| cyclical component of GDP | Fluctuations of output around its trend; the output gap.
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| deep parameters | Parameters that describe the preferences of individuals and the production of firms, and that can be identified from microeconomic studies.
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| difference stationary | Temporary shocks to a variable permanently affect its level.
A random walk is an example of a difference stationary process.
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| imperfect competition | Form of competition in which firms have market power—can choose, to some extent, the price at which they will sell the goods they produce.
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| imperfect-information model | Incomplete information. Forecasts based on imperfect information will be less than fully accurate, though not necessarily biased.
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| intertemporal substitution of leisure | The extent to which temporarily high real wages cause workers to work harder today and enjoy more leisure tomorrow.
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| Lucas critique | Points out that many macroeconomic models assume that expectations are given by a particular function, when that
function can change.
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| menu cost | Small cost incurred when the nominal price of a good is changed; for example, the cost for a restaurant of reprinting its menus when it raises/lowers its prices.
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| New Classical economics | Belief that the private economy is inherently efficient and that the government ought not to attempt to stabilize output and unemployment.
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| New Keynesian economics | Models whose basis is rational behavior and conclude
that the economy is not inherently efficient and that, at times, the government ought to stabilize output and unemployment.
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| parameters | Type of exogenous variable; gives a function its specific form. The
parameter θ in the function Kθ L1 – θ is an example.
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| perfect foresight | Assumption that people know the future value of all relevant variables, or that their expectations are always correct.
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| policy irrelevance | Refers to the inability of monetary or fiscal policy to affect output in rational expectations equilibrium models.
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| price stickiness | When prices are unable to adjust quickly enough to keep markets in equilibrium.
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| productivity shock | Change in technology that affects workers' productivity. See also supply shock .
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| propagation mechanism | Mechanism by which current economic shocks cause
fluctuations in the future, for example, intertemporal substitution of leisure.
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| random walk (of GDP) | Theory that suggests most shocks to output have permanent
effects—that supply shocks play a more important role in explaining business cycle fluctuations than demand shocks.
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| rational expectations | Theory of expectations formation in which expectations are
based on all available information about the underlying economic variable; frequently associated with New Classical macroeconomics.
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| rational expectations equilibrium | A model in which expectations are formed rationally, and markets are always in equilibrium.
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| real business cycle (RBC) theory | Theory that recessions and booms are due primarily
to shocks in real activity, such as supply shocks, rather than to changes in monetary factors.
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| trend (secular) component of GDP | Potential output.
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| trend stationary | A variable is trend stationary when temporary shocks do not permanently affect its level. Changes in AD , for example, can only temporarily affect output. If changes in output were driven primarily by demand shocks, output would be trend stationary.
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| trend stationary with breaks | Trend stationary, but with a trend that sometimes changes.
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