shock as it may constrain consumption and investment.
Supply side shock An economic event that impacts sharply on aggregate supply. Examples
include major increases in the oil price or natural disasters. Brexit and Covid
could both provide supply side shocks to the economy by disrupting supply
chains.
Cyclical = Unemployment resulting from lack of aggregate demand and resulting lack of
Keynesian = derived demand for labour.
demand deficient
unemployment
Structural Unemployment resulting from a mismatch between the characteristics of
unemployment workers and the characteristics required to fill vacancies. For example,
workers may not have relevant skills (occupational immobility) or may live in

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the wrong area (geographical mobility). Structural unemployment often
follows a change in the structure of the economy, such as the UK’s move
away from the manufacturing and heavy industry that contributed to high
unemployment in the 1980s.
Excess real wages Unemployment resulting from wages above the labour market equilibrium,
unemployment leading to an excess supply of labour. Excess real wages unemployment can
be caused by trade union activity, minimum wage legislation and other
factors that may cause “sticky wages” that fail to fall to equilibrium level.
Frictional Unemployment resulting from a search period when workers move from one
unemployment job to another.
Seasonal Unemployment that exists only at particular times of the year, such as
unemployment unemployment in the tourist industry out of season.
Voluntary Unemployment where workers choose not to accept work at the going wage
unemployment rate. Frictional, structural and classical unemployment are argued to be
voluntary. For example, the frictionally unemployed may be able to move
into work more quickly by reducing their search period and not holding out
for a better paid job.
Involuntary Unemployment where workers are willing to work at the going wage rate but
unemployment are unable to, for example due to insufficient demand for labour. Keynesian
unemployment is involuntary in nature.
The natural rate Unemployment as a percentage of the labour force when the labour market
of unemployment is in equilibrium (only frictional and structural unemployment exist). An
alternative definition is unemployment as a percentage of the labour force
when only voluntary unemployment exists (frictional, structural and excess
real wages).
Demand-pull Inflation caused by high levels of aggregate demand creating a situation of
inflation too much expenditure chasing too few goods and giving firms the confidence
to raise prices.
Cost-push Inflation caused by firms passing some or all of increased in production costs
inflation onto consumers in the form of higher prices.
Deflation A sustained fall in the general price level. An increase in the purchasing
power of money.
Disinflation A fall in the rate of inflation.
Fisher Equation MV = PT or where M is the money supply, V is the velocity of circulation, P is
the average price of each transaction and T is the number of transactions.
The two sides of the equation must balance by definition as PT as both sides
measure total expenditure in the economy.
Quantity theory The theory that the general price level of an economy is determined by its
of money money supply. Supporters of this theory believe that the velocity of
circulation is fairly constant over time and that the volume of transactions is
too, as the economy returns to its potential output in the long run. With V
and T held constant in the Fisher equation, there is a direct relationship
between M and P. The theory can be adapted to show that the general price
level of the economy will not rise over time if the money supply is allowed to
expand only in line with the trend growth of the economy.
Monetarism The idea that “inflation is always and everywhere a monetary phenomenon”
(Milton Friedman). Demand pull inflation can only occur if it is
accommodated by an increase in the money supply and cost push inflation
can only be sustained if it is validated by an increase in the money supply.
Inflationary The rate of inflation anticipated by economic agents such as firms and

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expectations workers. This plays an important role in determining the actual rate of
inflation. If, for example, both firms and workers expect inflation of 3%, this
may influence wage settlements helping to lead to price inflation at about
this level.
Costs of inflation Negative factors associated with inflation such as disruption to the price
mechanism through “inflationary noise”, reduced international
competitiveness, reduced investment, arbitrary redistributions from lenders
to borrowers, and relatively minor factors such as shoe leather and menu
costs.
Inflationary noise Difficulty for economic agents in interpreting price signals caused by high and
volatile inflation, which makes it difficult to know what is happening to the
price of one good relative to another. The price mechanism is thus damaged
and inefficient resource allocation may result.
Shoe leather Increased time spent by economic agents on price comparisons during
costs periods of inflation.
Menu costs Administrative costs incurred by firms due to adjustments of prices during
periods of deflation.
Costs of deflation Negative factors associated with deflation such as debt defaults, falling
output and high levels of unemployment.
Deferred Economic agents such as consumers postpone spending until a later date.
spending This may happen during periods of deflation, as consumers anticipate being
able to buy the same product at a lower price in the future.
Debt default Borrowers failing to pay repay debts and interest. Debt defaults are more
likely to occur during periods of recession and are associated with periods of
deflation as falling prices raise the real value of debts, making them more
difficult to repay.
Commodity prices The prices of homogeneous outputs traded in international markets such as
oil, agricultural outputs and metals. High commodity prices are often a
source of cost-push inflation.
Short run Phillips The relationship between unemployment and the inflation rate, showing a
Curve trade-off by which lower unemployment is achieved at the cost of higher
inflation. Each short run Phillips curve is based on a particular expected rate
of inflation.
Long run Phillips The relationship between unemployment and the inflation rate in the long
curve run. Classical economists believe there is no trade-off, so that the long run
Phillips curve is vertical at the non-accelerating inflation rate of
unemployment (NAIRU).
The non- The rate of unemployment consistent with a stable rate of inflation. This is
accelerating often regarded as corresponding to the natural rate of unemployment, the
inflation rate of rate that exists when the labour market is in equilibrium. If labour supply is
unemployment equal to labour demand, wages are likely to rise only in line with inflationary
(NAIRU) expectations. However, if aggregate demand grows such that labour demand
exceeds labour supply, wage growth is likely to be greater than expected,
resulting in a trade-off as unemployment falls but a higher rate of price
inflation is experienced. Over time, the higher rate of inflation may come to
be expected, resulting in a movement onto a new short run Phillips Curve.
Policy conflicts The conflict between achieving one macroeconomic objective and another
such as conflict between achieving low unemployment and achieving low
inflation caused by the trade-off represented by the short run Phillips Curve.
Changes in aggregate demand tend to be associated with policy conflicts (two
of the four macro objectives improve, two worsen) while changes in

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aggregate supply, especially long run aggregate supply do not (all four
indicators tend to improve or deteriorate simultaneously).
Money Any medium that fulfils the functions of money (medium of exchange, unit of
account, store of wealth, standard of deferred payment).
Medium of Money helps to facilitate the exchange of goods and services. This avoids the
exchange need for a “double coincidence of wants” which is required for a direct
exchange of goods and services in a barter economy: without money, an
exchange between two parties can only occur when each party wants to buy
what the other is selling.
Unit of account Money functions as a unit of account by enabling comparison between the
price of one good and another.
Store of wealth Wealth consists of assets and assets can be stored in the form of money (for
example, savings in a bank account).
Standard of Money functions as a standard of deferred payment by allowing for payment
deferred of goods at a date later than they have been purchased (“buy now, pay later”
payment deals).
Unanticipated Inflation that is not expected. The costs of inflation tend to be higher when
inflation the inflation is unanticipated and when inflation rates are volatile.
Hyperinflation Extremely high and rapid inflation, such as that experienced in Weimar
Germany and in more recent years in Zimbabwe and Venezuela.
Hyperinflation may result in money failing to fulfil its functions and a return
to a barter economy where goods and services are exchanged directly.
Narrow money A definition of the money supply that includes only forms of money that are
used mainly as a medium of exchange, such as cash and current accounts at
banks.
Broad money A definition of the money supply that includes money held for a variety of
purposes besides as a medium of exchange, such as deposits in long term
savings accounts. Some measures of broad money may also include “near
money” such as bonds that can easily be exchanged for cash.
Financial An institution, such as a bank, that channels funds from savers to borrowers
intermediary
Financial market A market in which savers lend funds directly to borrowers
Maturity date The date at which a debt is due to be repaid
Money market A financial market in which money is lent with maturity between 24 hours
and 12 months.
Capital market A financial market in which money is lent with medium to long term maturity.
Foreign exchange A market in which one currency is traded for another.
market
Debt Debt is incurred when a capital sum is borrowed, which must be repaid on its
maturity date.
Equity Equity gives the provider of funds part ownership of the business and
entitlement to part of its future profits. Shares are an example of equity and
shareholders receive the portion of business profits as an annual dividend.
Bond (= gilt = gilt An instrument used by governments and firms to borrow money with a
edged security) medium to long term maturity date (part of the capital market). The holder
of a bond may sell ownership of it to another agent. The bond pays its holder
a fixed sum of interest (coupon) each year until its maturity.
Bills An instrument used to borrow over a short period of up to 12 months (part of
the money market).
Coupon The fixed sum of interest paid to a bond holder each year.

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 Paper 2 (Macro) definitions
Bond yield Yield = (Coupon/market price of bond) x 100.
Market interest The rates of interest available in given financial markets, such as those for
rates personal loans, mortgages and credit card borrowing.
Commercial bank A financial intermediary with functions including: Accepting deposits from
(= High Street savers, lending to borrowers, providing efficient means of payment (such as
bank) debit cards). HSBC and Lloyds are examples.

Primary market A market in which a financial asset such as a bond or a share is initially issued.
Secondary A market in which asset holders can sell ownership of an asset to other
market agents (a second-hand asset market!)
Investment bank A bank that does not accept deposits from customers and has functions
including: helping firms and governments to raise finance on primary markets
(through bond and share issues), buying and selling assets in secondary
markets on behalf of clients, buying and selling assets in secondary markets
on their own behalf. The assets bought and sold by investment banks in
secondary markets include: bonds, shares, commodities such as metals and
food, currencies on foreign exchange markets.

Liquidity The extent to which an asset can easily be turned into cash and with little
penalty for doing so. Cash is the most liquid asset. Houses are an example of
an illiquid asset.
Central bank An institution with sole power to issue notes and coins, and functions
including acting as banker to the government and overseeing monetary policy
and regulation of the financial system. The Bank of England is the UK’s
central bank.
Bank rate The official interest rate set by the central bank. The bank rate influences
market interest rates in the economy.
Monetary policy Government policy with regard to the money supply, interest rate and
exchange rate.
Inflation targeting A government target for inflation. In the UK, the target is 2% plus or minus
1% for CPI inflation and the Bank of England’s Monetary Policy Committee
has responsibility for setting monetary policy to meet this target. It would be
possible instead for the government to target other macroeconomic
objectives such as economic growth.
Central bank This exists when the central bank determines monetary policy rather than
independence elected politicians. In the UK, central bank independence was established in
1997 when responsibility for monetary policy was passed from the
government to the Bank of England, although the government continues to
set the inflation rate.
Quantitative The purchase by the central bank of assets such as government bonds using
easing newly created money. This has the effect of increasing the money supply,
making monetary policy more expansionary, and increasing liquidity in the
banking system. Quantitative easing has been used by many governments,
including the UK’s, as a means of further expanding monetary policy once the
bank rate has already reached very low levels. This has been done in
response to the financial crisis of 2007-2009 and the Covid crisis that began in
2020.
Funding for A scheme launched in 2012 by which the Bank of England lent funds to
lending commercial banks cheaply to support commercial banks in lending to
consumers and small and medium sized firms.
Forward guidance Guidance issued by the central bank about the future path of monetary

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 Paper 2 (Macro) definitions
policy. For example, in 2013 the Bank of England said that it would not raise
the bank rate until unemployment fell below 7%. Forward guidance is
designed to give economic agents confidence, such as allowing firms the
confidence to invest.
Negative interest This occurs when the central bank sets the base rate below zero, with the aim
rate of encouraging lower market interest rates to support aggregate demand. In
February 2021, the Bank of England gave commercial banks six months to
prepare for the possibility of negative interest rates.
Profitability- Profit is a return to entrepreneurs for risk-taking. In general, the greater the
security trade-off risk accepted by a commercial or investment bank, the greater the profit
potential. However, this risk may also threaten the existence of the bank,
hence its security.
Credit (= money The process by which an initial deposit can lead to a bigger increase in the
creation) money supply. As banks need only keep a small proportion of deposits in
multiplier liquid (cash) form to meet the day to day demands of their customers to
withdraw cash, they are able to lend out a multiple of the initial deposit,
creating new deposits which become part of the money supply. The credit
multiplier can be calculated as 1/cash deposit ratio.
Borrowing short, Savers can withdraw deposits from banks at short notice (banks borrow
lending long short), but the banks cannot insist that those it has lent money to repay
immediately (banks lend long). This can lead to bank failure in the event of a
“run on the bank”.
Run on the bank This occurs when customers lose confidence in the security of a bank and
simultaneously withdraw their deposits, often resulting in the failure of the
bank. In 2007, the Northern Rock was the first British bank to experience a
run on the bank for 150 years.
Commercial bank A commercial bank’s assets give it a claim on other economic agents. For
assets example, a loan is an asset because the borrower will later repay the capital
sum borrowed and interest. Commercial bank assets are classified into liquid
assets (eg cash), investments (eg bonds) and advances (loans)
Commercial bank A commercial bank’s liabilities give others a claim on the bank. For example,
liabilities deposits are a liability because savers can withdraw these funds. Commercial
bank liabilities are classified into capital (share funding and retained profits),
long term borrowing and deposits (withdrawable at short or no notice).
Bank failure The closure of a bank either due to either (i) lack of liquidity – not having
enough cash to meet customer demands to withdraw deposits of (ii)
insolvency – the bank’s assets fall so much that its capital is wiped out.
Liquidity ratio A liquidity ratio is a ratio of liquid assets to the liabilities of a bank or some
part of them. The most important liquidity ratio is the Cash-deposit ratio =
Cash: Deposits
Capital ratio The ratio of a bank’s capital (shares and retained profits) to its assets

Capital ratio = Capital: Assets

“Too big to fail” The argument that some financial institutions such as major High Street
banks should never be allowed to fail because the consequences would be
too great. This helps to explain why the UK government nationalised some
banks, such as Lloyds, during the crisis of 2007-2009.
Moral hazard This occurs when the risk of an action is not borne by the economic agent
undertaking it. For example, it is argued that, following the government’s
interventions in 2007-2009, commercial banks know that they will not be

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 Paper 2 (Macro) definitions
allowed to fail. This may encourage them to undertake too much risk in the
pursuit of greater profit.
Systemic risk The danger that the failure of one bank or financial institution may threaten
the entire financial system. The collapse of institutions such as Lehman
Brothers in the USA and Northern Rock in the UK posed systemic risks as
these institutions owed money to other financial institutions and their failure
led to severe loss of confidence on the part of banks who then became
reluctant to lend to each other and to consumers.
Fiscal policy Policy in relation to government spending and taxation.
Direct taxes A tax on income, wealth or profit paid directly by to the government by the
individual or firm on which it is imposed. Income tax and corporation tax are
examples.
Indirect taxes A tax on the sale of a good or service, which raises the costs of firms but may
be paid indirectly by the consumer in the form of higher prices. VAT and
specific unit duties are examples.
Progressive taxes A tax for which the average rate of tax rises as income rises.
Proportional A tax for which the average rate of tax is constant as income rises.
taxes
Regressive taxes A tax for which the average rate of tax falls as income rises.
Marginal rate of The rate of tax paid on an extra £ of income.
tax
Average rate of (Tax paid/income) x 100. The average rate of tax rises if the marginal rate of
tax tax exceeds the average (progressive tax) but falls if the marginal rate is
below the average (regressive tax).
Tax burden (Taxation revenue/GDP) x 100
Tax base The economic activity which is taxable. For example, when incomes rise, the
tax base for income tax increases.
The principles of The criteria by which a tax can be evaluated. These include Smith’s canons of
taxation taxation – a tax should be: Certain – The timing and amount should be clearly
known to the taxpayer Convenient – The means and timing should be
convenient to the taxpayer Cheap to collect – Cheap to collect as a
percentage of the revenue yielded and Equitable – The amount paid should
be fair (related to the ability to pay). We may also wish to add Efficient –
improves efficiency of resource allocation Harmonised – in line with the tax
systems of other countries so as not to create distortions in international
trade the ability to adjust automatically to inflation.
Fiscal drag This occurs when wage increases to compensate for inflation drag workers
into a higher tax bracket, so that they pay a higher marginal rate of tax.
Budget deficit A budget deficit exists when government spending exceeds taxation revenue
(G>T), thus increasing the national debt.
Budget surplus A budget surplus exists when government spending is less than taxation
revenue (G<T), thus reducing the national debt
National debt The combined sum of past budget deficits and surpluses. The UK’s national
debt passed 100% of GDP amid the coronavirus crisis in 2020.
Cyclical deficit A cyclical budget deficit exists only during particular phases of the business
cycle, most likely a recession. This is because a recession leads to lower tax
revenue and increased government spending in the form of benefit
payments. Cyclical deficits are balanced by cyclical surpluses later in the cycle
and the national debt does not rise over the length of the cycle as a whole.
Structural deficit A structural deficit exists when government spending exceeds taxation

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 Paper 2 (Macro) definitions
revenue over the length of a complete business cycle. It may even be that
the deficit exists at all points during the business cycle.
Automatic fiscal Changes to the government’s fiscal position at various points of the business
policy cycle that occur without a change in policy. For example, fiscal policy
becomes more expansionary during a recession as tax revenue falls (smaller
leakage from the circular flow) and government spending on benefits rises
(greater injection). This helps to stimulate aggregate demand having an
automatic stabiliser effect on the economy.
Discretionary Policy changes made by the choice of the government, such as decisions to
fiscal policy increase or decrease tax rates.
Supply-side Policies designed to improve the efficiency of resource allocation,
policies productivity of resources, incentives and the capacity of the economy. Most
supply-side policies are free-market orientated and involve reducing the role
of government, for example cutting income tax as an incentive to work or
privatising firms to help reduce waste through the profit motive. However,
some policies may be interventionist, such as increasing spending on
education or reform to the education system.
Supply-side Supply-side improvements may come as a result of supply-side policies but
improvements they may also occur through the actions of firms or individuals. For example,
technological advances may improve the supply-side of the economy
whether or not they have been led by government policy.
Globalisation The increased integration of national economies such that the world
becomes more like a single economy. In a globalised economy, production
can take place anywhere and labour, capital and entrepreneurs are
internationally mobile. Financial capital can also move freely.
Multi-national Firms with production facilities outside of their country of origin, such as
corporations Japanese firm Nissan producing cars in Sunderland.
Foreign direct This occurs when a firm builds production facilities outside of its country of
investment (FDI) origin. In 2019, the UK missed out on top spot in the European rankings for
inward FDI for the first time since EY started their survey in 1997.
Competitiveness The ability of a nation to compete successfully with other nations. This
includes competitiveness in trade (on both price factors and non-price
factors, such as quality), the ability to attract FDI, and the ability to attract
skilled workers.
Absolute This occurs when a nation can produce a good or service at lower cost than
advantage other nations.
Comparative This occurs when a nation can produce a good or service at lower opportunity
advantage cost than other nations.
Heckscher-Ohlin A theory that suggests that countries will have comparative advantage in
factor goods where the production process makes intensive use of a factor that the
proportions country has in abundance. For example, labour often accounts for a high
theorem proportion of the resources of developing economies. These economies may
have comparative advantage in labour intensive areas such as agriculture.
Gains from trade The increase in world output that results from nations specialising and
trading with each other.
Benefits from The positive effects of trade, which include an increase in output, an increase
trade in choice and the ability to learn from producers in other countries.
Costs of trade The negative effects of trade, which may include environmental damage from
the transport of goods and dangers of over-specialisation, leading to an
economy with a narrow structure.

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 Paper 2 (Macro) definitions
Pattern of trade The pattern of trade has three main components: How much trade does a
country do? In which products does it trade? With which countries does it
trade?
Protectionism Measures undertaken by a government to give domestic producers an
artificial advantage in international trade.
Tariff A tax levied on imports.
Quota A limit on the volume of imports.
Export subsidy A payment to reduce the costs of firms making products for export.
Trade creation The increase in trade created by a change in policy such as the removal of
tariffs or quotas, leading to a welfare gain.
Trade diversion This occurs when a change in policy such as the removal of a tariff encourages
trade with less efficient nations rather than more efficient ones, leading to a
welfare loss. For example, joining a trading bloc such as the EU reduces trade
barriers when trading with other European nations and may incentivise trade
with them at the expense of trade with other countries where production
costs are lower.
Infant industry The argument that protectionism of start-up industries is acceptable in order
argument to shelter them from more established competitors in other countries. The
protectionism allows the start-up industry to grow and to achieve economies
of scale, so that it can compete successfully when support is later withdrawn.
Dumping The export of surplus output to other countries, often at below the cost of
production. Dumping is often seen as unfair competition and a justification
for protectionism.
Strategic industry An important sector of the economy such as food production, that a country
is dependent upon. It is argued that strategic industries should be protected
to ensure that the country does not become dependent on imports from
other countries, that could be lost (for example in the event of a trade war).
Over- Specialising in a single product or a narrow range of them, which may leave
specialisation the economy vulnerable to problems such as recession should the price of
that product fall significantly. It is sometimes argued that many developing
countries are over-specialised in agricultural outputs. Protectionism may be
used to avoid over-specialisation.
Demerit good A good which is over-consumed in a free market, such as alcohol or drugs.
Protectionism to reduce imports of demerit goods may increase economic
efficiency.
Trading bloc A group of countries that give preferential treatment to each other in
international trade.
Preference area The lowest level of integration in a trading bloc. Members giver preferential
treatment to each other, such as lower tariffs when trading with each other
than outsiders.
Free trade area A trading bloc in which there are no trade barriers such as tariffs and quotas
between member nations.
Customs union A free trade area with the addition that members have a common policy for
trade with outsiders (for example, a common system of tariffs).
Single market A customs union, but with the addition of free movement for factors of
production. In a single market such as the EU, for example, workers do not
need a visa to work in another EU nation.
Monetary union The highest form of integration in a trading bloc. The countries adopt a single
currency with a common monetary policy. The Euro is an example.
Current account A record of the international income and expenditure for economic agents in

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 Paper 2 (Macro) definitions
of balance of an economy over a given period of time.
payments
Capital account of A record of the creation of international assets and liabilities by a country’s
the balance of economic agents over a given period of time. Entries into the capital account
payments occur as a result of factors such as cross border loans, cross border financial
investments (eg purchase of shares in a foreign company) and foreign direct
investment and changes in foreign currency reserves. The capital account
shows how a current account surplus is used or how a deficit is financed. The
sum of the current and capital accounts is zero.
Current account When credits to the current account of the balance of payments
surplus (international income) exceed debits (international expenditure).
Current account When credits to the current account of the balance of payments
deficit (international income) are less than debits (international expenditure).
Cyclical current A deficit on the current account that exists only at certain phases of the
account deficit economic cycle. This is most likely a recovery or boom phase as growing
incomes lead to greater imports and is likely to be balanced by a surplus
during the recession phase of the cycle.
Structural deficit A deficit on the current account that exists at all phases of the economic
cycle. This may be a sign of a fundamental lack of competitiveness.
Expenditure Policies designed to switch expenditure from other economies towards the
switching policies domestic economy, often as a means of reducing a deficit on the current
account of the balance of payments. Tariffs, quotas and policies to cause
exchange rate depreciation are examples. Expenditure switching policies are
sometimes called “beggar thy neighbour” policies.
Expenditure Policies designed to reduce expenditure, often as a means of reducing a
reducing policies deficit on the current account of the balance of payments. Examples include
contractionary fiscal or monetary policy, which lead to reduced incomes and
thus reduced imports.
Floating exchange The price of one currency in terms of another, determined by the forces of
rate supply and demand on foreign exchange markets.
Fixed exchange The price of one currency in terms of another, set at a fixed level or within a
rate fixed range, and maintained through government intervention.
Effective The exchange rate of a currency against a basket of other currencies,
exchange rate weighted according to the proportion of trade undertaken with each country.
Hot money Money that can be moved between countries at short notice in search of the
highest rate of return.
Currency The trading of currencies in the hope of making a capital gain, for example by
speculation buying a currency that is expected to appreciate and selling it once it has
appreciated.
Trend exchange Market exchange rates are volatile and currencies can gain or lose value
rate rapidly due to factors such as currency speculation and flows of hot money in
response to interest rate changes. When averaged over extended periods of
time, we might expect the trend value of a currency to maintain purchasing
power parity, so that a given sum of the currency will have the same
purchasing power when transferred into others. This is because a country
where products are cheap would experience greater demand for its exports
and thus its currency, putting upwards pressure on its value until purchasing
power parity is restored.
Over-valued A currency with an exchange rate higher than its trend rate or its purchasing
currency power parity rate. This may lead speculators to anticipate a future

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 Paper 2 (Macro) definitions
depreciation of the currency (a market correction).
Under-valued A currency with an exchange rate lower than its trend rate of purchasing
currency power parity rate. This may lead speculators to anticipate a future
appreciation of the currency (a market correction).
Foreign currency Stores of foreign currency held by a nation’s central bank. These can be used
reserves for intervention within a fixed exchange rate system. For example, if the
fixed exchange rate is above the equilibrium rate, it may be necessary to use
currency reserves to buy the domestic currency, adding to demand for it on
the foreign exchange markets. The only alternative would be to use higher
interest rates to attract flows of hot money.
Transaction costs Costs such as commission incurred when moving money out of one currency
into another. The removal of transaction costs is one advantage of the
adoption of a single currency such as the Euro, encouraging trade creation.
Exchange rate Uncertainty associated with exchange rate volatility, which may discourage
uncertainty trade as exchange rate fluctuations may reduce or eliminate profit margins in
trading contracts. The removal of transaction costs is one advantage of the
adoption of a single currency such as the Euro, encouraging trade creation.
Price The ease with which prices in different countries can be compared. Increased
transparency price transparency is one advantage of the adoption of a single currency such
as the Euro, encouraging trade creation.
One-size-fits-all A description of the fact that the members of a single currency must have a
monetary policy common monetary policy.
Economic This is achieved when economic conditions in different economies are similar.
convergence This may include cyclical convergence, so that the economic cycles of
economies are aligned such that they enter each phase of the cycle at the
same time. A deeper economic convergence is structural convergence so
that countries have similar economies to one another. Economic
convergence is important before the adoption of a single currency and a
common monetary policy.
Asymmetric A shock that affects one country differently from another. For example, the
shock UK’s economy may be particularly vulnerable to a financial crisis such as that
of 2007-2009 due to its specialisation in financial services. Asymmetric
shocks my cause economic divergence and are cited by some as an argument
against single currencies.
Optimal currency An area which is well suited to a single currency. Features of an optimal
zone currency zone include a high degree of economic convergence and a high
level of labour market flexibility.
Bailout Financial support to prevent the failure of an institution or an economy.
Bailouts have been given by the EU to a number of countries, including
Greece and Ireland, that have experienced difficulties within the Eurozone.
Many governments also gave bailouts to banks during the financial crisis of
2007-2009.
Economic The ability of an economy to meet the basic needs of its population and,
development beyond this, to achieve high standards of living.
Development-less Economic growth that is not accompanied by a greater ability of an economy
growth to meet its population’s basic needs and to reduce poverty. This may occur
where the benefits of growth are concentrated in the hands of those who
already enjoy high standards of living.
Human A development indicator published by the United Nations that factors in
Development national income per capita, life expectancy and number of years of schooling.

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 Paper 2 (Macro) definitions
Index (HDI)
Index of A measure of economic welfare that adjust GDP by taking into account the
sustainable harmful effects of economic growth such as environmental damage and
economic welfare excludes the value of expenditure on defence.
(ISEW)
Barriers to Factors that constrain growth and development, including conflict, narrow
growth and economic structure, geography (for example a lack of natural resources or a
development lack of a coastline to facilitate the shipping of goods), poverty traps
(insufficient saving to finance investment and growth as income is by
necessity devoted to consumption), corruption, population growth and
disease.
Rostow’s stages Rostow’s description of the stages taken by countries on the path to
of growth development: Traditional society (subsistence activity), pre-conditions for
take-off (savings and investment begin to grow), take-off (industrialisation
increases and savings and investment grow further), the drive to maturity
(growth is self-sustaining, industry becomes more diverse and technology
improves), the age of mass consumption (output levels are high).
Harrod-Domar A model of development that suggests that an economy’s growth rate is
model determined by its savings ratio, as savings provide the funds for investment.
Lewis model A model of structural change as an economy develops. The model sees
surplus labour in the rural, agricultural sector attracted to the urban,
industrial sector by the higher wages available.
Market based The promotion of free trade as a means of achieving development alongside
strategies for other policies such as openness to foreign direct investment and free-market
growth and supply side policies such as privatisation, lower taxes and lower regulation.
development
Interventionist Development policies that involve government intervention, such as the
strategies for protection of infant industries and public spending on infrastructure,
growth and education and healthcare.
development
Aid Financial support for economic development that is not motivated by entirely
commercial considerations on the part of the donor and is provided at lower
interest rates or with longer repayment periods than commercial loans.
Tied Aid Aid provided with conditions, such as the purchase of the exports of the
donor country. It is sometimes argued that tied aid is less effective in
promoting development than untied aid.
Aid dependency When aid accounts for at least 10% of GDP and the absence of aid would
result in the state not fulfilling many of its core functions. For example, the
World Bank in2018 estimated that aid accounted for 40% of Afghanistan’s
GDP.

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