Virtual Economy Glossary (Q-Z)

Virtual Economy Home page - Ground Floor.Case Studies - 1st Floor.Economic Policy - 2nd Floor.Library - 3rd Floor.The Model - 4th Floor.



Quantity theory of money The classical economists view of inflation revolved around this theory, and this theory was in turn derived from the Fisher Equation of Exchange. This equation says that:

MV = PT where:
M is the amount of money in circulation
V is the velocity of circulation of that money
P is the average price level and
T is the number of transactions taking place

Classical economists suggested that V would be relatively stable and T would (as we have seen above) would always tend to full employment. Therefore they came to the conclusion that:

^ M --> P ^

In other words increases in the money supply would lead to inflation. The message was simple; control the money supply to control inflation.


Rate of interest The rate of interest can be thought of as the price of money. It is the extra proportion that has to be paid when borrowing money or the extra that a saver receives when putting their money aside for the future (unless they keep it under the mattress). The level of the rate of interest is determined by the Monetary Policy Committee of the Bank of England that meets each month.
Real GDP Real GDP is the level of GDP after changes in inflation have been taken into account. See also Real terms.
Real terms If a variable is given in real terms, this means that the effect of inflation has been removed.
Reflate To reflate the economy means to try to boost the level of economic activity. This generally means using reflationary policies.
Reflationary policy Reflationary policies are any policies aimed to boost the level of economic activity. These could be either fiscal or monetary policies. For example, a reflationary fiscal policy could be to reduce the level of taxation. This would increase the amount of disposable income people had and encourage them to spend more, therefore increasing output and employment.
Regressive tax A regressive tax is a tax that takes a smaller proportion of a income as income rises. In other words it is a tax that hits less well-off people harder than the better-off. An example of a regressive tax is the television licence. It is exactly the same amount for everyone, which makes it a much smaller proportion of a large income than a small one.
Research and development This is money that is spent by the firm on trying to develop new products. It is vital that firms spent a significant amount on this if they are to stay ahead of the competition and be able to launch new and innovative products.
Return on capital employed Return on capital employed measures the profit as a percentage of the capital employed (the total capital invested in the business). It is a measure of how well the money invested in the business is providing a return to the investors.
Revenue-neutral policies If the government decide to reduce the level of taxation, they may also want to reduce the level of government expenditure by an equivalent amount. This would mean that the tax cut has no effect on the PSNCR (the level of government borrowing). It is therefore termed a revenue-neutral policy.


Savings Savings are any income that is not spent, but put aside. In an economic sense we would also include buying shares or securities as part of this. Savings are a leakage or withdrawal from the circular flow.
Say's Law Say's Law was developed by French economist Jean-Baptiste Say. It states:
"Supply creates its own demand"
This view is one adopted by classical economists to justify their argument that it is most important to improve the supply-side of the economy through supply-side policies. If this is done then the extra output will be demanded.
Search (frictional) unemployment When somebody loses their job (or chooses to leave it), they will have to look for another one. If they are lucky they find one quite quickly, but they may be unlucky and it may take some time. On average it will take everybody a reasonable period of time as they search for the right job. This creates unemployment while they look. The more efficiently the job market is matching people to jobs, the lower this form of unemployment will be. However, if there is imperfect information and people don't get to hear of jobs available that may suit them then search unemployment will be higher.
Social benefits Social benefits are the total of private benefits and any external benefits. See also Externalities - positive.
Social costs Social costs are the total of private costs and any external costs. See also Externalities - negative.
Stagflation This was a term coined in the 1970s for the twin economic problems of stagnation and inflation. Previously these two had not appeared together, it had been one or the other. Keynesian policy had no solution for this problem at the time.
Stagnation This term refers to a negative level of economic growth - the economy shrinking. If this only happens in the short-term it may be called a recession, but if it lasts longer, then it may be referred to as stagnation.
Supply-side See Supply-side policies
Supply-side policies Supply-side policies are policies that improve the workings of markets. In this way they improve the capacity of the economy to produce and so shift the aggregate supply curve to the right. This should enable the economy to grow in a non-inflationary way. Supply-side policies are usually advocated by classical and Monetarist economists who believe that free markets are the most important factor determining economic growth. Supply-side policies may include improving education and training, reducing the power of trade unions, removing regulations and so on.
Sustainable growth Sustainable growth is economic growth that can continue over the long-term without non-renewable resources being used up.


Trade cycle The trade cycle is the fluctuations in the rate of economic growth that take place in the economy. These fluctuations appear to occur around every five years and have probably occurred ever since economies have occurred! It is the aim of all governments to try to dampen the effects of the trade cycle and get more balanced long-term growth, but so far they have had limited success. The peak of the trade cycle is usually referred to as a boom, and the trough as a recession or depression.
Transfer payments Transfer payments are payments for which no good or service is exchanged. This includes things like benefits, pensions and lottery payments. A significant proportion of government expenditure is on transfer payments.
Treasury Bills Treasury Bills are a form of short-term government borrowing. When the government is a little short of funds temporarily they will make a Treasury Bill issue. The size of the issue depends on how much they need. The Bills are a promise to pay (an IOU) and usually mature after 91 days. They are offered to the money markets by a weekly tender.


Voluntary unemployment Voluntary unemployment exists when people have chosen not to work because they do not feel that wages at the existing equilibrium are high enough to justify them working. They may prefer instead to receive benefits. Classical economists argued that any unemployment remaining in the long-term would be voluntary as the economy would automatically tend towards full-employment. The level of voluntary unemployment is shown in the diagram below:

Voluntary unemployment

The actual supply represents those people who are willing to work at the existing wage, whereas the potential is all those of working age who are available to work. The distance shown by the arrow between the two represents voluntary unemployment - those who have chosen not to work at the equilibrium wage.


Wage-price spiral A wage-price spiral can occur when workers demand a pay rise above inflation. This will increase the firm's costs and mean that they in turn have to put their prices up further if they are to maintain their profit margin. If prices increase faster, then that will prompt workers to put in for a yet higher wage rise. If they are successful in this then the firm will have to put prices up further still, and if they do this then.............