Basic Economic Terms and Concepts Explained

Learn the definitions of a few key economic terms that everyone should understand.

• capital goods - items a business uses to produce goods or services to sell to consumers; examples include manufacturing equipment and business facilities
• commodity - raw material (like crude oil or iron ore) or agricultural product (like unprocessed wheat or corn) purchased in enormous quantities for production purposes
• consumer - anyone (person or business) that uses (consumes) goods or services
• demand - the extent to which there is a market for goods or services; when a lot of people want to buy something, demand is high
• elasticity - how much an economic variable changes in response to another; if demand spikes when prices are low but contract when prices are high, that is elastic demand
• equity - the amount of ownership in an asset; the equity a person has in their home is the difference between the property’s value and the amount owed on the mortgage
• leverage - the extent to which an investment is funded with borrowed money (debt); the investor is relying on earning a return in order to pay off the debt and still make a profit
• liquidity - the extent to which assets could quickly be converted to cash; for example, a checking account is more liquid than a one-year certificate of deposit
• market - any means that buyers and sellers use to exchange money for goods or services
• scarcity - resources or products that aren’t available in unlimited quantities are scarce; as scarcity of an item increases, so do prices
• shift in demand - when the demand for a product or service goes up or down due to factors other than a change in price
• supply - how much is available of a particular good or service; when supply of a product goes down, the item becomes scarce

Explore economic concepts so you can correctly interpret current events and news stories related to economic conditions.

• business cycle - refers to expected business fluctuations through times of growth and contraction (ups and downs); refers to the cyclical nature of business growth and decline
• consumer price index (CPI) - average change in the cost to consumers of certain goods and services over a set period of time; a CPI increase is an indicator of inflation
• economic growth - an increase in production of goods and services typically measured in the context of changes in GDP or GDP
• gross domestic product (GDP) - the total value (in money) of goods and services produced within a country during a certain timeframe; usually calculated annually
• gross national product (GNP) - GDP plus value of goods and services for which people who live in the country own the means of production; items can be made anywhere
• income - money a business or a person earns in exchange for providing services or products to a purchaser or employer
• macroeconomics - the area of economics that focuses on functioning of the overall economy on a large scale, such as globally or for a multinational region or country
• market economy - economic system in government doesn’t dictate prices or production; instead, these things are determined by producers and consumers via the fair market
• microeconomics - branch of economics that focuses on factors that impact the buying habits of individual consumers and businesses
• unemployment rate - calculated by dividing the number of people who are (a) not working and (b) seeking jobs into the total size of the labor force at a point in time

Make sure you recognize which terms potentially indicate weak or declining economic conditions.

• deflation - the result of sustained price decreases in an economy; indicates that the economy is weakening (contracting)
• economic depression - extended major recession that significantly impacts an entire economy; expected to last at least a year along with a big reduction in GDP
• inflation - the degree to which there are sustained price increases for certain items within an economy; leads to a reduction in the buying power of money
• negative equity - a situation in which someone owes more money on an asset than it is worth; sometimes referred to as “being upside down”
• recession - a significant, sustained economic downturn impacting an entire economy for a fairly long period of time; typically lasts several months or even longer
• stagflation - economic conditions during which prices are rising even though he economy is stagnant (not growing)
• stagnation - conditions in which there is little to no economic growth; consumers are hesitant to buy, so demand goes down and unemployment tends to climb

Learn the meaning of key investment terminology and concepts related to the stock market and other types of investments.

• bear market - refers to economic conditions in which stock prices are dropping; tends to occur when an economy is shrinking (contracting)
• bond - a debt based investment that represents a promise to pay from the bond issuer; the bond issuer owes money to bond investors on a certain date
• bull market - refers to economic conditions in which stock prices are rising; tends to indicate what investors would consider a healthy or sound market
• futures - legally binding agreement to sell or purchase a commodity at a set time in the future for a price that is specified at the time of the agreement
• hedging - seeking to protect oneself against economic fluctuations through entering into futures agreements; no matter what happens in the future, you know what your cost is
• securities - any type of contract that can be valued and traded; stocks and bonds are common examples of securities
• stock - an equity investment that represents ownership of a small portion of a company
• Dow Jones Industrial Average - benchmark that tracks the performance of only a few dozen established stocks traded via the two United States stock exchanges (Nasdaq and the New York Stock Exchange)

Learn these definitions and you’ll be on your way to developing a solid understanding of key terminology and concepts related to the economy. While this topic is on your mind, further expand your knowledge by mastering some commonly used financial abbreviations. Next, take a deeper dive into financial terminology by exploring accounting abbreviations.