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Economic Terms

All   0-9   A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

Excess supply

When the quantity firms supply is greater than the quantity customers want to buy. This is resolved when firms reduce prices to sell off excess supply. Lower prices discourage supply and encourage demand until the excess is removed.

Below is a diagram to illustrate how excess supply arises in a market. In this instance an increase in supply without an accompanying increase in demand will lead to supply exceeding demand and this causes the price to fall to P1 in order for the equilibrium to be restored.


An essential element in the development of economies. It enables progression from self sufficiency to trading. In under developed economies this is enabled by barter. As economies develop and grow, barter will be replaced by a system of money as the main medium of exchange.

Exchange rates

This is the price of a currency expressed in terms of another currency e.g. £1 will buy $1.65.

The diagram illustrates how an exchange rate is determined by the demand (generated by exports because foreign countries need the currency to purchase the domestic country's exports) and supply of the home currency (this happens because the domestic currency is supplied to acquire foreign currencies so that imports can be purchased) on the foreign exchange market. Demand and supply is generated by financial as well as physical transactions.

In this example at the point where Qd = Qs the exchange rate is ER. In modern times circa $5 trillion is traded every 24 hours. This means any imbalances in demand and supply produce almost immediate exchange rate adjustments so that the market continuously clears. As a result exchange rates are quite volatile and adjust quickly to changes in demand and supply. It should be appreciated that the majority of foreign currency transactions relate to financial transactions (approx 2/3) rather than trade in goods and services. 


Is an essential element of a normal market as it prevents free rider activity. When consumers buy a good or service they usually acquire private property rights which means that other people are excluded from using or benefiting from consumption of the good.

Expansionary fiscal policy

Changes in taxation or expenditure that are designed to inject demand into the economy.

Below are a set of graphs to show the impact of the government running an expansionary fiscal policy on the economy in an AD/AS framework. This is done through cutting taxes, increasing government expenditure or possibly both from the classical viewpoint. Regardless of whether the economy has spare capacity or not he impact of the policy is to shift the aggregate demand curve outwards to AD2.

However, what is important when evaluating the effects of an expansionary fiscal policy is to take into account the amount of spare capacity in the economy at the time. The greater the degree of spare capacity, the more effective and the less inflationary the policy is. In the case below, when an economy has significant spare capacity, an expansionary fiscal policy shifts the aggregate demand curve outwards , as a result of spare resources in the economy being available this creates little pressure for the inflation rate to accelerate. Therefore, the final impact on the economy is to achieve short-run growth - whether that is sustained in the long-run depends on what sectors of the economy the fiscal policy targeted. This is the Keynesian viewpoint of demand side fiscal policies such as this one - creates growth without inflationary pressures due to the presence of spare capacity in the economy.

However, an alternative viewpoint could be that if the economy is at full capacity then a policy that aims to inject economic activity and demand into the economy could cause the economy to overheat and create significant inflationary pressures in the process, without the benefits of higher economic growth. So effectively in the long-run we are just moving up the LRAS curve. This tends to be the classical viewpoint on these types of policies - unless there is an accompanying LRAS curve shift then effectively the policy just becomes inflationary. 


The amount of money spent on goods and services in the economy at a particular point in time.

Below illustrates how to calculate the total level of expenditure via adding up all the seperate components i.e. consumption, investment, government spending and net exports (exports - imports).



UK goods that are sold to other countries - any transaction that generates a positive monetary flow into the UK e.g. Land Rover cars sold abroad or foreign money flowing into the UK financial services industry.

Below is a diagram to show that exports represent an injection into a country's circular flow of income as it is money from other countries being spent on domestically produced goods.

Therefore exports contribute to the aggregate demand curve and if exports increase due to a weaker pound sterling then it will cause the AD curve to shift outwards as shown in the diagram below.

External benefit

Benefits arising from the consumption of a good or service that is experienced by third parties.

External consultants

Firms that specialise and develop expert knowledge in specific areas to provide specialist advice and services to firms, businesses and governments

External cost

Costs arising from the production of a good or service that are imposed on third parties.

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