IAI SA7 flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Real versus nominal GDP

Nominal GDP values output at current prices; real GDP uses constant base-year prices, so only real GDP changes reflect changes in the volume of output rather than price inflation.

Fisher equation

The Fisher equation links nominal and real interest rates: (1 + i) = (1 + r)(1 + π), so the real rate r is approximately i − π. It converts observed nominal rates into purchasing-power-adjusted returns.

Output gap

The output gap is actual GDP minus potential GDP, divided by potential GDP. A positive gap means the economy is above capacity and typically signals rising inflationary pressure.

NAIRU

The non-accelerating inflation rate of unemployment is the unemployment rate at which inflation is stable. Below it inflation accelerates; the long-run Phillips curve is vertical at this point.

Fiscal multiplier

The ratio of a change in equilibrium GDP to the initial change in government spending or taxes. It is larger when households spend a high share of extra income and smaller in open economies.

Leading versus lagging indicators

Leading indicators such as new orders, building permits and the yield curve turn before the business cycle; lagging indicators such as unemployment and consumer prices confirm a phase after it has begun.

Price elasticity of demand

The percentage change in quantity demanded divided by the percentage change in price. Demand is elastic when the absolute value exceeds one, so a price cut raises total revenue.

Lerner index

The Lerner index equals price minus marginal cost, divided by price. It runs from zero under perfect competition towards one under strong monopoly and equals one over demand elasticity in equilibrium.

Herfindahl-Hirschman Index

The sum of the squared market shares of all firms, ranging from near zero to 10,000. Values above 2,500 are usually treated as highly concentrated by competition authorities.

Nash equilibrium

A set of strategies where no player can improve their payoff by unilaterally changing strategy, given the others' choices. It need not be socially optimal, as the prisoner's dilemma shows.

Third-degree price discrimination

Charging different prices to identifiable customer groups for the same product, based on differing elasticities. It requires the groups to be separable and resale between them to be impossible.

Contestable market

A market where the threat of new entry constrains incumbent pricing even with few firms present, provided entry and exit costs are low and incumbents cannot respond before entrants exit.

Economies of scale

A fall in long-run average cost as output rises, arising from fixed cost spreading, specialisation and bargaining power. It creates a natural barrier to entry and can justify regulatory scrutiny.

Pigouvian tax

A tax set equal to the marginal external cost of a negative externality, so producers internalise the social cost and output falls towards the socially efficient level.

Coase theorem

With clearly defined property rights and zero transaction costs, bargaining between affected parties reaches an efficient allocation regardless of who holds the rights; only the distribution of wealth differs.

Adverse selection

A situation where better-informed buyers or sellers drive out low-risk participants, as when high-risk lives buy more insurance at pooled average prices and the pool deteriorates further.

Moral hazard

The tendency of insured or protected parties to take greater risks because they do not bear the full cost of loss, which insurers counter with deductibles, co-insurance, exclusions and monitoring.

Price cap regulation

A regulatory rule limiting price increases to inflation minus an efficiency factor, typically RPI minus X. It gives regulated firms incentives to cut costs and keep the gains for a period.

Regulatory capture

The process by which a regulator comes to act in the interests of the firms it supervises rather than the public interest, often through repeated interaction, information dependence and revolving doors.

Taylor rule

A policy rule setting the central bank interest rate as the neutral rate plus weighted responses of inflation to its target and output to potential; weights are commonly around one half.

Underwriting cycle

Recurring swings between soft markets, when abundant capital and competition depress premium rates, and hard markets, when losses erode capital and rates rise sharply.

Duration gap

The difference between asset duration and liability duration scaled by liabilities over assets. A positive gap means a rise in interest rates reduces the insurer's net worth.

Return period

The reciprocal of the annual probability that a loss event of a given size is exceeded, so a one-in-100-year loss has a one percent annual exceedance probability.

Expectations hypothesis

The theory that long-term interest rates equal the average of expected future short-term rates, implying forward rates are unbiased predictors and an upward slope signals expected tightening.

Covered interest parity

The relationship whereby the difference between domestic and foreign interest rates equals the forward premium or discount on the currency, preventing risk-free arbitrage between the two markets.

Purchasing power parity

The proposition that exchange rates adjust in the long run so that identical baskets of goods cost the same across countries, implying rate changes track relative inflation differentials.

Real option

The right, but not the obligation, to make a business decision such as deferring, expanding or abandoning a project, valued by adapting option pricing techniques to capture managerial flexibility.

Risk premium

The difference between the expected monetary value of a gamble and the certain amount a risk-averse decision-maker would accept, arising from diminishing marginal utility of wealth.

Principal-agent problem

A conflict where an agent acting for a principal has different objectives and better information, addressed through incentives, monitoring, bonding and careful contract design.

Loss aversion

A behavioural tendency to weigh losses roughly twice as heavily as equivalent gains, which can explain status quo bias, reluctance to realise losses and asymmetric risk choices.

Contribution margin

Unit price minus unit variable cost. Dividing fixed costs by contribution per unit gives the break-even quantity, and the ratio of contribution to price gives break-even revenue.

Network effects

The tendency for a product's value to rise as more users adopt it, creating winner-takes-most markets, high barriers to entry and a need for competition policy attention.