Economics terminology that differs from common usage
Encyclopedia
In any technical subject, words commonly used in everyday life acquire very specific technical meanings
, and confusion can arise when someone is uncertain of the intended meaning of a word. This article explains the differences in meaning between some technical terms used in economics
and the corresponding terms in everyday usage.
" to mean either a period of two successive calendar quarters each having negative growth of real gross domestic product—that is, of the total amount of goods and services produced within a country—or that provided by the National Bureau of Economic Research
(NBER): "...a significant decline in economic activity spread across the country, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales." Almost all academics, economists, policy makers, and businesses eventually defer to the NBER's determination for the precise dates of a recession's beginning and end, which may only be announced after a substantial delay.
In contrast, in non-expert, everyday usage, "recession" may refer to a period in which the unemployment rate is substantially higher than normal.
categorize people into three groups: "employed" - actually working at a job, even if part-time; "unemployed" - not working, but looking for work or awaiting a scheduled recall from a temporary layoff; and "not in the labor force" - neither working nor looking for work. People not in the labor force, even if they have given up looking for a job despite wanting one, are not considered unemployed. For this reason it is often thought, especially when a recession
has persisted for a sustained period, that the unemployment rate understates the true amount of unemployment because some unemployment is disguised by discouraged worker
s having left the labor force.
The everyday usage of the word "unemployed" is usually broad enough to include disguised unemployment, and may include people with no intention of finding a job. For example, a dictionary definition is: "not engaged in a gainful occupation", which is broader than the economic definition.
assets which are held at any moment in time. The units of measurement are dollars or another currency, with no time dimension, so this is a stock variable. There are several technical definitions of what is included in "money", depending on how liquid a particular type of asset has to be in order to be included. Common measures include M1, M2, and M3.
In everyday usage, "money" can refer to the very liquid assets included in the technical definition, but it usually refers to something much broader. When someone says "She has a lot of money," the intended meaning is almost certainly that she has a lot of what economists would call financial wealth, which includes not only the most liquid assets (which tend to pay low or zero returns), but also stocks, bonds and other financial investments not included in the technical definition. Non-financial assets, such as land and buildings, may also be included. For example, dictionary definitions of money include "wealth reckoned in terms of money" and "persons or interests possessing or controlling great wealth", neither of which correspond to the economic definition.
A related but different everyday usage occurs in the sentence "He makes a lot of money." This refers to a variable that economists call income
. Unlike the usages mentioned above, this one has the units "dollars, or another currency, per unit of time", where the unit of time might be a week, month, or year, making it a flow variable.
—the purchasing of a certain amount of newly produced productive equipment, buildings or other productive physical assets per unit of time—and inventory investment
—the accumulation of inventories over time. This is one of the major types of expenditure in an economy, the others being consumption expenditure, government expenditure, and expenditure on a country's export goods by people outside the country.
The everyday usage of "investment" coincides with the one used by financial economists—the acquisition and holding of potentially income-generating forms of wealth such as stocks and bonds.
Similarly, while financial economists use the word "capital"
to refer to funds used by entrepreneurs and businesses to buy what they need to make their products or to provide their services, macroeconomists and microeconomists use the term capital
to mean productive equipment, buildings or other productive physical assets.
As with the term "investment", the everyday usage of "capital" coincides with its use by financial economists.
s, which are payments such as welfare
payments intended to redistribute income. In economic models, transfer payments are normally treated as a negative component of "taxes net of transfers", leaving "government spending on (newly produced) goods and services" as a separate category, often referred to simply as "government spending".
In everyday usage, "government spending" refers to the broader concept of government spending on goods and services plus transfer payments.
is a branch of economics that uses microeconomic
techniques to evaluate economic well-being, especially relative to competitive general equilibrium, with a focus on economic efficiency
and income distribution
.
In general usage, including by economists outside the above context, welfare
refers to a form of transfer payment
.
All of these definitions involve the idea that nothing more can be achieved given the resources available.
In popular usage, efficient often has the similar but less precise meaning "functioning effectively".
, refers to the potential gain that is lost by foregoing one opportunity in order to take advantage of another. The lost potential gain is the cost of the opportunity that is accepted. Sometimes this cost is explicit: for example, if a firm pays $100 for a machine, its cost is $100. Other times, however, the cost is implicit: for example, if a firm diverts resources from producing output worth $200 into producing a different kind of output, then regardless of how much or how little of the latter output is produced, the opportunity cost of doing so is $200.
In accounting, there is a different technical concept of cost, which excludes implicit opportunity costs.
In common usage, as in accounting usage, "cost" typically does not refer to implicit costs and instead only refers to direct monetary costs.
refers to the strength of one or many consumers' willingness to purchase a good or goods at any in a range of prices. If, for example, a rise in income causes a consumer to be willing to purchase more of a good than before contingent on each possible price, economists say that the income rise has caused the consumer's demand for the good to rise. In contrast, if a change in market conditions leads to a decline in the price of a good resulting in a consumer's being willing to buy more of it, economists say that the consumer's quantity demanded of the good has risen. A change in quantity demanded is represented by a movement along the demand curve
, while a change in demand is represented by a shift of the demand curve.
In popular usage a change in "demand" can refer to either what economists call a change in demand or what economists call a change in quantity demanded.
" means "incremental". For example, the marginal propensity to consume
refers to the incremental tendency to spend income on consumer goods: the fraction of any additional income which is spent on additional consumption (or conversely, the fraction of any decrease in income which becomes a decrease in consumption). Likewise, the marginal product of capital
refers to the additional production of output that results from using an additional unit of physical capital
(machinery, etc.). If very small increments are being considered, so that calculus
is used, then this ratio of incremental amounts is a derivative
(for example, the marginal propensity to consume becomes the derivative of consumption with respect to income).
— the use of statistical techniques
in economics — "significant
" means "unlikely to have occurred by chance". For example, suppose one wishes to find if the minimum wage
rate affects firms' decisions on how much labor to hire. If the data show, on the basis of statistical techniques, an effect of a particular non-zero magnitude, one wants to know whether that non-zero magnitude could have arisen in the data by chance when in fact the true effect is zero. If a statistical test shows that there is less than, say, a 5% chance that one would have found this particular value if the true value were zero, then it is said that the estimate is "significant at the 5% level". If not, then it is said that the estimate is "insignificant at the 5% level".
Note, however, that the less precise phrase "economically significant" is sometimes used by economists to mean something very similar to the common usage of "significant". If the effect of the minimum wage on hiring decisions were found to be very small and yet the numerical result is very unlikely to have occurred only by chance, then the estimated effect is said to be statistically significant but not significant economically.
" if the technique that was used to obtain the estimate has the effect that, a priori, the expected value
of the estimated effect differs from the true effect, whatever the latter may be. In this case the technique, as well as the estimate obtained with the technique, is called "biased". Researchers are likely to view a biased estimate with suspicion.
" refers to flexibility. In economics it refers to a quantitative measurement of the degree of flexibility of something in response to something else. For example, the "elasticity of demand with respect to income" or the "income elasticity of demand" for a product refers to the percentage change in the quantity of the product demanded in response to a 1% change in consumers' income, or more generally to the ratio of the percentage change in quantity demanded to the percentage change in income. The change in the denominator always causes
the change in the numerator, so the elasticity can be said to be the ratio of a percentage change that is caused to the percentage change of something that is causative.
or some related goal. Economists assume that in the presence of uncertainty, an agent is rational in the sense of specifying a way of evaluating sets of possible outcomes (and associated probabilities) with some function: A consumer is assumed to choose his consumption levels of various goods so as to pick the set of possible outcomes, and associated probabilities, that maximizes this function, which is often assumed to be the expected value of a von Neumann-Morgenstern utility function; a firm is often assumed to maximize the expected value
of profit.
Technical terminology
Technical terminology is the specialized vocabulary of any field, not just technical fields. The same is true of the synonyms technical terms, terms of art, shop talk and words of art, which do not necessarily refer to technology or art...
, and confusion can arise when someone is uncertain of the intended meaning of a word. This article explains the differences in meaning between some technical terms used in economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
and the corresponding terms in everyday usage.
"Recession"
Economists commonly use the term "recessionRecession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
" to mean either a period of two successive calendar quarters each having negative growth of real gross domestic product—that is, of the total amount of goods and services produced within a country—or that provided by the National Bureau of Economic Research
National Bureau of Economic Research
The National Bureau of Economic Research is an American private nonprofit research organization "committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community." The NBER is well known for providing start and end...
(NBER): "...a significant decline in economic activity spread across the country, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales." Almost all academics, economists, policy makers, and businesses eventually defer to the NBER's determination for the precise dates of a recession's beginning and end, which may only be announced after a substantial delay.
In contrast, in non-expert, everyday usage, "recession" may refer to a period in which the unemployment rate is substantially higher than normal.
"Unemployed"
Labor economistsLabour economics
Labor economics seeks to understand the functioning and dynamics of the market for labor. Labor markets function through the interaction of workers and employers...
categorize people into three groups: "employed" - actually working at a job, even if part-time; "unemployed" - not working, but looking for work or awaiting a scheduled recall from a temporary layoff; and "not in the labor force" - neither working nor looking for work. People not in the labor force, even if they have given up looking for a job despite wanting one, are not considered unemployed. For this reason it is often thought, especially when a recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
has persisted for a sustained period, that the unemployment rate understates the true amount of unemployment because some unemployment is disguised by discouraged worker
Discouraged worker
Not to be confused with Disgruntled worker.In economics, a discouraged worker is a person of legal employment age who is not actively seeking employment or who does not find employment after long-term unemployment...
s having left the labor force.
The everyday usage of the word "unemployed" is usually broad enough to include disguised unemployment, and may include people with no intention of finding a job. For example, a dictionary definition is: "not engaged in a gainful occupation", which is broader than the economic definition.
"Money"
Economists use the word "money" to mean very liquidMarket liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
assets which are held at any moment in time. The units of measurement are dollars or another currency, with no time dimension, so this is a stock variable. There are several technical definitions of what is included in "money", depending on how liquid a particular type of asset has to be in order to be included. Common measures include M1, M2, and M3.
In everyday usage, "money" can refer to the very liquid assets included in the technical definition, but it usually refers to something much broader. When someone says "She has a lot of money," the intended meaning is almost certainly that she has a lot of what economists would call financial wealth, which includes not only the most liquid assets (which tend to pay low or zero returns), but also stocks, bonds and other financial investments not included in the technical definition. Non-financial assets, such as land and buildings, may also be included. For example, dictionary definitions of money include "wealth reckoned in terms of money" and "persons or interests possessing or controlling great wealth", neither of which correspond to the economic definition.
A related but different everyday usage occurs in the sentence "He makes a lot of money." This refers to a variable that economists call income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
. Unlike the usages mentioned above, this one has the units "dollars, or another currency, per unit of time", where the unit of time might be a week, month, or year, making it a flow variable.
"Investment" and "capital"
While financial economists use the word "investment" to refer to the acquisition and holding of potentially income-generating forms of wealth such as stocks and bonds, macroeconomists usually use the word for the sum of fixed investmentFixed investment
Fixed investment in economics refers to investment in fixed capital, i.e., tangible capital goods , or to the replacement of depreciated capital goods which have been scrapped....
—the purchasing of a certain amount of newly produced productive equipment, buildings or other productive physical assets per unit of time—and inventory investment
Inventory investment
Inventory investment is a component of gross domestic product . What is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather than in the year they were produced. Conversely, some of the goods sold in a...
—the accumulation of inventories over time. This is one of the major types of expenditure in an economy, the others being consumption expenditure, government expenditure, and expenditure on a country's export goods by people outside the country.
The everyday usage of "investment" coincides with the one used by financial economists—the acquisition and holding of potentially income-generating forms of wealth such as stocks and bonds.
Similarly, while financial economists use the word "capital"
Financial capital
Financial capital can refer to money used by entrepreneurs and businesses to buy what they need to make their products or provide their services or to that sector of the economy based on its operation, i.e. retail, corporate, investment banking, etc....
to refer to funds used by entrepreneurs and businesses to buy what they need to make their products or to provide their services, macroeconomists and microeconomists use the term capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
to mean productive equipment, buildings or other productive physical assets.
As with the term "investment", the everyday usage of "capital" coincides with its use by financial economists.
"Government spending"
Economists distinguish between government spending on newly produced goods and services, such as paying a company to build a new highway, and government spending on transfer paymentTransfer payment
In economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...
s, which are payments such as welfare
Welfare
Welfare refers to a broad discourse which may hold certain implications regarding the provision of a minimal level of wellbeing and social support for all citizens without the stigma of charity. This is termed "social solidarity"...
payments intended to redistribute income. In economic models, transfer payments are normally treated as a negative component of "taxes net of transfers", leaving "government spending on (newly produced) goods and services" as a separate category, often referred to simply as "government spending".
In everyday usage, "government spending" refers to the broader concept of government spending on goods and services plus transfer payments.
"Welfare economics"
Welfare economicsWelfare economics
Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it...
is a branch of economics that uses microeconomic
Microeconomics
Microeconomics is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources. Typically, it applies to markets where goods or services are being bought and sold...
techniques to evaluate economic well-being, especially relative to competitive general equilibrium, with a focus on economic efficiency
Efficiency (economics)
In economics, the term economic efficiency refers to the use of resources so as to maximize the production of goods and services. An economic system is said to be more efficient than another if it can provide more goods and services for society without using more resources...
and income distribution
Income distribution
In economics, income distribution is how a nation’s total economy is distributed amongst its population.Income distribution has always been a central concern of economic theory and economic policy...
.
In general usage, including by economists outside the above context, welfare
Welfare
Welfare refers to a broad discourse which may hold certain implications regarding the provision of a minimal level of wellbeing and social support for all citizens without the stigma of charity. This is termed "social solidarity"...
refers to a form of transfer payment
Transfer payment
In economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...
.
"Efficient"
Economists use the word efficient to mean any of several closely related things:- No one can be made better off without making someone else worse off (Pareto efficiencyPareto efficiencyPareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
). - More outputOutput (economics)Output in economics is the "quantity of goods or services produced in a given time period, by a firm, industry, or country," whether consumed or used for further production.The concept of national output is absolutely essential in the field of macroeconomics...
cannot be obtained without increasing the amount of inputsFactors of productionIn economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
. - ProductionProduction functionIn microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs...
proceeds at the lowest possible per-unit cost.
All of these definitions involve the idea that nothing more can be achieved given the resources available.
In popular usage, efficient often has the similar but less precise meaning "functioning effectively".
"Cost"
The economics term cost, also known as economic cost or opportunity costOpportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...
, refers to the potential gain that is lost by foregoing one opportunity in order to take advantage of another. The lost potential gain is the cost of the opportunity that is accepted. Sometimes this cost is explicit: for example, if a firm pays $100 for a machine, its cost is $100. Other times, however, the cost is implicit: for example, if a firm diverts resources from producing output worth $200 into producing a different kind of output, then regardless of how much or how little of the latter output is produced, the opportunity cost of doing so is $200.
In accounting, there is a different technical concept of cost, which excludes implicit opportunity costs.
In common usage, as in accounting usage, "cost" typically does not refer to implicit costs and instead only refers to direct monetary costs.
"Demand"
In economics, demandDemand (economics)
In economics, demand is the desire to own anything, the ability to pay for it, and the willingness to pay . The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time....
refers to the strength of one or many consumers' willingness to purchase a good or goods at any in a range of prices. If, for example, a rise in income causes a consumer to be willing to purchase more of a good than before contingent on each possible price, economists say that the income rise has caused the consumer's demand for the good to rise. In contrast, if a change in market conditions leads to a decline in the price of a good resulting in a consumer's being willing to buy more of it, economists say that the consumer's quantity demanded of the good has risen. A change in quantity demanded is represented by a movement along the demand curve
Demand curve
In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule...
, while a change in demand is represented by a shift of the demand curve.
In popular usage a change in "demand" can refer to either what economists call a change in demand or what economists call a change in quantity demanded.
"Marginal"
While "marginal" in common usage tends to mean "tangential", implying limited importance, in economics "marginalMarginal concepts
In economics, marginal concepts are associated with a specific change in the quantity used of a good or service, as opposed to some notion of the over-all significance of that class of good or service, or of some total quantity thereof.- Marginality :...
" means "incremental". For example, the marginal propensity to consume
Marginal propensity to consume
In economics, the marginal propensity to consume is an empirical metric that quantifies induced consumption, the concept that the increase in personal consumer spending occurs with an increase in disposable income...
refers to the incremental tendency to spend income on consumer goods: the fraction of any additional income which is spent on additional consumption (or conversely, the fraction of any decrease in income which becomes a decrease in consumption). Likewise, the marginal product of capital
Marginal product of capital
Marginal product of capital is the additional output resulting from the use of an additional unit of capital . It equals 1 divided by the Incremental capital-output ratio...
refers to the additional production of output that results from using an additional unit of physical capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
(machinery, etc.). If very small increments are being considered, so that calculus
Calculus
Calculus is a branch of mathematics focused on limits, functions, derivatives, integrals, and infinite series. This subject constitutes a major part of modern mathematics education. It has two major branches, differential calculus and integral calculus, which are related by the fundamental theorem...
is used, then this ratio of incremental amounts is a derivative
Derivative
In calculus, a branch of mathematics, the derivative is a measure of how a function changes as its input changes. Loosely speaking, a derivative can be thought of as how much one quantity is changing in response to changes in some other quantity; for example, the derivative of the position of a...
(for example, the marginal propensity to consume becomes the derivative of consumption with respect to income).
"Significant"
In common usage, "significant" usually means "noteworthy" or "of substantial importance". In econometricsEconometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...
— the use of statistical techniques
Statistics
Statistics is the study of the collection, organization, analysis, and interpretation of data. It deals with all aspects of this, including the planning of data collection in terms of the design of surveys and experiments....
in economics — "significant
Statistical significance
In statistics, a result is called statistically significant if it is unlikely to have occurred by chance. The phrase test of significance was coined by Ronald Fisher....
" means "unlikely to have occurred by chance". For example, suppose one wishes to find if the minimum wage
Minimum wage
A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...
rate affects firms' decisions on how much labor to hire. If the data show, on the basis of statistical techniques, an effect of a particular non-zero magnitude, one wants to know whether that non-zero magnitude could have arisen in the data by chance when in fact the true effect is zero. If a statistical test shows that there is less than, say, a 5% chance that one would have found this particular value if the true value were zero, then it is said that the estimate is "significant at the 5% level". If not, then it is said that the estimate is "insignificant at the 5% level".
Note, however, that the less precise phrase "economically significant" is sometimes used by economists to mean something very similar to the common usage of "significant". If the effect of the minimum wage on hiring decisions were found to be very small and yet the numerical result is very unlikely to have occurred only by chance, then the estimated effect is said to be statistically significant but not significant economically.
"Biased"
In common usage "biased" generally means "prejudiced". In econometrics, the estimate of the effect of one thing on another (say, the estimate of the effect of the minimum wage upon employment decisions) is said to be "biasedBias (statistics)
A statistic is biased if it is calculated in such a way that it is systematically different from the population parameter of interest. The following lists some types of, or aspects of, bias which should not be considered mutually exclusive:...
" if the technique that was used to obtain the estimate has the effect that, a priori, the expected value
Expected value
In probability theory, the expected value of a random variable is the weighted average of all possible values that this random variable can take on...
of the estimated effect differs from the true effect, whatever the latter may be. In this case the technique, as well as the estimate obtained with the technique, is called "biased". Researchers are likely to view a biased estimate with suspicion.
"Elasticity"
In general usage "elasticityElasticity
Elasticity may refer to:*Elasticity , continuum mechanics of bodies that deform reversibly under stressNumerous uses are derived from this physical sense of the term, which is inherently mathematical, such as used in Engineering, Chemistry, Construction and variously in Economics:*Elasticity , the...
" refers to flexibility. In economics it refers to a quantitative measurement of the degree of flexibility of something in response to something else. For example, the "elasticity of demand with respect to income" or the "income elasticity of demand" for a product refers to the percentage change in the quantity of the product demanded in response to a 1% change in consumers' income, or more generally to the ratio of the percentage change in quantity demanded to the percentage change in income. The change in the denominator always causes
Causality
Causality is the relationship between an event and a second event , where the second event is understood as a consequence of the first....
the change in the numerator, so the elasticity can be said to be the ratio of a percentage change that is caused to the percentage change of something that is causative.
"Rational"
In general usage, one is said to be rational if one is sane or lucid. In economics, rationality means that an economic agent specifies, or acts as if he implicitly specifies, a way to characterize his or someone's well-being, and then takes into account all relevant information in making choices so as to optimize that well-being. For example, an individual consumer is assumed to be rational in the sense that he maximizes a utility function, which expresses his subjective sense of well-being as a function of the amounts of various goods he consumes; firms are assumed to maximize profitProfit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...
or some related goal. Economists assume that in the presence of uncertainty, an agent is rational in the sense of specifying a way of evaluating sets of possible outcomes (and associated probabilities) with some function: A consumer is assumed to choose his consumption levels of various goods so as to pick the set of possible outcomes, and associated probabilities, that maximizes this function, which is often assumed to be the expected value of a von Neumann-Morgenstern utility function; a firm is often assumed to maximize the expected value
Expected value
In probability theory, the expected value of a random variable is the weighted average of all possible values that this random variable can take on...
of profit.