Professional Documents
Culture Documents
Economics Dictionary - MIT PDF
Economics Dictionary - MIT PDF
DICTIONARY OF
MODERN
ECONOMICS
FOURTH EDITION
edited by David W. Pearce
The MIT Dictionary of Modern Economics
is an up-to-date, authoritative reference
designed primarily for students of
economics but invaluable also to students
of business and other social sciences and
ideal for anyone who wants a brief
explanation of an economic concept or
institution.
In this fourth edition one entry in ten has
been revised and one entry in twenty is
new. Whereas the third edition increased
the coverage of American institutions, this
edition breaks new ground by including
entries considered important from an
Eastern European perspective. It also
supplies comparative statistics on major
economic variables for selected countries,
describes the origins of widely used
acronyms, and includes bibliographic
references at the end of featured entries.
The dictionary answers in a clear and
concise way the enduring questions,
which economists have considered for two
centuries or more, as well as the issues of
the moment, such as economic change in
Europe, the problems of pollution, or the
prospects for greater freedom of trade.
With close to 2,800 entries it is
comprehensive in its coverage, of theory,
national and international institutions,
schools of thought, and important
economists, including recent Nobel Prize
winners.
edited by
David W. Pearce
MIT Press editions, 1983
ыогагу ui
Robert Shaw
Aberdeen, April 1992
abatement cost. The cost of abating a nui- nition is obviously conceptually superior.
sance such as pollution or congestion. In Whether the tax system is progressive, pro-
terms of pollution the cost curve will typi- portional or regressive depends on which
cally slope upwards at an increasing rate as measure is employed and on the assumed
pollution is progressively reduced. This is slope of the MARGINAL UTILITY OF INCOME
because it is usually comparatively cheap to schedule(s). Any one definition is actually
'clean up' some part of a polluted environ- consistent with all three tax structures when
ment but extremely expensive to remove the different assumptions are made about the
last units of pollution. An example would be slope of the marginal utility of income sched-
noise where engines can be muffled thus ule. If the latter is assumed to be declining
reducing noise by a noticeable amount. the three measurements do not always give
Further reductions in noise, might, however, consistent conclusions about the appropriate
require expensive engine redesign or whole- tax structure. The equal marginal sacrifice
sale changes in road structures, locations definition produces the most progressive tax
etc. structure. The validity of the theory depends
on the ability to make INTERPERSONAL COM-
ability and earnings. Measures of ability PARISONS OF UTILITY. This is denied in
and levels of education ('schooling') are modern WELFARE ECONOMICS. The theory,
highly correlated, raising the possibility that although superficially attractive, thus has
much of the estimated return to education is several major limitations and defects.
in fact a return to ability. Until recently,
however, it was not thought that allowance abnormal profits.
for ability much reduced the rate of return to See SUPER-NORMAL PROFITS.
education. But studies of identical twins,
who presumably do not differ in ability, have abscissa. The value on the horizontal (or
yielded much reduced estimates of the rate X) axis of a point on a two-dimensional
of return to education; the true RATE OF
graph. (See also ORDINATE.)
RETURN may be as low as 5 per cent rather
than the usual estimate of 10 per cent and
above, although there are disputes over the absenteeism. Failure to report for work
findings. Persistence of schooling expendi- although the terms of the labour contract
tures in such circumstances might be attribu- require the worker to do so and the contract
table to the consumption value of education. is still operational. The OVER-EMPLOYED
Even so, schooling does influence earnings - WORKER will resort to this where control of
even for identical twins - and thus schooling the terms of the labour contract is lax or
can continue to be viewed as an investment. where sanctions for non-compliance are
(See HUMAN CAPITAL.) negligible. In particular employers who are
currently experiencing labour shortage may
ability to pay theory. An approach to tax- be reluctant to use the ultimate sanction of
ation which states that the burden of taxa- SACKING.
tion should be distributed in accordance with
ability to pay. The theory is based on the absentee landlord. An owner of land or
concept of EQUAL SACRIFICE. Sacrifice refers property who lives away from his estate,
to the loss of UTILITY which is incurred when collecting rents and administering his busi-
tax payments are made. There are three ness through some intermediary or agent.
Possible measures of equal sacrifice - equal
absolute, equal proportional and equal absolute advantage.
marginal (or least aggregate). No defi- See COMPARATIVE ADVANTAGE.
2 absolute cost advantage
absolute cost advantage. A concept refer- and services expressed directly in terms of a
ring to those advantages possessed by estab- quantity of the monetary unit. (See PRICE.)
lished firms which are as a consequence able
to sustain a lower average total cost than absolute scarcity.
new entrants irrespective of size of output. See SCARCITY.
Examples of sources of absolute cost advan-
tages are: control of the supply of key factor absolute value. (Also known as modulus).
inputs, patents and superior techniques The value of a variable ignoring its sign.
available only to established firms. (See BAR- Thus the absolute value of a positive number
RIERS TO ENTRY.) is just that number, while the absolute value
of a negative number is itself multiplied by
absolute income hypothesis. This hypoth- minus one.
esis states that consumption expenditures
( Q a r e a function solely of current personal absorption approach. A method of analys-
disposable income (Y d ): С = С (T d .) This ing the effects of a DEVALUATION or DE-
view of the determinants of consumption PRECIATION Of a Country's EXCHANGE RATE ОП
was detailed in The General Theory by its BALANCE OF TRADE. The approach focuses
KEYNES who hypothesized that consumption attention on the relationship between
would be functionally related to income in NATIONAL PRODUCT (Y) and national absorp-
the following way. First for any change in tion (A), where the latter is defined as the
income the corresponding change in con- use of goods for the purposes of CONSUMP-
sumption would be in the same direction but TION and INVESTMENT by the private and
of a smaller magnitude, the MARGINAL PRO- public sectors of the economy. The balance
PENSITY TO CONSUME would be less than 1; of trade (B) can only be positive (i.e. in
surplus) if У exceeds A. Thus in its simplest
0 < AC/AY < 1 form the relationship may be written as В =
where 'A' means 'small change in'. Second, Y-A.
the marginal propensity to consume would If the balance of trade is to improve then
be less than the AVERAGE PROPENSITY TO devaluation or depreciation must raise Y
CONSUME relative to A. In an economy with unem-
ployed resources this is possible, since the
< decline in the exchange rate should be a
AY Y greater stimulus to У than A. At full employ-
Finally, the rate of change of the marginal ment, however, У cannot be increased, so
propensity to consume would be negative; that В can only improve if A falls. The merit
that is, the slope of the CONSUMPTION FUNC- of the approach is that it draws attention to
TION will become flatter as income rises. the need for complementary action, e.g.
While short-run time series and cross-section some degree of DEFLATION, if a decline in the
evidence on the form of the consumption exchange rate is to improve the balance of
function broadly support Keynes' hypo- trade in conditions of full employment.
thesis, long-run evidence contradicts it. In
consequence this form of consumption func- abstinence. A term which describes the
tion enters only the most simple models. necessity of foregoing present consumption
(See also SHORT-RUN CONSUMPTION FUNCTION, in order to allow capital accumulation. It
CROSS-SECTION CONSUMPTION FUNCTION, was first used by Nassau SENIOR in his theory
LONG-RUN CONSUMPTION FUNCTION, RELATIVE of the RATE OF INTEREST. For Senior, the
INCOME HYPOTHESIS, LIFE-CYCLE HYPOTHESIS, creation of CAPITAL GOODS involved saving
PERMANENT INCOME HYPOTHESIS, ENDOGENOUS from current income in order to augment the
INCOME HYPOTHESIS.) CAPITAL STOCK, and create a greater future
stream of consumption goods. As such it
absolute monopoly. implies that a reward for such behaviour is
See MONOPOLY. required if capital accumulation is to con-
tinue. Interest is the reward for abstemious
absolute prices. MONEY PRICES as opposed behaviour, and the rate of interest reflects
to RELATIVE PRICES; that is the price of goods the scarcity of capital.
accession rate 3
j S MILL extended the notion of absti- form, known as the flexible accelerator, the
nence to include a reward for foregoing con- ratio 'a' is affected by the USER COST OF CAPI-
sumption of capital itself. Since capital TAL while further flexibility is introduced in
goods take time to produce commodities for those versions which take account of the
consumption the individual must wait for substantial construction lag some investment
some period before benefiting from an projects entail. As a result only a proportion
investment. Abstention in this sense of of any gap between actual and desired capi-
'waiting' is scarce and requires a reward or tal stock will be made up in any one period.
payment in the form of interest. The principle plays an important role in ex-
These two elements of abstinence provide planations of the TRADE CYCLE e.g. through
a theory of the supply of savings which can MULTIPLIER-ACCELERATOR INTERACTIONS, a n d
be used in conjunction with a demand for in the theory of economic growth - notably
investment to explain the existence of a posi- the HARROD-DOMAR MODEL. (See also CAPITAL
tive rate of interest. STOCK ADJUSTMENT PRINCIPLE.)
UTILITY of good a is dependent upon the similarly for У, then we know that the ratio
amount of good a alone and on no other of the marginal utilities at С must change in
good. If then each good is subject to DIMI- such a way as to make the indifference curve
NISHING MARGINAL UTILITY it will be the case steeper at С than at A. This is simply be-
that the INDIFFERENCE CURVE will be convex - cause we have more of У (its marginal utility
i.e. bent 'inwards' - to the origin. That is, has fallen) and the same amount of X (its
provided the utility function is additive and marginal utility is the same). Parallel analy-
diminishing marginal utility exists for each sis will show that the indifference curve
good then the indifference curve will be con- through D is less steep than it is at A, where
vex. Proof is given in the diagram. An indif- D also lies on the new parallel budget line
ference curve relating to two goods X and У and where D is directly 'east' of A. It follows
is shown. Consider point A on the indiffer- that the indifference curve which is tangen-
ence curve, and then consider the move to tial to the new budget line will be at a point
point B. At В there is more of X and less of between С and D, say E. But this implies
У. So long as the marginal utility of X that a change in income will, provided utili-
depends on the amount of X alone, we know ties are independent, always cause more of
that the marginal utility of X must be less at both commodities to be bought. In short
В than it was at A simply because the con- each good must be a NORMAL GOOD. One of
sumer has more of X. Since he has less of У the properties of additive utility functions,
his marginal utility of У will be more than therefore, is that they always imply that the
at A, hence the ratio of the two marginal goods entering into the utility function are
utilities, which defines the slope of the normal.
indifference curve (its MARGINAL RATE OF
SUBSTITUTION), must fall so that the indiffer- address principle. In a PLANNED ECONOMY
ence curve at В has a shallower slope than at such as the former USSR each target has an
A. It follows that additive utility functions organization or 'address' which is respon-
imply convexity of the indifference curve. sible for carrying it out.
A further feature of such utility functions
can be illustrated on the same diagram. adjustable peg system. This was instigated
Consider the move from A to C, where С is by the INTERNATIONAL MONETARY FUND ( I M F )
directly 'north' of Л on a near but parallel at the BRETTON WOODS conference and refers
BUDGET LINE. If the marginal utility of X is to a set of fixed, or 'pegged' EXCHANGE RATES
dependent upon the amount of X alone, and which are basically static, but allowed to
adjust or change by small amounts in either
direction. Adjustable peg systems have three
main problems: finding the necessary re-
serves to meet short term fluctuations in for-
eign receipts and payments to keep the rate
fixed, adjustments to long run trends and
crises due to speculation on changes in the
peg-
adjusted R2 (also known as R2, R bar
squared).
The COEFFICIENT OF DETERMINATION adjusted
for DEGREES OF FREEDOM, bearing the re-
lationship to the unadjusted coefficient.
added, if the latter do not significantly add to and as everyone pays the same amount of
the explanatory power of the equation, then tax on a unit purchase irrespective of his
R 2 will decrease. This figure thus provides a income this type of taxation is said to be
valid way of comparing the explanatory REGRESSIVE.
power of equations containing different
numbers of explanatory variables. (See advance. A loan, whether against an
GOODNESS OF FIT.) identified or an expected inflow of cash. (See
BANK LOAN.)
adjustment lag. The time taken for a vari-
able such as CAPITAL STOCK to adjust to
changes in its determinants. (See PARTIAL Advance Corporation Tax (ACT). When
ADJUSTMENT, CAPITAL STOCK ADJUSTMENT
a company in the UK makes a distribution of
dividends it has to pay advance corporation
PRINCIPLE.)
tax at the rate of 1/3 of the distribution (in
adjustment process. The generic term for 1990-91). As the name suggests it is an
the adjustment mechanisms which operate in advance payment of CORPORATION TAX and is
the international economy to remove imbal- credited against its liability for that tax. It is
ances in foreign payments. The most import- a device to collect some corporation tax
ant mechanisms which have been advanced earlier than otherwise would be the case. It
to explain the process are those involved in is noteworthy that when taxable profit is not
t h e GOLD STANDARD, t h e GOLD EXCHANGE
big enough to 'cover' all dividend payments
STANDARD, t h e FOREIGN TRADE MULTIPLIER
ACT cannot be fully recouped against cor-
poration tax. The existence of ACT in this
and the FLOATING EXCHANGE RATE.
situation means that imputation credit can-
not be claimed by shareholders without cor-
administered prices. Prices which are
poration tax being paid by the company. The
established by the conscious decision of
maximum ACT which can be set off against
some individual or agency rather than by
corporation tax liability is the amount which
the impersonal play of market forces.
after being added to the dividend equals the
Administered pricing is generally possible
taxable profit. The rules allow a surplus of
where a good is sold by a MONOPOLY firm or
ACT to be carried backwards for two years
public body.
against taxable income and forward without
limit. In recent years many firms in the UK
administrative lag. One of the lags in time have experienced unrelieved ACT because
affecting the impact of a MONETARY POLICY. It
of low profits and high capital allowances.
is the time between the recognition by the
authorities that action is necessary and the
actual taking of the action. Its length advance refunding. A new DEBT MANAGE-
depends on the efficiency of the authorities MENT technique used by US federal, state,
and whether they believe in prompt action and local governments. The US Treasury
or infrequent but more major changes. (See may want to extend the average maturity of
INSIDE LAG.) its marketable securities. This can be done
by offering owners of shorter issues the
ad valorem tax. A tax based on the value opportunity to buy new longer issues. To
°f a transaction. It is normally a given per- coax security owners to make the exchange,
centage of price at the retail, wholesale or slightly higher yields are offered. While the
manufacturing stage and is a common form higher yields increase the cost of servicing
°i SALES TAX. Examples are the retail sales the debt, the longer maturity of the debt
ax w
hich is common in the USA, the VALUE- reduces the number of times the Treasury
ADDED TAX widely employed in Europe and must borrow. State and local governments
jne PURCHASE TAX formerly employed in the use this technique when their bond ratings
K. Another common example is ROYALTIES have improved and they are able to take
evied on the production of minerals. advantage of lower interest rates. State and
£equently, the INCIDENCE of this type local governments call in their old higher-
ot yield, lower-rated securities in exchange for
sales tax will be at least partly on the
c new lower-yield, higher-rated securities.
°nsumers of the products concerned
8 advanced countries
advanced countries. The dividing line be- tO BARRIERS TO ENTRY and PRODUCT DIFFEREN-
tween advanced countries and DEVELOPING TIATION, established firms are given an ele-
COUNTRIES is usually based on per capita ment of discretion over price. In this way,
income. Those with per capita incomes of advertising can sustain existing levels of con-
less than one-fifth of the level of those in the centration within the industry. Further, N.
US are considered 'underdeveloped'. It is KALDOR has argued that because advertising
not an absolutely clear definition as there are is not a marketable product, consumers are
some countries, for example, Middle East not given the opportunity to determine the
oil producing countries which on this cri- volume of advertising they wish to consume.
terion would be advanced countries, but On the other hand, advertising is a source of
which, when the INCOME DISTRIBUTION and information on prices and product attributes
availability of various services are taken into available to potential buyers. In this way,
consideration, are obviously not very ad- advertising enhances information flows be-
vanced. (See UNDERDEVELOPMENT.) tween traders and thereby strengthens com-
petitive market forces. By enhancing sales,
adverse balance. A BALANCE OF PAYMENTS advertising may also enable firms to secure a
DEFICIT. MINIMUM EFFICIENT SCALE and thereby
acquire ECONOMIES OF SCALE. Recent theor-
adverse selection. The problem encoun- etical and empirical work has suggested that
tered in the INSURANCE industry that the sub- advertising be treated as a CAPITAL EXPENDI-
population taking out insurance is likely to TURE. This suggestion recognizes that adver-
have less favourable characteristics than the tising expenditures contribute to a stock of
population in general. In establishing the GOOD-WILL which decays gradually over
rates of premium for e.g. life insurance a time.
company may use the age-specific mortality
rates for the population as a whole. Non- advertising-sales ratio. The ratio of firms'
smokers know that their mortality rates are advertising expenditure to total sales reve-
less than the population as a whole and that nue. Rivalry in more highly concentrated
they are subsidising smokers in the premium market structures tends to take the form of
payment. They will, therefore, be reluctant non-price competition, hence we can expect
to insure themselves. Smokers have higher CETERIS PARIBUS, the intensity of advertising
mortality rates than the population as a (as measured by the advertising-sales ratio)
whole and are aware that they are being to increase as we move from a perfectly
subsidised by non-smokers. They have an competitive market structure to oligopolistic
incentive to insure themselves. The insur- market structures. (See ADVERTISING.)
ance company ends up with an adverse selec-
tion of people with higher than average AFL-CIO.
mortality rates. The problem can be over- See AMERICAN FEDERATION OF LABOR.
come by the introduction of policies targeted
at specific sub-populations with different age-earnings profile. The relationship be-
premia for each such population. tween earnings and age. The simplest age
earnings profile would be a horizontal line
advertising. Action by a firm to promote stepping up from zero at the age of leaving
the sales of its products, the basic aim being school with the size of step being determined
to increase the number of consumers who by the quantity of schooling. In fact the
prefer these products to those of its competi- typical post-school age-earnings profile is
tors. This can be achieved in two different more complex than this: the pattern for
ways. Firstly, advertising can be used to in- annual earnings is for a steep increase on
form consumers of the existence and loca- leaving school followed by a slower increase
tion of the product(s) to which it is directed. until a plateau is reached in the mid-forties,
Secondly, advertising can influence the after which a slow and then a faster descent
nature of consumers' preferences to the occurs. The modern explanation of the para-
benefit of the firm's products. It has been bolic path of earnings is that after leaving
argued that advertising is a source of MARKET school the individual does not cease to invest
IMPERFECTION, in particular, by contributing in his HUMAN CAPITAL. He is still willing to
aggregate expenditure 9
may vary systematically with changes in the to account for the shares of income. (See
general price level. (See AGGREGATE DEMAND WELL-BEHAVED, EULER's THEOREM, COBB-
CURVE.) DOUGLAS PRODUCTION FUNCTION, CONSTANT
ELASTICITY OF SUBSTITUTION PRODUCTION
aggregate income. FUNCTION.)
See NATIONAL INCOME.
aggregate supply curve. The schedule
aggregate output. detailing the quantity of NET NATIONAL PROD-
See NATIONAL INCOME. UCT that would be supplied at each general
price level given constant price expectations,
aggregate production function. A func- as shown below. In the short run the positive
tional relationship between the flow of out- slope derives from the hypothesis that
put in the whole economy (Y) and the total workers do not adjust their expectations
labour (L) and total capital (K) inputs actu- about the future level of prices to take
ally engaged in production. This is usually account of the current movement in prices.
written as In consequence the rise in nominal wages
that accompanies the rise in prices is mis-
У = F(K, L) taken for a rise in real wages and hence more
It may be extended to include LAND as an labour is offered and more output produced.
input, and technology. The rise in nominal wages follows from the
Such a relationship is usually taken as increase in the MARGINAL REVENUE PRODUCT
referring to the maximum flow of output of output due to the rise in prices which
associated with the factor inputs. While К encourages employers to increase output. In
and L are stocks it is the flow of capital and the short run the only way this can be
labour services which are considered as accomplished is by employing more labour
inputs to the process of production. The and hence they offer higher wages to secure
aggregate production function in common this. The rise in wages does not match the
with aspects of the microeconomic PRO- rise in prices and the real wage therefore
DUCTION FUNCTION is usually assumed to falls, a necessary condition on this view for
have one of two forms: increased employment. In the long run,
1. Fixed coefficient, which does not allow however, increased labour will only be forth-
CAPITAL-LABOUR SUBSTITUTION and allows coming if the real wage rises - labour supply
either some labour or some CAPITAL to be is assumed to be a function of the real wage -
unused. Along any EXPANSION PATH the ratio
of aggregate capital stock used to labour general price Long run
force actually used is constant. level aggregate supply curve
2. Continuous, which allows for the substi-
tution of aggregate capital for labour in the
production of output.
Great controversy has surrounded the use
of aggregate production functions particu-
larly of the continuous variety. Criticism has Short run
come in particular from the CAMBRIDGE aggregate
SCHOOL who question the existence of such a supply curve
phenomenon, at least at the aggregate level,
and the corresponding use of the MARGINAL
PRODUCTIVITY THEORY OF DISTRIBUTION a s ЭП
explanation of the economy-wide distri-
bution of income between capital and
labour. In the. view of the Cambridge
School, to be acceptable the aggregate pro-
duction function should not suffer from the
problem of RESWITCHING of techniques while Full employment Output
output
PERFECT COMPETITION is necessary for a mar-
ginal productivity theory of distribution aggregate supply curve
agricultural reform 11
and therefore this situation cannot be sus- where earnings are paid in kind, i.e. in agri-
tained Workers revise their expectations to cultural produce.
take account of the movement in prices and
the aggregate supply curve moves upwards agricultural exports. Agricultural products
with output and employment falling back to produced specifically for export and not for
their previous levels. In the long run the subsistence purposes or home markets.
aggregate supply curve is vertical above the
full employment level of output which corre- agricultural lag. This is the time gap be-
sponds tO the NATURAL RATE OF UNEMPLOY- tween actual and potential agricultural pro-
MENT. (See also AGGREGATE DEMAND CURVE duction in DEVELOPING COUNTRIES. With ЭП
a n d VERTICAL PHILLIPS CURVE). increasing number of people in these
countries moving to the cities, the supply of
aggregation problem. The problem of der- food and other agricultural raw materials has
iving predictable MACROECONOMIC behaviour to expand in order to satisfy the needs of the
from the behaviour of the underlying MIC- increased urban population. If there is a
ROECONOMIC units. Any attempt to derive shortfall, food will have to be imported, in-
macroeconomic or aggregate CONSUMER be- creasing the burden on the industrial sector
haviour from individual consumer prefer- and producing a lag in the development
ences runs into problems treated by the process.
IMPOSSIBILITY THEOREM, while attempts to de-
rive aggregate FIRM behaviour encounter the agricultural levies.
problems associated with the AGGREGATE See EC AGRICULTURAL LEVIES.
PRODUCTION FUNCTIONS. (See COMPOSITE COM-
MODITY THEOREM.) agricultural reform. One of the major ob-
stacles to ECONOMIC DEVELOPMENT is the use
of primitive and inefficient methods of agri-
agrarian revolution. The situation culture. The rural sectors in less developed
where agricultural output is substantially countries have to support an increasing
increased due to changes in organization urban population in terms of supplying basic
and techniques, ECONOMIC DEVELOPMENT is foodstuffs. The old primitive methods are
usually associated with both INDUSTRIALIZA- inefficient, yet new modern mechanized
TION and an agrarian revolution. The latter techniques are usually unsuitable, so one of
may require a change in social or legal type of reform is the implementation of an
arrangements, such as the abolition of the appropriate style of agricultural technology.
communal ownership of land, and the For example, hand-drawn ploughs, though
introduction of capital in the form of widely used, are very inefficient, yet the small
machinery and of improved strains of ani- farmer cannot afford a tractor and even if he
mals and plants. The associated rise in PRO- could he does not have the knowledge or
DUCTIVITY per worker makes available a equipment to maintain it. However, bullock-
surplus of food for export to the growing drawn ploughs have been introduced as a
cities or to foreign countries for cash and kind of intermediate level of technology;
also releases labour for re-employment in with great success in many situations.
the industrial sector. (See LEWIS-FEI-RANIS
Furthermore, there is great need for re-
MODEL, TODARO MODEL.)
form in the system of land ownership, where
often one of two extremes can exist: the land
agricultural earnings. The earnings of is sometimes too fragmented in terms of
those engaged in the AGRICULTURAL SECTOR; ownership, with no-one owning enough to
in developing countries there is a major dis- implement any efficient production methods
parity between urban and rural wages. The or produce food for marketing in excess of
Problem of large numbers of people moving his subsistence requirements. The other ex-
away from the rural areas can be largely treme is the situation of excessively large
fxplained by the very low agricultural earn- estates, sometimes owned by absentee land-
ln
gs compared to urban wage levels. Often lords so that arable land is not even being
Agricultural earnings cannot easily be quanti- utilized. Useful reforms here are the setting
sed, especially in subsistence agriculture or up of co-operatives in the first instance, and
12 agricultural sector
and interest paid on mortgages or other ation brought together major trades unions
loans for house purchase up to a maximum in the USA. It was based on the traditional
of £30,000. (See ALLOWANCES AND EXPENSES ideals of unions but each union remained
FOR CORPORATION TAX.) autonomous in terms of control over its own
affairs, and no union was to organize the
Almon lag. A DISTRIBUTED LAG formu- same set of workers. In 1935 the Congress of
lation in which the weights on successive Industrial Unions (CIO) was formed, not
values of the lagged variable follow a pattern least in order to secure increased power for
dictated by a POLYNOMIAL. For instance, a the unions, the AFL having declined in force
second degree polynomial may result in an during the years of inter-war recession.
inverted U-shape of weights over time. Whereas the AFL was organized by craft,
the CIO had an industrial basis, greatly in-
alpha coefficient. creasing its power. Until 1955 the AFL and
See CAPITAL ASSET PRICING MODEL. CIO effectively competed as the main
leaders of labour in the USA, but the two
alternative technology. One of the names organizations merged in 1955 as the
usually given to a type of technology which AFL-CIO.
has some or all of the following attributes:
minimum usage of NON-RENEWABLE RE- American selling price. This is a system
SOURCES; minimum interference with the en- whereby the US tariff on some imports is
vironment; either regional or local self- calculated on the basis of the value of a
sufficiency; and the absence of exploitation domestic substitute as opposed to the value
or ALIENATION of individuals. (See INTER- of the import. (See also GENERAL AGREEMENT
MEDIATE TECHNOLOGY, APPROPRIATE TECH- ON TARIFFS AND TRADE.)
NOLOGY, INTERMEDIATE TECHNOLOGY DEVEL-
OPMENT GROUP.) American Stock Exchange (ASE or
AMEX). The second largest organised
altruism. Concern for the well-being of STOCK EXCHANGE in the United States, hand-
others. Thus, the UTILITY FUNCTION of an ling approximately one-tenth of all shares
individual may exhibit the form: traded in the US. The exchange provides a
physical place for STOCK transactions to
U, = U(X, У, Щ occur. To be traded, a stock must be of a
where X and У are goods consumed by indi- listed company, one that meets the require-
vidual /, and Uj is the UTILITY of another ments of the exchange's board of directors.
individual,;. Because most of the companies are smaller,
the requirements for listing on the American
amalgamation. Exchange are less than those of the NEW
See MERGER. YORK STOCK EXCHANGE. Companies are listed
in order to insure sufficient volume for an
American Depository Receipt (ADR). A active market in the stock and to provide
security issued by a US bank normally to a information about the firm to interested
US resident against a holding by the insti- investors. Companies must make annual
tution of ORDINARY SHARES in a foreign com- financial reports, quarterly earnings reports,
pany. The holder of the ADR acquires the and limit trading by insiders. Many compa-
right to the DIVIDENDS etc. of the foreign nies are listed with several exchanges. If
company. The ADRs are themselves traded. interest in a particular stock falls, the com-
The advantages of the arrangement are that pany may become unlisted.
the CAPITAL MARKET is widened for non-US Member firms are the only ones which
companies, while the American desire for an may trade shares of the listed companies on
easily-traded 'heavy' share can be satisfied. the floor of the exchange. Member firms
(An ADR may be packaged so that it is title may buy and sell out of their own account or
to many ordinary shares). for clients. The majority of member firms
are brokerage houses. The member firms
"--»»-«*:«» *>f l a h n r ( A F L ) . play a variety of roles. First, they may be
• -.:„„ onH fi^ilino frr> i
annual capital charge 15
the calculation of the average annual charge and groups of cooperating firms (CARTELS).
or depreciation plus interest and comparing In the US the intent to possess monopoly
this with the annual net cash flow. If the net power by means of merger and acquisition,
cash flow is greater than the capital charge and its exercise through non-normal busi-
the project is acceptable. The annual capital ness practices is declared illegal. Non-
charge method charges depreciation on a normal business practices or RESTRICTIVE
SINKING FUND basis - its distinctive feature - PRACTICES include such behaviour as PRICE
and does so in such a way that the full capital DISCRIMINATION, PRICE LEADERSHIP, a n d ex-
invested is recovered at the end of the proj- clusive dealing. Such a policy has been called
ect's life. Interest is charged on the whole 'non-discretionary anti-trust' in contrast to
initial capital throughout the project's life, the UK legislation on monopolies and re-
the idea being that only then is it recovered. strictive practices where collective agree-
On some projects where the NET PRESENT ments and mergers are considered on the
VALUE a n d INTERNAL RATE OF RETURN C r i t e r i a grounds of public interest, and a balance is
both indicate acceptability the annual capital sought between their merits (such as econo-
charge method does the same. mies of scale) and demerits (such as restric-
tive practices and X-INEFFICIENCY.) (.See
annuity. A promise to pay a given sum CELLAR-KEFAUVER ACT, CLAYTON ACT, FED-
each period over a number of periods, the ERAL TRADE COMMISSION ACT, ROBIN SON-
sum in each period being constant. If the PATMAN ACT, SHERMAN ACT).
payments are made over an infinite period of
time the annuity is called a perpetuity and appreciation. A rise in the value of an
has a PRESENT VALUE of ASSET, the opposite of which is DE-
P PRECIATION. An asset may appreciate in
r value because its PRICE and hence its market
value has risen because of INFLATION or a
where P is the sum paid each period and r is change in DEMAND for the asset which leads
the discount rate. to increased scarcity value. (See also CUR-
RENCY APPRECIATION).
anomalies, pay. A break in the formal
linkages between the pay of different bar- apprenticeship.
gaining groups as a result of the introduction See GENERAL TRAINING.
of an INCOMES POLICY. For example, the
imposition of a freeze may prevent some
occupations in a JOB CLUSTER from achieving appropriate products. Generally discussed
a settlement in line with the KEY RATE be- with reference to products which are appro-
cause their settlement date falls after the priate for USe in DEVELOPING COUNTRIES. It is
starting date of the new policy. (See also argued by some economists that through
RELATIVITIES; WAGE DIFFERENTIALS.) INTERNATIONAL TRADE a n d MULTI-NATIONAL
COMPANIES inappropriate products are often
introduced into less developed countries
anticipated inflation. .
as well as inappropriate technology.
See EXPECTED INFLATION.
Multinational companies will have devel-
oped products suitable for the conditions
antilogarithm. The inverse function of a pertaining in Western economies. They tend
LOGARITHM, simply the base of the LOGAR- to use the same materials in developing
ITHM; raised to the power of the number countries where they will often be inappro-
whose antilogarithm is required. priate. For example, building materials suit-
able for cold weather conditions and for
anti-trust. An American term for legisla- sustaining twenty-floor blocks of flats may
tion to control the growth of market power not be the most appropriate to employ in the
exercised by firms. The term relates not only construction of single- or two-storey houses
to anti-monopoly policy but also to restric- in Africa. The use of APPROPRIATE TECH-
tive practices operated by individual firms, NOLOGY often goes hand in hand with appro-
groups of amalgamated companies (TRUSTS) priate products.
Ш
ARCH 17
the disturbance term and an effect arising pioneering work on decision-making under
from the variance of the disturbances called conditions of uncertainty. In his Social
the ARCH EFFECT. Thus in a model having Choice and Individual Values (1951) he pre-
disturbances which are free of serial corre- sented WELFARE ECONOMICS with a dilemma
lation the DURBIN-WATSON STATISTIC may in- when he demonstrated on the basis of
dicate significant serial correlation, an effect assumptions which broadly secure con-
which arises from the time dependence of sumers' sovereignty plus rationality, that it is
the variances of the disturbances. The normally impossible to define a social rank-
ARCH test attempts to distinguish between ing of alternative choices which will corre-
true serial correlation and an ARCH effect spond to individual rankings, so that it may
arising from intertemporal dependence of be impossible to devise a SOCIAL WELFARE
the variances. (See R.F. Engle, 'Auto- FUNCTION that is positively related to indi-
regressive conditional heteroscedasticity vidual choices; society might be unable to
with estimates of the variance of UK infla- make up its collective mind as to what it
tion', Econometrica, Vol. 50, 1982, pp 987- wants. Arrow is also responsible for the in-
1007) troduction into growth theory of the hypoth-
esis of learning by doing as a source of
ARCH effect. productivity growth. His major publications
See ARCH. are Studies in Mathematical Theory of
Inventory and Production (1958); Social
Aristotle (384-322 ВС). Greek philos- Choice and Individual Values (1951); Essays
opher whose work also covered economic in the Theory of Risk-bearing (1970);
matters and in whose writings can be found General Competitive Analysis (with F.H.
analyses of production, distribution and Hahn) (1971).
exchange. In analysing exchange he dis-
tinguished between USE VALUE and EX-
'A' shares.
CHANGE VALUE and offered a theory of
See FINANCIAL CAPITAL.
money as a conventional device for indirect
exchange. His condemnation of the use of
Asian Development Bank. The United
money to produce more money had a great
Nations Economic Commission for Asia and
influence on the medieval debate on usury.
the Far East recommended the creation of
He defended the institution of private prop-
this bank to encourage economic growth and
erty against the Platonic scheme of commu-
nism, largely for its influence on character co-operation in Asia and the Far East and to
and the promotion of responsibility. accelerate economic development in the
developing countries in the area. It was
arithmetic mean. established in 1966. The capital was pro-
See MEAN .
vided by the countries within the region with
the help of the US, West Germany, UK and
arithmetic progression. A series of num- Canada.
bers or algebraic terms in which each ele-
ment bears an additive relationship to its assessable income or profit.
predecessor and successor. The series See TAXABLE INCOME, ALLOWANCES AND
EXPENSES FOR INCOME TAX, ALLOWANCES AND
a, a + d, a + 2d , . . . , a + nd EXPENSES FOR CORPORATION TAX.
is an arithmetic progression. (See also GEO-
METRIC PROGRESSION.) assessable profits.
See TAXABLE INCOME.
Arrow, Kenneth J. (1921- ). American
economist, joint winner of Nobel Prize in asset. An entity possessing market or
Economics in 1972 with Sir John HICKS. He is exchange value, and forming part of the
best known for his work on GENERAL EQUI- WEALTH or property of the owner. In econ-
LIBRIUM systems and for the statement of the omics an important distinction is made be-
mathematical conditions necessary for such tween 'real' assets, which are tangible
a system to have a unique and economically resources like plant, buildings and land
meaningful solution. He has also done yielding services in production or directly to
asymptote 19
onsumers; and financial assets, which in- distinct set of policies has always operated in
°1ude MONEY, BONDS and EQUITIES, and which Northern Ireland. (See DEPRESSED AREAS,
are claims or titles to receive income, or to REGIONAL EMPLOYMENT PREMIUM, REGIONAL
receive value from others. DEVELOPMENT GRANT.)
INDEPENDENT VARIABLE becomes very large to go forward, any trading before that stage
or very small, but without ever reaching it. being designated 'false trading'.
For instance, in the function
ing', Econometrica, 1987, Vol. 55, pp 251- with the REAL WAGE and inversely with the
276.' RATE OF INTEREST. Modern Austrians include
von Mises, von Hayek, HABERLER and
augmented Phillips curve. Introduction of Machlup. The school is currently character-
a price variable into the basic PHILLIPS CURVE ized by the attention it pays to market pro-
effectively transforming the theory from an cesses and RELATIVE PRICES, a feature which
explanation of money wages to one cast in distinguishes it from the widely-accepted
Keynesian aggregative approach.
real terms. Now:
autarky. A situation where a country iso-
lates itself from international trade by re-
where AW is the change in nominal wages, strictions such as tariffs, in an attempt to be
U the unemployment rate, and Pe the self-sufficient, usually for reasons of employ-
expected price change, all in period t. That ment or politics.
is, the wage determination equation sugges-
ted by Phillips has been augmented by the autocorrelation.
introduction of a price expectations variable. See SERIAL CORRELATION.
At low levels of inflation the distinction be-
tween money and real wages may be trivial automatic stabilizers. Relationships which
so that the COEFFICIENT on price expectations reduce the amplitude of cyclical fluctuation
may be close to zero. At high rates of price in the economy without any direct action by
inflation the coefficient will rise until government, FIRMS or individuals. One of
at the extreme, a = 1. The hypothesis that the major benefits of automatic stabilizers is
a = 1 forms the basis of the Phelps-Friedman that their INSIDE LAG is zero. One of the most
approach which argues that the Phillips important stabilizers is a progressive INCOME
curve is vertical above the NATURAL RATE OF TAX which, through its effects on saving, re-
UNEMPLOYMENT. (See VERTICAL PHILLIPS duces the value of the MULTIPLIER as it oper-
CURVE.) ates on EXOGENOUS changes in AGGREGATE
DEMAND.
Austrian School. This name is applied to
economists from MENGER, WIESER and вонм- automation. While used in various ways,
BAWERK onwards who studied largely in the term 'automation' is generally regarded
Vienna, and who subscribed to a particular as being synonymous with the displace-
type of analysis. The school, through the ment of labour by some automatic process,
writings of Menger, dissociated itself from e.g. controlling machine parts by other
the German HISTORICAL SCHOOL and sub- machines, automatic paint spraying and so
scribed to a belief in deduction and theory. on. Automation is typically associated with
It developed a subjective theory of VALUE TECHNOLOGICAL UNEMPLOYMENT, b u t ПО SUCh
based on MARGINAL UTILITY in contrast to the direct linkage need occur if automation per-
prevalent cost of production (especially mits increases in LABOUR PRODUCTIVITY which
LABOUR THEORY OF VALUE) approach. The in turn permits the generation of ECONOMIC
Austrian treatment of capital, whose pro- GROWTH.
ductivity is held to arise from ROUNDABOUT-
NESS, is original and distinctive. Bohm- autonomous expenditures. Expenditures
Bawerk's work on capital and interest (the which are considered to be independent of
tetter explained in terms of a relationship the level of income in the INCOME-
between TIME PREFERENCE and physical PRO- EXPENDITURE MODEL. GOVERNMENT EXPENDI-
DUCTIVITY) has been a source of stimulus and TURE, certain types of INVESTMENT EXPENDI-
controversy up to the present time. While TURE and EXPORTS are the principal
Konm-Bawerk devised his theory to estab- examples. (See AUTONOMOUS INVESTMENT.)
f
sn conditions of long-run equilibrium, von
EK adapted it to explain the cycle, in autonomous investment. Capital invest-
wnich the period of production falls in the ment which is unrelated to changes in
pswmg and increases in the downswing, income levels. Public investment, invest-
n c e t h e
period of production varies directly ment which occurs in direct response to in-
22 autonomous transactions
ventions, and much of 'long range' invest- Average total cost will be comprised of aver-
ment which is only expected to pay for itself age fixed costs (AFC) and average variable
in the long run are examples. costs (A VC). Thus,
АТС = AFC + AVC
autonomous transactions. A term used in
the theory of the BALANCE OF PAYMENTS to In the SHORT RUN the average cost curve will
define those transactions, which take place tend to have the shape shown in the dia-
spontaneously for reasons of gain or profit gram. This 'U' shape is accounted for by the
on the part of firms or increased utility on fact that AFC declines as output expands
the part of individuals, e.g. the import of a and initially more than outweighs the rise in
foreign good, the taking of a holiday over- AVC. AFC falls since a fixed total cost is
seas. These transactions are to be contrasted being spread over a larger and larger output.
with ACCOMMODATING or compensatory AVC rises because of the operation of the
transactions which are related to the overall LAW OF DIMINISHING RETURNS. Eventually the
balance of the autonomous transactions. If rise in A VC more than outweighs the fall in
the outcome of the autonomous transactions AFC and АТС begins to rise. In the LONG
is an excess or deficiency of inward over RUN the shape is determined by the existence
outward payments the difference must be or otherwise of ECONOMIES OF SCALE. (See
covered by a compensatory transaction, such LONG-RUN AVERAGE COST.)
as a change in foreign reserves or a foreign
loan arranged specifically to meet the pay- average cost pricing. A pricing rule which
ments difference. postulates that firms add a mark-up onto
AVERAGE VARIABLE COSTS (A VC) SO a s to
autonomous variables. cover its AVERAGE TOTAL COSTS. Hence price
See EXOGENOUS VARIABLES. (P) can be written as
average.
See MEAN .
erage fixed costs. The FIXED COST per an EXPENDITURE TAX system and to total
3
it output. In the short run, some costs will tax burdens where total tax payments are
U expressed as a proportion of income.
o t change regardless of the level of output.
These fixed costs expressed per unit of out-
average revenue. Revenue per unit of out-
u t will then decline as output expands.
Thus put. If output is denoted by X and TOTAL
REVENUE by R, then
average propensity to save. The pro- average variable costs. The VARIABLE COST
portion of aggregate income, У, that is per unit of output. Thus, if TVC is total
saved, S. The average propensity to save = variable costs, average variable costs, AVC
S/Y. It may be stated as a propensity to save may be written
out of either NATIONAL INCOME or DISPOSABLE TVC
INCOME. (See also SAVINGS FUNCTION, MAR- ABC =
X
GINAL PROPENSITY TO SAVE.)
where X is output. For the relationship to
average rate of tax. (also known as effec- average cost see AVERAGE COST.
tive rate of tax.) Generally discussed with
regard to personal INCOME TAX but could be Averch-Johnson Effect. Refers to the
a
PpHed to other types of taxes. Usually profit-maximizing response of regulated
a
ken to mean total income tax payments as firms which, in facing a given allowance rate
a
Proportion of income. The definition of of return on capital, have the incentive to
j^come is normally the gross income, i.e. choose input combinations which are more
before allowances. With regard to company capital intensive than would have been
axation the effective tax take is most use- employed in the absence of a set rate of
ull stated as tax payments as a proportion
ully return.
r e S O u r c e s generated (i.e. revenue minus
a
c Prtal and operating costs). The concept axiom of completeness.
an
also be applied to WEALTH TAXES or to See AXIOMS OF PREFERENCE.
axiom of continuity. preferred to C. Transitivity also applies to
See AXIOMS OF PREFERENCE. indifference relationships. Violation of the
transitivity axiom is widely construed as an
axiom of convexity. indication of irrationality.
See AXIOMS OF PREFERENCE. 3. The axiom of selection which simply
states that the consumer aims for his most
axiom of dominance. preferred state.
See AXIOMS OF PREFERENCE. Axioms 1 to 3 are usually regarded as
axioms of rationality. The remaining axioms
axiom of selection. are really assumptions about behaviour.
See AXIOMS OF PREFERENCE. They are:
4. The axiom of dominance. This states
axioms of preference. In CONSUMER that consumers will prefer more of all goods
DEMAND THEORY, individuals are assumed to to less. Also known as the axiom of 'greed',
obey axioms of RATIONALITY and other non-satiation (see SATIATION) or mono-
axioms of behaviour which, combined, form tonicity.
a testable theory of consumer behaviour. 5. The axiom of continuity. Effectively,
Although terminology varies, some six this states that there is a set of points which
axioms are usually cited as being required form a boundary (an indifference curve)
for consumer theory based on INDIFFERENCE dividing those combinations of goods in COM-
CURVE analysis. These are: MODITY SPACE which are preferred from those
1. The axiom of completeness which that are non-preferred. More easily thought
simply states that the consumer is able to of as an axiom which ensures that the indif-
order all available combinations of goods ference curve is a curve or line rather than a
according to his PREFERENCES. 'smudge'.
2. The axiom of transitivity which states 6. The axiom of convexity (of prefer-
that if some combination of goods Л is pre- ences). The assumption that the indifference
ferred to another combination B, and В is curve is CONVEX to the origin. Similar axioms
preferred to С then (by transitivity) Л is are needed for REVEALED PREFERENCE.
в
backdoor financing. The practice under which the preferences of the work force are
which a US government agency borrows registered. (See SECULAR SUPPLY CURVE.)
from the US Treasury rather than requesting
Congressional appropriations. Backdoor backward integration.
financing originated with the Reconstruction See VERTICAL INTEGRATION .
Finance Corporation in the 1930s. This
agency was the first to be authorised to bor- backward linkage. The relationship be-
row from the Treasury. In recent years, tween an industry or firm and the suppliers
other Federal agencies have increased their of its inputs. A change in the output of the
use of this financing technique. industry will be transmitted backwards to
the supplier of its inputs by a change in
back-haul rates. Freight or transport demand for inputs.
charges for some route, which are lower for
movement in one direction than in the other. backwash effects. Backwash effects are
Most forms of transport require containers said to operate where the economic growth
or vehicles which must be returned to the in one region of an economy has adverse
point of origin after each trip. Since it is effects on the growth of other regions. These
unlikely that there will be exactly equal effects are said to consist principally of flows
demand for transport in both directions, ex- of FACTORS OF PRODUCTION (usually labour
cess capacity will exist on the 'back' journey. and capital) from slow growing to fast
It will be in the transport operator's interest growing regions. The CUMULATIVE CAUSATION
to attempt to fill this capacity by charging approach to regional economic growth
lower rates for the 'back' journey. argues that if one region's growth rises
above that of its neighbours, backwash
backstop technology. A substitute tech- effects will reinforce the initial advantage,
nology, which becomes economically feas- resulting in a widening gap between regional
ible once the price of a NON-RENEWABLE growth rates. Backwash effects are claimed
NATURAL RESOURCE has risen to a certain to result from increased efficiency in pro-
level as a result of cumulative extraction. duction arising from the geographical
For example solar energy may represent a concentration of activity. (See also AGGLOME-
backstop technology for oil and set an upper RATION ECONOMIES.)
limit to the price of oil.
bad. A commodity or product which gen-
backward bending supply curve of labour. erates DISUTILITY for its consumer. While ob-
A negative relation between the supply of viously ungrammatical, the term 'bad' is now
labour, however defined, and the real wage. quite widespread as a noun in economic
The outcome may be viewed as signifying literature. Especially used for EXTERNAL
the dominance of the negative INCOME COSTS. (See EXTERNALITY.)
EFFECT over the positive SUBSTITUTION EFFECT
(with respect to the particular supply 'Bad money drives out good'.
measure). Historically, the supply curve of See GRESHAM'S LAW.
hours has followed this configuration.
Even though at first sight it might appear Bagehot, Walter (1826-77). He was editor
that hours of work are largely influenced and co-editor of the Economist from
Ь
У institutional factors in the shape of 1860-77. An extremely influential commen-
Jrade unions and labour standards legis- tator in his day, he is still widely quoted. His
lation, the latter may be thought of as best known publication is Lombard Street: Л
bei
n g the institutional embodiments through Description of the Money Market (1873).
25
26 balanced budget
balanced budget. Current income exactly sense. It should be noted, however, that by
equals current expenditure. Most frequently its nature the 'market balance' is observable
used to describe the situation where only in its effects, e.g. on the EXCHANGE RATE
government income, TAX RECEIPTS, exactly or the level of EXTERNAL RESERVES. A S an
equals GOVERNMENT EXPENDITURE (See also accounting balance the 'balance of pay-
BALANCED-BUDGET MULTIPLIER.) ments' is a statistical statement summarizing
all the external transactions in which a
balanced-budget multiplier. The ratio of country is involved over a given period of
the change in real income to the change in time, say a year. The form of presentation of
GOVERNMENT EXPENDITURE when government the balance of payments accounts varies be-
expenditure and TAX REVENUES are changed tween countries, and between different
by equal amounts. Thus where an increase times for the same country, but most presen-
of £1000 in government expenditure is tations divide the balance of payments items
financed by an extra £1000 in taxes and this into two sections or sub-accounts. In the
leads to an increase in national income of present UK presentation these divisions are
£1000, then the balanced budget multiplier is termed 'current account', and 'transactions
1. In general, however, we might suppose in UK assets and liabilities'. In the current
that the act of transferring £1000 from the account are placed all transactions involving
private sector to the government would, in currently produced goods, or currently ren-
the framework of the simple INCOME- dered services. They include 'visible' trade
EXPENDITURE MODEL, lead to an increase in transactions on merchandise account, and
national income, since some of the £1000 'invisibles' which, broadly, cover payments
that was previously in the hands of the pri- for services like insurance, shipping and
vate sector will have been WITHDRAWN, tourism; transfers of interest, profits and
saved, and not passed on in the CIRCULAR dividends currently earned on assets held
FLOW OF INCOME. In contrast the government abroad; and other transfers such as gifts and
has spent all of the £1000 and it is therefore a migrants' remittances. Often referred to as
net INJECTION into the circular flow. the capital account transactions in UK assets
and liabilities include all payments arising
balanced economic development. The from transfers of capital or ASSETS (plus all
idea that all sectors of an economy should be extensions of credit), official or private,
developed simultaneously to achieve a which - roughly speaking - arise from con-
balanced type of development. Some argue siderations unrelated to the position of the
that it is not easy to define what constitutes balance of payments as a whole, e.g. profit
the correct balance and that planned careful possibilities and relative interest rates. A
but unbalanced development is more appro- final 'balancing item' is shown in the
priate. (See BALANCED GROWTH, BIG PUSH.) accounts. This reconciles the discrepancy be-
tween the outturns on the current and capi-
balanced growth. In GROWTH THEORY a dy- tal accounts, as statistically recorded, and
namic condition of an economy where all the actual total of official financing under-
real variables are growing at the same con- taken. The item arises from unrecorded
stant proportional rate (which rnay be zero transactions and from timing discrepancies
or negative). (See STEADY STATE GROWTH.)
between the recorded movement of goods
(from which the trade items in the account
balance of payments. This term is used in are derived) and the actual payments for
more than one sense, the two commonest them. But it also points to the fact that since
interpretations being the 'market balance of the accounts are constructed on the double-
payments' and the 'accounting balance of entry principles, so that every transaction is
payments'. Used in the sense of a 'market - in principle - recorded in two accounts,
balance' the term signifies the current or once as a debit, once as a credit, they must,
ongoing relationship between the two flows given complete and accurate recording, pro-
of payments, one coming in, one going out, duce a 'balance' in the sense of an equality of
in which a country is continuously involved. debits and credits.
Much theoretical analysis of the balance of It should be noted that the official
payments is concerned with 'balance' in this accounts use a sign convention whereby in
balance sheet 27
1988 1989
CURRENT ACCOUNT
Visible balance -21,078 -23,840
Invisibles
Services balance 4.502 4,709
Interest, profits and
dividends balance 4,971 4,582
Transfers balance -3,546 -4,577
Transactions in UK assets
and liabilities
UK external assets -56,244 -86,253
the current account a plus (+) indicates an balance principle. A basic method of
outflow and a minus (—) an inflow of Soviet planning, which involves double-
currently produced goods and services; entry book-keeping in physical or price
while in the capital and 'official financ- units. There are material balances for the
ing' sections a minus ( - ) indicates a flow production and distribution plans, labour
(e.g. an 'export' of capital) which increases balances for the labour plans, energy
UK foreign assets (including external re- balances for the energy sector and finan-
serves) or decreases UK liabilities to non- cial balances for the financial plan. The
residents. The examples here show figures purpose of the balances is to ensure con-
for two years. See Johnson, C, Measuring sistency in the plans. The balances, which
the Economy, Penguin, Harmondsworth are less sophisticated than INPUT-OUTPUT
(1988). tables, fulfil a similar role in planning. For a
separate meaning see MATERIALS BALANCE
PRINCIPLE.
balance of trade. This normally means the
balance on 'visible' trade, that is trade in
goods on merchandise account, over a given
period. Thus if exports of goods exceed im- balance sheet. A statement which shows
PP r t f t h e trade balance is said to be 'favour- the WEALTH of a trader or company at a
able' whereas an excess of imports over given date. Traditionally, a balance sheet
exports yields an 'unfavourable' trade bai- was set out in two halves, the ASSETS on the
l e e . In fact the balance of trade is only one right and the LIABILITIES on the left.
element, the other being invisibles, within However, a more common format today is
the current balance' which is itself only one the single column presentation showing the
P a rt of the total BALANCE OF PAYMENTS of a net asset position, followed by the method of
country. financing that position. The example given
28 bancor
below shows this. The 1981 Companies Act, by the INTERNATIONAL MONETARY FUND in the
in order to incorporate the EC Fourth 1970s are a similar concept.
Directive, has a requirement for companies
to produce accounts for shareholders in a bandwagon effect. The effect whereby as
specified format, with fuller disclosure than the price of a good falls and demand by some
in the past. The example here does not sections or individuals in the community
attempt to follow this strict format, but illus- expands other individuals or sections 'imi-
trates the general principles. tate' the reaction and expand their demand
also. If it exists it may mean that the MARKET
bancor. The name given by KEYNES to an DEMAND CURVE cannot simply be an aggre-
international currency which he proposed gation of individual demand curves. Instead,
should be created by an international bank, demand will expand more than expected as
used for settling international debts and additional consumers 'join the bandwagon',
which would constitute part of international giving the market demand curve a gentler
liquidity. These proposals were part of the slope than would otherwise be the case.
KEYNES PLAN for international monetary re-
form which were put forward at the BRETTON bank. A FINANCIAL INTERMEDIARY which
WOODS Conference in 1944. His proposals takes in funds principally as deposits repay-
were rejected at that conference, but the able on demand or at short notice, and
Special Drawing Rights (SDRs) introduced which it employs to make advances by OVER-
Fixed Assets £ £ £
Premises 10,000
Plant & Machinery 6,500
Vehicles 3,500
20,000
Current Assets
Stock 4,500
Debtors 500
Cash at bank 1,000
Cash in hand 250
6,250
Less Current Liabilities
Bank loan 5,000
Sundry Creditors 750
(5,750)
500 500
20,500
Financed by
Share Capital
10,000 Ordinary shares at £1 each 10,000
9,000 10% Preference shares of £1 9,000
19,000
Reserves
Profit & Loss Account 1,500 1,500
20,500
bank bill 29
RAFTS and LOANS, and by discounting BILLS, unless licensed by the BANK OF ENGLAND; and
a
nd to hold other, mainly financial assets all authorized deposit-taking institutions
such as marketable securities. An important were divided into two classes, 'recognized
banking function is to maintain a money banks' and LICENSED DEPOSIT TAKERS, with
transmission system by accepting deposits on differing powers and conditions of operation.
CURRENT ACCOUNT and operating a system of One consequence of this Act was to provide
transferring funds by CHEQUE, GIRO transfer at least a formal definition of a 'bank' since
o
r electronic transfer. Other important only banks 'recognized' under the Act could
banking activities are providing FOREIGN so describe themselves. The second Act
EXCHANGE services for customers, financing established a single category of authorized
foreign trade, operating in wholesale MONEY institution eligible to carry out banking busi-
MARKETS and providing a wide range of ness. Again authorization has to be obtained
financial advisory services. In a developed from the Bank of England, which has to be
financial system only certain institutions supplied on a regular basis with statistical
cover all or most of these operations. In the information. The Bank of England has as
UK the CLEARING BANKS satisfy this criterion, part of its supervisory duty laid down mini-
but the term 'bank' is by convention, and mum standards of capital adequacy and of
subject to regulation, applied to institutions liquidity.
like savings banks and MERCHANT BANKS Finally it should be noted that in other
which engage in some of these activities countries with different banking traditions,
(along with others not listed). Yet other in- or in the international context, the term
stitutions, such as BUILDING SOCIETIES and 'bank' is applied to a variety of institutions
FINANCE HOUSES in the UK, and SAVINGS AND which provide funds, by no means always or
LOAN ASSOCIATIONS in the US, engage in even usually derived from deposits, for a
some of them but conventionally have not variety of capital purposes, e.g. 'develop-
been termed 'banks'. In the UK the clearing ment banks', 'investment banks', 'mortgage
banks occupy a central position in the finan- banks' and so on. An international example
cial system by virtue of their control of the is the INTERNATIONAL BANK FOR RECONSTRUC-
money payments mechanism and because TION AND DEVELOPMENT ( t h e 'world b a n k ' ) .
their deposit liabilities form a major com- (See COMPETITION AND CREDIT CONTROL,
ponent of the money stock. These facts, RETAIL BANKING, WHOLESALE BANKING.)
coupled with their earlier predominance as
short-term lenders to business, caused them bank advance. A general term for any
to be subjected to special control under form of bank lending. In the UK the term is
monetary policy arrangements. In recent normally restricted to lending by way of
years, with the widespread diversification of OVERDRAFT or by an outright loan made on
many financial institutions and the growth of various terms. In the case of some European
competition between them, the position is countries where bank lendings is conducted
now recognized to have changed; and while to a large extent through the DISCOUNTING of
the quantity of bank deposits does attract BILLS the use of the term may be extended to
special attention as part of monetary con- include such finance. In the UK the term
trol, present credit control arrangements do does not normally include bill finance,
not concentrate, as formerly, on the clearing though bankers do extend some CREDIT
banks. The regulation of the banking sys- through this medium. (See BANK LOAN.)
tem, in the sense of sustaining the strength bank bill. Traditionally, in the London bill
a
nd soundness of banking institutions, market, a BILL which has been accepted by
became a matter of heightened concern, fol- a n ACCEPTING HOUSE, a CLEARING BANK, ОГ
lowing the SECONDARY BANKING Crisis of one of a group of other British or ex-
19/4-6. In the UK while such regulation had Dominions banks on behalf of a customer
been by no means absent, it had not been for whom an acceptance credit has been
comprehensively applied under a single opened. By accepting a bill the institution
bank Act. This situation has now been rem- concerned engages to pay it on maturity and
edied by the Banking Acts of 1979 and 1987. because of the acceptor's standing such a bill
. l n e former Act made it illegal for a new may be discounted in the London market at
"istitution to be established to take deposits the most favourable rates. Bank bills have
30 Bank Charter Act
also traditionally constituted ELIGIBLE PAPER bank deposits. In simple terms, funds
in terms of the operation by the BANK OF deposited in BANK accounts. In reality they
ENGLAND of itS LENDER OF LAST RESORT f u n c - are simply records of indebtedness of a
tion. Since the new monetary control bank to the depositor, and they arise from
arrangements, introduced in August 1981, the character of banks as FINANCIAL INTER-
greatly extended the list of banks whose MEDIARIES. Deposits are held in various
name on a bill established it as ELIGIBLE types of accounts, involving varying con-
PAPER to include all the major overseas banks ditions of use or withdrawal. In the UK the
operating in London, bills carrying their two main types are termed current accounts
names must now be classed as bank bills. - deposits which are withdrawable or trans-
(See ACCEPTANCE, DISCOUNT HOUSE.) ferable by cheque without notice - and DE-
POSIT ACCOUNT balances which - in England
Bank Charter Act. Usually refers to the and Wales, though not in Scotland - are
Bank Charter Act of 1844 passed under Sir formally subject to seven days' notice of
Robert Peel's administration. While renew- withdrawal (though this is not strictly
ing the BANK OF ENGLAND'S charter this Act enforced). In the US the terms 'demand de-
introduced a major reform of the currency posits' and 'time deposits' are used to
based on the monetary principles of the CUR- denote balances in these two types of
RENCY SCHOOL. The Bank's activities as a account. Current account deposits are
banknote issuer were separated from its universally regarded as forming part of the
other banking business, at that time exten- money stock, and in financially developed
sive, and its powers of issue were limited to countries are the major component of it.
the amount of a fixed FIDUCIARY ISSUE plus Deposits in deposit accounts (time deposits)
notes equal in value to the gold held in the are excluded from certain definitions of the
Issue Department which was set up to ad- MONEY SUPPLY, e.g. Ml in the UK, but in-
minister its issuing business. The profits of cluded in others, e.g. M3.
note issue, i.e. the income from the securi-
ties held against the fiduciary issue minus the Bank for International Settlements. An
costs of issue, were reserved to the Treasury. intergovernmental financial institution
The same Act prohibited the setting up of originally established in 1930 to assist and
any new banks of issue in the UK, put fixed co-ordinate the transfer of World War I
limits on the note issues of the provincial reparations payments among national CEN-
banks of issue in England and Wales and TRAL BANKS. Although a moratorium on
provided for the lapse of their note issuing reparations payments emerged soon after
rights when they merged with others (as all the bank began operations, it continued to
eventually did). provide facilities for international financial
transactions and gradually emerged as a
bank credit. Lending by the banking sys- bank for central banks. The creation of the
tem by whatever means: BANK ADVANCES, INTERNATIONAL MONETARY FUND following
DISCOUNTING BILLS ОГ p u r c h a s i n g SECURITIES. the BRETTON WOODS conference in 1944, how-
In the theory of banking and money supply a ever, constrained the subsequent expansion
change in the amount of bank credit out- of the bank's international monetary role
standing produces a change in trie same and activities. Nonetheless, the increasing
direction in bank deposits, the size of this reliance on SWAP ARRANGEMENTS by the US
effect depending on the scale of 'leakages' of to finance BALANCE OF PAYMENTS deficits and
reserve assets from the banking system the growth of the EUROCURRENCY market
induced by the credit and deposit change increased the importance of the bank as an
itself. Such 'leakages' arise, for example, international financial institution. Current
through increased demand for currency in activities of the bank, in addition to its tradi-
circulation, or an increase in imports. A tional role as a bank which assists central
proxy for bank credit is obtained by sub- banks in managing and investing their mone-
tracting the reserves in the banking system tary reserves, include acting as agent for the
from its total liabilities (liabilities plus net EUROPEAN MONETARY CO-OPERATION FUND
worth of the banking system). (See MONEY and the Committee of Governors of the
MULTIPLIER, MONEY SUPPLY, 'NEW VIEW'.) Central Banks of the Member States of
Bank of England 31
the European Community. The bank is also banks to ensure that the note issue was kept
the official depository for the EUROPEAN COAL within these bounds. They further denied
A N D STEEL COMMUNITY. A board of directors that the government could control the
comprising the governors of the central money supply since it had no control over
banks of Belgium, France, the Federal BILLS OF EXCHANGE and BANK DEPOSITS.
Republic of Germany, Italy, the Nether- Although in the framing of the BANK
lands, Sweden, Switzerland, the UK and the CHARTER ACT of 1844 their doctrines were
US and six representatives of commerce, rejected in favour of those of the Currency
finance and industry, is responsible for the School, some of their views, e.g. on the
administration of the bank's activities. The monetary significance of BANK DEPOSITS and
board of directors also provides a forum for of CREDIT instruments, have been vindicated
the bank to encourage co-operation among by financial developments.
central banks in controlling short term inter-
national monetary fluctuations arising from bank loan. This commonly means any
speculative activity. The bank also collects advance by a bank, but there is a distinction
and disseminates information on macroeco- in bank lending between OVERDRAFT terms
nomic topics and international monetary and loan terms. A BANK ADVANCE specifically
affairs. in the form of a loan is credited in full to the
borrower's account at the outset and the
banking panic. An episode in which a fail- interest liability may be a fixed sum calcu-
ure of confidence in one or more BANKS lated on the initial loan and its duration. In
produces a sudden and widespread 'run' by some cases, e.g. personal and term loans,
the public on banks in general, to withdraw there is provision for repayment by regular
DEPOSITS, or in times when private BANKNOTE instalments.
issues were common, to demand payment of
such notes in another medium. Such panics banknote. A form of currency issued by a
may and did cause bank failures, not necess- bank, and in essence a 'negotiable' (i.e.
arily restricted to unsound banks. The last transferable simply by delivery) evidence of
true banking panic in the UK was in 1866 the bank's indebtedness to the value of the
following the failure of Overland, Gurney & note. The banknote developed from the
Co., though there have been banking crises BILL, and is in principle a bill payable 'at
unaccompanied by panic since then, includ- sight' (on demand) in some other medium.
ing the crisis of 1973-4 when a number of Originally the other medium was FULL-
SECONDARY BANKS failed or had to be sup- BODIED COIN (silver or gold coin), or in prac-
ported. (See LENDER OF LAST RESORT, tice, BANK OF ENGLAND notes which were
'LIFEBOAT'.) themselves so payable. When sterling finally
went off the GOLD STANDARD in 1931, Bank
of England notes ceased to be convertible
Banking School. A body of opinion con-
into any other medium, and became practi-
cerned with the debate over the regulation
cally, if not legally, FIAT MONEY.
of note-issue by the BANK OF ENGLAND in the
first half of the nineteenth century. In oppo-
sition to the CURRENCY SCHOOL this group Bank of England. The CENTRAL BANK of
argued that regulation was largely imposs- the UK. It was promoted as a commercial
!ble and any attempt to limit the issue of bank by London merchants and established
banknotes would have undesirable effects on by Act of Parliament in 1694. In return for a
fhe financial system. The banking system loan to government it was granted the privi-
rtself, they argued, was the best judge of the lege of incorporation as a JOINT STOCK COM-
needs of the economy for banknotes. All PANY, and retained a monopoly of joint stock
that was required was strict convertibility of banking in England and Wales until 1826.
notes into gold; this would automatically This gave it an early dominating position in
ensure that banks supplied notes in the cor- English banking and it became the de facto
net amount according to the needs of the repository and manager of the country's
Public and the state of the economy. They EXTERNAL RESERVE. In the 19th and 20th
Placed faith in the competition between centuries its public role developed so that by
Bank of the United States
the time it was nationalised, by the Bank system, extending this to the DISCOUNT
of England of 1946, it had long conducted HOUSES, through which it has traditionally
itself as a public and not a private institution. performed the function of LENDER OF LAST
The Bank is banker to the government and RESORT by loans or rediscounting BILLS, and
to the banking system, but above all is the t h e ACCEPTANCE HOUSES w h o s e ACCEPTANCES
institution responsible, in consultation with figured in these operations. This concern
the TREASURY, with implementing financial embraces the interests of the depositing
and MONETARY POLICY. As the government's public. With the rapid development of the
banker it holds the accounts of central financial system the Bank has been increas-
government departments, receiving revenue ingly concerned with the efficient operation,
proceeds and making payments; manages and with the development of suitable regu-
the national debt through the issue and retir- latory mechanisms. The Banking Acts of
ement of TREASURY BILLS and longer-term 1979 and 1987 have laid upon the Bank the
SECURITIES; and makes advances to govern- duty of authorizing institutions to carry out
ment by WAYS AND MEANS ADVANCES. banking business and of establishing appro-
The Bank implements monetary policy priate standards to be maintained by banks
through its daily management of the MONEY with regard to liquidity and capital. {See 'BIG
MARKET ( u s i n g OPEN MARKET OPERATIONS), BANG', 'LIFEBOAT', MONETARY MANAGEMENT.)
through debt management and other oper-
ations in GILT-EDGED SECURITIES, and through Bank of the United States. From
other controls over the liquidity of the 1791-1811, and from 1816-1836 some cen-
financial system. Since 1981 it has operated tral banking functions in the US were carried
on interest rates by these indirect means, not on by the First and Second Banks of the
directly via MINIMUM LENDING RATE or the United States respectively. The First Bank
older BANK RATE. The Bank is also respon- was a private corporation, chartered for 20
sible for managing the EXCHANGE EQUAL- years and initially capitalized at $10 million
ISATION ACCOUNT and for market inter- of which 20 per cent was provided by the
ventions to influence the EXCHANGE RATE. federal government. At its inception it was
Following the BANK CHARTER ACT of 1844 the largest private corporation in the United
the Bank's activities were divided between States. The head office was in Philadelphia
an Issue Department responsible for note with eight branches in major cities. It served
issue, and a Banking Department to conduct as the federal government depository insti-
other business. The provisions of the Act led tution as well as providing private banking
to the concentration of all note issue in services. The Bank was so large that its lend-
England and Wales on the Bank, and to the ing activities had a powerful impact on the
effective basing of the Scottish and Northern reserves and hence monetary expansion
Irish banks' issues on the Bank's notes. The capabilities of state banks. The Bank was
assets of the Issue Department, once almost not rechartered in 1811 because the growing
entirely government securities, but now numbers of state banks resented the Bank's
largely bills and local authority debt, form conservative policies.
the Bank's masse de manoeuvre for money After five years with no central banking
market and debt management operations. functions and the financial chaos resulting
The Banking Department conducts the from wildcat banking, Congress chartered
Bank's business as banker to the govern- the Second Bank of the United States in
ment and other public bodies, to the COM- 1816, with an initial capitalization of $35
MERCIAL BANKS, to overseas central banks million. It performed most of the same func-
and international organisations, and to a tions as the First Bank, but it experienced
small residium of private bodies and serious political difficulties as a result of
individuals. differences between its president, Nicholas
The 1946 Act gave the Bank wide formal Biddle, and the US president, Andrew
powers to control the commercial banks, but Jackson. Jackson led a populist agricultural
for monetary policy purposes the Bank has faction of the Democratic party which was
relied mainly on informal influence. The opposed to any form of centralized financial
Bank has long assumed responsibility for the control. When its charter ran out in 1836,
security and sound operations of the banking the Second Bank was also not renewed. For
bargaining theory of wages 33
period of almost thirty years (until the bargaining tariff. Tariff imposed by a
Rational Banking Act of 1864), there was country to strengthen its position in trade
virtually no central banking function in the negotiations with other countries, when it
United States. In fact, it was not until the may use the promise of reductions in the
Federal Reserve Act of 1913 that the US had tariff to obtain trade concessions.
a true central bank.
bargaining theory of wages. Wages are
Bank Rate. Before September 1971, the commonly fixed in a collective bargaining
minimum rate at which the BANK OF ENG- process, an arrangement that differs mech-
LAND would rediscount ELIGIBLE PAPER anically from the orthodox demand-supply
brought to the Discount Office by the insti- adjustment process. The bargaining theory
tutions to which this facility was available, of wages refers to models of the bargaining
namely the DISCOUNT HOUSES. The need for process applicable to union-management re-
such rediscounting arose when there was a lations that seek to go beyond the BILATERAL
general shortage of LIQUIDITY in the banking MONOPOLY model, in which the final outcome
system, and the banks were 'calling' (i.e. of bargaining is indeterminate, to deduce a
recalling) money lent at call to the houses. If determinate solution. In most of these
the position was not relieved bv the BANK models it is assumed that each side attempts
itself, operating through the 'BACK DOOR', to maximise some quantity which may be
the houses were compelled to turn to the subjective, e.g. UTILITY, or objective, e.g. the
Bank as LENDER OF LAST RESORT. Bank rate discounted values of future profit or wage
was an administered rate which the Bank income streams; and that bargaining behav-
moved as its policy needs directed. Such iour is then subject to factors such as product
movements were significant in that they demand, and the perceived bargaining strat-
influenced other short-term rates through egy of the other party. Since it is convention-
their effect on the rates at which the discount ally assumed that a settlement achieved after
houses were prepared to deal; but also, a stoppage is ПОП-PARETO OPTIMAL the ortho-
more directly, in that under the pre- dox bargaining models argue that there will
September 1971 arrangements the CLEARING be a tendency for the parties to reach agree-
BANKS altered their own deposit and lending ment without a stoppage; such stoppages as
rates in step with Bank rate, a practice which are observed in practice are attributed to
had wide effects on financial institutions and mistakes or even irrationality.
markets. In 1971 Bank rate was replaced by Three types of conventional bargaining
MINIMUM LENDING RATE, a rate which fulfilled models are represented by those of De
some of its functions but which for a time at Menil (Bargaining: Monopoly Power Versus
least was operated in a different way and was Union Power, MIT Press, Cambridge,
itself suspended in changes introduced in Mass., 1971), Zeuthen (Problems of Mono-
August 1981. (See COMPETITION AND CREDIT poly and Economic Warfare, Routledge and
CONTROL, MONETARY POLICY.) Kegan Paul, London, 1930), and HICKS (The
Theory of Wages, 2nd Edn, Macmillan,
bankruptcy. A legal proceeding under London, 1963). De Menil builds upon GAME
which the property of an insolvent debtor is THEORY to produce a deterministic theory of
taken for the benefit of his creditors gener- wage bargaining. Assuming that both union
ally. In the UK control of a bankrupt's prop- and management are RENT maximizers, he
erty is initially in the person of the official derives the prediction that they will act so as
RECEIVER, who is an officer of the courts. to maximize the revenue surplus of the
Subsequently a trustee is appointed and it is enterprise which they will divide between
his duty to realize the property and to dis- them in some proportion. Zeuthen's model
tribute it among the creditors in proportion emphasizes RISK, with the parties con-
t o
their claims and in accordance with tinually comparing the options of accepting
certain priorities laid down by the law. the opponent's offer or holding out at risk of
Ultimately the bankrupt may be granted a a stalemate. A process of successive
discharge which, subject to certain excep- concessions ensues which in the limit reaches
tions, releases him from his past debts and the point of maximum joint utility of the
«abilities. parties. Hicks adopts a COST-BENEFIT
34 bargaining unit
approach. Either party will choose or threa- covered: all employees or just those in a
ten a strike in preference to a concession if it particular occupation. The bargaining unit
expects the strike to cost less than the con- negotiates a contract with the employer. To
cession, and Hicks argues that there is some become a bargaining unit an employee
unique wage rate that both parties associate organization must be certified by the
with a strike of a given length. National Labor Relations Board. An
All these models attribute strikes to mis- employer is required to negotiate with a cer-
takes or irrationality. More recent models tified employee organization. (See NATIONAL
have reverted to less sophisticated interpret- LABOR RELATIONS ACT, TAFT-HARTLEY ACT.)
ations of the bargaining process. Thus the
political bargaining model of Ashenfelter Barlow Report. The findings of a British
and Johnson ('Bargaining Theory, Trade Royal Commission which analysed the geo-
Unions and Industrial Strike Activity', graphical distribution of British Industry and
American Economic Review, 1969) is based had a strong influence on the development
on the notion of three-party involvement in of postwar REGIONAL POLICY in Britain
the process - management, union leader- (HMSO: Royal Commission on the Indus-
ship, and rank and file union members. trial Population, Cmd.6153; London, 1940).
Differences of awareness and expectations The report urged that policies be adopted to
between union leaders and rank and file may promote a more even geographical distri-
have to be eroded by a strike in which the bution of industry and population on the
wage aspirations of the membership are grounds that this would:
scaled down. Management for its part in 1. reduce congestion in the cities
making concessions balances foregone pro- 2. improve economic conditions in the
fits against increased labour costs after the less prosperous regions, and
strike since in this analysis the union's be- 3. be beneficial in terms of national
haviour is quasi-mechanical, the model is defence strategy.
widely acknowledged as not constituting a
theory of bargaining. In practice, unions and barometric price leadership.
employers do bargain, and most bargaining See PRICE LEADERSHIP.
sessions reach a conclusion without a stop-
page. That said, it has proved difficult to barriers to entry. Factors which place new
move from theory to application with the entrants at a cost disadvantage relative to
more traditional bargaining models. It established firms within an industry. As long
should be noted that although the collective as established firms then price at a level just
bargaining process differs from that assumed below the minimum point of the long-run
in neo-classical demand-supply analysis, the average cost curve of the best placed poten-
two approaches are conformable to the ex- tial entrant, these established firms can earn
tent that demand and supply conditions super-normal profits in the long run without
establish the context within which bargain- fear of new entry. Sources of entry barriers
are ABSOLUTE COST ADVANTAGES, ECONOMIES
ing lakes place. (See STRIKES, WAGE THEORY.)
OF SCALE, LARGE INITIAL CAPITAL REQUIRE-
MENTS and PRODUCT DIFFERENTIATION. (See
bargaining unit. A unit representing the LIMIT PRICING.)
interests of labour in labour management
negotiations in the US. Units may be very barter. A method of exchanging goods
narrow - persons employed in a single firm, and services directly for other goods and
or very broad - all persons employed in services without using a separate UNIT OF
a particular trade across the country. ACCOUNT ОГ MEDIUM OF EXCHANGE. A SUC-
Bargaining units differ in size and compo- cessful transaction requires the existence of
sition. The size of the bargaining unit refers a DOUBLE COINCIDENCE OF WANTS.
to whom it covers: workers in a single plant,
several plants,or many companies. Size is an barter agreements. Agreements between
important determinant of the power of a countries, usually with BALANCE OF PAYMENTS
bargaining unit in contract negotiations. The troubles, for the direct exchange of agreed
composition of the bargaining unit refers to quantities of goods without the mediation of
which employees in the employing unit are international finance. (See COUNTERTRADE.)
Bayesian techniques 35
OPTIMAL. Another criticism of the model is through his writings of the great social re-
the lack of any conceptually sound basis for forms carried out in the UK in the first half
determining the optimal distribution of of the nineteenth century.
public and private goods. The principle has
undergone a revival in recent years espe- Bergsonian Social Welfare Function. The
cially in the writings of economists at the Bergsonian SOCIAL WELFARE FUNCTION is a
University of Chicago and in the publi- real value function, the arguments of which
cations of the Institute of Economic Affairs consist of magnitudes representing different
in London. Its proponents have indicated aspects of a social state, usually the utility of
areas of public expenditure where it can each individual or household. The social
be applied. They have shown that schemes welfare function assigns index numbers to
can be devised which force consumers to pay each social state, such that if social state A is
for public goods in accordance with the preferred to social state В the value of the
benefits they derive from their provision. function is higher for A than for B.
The benefit principle has only very limited
applicability to the DISTRIBUTION FUNCTION of Bernoulli Hypothesis. Daniel Bernoulli, a
public finance. mathematician of the eighteenth century,
proposed a solution to a celebrated paradox,
Benelux Economic Union. A CUSTOMS the so-called 'St Petersburg paradox'. The
UNION, established initially by the Con- problem was one of explaining why indi-
vention of Ouchy in 1932, between the gov- viduals would not pay extremely large sums
ernments of Belgium, Luxembourg and the to play the following game. A coin is tossed
Netherlands. The present organization was until, say, a head appears. If the head
created by the Benelux Economic Union appears on the second toss the player
Treaty in 1958. The union seeks to develop receives 22 units of reward (e.g. £4). If the
tighter economic and social links among its head appears on the third toss, the payment
members by encouraging the free movement would be 23 units, on the fourth toss 24 units,
of LABOUR, goods and CAPITAL between the and so on. The sum of the probabilities of
member countries and establishing a com- the prizes occurring must sum to unity but
mon policy with respect to foreign trade. for an infinite number of tosses the EXPECTED
The union has succeeded in abolishing inter- VALUE of the prize is infinite. Thus one
nal passport controls and labour permits, would expect players to gamble very large
removing intra-union import tariffs and most sums of money on such a game. To explain
import quotas, decreasing the VALUE ADDED why the gamble is not accepted, Bernoulli
TAX among member countries and imple- argued that gamblers were less interested in
menting a common system of EXCISE tax. A the money rewards than in
uniform external TARIFF on non-EC imports the UTILITY of those rewards. By hypothesiz-
is levied by the union which also concludes ing DIMINISHING MARGINAL UTILITY of income
uniform trade and emigration agreements Bernoulli showed that the game may well
with non-EC countries. have an expected money value of infinity but
a finite expected value of utility. The
Bentham, Jeremy (1748-1832). An hypothesis is therefore of prime interest as
English social scientist, he was a passionate an early attempt to substitute UTILITY maxi-
advocate of quantitative methods of obser- mization for some monetary objective in
vation at a time before data were available. contexts of RISK or UNCERTAINTY.
He aimed to extend the experimental
method of reasoning from the physical Bertrand's duopoly model. A model of a
branch of knowledge to the moral. Though two firm market developed by J. Bertrand in
not the first utilitarian radical philosopher he 1883. The model differs from the COURNOT
!s the best known and his schemes for social DUOPOLY MODEL in that each firm is assumed
reorganization were guided by the Principle to maximize profits on the presumption that
°f Greatest Happiness, i.e. those actions the other firm will not change its price.
should be undertaken which led to the Bertrand's model results in a stable equilib-
greatest net sum of happiness for society. rium for the two firms. This can be shown in
Bentham is credited with being the instigator a diagram illustrating the reaction curves of
38 Best Linear Unbiased Estimator
ox PROFIT. In general it is argued that bid- the 1950s and 1960s as to whether balanced
rents are higher the nearer one is to the or unbalanced growth was the most appro-
central point. This follows as accessibility is priate development strategy for developing
held to be a desirable attribute in terms of countries to adopt. The 'big push' concept,
utility or profitability while the centre of an originated by Rosenstein-Rodan, supported
area is the most accessible point. If the bid- the balanced growth philosophy and sugges-
rent functions of various individuals and ted that a large investment programme on
activities are known, the bid-rent for each many projects would surmount the indivisi-
activity at each distance can be compared bilities in demand and supply. There are
with market rents to determine which constraints on the demand side in develop-
activity will occupy each location. (See also ing countries because of the small size of
ACCESS/SPACE TRADE-OFF MODEL.) markets. If a number of industries were sim-
ultaneously established, each could create
Bifurcation Hypothesis. The hypothesis demand for the products of the others. Total
that while the availability and cost of EXTER- demand would increase so that industries
NAL FINANCE are important determinants of which otherwise would be uneconomic
INVESTMENT in t h e BOOM, RETAINED EARNINGS
became viable. The difference between
are most important in the RECESSION. social and private MARGINAL PRODUCTS is thus
reduced or removed. Critics have suggested
that the strategy would lead to rapid infla-
'Big Bang'. A popular term used to de- tion and that it is unrealistic to hope for a
scribe the changes in institutional and regu- massive investment programme taking place
latory practices in the City of London, i.e. simultaneously across many industries in
the financial centre in the UK, in October developing countries. (See BALANCED ECON-
1986. Against a background of increased OMIC DEVELOPMENT.)
international competition in financial ser-
vices and the revolution in communications
effected by micro-electronics, firms in the bilateral assistance. Assistance or aid
CAPITAL MARKET were permitted to have which is based on a direct arrangement be-
'dual capacity', i.e. the right to be both tween two countries; this differs from MULTI-
STOCKBROKERS and JOBBERS or market- LATERAL AID which can come from a group of
makers as they are now called, activities countries or an international organization.
which had previously been rigidly divorced. (See FOREIGN AID, TIED AID.)
There were also changes in the ownership
rules, which allowed firms which were non-
members of the Stock Exchange to buy bilateral monopoly. A market in which a
member firms, so that most Stock Exchange single buyer faces a single seller. Economic
firms are now part of large financial services analysis of bilateral monopoly suffers from
conglomerates where formerly they were the same difficulties as DUOPOLY, for per-
small individual firms. In the interests of ceived interdependence in decision making
increased competition the charging of a fixed is an important feature.
scale of commissions by stockbrokers came
to an end.
bilateral trade. Trade, usually the subject
A new body, the Securities and Invest- of government negotiation, between two
ments Board (the SIB) was established to countries, whereby one exports a given
regulate the overall financial sector, while quantity or value of goods to the partner in
Particular sectors of the financial market exchange for an agreed quantity or value of
operate their own Self-Regulatory Organiza- imports from the partner. Such arrange-
tons (SROs). The 'Big Bang' also saw the
ments may take the form of BARTER of speci-
^ nt ry to the UK financial sector of many
fied goods on each side. Bilateral trade is
foreign firms, particularly American and
often arranged for political reasons or be-
Japanese.
cause of BALANCE OF PAYMENTS problems and
usually ignores the international DIVISION
'Bjg Push'. This refers to one of the con- OF LABOUR on the basis of COMPARATIVE
tributions to a debate which took place in ADVANTAGE.
4U bill
bill. A short-term instrument in the form bills only. The doctrine, prevalent in the
of a document ordering the drawee (i.e. the US in the 1950s, that in engaging in OPEN
debtor) to pay the drawer (the creditor) a MARKET OPERATIONS, t h e FEDERAL RESERVE
stated sum at a specified date, or 'at sight' SYSTEM should operate only in BILLS. This
which means on demand. Once accepted, was based on the view that by being concen-
i.e. signed by the drawee (who may be an trated at the short end of the capital market,
ACCEPTING HOUSE or bank); and 'endorsed', these operations would achieve their
i.e. signed on the back by the acceptor, a bill intended effect on bank liquidity with the
becomes negotiable and may be discounted, minimum disturbance to financial markets in
i.e. sold at a discount on its face value, at a general. At the same time the induced
rate which reflects current short term rates changes in short term interest rates would
of interest. A bill normally has a maturity of influence other markets through the 'nor-
up to six months and historically was used mal' means of portfolio adjustments by
extensively to finance trade (especially the ASSET holders.
shipment period of goods) and the WORKING
CAPITAL needs of manufacture and agricul- binary variable. A variable which can only
ture. An 'inland bill' is one drawn to finance take two values (e.g. 0 and 1), normally used
domestic business; a 'foreign bill' or bill of to account for qualitative, or non-
exchange is drawn in the course of foreign quantifiable influences in REGRESSION analy-
trade transactions. The inland bill was sis. (See also DUMMY VARIABLE.)
largely supplanted by the BANK ADVANCE or
TRADE CREDIT, but has had some revival in biological interest rate. A value for the
the UK, first in the finance of hire purchase interest rate in GROWTH THEORY where,
contracts, but latterly as a means of raising amongst all BALANCED GROWTH paths, the
finance for general purposes on the part of highest per capita CONSUMPTION is achieved
major companies. In the US major corpor- and sustained by the path on which the mar-
ations make very large and continuous use of ginal productivity of capital (equal to the
short-term 'paper', in effect bills, to meet rate of PROFIT under PERFECT COMPETITION) is
their general financial needs. In the UK equal to the constant EXOGENOUSLY deter-
another important bill is the TREASURY BILL, mined rate of growth of the labour force.
issued by the government as a short-term (See GOLDEN RULE OF ACCUMULATION.)
instrument of borrowing. (See BANK BILL,
BILL BROKER, DISCOUNT HOUSE.) birth rate. This is defined as the average
number of live births per 1000 of population
per year. Although it appears to be declining
bill broker. A person who specializes in
in advanced countries, it is a major problem
bringing together, for a commission, buyers in underdeveloped countries where it is very
and sellers of BILLS. In the nineteenth cen- high, such that very poor countries find it
tury, before the emergence of DISCOUNT more and more difficult to support an ever-
HOUSES, bill brokers performed a key role in increasing population. There are various
the financial system since the initial dis- reasons for high birth rates in less developed
counter (buyer) of a bill, frequently a bank, countries. First, people in rural areas need a
might not have the resources to hold it to large family to help on the land to produce
maturity, and the broker found someone, food for subsistence and to provide income.
frequently another banker, who had surplus Second, without a welfare state, people want
funds. Today in the London discount mar- children to look after them in their old age.
ket, whilst there is a small number of 'run- Third, people, especially in rural areas, are
ning' or 'discount brokers' who carry out ignorant of and have no provided source of
some bill broking of this kind, most bills are effective methods of birth control. There has
absorbed by institutions which are either also been a fall in infant mortality rate,
dealers in, or firm holders of, bills. (See meaning more live births due to the spread
DISCOUNT HOUSE.) of health measures by the World Health
Organization and other international agen-
bill of exchange. A BILL drawn to finance a cies. (See POPULATION EXPLOSION, POPU-
foreign trade transaction. LATION POLICY.)
Bohm-Bawerk, Eugen von 41
bond. Although it has some narrower and from the entrepreneurial (business risk-
more precisely legal meanings, this term is bearing) elements in holding, say, equities.
used generally and more loosely to denote Alternatively, the significance of LIQUIDITY -
any fixed-interest (debt) security, e.g. a GILT- or the lack of it - in relation to the rate of
EDGED stock or a DEBENTURE. The asset is interest can be examined by postulating one
negotiable (saleable) and contracts to pay non-liquid alternative to holding money, in
the holder a certain fixed money sum at place of the real choice which is exercised
regular intervals (the coupon payments) over a spectrum of assets of more or less
until maturity, that is until such time as the liquidity.
liability is discharged and the outstanding
sum (the principal) is repaid. The yield, a bond market. The term describing any
percentage rate of return, is calculated in the place, or incidence of transactions, in which
following manner. Let С be the coupon pay- any kind of BOND changes hands: the obvious
ments, which are paid annually for t years example is the STOCK EXCHANGE.
until repayment of the principal P. Then the
yield, r, is that unique rate of discount which
bonus issue. This refers to shares issued by
equates this income stream to its present
a company to existing shareholders not in
selling price V. That is
respect of the subscription of new capital but
С С as a CAPITALIZATION of reserves. The extra
V = shares are issued free on a PRO RATA basis.
(/ + г) (1 + г)2 They should not by themselves confer any
С С + Р benefits to shareholders. They bring the
( / + г ) 3 •'• г)' issued capital more into line with the real
capital employed by the company.
In the case of a perpetual bond, a CONSOL,
this simplifies to book value. A term used in accounting.
C
To determine the book value of a share, all
the company's assets are added up, all debts
V = - and liabilities deducted, including liquida-
That is, the yield is inversely related to the tion prices of preference shares. This total is
price of the bond. At any one time coupon divided by the number of ordinary shares
rates will differ widely across different secur- issued to obtain book value per share. This
ities for these will have been issued in differ- value may well have little relationship to
ent years. However if we abstract from the market value.
risk in holding financial assets of different
maturities the pure yield will tend to equality boom. The EXPANSIONARY PHASE of the
across all securities, ARBITRAGE will bring the TRADE CYCLE. The term is usually only ap-
yields of all securities into line and thus a plied to particularly fast rates of upward
single rate of return, or INTEREST RATE, is divergence from the SECULAR TREND. It is
determined. The market interest rate is thus usually characterized by a SPECULATIVE
established and varies inversely with the BOOM. Its opposite is a SLUMP.
price of bonds.
Economists make wide use of the term, Borda Count. A system of COLLECTIVE
bond, in theoretical analysis to denote an CHOICE in which each voter ranks each of a
asset which 'stands for' the whole range of set of, say, /2, alternatives, giving n points to
non-monetary financial assets. For example, the proposal ranked first down to one point
macroeconomic models examining the for the proposal ranked last. The points
determination of INVESTMENT or of the rate awarded to each alternative by each voter
of interest may assume (as KEYNES did, in his are summed and the proposal obtaining
'General Theory') a financial world in which most points is chosen. This system, first
money and 'bonds' are the only assets. Such proposed in 1781 by J.C. de Borda, avoids
an abstraction from reality allows one to the possible inconsistency known as the
isolate the pure capital-providing function in PARADOX OF VOTING which arises with a
the purchase of a financial asset, divorced simple MAJORITY RULE system. (See APPROVAL
break-even analysis 43
OTING, CONDORCET CRITERION, SOCIAL DE- capture the trend, cyclic and other system-
CISION RULE, SOCIAL WELFARE FUNCTION.) atic characteristics of the time series statisti-
cally. It has proved to be a very accurate
boulwarism. The process of collective bar- forecasting method for the short-run (up to
gaining over terms and conditions of two years ahead), but this precision tends to
employment is normally one of compromise decline rapidly thereafter.
and concession; the two parties bargain and
approach one another until a point some- brain drain. The migration of educated
where between their original or opening pos- and skilled labour from poorer to richer
itions is attained that is mutually satisfactory countries. Education or skill, which rep-
to them. In the US General Electric resents investment in HUMAN CAPITAL, is
Company, however, it was once the practice usually cheaper to acquire in poorer, labour-
to make a firm offer to the union and refuse abundant countries, since its provision is
to bargain thereafter. This approach to bar- usually a labour-intensive activity. Those
gaining is named after Lemuel Boulware, a with the skills or education then move to
former GE vice-president for industrial re- more developed countries where the return
lations. The practice has since been declared to their human capital is higher. Such mi-
contrary to the legal requirement to bargain gration is often encouraged by laws and
in good faith by the US National Labour institutional factors, as most countries look
Relations Board. However, bargaining se- more favourably on immigration by those
quences within the US public sector show with skills than those without.
that Boulwarism is not yet dead, despite its
abandonment by GE. branch banking. The provisions of bank-
ing services through a network of branch
bounded rationality. A notion, developed offices owned by a single banking company.
by H.A. SIMON, which proposes that The development of branch banking, in
although individuals behave rationally, in which Scottish banks were the pioneers, is
that their preference ordering is complete, an important, though not an indispensable,
consistent and transitive, their ability to ob- condition of concentration and large-scale
tain and process information is bounded, i.e. operation in banking, since historically the
it is limited by the computational capacity of branch bank ousted, or replaced through
the human mind. In consequence as tasks mergers, the small independent local bank.
become more complicated individuals adopt An important early condition of branch
simplifying strategies and the use of DECISION banking was the development of control of
RULES and heuristics become more common. lending through trained branch managers. In
Economists have used this notion to explain many states of the US branch banking is
the existence of and to analyse the role of illegal; this derives from populist fears of the
the rules, customs and other social insti- concentration of 'money power' in large
tutions which abound within most markets. banks and is responsible for the untypically
atomized structure of much US banking.
bourgeoisie. A term used to describe that
section of industrial society which came into brand loyalty. Psychic allegiance to the
prominence in the course of the Industrial attribute combination of a branded product.
Revolution as entrepreneurs and pro- In markets in which a heterogeneous prod-
fessional persons. Generally used to de- uct is sold firms use advertising in order to
scribe the property-owning middle classes, build up this allegiance to their products,
and since Karl MARX'S discussion of their role thus increasing the psychic costs of switching
l
he term has often been used in a pejorative to a competitor brand.
sense.
break-even analysis. The costs of produc-
B
ox-Jenkins. A forecasting method based ing a good can be split into two main parts.
V1 ARIMA TIME SERIES models. The technique FIXED COSTS are those that remain the same
°es not take causal factors into account, as for the firm however many goods are pro-
°uld forecasts based on REGRESSION ANALY- duced, e.g. interest on fixed capital, factory
IS
> юг instance, but relies on being able to upkeep, etc. VARIABLE COSTS vary with the
44 'break-even' level of income
number of items produced, e.g. raw ma- INTERNATIONAL MONETARY FUND. {See also
terials for the goods, labour to produce KEYNES PLAN, WHITE PLAN.)
them, etc. From the cost accountant's point
of view, the break-even sales volume is that Bretton Woods System.
which ensures that all fixed and variable See INTERNATIONAL MONETARY FUND.
costs are covered, given a particular selling
price. British Technology Group. The Group
Break-even volume = was formed by the merger in July 1981 of the
remnants of the NATIONAL ENTERPRISE BOARD,
Fixed costs which in 1980-81 had disposed of most of its
Selling price minus variable cost per unit investment holdings, and the NATIONAL RE-
This can also be illustrated graphically: SEARCH DEVELOPMENT CORPORATION. The
Costs Group has concentrated on limited but stra-
tegic attempts to promote new technology-
based developments with private companies.
Since 1983 it has been given the additional
role of translating new research ideas into
Revenues
(selling price x no. of units) commercial products. In 1991 it was pro-
posed that it be privatized.
f the economy into a large scale but man- decisions about the purchase of goods and of
°creable form, and is a landmark in the FACTORS OF PRODUCTION, it had nothing to say
development of large econometric models. about economic decision-making in the
PUBLIC SECTOR. Influenced by the VOLUNTARY
Brussels, Treaty of. A pact of mutual EXCHANGE MODEL of WICKSELL, Buchanan
assistance between the United Kingdom, views the political process as a means of co-
prance and the Benelux Countries signed in operation to achieve reciprocal advantages.
1948. It recognised the perceived military The dynamics and the results of this process
threat from the USSR and also to some will depend on the 'rules of the game', so
extent maintained the World War II alliance that Buchanan has stressed the importance
against Germany. This treaty was followed of the choice of these constitutional rules:
by the North Atlantic Treaty in 1949, which the concrete outcomes of policies are predic-
linked the Brussels treaty signatories with table and predetermined by these very rules.
Denmark, Iceland, Italy, Norway, Portugal, Buchanan has published more than 20 books
the USA and Canada for the defence of the and 300 articles.
countries involved. The Brussels Treaty
organisation eventually merged into the budget. In the UK the Government pres-
West European Union which included ents a major budget every year normally in
Western Germany with other European March or April. In recent years this has
countries, with defence the main objective. often been supplemented by 'mini-budgets'.
The Treaty of Brussels is seen as a step in the Traditionally the budget in the UK was the
direction of European integration which pre- occasion when the Government made
ceded the Treaty of Rome (1957) and the changes to the level and structure of
beginnings of the EUROPEAN ECONOMIC COM- TAXATION.
MUNITY (EEC), now known as the EUROPEAN Strangely, government expenditure plans
COMMUNITY (EC).
have been made separately, though a budget
is defined as the plans for current and capital
Brussels, Treaty of (also known as Treaty of government expenditure as well as current
Accession.) See EUROPEAN ECONOMIC COM-
and capital government revenue. In recent
MUNITY.
years more attention has been given to plans
for government expenditure as well as
Brussels Conference. An international
revenue.
monetary conference, held in Brussels in
1920 under the auspices of the League of Since the Second World War it has been
Nations, which addressed the problem of accepted that the government budget is a
FOREIGN EXCHANGE stability. The conference major instrument for regulating the overall
recommended the creation of an inter- economic situation in the economy. Thus if
national organization designed to assist inflationary pressures are thought to be too
financially weak countries, an International strong a restrictive budget will be introduced.
Clearing House and the establishment of This means that taxes will be increased and/or
national CENTRAL BANKS as means of restor- government expenditure reduced. It has be-
m
g and maintaining international monetary come accepted that the government could
run BUDGET DEFICITS or SURPLUSES to achieve
stability. {See also GENEVA CONFERENCE.)
its objectives in managing the economy. The
Brussels Tariff Nomenclature. The stan- appropriate level of deficit (or surplus) has
dard classification of goods, adopted by the become a matter of major controversy in
jnajonty of countries throughout the world, recent years. In the budget the government
10
Г TARIFF purposes. also makes changes in the structure of taxa-
tion and, to a less extent, in the structure of
Buchanan, James M. (1919- ) American government expenditure. This is to achieve
c
p onomist,
who was awarded the Nobel economic goals. For example, income taxes
nze for Economics in 1986 for his contri- may be reduced to encourage work effort and
iions to the theory of political decision- risk-taking. On the other hand the schedule
of tax rates may be changed to increase the
Whg
a n d PUBLIC CHOICE
-
trac degree of VERTICAL EQUITY as seen by the
^ t i o n a l economic theory could
how CONSUMERS and producers made government of the time.
46 budget deficit
Conceptually a budget has three branches. so that the slope of the budget line is the
These are the ALLOCATION BRANCH, the DIS- ratio of the two prices (see diagram). The
TRIBUTION BRANCH, and the STABILIZATION budget line is also known as the income line,
BRANCH. They are brought together in one consumer possibility line, budget constraint,
budget for reasons of administrative expedi- wealth constraint and even price line. (See
ency. Each branch actually requires its own CONSUMER EQUILIBRIUM.)
separate solution.
In the actual budgets presented in the UK budget surplus. Current income in excess
the Government has frequently taken the of current expenditures. Most frequently
opportunity to initiate MONETARY changes as used to describe the situation where govern-
well as FISCAL ones. Strictly speaking these ment income, TAX receipts, exceeds GOVERN-
are not actually part of a budget. MENT EXPENDITURE. (See BUDGET.)
which are used as factor INPUTS for further capital asset pricing model. This model,
PRODUCTION. As such capital can be dis- developed in the 1960s, gives a specific form
tinguished from LAND and LABOUR which are to the general notion of a TRADE-OFF between
not conventionally thought of as being them- RISK and return. It postulates a positive
selves produced by the economic system. As linear relationship between the expected re-
a consequence of its heterogeneous nature turn on a diversified PORTFOLIO of assets and
the measurement of capital has become the the systematic risk of that portfolio as
source of much controversy in economic measured by the (3 parameter in the
theory. equation
2. The word is also used as a term for
г = rf - rc)
financial ASSETS. (See FINANCIAL CAPITAL,
CAPITAL CONTROVERSY, FINANCE.) where r is the expected return on the portfo-
lio, r f is the riskless rate of interest, e.g. on
capital account. Treasury Bills, (3 is a measure of the extent
See BALANCE OF PAYMENTS. to which the returns on the portfolio move
with the market portfolio, i.e. a combination
of all securities each in proportion to its
capital accumulation. The building up of
share of total market value (because of its
t h e CAPITAL STOCK t h r o u g h positive n e t I N -
broad-based nature all avoidable risk has
VESTMENT. (See GOLDEN RULE OF ACCUMULA-
been removed in the market portfolio, so
TION.)
that the risk which remains, termed system-
atic or market risk, is associated with move-
capital allowances. Allowances against ments of the economy), and r m is the
CORPORATION TAX which are related to firm's expected return on the market portfolio.
CAPITAL EXPENDITURE. Generally corporate The term (r m - r f ) is the market risk pre-
tax systems provide for the DEPRECIATION of mium. Thus if r f = 3%, r m = 8% and p - 2
capital equipment to be allowed as a deduc- (a (3 of this value would represent a risky
tion. In the UK depreciation provisions portfolio where any change in the return in
which appear in a firm's accounts may not be the market portfolio is magnified two-fold).
the same as the capital allowances allowed
by the Inland Revenue. For expenditure on r = 3 + 2 ( 8 - 3 ) = 13%
plant and machinery and industrial buildings A closely related model, the market
generous rates were in force in the UK for model, states that the return on a security or
some years. In 1972 first-year allowances on portfolio comprises a market component
machinery were raised to 100 per cent, and a non-market component, that is
whilst the initial allowance on industrial
building was raised to 50 per cent in 1974. In r = a + (3rm + u,
1984 initial and first-year allowances on
where the non-market component is u, an
machinery and buildings were phased out.
error term, and a, the average return on the
The existence of capital allowances obvi-
security or portfolio, when the return on the
ously postpones the payment of corporation
market portfolio is zero. This model can be
tax and so improves discounted post-tax re-
shown to be formally equivalent to the capi-
turns. In the post-war period trie UK gov-
tal asset pricing model in the absence of the
ernment has often made capital allowances
a term, which should in any case tend to
more generous in DEVELOPMENT AREAS than
disappear in an EFFICIENT MARKET as funds
in the rest of the country to encourage
investment in the former regions. Invest- are moved towards this higher yielding
ment grants have often been used as a substi- security or portfolio.
tute for generous capital allowances or even
as a supplement to them. capital budgeting. The process of allocat-
ing investible funds to capital projects. Many
techniques have been suggested for this pur-
capital asset. An ASSET which is not pose. There are traditional accountants'
bought or sold as part of the everyday run- methods such as PAYBACK PERIOD and RATE OF
ning of a business. Examples would be build- RETURN on capital employed but these are
ings, machinery, land, or SECURITIES. not highly regarded by economists who have
capital gain 51
they are often subject to special forms of the ratio of capital to other FACTORS OF PRO-
taxation. (See CAPITAL GAINS TAX.) DUCTION is greater in A than in B.
capital gains tax. A tax levied on the capi- capital-intensive economy. An economy
tal APPRECIATION of ASSETS. In most Western in which the majority of production tech-
countries capital gains are not classed as niques are CAPITAL INTENSIVE. Most ad-
income but it is recognized that they confer vanced industrial countries have this
purchasing power and so are a fit subject of property which has led some people to
taxation. In practice it is only realized gains suggest that this is the only means to growth,
which are taxed rather than accrued. but the CORRELATION between CAPITAL INTEN-
Generally it is monetary gains which are SITY and advanced countries does not necess-
liable rather than real gains. This has given arily imply causality. (See CAPITAL
rise to controversy in recent years when INTENSITY.)
inflation rates have been high. Some other
forms of capital gain such as those reflecting capital-intensive sector. A sector in an
falls in interest rates on government securi- economy where the majority of production
ties have also been the subject of techniques are CAPITAL INTENSIVE in nature.
controversy. The industrial sectors in less developed
In the UK, gains from April 1982 are countries are usually capital-intensive
calculated after taking account of inflation although there is often a scarcity of capital
by the indexation of acquisition costs. The and surplus labour. Some development
coverage of the tax includes a wide range of theorists have maintained that the only way
assets with significant exceptions. In the UK, to achieve growth is by this type of industrial
gains from main private residences are development. (See CAPITAL INTENSITY,
exempt as are those from private cars, life CAPITAL-INTENSIVE TECHNIQUES, APPROPRIATE
insurance policies, and the first £5000 of TECHNOLOGY)
gains. In the UK income and capital gains
have been taxed at the same rate since 1988. capital-intensive techniques. A produc-
Prior to this the standard rate of capital gains tion technique which has a higher proportion
tax in the UK was 30 per cent with lower of CAPITAL than any other factor of pro-
rates for small gains. duction. (See CAPITAL, FACTORS OF PRODUC-
Under present US law, realized capital TION.)
gains are, with two primary exceptions,
taxed as regular income. First, capital losses, capital, marginal efficiency of.
up to a limit of $3000, may be used to offset See MARGINAL EFFICIENCY OF CAPITAL.
any capital gains. Secondly, for persons aged
55 or over there is a one time exemption of capitalism. A political, social and econ-
up to $150,000 of any capital gain resulting omic system in which property including
from the sale of a primary residence. capital assets are owned and controlled for
the most part by private persons. Capitalism
capita] gearing. contrasts with an earlier economic system
See GEARING. FEUDALISM, in that it is characterised by the
purchase of labour for money wages as
capital goods. opposed to the direct labour obtained
See CAPITAL. through custom, duty or command in feuda-
lism. It differs from SOCIALISM principally in
capital intensity. The ratio of capital to its prevalence of private ownership as
labour employed in the process of pro- opposed to social ownership of the elements
duction. The higher the ratio the more CAPI- of production. Under capitalism the price
TAL INTENSIVE the production process. [See mechanism is used as a signalling system
PRODUCTION FUNCTION.) which allocates resources between uses. The
extent to which the price mechanism is used,
capital intensive. A technique of pro- the degree of competitiveness in markets,
duction A is said to be more capital intensive and the level of government intervention
than some other equivalent technique В if distinguish the exact forms of capitalism-
capital rationing 53
(See MARKET ECONOMY, MIXED MARKET ECON- capital-labour substitution. The process of
oM y and FREE ENTERPRISE.) See Gregory, altering the FACTOR PROPORTIONS of CAPITAL
p R. and Stuart, R.C., Comparative Econ- and LABOUR in a production technique; if one
omic Systems, Houghton Mifflin, Boston, factor costs less than the other, there will be
MA (1985). a tendency for the expensive factor to be
substituted by the cheaper one in a free
market situation. (See CAPITAL, LABOUR,
capitalization. The total amount and
TECHNOLOGY, CHOICE OF.)
structure of the share CAPITAL of a company.
All companies must have owners who own capital loss.
t h e ORDINARY SHARES ОГ EQUITIES. А СОГП-
See CAPITAL GAIN.
pany with only one class of share is said to
have a straight capitalization. Many compa- capital market. The market, or realisti-
nies have several different types of capital cally the group of interrelated markets, in
issued and are then said have a differen- which capital in financial (i.e. monetary)
tiated or structured capitalization. The total form is lent and borrowed or 'raised', on
market value of a company's issued share varying terms, and for varying periods.
capital is termed its market capitalization. These vary from the ultra-short to long or, as
The term capitalization also refers to the act in the case of EQUITIES, non-specified
of converting net retained profits or reserves periods. There are strong forces causing con-
into issued share capital. ditions in one set of financial markets to
affect others, notably the propensity of some
capitalization issue. lenders or borrowers to switch between
See BONUS ISSUE. them as opportunities for cheaper borrowing
or higher returns open up. This transmission
effect, the result of arbitrage, is far from
capitalization rates. A concept which re- perfect, and is subject to complicating expec-
lates the proportion of each class of share or tational effects, but it is sufficiently strong to
debt capital in a company to its total market justify reference to 'the' capital market in
CAPITALIZATION. Many large companies have certain contexts. (See TERM STRUCTURE OF
several classes of SHARES, for example,
INTEREST RATES.)
ordinary shares, preference shares and
debentures, and the use of this ratio indi- capital movements. International flows of
cates the relative importance of each in the funds which may be undertaken by either
CAPITAL STRUCTURE. private individuals or governments. An im-
portant element in the BALANCE OF PAY-
capitalized value. The value which would MENTS.
be placed on an asset at its existing level of
earnings and at current market rates of inter- capital-output ratio. The ratio of the
est. Thus if an asset were yielding £10 and amount of capital to the amount of output
the current rate of interest were 10 per cent produced by that capital. A constant capital-
the capitalized value would be £100. It is output ratio forms the basis of the ACCELERA-
TOR PRINCIPLE. (See also INCREMENTAL
sometimes argued that values calculated in
this manner are not always satisfactory for CAPITAL-OUTPUT RATIO.)
valuing assets, for example in the case of
capital rationing. Generally employed to
compulsory purchase. This is because an
define a situation where there is a budgetary
owner might himself value the asset more
constraint on the amount of funds available
highly and might be prepared to pay more in
for investment in projects over and above
order to retain it.
the normal market constraint determined by
the relationship between cost of capital and
capital-labour ratio. The ratio at which expected returns. Frequently this rationing
LABOUR and CAPITAL are combined within the will be self-imposed. A family firm may be
Production process. Generally labour and unwilling to raise more EQUITY CAPITAL for
capital are measured as flows per unit of fear of losing control or because a quiet life
time. (See INVESTMENT.) is preferred. Similarly, the directors may be
54 capital requirements
unwilling to borrow large sums because of past embodied LABOUR and thus can be
restrictive conditions imposed by lenders. reduced to and valued in common units
An important example of externally im- of labour time. {See also CAPITAL CONTRO-
posed capital rationing in the UK is that VERSY.)
imposed by the government on nationalized
industries. The presence of capital rationing Capital Stock Adjustment Principle. A
means that ranking of projects is required to theory which suggests that the level of NET
maximize the returns to scarce capital. The INVESTMENT is a proportion of the difference
normal project appraisal in terms of NET between the desired CAPITAL STOCK and the
PRESENT VALUE may have to be modified in actual capital stock, reflecting the possibility
these circumstances to maximize returns. of imperfect adjustment to an optimal level
in any finite period of time. (See ACCELERA-
capital requirements. The estimation of TOR PRINCIPLE.)
capital requirements necessitates the deter-
mination Of the INCREMENTAL CAPITAL- capital structure. The composition of a
OUTPUT RATIO, that is, the relationship be- company's CAPITAL. A company must have
tween INVESTMENT and the consequent in- ORDINARY SHARE capital but it can have sev-
crease in INCOME. eral other types such as PREFERENCE SHARE
capital and DEBENTURES or long-term debt
capital. The capital structure refers to the
capital-reversing. The adoption of a tech- weight which the different classes have in the
nique of production when the value of the total capital employed. The question of capi-
associated capital stock and the rate of profit tal structure becomes particularly significant
have both risen. It implies a positive re- when a choice between debt and EQUITY
lationship between the value of capital and capital is made. There is a major debate as to
the rate of profit. When only two techniques whether there is some optimal debt-equity
are being considered capital reversing ratio which minimizes a company's overall
implies DOUBLE SWITCHING as the rising rate COST OF CAPITAL. The conventional view is
of profit means that a technique abandoned that at very low levels of GEARING debt capi-
as the less profitable of the two will be re- tal will be cheaper than equity capital be-
adopted at a higher rate of profit implying a cause the level of risk is low with debt
higher value of the capital stock associated interest being a prior charge. The overall
with the abandoned technique. If more than cost of capital is thus brought down with the
two techniques are compared it is possible to use of debt. As the debt-equity ratio in-
have capital reversing without double creases INTEREST becomes a bigger pro-
switching, as a technique once abandoned portion of expected profits. The risks
may never be readopted for higher rates of perceived by both equity owners and debt
profit, but techniques considered unprofi- owners increase and so the required return
table at lower profit rates are adopted for by both rises as well. Even though interest is
higher rates. a prior charge there are still risks that at very
high levels of gearing, profits may become
capital services. The flow of services over adverse and be insufficient to pay the
time which stem from a stock of capital interest. The overall cost of capital is thus
equipment. (See CAPITAL.) U-shaped as gearing is increased.
This view was challenged by the American
capital stock. The aggregate or sum of economists MODIGLIANI and MILLER who
CAPITAL goods in an economy. This implies argued in their original contribution that the
that the stock of capital can be measured by overall cost of capital remained constant as
a single number, and requires the heroic gearing was increased. Essentially a situ-
assumption that the diverse constituents of ation where two companies with equal
this stock (factories, roads, machinery, etc.) expected profits or equal risk but different
can be reduced to a common unit and levels of gearing had different total market
summed to obtain an unambiguous measure values for their debt plus equity would be a
of society's physical stock of capital. Karl non-equilibrium one. If one company had no
MARX argued that capital consists merely of gearing and the other had some debt which
cardinal utility 55
reduced its overall cost of capital (and so countries. The criterion has been the subject
enhanced its market value) it would pay in- of much criticism. Thus it does not take into
dividual shareholders in that company to account the fact that in many projects, e.g.
indulge in gearing of their own to the same in the agricultural sector, fixed capital may
extent as that company's, sell their shares in be a small proportion of the total investible
that company and use the proceeds plus inputs required and so the use of the cri-
their borrowing to buy ordinary shares in the terion could lead to projects being ranked in
company with no gearing. A higher return an inappropriate manner. It does not take
would be obtained and the process would sufficient cognizance of the fact that there
continue until the total market value of each are other scarce resources in developing
company was the same. This analysis has countries. The criterion takes no account of
been criticized on a number of grounds in- EXTERNALITIES and complementarities of
cluding the assumption that a given gearing projects. Further, it does not take into
ratio of an individual was no more risky than account the possibility that scarcity of skilled
the same undertaken by a company, the labour may be an impediment to growth.
omission of the danger of bankruptcy and
the deductability of interest for CORPORATION capital widening. The process of accumu-
TAX. If interest deductability is allowed the lating CAPITAL at the same rate as the growth
theory suggests that a maximum debt-equity of the LABOUR FORCE so that the CAPITAL-
ratio minimizes the cost of capital. On its LABOUR RATIO remains constant. (See also
own assumptions the Modigliani-Miller CAPITAL DEEPENING.)
theory may be valid but the assumptions in
the conventional analysis are more realistic. capitation tax.
(See COST OF CAPITAL.) See POLL TAX.
bundle of goods is capable of absolute deposits. In the case of BANKS the term
measurement in terms of some units such as covers currency in tills or vaults plus bal-
'utils' (a term used for example by JEVONS in ances held with the CENTRAL BANK.
his Theory of Political Economy in 1871)
which would be comparable to the units used cash balance approach.
for height, weight and distance. That is, ab- See QUANTITY THEORY OF MONEY.
solute numbers would be placed on the uti-
lity level and those numbers would be cash crops. This term refers to crops
related to a 'real' origin of zero (we do not grown by peasant farmers specifically for
speak of minus weights or distances). sale in the market as opposed to crops
The second and more widely used concept directly consumed for SUBSISTENCE purposes.
relates only to the intervals between utility
levels. Thus, faced with four situations 1,2,3 cash flow. The sum of retained earnings
and 4, if a consumer can say that the differ- and depreciation provision made by firms.
ence between the utility levels of 1 and 2 is As such it is the source of internally gener-
some multiple or fraction of the difference ated long term funds available to the
between the utility levels of 3 and 4, he can company.
be said to have scaled his utility levels in
cardinal terms. The difference between this cash limit. A form of control on PUBLIC
'interval' interpretation and the absolute in- EXPENDITURE introduced in the UK. The
terpretation given above is that the 'interval' technique involves setting a pre-ordained
approach does not require us to attach absol- limit to the amount a government depart-
ute numbers to levels of utility. ment will be allowed to spend in total rather
In general, few economists now believe than judging each element of expenditure on
that utility is measurable in cardinal terms in its merits as it arises. The system was intro-
either of the senses above. Indeed, it was the duced in response to a belief that govern-
reaction against the unreality of cardinal ment expenditure was growing out of
measurement that gave rise to ORDINALISM. control. Cash limits are a rather blunt instru-
(See also ORDINAL UTILITY.) ment in that their existence may prevent
economically worthwhile projects from go-
cartel. Formal agreement between firms in ing ahead simply through lack of funds. (See
an oligopolistic market to co-operate with also PUBLIC EXPENDITURE SURVEY COMMITTEE.)
regard to agreed procedures on such vari-
ables as price and output. The result is dim- cash ratio. The ratio which banks maintain
inished competition and co-operation over between their holdings of CASH and their
objectives as, for example, joint PROFIT MAXI- deposit liabilities, and sometimes referred to
MIZATION or avoidance of new entry. In gen- as the cash reserve ratio. Historically it was
eral side-payments must be made between determined by day-to-day LIQUIDITY needs,
cartel members in order to induce adherence but it tended to become conventionalized
to these objectives. and in most banking systems became fixed
Interest in the economic analysis of cartels by law or regulated in some way by the
has focused on the conditions which can lead CENTRAL BANK. This regulation or prescrip-
to instability in cartel organizations. In par- tion, always of a minimum ratio, was partly
ticular, the problem of the flefector has to ensure prudent operation and maintain
attracted considerable attention. (See public confidence in the banks. With the
OLIGOPOLY.) development of the theory of CREDIT CREA-
i I
TION, and its consequences for the MONEY
cartel sanctions. Penalties imposed by
SUPPLY, a stable or controllable minimum
members of a CARTEL to induce adherence to
cash ratio came to be regarded as a necess-
the joint goals of the group.
ary condition of monetary control, and a
cash. In its broadest sense simply denotes controlled variable cash ratio a positive in-
MONEY, including CURRENCY and BANK DE- strument of such control. In some systems
POSITS. In some contexts it may be restricted where cash ratios are subject to legal or
to the most liquid forms of money, i.e. cur- other control, differing ratios may be
rency and CURRENT ACCOUNT (or demand) required for demand and TIME DEPOSITS, and
central bank 57
banks and other financial institutions on Central Limit Theorem. This states that
their lending activities. An important func- the sum (and MEAN) of a set of RANDOM
tion, from which much of the influence and VARIABLES will follow a NORMAL distribution
powers of a central bank derive, is to act as if the sample is sufficiently large, regardless
LENDER OF LAST RESORT. Yet another import- of the form of the distribution from which
ant function is to set and maintain standards the individual variables come. The theorem
of integrity, financial strength and sound is often used to justify the assumption of
lending practice on the part of banks and normality of the error term in econometric
other financial institutions. Where the work, which allows the use of the usual т-
national debt is large, as in the UK, its man- STATISTICS for HYPOTHESIS TESTING, since this
agement cannot be separated from open error term is supposedly composed of the
market operations and the general conduct sum of a set of random omitted factors.
of monetary policy, and this therefore be-
comes an essential function of the central Central Place Theory.
bank. The same applies, under modern con- See LOCATION THEORY.
ditions, to the management of the EXTERNAL
RESERVES and the EXCHANGE RATE. Currency central planning.
issue is a common, though non-essential, See PLANNED ECONOMY.
function of central banks, as is the provision
of general banking services to government Central Policy Review Staff. An office, set
departments and agencies. As a general rule up in the UK in 1970, whose responsibilities
central banks are precluded from engaging included conducting analyses of major econ-
in banking business with the public, that of omic policy issues for the Cabinet office. The
the Bank of England being a historical sur- office, colloquially known as the 'think
vival of limited extent. tank', co-ordinated its operations with those
Of the PUBLIC EXPENDITURE SURVEY COM-
Central Bank of Central Banks. MITTEE and various government depart-
See BANK FOR INTERNATIONAL SETTLEMENTS ments. The CPRS was wound up in 1983.
a n d INTERNATIONAL MONETARY FUND.
Central Statistical Office. A British gov-
ernment office responsible for compiling,
central business district. The area at the synthesizing and publishing statistics
centre of most cities and large towns which is generated by government departments and
dominated, in terms of land use, by commer- semi- and non-official bodies in the UK. The
cial activities. The central business district is office publishes a comprehensive survey of
generally the area of highest land values and national economic data via regular reports
rents in the city since commercial and finan- on NATIONAL INCOME and expenditure,
cial activities are willing to pay high rents in employment, industrial production indices,
order to obtain the advantages of a central, INPUT-OUTPUT TABLES, financial flows and the
and thus highly accessible, location. (See
BALANCE OF PAYMENTS.
also ACCESS/SPACE TRADE-OFF MODEL.)
include a 'service7 or interest charge on out- name derives from the fact that many promi-
standing balances owed. nent members of the 'school' (e.g. FRIED-
MAN, KNIGHT, SCHULTZ and STIGLER) have
charged in full. been associated with the University of
See CIF. Chicago.
cheap money. Denotes a phase in which child allowance. In most INCOME TAX sys-
loans are available at low rates of interest or tems an allowance for dependent children is
a policy which creates this situation. The given. The idea is to provide some relief for
term is frequently used to describe the policy the costs of maintaining children. In the UK
of low rates in the UK after 1931, a policy the value of the allowance increased with the
initiated by a conversion of the then age of the dependent child reflecting the
NATIONAL DEBT to lower interest rates. higher living costs of older children. Under a
PROGRESSIVE income tax the value of this type
check-off. The direct deduction by the of allowance increases with the marginal rate
employer of union dues from the employee's of tax and assistance for people receiving
wage, which charge is then paid over to the low incomes could be zero or negligible. In
union. Check-off arrangements require the the UK the income tax allowance has been
written assignment of the employee. phased out and replaced by child benefit
which is a straight, untaxed cash payment
cheque. A document, normally supplied per child.
in printed form by a BANK, ordering the bank
to transfer funds from the drawer's CURRENT Chi-square Distribution. (also known as
ACCOUNT to a named payee. If the payee X2) A probability distribution with para-
signs the reverse side of a cheque it becomes meter n degrees of freedom. The distri-
'negotiable', i.e. he may assign his claim in it bution is useful in econometric work since
to someone else simply by handing it over. A
the sum of squares of n independent stan-
cheque 'crossed' with two lines and bearing
dard normal variables follows approximately
the words 'and Co.' effectively can be paid
a Chi-square distribution with n degrees of
only by being credited to a bank account; it
freedom. (See also CONTINGENCY TABLES.)
should not be paid in cash over a bank's
counter.
choice of technology.
See TECHNOLOGY, CHOICE OF.
cheque card. Cards issued by banks to
CURRENT ACCOUNT customers, which guaran-
tee the payment of CHEQUES drawn by these choice variable. A variable in an optimiza-
customers up to specified limits. Such cards tion problem, whose value is 'chosen' so as
also permit the holder to obtain cash up to to optimize the value of the OBJECTIVE FUNC-
this limit, on demand, from any branch of TION. Choice variables are normally the IN-
the issuing bank. DEPENDENT VARIABLES of the objective
function.
Chicago School. The name» applied to
those economists who share four primary CIF. Cost, Insurance, Freight or Charged
beliefs. Firstly, they believe that economics in Full. A term which describes pricing or
is (or can be) value-free in the same manner valuation of a good to include all of the
as the physical sciences. Secondly, they be- costs, known as TRANSFER COSTS, of deliver-
lieve neo-classical price theory provides an ing the good to the point of consumption. It
accurate explanation of how economic sys- may be contrasted with the FOB or free on
tems work. Thirdly, they believe that the board method where the transfer costs are
operation of free, competitive markets pro- excluded. In British overseas trading
vide the best possible solution to the prob- accounts imports are measured CIF while
lem of resource allocation. Finally, they are exports are calculated FOB. However, for
staunch adherents of MONETARISM. All this the purpose of calculating the BALANCE OF
leads them to advocate limited government PAYMENTS both are calculated FOB. Transfer
intervention in the economic system. The costs are then counted in INVISIBLES.
classical economics 61
when the market failed. Its successor, NEO- classical techniques. A term normally
CLASSICAL ECONOMICS, was static in outlook, used to describe standard statistical tech-
since it concerned itself with a study of the niques, in order to distinguish them particu-
principles determining efficient resource larly from BAYESIAN TECHNIQUES. The feature
allocation. of classical methods is that no information
Classical economics also examined mic- other than the sample data is used to make
roeconomic problems. The classical theory STATISTICAL INFERENCES, ОГ in t h e ESTIMATION
of value stressed the costs of production and of parameters of REGRESSION equations.
LABOUR THEORY OF VALUE, while neo-classical
economics stressed the subjective aspects of clay-clay. An aspect of the PRODUCTION
value. While in neo-classical economics all FUNCTION in GROWTH THEORY which does not
prices are determined by the same forces allow the capital-labour ratio to be varied
(supply and demand and their underlying either before or after investment is carried
cost and demand conditions), classical econ- out. The term 'clay', referring in particular
omics has to rely on special theories. The to capital, is used due to that substance's
prices of products are derived from the assumed lack of malleability when compared
'natural' rates of reward of the factors used with 'putty'. (See PUTTY-CLAY and PUTTY-
in their production: the reward to land, rent, PUTTY.)
is determined by scarcity and the differential
fertilities of land, the wage by the long-run Clayton Act. Passed in the US in 1914. Its
cost of the means of subsistence of labour, purpose was a specific definition of anti-trust
while profit is a residual. Unlike other violations in an attempt to make the
schools of thought, with the exception of Sherman Act less vague. The Clayton Act
MARX, classical economics is distinguished by prohibits PRICE DISCRIMINATION which sub-
the fact that it had a theory of population, stantially lessens competition or creates a
since the MALTHUSIAN approach was monopoly; contracts which prevent buyers
accepted by most members. Where classical from dealing with seller's competitors; TYING
economics had weaknesses was in its inad- CONTRACTS; acquisition of one corporation's
equate treatment of aggregate demand (see shares of stock by another which will sub-
SAY'S LAW) and its lack of clarity on what stantially lessen competition; and INTER-
determined the supply of capital to meet the LOCKING DIRECTORATES between competitors.
wage bill (the WAGE FUND) and physical The Act exempts labour from antitrust pro-
investment. visions. (See also CELLER-KEFAUVER ACT and
In their methodology the classical eco- ROBINSON-PATMAN ACT.)
nomists fell into two camps. There were
those who followed the inductive method, clean float. When a FLOATING EXCHANGE
e.g. SMITH, who formulated premises on the RATE is allowed to vary in complete freedom
basis of empiricism, derived empirical laws, from any intervening influence by the MONE-
reasoned on the basis of these and tested the TARY AUTHORITIES, there is said to be a 'clean
result against other empirical data. There float'. This rarely happens in practice. (See
was a second group, of whom the best also DIRTY FLOAT.)
known was RICARDO, which followed the
deductive method of making* hypothetical clearing banks. In the UK, denotes those
premises, deducing conclusions from them COMMERCIAL BANKS which traditionally oper-
and making no attempt to verify the results, ated and had access to a CLEARING HOUSE or
a procedure which SCHUMPETER in his History its equivalent for the purpose of clearing
of Economic Analysis (1954) has called 'the CHEQUES drawn against one another. The
Ricardian vice'. 'London Clearing Banks' embraced the
major domestic RETAIL BANKS of England
and Wales, and similarly in the case of the
classical school. Scottish clearing banks. The term has not
See CLASSICAL ECONOMICS.
been used in connection with the Northern
Irish banks, though these banks do operate a
4
classical' system of company taxation. clearing arrangement for local cheques. In
See CORPORATION TAX. the case of the London clearing banks,
closed shop 63
clearing house. The place in London closed economy. A concept used mainly in
where the London CLEARING BANKS and the theoretical models to describe an economy
BANK OF ENGLAND - and in Edinburgh, the with no external trade, which will be com-
Scottish joint stock banks - carried out pletely self-sufficient and insulated from ex-
the daily clearing of cheques and other ternal forces.
claims on each other. 'Clearing' is an oper-
ation by which a group of banks (or any closed shop. In its American usage the
group of transactors for that matter) holding term refers to an arrangement requiring
CHEQUES, BILLS or other documentary claims workers to be members of the union before
on each other, in presenting them for pay- they are hired by a firm. In Britain, on the
ment engage in a process of mutual offset- other hand, it is conventional to distinguish
ting of these claims which results in each between pre-entry and post-entry forms, i.e.
bank emerging with a single net debtor or pre or post employment, of closed shop - the
creditor position which it settles with the latter would be termed a UNION SHOP in the
clearing organisation, usually by transfer of US.
balances with the CENTRAL BANK. In 1975 the Historically, closed shop agreements have
Central Trustee Savings Bank and the been restricted to the skilled crafts and
Cooperative Bank, and in 1983 the National casual occupations in which the employer
Girobank, were admitted to membership of depended on the union to supply workers
the London Clearing House. In Scotland, who were often only in temporary demand.
with the consolidation of the banking system Under this arrangement, the employer had a
into three banks the centralised clearing of ready source of labour and the worker a
cheques was discontinued in favour of each place to get jobs. The closed shop thus made
bank presenting cheques individually to the it possible to allocate scarce jobs. Equally, a
others. In 1969, in London, the Bankers' worker might lose his job ticket via expul-
Automated Clearing System (BACS) was sion from the union, and favouritism as well
established to handle electronically the as equity could enter the job allocation
clearing of regular payments, such as credit mechanism.
transfers and direct debits. In 1984 the The closed shop presents unions with
Clearing House Automated Payments monopoly power, because of the control of
System (CHAPS) was launched to provide a labour supply. Also firms and unions may
64 closing-prices
collude with the express intention of mono- In 1937 in an article, 'The Nature of Firm',
polizing a particular trade. Because of this Economica New Series IV, he raised the
and other facets of the closed shop, it has question of why certain economic activities
been declared illegal in the US. Similarly the were left to market exchange and others
post-entry closed shop is illegal in the UK. carried out within firms. As markets and
firms are alternative ways of organizing pro-
closing-prices. This is most commonly duction, what is it that determines when
used in connection with the STOCK-MARKET to each is used? Coase answered the question
describe the prices of the STOCKS and SHARES by saying the firm would expand to the point
etc. at the close of trading on a particular where the cost of conducting the activity
day. within the firm became the same as conduct-
ing it through a market transaction. This was
club good. An intermediate case between the starting point for viewing industrial
purely PUBLIC GOODS and PRIVATE GOODS. organization from a transaction-cost per-
With the club good EXCLUSION is feasible but spective, namely that that form of organiz-
the optimal size of the club is in general ation will be chosen which minimizes the
larger than one individual. An example costs of an economic transaction.
would be cinema shows. Here it is possible In 1960 in an article, 'The Problem of
for the good to be priced (exclusion can be Social Choice', Journal of Law and
practised) and for a number of people to Economics, Vol. 3, Coase argued what has
share the same good without diminishing become known as COASE'S THEOREM, that a
each other's consumption of it. The size of Pareto optimum is still possible in the pres-
the OPTIMAL sharing group is that which max- ence of externalities in the absence of state
imizes their joint UTILITY. (See CLUBS, THEORY intervention, if bargaining is possible be-
OF.) tween the producer and recipient of an ex-
ternal effect and if PROPERTY RIGHTS are
clubs, theory of. The theory of clubs is clearly specified.
part of the theory of IMPURE PUBLIC GOODS. A
CLUB GOOD is EXCLUDABLE (i.e. it is possible Coase's theorem. This theorem is based
to prevent its consumption by whole groups upon the argument that EXTERNALITIES do
of people, in contrast with PUBLIC GOODS) but not give rise to a misallocation of resources
NON-RIVAL in that the consumption of the provided there are no TRANSACTION COSTS
good by one person does not reduce the and given PROPERTY RIGHTS that are well de-
consumption of the same good by other per- fined and enforceable. Here the parties - the
sons. Examples would be swimming pools, producer and consumer of the externality -
museums, beaches and parks. Obviously, would have a market incentive to negotiate a
the non-rivalry will cease when congestion mutually beneficial trade, that is, to interna-
occurs and the UTILITY of any one individual lize the externality. The neutrality theorem
will therefore be affected by the presence of states that the outcome of this trading pro-
more 'members' of the club. The aim of the cess would be the same irrespective of
theory is to determine the optimal size of the whether it was the producer or consumer of
club, and the optimal provision.of the good. the externality who held the property right
(See Sandler,T and Tschirhart, J.T. (1980). of veto over the use of the resource.
T h e Economic Theory of Clubs.' Journal of
Economic Literature, pp. 1481-1521. Cobb-Douglas production function. A
PRODUCTION FUNCTION with the algebraic
form:
Coase, Ronald H. (1910- ). A
British-born economist who was awarded Q = A.La.Kh
the Nobel Prize for Economics in 1991 for
his seminal work in the THEORY OF THE FIRM where Q is output, Л, a and b are constants
and in the economics of EXTERNALITIES. and L and К are labour and capital respect-
Coase, who was educated at and taught for a ively. The function is homogeneous of de-
time at the London School of Economics, gree a + b (see DEGREE OF HOMOGENEITY and
worked for most of his life at the University PRODUCTION FUNCTION) since multiplication
of Chicago. of L and К by some constant, k, will raise
co-determination 65
a+h
output by a proportion k .. The proof is
straightforward:
Q1 = A.kLa.kKb = ka+h(A.La.Kb)
If the exponents sum to unity the Cobb-
Douglas function is LINEARLY HOMOGENEOUS
- that is it exhibits constant returns to scale.
If the exponents sum to more than unity the
function exhibits increasing returns to scale,
and if less than unity there are decreasing
returns to scale.
The ISO-PRODUCT CURVE relating to a
Cobb-Douglas function will exhibit the fam-
iliar convex shape and will be 'smooth'. If
the function is linearly homogeneous it is
possible to derive several propositions of
interest. These are (i) that the AVERAGE and
cobweb theorem
MARGINAL PRODUCTS of capital and labour are
functions of the capital/labour ratio alone
The diagram shows an example of a con-
and (ii) EULER'S THEOREM holds. Moreover,
vergent cobweb process. For convergence to
(iii) if each input is paid according to its
occur the slope of the demand curve must be
marginal product, then the exponents a and
less than the slope of the supply curve
b will actually measure the share of total
(measured in absolute terms - i.e. ignoring
production accruing to labour and capital
the sign of the slope). At P() a supply of S\
respectively. Proofs of these propositions
occurs in the next period (since supply in
may be found in A.C. Chiang, Fundamental
period 1 is dependent upon price in the pre-
Methods of Mathematical Economics, 2nd
vious period 0). But supply now exceeds
edition, McGraw Hill, New York (1974).
demand in period 1 so price falls to P\. Price
in period 2 is now based on P\ and is S2.
Supply is now less than demand so that price
cobweb theorem. The simplest form of a moves to P3 and so on.
DYNAMIC MODEL in which the supply of a
good in year t is a function of the good's
price in year t—\ and where, in any period, Cochrane-Orcutt. The name of a com-
price is adjusted so as to 'clear the market'. monly used procedure designed to estimate
Such examples may occur in agriculture the parameters of an equation whose RESI-
where the decision to grow a crop or breed DUALS are subject to SERIAL CORRELATION,
certain animals for food may be based on whereby the date is subjected to partial FIRST
conditions in previous years. The effect can DIFFERENCE before estimation by ORDINARY
be to generate a process of fluctuating LEAST SQUARES. It approximates to the
prices, with the fluctuations being 'damped' GENERALIZED LEAST SQUARES ESTIMATOR. (See
so as to converge on an EQUILIBRIUM of also PRAIS-WINSTEN.)
prices, or 'anti-damped' so as to continue
fluctuating from one period to the next.
Indeed, it is possible for the process to be co-determination. Worker participation in
such that the fluctuations grow over time. In the process of policy decision-making in
this way 'cycles' of prices and output are firms. In Germany the system of Mitbestim-
generated and the process is sometimes mung has been in existence since the early
called the 'cobweb cycle' or 'hog cycle', in 1950s and provides for worker participation
the latter case because the phenomenon was in decision making at board level. Worker
observed in pig prices in the USA in the directors together with shareholders sit on a
ГW ° S C o n t i n u e d fluctuations only seem supervisory board, which together with the
•ikely, however, if producers do not 'learn' managing board constitute, respectively, the
jrom previous experience. It seems probable policy and executive authorities within the
hat a LEARNING PROCESS will in fact operate. firm.
66 coefficient of determination
coefficient of determination (also known Coins are pieces of metal, normally shaped
as R2 multiple correlation coefficient.) A and stamped with a device which is evidence
statistic which summarizes the explanatory of their value and of their legal status as
power of an equation. It is the proportion of money. In the case of 'full-bodied' coins,
the variation in the dependent variable which circulate at a value equal to that of the
which is accounted for by the composite metal in them (less a seignorage charge),
variation of the explanatory variables and is coining is an evidence of their metallic con-
defined as tent. With token coins, the circulating value
1 - Xe2 of which is unrelated to their value as metal,
R = coining declares value and establishes their
legal status. In almost all countries with
where Xe2 is the residual sum of squares, established political orders coinage has been
and 2y 2 is the sum of squares of the depen- reserved to the state.
dent variable. Thus R2 lies between zero and
unity. The closer to zero it is, the less is the coinage debasement. Historically a re-
explanatory power (the higher the residual duction in the quantity of the prime metal in
variation as a proportion of the total), and a full-bodied coin, without a corresponding
vice versa for values close to unity. (See also reduction in its legal nominal value.
ADJUSTED R 2 , GOODNESS OF FIT.) Debasement occurred in various ways: by
clipping and 'sweating', by reduction in the
fineness of the metal in new coins, and by
coefficient of variation. (also known as
reduction in the actual weights of coins on
relative dispersion.) A commonly used
recoinage. It was widely practised by rulers
measure of the degree to which a variable is
and ruled to obtain finance. Theoretically it
distributed around its MEAN value. It is de-
should have eventually led to a rise in the
fined as price of commodities, either by direct mar-
kup when debasement was detected and was
widespread, or by the consequent increase in
the amount of money in circulation.
that is the ratio of the STANDARD DEVIATION However, in periods of money shortage its
to the sample MEAN. The advantage of this effect could be anti-deflationary rather than
measure is that it standardizes for the scale inflationary. (See COINAGE.)
of the variable concerned, so that compari-
sons between the degree of dispersion of
variables with widely differing typical values coincident indicator. An economic data
is possible. (See also VARIANCE, SUM OF series that moves with the business cycle;
SQUARES.)
that is, the economic data series will peak at
approximately the same time as the business
cycle reference peak and bottom out at the
coercive comparisons. Comparisons business cycle's trough. The Coincident
drawn between the pay of different groups Index Indicator, which is a composite of four
of workers and used by the representatives coincident economic data series, is used to
of employees as justification for a pay in- track current economic activity. The four
crease. Such comparisons may result from coincident indicators included in the US
formal or informal comparability exercises index are: 1) employees on non-agricultural
or may be drawn between jobs with a widely payrolls, 2) personal income less transfer
differing content. (See COMPARABILITY.) payments in 1972 dollars, 3) total industrial
production, and 4) manufacturing and trade
cofactor. The cofactor of an element in a sales in 1972 dollars. The journal, Business
MATRIX is the DETERMINANT of the new matrix Conditions Digest, in which the series
which is formed by deleting the row and appeared ceased publication in November
column of the original matrix in which the 1990.
element is situated.
cointegration. This is a method of defining
coinage. That part of the hand-to-hand the long run relationship amongst a group of
CURRENCY that consists of metallic coins. TIME SERIES variables. It uses the idea of an
commercial banks 67
integrated TIME SERIES in describing the long which they lead. In particular, economists
run interaction, and arose in the context of have been interested in the PARETO OPTIMA-
the spurious regression problem. To be re- LLY of collective choices and the extent to
lated to one another statistically in the long which such choices reflect the PREFERENCES
run variables must be of the same order of of individuals. The IMPOSSIBILITY THEOREM of
integration. For example if a two variable K.J. ARROW indicates that there are serious
regression model is specified as difficulties in obtaining collective choices
from individual values. {See also SOCIAL WEL-
yt = $xt+ u, FARE FUNCTION, PUBLIC CHOICE.) See Mueller,
then щ will only be 1(0), integrated of order D.C., Public Choice, 2nd edn., Cambridge
zero and, therefore, having the property of University Press (1989).
STATIONARITY, if yt and xt are both of same
order of integration l(d). The simplest and collective goods. Commodities or services
most common case is where xt and yt are that possess the characteristics of NON-
both 1(1)- Then if ut is 1(0) the series xt and yt EXCLUDABILITY alone. In such cases,
are said to be cointegrated. Cointegration is although it is technically feasible to exclude
closely linked to error correction models. people from consuming the commodity or
See R.F. Engle and C.W.J. Granger, 'Co- service in question it is nonetheless unecono-
integration and Error Correction: Repre- mic because the revenue would be less than
sentation Estimation and Testing', Econo- the costs of collection. (See PUBLIC GOODS.)
metrica, 1987, Vol. 55, pp. 251-276.
collinearity.
COLA. Cost of living adjustment. (See See MULTICOLLINEARITY, LINEAR DEPENDENCE.
ESCALATORS.)
traditionally for non-fixed capital purposes, in particular crops. Farmers who are in com-
usually accounts for the greater part of their pliance with these acreage restrictions are
assets. The term distinguishes such banks given loans based on some percentage of
f r o m SAVINGS BANKS ОГ MERCHANT BANKS ОП 'parity' prices established at the beginning of
the one hand, or banking type institutions the year. If the farmer defaults, the col-
like BUILDING SOCIETIES and FINANCE COMPA- lateral is surrendered to the Commodity
NIES on the other. Credit Corporation. This amounts to a con-
ditional purchase plan by the government to
commercial bill. A BILL drawn to finance establish a price floor on farm products. The
trade or other commercial or production Corporation also buys and stores commodi-
activities. It is distinguished from a TREASURY ties. The Corporation is capitalized at $100
BILL or local government bill which are in- million and authorized to borrow an addi-
struments of public financial operations. tional $30 billion backed by the United
States government. In 1988, the Corporation
commercial paper. A collective term for provided over $13.3 billion in loans. (See
COMMERCIAL BILLS. PARITY PRICE SYSTEM.)
lii
communism 69
most of the major agricultural commodities. members. While the rate for any given
ддпси1шга1 prices within the Community imported good is identical in all member
ar
e based on common 'target' prices. The countries, different rates of duty are applied
target prices once set are converted into to different goods.
different national currencies using adjusted
rates of exchange known as 'green' rates common facility co-operatives. A policy
(e.g. the GREEN POUND.) measure designed to facilitate the growth of
д system of levies on non-EC agricultural progressive technology, by forming co-
imports is used to protect target prices when operatives which use common facilities or
they are set above the general level of world joint production workshops to raise produc-
prices. In addition, the Community has tivity of local artisans and craft industries.
established an internal price support system (See ALTERNATIVE TECHNOLOGY.)
based upon a set of 'intervention' prices set
common market. An area, usually com-
slightly below target price. If, for example,
bining a number of countries, in which all
the level of supply is in excess of that required
can trade on equal terms. Such a system
to clear the market at the target price, the
requires the establishment of a CUSTOMS
excess supply is bought by the Community at
UNION, with a COMMON EXTERNAL TARIFF, the
the intervention price, thereby preventing
free movement of FACTORS OF PRODUCTION as
over-production from depressing the com-
well as of goods and services, and consider-
mon price level. The Community also sup-
able harmonization of tax and other policies.
ports prices by means of export subsidies
(See also EUROPEAN COMMON MARKET.)
adjusted to influence the internal supply of
agricultural commodities. The guarantee sec- common stock. A financial instrument
tion Of the EUROPEAN AGRICULTURAL GUID- (financial agreement) which conveys owner-
ANCE AND GUARANTEE FUND finances the price ship and voting rights in a corporation to the
support programmes. The Community also instrument's holder. In the case of common
offers assistance to farmers in the form of stock, holders have claims to the corpor-
grants designed to improve and rationalize ation's remaining net earnings and assets
methods of agricultural production. after all other classes of debt and equity have
received their promised return. Such claims
Common Customs Tariff. The common are based on the ratio between their hold-
external TARIFF of the EUROPEAN COMMUNITY ings and total shares outstanding. Preferred
(EC). There are no tariffs on trade between stock holders, who are given dividend
member countries of the EC and a common guarantees, have prior claim to the corpor-
tariff on imports from third countries. This is ations earnings and assets. Similarly, debt
essentially for protective purposes. There are holders have claims prior to those of both
many concessions. Thus most industrial common and preferred stock holders.
products from the EUROPEAN FREE TRADE Common stock holders elect the board of
ASSOCIATION (EFTA) enter duty free. Under directors. Voting rights are in proportion to
the Generalized System of Preferences a ownership rights. (See PREFERENCE SHARES,
wide range of goods from developing EQUITIES.)
countries may be imported on a non-
reciprocal tariff preference basis. Similarly, communism. In the strict sense, a stage of
under the LOME CONVENTION the EC members economic development which is said to
entered into a trade, aid and co-operative occur when all classes in society have been
agreement with 46 developing countries from absorbed into the PROLETARIAT. In this ideal
Africa, the Caribbean and the Pacific (the society the state would have withered away
ACP countries). This agreement allowed the and each person would contribute according
free entry of all industrial and many agricul- to ability and receive according to needs.
tural goods from these countries. This Utopia envisaged by MARX is seen to be
the stage of economic development which
common external tariff. A TARIFF applied follows on from CAPITALISM and SOCIALISM.
by members of a CUSTOMS UNION, COMMON The term is however often used to denote
MARKET or ECONOMIC COMMUNITY at an the planned economic system operated in
a
greed, similar rate on imports from non- the COMECON countries (until the revolutions
70 Community Charge
in Eastern Europe in the late 1980s), China LIABILITY companies', that is, the
and elsewhere where the government has liability of the shareholders for the com-
centralized economic decisions and taken pany's debts, e.g. on insolvency, is limited to
control of productive activity. what they have paid for their shares plus any
amount unpaid on the shares. Companies
Community Charge. A tax introduced in the are of two basic kinds, public and private,
UK in the late 1980s as a replacement for each subject to different regulatory con-
rates. It proved to be exceptionally unpopu- ditions in certain respects. Public companies
lar and expensive to collect. It was based on must have an issued capital of not less than
the principle that all adults living in a par- £50,000, before they are permitted to do
ticular local government area should pay the business. They may offer their shares for
same amount, if their income was above a public subscription, and provided they
minimum threshold. Those with incomes be- satisfy the requirements of the STOCK
low the threshold paid at a reduced rate. EXCHANGE these shares may be 'listed' (or
Commonly referred to as the POLL TAX it is 'quoted') and hence traded on the exchange.
due to be replaced by a new tax based on Private companies may not invite the public
property values (to be known as the council to subscribe for their shares, but they are not
tax). subject to any minimum capital require-
ments. The transfer of shares in private
community indifference curve. A curve companies is often subject to control by
along which each individual in a community the other members. The private company's
receives an unchanging level of UTILITY. The form is well suited to small businesses; but if
points along such a curve represent bundles the company grows and its capital needs
of commodities which can be distributed expand, it may need to convert itself into a
among individuals so as to maintain this par- public company. Private companies are
ticular distribution of utility. Community much the more numerous type; but the aver-
indifference curves (unlike individual INDIF- age size of public companies is much greater,
FERENCE CURVES) can intersect. As many in- the capital requirements of the stock
difference curves will pass through any point exchange being even greater than those of
in commodity space as there are different the Companies Acts. {See UNCALLED CAPI-
ways of distributing that commodity bundle. TAL, EQUITIES.)
If one curve lies entirely outside another this
implies that at least one individual experi-
ences higher utility and no individual company bargaining, COLLECTIVE BARGAIN-
receives any less. ING between the representatives of a single
company, which may have one or more
plants throughout the country, and
company. This normally signifies a JOINT
employees' representatives to establish rates
STOCK COMPANY, which is a legal entity set up
of pay and conditions of work throughout
for the purpose of conducting commercial or
industrial operations, and with a capital the company. Where a company has a num-
divided into SHARES that are held by its ber of plants throughout the country in the
members. In principle, the, shareholders same industry and the company is a mono-
control the company through their right to polist this form of bargaining is equivalent to
NATIONAL BARGAINING. (See also PLANT BAR-
vote at annual meetings and to elect the
GAINING.)
board of directors, whose function is to over-
see the running of the company. The forma-
tion and conditions of operation of company director. A person elected by
companies are regulated by the Companies SHAREHOLDERS to participate with the other
Acts which confer rights as well as apply directors in the running of a COMPANY. A
restrictions. The basic feature of a joint director may be concerned solely with the
stock company is that it is a 'legal person', shared responsibility for general policy, or
entirely separate from the individual share- may have additional specialized responsibili-
holders, and able to act - for example, make ties with respect to a particular branch of the
contracts, undertake legal proceedings - in firm's activities as, for example, with
its own right. Most companies are 'LIMITED MARKETING.
comparative dynamics 71
Company Savings. That part of firms' PRO- Portugal has an absolute advantage in the
FITS which is neither paid out in TAXES nor production of both commodities since the
distributed to shareholders as DIVIDENDS. input requirements for both commodities
(See also SAVINGS.) are less than those of England. Portugal has
a comparative cost advantage in wine for the
comparability. Formal and informal com- ratio of Portuguese to English costs is
parisons drawn by work groups between 80:120, which is less than the ratio of 90:100
their pay and the pay of other workers. Such in cloth. If Portugal specializes in accord-
comparisons influence the wage determi- ance with her comparative cost advantage,
nation process. Formal comparisons are for every yard of cloth she ceases to produce
those embodied in the procedures for deter- she can have one and one-eighth gallons of
mining pay, for example the rates of pay of wine, for both embody 90 labour hours. If,
civil servants are established after detailed as Ricardo postulates, the exchange rate
enquiries into the pay of individuals per- after trade between cloth and wine is 1 to 1,
forming similar work in the private sector of then Portugal can exchange her one and
the economy. Informal comparisons are one-eighth gallons of wine to obtain one and
those used as points of reference by either one-eighth yards of cloth; with 90 labour
employers and employees but which are not hours Portugal can have 1 yard of cloth pro-
recognized simultaneously by both parties as duced by herself or one and one-eighth in-
serving as a suitable frame of reference for directly. Despite her absolute inferiority
establishing pay. (See RELATIVE DEPRIVATION, England can simultaneously gain from trade.
COERCIVE COMPARISONS.) For every gallon of wine, which England
ceases to produce, 120 hours of labour will
be set free to make one and one-fifth yards
comparability argument. The belief that of cloth, which by international exchange
workers doing similar jobs and producing can be converted to one and one-fifth gallons
the same amounts should be paid the same of wine. A situation of equal advantage,
wage. where one country is superior to another in
the same ratio in all products, precludes the
comparable worth. Equal pay for work of possibility of gains.
equal value. Designed to remove wage dis- Modern theory, no longer reliant on
crimination that arises where women are RICARDO'S labour theory, has established that
crowded in to low paying predominantly 'fe- the only necessary condition for the possi-
male' jobs, this concept proposes to pay bility of GAINS FROM TRADE is that price ratios
women according to the intrinsic value of should differ between countries.
their jobs. This value is to be established by The post-trade exchange rate between the
observing the pay of equally qualified males commodities, whose determination Ricardo
in other similar jobs. could not explain, is established by the LAW
OF RECIPROCAL DEMAND.
comparative advantage. Credit for the dis-
covery of the doctrine of comparative advan-
comparative costs.
tage, which is the basis of the case for
See COMPARATIVE ADVANTAGE.
SPECIALIZATION on the part of nations or indi-
viduals and for freedom of trade, is given to
David RICARDO who explained the principle comparative dynamics. A method
by means of the following example. employed in DYNAMIC ECONOMICS with a
special feature that the rates of change in the
values of the PARAMETERS and in the equilib-
Labour hours required to rium values of the VARIABLES are constant.
produce Comparative dynamics compares equilib-
rium values of the ENDOGENOUS VARIABLES
1 gallon 1 yard
wine cloth for different rates of change for one of the
Portugal
parameters. The economic models within
80 90
England 120 100
which this method is employed are often
referred to as steady state models.
72 comparative statics
comparative statics. The comparison of a off than they were before the change. The
new EQUILIBRIUM position with an old one compensation is hypothetical and not
after some change in the variables, without required to take place. The best known of
reference to the way in which the new pos- such tests is the KALDOR-HICKS TEST.
ition is reached, and usually without quanti-
tative aspects. Simply, the determination of Competition Act 1980. This legislation
the direction in which variables will change emphasized the importance in competition
consequent upon some disturbance to the policy of business conditions and practices.
original equilibrium. It empowered the Director General of Fair
Trading to undertake preliminary investi-
compensated demand curves. A DEMAND gations (subject to the approval of the rel-
CURVE in which the INCOME EFFECT of a price evant Secretary of State) into anti-
change has been removed so that along the competitive practices (in both private and
demand curve real income is held constant. NATIONALIZED INDUSTRIES), defined as busi-
The demand curve then exhibits the shape it ness conditions which may restrict, distort or
does because of the SUBSTITUTION EFFECT prevent competition. The findings of these
Only. T h e MARSHALLIAN DEMAND CURVE in- investigations must be published. In re-
cludes both income and substitution effects. sponse to these findings the Director
The method of taking the income effect out General of Fair Trading can accept an
depends on how that effect is measured. The undertaking from the firm(s) involved to
two procedures are those of HICKS and modify or drop the business practices in
SLUTSKY (see INCOME EFFECT, SUBSTITUTION question. Alternatively, the Director
EFFECT.) For normal goods, the compensated General can (with the approval of the
demand curve will be steeper in slope than Secretary of State) make a reference to the
the Marshallian curve. Monopolies and Mergers Commission.
These references are known as 'competition
references'. The commission has six months
compensating variation. to report on whether the practices, if con-
See CONSUMER'S SURPLUS. firmed, operate against the public interest.
The Secretary of State can prohibit the prac-
compensation principle. tices in the event of an adverse finding. (See
See COMPENSATION TESTS.
RESTRICTIVE TRADE PRACTICES ACT 1 9 5 6 , MONO-
POLIES AND MERGERS ACT I 9 6 5 , RESTRICTIVE
compensation rules. A formula for deter- TRADE PRACTICES ACT 1 9 6 8 , FAIR TRADING ACT
mining an individual's income. There are 1 9 7 3 , COMPETITION ACT I 9 8 0 . )
four principal categories of these. First,
compensation based on the time an indi- Competition and Credit Control. The title
vidual works. These are called time rates. of a consultative document issued by the
Second, compensation based on an indi- BANK OF ENGLAND in mid-1971, outlining
vidual's performance. When performance is proposals for a major revision of the credit
measured by the amount produced, such control arrangements applying to the BANKS
payments are known as PIECE RATES, and and other financial institutions, and which
when measured by the value of sales they are were put into operation later that year. The
known as commissions or ROYALTIES. Third, essence of the changes was that they should
compensation may be based on team per- permit an ending of quantitative controls
formance as in profit sharing schemes or over lending, especially that of the CLEARING
group bonus schemes. Finally compensation BANKS; and that they should apply to the
may be based on an individual's comparative banks and FINANCE HOUSES in as wide and
performance as with a RANK TOURNAMENT non-discriminatory a fashion as possible.
COMPENSATION RULE. The requirement of the London and Scottish
clearing banks to maintain certain minimum
compensation tests. Such tests ask the LIQUIDITY RATIOS was ended; instead all
question whether the losers from some par- banks operating in the UK, as well as the
ticular change can be compensated for their larger finance houses, were required to ob-
losses while still leaving the gainers better serve a minimum RESERVES ASSETS RATIO
compound interest 73
At the end of year t, the investment will have used as a 'base' (e.g. population). A value of
a value of zero would indicate a spread of the activity
which corresponded exactly to that of popu-
£ (1 + r)'.
lation, while the greater the value of the co-
efficient the greater the degree of geographi-
concave function (concavity). A function cal concentration of the activity. (See also
which is concave towards the origin, and LOCATION QUOTIENT, SPECIALIZATION, COEF-
therefore, one whose second DERIVATIVE is FICIENT OF.)
negative. Such a function is also CONVEX
away from the origin. concentration ratio. The percentage of
total industry size accounted for by the few
concentration. largest firms in the industry. The measure
1. A term indicating the state of competi- may be used as a proxy for one dimension of
tive conditions prevailing in an industry. market structure, i.e. the degree to which an
Two extremes are PERFECT COMPETITION and industry is centralized. (See STANDARD
MONOPOLY with market structures in between INDUSTRIAL CLASSIFICATION.)
representing various degrees of imperfect
competition. Conventionally, it is thought concerted action. The name given to the
that the higher seller concentration is, the German variant of INCOMES POLICY in which
less competitive the market. the government, although not a party to the
2. A concept used either in connection COLLECTIVE BARGAINING process, sets out cri-
with the SIZE DISTRIBUTION OF FIRMS in an teria for relating pay increases to the aims of
industry or economy, or with reference to stability and growth. Since 1967, representa-
the location of industry. In its former use tives of the German employers, trade
concentration refers to the extent to which a unions, government and other official bodies
market's or an economy's total output is (including the Bundesbank and the Council
accounted for by the few largest member of Economic Advisers) have met several
firms. When used in the context of industrial times a year to discuss the government's
location, concentration means the degree to economic forecasts and analyses. The inten-
which an industry has become localized tion of such concerted action has been to
within a particular area. (See also CONCEN- provide an opportunity for the co-ordination
TRATION RATIO, LORENZ CURVE, HERFINDAHL of private decisions and official policy, and
INDEX.) on occasions the government has quite expli-
citly given its view of the consequences of
concentration, coefficient of. A statistical alternative actions.
measure of the degree to which an economic
activity or feature is geographically concen- concertina method of tariff reduction. A
trated within (say) a nation. The coefficient procedure of TARIFF reduction, which in-
of concentration of an industry may be cal- volves cutting the higher tariff rates, while
culated as the relation between the distri- leaving lower rates unchanged, so that the
bution of that industry across the regions of gap between tariffs is diminished. (See
the nation and the distribution of some other ACROSS-THE-BOARD TARIFF CHANGES.)
characteristic - for example population. If
the pattern of location of the industry is conciliation. Intervention in an INDUS-
greatly different from that of the population TRIAL DISPUTE at the request of the parties to
we would regard the industry as being the dispute by an independent and impartial
spatially concentrated. The formula for the third party in an attempt to reconcile the
coefficient is views of the two parties. (See also MEDIA-
TION, ARBITRATION.)
2 Л Paj-PiA
(where the vertical lines indicate absolute Condorcet Criterion. A system of COLLEC-
values) where Paj is the percentage of the TIVE CHOICE in which the chosen alternative is
activity (a) under analysis located in region j that which defeats all other alternatives in a
and Pij is region ;'s percentage share of the series of pairwise (one to one) contests using
characteristic, /, majority rule. The procedure is named after
confidence problem 75
congestion costs. When an increase in the consistent estimator if there are no econo-
use of a facility or service which is used by a metric problems.
number of people would impose a cost (not
necessarily a monetary cost) on the existing consolidated fund. Another term for the
users, that facility is said to be 'congested'. UK EXCHEQUER which is the government's
Thus, for example, if an increase in the account into which money collected as taxes
number of vehicles using a road lengthens is paid. The government then makes its
journey times then congestion occurs. expenditures according to the BUDGET from
Alternatively, if an increase in the number this account. The servicing for the NATIONAL
of economic activities located in a geo- DEBT is paid out of this fund and constitutes
graphical area reduces the efficiency of those one of the consolidated fund standing ser-
activities then the area gets congested. In the vices which does not have to be agreed by
latter case congestion represents a diseco- the UK Parliament as part of the budget.
nomy of agglomeration. Costs imposed by
congestion are important in such areas as
COST-BENEFIT ANALYSIS (especially of projects consols. Today this term denotes 2.5 per
involving transport), the explanation of the cent Consolidated Stock, a GILT-EDGED
actual pattern of economic activity and in security issued in a conversion and consoli-
the analysis of jointly consumed goods by dation operation in 1888. But the name is
the theory of CLUBS. (See also AGGLOME- much older than that, going back to the mid
RATION ECONOMIES.) eighteenth century and the introduction of 3
per cent Consolidated Bank Annuities, a
conglomerate. A firm comprising a HOLD- security issued in considerable amounts to
ING COMPANY and a diverse group of subsidi- raise money down to 1815, and issued after
that mainly in conversion operations for
ary companies which are generally unrelated
other stocks. By 1914 the great part of the
in their activities and markets. Conglomer-
NATIONAL DEBT was in consols, now the 2.5
ates are typically built up by MERGERS and
per cent issue, and it formed the largest
TAKE-OVERS, and the rationale for their for-
single stock traded on the stock market.
mation is the reduction of risk through the
Because of their security as government
consolidation into one group of a diverse debt, and the ease with which they could be
range of enterprises. But some conglomer- sold in a very active market, they enjoyed an
ates have resulted from the flair of particular unequalled reputation as a safe asset of high
ENTREPRENEURS for taking over firms with LIQUIDITY (banks held them as liquid re-
underused assets, or which are otherwise serves). In 1888 the stock was issued as
underperforming. redeemable 'on or after 1923' which effec-
tively makes them an UNDATED security. The
conjectural behaviour. growth of the national debt in two World
See CONJECTURAL VARIATION. Wars, and since 1945, and the fact that in
recent decades it has been possible to issue
conjectural variation. Refers to firm be- only DATED debt has reduced consols to a
haviour in OLIGOPOLISTIC MARKETS where, tiny element within the national debt.
due to the small number of active firms, the
decision-maker must before deciding upon
appropriate strategies take into account consortium bank. A type of international
rivals' potential responses. One of the appli- bank formed by groupings of existing banks
cations of GAME THEORY in economics has usually drawn from different countries.
been the analysis of firm behaviour under These banks appeared in the 1960s and are
such conditions. (See also OLIGOPOLY.) now established in several financial centres,
including London. They engage to a con-
consistency. A desirable property of eco- siderable extent in medium-term lending,
nometric estimators. A consistent ESTIMATOR frequently to multinational companies; they
is one whose mean tends to the true value of obtain the greater part of their funds in
the PARAMETER, and whose variance tends to the EUROCURRENCY MARKET; but they also
zero as the sample size becomes very large. arrange 'syndicated' loans (i.e. loans raised
T h e ORDINARY LEAST SQUARES ESTIMATOR is a among a group of lenders) frequently bring-
consumer demand theory 77
n
ing i lenders outside the consortium mem- TION where the CHOICE VARIABLES are subject
bers. (SeeuBOR.) to some CONSTRAINT. Examples include the
maximization of UTILITY subject to a BUDGET
conspicuous consumption. CONSTRAINT. Mathematical methods to deal
See VEBLEN. with this sort of problem include LAGRAN-
GEAN TECHNIQUES. (See also LINEAR PROGRAM-
constant amplitude. A characteristic of MING.)
the TRADE CYCLE, where the AMPLITUDE does
not change with time. This implies that the
system being considered lies between one constraint. Usually, a mathematical re-
with an EXPLOSIVE CYCLE and one with a lationship between the CHOICE VARIABLES of
DAMPED cycle. an optimization problem, in which some
function of the variable (e.g. a LINEAR FUNC-
constant capital. In the Marxian scheme, TION) is not equal to a constant. An example
that part of CAPITAL which is represented by is a budget constraint on the maximization of
the means of production, raw materials and UTILITY. (See also LINEAR PROGRAMMING.)
instruments of labour. It is defined as con-
stant since it can add no more to the value of consumer. Any economic agent respon-
output than its own value, value being de- sible for the act of consuming final goods and
fined as hours of embodied SOCIALLY NECESS- services. Typically, the consumer is thought
ARY LABOUR. (See VARIABLE CAPITAL.) of as an individual but in practice consumers
will consist of institutions, individuals and
Constant Elasticity of Substitution (CES) groups of individuals. In the last respect, it is
production function. The CES production noteworthy that the consuming agent for
function is a LINEARLY HOMOGENEOUS PRO- many decisions is the household and not the
DUCTION FUNCTION with a constant ELASTICITY individual. This matters in so far as house-
OF INPUT SUBSTITUTION. This elasticity can holds may well take 'group' decisions based
take on values other than unity. The actual on some compromise of individual wants
form of the CES production function is: within the household, or, even more likely,
Q = A [aK~b + (1 - c) L-h]~Vh on paternalistic judgements by older mem-
bers of the household. Consumer demand
where Q is output, К and L are capital and may therefore be partly considered in the
labour, and a,b,с are constants. It was first context of group decisions reflecting some
introduced by K.J. ARROW, H.B. Chenery, SOCIAL WELFARE FUNCTION which covers all
B.S. Minhas and R.M. SOLOW, in 'Capital- members of the household.
Labor Substitution and Economic
Efficiency', Review of Economic Studies,
1961. consumer credit. A general term denoting
lending to CONSUMERS to finance the pur-
constant market share demand curve. chase of goods and services, but usually ex-
The relation between quantity sold and price cluding house purchase finance. Such
which faces the firm if all its competitors lending may be of money untied to the pur-
exactly match any price change made by this chase of any specific good, or it may be
firm. It is therefore more inelastic than the finance converted with specified goods as in
HIRE PURCHASE ОГ CHARGE ACCOUNT C r e d i t .
conventional DEMAND CURVE, as each point
will represent an equal share of the market.
This concept has been used analytically in consumer demand theory. That area of
the KINKED CURVE model of oligopoly and the economics which defines testable theories of
theory of MONOPOLISTIC COMPETITION. (See how consumers behave in response to
ELASTICITY.) changes in variables such as price, other
prices, income changes and so on. The two
constant returns to scale. main schools of thought are those based on
See ECONOMIES OF SCALE, RETURNS TO SCALE. INDIFFERENCE CURVE a n a l y s i s a n d REVEALED
PREFERENCE THEORY, but considerable atten-
constrained optimization. The maximiz- tion has also been given to the theories
a
tion or minimization of an OBJECTIVE FUNC- based on the CHARACTERISTICS of goods.
78 consumer durable
consumer durable. Any consumer good consumer goods and services. Tangible
which has a significant 'life' and which is not and intangible COMMODITIES which are con-
therefore immediately consumed (like sumed for their own sake to satisfy current
food). Consumer durables have some wants.
characteristics of capital goods in that they
tend to yield a flow of services over their consumer price index.
lifetime rather than one immediate 'service' See RETAIL PRICE INDEX.
in one act of consumption. Nonetheless, the
dividing line between consumer goods, con- consumer sovereignty. The idea that the
sumer durables and capital goods is a hazy CONSUMER is the best judge of his or her own
one in practice. welfare. This assumption underlies the
theory of consumer behaviour and through it
consumer equilibrium. The situation in the bulk of economic analysis including the
which the consumer maximizes UTILITY sub- most widely accepted optimum in WELFARE
ECONOMICS, the PARETO OPTIMUM. The notion
ject to a given BUDGET CONSTRAINT. In terms
is, however, challenged in that governments
do provide MERIT GOODS, while ADVERTISING
is held, especially by J.K. GALBRAITH, to dis-
Good Y tort consumers' preferences.
theoretically precise there are practical 2. The variables С and Y can either be
problems in measuring consumption. The measured in current pounds or dollars or
Jnain problem arises in the treatment of CON- they can be DEFLATED by the CONSUMER PRICE
SUMER DURABLES. If they are included they INDEX to transform them into real terms;
overstate current consumption expenditure; 3. Aggregate, per capita, or even house-
if excluded they understate them. Ideally we hold values for С and У can be chosen. See
wish to include only the value of the flow of Speight, A.E.H., Consumption, Rational
the services of the consumer durables that Expectations and Liquidity, Harvester
are consumed in each period. (See CONSUMP- Wheatsheaf, L o n d o n (1990). (See also MAR-
TION FUNCTION.) GINAL PROPENSITY TO CONSUME, AVERAGE PRO-
PENSITY TO CONSUME.)
consumption expenditure. Aggregate
expenditures on goods and services to satisfy consumption tax. The taxation can take
current wants. (See CONSUMPTION.) two forms; one where the consumer himself
is taxed as with an EXPENDITURE TAX, and
consumption function. The schedule another where the goods or services which
detailing the relationship between aggregate the consumer purchases are taxed. In the
CONSUMPTION EXPENDITURES and INCOME, former case the tax is imposed on the firm
that is С = C(Y). Consumption expenditure supplying the good or service.
may be related to either NATIONAL INCOME or
DISPOSABLE INCOME. This functional relation- contestable market. A MARKET where
ship is one of the cornerstones of KEYNES' there is freedom of entry and exist is cost-
general theory, as consumption is the largest less. Potential entrants can enter such mar-
single component of AGGREGATE EXPENDI- kets whenever profits exceed the normal
TURE in most developed countries. Keynes rate. Oligopolistic markets can thus be con-
initial developments have come to be known testable. Costless exit implies SUNK COSTS are
as the ABSOLUTE INCOME HYPOTHESIS but zero. Such markets are subject to 'hit-and-
more recent developments have explained run' entry and exit, and firms will produce
aggregate consumption expenditures in where price equals marginal cost and mar-
terms of relative income, the RELATIVE ginal cost equals average cost. See Baumol,
INCOME HYPOTHESIS, life-cycle income, the W.J., Panzar, J.C. and Willig, R.D.,
LIFE-CYCLE HYPOTHESIS, permanent income, Contestable Markets and the Theory of
the PERMANENT INCOME HYPOTHESIS and re- Industrial Structure, Harcourt Brace
lated it specifically to wealth, the ENDO- Jovanovich (1982).
GENOUS INCOME HYPOTHESIS. Considerable
controversy surrounds the actual specifi- contingency reserve. The unallocated re-
cation of the consumption function. Empiri- serve for contingencies and other require-
cal studies have by and large revealed that ments which cannot be quantified when UK
the SHORT-RUN CONSUMPTION FUNCTION and public expenditure plans are being con-
CROSS-SECTION CONSUMPTION FUNCTION СОП- sidered. Formerly, only expenditure de-
firm Keynes' absolute income hypothesis. In cisions increasing the volume of expenditure
contrast evidence on the LONG-RUN CON- were charged against the reserve. However,
SUMPTION FUNCTION suggests a quite different in line with the move to cash planning,
form. Hence all of the above theories, which approved increases in cash limits have been
post-date Keynes' pioneering work, have charged to the contingency reserve since
sought to reconcile the conflicting evidence. 1981-2.
Further problems abound with empirical
work in this area and at present there exists contingency table. A device whereby the
no consensus for dealing with these. degree of association or dependence be-
Principal among the problems are: tween two variables or characteristics can be
1. In practice it is difficult to measure assessed. Sample information is compared to
consumption accurately, CONSUMER DUR- a theoretical situation in which there is com-
ABLES provide a flow of services beyond the plete independence between the character-
time of purchase and it is these services istics. A STATISTIC can be calculated from the
which should be included in consumption. table which is approximately CHI-SQUARE dis-
80 contingent valuation
tributed under the NULL HYPOTHESIS of in the late 1980s can be considered to have
independence. disproved the mechanism of convergence,
for while the convergence appears to be tak-
contingent valuation. Attempts to elicit ing place, it is in a general move to a capita-
consumer valuations of goods and services list form of organization.
which are not usually traded in markets.
Individuals are confronted with hypothetical convergent cycle.
choices and are asked either willingness to See DAMPED CYCLE.
pay or willingness to accept compensation
questions. This approach has been most conversion. The practice of issuing new
widely used in the area of environmental STOCKS and SHARES in exchange for others.
economics. For example, the government may offer new
stock to holders of existing stock at the time
continuous variable. A variable which can when it is due for redemption.
take on any value (i.e. which can vary with-
out interruption) between given limits (poss- convertibility. An attribute of a currency
ibly infinite). (See also DISCRETE VARIABLE.) which is freely exchangeable for another cur-
rency, or for gold. (See also EXCHANGE
RATES, GOLD STANDARD, EXCHANGE RESERVES,
contract curve. In the context of two con- GOLD RESERVES.)
sumers exchanging two goods the curve rep-
resents the locus of points where the convertible bond.
MARGINAL RATE OF SUBSTITUTION between the
See CONVERTIBLE SECURITY.
pair of goods is the same for both indi-
viduals. These points of tangency between
convertible loan stock.
the individuals' INDIFFERENCE CURVES are
See FINANCIAL CAPITAL.
efficient or exchange optima in the sense
that it is not possible by any reallocation to
convertible security. A security, that is a
make one individual better off without the
claim on the issuer, which is convertible into
other becoming worse off.
something else, including cash. The term is
In the production case the contract curve most commonly met in the form of 'convert-
represents the points of tangency between ible stock' or 'convertible debentures',
ISOQUANTS and thus is the locus of points for which are fixed interest securities that are
which the MARGINAL RATE OF TECHNICAL SUB- convertible into another type of holding,
STITUTION is the same for the production of usually EQUITIES, on specified dates and
each good or in the one good for each firm. terms.
(See EDGEWORTH BOX.)
convex function (convexity). A function
contractionary phase. The phase of the which is convex to the origin and therefore is
TRADE CYCLE following a PEAK and lasting to one whose second DERIVATIVE is positive.
the next lower turning point or trough. It Such a function is also CONCAVE away from
marks a decline in the level of economic the origin.
activity.
cooling off period. A period of legally
convergence thesis. The idea that socialist enforced delay before STRIKE activity can
and capitalist economies are departing from commence so as to permit a de-escalation or
their respective 'ideal' forms and are evolv- cooling off of emotions and thus, it is
ing increasingly similar modes of behaviour assumed, a more rational evaluation of mat-
and thinking, institutions and methods. The ters in dispute. In the US, the TAFT-HARTLEY
hypothesis that the two systems are converg- ACT makes a postponement of up to 80 days
ing was originally put forward by Jan TINBER- possible for a strike judged likely to threaten
GEN and has developed into a theory of national health and safety. Moreover,
inevitable convergence based on the neces- strikes require 60 days' notice if contem-
sity of similar patterns of technological plated during the currency of a collective
development. The events in Eastern Europe agreement. In the UK, an attempt was made
corporation tax 81
to institute similar procedures under the ill- adopted instead a widespread sense of res-
fated Industrial Relations Act. ponsibility to the general public. Corporate
conscience is a term used to represent this
co-ordinated wage policy. The co- development in managerial behaviour. {See
ordination by employers and unions of the also CORPORATE CAPITALISM.)
timing of, respectively, their wage offers and
wage claims. This type of collective bargain- corporate risk. The total risk involved in a
ing arrangement has been suggested to elim- business can be defined as corporate risk.
inate the wage and price inflation which This comprises two main types of risk: finan-
results when each group of workers tries to cial risk which arises out of DEBT FINANCE,
'leap-frog' - to gain a higher wage award and business risk which is the basic risk in-
_ its predecessor in the WAGE ROUND. volved in the firm's day to day operations.
Vlx2 VXy2
This system does not contain nearly such a where л: and v are the deviations from the
big incentive to retain profits as was the case means of the two variables respectively. This
with the so-called 'classical' system which coefficient can take on values between plus
existed in the UK from 1965 to 1973. Under and minus unity. A value of —1 indicates a
this scheme if pre-tax profits of £100 were perfect negative relationship, +1 indicates a
made, corporation tax at 33 per cent left £67 perfect positive relationship, and zero indi-
which could then be retained and reinvested. cates no relationship. Values in between the
If a distribution were desired, £67 became extremes indicate the strength of relation-
the gross dividend which was taxable at a ship. Note that this will only reflect the
shareholder's marginal rate. Thus a net dis- degree to which variables are linearly re-
tribution of £50.25 would be made to a stan- lated. For instance, two variables may be
dard rate shareholder. There is thus a perfectly related in a non linear way (e.g. У
considerable discrimination against distrib- = x2) and still result in a low value of r. (See
also RANK CORRELATION.)
uted profits in this scheme.
A debate took place in the 1960s and early correlogram. Normally, a graphical plot of
1970s concerning the advantages and dis- the CORRELATION COEFFICIENT between the
advantages of this form of discrimination. current value of a variable and its own
cost-benefit analysis 83
lagged values, against the length of the lag. cost-benefit analysis. A conceptual frame-
The correiogram can give valuable infor- work for the evaluation of investment proj-
mation about, for instance, the character- ects in the government sector, although it
istics of SERIAL CORRELATION characteristics can be extended to any private sector proj-
of the RESIDUALS in REGRESSION analysis. ect. It differs from a straightforward finan-
cial appraisal in that it considers all gains
correspondent banks. A BANK which acts (benefits) and losses (costs) regardless of to
as agent for another bank in a place where whom they accrue (although usually con-
the latter has no office, or for some reason is fined to the inhabitants of one nation). A
unable to conduct certain operations for benefit is then any gain in UTILITY and a cost
itself. Examples of business conducted by a is any loss of utility as measured by the
correspondent include paying cheques and OPPORTUNITY COST of the project in question.
bills drawn OP the 'client bank', or obtaining In practice, many benefits (which may be
payment of them for that bank. All banks positive or negative) will not be capable of
with overseas business require correspon- quantification in money terms (e.g. loss of
dent banks abroad, and the arrangements wildlife, destruction of natural beauty, des-
are usually reciprocal with each party main- truction of community ties etc.) while the
taining balances with the other (in 'nostro' costs will be measured in terms of the actual
or 'vostro' accounts). However, in non- money costs of the project. Where money
concentrated banking systems, such as the measures are secured, however, they should
US system, banks require correspondents in be corrected for any divergence between the
places within their own country. In some SHADOW PRICE and the market price if poss-
systems and conditions a bank's balances ible. Strictly pursued, cost-benefit analysis
with its correspondents may go beyond day- would value all outputs and inputs at their
to-day business needs and include an ele- shadow prices. Similarly, where inputs and
ment of reserves. Historically, in some sterl- outputs have no observable market (e.g.
ing area banking systems, balances held with clean air, quietness) it is necessary to dis-
London correspondents effectively formed cover what the price would have been had a
part of the country's external reserves. market existed. This involves the construc-
tion of models of 'surrogate markets' in
which shadow prices may be derived. An
'corset'. The market colloquialism for the example would be the difference between
SUPPLEMENTARY SPECIAL DEPOSITS require- the price of a house in a quiet area and the
ment, introduced in 1973 to strengthen the price in a noisy area. This differential can
BANK OF ENGLAND'S control over the volume then be thought of as a first approximation
of bank deposits. It was discontinued in June of the 'price' of peace and quiet, although in
1980. (See COMPETITION AND CREDIT CON- practice there are formidable problems in
TROL.) making this translation. Cost-benefit analy-
sis should also be 'timeless' in that all costs
cost. In general, a measure of what must and benefits which occur and which are due
be given up in order to obtain something to the project in question must be counted
whether by way of purchase, exchange or regardless of when they occur. In practice,
production. Economists usually employ the future costs and benefits may not get
concept of OPPORTUNITY COST which measures counted if the DISCOUNT RATE is relatively
costs as the value of all of the things which high. That is, £1 in 50 years' time will have a
must be foregone, lost or given up in obtain- very low PRESENT VALUE if the discount rate
ing something. The opportunity cost is positive and, say, 5 per cent or 10 per cent.
measure may, but will not always, coincide Cost benefit practitioners therefore tend to
with the money outlays which an accountant ignore any costs and benefits which occur at
would measure as cost. We should also note far distant dates in the future. Others argue
that economists sometimes distinguish be- that the only 'just' discount rate for cost-
tween the private costs of a good or activity benefit purposes is zero since this treats all
to the consumer or producer and the costs generations as equals instead of downgrad-
known as SOCIAL COSTS imposed on the com- ing the gains and losses to future gener-
munity as a whole. ations. The discount rate used should be the
84 cost-effectiveness analysis
cost-inflation.
See COST-PUSH INFLATION. cost minimization
cost-push inflation 85
minimization, cost minimization does not PRESENT VALUE from new projects and is
ecessarily imply profit maximization. For compared with the internal RATE OF RETURN
nstance, a sales revenue maximizing firm from projects. (See CAPITAL STRUCTURE.) See
will choose input combinations which mini- Bromwich, M., The Economics of Capital
mize total cost so as to generate the maxi- Budgeting, Penguin, Harmondsworth
mum possible sales revenue from any given (1976).
c o st outlay. (See EXPANSION PATH.)
cost of living.
See RETAIL PRICE INDEX.
cost of capital. The cost, measured as a
percentage rate, of the various sources of
CAPITAL required to finance CAPITAL EXPENDI- costs of protection. The protection of
TURE. All sources of capital have a cost domestic industry by TARIFF, QUOTA or other
which can be a direct one as, say, with a loan restriction normally imposes a cost on the
or an OPPORTUNITY COST as, say, with retained protected economy in the two forms of a
earnings. At any time a company's cost of misallocation of resources in production and
capital will be the weighted average of the a distortion in the pattern of consumption.
cost of each type of capital. The weight is The former involves a reduced MARGINAL
determined by the ratio of the value of each REVENUE PRODUCT from FACTORS OF PRO-
type to the total value of reserves and all DUCTION and the latter a loss of CONSUMERS'
securities issued by the company. These SURPLUS.
would include all ordinary shares, prefer-
ence shares and long-term debt. The
cost-plus pricing. A pricing practice
weighted costs are simply added together.
The cost of raising new capital is the mar- whereby firms add a margin on to AVERAGE
VARIABLE COST in order to cover FIXED COSTS
ginal cost of capital. The cost of ORDINARY
SHARES is related directly to the rate of re- and some reasonable level of profits. (See
FULL COST PRICING, AVERAGE COST PRICING.)
turn that the ordinary shareholders require
before they will hold shares in the organiz-
ation. This expected return, when capital- cost-push inflation. A sustained rise in the
ized, must exceed the current market price. general price level arising from an auton-
The cost of ordinary shares is often stated as omous rise in costs. This may result from
dividend per share/market price per share + either an autonomous decision by employees
growth rate of dividend. The cost of PREFER- to demand higher REAL WAGES or by
ENCE SHARES is equal to the fixed dividend employers to raise their PROFIT MARGINS or it
rate. Dividends on both ordinary shares and may result from an autonomous increase in
preference shares are generally paid out of IMPORT prices. Such events may be illustrated
earnings after tax and so the cost of these is by an upward shift in the AGGREGATE SUPPLY
on an after tax basis. The cost of retained CURVE. However a MONETARIST would argue
earnings is an opportunity cost which is that these events will result in inflation only
argued by some to equal the rate of return if they are accompanied by an accommodat-
which shareholders could earn if the re- ing increase in the nominal MONEY SUPPLY
sources were distributed. Another view is which shifts the AGGREGATE DEMAND CURVE
that if the reserves were not there the com- out to the right. In the absence of such an
pany would have to raise new equity. Then increase in the money supply monetarists
the cost would be equal to the cost of ordin- would argue that autonomous cost-push
ary shares. The cost of debt capital is the would result in deflation. Extreme KEYNE-
effective interest charged. Interest is an SIANS would deny that monetary policy could
allowable expense and so it is the after tax exert such a restraining influence on cost-
rate payable which is relevant here. push pressures while moderate Keynesians
Companies have a choice in the CAPITAL would emphasize that the money supply
STRUCTURE which they adopt and will gener- plays a largely passive role and expands to
ally try to minimize the overall cost of capital accommodate these pressures. (See also
in making their choice. The cost of capital is
DEMAND-PULL INFLATION, the WAGE-WAGE
used as the discount rate to find the NET
SPIRAL.)
86 cost-utility analysis
institutions. They may take the form of OPEN units being used, the measure is expressed
MARKET OPERATIONS and movements of as:
JNTEREST RATES without any direct inter-
Cross Elasticity of Demand =
ference with the operations of financial insti-
tutions. Alternatively, banks and other
institutions may be required to observe 100 \ + 100 =
Qt
specified limits or criteria in their lending
business. (See COMPETITION AND CREDIT
where Qt is the quantity of good /, and P, is
CONTROL.) the price of another good j. The symbol A
refers to a change in the variable in question.
credit squeeze. A policy phase of CREDIT Where goods / and j are SUBSTITUTES the
RESTRICTIONS. (See MONETARY POLICY, OPEN cross elasticity will be positive - i.e. a fall in
MARKET OPERATIONS.) the price of good / will result in a fall in the
demand for good / as ; is substituted for i. If
credit transfer. The system by which funds the goods are COMPLEMENTS the cross elas-
can be transferred directly through the bank- ticity will be negative. Where / and/ are not
ing system to the account of a specified related, the cross elasticity will be zero.
recipient. Such a transfer may be initiated cross-entry. A concept used with regard to
simply by anybody, whether a customer or new entrant firms which are already estab-
not, paying money into a bank office with lished in industries using similar technology
the necessary credit slip. A large number of to that in which entry is now taking place.
credit transfers are made under regular
'standing orders', by payments from the cross partial derivative. The DERIVATIVE of
transferors' accounts. As a mode of payment a function first taken with respect to one
the credit transfer is an alternative to the INDEPENDENT VARIABLE, and then with re-
CHEQUE, and of comparatively recent growth spect to another. For example in
in the UK. It has a longer history on the
continent where it has been operated by GIRO Y = f(X,Z).
banks. (See CLEARING.) the cross partial derivative is
djdYldX)
creeping inflation. A slow, but continuous fxz = dZ
INFLATION, which can result inter alia from
In general, it makes no difference with re-
increases in AGGREGATE DEMAND. (See
spect to which of the independent variables
DEMAND-PULL INFLATION, COST-PUSH INFLA-
TION.)
the derivative is taken first.
cross-sectional analysis. Analysis of a set
critical value. The a per cent critical value of data involving observations taken at one
of a probability distribution is that value point in time. For example, cross section
above (or below) which only a per cent of data on income would involve observations
the probability lies. Thus there is only a 0.05 on say the incomes of different households
probability that a Standard Normal Variable in a country or the NATIONAL INCOMES of a set
will take on values above the 5 per cent of countries in a given year. (See also TIME
critical value of the Standard NORMAL DISTRI- SERIES.)
BUTION (in this case, 1.65). This concept is
cross-section consumption function. The
usually used to define acceptance criteria for
functional relationship between consump-
statistical tests, and in the calculation of con-
tion and income measured across different
ndence intervals. (See also HYPOTHESIS TEST-
IN income groups at a point in time. These
G , STATISTICAL INFERENCE.)
findings reported a positive association be-
tween income and consumption and found:
c
ross elasticity of demand. The respon- 1. 0 < MARGINAL PROPENSITY TO CONSUME
siveness of quantity demanded of one good < l;
r
° a change in the price of another good. To 2. Marginal propensity to consume <
v
°id the measure being sensitive to the AVERAGE PROPENSITY то CONSUME and there-
92 cross-subsidization
British monetary policy in the first half of the current assets. There are three main com-
nineteenth century. They believed firmly in ponents of current assets. The first is stocks,
the CURRENCY PRINCIPLE and were active in including finished goods, work-in-progress,
promoting Peel's Bank Charter Act of 1844 and raw materials. The valuation of stocks is
and the Acts of 1845 which applied corre- a difficult and sometimes contentious mat-
sponding regulations to the note issuing ter. The second item is accounts receivable
powers of the Scottish and Irish banks. The or short-term debtors. The main problem
group were strongly opposed by the adher- under this heading concerns the estimation
ents of the BANKING SCHOOL. (See MONETARY of bad debts. The third element is cash and
POLICY.) short-term investments. The size of current
assets, particularly in relation to other finan-
cial indicators in the form of FINANCIAL
currency substitution. The practice in an
RATIOS, is a main indicator of the liquidity of
era of convertible currencies of changing the
the company. (See WORKING CAPITAL RATIO.)
composition of international monetary hold-
ings with a view to making gains or avoiding
losses from expected changes in CURRENCY current cost accounting.
values. Such switches may be undertaken by See INFLATION ACCOUNTING.
e.g. speculators or by MULTINATIONAL COR-
PORATIONS simply trying to avoid losses from current income.
changes in currency values. See PERMANENT INCOME HYPOTHESIS.
Currency substitution has important
consequences for national demand functions current liabilities. This is a statement of a
for money, for apparent stability of the func- company's debts which have to be settled
tion can be upset by changing patterns in the within the subsequent year. It is the measure
international holding of domestic money. of a company's total short-term debt. The
This in turn has made it difficult for the debts may be for goods purchased, or for
MONETARY AUTHORITIES to achieve their tar- services received. They include credit obli-
get rates of growth for the MONEY SUPPLY. gations and interest payments. Their
Currency substitution also has the effect of amount, especially in relation to other finan-
breaking the link between rates of growth of cial indicators, give a picture of the LIQUIDITY
the domestic money supply and domestic position of a company.
inflation, so that if the monetarist prop-
osition of the connection between monetary current profits. That excess of revenue
growth and inflation holds, it must be con-
over total OPPORTUNITY COSTS which is earned
sidered to hold between the growth of world
during the current planning period of the
money supply and world inflation. (See
firm. (See PROFITS.)
MONETARISM, MONETARY POLICY.)
though on conventional standards the heavy excise duties on the sale of oil prod-
Amb in the market may be sufficient to ucts, tobacco and alcohol. Generally these
ensure reasonably competitive behaviour. taxes are specific, i.e. so much per unit sold,
Because 'shopping' is a costly process buyers but sometimes there is an AD VALOREM ele-
prefer doing business with customary sup- ment as well. As a member of the EC the
pliers, whilst the suppliers have an incentive UK has to admit goods from partner
to avoid actions that encourage customers to countries free of protective import duty and
go shopping. Cost-based MARK-UP pricing be- has to apply a common external tariff known
comes a convention, or a rule of fair play, as the COMMON CUSTOMS TARIFF to imports
that helps suppliers and customers to main- from non-members. There are concession-
tain the joint benefit of their interdependent ary agreements which reduce the burden of
relationship. These relationships create a this tariff. Thus many industrial goods are
zone of indeterminacy for prices and a need admitted duty-free from EUROPEAN FREE
for 'fair' formulas for the sharing of BILAT- TRADE ASSOCIATION (EFTA) countries.
ERAL MONOPOLY surpluses. They also leng- Under the GENERALIZED SYSTEM OF PREFER-
then the lags and weaken the causal ENCES a non-reciprocal system of tariff
connections between changes in demand and preferences is given for a wide range of
changes in prices. goods from developing countries by the EC
Similar arrangements are likely to be countries. Similarly, under the LOME CON-
found in labour markets, especially because VENTION free entry into the Community is
of the non-standardized nature of the labour provided for all industrial goods and many
input. These have been termed 'obligational agricultural products from the group of
markets'. African, Caribbean and Pacific (ACP)
countries associated with the EC. Protective
Customs Co-operative Council. A coun- customs duties collected in the UK do not
cil, established in 1950, which seeks to im- flow into the UK Treasury but are paid over
prove and harmonise customs operations. to the EC as part of that organization's 'own
The council is primarily a consultative body resources'. The funds constitute a share of
which prepares draft customs conventions, the revenue for the EC budget. Special
provides information regarding customs pro- arrangements apply to imports of agricul-
cedures and supervises the application of tural commodities. (See EC AGRICULTURAL
nomenclature and valuation conventions. In LEVIES.)
addition, the council, whose membership in-
cluded 85 countries in 1979, has extended
technical assistance to developing countries customs union. A grouping of countries
which are adjusting their tariffs in accord- within which trade restrictions are abolished
ance with the BRUSSELS TARIFF NOMENCLA- but which has a concerted commercial policy
TURE. (See CUSTOMS, EXCISE AND PROTECTIVE towards non-members and a COMMON EXTER-
DUTIES.) NAL TARIFF on imports from them, though
the tariff rate may vary between commodi-
customs, excise and protective duties. ties.
These are taxes imposed on the import or
sale of specific commodities. Traditionally cyclical unemployment. Short-run DE-
customs duties have related to imported MAND DEFICIENT UNEMPLOYMENT. The impli-
goods and excise duties to domestically pro- cation is that during certain phases of the
duced ones but the distinction is not rigid. BUSINESS CYCLE there will be insufficient jobs
The motives for imposing these charges are for the whole of the labour force no matter
generally (1) to raise revenue (2) to protect how it is trained or deployed.
domestic industries and (3) to give prefer-
ence to imports from certain countries (e.g.
less developed countries or EUROPEAN COM- cycling.
MUNITY (EC) partners). In the UK there are See PARADOX OF VOTING.
D
damage cost. The money cost of damage deadweight-loss. Commonly used with
done, usually confined to damage done by reference to that loss of consumer surplus
pollution. In economics, pollution is gener- incurred by buyers and not captured by pro-
ally regarded as an instance of an EXTERNA- ducers, which is consequent upon an initially
LITY. Placing money values on externalities is competitive industry becoming monopolistic
a complex and often dubious procedure as and therefore, CETERIS PARIBUS, charging a
with valuing injuries, death, loss of recrea- higher price and selling a lower level of
tional land, loss of wilderness, wildlife and output.
so on. In other cases valuation may be more
straightforward as with the loss of commer- dear money. INTEREST RATES which are
cial fisheries due to, say, oil pollution. high compared with their historical average
values.
damped cycle. (also known as convergent
cycle.) One of a series of cyclical fluctuations debased coinage.
which show a decreasing AMPLITUDE over See COINAGE, GRESHAM'S LAW, 'BAD MONEY
time. DRIVES OUT GOOD'.
secondly analysed the question of the STAB- having to repay the capital of the loan, while
ILITV of the equilibrium of a market economy the bank may be able to substitute a non-
and has been able to show that in large performing loan with an ASSET yielding a
economies with numerous market agents the DIVIDEND and has the further option of sell-
market equilibrium will be stable. ing the shares. In the case of a loan to a
His major book, Theory of Value (1959), government, the loan may be traded for
is renowned for its universality and its ele- local currency to finance an equity purchase.
gant analytical approach, for Debreu is able Debt for debt swaps are also possible,
within the same general equilibrium model where a less onerous form of debt is substi-
to integrate the theory of location, the tuted for the original debt by, for example,
theory of capital and the theory of behaviour denominating the substitute in domestic cur-
under uncertainty. rency in place of an international currency,
so that debt service is now carried out in the
debt. An obligation or liability arising local currency. In debt for nature swaps,
from the borrowing of finance or the taking part of the debt is converted into an invest-
of goods or services 'on credit', i.e. against ment in environmental protection. This
an obligation to pay later. Depending on the recognizes the frequent link between the
terms of the transaction, INTEREST is payable indebtedness of developing countries and
at specified periods on most forms of debt the destruction of their environment caused
and the repayment on maturity date (or by the investment.
dates, if repayment is by instalments) is also
usually specified. Important forms of debt, debt management. Term used, generally
e.g. Government debt, are marketable, that in connection with public DEBT, to denote
is, they may be traded on particular markets the action taken by the debt-issuing auth-
such as the STOCK EXCHANGE. (See CREDIT,
ority, or by the CENTRAL BANK acting for it, to
regulate the size and structure of the out-
GILT-EDGED, FLOATING DEBT.)
standing debt. Such management includes
deciding the types of debt to be issued, e.g.
debt conversion. short-term or long-term, marketable or non-
See CONVERSION.
marketable, and the conditions of issue, e.g.
COUPON, issue price, maturity date. An
debt finance. This concept is used in two important objective is to control the term
distinct senses, but in both cases it involves structure (relative amounts of different
borrowing. It can refer to the use of loans by maturities), e.g. by funding short-term into
COMPANIES to finance their operations, par- longer-term debt. Because of its large size,
ticularly CAPITAL EXPENDITURE through long- almost continuous growth and predomi-
term loans. The overall cost of capital may nantly dated character (i.e. having a contrac-
be reduced by the use of debt. Governments tual maturity date) the management of the
also borrow to finance their operations and UK's national debt is essential to control the
to help regulate the volume of aggregate
C o u n t r y ' s MONEY SUPPLY. (See FLOATING
activity in the economy. Such borrowing in-
DEBT, GILT-EDGED, OPEN-MARKET OPERATIONS,
volves the issues of short-term and/or long-
TAP ISSUE.)
term securities. In a recession, Keynesians
argue, a government should be prepared to debtor nation. A nation which has been a
incur a BUDGET DEFICIT and increase its bor- net borrower from other countries, or has
rowing to stimulate the economy. (See GEAR- been at the receiving end of investment by
!NG, CAPITAL STRUCTURE, DEBT MANAGEMENT.) foreign enterprises, and has thereby
accumulated a volume of net debts and other
debt for equity swaps. A technique devel- obligations to these countries. In order to
oped to reduce the DEBT burden on less service its foreign debts, or allow repatria-
developed and Eastern Bloc countries, by tion of profits and dividends of foreign-
which the debt is converted from a loan to a owned enterprises, such a country will have
firrn or government into an EQUITY holding. to develop a surplus position on other items
A commercial loan by a bank to a firm can of the BALANCE OF PAYMENTS, e.g. the VISIBLE
be swapped for an equity holding in the firm; BALANCE. (See KEYNES PLAN, INTERNATIONAL
the firm is then freed from the obligation of MONETARY FUND, INTERNATIONAL LIQUIDITY.)
98 debt ratio
deficit units. Economic units who cannot degrees of freedom. (also known as df).
tneet their expenses in a given period from The number of pieces of information which
their incomes which arise during that period, can vary independently of each other. Thus,
either from the sale of their labour, or their a sample of n observations has n degrees of
assets. They are therefore dependent on freedom. However, the calculation of the
borrowing money or obtaining CREDIT. sample mean involves the loss of one degree
of freedom, since independent changes in
deflation. A sustained fall in the general n — 1 of the sample observations would re-
price level. A proportionate rate of decrease quire a specific offsetting change in the rcth
of the general price level per unit of time. to maintain the value of the sample mean.
(See also DEFLATIONARY GAP.) Similarly, the calculation of к parameter
estimates in an econometric exercise in-
deflationary gap. A situation in which volves the loss of к degrees of freedom,
AGGREGATE EXPENDITURE falls short of that leaving (n - k). Degrees of freedom often
required to produce a level of NATIONAL enter as parameters of probability distri-
INCOME which would ensure FULL- butions, such as the 4' and CHI-SQUARE DIS-
EMPLOYMENT. In the INCOME-EXPENDITURE TRIBUTIONS, and can fundamentally affect
MODEL this is shown by an aggregate expen- their shapes.
diture function which cuts the 45° line, deindustrialization. A development in a
where E = Y, at less than the full employ- national economy towards an increasing
ment level of national income. The diagram share of the GROSS DOMESTIC PRODUCT or
below illustrates that an UNEMPLOYMENT of EMPLOYMENT being accounted for by
EQUILIBRIUM exists at Y\ and that there is a SERVICES. For this to occur the rate of growth
corresponding deflationary gap of magni- of the service sector must be greater than
tude AB at full employment Yf. that of the manufacturing sector. De-
industrialization tends to typify those AD-
Expenditure VANCED ECONOMIES that have secured
industrialization first, as with the UK, or
where rapid industrialization has occurred
and high levels of national income have
been achieved, as with the US. Deindustrial-
Deflationary gap ization is regarded as a matter of concern by
some economists since it is thought to be
associated with a decline in international
B | Aggregate competitiveness. The evidence for this is
expenditure however far from conclusive.
Delors Report. This report presented to
the European Council at its Madrid meeting
in June 1989 is part of the current phase of
the plan for MONETARY UNION in the EURO-
PEAN COMMUNITY. It envisages a three stage
Yf Real income process with stage one based on consolidat-
ing the single European Market. It covers
deflationary gap strengthening of competition policy, closer
coordination of economic and monetary
deflator. An implicit or explicit PRICE policies, expansion of regional aid, deregula-
INDEX used to distinguish between those tion of financial markets, expansion of the
changes in the money value of GROSS EUROPEAN MONETARY SYSTEM and the adop-
NATIONAL PRODUCT which result from a tion of the European Currency Unit for
change in prices and those which result from private transactions.
a ch
ange in physical output. Stage two would be transitional involving
the strengthening of existing institutions and
degree of homogeneity. the establishment of new ones including a
^ee HOMOGENEOUS FUNCTIONS. European System of Central Banks (ESCB),
100 demand
which would mark the institutional begin- the existence of rigid money wages that
ning of a European CENTRAL BANK. Stage prevents a fall in the real wage and an elim-
three would include a further strengthening ination of this demand-deficient unemploy-
of regional policy, a move to fixed exchange ment. Indeed classical economists would
rates, constraints on national budgets, cen- argue that by its very nature this form of
tralisation of international policy measures unemployment resulting from rigid wages
and the passing of responsibility for mone- can only be temporary. The concept is there-
tary policy to the ESCB including exchange fore essentially a KEYNESIAN one for it
rate policy with non-EC currencies. Finally emphasizes that a reduction in real wages
a single European currency would be will lead to a reduction in aggregate demand
established regulated by the ESCB or its and in the Keynesian model wages and
successor. employment are jointly determined by the
Stage one can be accommodated within level of aggregate demand. The causality
the TREATY OF ROME but stages two and three therefore runs from aggregate demand to
will require amendment of the Treaty. To employment and wages. (See NEO-CLASSICAL
this end an intergovernmental conference SYNTHESIS.)
has been called to negotiate the necessary
changes in t h e T r e a t y of R o m e . (See EURO- demand deposit.
PEAN ECONOMIC COMMUNITY, EUROPEAN UNIT See SIGHT DEPOSIT.
OF ACCOUNT.)
demand for inflation. The notion that
demand. The quantity of a good or service there are potential gains for some groups as
which an individual or group desires at the a result of inflationary policies. The resultant
ruling price. The total demand in an econ- political (voting or lobbying) pressure from
omy is referred to as aggregate demand. such groups is viewed as an implicit
Aggregate demand backed by actual pay- 'demand' for inflation. Although no group in
ment may be described as EFFECTIVE society explicitly demands more inflation,
DEMAND. (See DEMAND CURVE, NOTIONAL pressures for the government to follow a
DEMAND.) more inflationary policy emanate from a var-
demand curve. A graphical illustration of iety of sources: tax payers who resist tax
a DEMAND SCHEDULE ОГ DEMAND FUNCTION
increases made necessary by increases in
but, given that diagrams can only be drawn expenditures, beneficiaries of government
in two or three dimensions, showing the re- expenditure programmes who resist cuts,
lationship between demand and only one groups attempting to increase their share of
or two variables affecting demand, the the national income, and so on. Trade
others being held constant. Most typically, unions are commonly depicted as the pri-
the demand curve is shown as a curve relat- mary potential beneficiaries from inflation.
ing quantity demanded to the price of the However, although labour can raise its share
good in question (the 'own price'). It is also of national income by pushing for higher
usually shown as sloping downwards from wages, this possibility is restricted to the
left to right. Slightly confusingly, the short run. In the long run, unions cannot
demand curve is almost always sjiown with redistribute income to their memberships.
price (the INDEPENDENT VARIABLE) on the
The problem is thus one of explaining the
vertical axis and quantity (the DEPENDENT incentive for unions to push continuously.
variable) on the horizontal axis, contrary to
mathematical convention. demand for money.
See MONEY, THE DEMAND FOR.
demand-deficient unemployment. A situ-
ation in Which AGGREGATE DEMAND is tOO low demand function. An algebraic expression
to provide work for all those who wish of the DEMAND SCHEDULE expressed either in
to work at the current real wage no matter general terms or with specific numerical
how they are trained or deployed. The values expressed for the various PARA-
unemployed outnumber the existing job METERS, and usually including all factors
vacancies at the current levels of money affecting demand. Thus, a general form
wage rates. On a classical view it is only might be:
density gradient 101
demand-pull inflation. A sustained rise in density gradient. The rate at which the
aggregate demand which results in a sus- intensity of land use changes with radial dis-
tained rise in the general price level. tance from the centre of an urban area.
Demand pull inflation may be illustrated by Studies of a large number of cities in
either upward shifts in AGGREGATE EXPENDI- industrial countries have indicated that
102 dependence structure
population densities and the intensity of use national economy and defence; however, it
of land for non-residential purposes decline can also prompt integrated producers to set
steadily from the centre of a town or city high prices at the extraction stage, along
outwards. Indeed, it has been argued that with other devices, to shift reported earnings
for population densities, this gradient can be to this stage and thus reap the benefits of the
represented by an equation of the form tax preferences.
Dx = Doe -bx
deposit. Sums lent to certain financial in-
where Dx is density at x distance from the stitutions, e.g. BANKS, BUILDING SOCIETIES
centre, Do is the 'central' density, e is the and FINANCE HOUSES, on terms allowing
base of natural logarithms and b is a slope withdrawal with or without notice, or pro-
factor. This gradient is one of the observed viding for repayment after specified periods
regularities which economic models of urban - such sums are usually described as 'on
spatial structure must seek to explain. In deposit', CURRENT ACCOUNT deposits in banks
general, the intensity of land use towards the are directly transferable by CHEQUE; while
town or city centre is explained in terms of those deposits for which CERTIFICATES OF DE-
the value placed on accessibility (which is POSIT are issued are effectively transferable
argued to be greatest at the centre). (See since the certificates of deposit themselves
also ACCESS/SPACE TRADE-OFF MODEL.) may be bought and sold.
dependent variable. The variable on the deposit money. Or, more generally, bank
left hand side of the equality sign in an deposit money. Refers to that component of
equation, so called because its value is 'de- the money stock which is in the form of bank
pendent' or determined by those of the INDE- deposits. Whether or not both DEMAND and
PENDENT or EXPLANATORY variables on the TIME DEPOSITS are included depends on the
right hand side. (See also ENDOGENOUS VARI- MONEY SUPPLY definition adopted. In turn
ABLE, REGRESSAND.) this depends partly on the practices of the
system considered, e.g. as to withdrawal no-
depletion allowance. A tax advantage that tice required for time deposits. (See DEPOSIT
allows the owner of natural resources to ACCOUNT.)
deduct from gross income the depletion in
value of a nonrenewable asset, such as Depository Institutions Deregulation and
minerals, oil or gas. The deduction may be Monetary Control Act of 1980 (DIDMCA).
based on recovery cost or on a set percent- An act passed in 1980 by the US Congress,
age of related gross income. This can serve DIDMCA was claimed to be the most exten-
as an incentive to spur the discovery and sive banking and financial market legislation
extraction of resources essential to the since the Federal Reserve Act in 1913 and
deregulation 103
t h e Banking Acts of 1933 and 1934. The allowance for this is made before net profit is
legislation arose out of near crisis situations arrived at. Conventional accounting seeks to
in the 1970s when high interest rates in the allocate the decline in value of the asset over
US drove financial institutions to create a its projected economic life. Annual provi-
whole array of competing financial instru- sions are conventionally calculated by one of
ments to try and attract funds. The Act itself two methods. The first is the 'straight-line
contains nine titles. There are ten important method' where the cost of the asset minus
provisions in the act. 1) Reserve require- the residual disposal value is divided by the
ments for all depository institutions were set number of years of its expected life to give
at 3 pe r c e n t °f t n e ^ r s t $25 million in trans- the annual figure. The second is the 'declin-
action account deposits, and 12 per cent for ing balance method' where the figure
deposits in excess of $25 million. 2) Interest employed is a constant proportion of the
rate ceilings, in particular Regulation A, value of the asset and so an annually dimi-
were to be phased out over the next six nishing amount. Generally historic values of
years. 3) The Depository Institutions capital have been employed. At times of
Deregulation Committee was established to high inflation, replacement cost values could
oversee the phase out of interest rate ceil- become much greater than historic costs and
ings. 4) Savings and loan institutions were historic depreciation provisions will not
authorized to expand their lending powers ensure that capital costs are recovered in
and allowed to invest up to 20 per cent of real terms. The problem could be dealt with
their assets in consumer loans, COMMERCIAL by periodically revaluing assets by an index
PAPER, and corporate debt obligations. 5) of capital costs and adjusting the de-
NOW (Negotiable Order of Withdrawal) preciation charges accordingly. This is
accounts were legalized with a uniform termed replacement-cost depreciation.
interest rate ceiling. Share drafts of credit Depreciation is generally permitted as an
unions (in effect, cheques drawn upon de- allowance against profits for CORPORATION
posits at credit unions), automatic transfer TAX purposes but the allowances have to be
accounts of banks, and remote service units calculated according to rules set down by the
(computerised banking machines, operated tax authorities and these need not corre-
by credit card and located off the premises spond to the depreciation charged by a firm
of a banking office) were also legalized. in its accounts. In the UK they are called
6) The Fed was also authorized to begin capital allowances.
pricing its services. 7) Non-member banks The term is also used in economics to refer
were permitted to pass their reserves to a situation where a currency falls in value
through member banks. 8) State usury laws against other currencies through changes in
that limited the interest charged on different the forces of supply and/or demand.
kinds of loans were overridden for all
federally insured lenders. 9) Federal usury
limits were pegged to the discount rate. 10) depressed area. A geographical area or
Lending requirements were simplified. region within a nation which experiences a
significantly poorer economic performance
The Act provided for many other changes
than the nation as a whole. The index of
in what is becoming known as the financial
'depressed-ness' most frequently used is the
services industries. The intent of all of these
rate of unemployment. However, other
changes was to improve the competitive
environment within which all financial insti- indices of economic performance used in-
tutions operate and to improve the control clude economic growth rates and income
of the Federal Reserve Board of Governors per head, while persistent out-migration
over the money supply. (See HUNT COMMIS- is also regarded as a characteristic of a
SION.)
depressed area. In many countries govern-
ments pursue REGIONAL POLICY which aims to
improve the economic performance of
depressed areas.
depreciation. The reduction in the
value of assets, generally arising from wear
a
nd tear. The consumption of capital is depression.
recognized as a cost of production and an See SLUMP.
104 deregulation
deregulation. The removal of central or desired capital stock. The optimal stock in
local government laws and by-laws, which the long run. The adjective 'desired' is often
restrict entry to certain activities. For introduced in dynamic economic models to
example in western economies bus and taxi give substance to the concept of the long run
services are often subject to regulation, optimal value of the CAPITAL STOCK. (See PAR-
while in the former Eastern Bloc countries TIAL ADJUSTMENT.)
many activities e.g. foreign trade, were re-
stricted to the state. (See PRIVATIZATION.) determinant. (also known as Det. or de-
noted by | Л | ). The determinant of an nth
derivative. The change in the DEPENDENT order matrix Л is defined as
VARIABLE of a function per unit change in the
INDEPENDENT VARIABLE, calculated for an \A\ = S,y±a,,c,y
infinitesimally small interval for the latter. where а у is the element in the ith row and yth
The process of calculating the derivative is column, and c,y is the cofactor of this ele-
called differentiation with respect to the in- ment. The sign of the term is determined as
dependent variable. In NON-LINEAR func-
tions, the derivative will itself be a function -I- if / + / is even
of the independent variable. The derivative — if / + j is odd.
of the derivative is called the second deriva- The determinant is often used in matrix in-
tive. The derivative of this is called the third version, and in the determination of the rank
derivative, and so on. of the matrix.
The derivative has a graphical interpret-
ation in the slope of the graph of the func- detrending. The process by which a time
tion. In economic terms, the first derivative trend is removed from data, often by prior
of any total function can be interpreted as estimation of a time trend, and the calcu-
the MARGINAL function. Thus, the first de- lation of residuals. (See also FILTER.)
rivative of the TOTAL COST function with re-
spect to quantity, is MARGINAL COST. The devaluation. A fall in the fixed EXCHANGE
derivative of the function RATE between one currency and others.
Y = f(X) When the relative values of two currencies
have been fixed at an officially agreed level,
is conventionally written as any reduction in the value of one currency
against the agreed fixed level is a devalua-
§ . orf(X). tion. Two examples of a sterling devaluation
occurred in 1949, when the pound fell from
[See also PARTIAL DERIVATIVE.)
being equivalent to US $4.03 to US $2.80
derived demand. Demand for a FACTOR OF and then subsequently in 1967, when the
PRODUCTION is sometimes called a derived pound was devalued again to US $2.40.
demand. This means that it is derived from Devaluation is used to correct a BALANCE
the demand for the final good that the factor OF PAYMENTS deficit but only as a last resort
co-operates in producing. In some cases, as it has major repercussions on the domestic
however, a factor of production, say labour, economy. For example holders of foreign
is demanded for itself. A case in point is the currency will then pay a lower price for
hiring of a baby-sitter. Here the demand for British goods and the price of imports on the
labour is identical with the demand for the home market will rise. If there is no increase
service itself. in the production of export goods, they will
then earn less foreign exchange, which will
deseasonalization. The process of remov- exacerbate the balance of p a y m e n t s prob-
ing seasonal influences, regular seasonal lem. (See CURRENCY DEPRECIATION, EX-
occurrences which distort the underlying CHANGE RATE, BALANCE OF PAYMENTS.)
trend, from data. This can be achieved in a
number of ways including MOVING AVERAGES, developing countries. This description of
DUMMY VARIABLES and the calculation and the economic position of the poorer nations
subtraction of seasonal indices. (See also of the world came into current usage in the
FILTER.) 1960s and began to replace the less compli-
difference stationary process 105
indirect tax being levied on expenditure on both inwards and outwards - are worth less
em
ployees and that it was probably passed in today's terms because of individuals'
o n
in higher prices anyway. The distinction positive RATE OF TIME PREFERENCE. Income
is not analytically useful as it provides no received now can be reinvested to produce
information about the INCIDENCE of the tax. additional income. The two best known
techniques using the discounting procedure
directors. are NET PRESENT VALUE and internal RATE OF
See COMPANY DIRECTOR. RETURN. They both involve discounting all
future net cash flows and finding their sum.
Director's Law. A hypothesis, formulated Use of this method of project appraisal is
by Aaron Director, that in a democratic sys- considered superior to traditional accoun-
tem the government will tend to pursue poli- tants' methods where discounting is not
cies which redistribute income from the employed. The technique has been widely
relatively rich and poor towards the middle employed in the USA for many years and is
income groups. The hypothesis follows from now increasingly employed by both industry
the MEDIUM VOTER THEOREM which argues
and government in the UK. The net cash
that, in a democracy, politicians will most flows which are discounted include all in-
closely reflect the preferences of those voters flows and outflows including interest and
in the middle of the political or social spec- taxation. Depreciation does not appear in
trum. Consequently politicians will pursue net cash flow. (See CAPITAL BUDGETING.)
policies which favour middle income groups.
discounting. The process of applying a discount rate. The rate at which future
rate of interest to a capital sum. It is widely benefits and costs are discounted because of
employed to find the equivalent value today TIME PREFERENCE or because of the existence
of sums receivable or payable in the future. of a positive INTEREST RATE. Thus, if £100
Thus if the rate of interest or DISCOUNT RATE accrues each year to an individual, the £100
is 10 per cent and if the sum of £110 is in year 1 is worth less than £100 in the pres-
receivable in one year's time its present ent. This is because the individual prefers his
value is £100. Discounting is the reverse of benefit now rather than later, or because
compounding and the formula for executing £100 now can be invested at the rate of
it on any sum interest, r, to become £100(1 + r) in one
year's time. Hence the individual is indiffer-
ent between £100 now and a £100 (1 + r) in 1
(1 + r)' year's time. It follows that he is also indiffer-
ent between £100/(1 + r) now and £100 next
year (dividing both sides of the previous op-
where r refers to the rate of discount. The tion by (1 + r)). The sum:
procedure is widely used in appraising proj-
ects where expenditure and income are £100
spread over a number of years. It enables £100 +
projects of different lives to be compared. (1 + r)
The concept is also employed to find the is the NET PRESENT VALUE and r is the dis-
current value of a BILL OF EXCHANGE. The count rate. {See DISCOUNTING.)
term is employed in relation to SECURITY 2. In the US, the interest rate charged by
prices and EXCHANGE RATES to refer to the the FEDERAL RESERVE SYSTEM for loans to
impact of some political or economic event member banks, set at the discretion of the
on current values. For example the expec- Federal Reserve. The discount rate is cut or
tation of, say, a miners' strike may already raised in response to market rate movements
be reflected in, be discounted, in the current when authorities wish to signal their inten-
level of security prices. tion to maintain the new rates in the market.
Finally the term is used for the act of
selling a BILL at a discount on (i.e. at less
than) its face value. This is normal practice Discouraged Worker Hypothesis. Those
for someone who draws a bill on another workers who leave the labour market when
party but is unable or unwilling to provide unemployment rises. It represents one
the FINANCE which the bill represents. The hypothesis about the responsiveness of
rate at which such a bill is discounted will LABOUR FORCE PARTICIPATION RATES tO Cyclical
reflect current rates of interest for finance of changes in the economy. When the economy
corresponding duration. (See NET PRESENT turns down it has been argued there will be a
VALUE, RATE OF RETURN.)
fall in the real wage and family incomes.
This fall in the price of market work will, on
balance, induce a reduction in the labour
force as a result of the dominance of the
discount market. Narrowly defined, the SUBSTITUTION EFFECT. Some SECONDARY
London market in which TREASURY and COM- WORKERS will leave the labour market and
MERCIAL BILLS are traded. The core of the others will be deterred from entering it. A
market is formed by the DISCOUNT HOUSES cruder version of the argument is that sec-
which are members of the London Discount ondary workers looking for employment in
Houses Association, plus a small number of conditions of high unemployment will be-
BILL BROKERS who act as intermediaries be- come so disheartened by fruitless search for
tween other operators in the market. The employment that they give up the attempt
term is frequently used in a broader sense to and withdraw from the labour force. On this
cover the activities of placing (lending) short interpretation the phenomenon is a cause for
term funds with the discount houses by concern. An alternative explanation of the
banks and other institutions, and as such decline in labour force participation rates as
is interchangeable with the term MONEY unemployment rises suggests this represents
MARKET. the efficient outcome of an optimization
diseconomies of scale 109
process. Individuals' participation in the groups receive lower pay in a given job de-
labour market is concentrated in those scription than their direct counterparts.
periods in which real wages are rising fastest, There are three main economic expla-
generally those periods in which unemploy- nations for discrimination within the labour
ment is falling, and is thus a strength of the market: 'power' and 'taste' factors plus in-
economy. On this view secondary workers formation externalities. The power expla-
constitute the important source of labour nation focuses upon the ability of one group
reserves in the economy. (See ADDITIONAL to use its superior power to enable it to
WORKER HYPOTHESIS.) benefit economically at the expense of
another. The more conventional 'taste' ex-
discrete variable. A variable which can planation requires that numbers of one
take on only certain values. For instance, a group act as if they prefer not to be associ-
variable which can only take on INTEGER ated with members of another. The third
values is a discrete variable, since it cannot explanation results from the use of out-
take on fractional values. (See also CONTINU- moded rules of thumb or stereotypes in hir-
OUS VARIABLE.) ing and promotion decisions and is often
termed statistical discrimination.
discretionary profits. Those PROFITS in ex-
cess of the minimum necessary to ensure discriminatory pricing.
shareholder acquiescence. This is a concept See PRICE DISCRIMINATION.
used in the MANAGERIAL DISCRETION model of
the firm where discretionary profits are
posited as an argument within the manager- diseconomies of growth. The dynamic
ial UTILITY FUNCTION. (See MANAGERIAL constraints which set in beyond some high
THEORIES OF THE FIRM.) rate of growth and impair the efficiency
of the firm's activities. On the SUPPLY side,
discretionary stabilization. Direct inter- organizational and financial constraints
vention by the government usually in the operate. The organizational constraint (the
form of MONETARY or FISCAL POLICY to stabil-
Penrose effect) is the limit set by the existing
ize the growth or level of NATIONAL INCOME.
management personnel of the firm who at
(Contrast AUTOMATIC STABILIZERS.)
successively higher rates of growth will find
it increasingly difficult to impart the knowl-
edge and experience to new personnel which
discriminating monopoly. is necessary for effective organization of the
See PRICE DISCRIMINATION. firm's activities. Finance is a constraint be-
cause its supply is limited and growth of the
discrimination. The unequal treatment of CAPITAL STOCK must be financed. The
equals. In the labour market this manifests GROWTH-PROFITABILITY FUNCTION implied by
itself in the valuation of personal character- diseconomies of growth ensure that this be-
istics of the worker that is unrelated to pro- comes increasingly difficult with increases in
ductivity and is of three main types along the the growth rate.
principal dimensions of race and sex. The On the demand side, growth requires the
first is that which occurs even before those shifting of the firm's demand curve and the
discriminated against enter the market. This introduction of new products. This requires
pre-entry discrimination assumes its most expenditure on demand creation and is sub-
tangible form in the inferior public provision ject to diminishing effectiveness as at suc-
of schooling and formal training for minority cessively higher growth rates resource
groups, particularly blacks. The second type requirements, such as design and develop-
is known as employment discrimination and ment and marketing, grow at a proportion-
refers to the less favourable job slots occu- ately greater rate given a finite number of
pied by women and blacks even after having markets. (See also ECONOMIES OF GROWTH.)
standardized for their generally lower HU-
MAN CAPITAL endowments. The third type
which also occurs within the labour market is diseconomies of scale.
termed wage discrimination. Here, minority See ECONOMIES OF SCALE.
110 disembodied technical progress
disembodied technical progress. Technical war or other national crisis but not to fall to
progress which appears costless like 'manna the original level after the crisis. In this way,
from Heaven', completely independent of such crises lead to a permanent increase in
capital accumulation or any other variable in government expenditure. This phenomenon
the economic system. (See EMBODIED TECHNI- formed part of the explanation of public
CAL PROGRESS.) expenditure growth put forward by A.T.
Peacock and J. Wiseman (see The Growth of
disequilibrium. A state of not being in Public Expenditure in the United Kingdom,
equilibrium. In such cases forces may exist London, Allen and Unwin, 1961). These
which will automatically bring the system authors argued that war or crises helped to
back into equilibrium, or it may be the case overcome tax-payer resistance to higher
that the system will diverge further from taxes, the THRESHOLD EFFECT, and also led to
equilibrium. (See EQUILIBRIUM.) increased centralization of various activities
which thereafter remained in government
disguised unemployment. control. (See WAGNER'S LAW, INSPECTION
See HIDDEN UNEMPLOYMENT. EFFECT.)
t'nguish between the functional distribution terms of distributional equity facilitates the
f income which refers to the division of evaluation of alternatives. Distributional
national product between the owners of equity is sometimes expressed in terms of
different FACTORS OF PRODUCTION - land, the distribution of income, of wealth or, par-
labour and capital, and the personal distri- ticularly in the case of theoretical WELFARE
bution of income which refers to the deter- ECONOMICS, in terms of UTILITY. {See also
minants of individuals incomes regardless of EQUITY, DISTRIBUTIVE JUDGEMENT.)
the factor from which income is derived. An
example of empirical work on the personal distributional weight. A numerical factor
distribution of income and wealth in the UK applied to changes in income of different
is the Royal Commission on the Distribution individuals or groups of individuals and
of Income and Wealth (1975). embodying some DISTRIBUTIVE JUDGEMENT
The functional distribution of income in for the purpose of evaluating the distributio-
the economics of the CLASSICAL SCHOOL and nal consequences of a policy or project. As
particularly D. RICARDO, emphasized the an- an example, consider a case in which group
tagonistic relationship between the rate of A is given a weight of 1 and group В a weight
profit on capital, a fixed subsistence wage, of 2 - perhaps because group В consists of
the growth of population and the marginal poorer individuals than A. A project which
productivity of labour. The relative share of has among its consequences a transfer of
each factor is determined by the technical £100 from group A to group В will then
and social relationships in the economy. The record as a cost the loss of £100 by A but a
neo-classical MARGINAL PRODUCTIVITY DOC- benefit of £200 to В thus giving a net gain.
TRINE treats the factors of production like Such weights are used on occasion in COST-
any commodity and their prices are deter- BENEFIT ANALYSIS. Many economists object
mined by the forces of demand and supply. to their use on the grounds that distribu-
This MICROECONOMIC approach has been tional effects are best handled directly
questioned by those who emphasize the non- through the tax system or that distributive
competitive nature of markets and role of judgements are, somehow, not within the
sociological factors in determining the distri- province of economics.
bution of the product. Karl MARX'S theory of
distribution is based on the interdependence
of the class struggle, changes in technology, distribution function. That part of govern-
population growth, the organization of ment tax and expenditure policy which is
workers and the extension of capitalist pro- concerned with altering the distribution of
duction to new areas. The ПСО-KEYNESIAN income or wealth within society. This func-
models of distribution associated with the tion will be undertaken if the distribution of
theories of M. KALECKI, Joan ROBINSON, N. income or wealth which emerges in the ab-
KALDOR, and others, emphasize the role of sence of government action is deemed to be
market structures, the organization of undesirable.
workers and factors determining demand in
macroeconomic models of the economy. distributive judgement. When economists
Modern microeconomic approaches to the are evaluating policies or projects, they face
functional distribution of income also em- the difficulty that, in general, policies will
phasize the imperfection of markets and in- affect not only the total output of the econ-
troduce models of WAGE BARGAINING. See omy but also the way in which that output
Atkinson, А.В., The Economics of Inequal- and its benefits are distributed between
ity. Oxford University Press (1975). individuals. Given this, in the formation of a
policy recommendation some judgement
distributional equity. Justice or fairness in must be made concerning the desirability or
the manner in which the economy's output is undesirability of a policy's distributional
distributed between individuals. It is of effects since any decision will have distribu-
mterest to economists in that alternative tional consequences. This distributive judge-
economic arrangements, projects or policies ment is a VALUE JUDGEMENT - a matter of
generally have different effects on distri- ethics not facts. (See also SOCIAL WELFARE
bution, thus a concept of what is desirable in FUNCTION.)
112 distributive justice
hare- Where dividends are declared as a economy, developed and strongly advocated
S
e r c e n t a g e of the nominal value of the share b y t h e INTERNATIONAL MONETARY FUND in t h e
[he formula is 1960s as a truer current measure of expan-
sionary forces in the monetary system than
dividendpercentage x nominal share value ^ ^ measured changes in the money stock.
100 x market price of share Broadly, it measures the total change within
Xhe dividend yield shows the percentage a given period in those types of credit which
return available to an investor at current lead directly to changes in the MONEY SUPPLY,
market prices. Dividends are paid out of as conventionally defined. As such, and put
PROFITS after payment of CORPORATION TAX.
simply, it is equal to that part of the PUBLIC
SECTOR BORROWING REQUIREMENT that is n o t
From the point of view of a company raising
new EQUITY the dividend yield is a main com- covered by borrowing from the non-bank
ponent of the cost that has to be paid for public (and hence must be covered either by
such capital. (See COST OF CAPITAL.) borrowing from the banks or from abroad,
or by using the sterling proceeds of net sales
of foreign currencies from the external re-
division of labour. The process whereby serves), plus the increase in bank advances.
labour is allocated to the activity in which it DCE is not normally equal to the change in
is most productive - i.e. in which it can make the money supply: the difference between
best use of its skills. As a result no one the two is accounted for, broadly, by the
person carries out all the tasks in the pro- BALANCE OF PAYMENTS on current and capital
duction, instead each specializes in that in accounts. In an expansionary phase, DCE
which he has a COMPARATIVE ADVANTAGE. takes account of that expansion which, by
spilling over into foreign expenditures, does
dollar certificate of deposit, CERTIFICATE OF not show up in increased money supply. By
DEPOSIT (CD) denominated in dollars and stipulating a DCE limit as a condition of
issued in exchange for a DEPOSIT in dollars. assisting a member country with an external
CDs originated in the US in 1961, but dollar payments deficit, as in certain cases - e.g.
CDs are now issued in other financial the UK - it did, the IMF was in its view
centres. In London, where they were first applying a more appropriate monetary dis-
issued in 1966, a large number of BANKS, cipline than a straight money supply con-
British and foreign, issue them and there is a dition would impose.
SECONDARY MARKET in which they are traded.
dominant firm price leadership.
See PRICE LEADERSHIP.
Domar, Evsey D. (1914- ). Polish-born
American economist recognized for his work Doolittle method. A systematic approach
on the theory of ECONOMIC GROWTH. He
to solving sets of four or more simultaneous
stressed that investment expenditures had equations developed by M.H. Doolittle. It
a two-fold effect, namely an income- involves a set pattern of multiplication of
generating effect and a capacity-augmenting equations by the reciprocals of their coef-
effect, KEYNESIAN economics recognized ficients, followed by a systematic process of
only the former and Domar set out to ascer- addition which ultimately yields numerical
tain what conditions had to hold for the solution values for the unknowns. A simple
growth in demand and the growth in ca- process for checking accuracy at each stage
pacity to proceed in balance. The results is built into the method. This and other sys-
which he established turned out to be similar tems for solving equation sets have largely
to those derived independently by HARROD, been supplanted, within economics at least,
so
that they are now known as the by the matrix inversion methods used in
Harrod/Domar conditions. His main publi- computerized solution algorithms.
cation is Essays in the Theory of Economic
Growth (1957).
double-coincidence of wants. If trade is to
take place under a system of BARTER then it
domestic credit expansion (DCE). An is necessary for there to be a double-
indicator of monetary change within an coincidence of wants between the two
114 double counting
parties to the transactions. That is, the set of Dow Jones Index. The INDEX NUMBER of
goods or commodities each individual is will- WALL STREET Stock Exchange share prices
ing to exchange must be exactly what is that is most commonly referred to. It is the
required by the other party. United States equivalent of the FINANCIAL
TIMES INDUSTRIAL ORDINARY SHARE INDEX.
double counting. The counting of a single
element of benefit or cost more than once in dual decision hypothesis. In modern
developments of KEYNESIAN ECONOMICS, the
a COST-BENEFIT ANALYSIS. For example, if the
construction of a new bridge makes a par- argument that conventional demand and
supply functions do not provide the relevant
ticular location more attractive to live in,
signals for equilibrium to come about in
due to its increased accessibility, property
markets. The argument is that conventional
values will increase. This should not be
demand and supply curves yield quantities
counted as part of the benefits since it repre-
that buyers and sellers wish to exchange
sents simply the capitalized value of future
given their planned receipts. If realized cur-
time saving, improved job and shopping
rent receipts differ from these planned
opportunities, etc. which already will have
receipts, buyers and sellers are accordingly
or should have been included in the cost-
constrained by their actual incomes and
benefit analysis. Double counting is also
must therefore revise their plans. The 'dual-
a potential danger in the estimation of ity' in question relates to the initial and re-
NATIONAL INCOME.
vised demand and supply plans.
double factorial terms of trade. dualism, theory of. This theory was out-
See TERMS OF TRADE.
lined originally by MALTHUS who saw an
economy as consisting of two major sectors,
double switching. one industrial and one agricultural; breaking
See RES WITCHING. the economy into two sectors and looking at
the interaction between them is said to
double taxation and double taxation re- increase the understanding of the deve-
lief. An individual or organization obtain- lopment process. The agricultural sector
ing income in a foreign country may be liable features subsistence farming often using
for TAXATION on that income in both the primitive and inefficient techniques. Stan-
foreign country and the country of origin. A dards of living and wages are low. In the
system of reliefs for such double taxation has urban industrial sector, although wage levels
been developed by most countries in the are often high there is widespread poverty
world. Sometimes the nature of the relief is and unemployment because people are
contained in double taxation agreements but attracted to the urban areas by the high
sometimes relief is given on a unilateral wages but are unable to find employment.
basis. For example, a UK company oper- This is a major problem in most developing
ating in a foreign country may have to pay countries but some of the worst examples
income tax to the government of that are in South America where huge shanty-
country. In the UK the company will be towns have grown up around the major cities
liable for CORPORATION TAX on the income because people cannot find employment or
earned overseas. The UK tax system allows accommodation and are unwilling or unable
the foreign income tax to be set against the to return to the rural areas. (See LEWIS-FEI-
UK tax liability. The company ends up by RANIS MODEL.)
paying the higher of the foreign or UK rate.
Credit is given for INCOME TAXES but not duality. A method of deriving systems of
others such as ROYALTIES. Where the foreign demand equations which are consistent with
operation is via a subsidiary, credit is usually optimising behaviour on the part of the con-
given not only for the WITHHOLDING TAX on a sumer or producer by simply differentiating
dividend but for the underlying income tax a function instead of explicitly solving a con-
as well. Credit is frequently given for income strained optimisation problem. It has been
taxes paid in the foreign country to state or applied to unit cost functions and constant
local governments. RETURNS то SCALE production functions. The
duopsony 115
basic idea is that maximising profit is directly dummy variable. A binary (off-on) vari-
Inked to minimisation of costs in such a way able designed to take account of exogenous
hat both will result in the same behaviour shifts (shift dummy) or changes of slope
tterns, but one may be a much easier sol- (slope dummy) in an econometric relation-
ution to'the given problem than the other. ship. For instance, dummies can be used to
The duality approach can also be used in account for seasonal influences in the data.
LINEAR PROGRAMMING as a maximising prob- By specifying a dummy to take on the value
lem with inequality constraints for the sys- of unity for, say, winter months and zero at
tem may be more easily solved in its dual other times, it will indicate the degree to
minimising form where the number of con- which a relationship shifts during the winter,
straints is different and the direction of the compared to other seasons, by augmenting
inequalities reversed. the constant term of the equation. This type
As a method of generating systems of fac- of variable can also be used to include quali-
tor demand equations consistent with cost tative factors in a regression (e.g. male or
minimisation, duality was rigorously intro- female, or policy on-policy off periods).
duced as Shephard's lemma.
dumping. The practice of selling a good
dual labour market hypothesis. The hypo- abroad at a price lower than that charged for
thesis that the labour market is dichoto- the same good in the domestic market.
mized into a primary and secondary sector. Dumping may be private on the part of a
'Good' jobs, characterized by high pay, pro- firm, subsidized by the state or may take
motion prospects, security and good fringe place directly by a state-owned company.
benefits, make up the primary sector of the Where dumping is long run on the part of a
dual economy, while 'bad' jobs and the private company, it is acting as a DISCRIMI-
workers frozen out of the primary sector NATING MONOPOLIST in the international
comprise the secondary sector. In the latter, sphere. Short term dumping may be spor-
wages are established by competition and adic, to remove unwanted stocks on the part
jobs are sufficiently plentiful to employ all of a foreign producer, or predatory, where
workers. However, they are low paying, un- a foreign producer may temporarily reduce
stable and generally unattractive. Workers his supply price to force out a domestic
in that sector are precluded from entering producer in order to gain a monopoly pos-
the primary sector not so much by their lack ition. Predatory dumping may justify anti-
of HUMAN CAPITAL and trainability as by insti- dumping duties on anti-monopoly grounds.
tutional restraints in the form of DISCRIMINA- Economic analysis suggests that where the
TION, the restrictive practices of unions, and dumping is long-run and there are no fears
a simple dearth of good jobs. Workers in about the exercise of monopoly power by
the secondary sector are thus subject to the foreign supplier, the country subject to
dumping should accept the favourable terms
UNDER-EMPLOYMENT.
of trade implicit in the dumping.
The policy prescription of the dual labour
market hypothesis is the creation by the gov-
ernment of better jobs or more good jobs duopoly. A market structure where there
accompanied by legislation to remove discri- are only two firms. Models purporting to
mination. This conflicts with the basic neo- explain the determination of output and
classical analysis which would interpret price in this market structure base their
labour market disadvantage as reflecting analysis upon assumptions regarding de-
deficiencies in human capital investments. cision making where there is perceived inter-
However the lower level of human capital dependence. (See COURNOT'S DUOPOLY
mvestment by secondary workers may be a MODEL, BERTRAND'S DUOPOLY MODEL, STACK-
rational response to the lower returns to
ELBERG'S DUOPOLY MODEL.)
mvestment experienced by these workers as
a
result of discrimination. In this model in
contrast to most other economic models duopsony. A particular market in which
TASTES, for education and training, become there are only two buyers of the product or
endogenous. service being traded.
io duration of unemployment
« vna mic theories of comparative advan- omically relevant knowledge, have been
ce. New theories of international trade developed to supplement the traditional ap-
hich emphasize the role of information proaches. New products are developed for
ifiityy and diffusion in explaining the high income markets where there are in-
attern of international trade and pro- creasing demand levels and where there is an
duction. The major explanations of the pat- incentive to economize on high cost labour
tern of international trade, the RICARDIAN and to introduce labour saving innovations.
d the HECKSCHER-OHLIN opportunity cost Exports of new goods represent technologi-
n
nproaches, are deficient in explaining and cal gap trade, since knowledge of the tech-
oredicting the pattern of trade in manufac- nology is still lacking in the rest of the world.
tures, since it is only possible to refer back to Eventually this knowledge becomes wide-
COMPARATIVE ADVANTAGE ОГ tO f a c t o r a b u n - spread and new locations for production
dance once the export commodity is known. arise. These tend to be where wages are low,
New theories, which emphasize the process so that exports of this product now represent
of the generation and diffusion of new econ- low-wage trade. (See also PRODUCT CYCLE.)
Е
earmarking. The practice of linking par- general choose to distribute only a part of
ticular elements of PUBLIC EXPENDITURE to these. (See DISTRIBUTED PROFITS.)
the revenue raised by specific taxes. This
process of assigning certain revenues for earnings drift. A rise in weekly earnings in
specific purposes is also referred to as excess of the rise in negotiated WAGE RATES.
hypothecation. Economists are divided on As distinct from WAGE DRIFT this measure
the merits of earmarking, some holding that makes no adjustment for changes in over-
the practice may impose an undesirable rigi- time or any other payments received under
dity on certain expenditures, while others other recognized procedures for scheduling
argue that such taxes can help improve ALLO- rates.
CATIVE EFFICIENCY b y a c t i n g a s PRICES рГО-
vided the taxes are levied on those who earnings function. The functional relation-
benefit from the expenditure. (See also ship between earnings levels and their deter-
BENEFIT PRINCIPLE.) minants. A standard earnings function may
be written
earnings. The term is used in two ways: lnYi = f(sh th tf, Zt)
one to describe the return for human effort; where In У, is the natural logarithm of ob-
the reward for input of the factor of pro- served earnings of the /th individual;
duction labour, and the other to describe the Si is education measured in years;
income of a business. ti is years of work experience;
1. In labour economics, earnings is used to tf is the square of years of work ex-
describe the total payments an individual perience; and
receives from his employment. Gross earn- Zj is a VECTOR of other variables.
ings comprise the basic pay the individual
receives together with any payments for shift Earnings are a positive function of education
and overtime working or any form of incen- work experience and a negative function of
tive scheme. Gross weekly earnings, the the square of work experience (basically be-
total payments received in a single week may cause HUMAN CAPITAL investments decline
be distinguished from gross hourly earnings with age). These crude human capital vari-
which are computed by dividing weekly ables have been shown to explain up to two-
earnings by the total number of hours thirds of the observed variation of actual
worked. Earnings may be quoted in pre- or earnings.
post-tax terms (gross or net) and in real or
money terms. (See also WAGE RATES.) easy money. A general state of ease and
2. The earnings of a business refers to the cheapness of borrowing in the financial sys-
income of that business which may be either tem. It may result from policy action to re-
distributed to shareholders or retained. duce INTEREST RATES, increase LIQUIDITY of
Earnings per share is a measure of the total the banking system, relax any non-price re-
earnings of a company on its ORDINARY strictions on lending such as CREDIT CEILINGS
SHARE capital and is calculated by dividing and restrictive conditions on HIRE PURCHASE
net income by the number of ordinary contracts. But at some periods it has resulted
shares. Net income represents gross income from a slack demand for finance produced
less deductions for DEPRECIATION, INTEREST by RECESSION conditions. (See MONETARV
payments, the earnings of preference shares POLICY, OPEN MARKET OPERATIONS.)
and corporation tax liability. Earnings per
share will in most cases be higher than divi- EC Agricultural Levies. Duties levied by
dends per share because the firm will in members of the EUROPEAN COMMUNITY (EC)
118
economic good 119
imp°
rts 0
^ agricultural produce from non- economic base multiplier. A form of RE-
°*етЬег countries. It is a system to protect GIONAL MULTIPLIER which estimates the effect
domestic agriculture in the EC. The price of of changes in an area's ECONOMIC BASE on the
p rted agricultural products from third
m O
economy of the area as a whole.
^untries is kept up to a minimum or
'threshold' price by variable import levies. economic community. An economic union
The revenue collected by these levies does among countries which have COMMON EXTER-
n
ot accrue to national Treasuries but is part NAL TARIFF and COMMERCIAL POLICY and have
of the 'own resources' of the EC. Those removed restrictions on trade between mem-
countries which traditionally have had a ber countries. Such a union ultimately in-
large trade in agricultural products with volves the harmonization of industrial and
third countries accordingly contribute a social policies, and concerted monetary and
large share of the EC's 'own resources' exchange rate policies as a step to a common
under this regime. currency.
conomic rent. A payment to a factor in cannot be absorbed (or used) will not be
excess of what is necessary to keep it to its produced, so that stagnation is likely to be
oresent employment. For example, if a man the prevalent state in modern advanced capi-
$ earning £10,000 in his current job and his talist economies.
next best alternative pays £9,000, the econ-
omic rent which he enjoys is £1,000. This economic theory of politics. A model of
definition of rent stems from PARETO and can political behaviour which assumes that
be contrasted to that developed by RICARDO, voters are UTILITY maximizers and that politi-
MILL and MARSHALL, which sees rent as the cal parties are VOTE MAXIMIZERS. The indi-
difference between what a factor receives vidual voter will opt for that political party
and the payment which would be necessary which he considers will provide him with the
to entice it into employment. In terms of the highest utility from government activity.
above example, if a man would remain Political parties aim to supply policies which
unemployed if offered less than £3,000 but will gain most votes. Politicians are assumed
would supply his labour at this figure, the to be motivated by self-interest and the
Ricardo-Mill-Marshall definition would set desire to hold office, and consequently for-
the rent at £7,000. The latter definition mulate policies to achieve these goals. This
stems from Ricardo's view of the rent of view conflicts with the social welfare maxi-
land, since he regarded all payments to land mizing model of governmental behaviour in
as the unnecessary surplus on the grounds which politicians seek office to expedite pre-
that land had no alternative use. (See TRANS- conceived policies designed for the social
FER INCOMES, QUASI-RENT.) good. Instead, policies will reflect the prefer-
ences of the MEDIAN VOTER and the influence
economics. The study of the way in which of producer interest groups (management
mankind organises itself to tackle the basic and organized labour) and BUREAUCRACIES.
problem of scarcity. All societies have more Voter interests are likely to reinforce pro-
wants than resources (the factors of pro- ducer interests for the basic reason that their
duction), so that a system must be devised to own producer-interest (earning and produc-
allocate these resources between competing ing) is more immediate and concentrated
ends. than their consumer interest which is dis-
persed over many product markets.
economic surplus. The difference between
the output of an economy and the necessary economic union.
costs of producing this output, where by See ECONOMIC COMMUNITY.
necessary costs is meant WAGES, DE-
PRECIATION of capital and the cost of raw economic welfare. That part of human
materials. welfare which results from the consumption
The concept is used in development econ- of goods and services. It may be defined in
omics, where it is argued that to attain sus- terms of the welfare of individuals or groups.
tained progress an underdeveloped economy PIGOU argued that it was that part of welfare
must produce a surplus over SUBSISTENCE, which could be expressed in monetary
which should be devoted to CAPITAL terms. Although welfare was originally
ACCUMULATION. regarded as being synonymous with satisfac-
The concept has also been used by Baran tion or UTILITY, some economists have
and SWEEZY (Monopoly Capital, 1966). They objected that welfare is an ethical concept
extended the Marxian notion of SURPLUS and that to say that the satisfaction of an
V individual's desires increases his welfare is to
ALUE, which could be measured as the sum
of PROFITS, RENT and INTEREST, to include make a VALUE JUDGEMENT that the satisfac-
other disguised forms of surplus such as the tion of those desires is a good thing. Other
costs of sales promotion and the activities of economists would persist in arguing that
government, many of which are directed 'economic welfare' has a precise meaning
towards military expenditure. They argue and has no ethical overtones. Further diffi-
tn
at the modern capitalist economy is culties and limitations arise when we wish to
characterized by a law of rising surplus, measure welfare, either for the purpose of
a considering changes in economic welfare or
nd they are concerned that surplus which
122 economies of growth
high wages and unemployment coexist. Four forward market in this respect; this does not
main versions of the theory have been pro- necessarily imply irrationality on the part of
posed: 1. The shirking model. This proposes market participants, for the failure of the
that firms can induce employees to work forward market to be an unbiased predictor
efficiently if they pay wages in excess of the may be due to a RISK PREMIUM, transaction
opportunity wages of their workforce. Such costs or changes in government policy.
payments ensure that any dismissals for poor
performance effectively penalise workers effort aversion. A formal concept used to
and thereby discourage shirking. 2. The represent the assumption that effort enters
turnover model. Firms are suggested to pay as a negative argument in the UTILITY FUNC-
higher wages to reduce labour turnover. 3. TION of individuals, i.e. effort yields a MAR-
The superior job applicant pool. This ver- GINAL DISUTILITY. This is an assumption
sion of the theory suggests that where firms commonly used in economic analysis of the
are unable to distinguish the most pro- allocation of time between work and leisure
ductive among the applicants for jobs, they activities.
may adopt a strategy of paying high wages.
By paying high wages the firm will attract EFTA.
See EUROPEAN FREE TRADE ASSOCIATION.
more high quality, more high productivity
workers into the pool of applicants, with the
EIB.
result that even though they hire at random
See EUROPEAN INVESTMENT BANK.
from this pool, they will recruit a more pro-
ductive workforce. 4. The fair wages model. elasticity. A measure of the percentage
Higher wages satisfy individuals' demands change in one VARIABLE in respect of a per-
for equitable and fair treatment and produce centage change in another variable.
superior performance in return. See Elliott, Measures of elasticity tend to be carried out
R.F., Labour Economics: Л Comparative for very small changes in the variable
Text, McGraw Hill (1991), pp. 346-52 and causing the response - e.g. a percentage
Weiss, A., Efficient Wage Theory. change in quantity due to a very small
change in price. (See PRICE ELASTICITY OF
efficient market hypothesis. The view that DEMAND.)
the prices of shares on the stock market are
the best available estimates of their real elasticity of demand. Usually taken to re-
value because of the highly efficient pricing fer tO the (own) PRICE ELASTICITY OF DEMAND,
mechanism inherent in the stock market. but care should be taken to specify which
There are three levels of efficiency. First, the elasticity of demand is being discussed. (See
market is held to be 'weak-form efficient' if PRICE ELASTICITY OF DEMAND, CROSS ELAS-
share price changes are independent of past TICITY OF DEMAND.)
price changes. Second, semi-strong form
efficiency is present if share prices fully elasticity of input substitution. A measure
reflect all publicly available information. of the responsiveness of the OPTIMAL labour-
Third, strong-form efficiency will imply /capital combination to a change in the rela-
share prices will have taken full account of tive prices of the two inputs (or the term may
all information whether publicly available be generalized to refer to any two inputs).
or not. Since the detailed expression is somewhat
This is a highly controversial subject; unwieldy we present it here in its general
weak-form efficiency is generally accepted, form:
and semi-strong form efficiency is becoming _ percentage change in K*/L*
more so. There are few adherents to the
percentage change in PJPK
strong form version.
The efficient market hypothesis also arises where K*/L* is the optimal capital/labour
in the context of foreign EXCHANGE RATES, ratio and PL and PK are the prices of labour
where the hypothesis is that the FORWARD and capital.
EXCHANGE rate is the best unbiased predictor If the elasticity of substitution is zero, then
of the future SPOT RATE. The empirical factors are always used in fixed proportions.
findings throw doubt on the efficiency of the An elasticity of substitution greater than
Employment Act of 1946 125
zero implies that the CAPITAL-LABOUR RATIO embodied technical progress. (See DISEMBO-
WILL RESPOND TO CHANGES IN RELATIVE FAC- DIED TECHNICAL PROGRESS.)
T O R PRICES.
emoluments. Are defined as that portion
eligible assets ratio. of management's SALARY and NONPECUNIARY
See RESERVE ASSETS RATIO. benefits which are not part of the ENTREPRE-
NEURIAL SUPPLY PRICE. They characterise
eligible paper. Financial ASSETS which the firms which have MONOPOLY POWERS suf-
CENTRAL BANK is prepared to buy (redis- ficient to allow managers discretion over the
count) or accept as security for loans, in distribution of returns.
particular circumstances and usually in deal-
ings with defined institutions. The redis- Employee Stock Ownership Plan (ESOP).
counting of, or lending against, eligible A plan which permits employees in US firms
paper is the means by which a central bank to share in profit and growth of a business by
relieves a shortage of CASH in the financial owning shares of common stock in the firm.
system where it considers it appropriate to The most popular current form for such
do this. The need for such assistance arose plans is called an ESOP. This type of pro-
originally in periods of financial crises when gramme allows employees to share owner-
public confidence in banks and in the finan- ship while also permitting the business more
cial obligations of private borrowers was col- access to capital markets. Under this plan,
lapsing. In such circumstances the BANK OF an employee benefit or pension plan bor-
ENGLAND, for example, learnt to act as rows money to buy newly issued company
LENDER OF LAST RESORT, evolving the practice
stock. The company annually contributes
of rediscounting or making advances on additional stock to the fund as well as cash
COMMERCIAL BILLS carrying two 'good'
payments sufficient to cover interest and
British names for approved DISCOUNT AMORTIZATION on the loan. These payments
HOUSES and BILL BROKERS. The object of re-
are tax deductible for the business. This pro-
quiring eligible paper as the vehicle of such vides significant financing benefits to the
assistance was an attempt to maintain stan- company which could not deduct amortiza-
dards of credit-worthiness in bill finance and tion if it borrowed the money directly.
to discourage its use for speculative, con- ESOPs began to be adopted in the UK in
sumption or other purposes regarded - at 1986 on the basis of case law but they were
particular periods - as undesirable. In the given statutory recognition in 1989. The
UK under the arrangements of monetary financial inducements to start a plan are that
control introduced in August 1981, the list of the employee avoids INCOME and CAPITAL
banks whose names on a BANK BILL estab- GAINS TAX, while the company can offset the
lishes it as eligible paper has been greatly costs of purchasing the shares against cor-
extended to include all the major foreign poration tax. In 1991 about 100,000
banks operating in London - almost a hun- employees participated in the schemes.
dred institutions in all. Of course it also
includes Treasury bills and local authority
bills. Employment Act of 1946. Section 1 of this
Act mandates that the Federal Government
elitist good. of the United States do everything within its
power to create and maintain employment
See LUXURY.
opportunities, sustained growth, and a
EMA. stable purchasing power for its currency. In
See EUROPEAN MONETARY AGREEMENT. short, the Act sets out what are considered
to be the three major goals of FISCAL and
embodied technical progress. Technical MONETARY POLICY. The Act also established
progress which cannot take place unless it is two groups to evaluate the government's
embodied in new capital. For example the progress in meeting these goals: the council
silicon chip has rendered the capital of whole of Economic Advisors and the Joint Econ-
industries obsolete, requiring completely omic Committee of the Congress. The
new physical capital to realise its poten- Council of Economic Advisors is a three-
tial. The silicon chip therefore represents person panel charged with keeping the Presi-
126 employment service
dent of the United States informed about the the individual utility function in the first
current economic situation, preparing an place, but suggests wealth is a buffer against
annual Economic Report of the President, an uncertain future rather than against latent
and helping the President construct a budget future consumption. (See WEALTH EFFECT,
for the next fiscal year. The Joint Economic REAL BALANCE EFFECT, PIGOU EFFECT, MONE-
Committee is an eleven-member group TARISM, DEMAND FOR MONEY.)
whose responsibility is to aid Congress with
its legislative duties by evaluating the endogenous money supply. The level of
Council's Report and the President's pro- the money supply is on this view determined
posals. by forces within the economy itself, such as
RATES OF INTEREST and the level of business
employment service. Public or private activity. The CENTRAL BANK does not impose
agencies which attempt to match job appli- any limit but merely provides what the mar-
cants with existing job VACANCIES. Firms ket needs. (See MONEY SUPPLY, MONETARISM,
notify employment agencies of the type and MONETARY POLICY.)
number of their job vacancies and the agen-
cies then frequently conduct a preliminary endogenous variable. A variable whose
SCREENING of applicants before referring value is determined within the framework of
them on to the firms. an economic or econometric model. Thus, if
a variable appears as a dependent variable in
employment subsidies. an equation, it is an endogenous variable.
See JOB CREATION. (See SIMULTANEOUS EQUATIONS, REDUCED
FORM.)
EMS.
See EUROPEAN MONETARY SYSTEM. endowment effect. Individuals demand
more to induce them to give up a commodity
encompassing test. This non-nested test is they already possess than they would be will-
based on the principle that a MODEL should ing to pay to acquire that same commodity.
account for the salient features of different, Such an anomaly reflects an asymmetry of
and perhaps rival, models. It can be seen as value called loss aversion.
a mean encompassing test and a variance
encompassing test with the j-test mean energy intensity. An indicator of effi-
encompassing and the F-test (see F-STATISTIC) ciency in the use of primary energy in the
variance encompassing. See G.E. Mizon and production of one unit of gross domestic
J.F. Richard, T h e Encompassing Principle product. For example, in the 1980s the
and its Application to Testing Non-nested Soviet Union and the Eastern Bloc countries
Hypotheses', Econometrica, Vol. 54, 1986, used respectively three and a half times as
pp. 657-678 much and two and a half times as much
primary energy to produce one unit of GDP
endogenous income hypothesis. A theory as the industrialized Western countries.
which suggests that utility is a function of
both CONSUMPTION expenditure» and of enfranchisement of the nomenklatura. An
WEALTH. The implications are that once informal and dubious approach to the rapid
some optimum level of wealth has been PRIVATIZATION of state property in the former
achieved, all income will be spent whereas communist (and some other) countries, by
normally one would expect some saving still means of which former party activists and
to occur. The approach is derived from a state officials acquire state property at below
microeconomic approach to the CONSUMP- market prices. The term nomenklatura re-
TION FUNCTION which basically presents the fers to those persons, who were selected for
household with a choice between commodi- top posts not on the basis of merit but
ties and wealth, both of which have positive according to the arbitrary criteria of the then
MARGINAL UTILITY, but with a diminishing ruling party.
MARGINAL RATE OF SUBSTITUTION of COnSUmp-
tion for wealth. The theory does not engagements. (also known as new hires.)
'explain' why wealth would be included in The total number of people entering
entrepreneur 127
employment in any single period. These in- is the average propensity to consume then
dividuals may previously have been among
the REGISTERED UNEMPLOYED ОГ HIDDEN AQIAY _ AQ • Y
UNEMPLOYED or they may be new entrants QIY AY • Q
into the LABOUR FORCE. Engagements are
which is the INCOME ELASTICITY OF DEMAND
one aspect of LABOUR TURNOVER.
for the good.
Engel curve. A line which plots the re-
lationship between an individual's income Engel's Law. An empirical Maw' of con-
and his consumption of a specified good. An sumption developed by Ernst Engel. The
Engel curve is illustrated in the diagram be- idea that the proportion of a nation's income
low. The slope of the curve at any point is spent on food is a good index of its welfare.
the individual's marginal propensity to con- The lower the proportion, the higher is
sume the good and indicates the ratio of welfare.
change in consumption to change in income.
The ratio of total consumption of the good
to total income is the average propensity to engineering method. A method used in
consume the good - this is equal to the slope STATISTICAL COST ANALYSIS, where engineers'
of a line such as О А. The ratio of the mar- estimates of the input-output relationship
ginal propensity to consume the good to the form the basis upon which to calculate mini-
average propensity to consume is the INCOME mum production cost at different levels of
ELASTICITY OF DEMAND for the good. This output. The advantages of this method are
may be seen mathematically, let Y be con- that input prices and technology can be held
sumer income and Q consumption of the constant and homogeneity of output and
good in question: inputs can be satisfied. A major drawback is
that non-production costs are not included.
decisions entrepreneurs make. The nature of mental condition. (See APPROPRIATE TECHNO-
the entrepreneurial input differs between LOGY.)
the principal firms of modern business enter-
prise. Within the sole proprietor firms for environmental determinism. The hypo-
instance, the entrepreneur both accepts the thesis that the physical environment is a
financial risks of the enterprise and is solely major determinant of the level of a country's
responsible for its management. On the economic development. This question fea-
other hand, in the PUBLIC COMPANY these two tures prominently in development econ-
main functions are divided between share- omics for if the UNDERDEVELOPED COUNTRIES
holders, that is, the owners who bear the of the world are plotted on a map, it can be
risk, while the board of DIRECTORS are in seen that they are either in tropical areas or
effect controllers of policy and decision mak- very cold climatic zones. This raises the
ing, that is the management of the firm. This question as to whether the physical environ-
division of functions is often stated as a ment is a major determinant of the level of
source of change in business behaviour, par- development: however the differences in
ticularly with respect to the objectives pur- rates and levels of development between
sued by firms. See Casson, M., The countries suggest that although important,
Entrepreneur, Martin Robertson, Oxford environmental conditions are not the only
(1982). cause of underdevelopment. Indigenous re-
sources are nonetheless more significant in
entrepreneurial supply price. That return countries which have limited supplies of
which is just sufficient to keep an executive capital, skilled labour, technology and entre-
of some given quality in his current employ- preneurial experience; so their lack would
ment. The supply price will then be that be more keenly felt in the less developed
portion of an executive's salary and perqui- areas.
sites left after the deduction of EMOLUMENTS.
(See also NORMAL PROFITS.) environmental impact analysis. An analy-
sis which seeks to identify the effects on the
entrepreneurship. whole environment of any investment proj-
See ENTREPRENEUR.
ect. This would include the forecasting of
entry barriers. potential pollution emission, loss of visual
See BARRIERS TO ENTRY.
amenity etc.
discharge of workers, the EQUAL EMPLOY- the ABILITY-TO-PAY theory each tax-payer
MENT OPPORTUNITY ACT OF 1972 empowered makes the same sacrifice of utility which he
the Commission to bring suits. The influence obtains from his income. There are three
o f the EEOC grew throughout the 1970s, definitions of equal sacrifice, namely equal
but has been sharply curtailed by the absolute sacrifice, equal proportional sacri-
leadership of the Reagan and Bush fice and equal marginal (or least aggregate)
administrations. sacrifice. Under the first each tax-payer sac-
rifices the same absolute amount of utility
which he obtains from his income. Under
equalization grants. Funds made available
the second each gives up the same pro-
by a national government to sub-national or
portion of utility which he receives from his
local governments with the objective of re-
income and under the third each sacrifices
ducing the degree of inequality in the levels
the same utility from the last unit of income
of income or revenue raised by the local
which is sacrificed in tax. Whether or not the
governments. Thus the lower the amount of
income tax system is PROGRESSIVE, PRO-
revenue per head of population raised by a
PORTIONAL or REGRESSIVE depends partly on
given rate of local taxation, the greater the
which definition is employed and on what
amount received by way of the equalization
assumptions are made about the slope of the
grant. The RATE SUPPORT GRANT which is the
MARGINAL UTILITY OF INCOME schedule. Each
means by which the British government pro-
definition of equal sacrifice can justify all
vides funds to local authorities, functions, to
three tax systems depending on what
some extent, as an equalization grant.
assumption is made about the marginal uti-
lity of income schedule. If it is assumed that
equalizing differences, the theory of. the latter declines, only the equal marginal
See NET ADVANTAGES. sacrifice definition gives unqualified support
to progressive income tax. On the other two
definitions the outcome depends on how fast
equal pay. Equality between the sexes as the marginal utility schedule falls. No defi-
regards the terms and conditions of employ- nition can be proved superior to another
ment: a concept of equal pay for work of without involving VALUE JUDGEMENTS. The
equal value, although the precise definition whole approach depends on making inter-
of 'equal pay1 and 'work' differs by country. personal comparisons of utility which is not
In Britain, under the Equal Pay Act of 1970 permitted in modern WELFARE ECONOMICS.
which became fully operational in December
1975, employers are required to grant equal
treatment to men and women where they are equation of exchange.
See QUANTITY THEORY OF MONEY.
employed on the same or broadly similar
work or where, with respect to different
jobs, a woman's job has been rated as equiv- equilibrium. A term borrowed from phys-
alent to that of a male employee by means of ics to describe a situation in which economic
a JOB EVALUATION exercise. Subsequently this agents or aggregates of economic agents
was broadened to require equal pay for work such as markets have no incentive to change
of equal value. their economic behaviour.
Applied to an individual agent, such as a
The British equal pay legislation is des- CONSUMER or FIRM, it denotes a situation in
igned to prevent WAGE DISCRIMINATION. It
which the agent is under no pressures or has
does not seek to ensure equality of oppor- no incentive to alter the current levels or
tunity as regards access to jobs. Employment states of economic action, because given his
discrimination is covered by separate legisla- aspirations and the constraints he faces he
tion; namely, the Sex Discrimination Act of cannot improve his position in terms of any
1975, which created new rights for women economic criteria. When applied to MAR-
a
nd established an Equal Opportunities KETS, equilibrium denotes a situation in
Commission with wide investigative powers. which, in the aggregate, buyers and sellers
are satisfied with the current combination of
equal sacrifice theories. The sacrifice by prices and quantities bought or sold, and so
tax-payers of an equal amount of UTILITY. In are under no incentive to change their
130 equilibrium error
present actions. If, for some reason, the INVOLUNTARY UNEMPLOYMENT exists we are
equilibrium price is not observed then forces Off the LABOUR SUPPLY CURVE. For NEO-
will occur which bring the market back to CLASSICAL economists the equilibrium level
the equilibrium price. Thus, if supply ex- of national income is the FULL EMPLOYMENT
ceeds demand, producers' stocks (inventor- LEVEL OF NATIONAL INCOME; the level of
ies) will increase, signalling to them a state income consistent with the NATURAL RATE OF
of excess supply. They will lower prices until UNEMPLOYMENT. (See also NEO-CLASSICAL
supply and demand are just equal again. SYNTHESIS.)
Such an equilibrium is known as a stable
equilibrium. equilibrium price. The PRICE at which a
Unstable equilibria will occur if some MARKET is in EQUILIBRIUM.
divergence from the equilibrium price sets
up forces which move price further and equilibrium rate of inflation. The fully
further away from the equilibrium price. In anticipated rate of INFLATION. That rate of
supply and demand analysis this can occur if price inflation at which expectations are fully
both supply and demand curves are nega- realized; that rate at which the EXPECTED
tively sloped and the supply curve cuts the INFLATION rate equals the actual inflation
demand curve from above. If it cuts it from rate. (See VERTICAL PHILLIPS CURVE.)
below, the equilibrium will still be a stable
one. Equilibria may not in fact exist. Using equities. Otherwise known as 'ordinary
the supply and demand example again, the shares', these are shares in the issued capital
curves may not intersect at all, in which case of a COMPANY which are held on terms that
no equilibrium price exists since there is no make the holder a 'member' of the com-
price at which suppliers and demanders are pany, entitled to vote at annual meetings
willing to trade. Lastly, supply and demand and elect directors, and to participate
curves may intersect more than once in through dividends in the profits of the com-
which case it is possible to have more than pany. The holders of the ordinary shares
one equilibrium price, each of which is carry the residual risk of the business: they
stable. This is said to be a situation of rank after DEBENTURE holders and PREFER-
'non-uniqueness'. ENCE SHAREHOLDERS for the payment of divi-
Although the supply and demand context dends and they are liable for losses, although
has been used here, the features of exist- in a limited liability company this liability is
ence, uniqueness and stability are more limited to the value of the shares themselves
often discussed in the context of GENERAL plus any uncalled liability on them. If the
EQUILIBRIUM theory. All three features are company is a PUBLIC COMPANY and has a
regarded as desirable attributes of a general STOCK EXCHANGE listing, its shares may be
equilibrium system. traded on the exchange. (See UNCALLED
CAPITAL, VOTING SHARES.)
equilibrium error. Where a group of vari-
ables linked in a REGRESSION model are co- equity. Fairness or justice. This concept is
integrated (see COINTEGRATION) then the of importance to economists in a number of
disturbance term is known as.the equilib- situations. For example, judgements of
rium error. economic arrangements sometimes dis-
tinguish issues of efficiency - the production
equilibrium level of national income. That of maximum output - from issues of equity -
level of NATIONAL INCOME which exhibits no the manner in which that output is distrib-
tendencies to change. In the simple uted. Conversely, the burden of taxation
Keynesian INCOME-EXPENDITURE MODEL this may also be judged in terms of equity con-
would be where the level of INJECTIONS siderations. To some extent the distinction
equalled the level of WITHDRAWALS. In this between equity and efficiency may be held to
model such an equilibrium could exist at full be a false dichotomy as the theory of PARETO
employment or at less than full employment: OPTIMALITY indicates that a change in the
an UNEMPLOYMENT EQUILIBRIUM. Neoclassical distribution of income will change the OPTI-
economists would argue that equilibrium is MAL pattern of output. Equity should not be
possible at full employment only and that if confused with equality since one need not
escalators 131
imply the other. For example, equity may or by 1.25 in order to maintain living standards.
may not be held to require equality of Such scales can be used in studies of poverty
incomes - depending upon one's view of the and in settling levels of social security bene-
nature, sources and implications of income fits. The income scale represents an attempt
differences. (See HORIZONTAL EQUITY, VERTI- to measure the INCOME EFFECT of different
CAL EQUITY, DISTRIBUTIONAL EQUITY.) household circumstances. (See EQUIVALENCE
SCALES, EQUIVALENT COMMODITY SCALE.)
equity capital.
See EQUITIES. equivalent variation.
See CONSUMER'S SURPLUS.
equivalence scale. A ratio or 'weighting'
factor employed in evaluating levels of ERM.
income or consumption required for house- See EXCHANGE RATE MECHANISM.
holds in different circumstances to reach a
given 'standard of living'. The scales rest on error correction models (ECMs). In RE-
the assumption that one can validly compare GRESSION analysis an ECM combines long
levels of living standards or UTILITY for and short run interaction amongst a group of
different individuals and households, even variables. It is closely related to COINTEG-
although this assumption is generally RATION amongst the same group of variables
rejected in theoretical WELFARE ECONOMICS. and implies that differences (the short run
(See also EQUIVALENT INCOME SCALE, EQUIV- effect) and levels (the long run effect) of the
ALENT COMMODITY SCALE.) variables may be specified in the same re-
gression model without introducing a SPURI-
equivalent commodity scale. A numerical OUS REGRESSION problem.
factor applied to the level of consumption of If yt and xt are both of the same order of
certain commodities by households in differ- integration (d) (see INTEGRATED TIME SERIES),
ent circumstances in order to indicate levels and assuming that d — 1, then an equation of
of consumption required for each type of the form
household to reach a given standard of liv-
ing. Thus a couple with a child will require i(yt - $xt) + vt
more total food consumption than a childless is a valid equation provided y, and xt are
couple to achieve the same standard of liv- cointegrated. Thus Ayr, Axt, (y, - $xr) and v,
ing. The equivalent commodity scale seeks are all integrated of order zero.
to quantify this difference in requirement
and express it as a ratio - thus it may be that error learning process.
the addition of a child requires food con- See ADAPTIVE EXPECTATIONS.
sumption to be increased by 1.25. (See also
EQUIVALENT INCOME SCALE, EQUIVALENCE errors in variables. (also known as
SCALES.) MEASUREMENT ERROR.) An еСОПОПШПС prob-
lem whereby particularly the EXPLANATORY
equivalent income scale. A numerical fac- variables in a REGRESSION analysis are imper-
tor applied to the incomes of households in fectly measured, either because their actual
different circumstances to give estimates of values are unobservable, or through impre-
the income required for each household to cision of recording. This problem can give
reach a given standard of living. If we com- rise to biased and inconsistent ORDINARY
pare two households, one consisting of a LEAST SQUARES estimates, and is usually cor-
childless couple and the other consisting of rected by the use of INSTRUMENTAL VARI-
two adults and one child, it is clear that the ABLES.
larger household would require a higher
income in order to achieve the same living escalators. Cost of living clauses in collec-
standard as the smaller household. Equi- tive bargaining agreements. Escalators pro-
valent income scales attempt to quantify vide a mechanism for periodic adjustments
these differences. For example it might be of wage rates based on movements in a
estimated that the addition of a child specified PRICE INDEX. Escalators rarely fully
required household income to be multiplied compensate for price changes. This results
132 estate duty
from a number of factors. First, the relevant agriculture of the local people and it was
formula is generally insufficient to produce always very much in the interests of the
full compensation at other than relatively estate owners to maintain that differential; if
low wage earnings. Second, limits or caps the native people were very poor, they
may be placed on the maximum cost of living would be more ready to work hard for low
adjustment. Third, escalator adjustments wages.
typically lag behind price changes. Fourth,
escalators may not be 'triggered' until a sig- estimation. The quantitative determi-
nificant rise in the price index occurs. nation of the parameters of economic
Finally, escalators are, of course, not the models through statistical manipulation of
sole wage adjustment mechanism. data. This is achieved through the use of
Escalators are less common in UK than in estimators (i.e. formulae) which convert ob-
the US, largely because of greater contract servations into parameter estimates.
length in the latter country. In mid-1991 Examples of econometric estimators include
nearly 2 million of the 5.7 million workers ORDINARY LEAST SQUARES a n d FULL INFOR-
covered under major collective bargaining MATION MAXIMUM LIKELIHOOD. {See POINT
agreements in the USA (i.e. those agree- ESTIMATION, INTERVAL ESTIMATION, STATISTI-
ments covering 1000 or more workers) were CAL INFERENCE.)
covered by escalators.
estimator. A formula, or procedure by
estate duty. (also known as death duty.) which estimates of statistical quantities (such
as the MEAN or VARIANCE of a variable), or
The main form of wealth taxation in the UK
before its replacement by the CAPITAL TRANS-
the parameters of an equation are obtained
FER TAX in 1974. It was levied at PROGRESSIVE
from data. Examples of econometric esti-
tax rates on estates at the death of the mators include ORDINARY LEAST SQUARES and
FULL INFORMATION MAXIMUM LIKELIHOOD.
owner. The progressive rates applied to the
(See ESTIMATION, STATISTICAL INFERENCE,
whole estate rather than simply to incre-
LINEAR ESTIMATOR, BEST LINEAR UNBIASED
ments of WEALTH. It is doubtful whether this
ESTIMATOR.)
tax made a major contribution to the redis-
tribution of wealth in the UK. Liability
could be escaped by transfers of wealth inter EUA.
See EUROPEAN UNIT OF ACCOUNT.
vivos and by the setting up of discretionary
trusts. Under the latter scheme a settler pro-
vided trustees with a list of beneficiaries and Euler's Theorem. The theorem states that
before 1969 no estate duty was paid when a if the function
beneficiary died as he had no right to any Y = / № , . . .,*„)
part of the fund. After 1969 the position was
changed and someone who received income is HOMOGENEOUS of degree 1, then it can be
or capital from a discretionary trust was li- written as
able to estate duty. Gifts inter vivos made
within 7 years of death were made subject to
estate duty in the 1969 budget. The short-
comings of the tax led to its being replaced where X{, . . ., Xn are INDEPENDENT VARI-
by Capital Transfer Tax, which in turn was ABLES,and
replaced by the INHERITANCE TAX.
BY
a PRODUCTION FUNCTION expressing output as market, which is now the most important
a function of CAPITAL and LABOUR, then if it segment of the international capital market.
displays constant returns to scale (i.e. homo- A Eurobond is underwritten by an inter-
geneous of degree 1) then it can be written national syndicate of banks or other securi-
ties firms and sold principally in countries
n dQ dQ
L other than the country in whose currency the
dL'L issue takes place. (See MONEY MARKETS.)
where
Eurodollars.
дК ' dL See EUROCURRENCY MARKET.
steel, pig-iron and scrap iron had been have large agricultural sectors and particu-
removed. A gradual harmonization of exter- larly those which export agricultural
nal tariffs on these products culminated in products.
the adoption of a common external tariff by
the Community in 1958. The Commission of European Common Market.
the European Community, which super- See EUROPEAN ECONOMIC COMMUNITY.
seded the High Authority of the Community
in 1967, is empowered to fix prices and pro- European Community. The collective
duction quotas, limit imports from third designation of the EUROPEAN COAL AND STEEL
countries, impose fines on firms violating COMMUNITY, EUROPEAN ECONOMIC COMMUNITY
treaty regulations and raise finance by means a n d EUROPEAN ATOMIC ENERGY COMMUNITY.
of a levy on the value of coal and steel
production in the Community. In 1977 the European Currency Unit.
Commission introduced the Simonet Plan See EUROPEAN MONETARY SYSTEM.
which regulates price controls and pro-
duction quotas throughout the coal and steel European Development Fund. A special
industries. The Commission also grants and fund established by the EUROPEAN ECONOMIC
guarantees loans for redevelopment and COMMUNITY to provide financial and technical
investment programmes, finances resettle- assistance to the countries associated with
ment and retraining schemes for redeployed the EC by, respectively, the TREATY OF ROME,
or redundant workers and provides financial YAOUNDE CONVENTIONS a n d LOME CONVEN-
aid for the housing of miners and steel- TION. (See EUROPEAN INVESTMENT BANK.)
workers. In 1967 the original institutional
structure of the European Community, was European Economic Area. See EUROPEAN
merged with that of the EEC and FREE TRADE ASSOCIATION.
EURATOM to create the common insti-
tutions of the European Community. (See European Economic Community. The
CUSTOMS UNION.) European Economic Community was for-
mally established on 25 March 1957 by the
European Community Budget. A budget Treaty of Rome, agreed to by the govern-
which raises funds from members of the ments of Belgium, France, the German
European Community to finance communal Federal Republic, Italy, Luxembourg and
activities. Payments are obtained from mem- the Netherlands. The treaty provided for the
bers in the form of 90 per cent of the revenue gradual development of a full CUSTOMS
from AGRICULTURAL LEVIES and the COMMON UNION, removal of all barriers to the free
CUSTOMS TARIFF and from up to 1 per cent of movement of CAPITAL, LABOUR and SERVICES
VALUE-ADDED TAX revenue calculated for this and the establishment of common agricul-
purpose as if it had been levied on a harmon- tural and transport policies among member
ized basis. Transitional arrangements were countries. It also created the EUROPEAN
made for the members joining in 1973 INVESTMENT BANK a n d t h e EUROPEAN SOCIAL
whereby contributions were based on differ- FUND, two common institutions designed to
ent principles. On the revenue side the sys- assist and co-ordinate economic develop-
tem discriminates against countries which ment in the Community. By 1961 the
have a relatively large amount of imports Community had removed all QUOTAS on
from non-member states. The UK which ob- industrial goods. The removal of all internal
tained considerable food imports from third TARIFFS and adoption of a common external
countries particularly in the Commonwealth tariff resulted in the establishment of a full
has been particularly disadvantaged. On the customs union in July 1968. The level of the
expenditure side the overwhelmingly biggest common external tariff was agreed upon fol-
item has been on the COMMON AGRICULTURAL lowing the KENNEDY ROUND of trade negotia-
POLICY especially in the form of intervention tions, held under the auspices of the
buying and export subsidies. Other cat- GENERAL AGREEMENT ON TARIFFS AND TRADE,
egories of expenditure include regional and in which the Community had negotiated as a
industrial development and aid. The system single unit. In 1977 the Community con-
discriminates in favour of members which cluded a customs union agreement with the
European Free Trade Association 135
EUROPEAN FREE TRADE ASSOCIATION w h i c h w a s Community. The original six members of the
the culmination of a series of bilateral free Community were joined by Denmark, the
trade agreements originally introduced in Irish Republic and the UK in 1973 following
1973 between several EFTA member ratification of the Brussels Treaty, or Treaty
countries and the EEC. The Community has of Accession, in 1972. By 1977 Denmark,
also reduced a number of non-tariff barriers Ireland and the UK had adjusted their re-
to intra-Community trade by standardizing spective trade policies to coincide with the
trade and customs procedures, abolishing absence of intra-Community tariffs and the
national discrimination in road, rail and common external tariff. The Common
water transport rates and banning discrimi- Agricultural Policy was also adopted by the
nation in awarding public works contracts. three new members over a five year tran-
CARTELS and MONOPOLIES are also banned if sition period which ended in 1978. Greece
they engage in, for example, market sharing joined the Community in 1982 and Portugal
or PRICE DISCRIMINATION practices which re- and Spain joined the Community in 1986.
strict or distort trade among member The Community has also established strong
countries. Although restrictions on the free links with developing countries. It has con-
movement of labour were largely removed cluded a large number of association, co-
by 1969, the Community has yet to harmo- operation and trade agreements, including
nize the disparate licences and professional the YAOUNDE CONVENTIONS and the LOME
qualifications which control the provision of CONVENTIONS, adopted the generalized sys-
services in member countries. Likewise, a tem of preferences which enables duty-free
wide range of controls on capital movements imports of manufactured goods from DEVEL-
have persisted despite efforts to liberalize OPING COUNTRIES, and provided financial aid
capital flows throughout the Community. for development programmes via the EURO-
The removal of these final barriers and the PEAN DEVELOPMENT FUND. In 1967 the
creation of a single market by 1992 is the Community's institutional structure was
objective of the SINGLE EUROPEAN ACT of merged with that of the EUROPEAN COAL AND
1987. STEEL COMMUNITY and the European Atomic
In 1962 the Community adopted a COM- Energy Community to create the common
MON AGRICULTURAL POLICY which guarantees executive, judicial and legislative institutions
common internal price levels, using a combi- of the EUROPEAN COMMUNITY. See El-Agraa,
nation of internal price supports and vari- A.M., The Economics of the European
able import levies adjusted to reflect the Community, Philip Allan, London (1990).
difference between an internal support or
'target' price and the world price. The European Free Trade Association.
Community !ias also attempted to co- Created in 1960 following approval of
ordinate a common transport policy regard- the Stockholm Convention by Austria,
ing the development and regulation of road, Denmark, Norway, Portugal, Sweden,
rail and inland water networks. Following Switzerland and the UK. The association
the collapse of the BRETTON WOODS system attained its initial objectives of establishing
Of FIXED EXCHANGE RATES in 1971, the free trade in industrial goods among mem-
Community has increasingly sought to co- ber countries and negotiating a comprehen-
ordinate its economic and monetary policies. sive trade agreement with the EUROPEAN
In 1972 the Community introduced the COMMUNITY (EC). All internal export QUOTAS
European Currency Snake which narrowed were eliminated in 1961 while internal im-
the margin of exchange rate fluctuations be- port quotas and TARIFFS were removed in
tween member currencies. Furthermore, the eight stages by 1966. All members are free,
EUROPEAN MONETARY CO-OPERATION FUND Was however, to impose tariffs or quotas on
created in 1973 primarily to act as a clearing goods produced in non-association
union for the snake margin system of float- countries. Bilateral trade agreements have
mg exchange rates. In 1979 the EUROPEAN also been negotiated to increase trade in
MONETARY SYSTEM, comprising a new ex- agricultural products. Finland became an
change rate intervention and credit system, associate member in 1961 and Iceland has
w enjoyed full membership since 1970. Den-
as introduced as a means of increasing
monetary co-operation and stability in the mark and the UK left the association
136 European Fund
ation upon their accession to the European developed regions, industrial modernization
Community in 1973. In 1973 Free Trade or conversion schemes and joint industrial
Agreements between individual members projects. Although the bank's activities were
and the EC were introduced, leading initially confined to EUROPEAN COMMUNITY
eventually to the establishment of a full cus- (EC) countries, various association agree-
toms union in manufactured goods between ments and conventions have enabled the
the association and the EC in July 1977. The Bank to extend its services to overseas depen-
association has also addressed the problems dencies of member countries, to the African,
of eliminating non-tariff barriers to trade. Caribbean and Pacific countries of the LOME
Highly integrated into the EC, which CONVENTIONS and to Mediterranean countries
accounted in the early 1990s for nearly 60 that have association or co-operation agree-
per cent of the Association's exports and ments with the EC. Moreover, the Bank's
imports and being in turn the largest market Board of Governors, comprising the finance
for EC exports (greater than the US and ministers of each member country, may auth-
Japan combined), the EFTA countries orize loans to countries not linked to the
feared substantial trade diversion after 1992 Community, especially if the projects under
as a result of the single market following consideration are of interest to EC members.
from the SINGLE EUROPEAN ACT. TO forestall The Bank finances its operations by borrow-
this, EFTA engaged in discussions with the ing on both Community and international
EC in an attempt to create a European capital markets. As the Bank is a non-profit
Economic Area, which would extend the institution its interest rates closely corre-
free trade in industrial goods to services, spond to those charged on the capital markets
capital and persons. An agreement to this where it obtains its funds. Individual project
effect was reached between the two groups loans, which generally represent less than 40
in October 1991, under which EFTA per cent of the project's fixed assets, may be
accepted the existing EC regulations in the made directly to firms, public authorities or
area and also undertook to accept EC com- through financial institutions. In addition,
petition policy, social policy and environ- the Bank may finance projects via 'global
mental policy. The implication of the loans' granted to financial institutions who in
agreement is that EFTA countries will be turn extend sub-loans for specific investments
fully integrated into the single market. (See approved by the Bank. In 1981 the Bank
TRADE CREATION.) adopted the European Currency Unit (ECU)
as its Unit of Account in place of the
European Fund. The EUROPEAN MONETARY European Unit of Account (EU A) which had
AGREEMENT, approved in 1955 by the OEEC the same composition and value in relation to
Council, provided for a European Fund to the currencies of member states. The banks
help finance temporary BALANCE OF PAY- loans are disbursed in various currencies
MENTS deficits arising from the decision of according to the Bank's currency holdings
member countries to make their currencies and the borrower's currency preferences.
convertible into dollars. Although it began
operations in 1958 with an initial capital European Monetary Agreement. The
account of approximately $600 million, in- European Monetary Agreement was ap-
cluding $272 million from the old EUROPEAN proved by the ORGANIZATION FOR EUROPEAN
PAYMENTS UNION, the fund was eventually ECONOMIC CO-OPERATION Council in August
drawn upon only to finance a few small loans 1955. The Agreement represented the de-
to Greece, Ireland, Spain and Turkey. cision of European countries to make their
currencies gradually convertible into dollars,
European Investment Bank. A develop- thereby replacing the EUROPEAN PAYMENTS
ment bank created in 1957 by the TREATY OF UNION by a new international payments
ROME which established the EUROPEAN ECON- system in which all transactions had to be
OMIC COMMUNITY. The Bank's primary func- executed in gold or convertible curren-
tion is to promote the development of the cies. The agreement was finally implemented
European Common Market by providing in December 1958, using the BANK FOR
long term loans and loan guarantees which INTERNATIONAL SETTLEMENTS as agent for
facilitate the financing of investments in less financial operations. Although the granting
European Payments Union 137
of automatic credits was eliminated, the superseded. The ECU is the currency in
agreement created a EUROPEAN FUND which which debts and credits in the EMS are
could be drawn upon to finance temporary denominated and the intention was that the
BALANCE OF PAYMENTS d e f i c i t s . ECU should become an international re-
serve asset. Member countries have de-
European Monetary Co-operation Fund. A posited part of their reserves with the
special fund of the EUROPEAN COMMUNITY European Monetary Co-operation Fund in
established in 1973 to implement the 1972 exchange for an ECU account, which can be
BASLE AGREEMENT which created the Com- used for settling inter-member debts includ-
munity's system of managed currency mar- ing the repayment of credits extended by the
gins, commonly known as the European Monetary Co-operation Fund. The EMS is
Currency Snake. The fund, via the BANK FOR an attempt to revive a previous effort at
INTERNATIONAL SETTLEMENTS acts as a clear- currency stability among members of the EC
ing agent for the settlement of debits and plus Norway but one which was much
credits arising from intervention in Com- impaired when appreciation of the Deutsche
munity currencies on the exchange markets. Mark and depreciation of the French franc
In addition, the fund manages the Commun- made it necessary for France to leave the
ity's system of short term credits which can arrangement. This was the so-called SNAKE
be extended to member countries experienc- or snake-in-the-tunnel, since the time path
ing temporary BALANCE OF PAYMENTS difficul- of a currency's exchange rate could exhibit a
ties. The Fund has continued to play a snake-like movement within the constraints
similar role under the European Monetary set by the limits to the degree of fluctuation.
System. In its early years the EMS had only limited
success in maintaining exchange rate stab-
European Monetary Fund. ility, for there were nine currency realign-
See EUROPEAN MONETARY SYSTEM. ments between March 1979 and April 1986
but only a further one to the end of
European Monetary System. Introduced 1991. The snake and EMS were seen by
in March 1979 the European Monetary some as steps towards complete MONETARY
System (EMS) represents an attempt to UNION within the EC and the establishment
create an area of exchange rate stability of one European currency, a view vindicated
among members of the EUROPEAN COMMU- in the Delors Report, while others saw them
NITY, for most members undertook to limit as brought about to hide some of the absur-
the fluctuations in their exchange rates to dities Of the COMMON AGRICULTURAL POLICY,
plus or minus 2.25 per cent of the agreed which had constantly been broken when
central rate for their currencies. Though a exchange rates diverged. (See GREEN
member of the system the UK remained POUND.)
outside the Exchange Rate Mechanism
(ERM) until October 1990; until then there European Monetary Unit of Account.
was no par value for sterling against other See EUROPEAN UNIT OF ACCOUNT.
currencies. On joining the ERM the UK
entered with a 6 per cent spread on either European Payments Union. In 1950 the
side of the central rate, a position similar to ORGANIZATION OF EUROPEAN ECONOMIC CO-
that of Spain. OPERATION created the E u r o p e a n Payments
As part of the EMS there was introduced Union which replaced the system of Euro-
a
new international currency, the EURO- pean payments schemes introduced by the
PEAN CURRENCY UNIT (ECU), composed of Intra-European Payments Agreements of
weighted averages of currencies of EC mem- 1948 and 1949. Its purpose was to enable
bers, including the UK, and equal in value to the multilateral settlement of surpluses or
the EUROPEAN UNIT OF ACCOUNT. As parties to deficits between European countries (and
the EMS have agreed on the limits to which their respective overseas monetary areas)
their currency parities may depart from their and encourage trade liberalization policies
ECU central rates and as these are narrower by offering automatic credit facilities to
than the 2.25 per cent of the currency grid members experiencing balance of payments
ab
ove, the 2.25 per cent limit is effectively deficits. The Union, utilizing the BANK FOR
138 European Recovery Programme
MC
LRAC
Output
0 XN XM Demand - 0 + Excess
Supply Demari
excess capacity theory
excess demand
will produce on the downward sloping seg- by law to cover liabilities. Institutions m
ment of their long-run AVERAGE COST curves, want to hold more than is legally required ir
therefore producing at more than minimum order to maintain flexibility under changing
cost. conditions and/or because existing opportu]
Thus, in the diagram, the forces of com- nities to lend do not offer enough return
petition are assumed to drive the demand adequately to cover risk. (See FREE RESERVES
curve facing firm to the left until the demand RESERVE RATIOS.)
curve (D) is tangential to the long-run aver-
age cost curve (LRAC). At this point, each excess supply. A state in which SUPPLY
firm earns NORMAL PROFITS, and also pro- exceeds DEMAND at some given price. Ar
duces at a point higher than minimum aver- excess supply curve can be constructed b)
age cost (at X N rather than X M in the subtracting the level of demand from th(
diagram). Note that while there is excess level of supply at each level of price. The
capacity, the normal profits earned are at a resulting excess supply curve will, for norma
maximum since marginal cost and marginal demand and supply situations, slope up
revenue are equated for the firm. (See EX- wards from left to right but will He to the lef
CESS CAPACITY.) of the vertical axis at first, cutting the axis a
the equilibrium price.
excess demand. A state in which DEMAND
exceeds SUPPLY at some given price. The excess wage tax. A tax designed to detei
excess demand curve will slope downwards large wage increases in an attempt to reduc<
from left to right and will cut the vertical the rate of inflation. The tax has been intro
(price) axis at the equilibrium price. To con- duced in Poland and some other countries
struct the excess demand curve, subtract Wage increases above the growth of labou
supply from demand at each given price. In productivity by more than a certain percent
the diagram, for example, demand level DL age are subject to a progressive excess wag<
is less than supply at that relevant price, P t . tax. |
Excess demand is therefore negative, as
shown. At P 2 , supply and demand are equal, exchange.
so that excess demand is zero. At P 3 , there is See TRADE.
excess demand equal to D 3 -S 3 .
exchange control. The system whereb
excess reserves. The difference between the State exercises control over all or som
total legal reserves held by a US depository transactions in foreign currencies and gold
mstitution and those REQUIRED RESERVES held undertaken by its nationals. Exchange con
140 Exchange Equalization Account
trol is applied for BALANCE OF PAYMENT deriving from a MONETARIST perspective sees
reasons, and in the final analysis to avoid the the exchange not as a price equating the flow
depreciation of the EXCHANGE RATE, which, it supply and demand for a currency but as
is supposed, complete freedom in foreign the relative price of two currencies, so that
transactions would produce. Exchange con- any factor which influences the value of a
trol was introduced in the UK in 1939, to currency will influence its international
meet war-time conditions; and while it has exchange rate. The most important factor is
been considerably and progressively relaxed held to be changes in domestic money sup-
since the 1950s it was completely dismantled plies, and since people begin to form
only in October 1979 when controls on capi- expectations about the likelihood of such
tal transactions and dealings in gold were changes and of their effects, expectations are
finally abolished. (See BRETTON WOODS, CON- given a considerable role in determining the
VERTIBILITY, STERLING AREA.) exchange rate and help to explain the ob-
served volatility of exchange rates since
1973.
Exchange Equalization Account. The sys- When there is no official intervention in
tem or arrangement, rather than simply an the foreign exchange market, the rate is
'account', established in 1932 and operated freely floating and will rise or fall to equilib-
by the BANK OF ENGLAND, for controlling rate the supply of and demand for that cur-
undesired fluctuations in the sterling rency. 'Intervention' may take a number of
exchange rate following the UK's departure forms, from EXCHANGE CONTROL to action
from the GOLD STANDARD in 1931. Initially which does not interfere with the operation
endowed with a quantity of TREASURY BILLS, of the market, but aims to stabilize or con-
with which to acquire sterling, and some trol the movement of the exchange rate.
FOREIGN EXCHANGE transferred from the Under the BRETTON WOODS system in force
Treasury and the Bank, the Account was, from the late 1940s to the early 1970s,
and continues to be, operated essentially on exchange rates were stabilized at agreed PAR
BUFFER STOCK lines with purchases or sales of VALUES, though changes in these values by
sterling according to whether the aim is to REVALUATION and DEVALUATION were permit-
support the rate or to moderate its upward ted. The STABILIZATION was effected by the
movement. In 1939, at the outbreak of war, central bank operating as buyer or seller of
the entire gold holdings of the Issue its currency when it was tending to move
Department of the Bank were transferred to outside a permitted range of movement.
the Account. Since then it has effectively Since the abandonment of this 'adjustable
been the agency for holding and managing peg' system in 1971, exchange rates have
the country's external reserves, as well as the generally been subject to a system of
instrument for exercising control over the managed flexibility, with central banks inter-
exchange rate. (See FIDUCIARY ISSUE.) vening to smooth out what were considered
to be inappropriate fluctuations, although
(in theory) not opposing movements con-
exchange rate. The price of a currency in sidered to reflect longer-term, underlying
terms of another currency. Exchange rates forces. In the case of some groups of curren-
are regularly quoted between all major cur- cies, the exchange rates have been linked so
rencies, but frequently one important cur- as to limit the range of movement between
rency, e.g. the dollar, is used as a standard in them, as in the European 'Snake' and the
which to express and compare all rates. The EUROPEAN MONETARY SYSTEM. The situation
exchange rate of all fully convertible curren- of managed flexibility of exchange rates is
cies is determined, like any price, by supply sometimes referred to as 'dirty floating'
and demand conditions in the market in implying that the influences exerted by
which it is traded, i.e. the FOREIGN EXCHANGE countries over their own rates is dictated by
MARKET. More fundamentally, such supply self-interested motives. (See CRAWLING PEG,
and demand conditions are determined by PORTFOLIO APPROACH.) See MacDonald, R
whether the country's basic balance of pay- and Taylor, M.P., Exchange Rates and Open
ments position is in surplus or deficit. Economy Macroeconomics, Blackwell,
Oxford (1989).
An alternative view of the exchange rate
exit-voice model
Exchange Rate Mechanism. The Ex- individuals. Individuals will then ha1
change Rate Mechanism (ERM) is a system incentive to pay for the good but will b
by which members of the EUROPEAN MONE- to be FREE TRADERS. The provision of
TARY SYSTEM (EMS) may be obliged to main- such as National Defence or environn
tain their EXCHANGE RATES within certain protection, where the exclusion pri
bands. All countries in the EMS except does not hold, generally requires some
Greece and Portugal are members of the of government action. Although exc
ERM. Each currency in the ERM has a by the supplier is used as a criterion t
central exchange rate with each of the other tinguish public and non-public goods, i
currencies in the system, and each is permit- not suffice to define the case of a pure
ted to move up to 2.25 per cent above or good. In this case we must also consid
below the central rate. The peseta and the whether exclusion can be practised t
pound sterling have a wider margin of ± 6 consumer - i.e. is the consumer 'fore
per cent, CENTRAL BANKS have undertaken to consume the good and (2) whether the
maintain the value of their currencies within is RIVAL in consumption, that is wheth<
these limits, by MONETARY POLICY and if person's consumption reduces the qu
necessary by direct intervention in FOREIGN available to others.
EXCHANGE markets. If the bands are unsus-
tainable a realignment conference may be executive. An individual who has n
called and new mutually agreed exchange sibility with respect to some branch or
rates adopted. of a firm's activities. The term is oftei
to cover a fairly wide range of manag
exchange reserves. levels from the executive DIRECTORS to
See EXTERNAL RESERVES. echelons where responsibilities are
limited.
Exchequer. The central account of the
UK government held by the TREASURY at the exempt goods.
BANK OF ENGLAND. (See CONSOLIDATED See VALUE-ADDED TAX.
FUND.)
exhaustive voting. A form of COLL
excise duty. CHOICE in which each voter indicates hi
See CUSTOMS, EXCISE AND PROTECTIVE DUTIES.
favoured alternative. The alternative r
excludable. lowest by the greatest number of vo
then removed. The process is repeate
See EXCLUSION PRINCIPLE.
the remaining alternatives until only
exclusion. The procedure whereby a con- left. This is the chosen alternative,
sumer is 'excluded' from the purchase of a complex, this system may be said to
good by virtue of the fact that his willingness more about individual preferences tha
to pay for it is less than the market price. In pie MAJORITY RULE voting and avoi<
some cases, as with PUBLIC GOODS, exclusion problem of inconsistent choice known
may not be technically possible, whatever is PARADOX OF VOTING. (See APPROVAL V
supplied to one consumer being automati- BORDA COUNT, CONDORCET CRITERION, i
cally supplied to all others. (See EXCLUSION DECISION RULE, SOCIAL WELFARE FUNCT
PRINCIPLE.)
existence, theorem of. Any th
exclusion principle. A criterion by which which seeks to establish, usually in a g
w
e may distinguish PUBLIC GOODS from non- equilibrium context, that there exists
public goods. Where a producer or seller can of equilibrium prices and quantities
prevent some individuals from consuming EQUILIBRIUM, GENERAL EQUILIBRIUM.)
his product - generally speaking, those indi-
viduals who do not pay for the good - then exit-voice model. A classification
tn
e product can be supplied by means of a systems which individuals use to reve<
"market. Where this principle does not hold, preferences which distinguishes th(
the provision of the good to one individual which entry or exit is the mode of
Wl
H automatically make it available to other from those which require some
142 exogeneity
externalities. Externalities are variously external labour market. The market for a
known as external effects, external econo- particular number of workers that are either
mies and diseconomies, spillovers and immediately available or potentially avail-
NEIGHBOURHOOD EFFECTS. The term 'techno- able for new jobs. Within the external labour
logical external effects' is also sometimes market, pricing and allocating decisions are
used, the adjective 'technological' being controlled directly by economic variables -
introduced in order to differentiate it from there is a competitive market for the jobs in
PECUNIARY EXTERNAL ECONOMIES. Extem- question. (See LOCAL LABOUR MARKET, INTER-
alities involve an interdependence of UTILITY NAL LABOUR MARKET.)
extrema 147
external reserve. This normally refers to members, and transferable between them in
a
country's holdings of internationally settlement of international indebtedness.
acceptable means of payments for the pur- The need for external reserves is greatest
pose of covering short to medium-term defi- where a country or group of countries is
cits on its external BALANCE OF PAYMENTS, maintaining a regime of stabilized exchange
and the related purpose of exerting control rates: such countries have to be prepared
over the movement of the EXCHANGE RATE of and able to intervene in the FOREIGN
its currency. Such reserves are held princi- EXCHANGE MARKET to support the exchange
pally in gold or in one or other of the major rate of their currency at times when it is
currencies widely used in international trade weakening due to an adverse balance of pay-
and settlements. Historically, the two princi- ments or a decline of confidence in it. The
pal currencies held for this purpose have power to do this depends on the possession
been the pound sterling and the dollar. But of the necessary stocks of international
sterling's role as a reserve, and also a trading means of payment with which to make the
currency, has much diminished since the intervention. Even under conditions of vari-
mid-1960s; while the dollar is now subject to able rates, CENTRAL BANKS intervene exten-
the recurrent crises of confidence that have sively and frequently to oppose or moderate
affected sterling, it is still the major reserve what are regarded as inappropriate move-
currency in international use. For many ments of exchange rates. (See EXCHANGE
countries one attraction of holding a reserve EQUALIZATION ACCOUNT, INTERNATIONAL
currency rather than gold is that they derive LIQUIDITY.)
some return from the reserves in that the
currency holdings are normally invested in extraneous information. Prior information
short-term income-yielding SECURITIES of the (possibly a previous parameter estimate),
reserve currency country. which is combined with sample information
It should be noted that one of the original for the purposes of STATISTICAL INFERENCE OI
roles of the INTERNATIONAL MONETARY FUND ESTIMATION of parameters in REGRESSIO>
was to provide foreign currency resources analysis, usually to improve prevision 01
for member countries faced with balance of overcome problems such as MULTICOLLI
payments deficits for which their own re- NEARITY. (See BAYESIAN TECHNIQUES, RESTRIC
serves were inadequate. The Fund's powers TED LEAST SQUARES, PRIOR DISTRIBUTION.)
to fulfil this role have been extended by the
establishment in 1970 of SPECIAL DRAWING extrema. (also known as extreme points о
RIGHTS (SDRs) which are in effect a new extreme values). The highest and lowes
form of international means of payment, values of functions. (See MAXIMUM
created by the Fund, distributed among its MINIMUM.)
factor augmenting technical progress, TECH- TO INTERNATIONAL TRADE, which argues on a
NICAL PROGRESS which raises the level of out- set of restrictive assumptions that FREE
put even though the stock of CAPITAL and the TRADE is a perfect substitute for factor mo-
LABOUR FORCE have not been changed. bility and will have the effect of equalizing
the rate of payment to any factor of pro-
duction throughout the world, e.g. the wage
factor endowment. rate should be the same in all countries.
1. The levels of availability of FACTORS OF Apart from the obvious need for free trade
PRODUCTION in an area, or country: these are and the absence of transport costs, other
usually defined as land, LABOUR, CAPITAL and crucial assumptions must be fulfilled such as
entrepreneurial skills. The high-level tech- the closeness in the factor endowments of
nology of the western world uses a very countries and the absence of factor
different factor mix to that which is available reversals.
in underdeveloped countries which causes
many problems with transfer of technology. factor-price frontier. The name given by
{See TRANSFER OF TECHNOLOGY, APPROPRIATE Paul SAMUELSON to the negatively sloped
TECHNOLOGY, INTERMEDIATE TECHNOLOGY.) trade off between the wage rate and the rate
2. The quantities of FACTORS OF PRO- of profit in growth theory. CAMBRIDGE
DUCTION in a country. The different relative SCHOOL economists preferred the title 'wage/
abundance of factors of production is made rate of profit frontier', while John HICKS
the basis for explaining comparative cost referred to the same notion as the wage
differences in the HECKSCHER-OHLIN APP- frontier. In equilibrium the elasticity of the
ROACH TO INTERNATIONAL TRADE. factor-price frontier is equal to the ratio of
the shares of output going to the two factors.
(See RES WITCHING.)
factor incomes. Incomes derived directly
from the current production of goods and factor proportions. The ratio in which FAC-
services. The reward to the FACTORS OF PRO- TORS OF PRODUCTION are combined.
DUCTION for services to current production of
goods and services. It is usual to distinguish factor reversals. One of the assumptions
four main categories: rent; wages and salar- Of the HECKSCHER-OHLIN APPROACH TO INTER-
ies; interest; profits. (See NATIONAL INCOME NATIONAL TRADE is that the PRODUCTION
a n d TRANSFER INCOMES. FUNCTIONS for commodities differ in the
ratios (intensities) in which they use FACTORS
OF PRODUCTION and that a commodity which
factoring. A method of disposing of trade uses a higher ratio of, say, labour to capital
DEBTS where a company 'sells' these debts to than another will do so at all possible rela-
a financial institution. tive factor prices. It is logically and empiri-
cally possible for intensities to reverse
themselves so that e.g. the original labour
factor-price differentials. Two distinct
intensive commodity might become capital
prices for a factor of production. For
intensive if the relative price of labour rises,
example the price of labour in capitalist
through being able to substitute capital for
wage-based production and in family based labour at a faster rate than the originally
production activities. (See FACTOR-PRICE capital intensive commodity. The possibility
EQUALIZATION.)
of factor reversals throws doubt on some of
the accepted conclusions of international
factor-price equalization. A proposition de- trade theory such as FACTOR-PRICE EQUALIZA-
rived from the HECKSCHER-OHLIN APPROACH TION and the STOLPER-SAMUELSON THEOREM.
148
fair wages 149
selective tendering list. In 1982 the govern- change. Accordingly, concerted action is less
ment rescinded the resolution. easily practised.
Featherbedding will certainly increase
false trading. Trading at DIS-EQUILIBRIUM unit costs and, in the general case, prices
prices. (See AUCTIONEER, WALRAS, WALRAS' too. But because of the potentially smaller
LAW.) impact on prices in monopolistic industries,
featherbedding tends to be more prevalent
family credit. See BEVERIDGE REPORT. in precisely such industries.
family expenditure survey. An annual Fed., the. Abbreviation for the FEDERAL
RESERVE SYSTEM.
sample survey of household expenditure pat-
terns carried out by the British government.
About 7000 household units (defined as a Federal Deposit Insurance Corporation
group of individuals sharing living or eating (FDIC). A US corporation which insures
arrangements) are surveyed over a two- deposits in COMMERCIAL BANKS and savings
week period. The results are published by and loan associations up to a limit of
Her Majesty's Stationery Office. The infor- $100,000 per account per institution. The
mation is useful in analysing changes in liv- FDIC also acts as one of the agencies which
ing standards and patterns of consumption. regulates financial institutions. Members pay
to the FDIC insurance premiums which are
invested and, when necessary, used to pay
family-unit agriculture. An agricultural depositors of failed institutions. Since estab-
system prevalent in less-developed areas, lishment in 1934, no depositor in the US has
which is based on the family unit. lost funds in an FDIC insured institution.
Production is usually for SUBSISTENCE pur- However, the FDIC's potential liabilities far
poses with some produce being sold or exceed its assets, so that questions have been
traded locally to provide other needs. raised as to its usefulness in times of general
Agricultural methods are often primitive financial crisis.
and inefficient and are usually on a very
small scale and very LABOUR-INTENSIVE.
Federal Funds Market. In the US the mar-
ket in which 'immediately available' funds
FAO. are lent and borrowed, mostly on an over-
See FOOD AND AGRICULTURE ORGANIZATION.
night basis, between member banks of the
FEDERAL RESERVE SYSTEM, other major finan-
FASB. cial institutions and branches and agencies of
See FINANCIAL ACCOUNTING STANDARDS non-US banks. The market originated in the
BOARD. borrowing and lending of surplus reserve
balances (i.e. balances in excess of required
FCI. minima) at Federal Reserve Banks by mem-
See FINANCE FOR INDUSTRY. ber banks, and served to redistribute re-
serves, from temporarily overprovided to
featherbedding. Make-work practices that underprovided banks. In recent years the
encompass over-manning and/or rejection of market has extended greatly to include other
technologically advanced machinery. financial operators and the balances lent are
Featherbedding often has its origin in techni- no longer confined to funds in Federal
cal change and can thus be viewed as the Reserve accounts. It is thus a general MONEY
carrying forward of a set of practices appro- MARKET.
priate for one technology to another where it
is alien - more a 'protective 1 than a 'restric- Federal Home Loan Bank System
tive' practice. Featherbedding tends to be (FHLBS). US government agency which
more of a problem with CRAFT than INDUS- uses its power in money markets to provide
TRIAL UNIONS. This is because industrial liquidity to SAVINGS AND LOAN ASSOCIATIONS.
unions generally comprise a number of Created in 1932, it was originally viewed as a
diverse groups, some of which will be helped rescue mechanism, but in the postwar period
and others harmed by a given technological it became an important source of funds for
feedback/entrapment effects
ne
w lending by savings and loans associ- observe the regulations of the System;
ations. Particular strain is put on the FHLBS banks chartered under state laws memt
in periods of tight credit, such as 1973-4 and ship is optional. The System is respons
1980-2. for currency issue; holds reserve balar
(other than vault cash) of member bar
Federal National Mortgage Association acts as LENDER OF LAST RESORT and provi
(FNMA). Agency established in 1938 by of liquidity through discount facilities; o]
the US government to support the market ates on the volume of BANK DEPOSITS and
for government-sponsored mortgages. In the level and structure of INTEREST RATES
1968 FNMA became a private corporation, setting minimum reserve requirements
nO
w listed on the New York Stock member banks and engaging in OPEN MAB
Exchange, and makes secondary mortgages OPERATIONS (under the Federal Open Mai
of all types. FNMA's former function is now Committee); is responsible for MONET
fulfilled by two US government agencies, the MANAGEMENT a n d MONETARY POLICY Wli
Government National Mortgage Association the US and in conjunction with the Treai
and the Federal Home Loan Mortgage for EXCHANGE RATE policy and exte
Corporation, which is part of the FEDERAL monetary relations. Although a creatio
HOME LOAN BANK SYSTEM ( F H L B S ) . Also government, with the Federal Res<
known as 'Fannie Mae . Board Governors (and the Chairman) b
appointed by the President, the System
Federal Open Market Committee. generally maintained a considerable ii
See FEDERAL RESERVE SYSTEM. pendence in its own policy decisions, an
its comment on wider economic events
Federal Reserve Note. A debt instrument policies.
issued by the FEDERAL RESERVE SYSTEM in
various denominations. Federal Reserve Federal Trade Commission Act. Ena
Notes, like all legal notes, are a promise to in the US in 1914 to create a Commisi
pay the bearer the designated amount on the (FTC) with competence in business affaii
note. At one time the Federal Reserve order to investigate 'the organization, t
issued Certificates for gold or silver. The ness conduct, practices and managemen
bearer of these Certificates could demand companies engaging in interstate comm
the gold or silver backing the certificate. and to challenge 'unfair methods of con
Now, the bearer of a Federal Reserve Note tition'. The FTC also was to chalk
can only request another note in exchange 'unfair or deceptive acts or practices ii
for its surrender. Nonetheless, Federal affecting commerce'. The act include;
Reserve Notes, along with the coin minted clear definition of what constitutes unfa
by the US Treasury, are legal tender in the deceptive practices, but has left inter]
United States; that is, they must be accepted ation to the Commission and, ultimatel;
in payment of all debt. the Supreme Court.
fiduciary issue. That part of the Bank of final goods. Those goods used for the pur-
England's note issue which, under Sir poses of consumption and not utilized as
Robert Peel's BANK CHARTER ACT, 1844, it INPUTS by firms in the process of production.
was empowered to make against govern- As such they should be distinguished from
ment securities as distinct from gold (and to INTERMEDIATE PRODUCTS. It is of COUrse pOSS-
an extent, silver) coin and bullion. In 1844 ible for a good to be produced for use in
the amount was fixed at £14 million, but this both functions.
was subsequently increased, e.g. as the note
issues of other note issuing banks lapsed. In final offer arbitration. Intervention in an
1939, at the outbreak of war, all the gold INDUSTRIAL DISPUTE by an independent and
held in the Bank's Issue Department was impartial third party who examines the argu-
transferred to the EXCHANGE EQUALIZATION ments of both sides and recommends that
ACCOUNT, the Bank's note issue becoming the final offer, the final position, of one of
wholly fiduciary which it has remained ever the parties to the dispute be implemented.
since. The size of the issue is still subject to The award of the arbitrator is binding and
financial capital 15:
the practice is frequently used in the US. commercial companies and who are lending
(See ARBITRATION, CONCILIATION a n d MED- and borrowing actively in the other mone^
IATION.) markets, notably the INTERBANK, EURO
CURRENCY a n d CERTIFICATE OF DEPOSIT MAR
final product. (also known as gross dom- KETS. The FINANCE HOUSES attract mone^
estic product.) All those goods and services from small depositors, but they also taki
which are purchased by their ultimate users. up considerable funds, through mone^
The total output of the economy after BROKERS, in the wholesale money markets
eliminating INTERMEDIATE PRODUCTS. (See As in these other markets the funds are len
NATIONAL INCOME.) without security. (See 'LIFEBOAT1.)
or loan shares rank first in the capital line. GEARING RATIO) within a company's overall
They have least risk attached to them, and capital structure. Financial ratios are used to
generally the (fixed) interest has to be paid give summary indications of the financial
even if profits are not earned in a particular performance, prospects or strength of a
year. Often the loan is secured on the fixed company.
assets of the company, though unsecured
loan stock where no stock security exists is financial risk.
fairly common. Debentures may be irre- See CORPORATE RISK.
deemable, meaning the capital is not repaid
until the company goes into liquidation, or
redeemable at a specified price and date(s). Financial Times Actuaries Share Indices.
Loan stocks may be inconvertible or con- A set of PRICE INDICES and AVERAGE EARNINGS
vertible, the latter meaning that the holders and yields for UK SECURITIES on the STOCK
have the option at certain times to convert EXCHANGE. These are published every day by
into ordinary shares. the Financial Times newspaper. The London
and Edinburgh Actuary Institutes assist in
financial instrument. Any document their production. The index summarizes
which is an evidence of DEBT, and the sale or over 700 securities,about a quarter of all
transfer of which enables the seller to quoted securities on the Stock Exchange. Of
acquire FINANCE. Examples are BILLS, BONDS the securities in the indices approximately 92
and other securities, CERTIFICATES OF per cent are EQUITIES and the other 8 per
DEPOSIT. cent fixed-interest STOCKS. This index differs
from the Stock Indices of the Financial
financial intermediary. In the wide sense, Times in that it is a base-weighted chain-link
any operator engaged in bringing together index with base year 1962 = 100. (See INDEX
ultimate providers and ultimate users of NUMBERS, FINANCIAL TIMES INDUSTRIAL ORD-
FINANCE. An important distinction is be- INARY INDEX, FT-SE 100 INDEX.)
tween intermediaries engaged as BROKERS in
bringing together borrowers and lenders, or Financial Times Industrial Ordinary Index.
buyers and sellers of securities, without Prior to the advent of the FT-SE IOO INDEX in
entering into the transaction as principals; 1984 the most commonly quoted index of
and intermediaries who themselves borrow SHARE prices used as a general indicator of
or take up funds in order to on-lend them. the state of the STOCK MARKET in the UK. It
Prominent among the latter are institutions has a base year of 1935 = 100 and is only one
like BANKS, BUILDING SOCIETIES, and INSUR- of a number of Stock Indices published daily
ANCE COMPANIES, which in taking up funds by the Financial Times newspaper; it is
create claims on themselves, these being simply an average of thirty BLUE-CHIPS. (See
matched by the assets, largely claims on INDEX NUMBERS, STOCK MARKET.)
others, which they acquire. The term 'non-
bank financial intermediaries' distinguish
those institutions, e.g. building societies and financial year. Different bodies use diff-
insurance companies, whic^h create claims erent financial years for financial account-
that are not normally reckoned as part of the ing and this need not be coincident with the
money stock. standard calendar year. Thus, the UK
government's tax year is from 6th April
financial ratios. Ratios between particular in one year to the 5th April in the next
groups of the ASSETS or LIABILITIES of an
year, whereas the USA tax year runs be-
enterprise and corresponding totals of assets tween 1st July of one year and 30th June of
or liabilities; or between assets or liabilities the next.
and flows like turnover or revenue. A lead-
ing example is the price/earnings ratio which fine tuning. A term used to refer to gov-
is the ratio of the current quoted STOCK ernment policies which aim to make small
EXCHANGE price of an EQUITY to the most changes in taxation or expenditures which in
recent declared dividend per share. Another turn are designed to influence employment
is the ratio of equity to DEBT FINANCE (the levels, NATIONAL INCOME and price levels.
fiscal federalism 155
finite memory. A property of a TREND STA- first difference. The difference between a
TIONARY PROCESS. variable and its own value lagged by one
time period. We can also calculate a second
difference as the first difference of the first
firm. In standard neo-classical economics
difference. Similarly, the third difference is
an analytical label for the institution which the first difference of the second difference,
transforms inputs into output. Thus the firm etc.
is viewed as an abstract entity which fulfils a
mainly technical role. Though simple, when
first order condition. Generally the con-
combined with the assumption of profit
dition which states that the first derivative(s)
maximization it provides useful insights into
of the OBJECTIVE FUNCTION with respect to the
firm behaviour and the determination of
CHOICE VARIABLE(S) should be equal to zero
industry output and price as in PERFECT COM-
for the determination of an EXTREME VALUE
PETITION and MONOPOLY. A more sophisti-
(maximum or minimum). {See SECOND
cated definition of the firm would take into
ORDER CONDITION.)
account its role as a coordinating device
which allocates resources within itself. This
fiscal decentralization.
role has been a central concern of BEHAV-
See FISCAL FEDERALISM.
IOURAL THEORIES OF THE FIRM.
fiscal drag. The effect of inflation on AVER-
firm, theory of the. The theory of the FIRM AGE OR EFFECTIVE TAX RATES. Thus under an
is an important topic in MICROECONOMICS unindexed PROGRESSIVE income tax system
which is concerned with explaining and pre- the effective tax rate is increased when
dicting the behaviour of firms, particularly money incomes increase even though real
with respect to pricing and output decisions. incomes may not be increasing. This is be-
{See THEORY OF PRICE.) It also includes con- cause income earners are pushed into
sideration of such topics as choice of pro- income brackets where high MARGINAL RATES
duction process, ADVERTISING, PRODUCT apply. The result of this is to cause a dam-
INNOVATION, INVESTMENT decisions and DIVI- pening effect on the volume of economic
DEND policy. The traditional theories are activity. Its prevalence led to a campaign for
based on the assumption of profit maximiz- indexation of tax allowances.
ation and generate different pricing and out-
put predictions depending on the degree of fiscal federalism. A system of TAXATION
competition in the markets in which the firm and PUBLIC EXPENDITURE in which revenue
operates. Modern theories of the firm em- raising powers and control over expenditure
phasize the separation of ownership and are vested in various levels of government
control that has taken place historically. This within a nation, ranging from the national
separation, in the presence of imperfections government to the smallest unit of local gov-
in the capital market and product markets, ernment. Most western nations operate
permits the managers of firms to pursue poli- some degree of fiscal federalism though, for|
cies other than profit maximization, MANA- example, the autonomy of local govern-j
GERIAL THEORIES OF THE FIRM analyse the ments in the US is rather greater than that of
consequences for firms conduct and per- local authorities in the UK.
formance, when objectives other than profit A system of multi-level finance may be
maximization are adopted. (See SALES MAXI- justified in terms of ALLOCATIVE EFFICIENCY
MIZATION HYPOTHESIS, DISCRETIONARY PROFITS on the grounds that while some PUBLIC
and GROWTH THEORIES OF THE FIRM.) Another GOODS, such as national defence, confer
modern departure from traditional theories benefits on the nation as a whole, the bene-
are the BEHAVIOURAL THEORIES OF THE FIRM fits of other goods, such as refuse collection,
where the assumption that something is are more limited in geographical incidence.
maximized is replaced with one of SATISFIC- It is argued that by making decisions con-
ING BEHAVIOUR. See Archibald, G.C., 'The cerning the provision and financing of the
Theory of the Firm', The New Palgrave - Л latter type of goods at the level of local
Dictionary of Economics, Macmillan, Lon- rather than national governments, the 'best'
don (1987), Vol. 2, pp. 357-363 or OPTIMAL level of provision is more likely
156 fiscal illusion
to be achieved. Further, allowing local com- may be varied to stimulate the level of
munities to vary the 'mix' of taxes and public AGGREGATE DEMAND for this p u r p o s e . T h e
services they provide is said to enable indi- overall effect on economic activity will
viduals to choose to live in that community depend on the size of the tax cut and the
which offers the combination of taxes and value of the MULTIPLIER. Increasing govern-
services most in line with their preferences. ment expenditure will raise the level of
(See TIEBOUT MODEL.) activity by an amount equal to the change in
The economic theory of fiscal federalism expenditure times the multiplier. It is argued
analyses such issues as the optimal size and by some economists who advocate the use of
number of local governments and the div- fiscal policy that the changes in taxation
ision of tax and expenditure powers between together with TRANSFER PAYMENTS pro-
the various levels of government. In so doing portional to the existing distribution of
it draws on the economic theory of CLUBS. income are the appropriate weapons to regu-
late aggregate activity. They argue that
fiscal illusion. A situation in which the changes in government expenditure should
benefits of particular government expendi- only be made if there is a shift in demand for
ture are clearly identified by recipients but PUBLIC GOODS.
the costs are not, these being widely dis- The use of fiscal policy entails changes in
persed over time and population. The direct the government's budget including the possi-
fiscal costs may be spread over the entire bility of deficits. The conventional view is
tax-paying community and individual costs that the use of deficit finance in this situation
hidden amongst a large number of other is perfectly proper though attention has to
government spending programmes which be given to the impact of this as well,
the tax-payer is called to finance by general although this view has recently been chal-
taxation. The fiscal illusion of the tax-paying lenged by MONETARISTS and the NEW CLASSI-
public thus tends to produce a structure of CAL MACROECONOMISTS who emphasize the
incentives facing political decision-makers inflationary consequences of budget deficits.
that leads to the adoption of public spending (See also BUDGET DEFICIT, CROWDING OUT.)
programmes. (See ECONOMICS OF POLITICS.)
fiscal welfare benefits.
fiscal multiplier. A coefficient that indi- See TAX EXPENDITURES.
cates by how much an increase in fiscal
expenditure affects the equilibrium level
of income. For example, in the simple Fisher, Irving (1867-1947). American eco-
Keynesian model nomist, described by SCHUMPETER in 1948 as
America's greatest scientific economist.
A After training in mathematics he turned to
C+I+G economics. He was a joint founder and first
С + cY President of the Econometric Society in
1930. His work is permeated by a search for
_ numerical application; for him no theory was
= G of use unless it led to applied work and the
the reduced form for income, Y, is
quantitative analysis of factual data. His
abilities lay less in original thought than in
Y = (С + I + G ) = « A the provision of logically-consistent and ex-
1 -С
tremely lucid syntheses of existing theories.
where A is autonomous expenditure and a He made significant contributions to the
is the fiscal multiplier. (See MULTIPLIER, problems of capital, interest, money and
MONEY MULTIPLIER(2)). INDEX NUMBERS and to the theory of DISTRIB-
UTED LAGS.
fiscal policy. Generally refers to the use of In The Nature of Capital and Income
taxation and GOVERNMENT EXPENDITURE to (1906) Fisher analysed the relationship be-
regulate the aggregate level of economic tween the two concepts and explained the
activity. Thus if UNEMPLOYMENT is regarded value of capital in terms of the discounted
as excessive, INCOME and EXPENDITURE TAXES value of expected future income. In The
fixed labour costs 157
purchasing Power of Money (1911) he devel- fixed cost. For a firm the SHORT RUN is
oped the QUANTITY THEORY OF MONEY, MV = defined as the period of time over which
pQ, (where M is the stock of money in some FACTORS OF PRODUCTION cannot be
circulation, V" its velocity of turnover and Q varied. The latter are known as FIXED FAC-
the overall volume of transactions) to TORS and the costs associated with them as
explain changes in the price level P. He was fixed costs. Fixed cost does not therefore
well aware of the limitations of this theory, vary with output. An example would be the
namely that V and Q might be variable. In cost of a factory which, in the short run,
The Theory of Interest (1930), which rep- cannot be expanded to meet increased
resents a definitive treatment of earlier demand. Only labour and perhaps other
work, especially that of BOHM-BAWERK, he inputs can be varied - these are the variable
explains the determination of the rate of factors the costs of which are VARIABLE
interest by the balance between the supply COSTS. (See also AVERAGE COST.)
of capital funds, influenced by the psycho-
logical forces of TIME PREFERENCE, and the fixed exchange rate.
productivity of investment, or the rate of See EXCHANGE RATE.
return over cost as he calls it.
In The Making of Index Numbers (1922) fixed factors. Those FACTORS OF PRO-
he set out to identify the characteristics of DUCTION which cannot be changed in quan-
the best feasible index of prices for tity. Usually this will apply to some factors
measuring changes in the purchasing power such as CAPITAL, in the SHORT RUN.
of money, and he recommended the geo-
metric mean of the PAASCHE and LASPEYRES fixed investment. All FINAL GOODS pur-
indices as the ideal index.While the present chased by FIRMS other than those additions
is linked to the future in measuring capital as to INVENTORIES which are not intended for
the discounted value of future income, eventual resale. Additions to the CAPITAL
Fisher also saw the systematic dependence STOCK. (See INVESTMENT.)
of the present on the past and this led him to
investigate the properties of DISTRIBUTED fixed labour costs. These comprise costs of
LAGS. employment that vary less than proportion-
ately with hours worked. There are two
main forms of fixed cost. First, there are
Fisher equation.
turnover costs associated with the hiring,
See FISHER, IRVING, CAMBRIDGE SCHOOL,
lay-off or dismissal of employees. These in-
FRIEDMAN, QUANTITY THEORY.
clude the costs of recruitment, screening and
initial training, in addition to termination
Fisher open. costs in the form of SEVERANCE PAY. Second,
See UNCOVERED INTEREST PARITY. there are those costs which, although con-
tinuing throughout the period of employ-
ment, are not related or fully related to
fixed asset. Any non-financial capital hours of work. Examples include employ-
ASSET of a company which is relatively long- ment taxes that are based on numbers of
lived and specific to particular productive employees, and contribution to private pen-
processes, and the cost of which is normally sion schemes whose base has an annual earn-
recoverable only over an operating period of ings limit.
some duration, e.g. plant and buildings.
Such assets are illiquid compared with cur- The presence of these costs introduce an
rent (or short-term) ASSETS such as stocks of element of capital or fixity into the use of
materials or semi-finished or finished goods. labour, and because of this labour is com-
(See LIQUIDITY.)
monly said to be a quasi-fixed factor. As a
result, we would expect greater employment
continuity among workers with high fixed
fixed coefficients production function. A costs of employment, a pro-cyclical behav-
production function in which INPUTS must be iour of labour productivity, and more
combined in fixed proportions. (See FIXED reliance on OVERTIME working in those indus-
PROPORTIONS IN PRODUCTION.) tries and time periods where fixed costs of
158 fixed-price models
employment are relatively high. (See NON- flexitime. The name given to flexible
W A G E LABOUR COSTS.) working hours. Economic theory indicates
that there are gains to be made by following
fixed-price models. Models which assume flexitime because of the divergent tastes and
that transactions occur at non-equilibrium preferences of different workers. The bene-
prices and that these prices remain fixed. fits obtain from reduced absenteeism and
Such models are based on the assumption turnover, and perhaps from increased mor-
that prices and wages do not move immedi- ale and productivity. The basic argument is
ately and effortlessly to clear the market. that flexible working hours enable indi-
They describe a temporary equilibrium and viduals to make optimal supply choices
are, therefore, of greatest relevance in the whereas rigid working hours lead to in-
short run. The development of such models stances of suboptimization because of the
is most closely associated with the work of different tastes and preferences of workers.
Malinvaud. In The Theory of Unemployment Flexitime has its attendant costs in the form
Reconsidered (Basil Blackwell, Oxford, of monitoring, supervision, communication
1977), Malinvaud builds on the work of and co-ordination expenses. Recent in-
Clower and Leijonhufud who provided more creases in the use of flexitime would indicate
rigorous microeconomic foundations for that the benefits are outweighing the costs in
Keynesian economics. He distinguishes the many employment situations.
characteristics of temporary equilibria and
identifies circumstances in which real wage flight from cash. This refers to moving
rises will increase unemployment, which he WEALTH from cash into interest-bearing
labelled classical unemployment, and cir- ASSETS; either because of EXPECTATIONS of
cumstances in which real wage rises will re- price increases or a fall in the INTEREST RATE.
duce unemployment, labelled Keynesian
unemployment. float. The difference between uncollected
cash items or cash items in the process of
fixed proportions in production. This re- collection and deferred availability cash
fers to production processes in which the items. Float occurs because the records of
CAPITAL/LABOUR RATIO is fixed - i.e. they can the money balances of the parties involved
only be used in fixed proportions. The in a transaction are not adjusted simul-
resulting ISO-PRODUCT CURVE is 'L' shaped. taneously. There are delays (internal and
Since fixed proportions characterize INPUT- external) between the time one party's
OUTPUT analysis this type of iso-product account is credited with a payment and the
curve is sometimes called an input-output time another party's account is debited by a
isoquant, or LEONTIEF isoquant. payment. For example, if a cheque was writ-
ten on a New York bank and presented for
payment in California, the New York bank
fixprice and flexprice. A distinction first would have the money still on deposit while
introduced by J.R. HICKS between prices the cheque is clearing through the Federal
which do not respond to underlying changes Reserve System. Thus, the New York bank
in SUPPLY and DEMAND, fixprices, and prices
would have more reserves than it should
which respond immediately to excess sup-
have for a few days.
plies or demands, flexprices (see FIXED-PRICE
MODELS). Hicks explored the implications
floating capital. A term with the same
for the MULTIPLIER process of these two types
meaning as working capital; it refers to
of prices in The Crisis in Keynesian Econ-
money invested in work in progress, wages
omics, Basil Blackwell, 1974.
paid or any other type of investment which is
not a fixed ASSET. It is still considered an
flat yield. The annual amount paid in investment as it is part of productive ca-
interest on a security expressed as a percent- pacity being utilized.
age of the purchasing price.
floating charge. A form of security given
flexible exchange rate. by a borrower for loans, or other debt, e.g.
See EXCHANGE RATE. DEBENTURES. The security is not attached to
forced riders 15
specific items of the borrower's assets but sector a deficit, while the position varie
constitutes a floating charge on stocks or from time to time in the other two sectors.
other assets which individually are turning
o
ver in the course of trading. FOB. Free On Board. A term whic
describes a price for or valuation of a goo>
floating debt. That part of the NATIONAL which is calculated on the basis of the prc
DEBT borrowed on very short-term SECURI- cess of manufacture, and does not includ
TIES, and frequently denoting the part rep- the cost of transporting the good to the cor
resented by TREASURY BILLS. It is 'floating' in sumer. This may be contrasted with ci
that it is continuously falling due for repay- (cost, insurance, freight or charged in full
ment. Unless met from a fiscal surplus or the pricing or valuation which includes all of th
proceeds of selling longer-term debt, such costs of delivering the good to the point с
repayment requires the issue of new short- consumption. Where a firm prices its good
term debt or the creation of money. FOB we can be sure that the consumer pay
the transport costs. This eliminates th
floating exchange rate. p o s s i b i l i t y Of SPATIAL PRICE DISCRIMINATIO>
See EXCHANGE RATE. Note that in the UK overseas trade accoum
imports are valued CIF while exports ai
floating pound. valued FOB. However, in calculation of th
See EXCHANGE RATE. BALANCE OF PAYMENTS both exports and in
ports are measured FOB, the various TRANJ
FER COSTS being entered in the INVISIBLES.
floor. The limit to downward movements
in output in TRADE CYCLE theory. The funda-
mental element in the lower limit to move- Food and Agricultural Organization (FAO
ments in output (or incomes) is AUTONOMOUS Established in 1945 the FAO has its heac
INVESTMENT but in certain theories (i.e. that quarters in Rome. With a view to improvin
of J.R. HICKS) the interaction of the MULTI- the production and distribution of agricul
PLIER and ACCELERATOR will ensure that the tural commodities and food, the Organis
floor is never actually reached, in contrast to ation is entrusted with the task of collectin
the CEILING along which income 'crawls' in and studying relevant data and of promotin
the same theory. international commodity agreements an
technical assistance. As a specialized agenc
flotation. The practice of issuing shares to of the UN, the FAO has concentrated il
the public in order to raise new CAPITAL. (See activity upon technical assistance towarc
SHARES.)
less developed countries.
ated with the characteristics of PUBLIC actual outcome is the normal test of the
GOODS. Yet the presence of public goods acceptability of an econometric model. (See
may be a necessary but not sufficient con- FORECAST ERROR, VECTOR AUTOREGRESSION.)
dition for free riders. Moreover, it has been
argued that the 'public goods' dimension of foreign aid. Any capital inflow or other
certain services, and in particular those pro- assistance given to a country which would
vided by trade unions, has been overstated not generally have been provided by natural
in the public choice literature. market forces. There are four main types of
aid. First, long-term loans which have to be
forced saving. A form of saving which repaid in foreign currency but are usually
occurs because consumers are unable to repayable over ten or twenty years. The
spend their money on desired consumption advantage to the recipient is that the annual
goods simply because those goods are repayments are far less burdensome than
unavailable. In FREE MARKETS such a situ- those of short and medium-term loans.
ation is likely to be temporary - suppliers of Secondly, there are 'soft loans' which can be
goods will observe the unmet demand repaid in local currency. Some are paid in
through such 'signals' as decreases in INVEN- foreign currency but over long periods such
TORIES and will react by increasing supply. In as 99 years with very low interest rates while
PLANNED ECONOMIES such a response may not some which are repaid in local currency will
occur if increases in the supply of such goods then be lent back to the recipient for further
are deemed inconsistent with the overall development work. Sometimes straight
planning of the economy. Forced saving grants are given. The third type of aid is the
may therefore be persistent in such sale of surplus products to a country in
circumstances. return for payment in that country's local
currency, as with the PL480 programme of
forecast error. The difference between the the USA. This can be very valuable to an
predicted value of a variable obtained by underdeveloped nation with very little
forecasting methods and the actual outcome, FOREIGN EXCHANGE as it will enable them to
Tests of the acceptability of an ECONOMETRIC buy from abroad. They often need to import
MODEL may be based on forecast errors. foodstuffs and other consumption goods as
their own agricultural sectors cannot pro-
forecasting. A systematic method of duce enough to maintain the urban
obtaining an estimate of the future value of a workers involved in construction or other
variable, usually based on an analysis of investment-oriented work. The fourth type
observations on its past behaviour. Fore- of aid, although not strictly a capital inflow,
casting is normally based on one of two tech- is technical assistance given to underdeve-
niques involving TIME SERIES data. The first is loped countries.
the BOX-JENKINS methods, which are particu-
larly suitable for short-term forecasting but foreign balance.
less valuable for long-term forecasts. The See BALANCE OF PAYMENTS.
second approach is to use an ECONOMETRIC
MODEL, which specifies the variable of inter- foreign exchange. CURRENCY or interest-
est as an ENDOGENOUS variable, which is part bearing BONDS of another country, for
of a system. Forecasts can then be made example holdings by UK nationals of US
which take account of the interactions dollars, EURO-DOLLARS, Deutsche marks,
amongst many variables, provided appropri- Swiss francs, or US government bonds. (See
ate values of the exogenous variables are FOREIGN EXCHANGE MARKET, EXCHANGE CON-
available. TROLS, BALANCE OF PAYMENTS, EXTERNAL
Often forecasts are based on a combi- RESERVES.)
nation of both methods, with the forecasts of
the endogenous variables generated from foreign exchange market. The inter-
the REDUCED FORM of the econometric model national market in which currencies are
and the exogenous variables from Box- transferred between countries. The trans-
Jenkins methods. A comparison of the actions, mainly carried out by telephone
forecast values of a variable against the or cable are between financial institutions
foreign trade multiplie
buying and selling foreign currencies thus (or withdrawals) in the economy, i.i
making profits when the exchange rates and ings, imports and taxes, sum to $100 n
nterest rates differ between financial In the first round, factors in the
entres. The 'market' operates 24 hours a industry will receive an increment in i
a s e a c n c e n t r e
day throughout the world of $100 million. Of this part will be
begins trading during 'office hours' or when taxation, part will be spent on import
their respective STOCK MARKETS and BANKS will be saved and only that used I
are open. (See EXCHANGE RATES, STOCK- home-produced goods will generate 1
M A R K E T BANKS, INTEREST RATES.) income, because it is a demand upor
estic resources. In the next round i
foreign exchange reserve. will be allocated in like manner, anc
See EXTERNAL RESERVE. only that part spent on home goo<
generate further income.
foreign investment. This usually refers to The foreign trade multiplier is sim]
any investment in another country which is conventional MULTIPLIER but viewing e
carried out by private companies or indi- as the multiplicand so that its formula
viduals as opposed to government aid. There
are arguments for and against foreign invest-
ment in underdeveloped countries: those к = 1 - MFC '
against say that it constitutes economic
where к is the multiplier and MPC
colonialism and is an attempt to retain con-
MARGINAL PROPENSITY TO CONSUME d(
trol of ex-colonies. In addition, the country
becomes reliant on the foreign firms which cally produced goods. Alternatively it
may delay the setting up of domestic viewed as the reciprocal of all the m
industry or the training of experts while propensities to withdraw, i.e.
there are expatriates paid from abroad who
will do the job. In addition, foreign invest-
ment often involves the importation of
к = MPS - MPPT + MPM
totally inappropriate technology, in order where MPS is the MARGINAL PROPEN!
that the foreign company can benefit from SAVE, MPPT is the MARGINAL PROPEN:
cheap labour or a cheap power source. The PAY TAXES, i.e. the part of an incren
arguments supporting foreign investment income which goes on taxes and MPM
are that this type of investment achieved MARGINAL PROPENSITY TO IMPORT.
beneficial results in the Western world and The foreign trade multiplier has a
therefore will succeed elsewhere; that there play in the BALANCE OF PAYMENTS equil
will be spread effects and that local people mechanism. A rise in exports, whii
can be trained in the foreign firms. There proves the balance of payments, sets i
can be no general solution to this debate forces which will tend to reverse tl
since each individual case has to be judged provement, for out of the higher i
on its own merits. (See APPROPRIATE TECH- brought about by the multiplier, me
NOLOGY, FOREIGN AID.) ports will be induced, while the other
the coin is that countries which have
foreign payments. Any payment that has the extra imports will experience a rec
to be made to a foreign country whether in in income, which will cause an event
return for goods and services or as repay- in imports, thus tending to restore b
ment of debt: these usually have to be made by action on two sides.
Ш HARD CURRENCY. (See FOREIGN AID.) The foreign trade multiplier also of
explanation of the international transr
foreign trade multiplier. The ratio which a of BOOMS and DEPRESSIONS. A dec!
change in income bears to the change in INCOME in a major importing count
exports responsible for this change in lead to a decline in its IMPORTS, whi
mcome. If, for example, a country experi- some other country's EXPORTS. That с
ences a rise in exports to the value of $100 will suffer a reduction in income and i
"million, its national income will rise by a imports, which may affect the с
Multiple of this, until the induced leakages country or some third country. The f
162 forward contract
will continue until withdrawals on a world interest rates are higher, buy the currency of
scale match the decline in the income gener- that centre on the spot market and invest in,
ating factor in the country which first experi- say, three-month bills. At the same time, to
enced the RECESSION. cover the risk of an adverse exchange rate
movement they will sell the centre's cur-
forward contract. (also known as a rency forward. The effect of these actions is
future.) See FORWARD MARKET. to raise the spot rate and depress the for-
ward rate. When the discount on the for-
forward exchange market. A market in ward rate reaches a certain level it will cease
which currencies are bought and sold at rates to be profitable to move funds to the centre.
of exchange fixed now, for delivery at speci-
fied dates in the future. A transactor expect- foundation grant. A form of INTER-
ing to acquire a currency, or to have to make GOVERNMENTAL GRANT widely used in the
a payment in it, at a future time, may sell or USA which aims to equalize the cost to each
buy the currency forward, thus covering local community (in terms of the tax rate
himself against any changes in its exchange which it must set) of providing a given mini-
value in the intervening period, others may mum level of a public service. The required
operate in the market as pure speculators; grant is calculated by taking the amount of
this is facilitated by the fact that no payment money required to provide the service and
is due on a forward contract until it matures. subtracting from it the amount of revenue
which the local government would obtain by
forward integration. levying the tax under consideration at the
See VERTICAL INTEGRATION.
specified rate. If the revenue is less than the
cost of the service the local government
receives funds from a higher level govern-
forward linkage. The relationship be- ment to fill the gap. (See EQUALIZATION
tween an industry or firm and other indus- GRANTS.)
tries or firms which use its OUTPUT as an
INPUT. A change in output or price will be Fourier analysis. A method by which TIME
transmitted forwards to users of its product. SERIES data can be transformed to the fre-
quency domain. Suppose there are N points
forward market. Any transaction which x b . . .. xN and it is possible to derive a
involves a contract to buy or sell COMMODI- function x(t) which passes through each of
TIES, or SECURITIES at a fixed date at a price the N points. This can be done by making
agreed in the contract, is part of a forward x(t) a linear function of N trigonometric
market. (See FORWARD EXCHANGE MARKET, terms. Fourier analysis is the method by
OPTIONS.) which this can be done.
The Fourier version of the series xt is
forward rate. The rate of exchange at given by
which a currency may be bought or sold for V2
future delivery, on the FORWARD MARKET. XtN-^a{) + N cos Xjt + b,- sin X,-/)
Different rates apply to different forward
dates; and depending *on expectations the
forward rate of a currency may be at a dis- tor n = —
count or a premium on the SPOT RATE. With
completely neutral expectations the forward where /V is even and a0, #,, and b{ are the
rate between two currencies will theoreti- Fourier coefficients. When time series are
cally reflect the difference between short- transformed in this way the effects of oper-
term interest rates in the respective ations such as seasonal adjustment can more
countries, the currency of the country with effectively be analysed. (See A.C. Harvey,
the higher interest rate being traded at a Time Series Analysis, P. A. Allan, 1981.)
forward discount on the spot rate. The cause
of this is 'covered interest arbitrage'. fractional reserve banking. The practice
Holders of internationally mobile short-term by which COMMERCIAL BANKS maintain a re-
funds will move them to the centre where serve of highly liquid assets equal to some
free rider 16!
fraction, normally a small one, of their total the 'use' of clean air by pollution imposes
asset portfolios. The purpose of the reserve cost on society. Examples of free goods ar
• to meet unforeseen variations in the out- rare and perhaps becoming rarer still - sun
flow of deposits by withdrawals or transfers shine in the Sahara Desert provides on
(by CHEQUE) to other banks, and when calcu- example.
lated as a proportion of total deposits, as it
usually is, the fraction is termed the 'reserve free market. A market in which there is a
ratio'. The general level of the ratio may be absence of intervention by government an
determined by prudential considerations where the forces of supply and demand ar
based on experience, and be subject to vari- allowed to operate freely.
ations in the light of expectations and the
attractiveness of other assets. But in most free market economy.
modern systems reserve ratios are subject to See MARKET ECONOMY.
legal minima administered by the CENTRAL
BANK in the interest of MONETARY and CREDIT free on board.
POLICY. In the theory of bank CREDIT CREA- See FOB.
TION fractional reserve banking is a necess-
ary condition of the creation of CREDIT and free reserves. The total legal reserves he
BANK DEPOSITS by the banking system, and by a depository institution less the amoui
the reserve ratio is one factor determining of required reserves and less the amount <
the size of the CREDIT and MONEY MULTIP- reserves borrowed from the Feder
LIERS. (See OPEN MARKET OPERATIONS.) Reserve. Free reserves are no longer a pa
ticularly important reserve measure. Exce
franked investment income. This gener- reserves are now considered a much betti
ally refers to income which has already indicator of potential availability of cred
borne CORPORATION TAX and is thus not sub- and monetary expansion. (See EXCESS RJ
ject to further corporation tax in the hands SERVES, REQUIRED RESERVES, a n d RESER\
of a company which receives it. This nor- RATIOS.)
mally arises with incoming dividends from
other UK companies. free rider. A phenomenon arising fro
the characteristics of PUBLIC GOOD
free exchange rates. Basically, the fact that public goods are NOI
See EXCHANGE RATES. RIVAL means that the provision of the goc
to one person entails its provision to anotfr
freedom of entry. The ability of a new person. If potential consumers are therefo:
firm to enter a market for a good or service. faced with the issue of financing the pro\
In the complete absence of BARRIERS TO sion of the good, each one has an incentr
ENTRY, entry is free. not to state his true WILLINGNESS TO PAY sim
he can gamble on the good being provided
free good. A good, the supply of which is others who will express some willingness
at least equal to the demand at zero price. pay. Where the good cannot be varied in si;
Price in this context refers not simply to the good may therefore be provided ai
money price but rather to whatever has to be those who falsely stated their preference w
foregone in providing the good - OPPOR- nonetheless benefit from the existence of tl
TUNITY COST. A true 'free good' is one which good. If the size of the good can be varii
ls
not scarce and should thus be dis- (e.g. variable amounts of clean air) th<
tinguished from goods provided at zero price understatement of preferences will cau
ty governments (such as medical care in less of the good to be provided than won
^ritam) or available at zero price because of otherwise be the case. Those understati
n
e absence of ownership or PROPERTY RIGHTS their preferences may still gain howev
-•such as clean air. In both of these cases, since they will receive the amount of t
the good is available at zero cost to con- good in question and will still not pay for
sumers but a real cost is involved in their They are thus known as 'free riders'. If t
°nsumption - medical care requires re- free rider phenomenon is a strong or
sources which could be used elsewhere and public goods will be systematically und<
164 free trade
provided and there is a prima facie case for result unemployment and unfilled vacancies
the good to be provided through govern- can exist side by side. More recently, it has
ment action. Whether the degree of 'free been suggested that SPECULATIVE and PRE-
rider' understatement is significant in prac- CAUTIONARY UNEMPLOYMENT should also be
tice or not is debated. Some experiments in considered elements of frictional unemploy-
seeking hypothetical expressions of willing- ment. (See also JOB SEARCH.)
ness to pay suggest that true and 'revealed'
preferences do not diverge significantly. Friedman, Milton (1912- ). Appointed
Professor of Economics at the University of
free trade. A policy of non-intervention Chicago in 1948 and the leading member of
by the state in trade between nations, where the CHICAGO SCHOOL. He was awarded the
trade takes place according to the inter- Nobel Prize for Economics in 1976.
national DIVISION OF LABOUR and the theory His major works in economics include
Of COMPARATIVE ADVANTAGE. S u c h a p o l i c y Taxing to Prevent Inflation (1943); Essays in
would lead to the most efficient allocation of Positive Economics (1953); A Theory of The
resources on a world scale and to the maxi- Consumption Factor (1957); Price Theory
mization of world income. Despite its strong (1962); A Monetary History of the United
theoretical backing, free trade has rarely States 1867-1960 (1963); and Inflation
if ever been practiced by one country let Causes and Consequences (1963).
alone by the community of all countries. Friedman was a pioneer in developing the
Governments may intervene in international idea of HUMAN CAPITAL and his work on the
trade for non-economic reasons, e.g. for CONSUMPTION FUNCTION led to the formu-
national defence or for social reasons such as lation Of his PERMANENT INCOME HYPOTHESIS.
the maintenance of a particular class like the His methodological stance of POSITIVE ECON-
peasantry, or for economic reasons. The lat- OMICS, his libertarian ideology, and his for-
ter include the protection of established mulation Of the NATURAL RATE OF UN-
industries under threat from IMPORTS, the EMPLOYMENT have contributed to his stress
protection of INFANT INDUSTRIES, the terms on the limitations of Keynesian STABILIZ-
of trade (or optimum tariff) argument and ATION policies.
the PAUPER LABOUR argument. With Anna Schwartz he wrote a monu-
mental monetary history of US which pro-
free trade area. A loose grouping of vided much of the basis for his development
countries within which TARIFFS and other of the QUANTITY THEORY OF MONEY and his
barriers to trade are removed, while each revival of the pre-Keynesian faith in the
member country retains its own COMMERCIAL automatic stability of the economic system.
POLICY to countries outside the area. His expansion of the FISHER EQUATION to
include such variables as WEALTH, rates of
frequency distribution. A summary, usu- INTEREST and the expected rate of price
ally in the form of a table of numbers or a INFLATION, has led to a growth in the MONE-
HISTOGRAM, of the number of times a RAN- TARIST literature on macroeconomics. (See
DOM VARIABLE takes on certain values, or PHILLIPS CURVE, DEMAND FOR MONEY,
ranges of values in a sample of observations. METHODOLOGY.)
If each of the frequencies is divided by the
number of observations in the sample, the fringe benefits. All those non-wage and
resulting figures constitute a relative fre- salary elements in the total pecuniary re-
quency distribution, which approximates to wards an employee receives from his
the PROBABILITY DISTRIBUTION of the variable employment. Example would be employers'
as the sample size becomes very large. pension contributions on behalf of the
employee, the free use of a car, employers'
frictional unemployment. Traditionally payments of subscriptions to clubs and
thought of as SEARCH UNEMPLOYMENT that is associations or discounts on purchases of
the amount of unemployment that corre- certain goods and subsidized meals. (See
sponds to job VACANCIES in the same LOCAL also TOTAL LABOUR COSTS, NET ADVANTAGES,
LABOUR MARKET and occupation. It takes VARIABLE LABOUR COSTS a n d NON-WAGE
time to match workers and jobs and as a LABOUR COSTS.)
function 1(
Frisch, Ragnar (1895-1973). Norwegian AVERAGE FIXED COST and the NET PROFIT ma
economist and joint winner with Jan TINBER- gin. It is a concept used with reference 1
N o
f the first Nobel Prize for Economics in FIRM pricing rules. (See also FULL СО:
1969 for his achievements in rendering econ- PRICING.)
omic theory more mathematically stringent
and giving it forms, which are capable of full cost pricing. A pricing rule whei
em
pirical quantification and statistical FIRMS add a NET PROFIT margin onto unit cos
testing. where the calculation for the latter includ<
Frisch was responsible in the early 1930s all costs. (See AVERAGE COST PRICING.)
for pioneering work involving the dynamic
formulation of TRADE CYCLES, in which he full-employment budget surplus.
showed how a dynamic system with certain measure of the thrust of FISCAL POLICY whic
mathematical properties produced a damped does not rely solely on the magnitude of tr
cyclical movement with wavelengths of 4 to 8 BUDGET SURPLUS The budget surplus alor
years. When the system was subjected to can be misleading as to the direction of fisc
random shocks, the wave movements policy for it can change passively as a resu
became both realistic and permanent. An- of autonomous changes in private expend
other of Frisch's achievements was to be a ture. As the economy moves into RECESSIC
forerunner in devising methods for the sta- tax revenues decline and expenditures mj
tistical testing of hypothesis. In the field of rise and therefore the budget moves in
economic policy Frisch devised a system of deficit. Conversely an increase in econom
national accounting, which has been useful activity will cause the budget to move in
both for stabilization policy and longer term surplus. The budget deficit alone therefo
planning. More recently he has developed provides no guide as to whether fiscal poli<
decision models for economic planning, is expansionary or contractionary. Fr
introducing mathematical PROGRAMMING quently we wish to measure the way in whic
METHODS for use with modern computer fiscal policy is being actively rather than pa
techniques. sively used and by relating the surplus
His major works are Statistical Confluence question to what it would be at the FUL
Analysis by Means of Complete Regression EMPLOYMENT NATIONAL INCOME We а с Ы е ^
Systems (1943), Maxima and Minima (1966) just such a measure.
and The Theory of Production (1965).
full-employment national income. (ah
F-statistic. A statistic which follows the known as potential NATIONAL INCOME ar
F-distribution. Often used to test the overall national real output).
significance of a set of explanatory variables A measure of the real value of the goo<
in REGRESSION analysis. and services that can be produced when tl
country's factors of production are ful
FT-SE 100. An index of the prices of the employed; when the economy is at the NATI
100 most important SHARES quoted on the RAL RATE OF UNEMPLOYMENT.
London Stock Exchange. It was introduced i
in 1984 with a base of 1000, because it was full-employment unemployment rate.
felt that the Financial Times Industrial See NATURAL RATE OF UNEMPLOYMENT.
Ordinary Index was too heavily biased to-
wards manufacturing companies. The index, full information maximum Iikeliho<
published in the Financial Times newspaper, (FIML). A technique for estimating s>
is now the most commonly quoted index of terns of SIMULTANEOUS EQUATIONS, whi<
snare prices. (See FINANCIAL TIMES ACTUARIES may be linear or non-linear. It is an ESI
SHARE INDICES.) MATOR which takes account of the fact th
errors may be correlated between equation
bodied money. (See MAXIMUM LIKELIHOOD.)
TOKEN MONEY.
function. A mathematical formalization
full cost, is defined for any given level of the relationship whereby the values of a s
Ou
t p u t as the sum of AVERAGE VARIABLE COST, of INDEPENDENT VARIABLES determine tl
166 functional costing
value of the DEPENDENT VARIABLE. The usual medium or long-term securities, i.e., debt
notation is other than FLOATING DEBT. (See FUNDING.)
Y = f(Xj, . . ., Xn)
funding. Originally, the operation of sub-
where У is the dependent variable, stituting FUNDED DEBT for debt with a
Xi is the /th independent variable, redemption date. The term is now used
and more widely for the substitution of longer
/( ) denotes the functional for shorter-term debt. An example of fund-
relationship. ing is the net repayment of TREASURY BILLS
In economics, to say that 'Y is a function of (forming part of the FLOATING DEBT) from the
X1 normally implies that X in some sense proceeds of an issue of medium or long-term
'causes' Yto take on certain values. (See also securities. Similarly, a private sector enter-
EXPLICIT FUNCTION, IMPLICIT FUNCTION.) prise may fund borrowings by re-paying
short term bank loans with the proceeds of
functional costing. an issue of EQUITIES or DEBENTURES. (See
See OUTPUT BUDGETING. DEBT MANAGEMENT, OPEN MARKET OPERA-
TIONS.)
function of a function rule.
See CHAIN RULE.
future. (also known as a forward con-
funded debt. Traditionally, that part of tract.) See FORWARD MARKET.
government debt which has no contracted
redemption date. But the term is now ap- futures market.
plied more widely to debt in the form of See FORWARD MARKET.
GAB. General Arrangements to Borrow. idea of competition between buyers and
(See INTERNATIONAL MONETARY FUND.) sellers of commodities including labour. The
growth of large scale companies and unions
gains from trade. The increase in welfare for example has meant that WAGES are no
to the world economy as a whole or to an longer determined by competition for labour
individual country, depending on the view- but by the relative power of buyers and
point, as a result of engaging in international sellers of labour. Such power varies with the
trade. The gains can take the form of a level of activity in the economy.
greater real income for the world or country In The Affluent Society Galbraith criticizes
for the same input of factors or the same real the emphasis which capitalist society places
income for a lesser input of factors or some on the production of private goods to meet
combination of the two. The gains originate wants contrived by large scale business. Such
in two sources, which are the possibility of an emphasis, he argues, leads to instability,
EXCHANGE and the possibility of increased INFLATION and unbalanced production which
SPECIALIZATION. (See also COMPARATIVE ignores social needs such as PUBLIC GOODS
ADVANTAGE.) and SERVICES.
The New Industrial State summarizes
Galbraith, John Kenneth (1908- ). An much of Galbraith's thought on the giant
American economist and social critic. Born firms. Such a predominance of large scale
in Canada, he became Professor of enterprise is the result of the complicated
Economics at Harvard in 1949. An itinerant nature of modern technology. The SEPAR-
scholar and researcher in and out of govern- ATION OF OWNERSHIP FROM CONTROL has
ment and academic institutions in the US meant that decision making is undertaken by
and elsewhere, he was appointed US an overlapping bureaucracy of experts or
Ambassador to India between 1961 and what is called the 'technostructure'. Such a
1963. Among his best known publications structure no longer finds profit maximizing
are American Capitalism; The Concept of its aim but rather survival, security and the
Countervailing Power (1952); A Theory of elimination of risk. Such goals involve the
Price Controls (1952); The Great Crash use of internal financing, maximizing growth
(1955); The Affluent Society (1958); The by means of advertising and enlisting sup-
New Industrial State (1967); Economics, port from the workforce, government and
Peace and Laughter (1971); and Economics the population at large. In this way the aims
and the Public Purpose (1973). of the technostructure become the ethic of
The major theme of his books has been society or what may be called the 'cult of
that industrial societies, and in particular gross national product'.
American industrial society, no longer Galbraith discusses the other 'half of the
resembles the descriptive model of con- economy - the market system - in
ventional economic theory, namely the COM- Economics and the Public Purpose and
PETITIVE MARKET model of profit maximizing advocates the strengthening of this sector,
firms and utility maximizing sovereign con- government control, the emancipation of
sumers. As a consequence of this develop- women from their role of 'cryptoservant' in
ment, the capitalist economic system now the economy and the emancipation of the
Produces an excess of waste and a multitude state from its symbiotic relationship with the
°f undesirable products. technostructure.
Ь American Capitalism Galbraith intro- Whilst Galbraith's broad view of indus-
duces the concept of 'countervailing power' trial society by no means commands wide
a
nd substitutes the Smithian idea of compe- acceptance amongst academic economists
tition in the market between sellers for the many of his observations on the theory of
167
168 galloping inflation
firm, the role of ADVERTISING and CONSUMER equilibrium relative prices (the core) be-
SOVEREIGNTY are broadly accepted within the comes smaller. As the number of traders
profession and his work, which has been tends to infinity only one set of relative
extensively read by non-economists, has had prices is left. This corresponds to those
considerable influence. prices ruling in GENERAL EQUILIBRIUM. See
Bacharach, M., Economics and the Theory
galloping inflation. of Games, Macmillan, London (1976).
See HYPERINFLATION.
GATT.
game theory. A theory of individual ratio- See GENERAL AGREEMENT ON TARIFFS AND
nal decisions taken under conditions of less TRADE.
than full information concerning the out-
comes of those decisions. Modern game Gauss-Markov Theorem. This states that
theory begins with The Theory of Games and under certain conditions (including номо-
Economic Behaviour (1944) by Von SCEDASTICITY, ПО SERIAL CORRELATION, e t c . )
Neumann and Morgenstern. The theory
that the ORDINARY LEAST SQUARES estimator
examines the interaction of individual de- is the BEST LINEAR UNBIASED ESTIMATOR. The
cisions given certain assumptions concerning latter is a desirable property of econometric
decisions made under RISK (see VON estimators.
NEUMANN-MORGENSTERN EXPECTED UTILITY
HYPOTHESIS), the general environment, and
GDP. See GROSS DOMESTIC PRODUCT.
the co-operative or non-co-operative behav-
iour of other individuals. Whereas conven-
tional microeconomic theory provides us gearing. The indicator of the relative pro-
with a theory of decisions under conditions portion of debt capital and equity capital.
of certainty it is by no means obvious what The higher the proportion of debt the more
decisions a rational individual should make highly geared is the company. The degree of
under conditions of uncertainty and inter- gearing affects the overall COST OF CAPITAL.
action. Games are often described as 'zero The concept is difficult to measure in prac-
sum1 where one person's gain is another's tice. The most elementary measure is nom-
loss, 'non-zero sum' where all players may inal value of fixed-interest capital/nominal
gain from an individual decision, 'co- value of equity capital. This ignores the
operative' where collusion is possible, and value of reserves which should be added to
'non-co-operative' where antipathy is the the denominator. Nominal values may not
rule. The most famous example of a non- reflect current values and so a better
zero sum game is the PRISONER'S DILEMMA. measure is market value of fixed interest
This is an important example of game theory stock/market value of ordinary shares.
because it shows that contrary to the spirit of Preference shares have been included in the
LIBERALISM individual pursuit of self interest denominator but it can be argued that if they
in this case leads to a solution which is less are non-redeemable they are a permanent
satisfactory than a possible alternative. part of the investment in the firm and should
Game theory has also proved useful in ana- therefore not be included in the denomi-
lysing aspects of economic behaviour such as nator. The ratio has limitations as it ignores
oligopoly, natural resource depletion and some types of interest bearing finance such
PUBLIC GOODS. The theory of co-operative as bank loans and mortgages. (See CAPITAL
games which allows collaboration between STRUCTURE.)
individuals has been used to analyse CARTEL
formation and industrial and labour market gearing ratio. The ratio of debt finance to
collusion. the sum of debt and ordinary share capital
The limit theorem of F.Y. EDGEWORTH is finance. (See GEARING.)
an early example of an /г-person co-
operative game. This says that as the num- General Agreement on Tariffs and Trade
ber of participants in a pure exchange econ- (GATT). An agreement signed at the
omy grows large collusive behaviour Geneva Conference in 1947 which entered
becomes less useful and the set of possible into effect on 1 January 1948. It is a
general equilibrium 169
inult trade agreement which both sets were resumed in February 1991 with the
u t rules of conduct for international trade hope that they might be concluded by the
elations and provides a forum for multilat- end of 1991 with any agreement coming into
ral negotiations regarding the solution of effect in early 1993. GATT has also directed
trade problems and the gradual elimination special attention towards the trade problems
of TARIFFS and other barriers to trade. The of developing countries. In 1964 it estab-
agreement is based largely upon principles lished an International Trade Centre (jointly
o f non-discrimination and reciprocity so as operated with UNCTAD since 1968) which
to liberalize world trade. With the exception provides information on export markets and
of CUSTOMS UNIONS and FREE TRADE AREAS, all assistance regarding the formulation and
contracting parties are generally bound by administration of export promotion pro-
the agreement's most favoured nation grammes to developing countries. In addi-
clause. Protection is to be given to domestic tion, the General Agreement was amended
industries only through customs tariffs, in 1965 to include a section on Trade and
thereby prohibiting import QUOTAS and other Development which enables developing
restrictive trade practices. The agreement countries to trade with developed countries
also provides for the binding of the tariff on a non-reciprocal basis and permits a sys-
levels negotiated among member countries tem of generalized trade preferences by
and establishes a framework for the settle- developed for developing countries, thereby
ment of grievances put forward by members waiving the most favoured nation clause.
who argue that their rights, under the terms Since the conclusion of the Kennedy Round,
of the agreement, have been violated or GATT has also devoted attention to the
compromised by other members' trade prac- problems of non-tariff barriers to trade and
tices. Seven major trade negotiations, con- the effects on international trade of regional
ducted under the auspices of GATT, have economic institutions like the European
resulted in significant reductions in the aver- Community and the EUROPEAN FREE TRADE
age level of world industrial tariffs. The KEN- ASSOCIATION. See Corbet, H., 'Agricultural
NEDY ROUND, or sixth round of negotiations Issue at the Heart of the Uruguay Round',
held at Geneva between 1964 and 1967, National Westminster Bank Quarterly
marked the first time in which tariff re- Review (August 1991), pp. 2-19.
ductions were negotiated on whole groups of
goods, as opposed to the traditional tariff General Agreements to Borrow.
negotiations which had proceeded on an See INTERNATIONAL MONETARY FUND.
item-by-item basis. Unlike previous rounds
the TOKYO ROUND held between 1973 and General Classification of Economic Activi-
1979, addressed the problem of both tariff ties in the European Communities. An
and non-tariff barriers to trade. The URU- industrial classification of economic activi-
GUAY ROUND of negotiations was the eighth ties within the European Communities
and was scheduled to run from 1986 to the which is an alternative to the INTERNATIONAL
end of 1990. These were concerned with STANDARD INDUSTRIAL CLASSIFICATION. T h e
both old issues such as the unfinished busi- classification replaces and consolidates pre-
ness of previous GATT rounds and with vious partial classifications such as NICE.
grievances accumulated over the years, be-
cause of lack of political will on the part of general equilibrium. A situation where all
member countries, and with new issues such markets in an economy are simultaneously
as
trade in services, the protection of intel- in equilibrium, i.e. where prices and quan-
lectual property rights, e.g. copyrights, and tities do not change.
tr
ade related investment measures. The Economists have traditionally adopted
ma
Jor difficulties arose over agricultural two approaches in analysing economic sys-
supp o r t and protection, with the negotia- tems. The simpler approach, associated with
ttons failing to reach a conclusion by the end the name of A. MARSHALL, has been that of
°f 1990, because the EUROPEAN COMMUNITY
PARTIAL EQUILIBRIUM, where only a part of
(EC) was not prepared to reduce agricul- the system is examined, e.g. the market for
tural support sufficiently to satisfy other oranges, on the assumption of unchanged
countries, especially the USA. The talks conditions in the rest of the economy.
170 general grant
The second and more difficu.t approach, MENT in 1964 and formally accepted at the
both in conception and in its use of math- second in 1968, the industrialized countries
ematical tools, is general equilibrium analy- agreed to charge no duty on imports from
sis, which looks at an economic system as a developing countries, while maintaining
whole and observes the simultaneous deter- them on imports from other industrialized
mination of all prices and quantities of all countries, thereby conferring a margin of
goods and services in the economic system. preference on developing countries. While it
WALRAS is credited with being the founder of was hoped that the GSP would be a common
this approach. Economists have paid par- scheme, eleven schemes have emerged as
ticular attention to three questions, which 'donor' countries have excluded different
arise in the context of general equilibrium goods from the scheme. In the case of the
systems usually on the assumption of perfect USA it has been estimated that in 1978 the
competition. These are: (1) does a general effect of the exclusions has been to limit
equilibrium system have a solution, in the preference to just 8 per cent of dutiable
sense that the values for the variables are imports from all developing countries and 17
consistent with each other? (2) is the sol- per cent from the beneficiaries alone.
ution unique, in that there is just one value
for each variable consistent with the overall general price level. The prices of all the
solution? and (3) is the system stable, so that goods in an economy. Changes in the gen-
it will return to the equilibrium values after eral price level are best measured by the
some disturbance? Theoretical work has gross domestic product deflator, since this
enabled definitive statements to be made covers both CONSUMPTION and INVESTMENT
on these questions. See Mukherji, A., goods, whereas the RETAIL PRICE INDEX
Walrasian and Non-Walrasian Equilibria, measures changes only in the price of con-
Oxford University Press (1990). sumption goods.
general grant.
See GRANT. General Theory of Employment, Interest
and Money.
generalized least squares (GLS). (also See KEYNES.
known as Aitken Estimator.) A member of
the LEAST SQUARES family of ESTIMATORS general training. Training which develops
applicable to cases where the VARIANCE- skills of equal value to the firm providing the
COVARIANCE MATRIX of t h e DISTURBANCE TERM training and to other firms. The MARGINAL
of the REGRESSION equation does not consist PHYSICAL PRODUCT of the trainee increases by
of zeros in the off-diagonal positions, and/or the same amount in the firm providing the
does not have identical diagonal elements training as in other firms. This training,
(representing the problems of AUTOCORRELA- therefore, provides skills which are transfer-
TION and HETEROSCEDASTICITY respectively). able. For this reason the employee will tend
Under these circumstances, ORDINARY LEAST to bear all of the costs of training. He does
SQUARES is n o t t h e BEST LINEAR UNBIASED this by receiving a wage in his apprenticeship
ESTIMATOR, while GLS is. The estimator can that is equal to his net marginal product (i.e.
take various specific forms. {See WEIGHTED his contribution to value-added less the
LEAST SQUARES, COCHRANE-ORCUTT, PRAIS- direct costs of training) which is below the
WINSTEN.) wage an untrained individual could earn as
an unskilled worker in the LABOUR MARKET
general linear model (GLM). The most on the workers investment in HUMAN CAPI-
commonly used functional form in econo- TAL. The return accrues in the form of a
metric analysis, which specifies the DEPEN- higher post-training wage, again equal to his
DENT VARIABLE as a LINEAR FUNCTION of a Set now enhanced marginal product, that ex-
Of INDEPENDENT VARIABLES. ceeds the unskilled wage.The worker, there-
fore, pays all the costs and obtains all the
generalized system of preferences (GSP). benefits. There is no appreciable wedge be-
Under the GSP, proposed at the first UNITED tween wage and marginal product during the
NATIONS CONFERENCE ON TRADE AND DEVELOP- entire process. (See SPECIFIC TRAINING).
gilt-edged securities 1
the exception of the recently introduced form of a cheque to the payee to be 'col-
Treasury Variable Rate Stock, a short term lected' by his bank). Giro originated on the
security carrying an interest rate that varies Continent where it has a long history. The
with an average of recent Treasury bill rates, first British system, the National Girobank
gilt-edged stocks are issued at fixed rates of which operates postally and through Post
interest on their nominal value (the 'cou- Offices, was established in 1968 and offered
pon'); and these rates vary with the term of an ordinary cheque service, as well as giro
the stock and the level of market rates at the transfers. The National Girobank was sold
date of issue. to the Alliance and Leicester Building
Issues of gilt-edged stock are offered for Society in 1990.
sale on specific dates, but stock unsold on The lead set by the National Girobank
that day (which may be much or little) is was followed by the Bank Giro established
taken up by the BANK OF ENGLAND and other jointly by the English and Scottish CLEARING
public agencies and subsequently sold BANKS as a system for handling giro type
through the 'tap', i.e. by the government settlements through their combined organiz-
broker operating in the market at prices de- ations. (See CREDIT TRANSFER.)
termined by current conditions and policy
considerations. (See DEBT MANAGEMENT.) Glejser test. A test used to diagnose the
problem of HETEROSCEDASTICITY in the RESI-
Gini Coefficient. A measure of the DUALS of a REGRESSION equation. It involves
inequality of (usually) income DISTRIBUTION. the regression of the ABSOLUTE VALUE of the
It can be calculated as residuals on various functional forms of the
EXPLANATORY VARIABLES in the regression,
У"!
and testing for the STATISTICAL SIGNIFICANCE
of the PARAMETERS in this regression. (See
GOLDFELD-QUANDT.)
пу
where y\,. . .,yn represent individual GNP. See GROSS NATIONAL PRODUCT.
incomes in decreasing order of size,
у is the mean income, and
gold-bricking. The restriction of output by
n is the number of individuals.
workers under INCENTIVE PAYMENTS SYSTEM
the WARRANTED RATE OF GROWTH is equal to and general freedom of transactions in all
the NATURAL RATE OF GROWTH at full employ- other currencies.
ment. The term was coined by Joan ROBIN-
SO N indicating in her opinion the low gold export point.
probability of such a state of affairs arising in See GOLD POINTS.
a capitalist economy without intervention by
government. (See KNIFE EDGE.) Goldfeld-Quandt. The name of a test used
to diagnose the problem of HETEROSCEDASTI-
golden rule. The optimal growth path CITY in the RESIDUALS Of a REGRESSION
which gives the maximum sustainable level equation. It involves ordering the residuals
of consumption per person in an economy. according to increasing size of the variable
The term is due to E.S. Phelps in his 'Fable with which it is suspected that the heterosce-
for Growthmen' (American Economic Re- dasticity is associated, and calculating separ-
view, 1961) where the economic problems of ate sums of squares for the top and bottom
an imaginary Kingdom of Solovia were con- thirds (omitting the central third) of the ob-
sidered, parodying the name of R. SOLOW servations. An F-STATISTIC can then be calcu-
who was an original contributor to NEO- lated to test for the level of significance of
CLASSICAL GROWTH THEORY the difference between the sums of squares.
If significant, then the problem is likely to
exist. (See also GLEJSER TEST.)
golden rule of accumulation. That path of
balanced growth where each generation gold import point.
saves for future generations that fraction of See GOLD POINTS.
income which past generations saved for it.
The BIOLOGICAL INTEREST RATE is an aspect of gold market. The market in which metallic
the same idea. Sometimes called the biologi- gold, coin or bullion, is traded. There are
cal interest rate rule. gold markets in all the main financial centres
except New York, but freedom to trade in
gold exchange standard. A variant form of gold is not everywhere unrestricted. The
the GOLD STANDARD under which a country London market is now completely free,
pegged the value of its currency to the value though until the abolition of EXCHANGE CON-
of the currency of a centre country, e.g. TROLS in October 1979 trading was restricted
sterling, which was itself on gold. The peg- to authorized dealers and non-residents oi
ging was effected by the monetary authori- the UK.
ties holding all or part of the country's
external reserves in reserve currency assets, gold points. Those exchange rate levels ai
and by exchanging the domestic currency for which, when a currency is on a GOLD STAN-
the reserve currency at determined and DARD, it becomes profitable to buy gold frorr
stable rates. The term itself and the wide use the CENTRAL BANK and export it (the 'golc
of the system originated in the 1920s when it export point') or import gold and sell it tc
was strongly advocated as a means of pre- central bank (the 'gold import point'). Thes(
serving the gold standard in the face of a points lie on either side of the central golc
feared shortage of metallic gold. Its ante- parity, the export point below, the impor
cedents, however, lay in the practice of point above, the range being determined b}
colonial territories in pegging their curren- the difference between the central banks
t s , formally or informally, to those of the buying and selling prices for gold (a differ
metropolitan states. The international ence applied to cover minting and othe
monetary regime in force between 1958 and costs), and in the earlier phases of the golc
!970 is frequently described as a 'gold standard, the costs of shipping gold to othe
exchange standard' system, because of the centres.
w
*de use of the dollar, itself pegged to gold,
j*s a VEHICLE CURRENCY and reserve currency, gold standard. The system of monetar
bu
t it lacked some major features of the organization under which the value of
earlier gold exchange standard, e.g. unfet- country's money is legally defined as a fixe<
tered convertibility of the reserve currency quantity of gold, and domestic currenc
174 Goodhart's Law
takes the form of gold coin and/or notes variable becomes distorted by the very act of
convertible on demand into gold at legally targeting it. (See MEDIUM TERM FINANCIAL
determined rates. For a full gold standard to STRATEGY.)
exist requires two basic conditions: the
obligation of the monetary authority to goodness of fit. A general term describing
exchange domestic currency for gold to any the extent to which an econometrically esti-
amount at the specified rates (this includes mated equation fits the data. There are vari-
the unrestricted minting of gold coin from ous ways of summarizing this concept,
bullion brought to it) and the freedom of including the COEFFICIENT OF DETERMINATION
individuals to import and export gold. and ADJUSTED R2.
Normally the authority applied a small
difference between the buying and selling goods. Tangible COMMODITIES which con-
prices of gold, originally to cover the minting tribute positively to ECONOMIC WELFARE. TO
costs of coin. Historically there have been be distinguished from BADS.
three variant forms of the gold standard: the
gold circulation standard, when gold coin goodwill. A term used in accounting for
was in active circulation and the authority's intangible assets usually measured by the
selling obligation was to sell gold coin; the difference between the price paid for a going
gold bullion standard when gold coin was concern and its BOOK VALUE. If a firm is sold
not in active circulation, free minting was with a 'good name' or large set of customers
suspended, and the authority's selling obli- or clients likely to remain after the sale,
gation was to sell gold in bar form; and these are part of the firm's goodwill. For a
the GOLD EXCHANGE STANDARD, when practi- separate meaning see BRAND LOYALTY.
cally if not formally, the authority would
exchange domestic currency for another cur- Gosplan. A Russian term for the former
rency which was itself on a gold standard. State Planning Commission in the USSR. It
The UK was on a gold circulation standard was responsible for working out production
down to 1914; and then on a gold bullion plans and passing them on to the relevant
standard from 1925 to 1932. organizations for execution. Its functions
The effect of a gold standard is to stabilize have been taken over by the Ministry of
a country's exchange rate, within narrow Economics and Forecasting, which makes a
limits, in terms of other gold standard cur- greater use of market principles in regulating
rencies. The further consequence is that a the economy. (See PLANNED ECONOMY.)
deficit on the BALANCE OF PAYMENTS tends to
produce an outflow of gold which, provided government deficit.
no offsetting action is taken by the central See BUDGET DEFICIT.
bank, causes a contraction of the money
supply. According to the traditional theory government expenditure. For a detailed
of gold standard adjustment (based on the description see PUBLIC EXPENDITURE. These
QUANTITY THEORY OF MONEY) provided money expenditures form an important part of
prices and income were flexible a declining AGGREGATE EXPENDITURE which although
money supply would produce a fall in dom- considered EXOGENOUS in the simple INCOME
estic prices relative to those in other EXPENDITURE MODEL play an important part
countries; with the exchange rate fixed this in this Keynesian model in determining the
would encourage exports and discourage im- EQUILIBRIUM LEVEL OF NATIONAL INCOME. I n
ports. The equilibrating process would also particular, the government's manipulation
be helped by capital movements attracted to of their expenditures, an element of FISCAL
the deficit country by rising interest rates. POLICY, is considered to be one of the main
(See GOLD POINTS, SPECIE FLOW THEORY.) See methods of ensuring that national income is
Walter, A., WorU Power and World Money, at t h e FULL EMPLOYMENT NATIONAL INCOME
Harvester Wheatsheaf, London (1991). level.
i
gravity model Г
two places as being determined by the size or labour-intensive techniques requires trained
importance of the places and the distance experts to guide it and not party officials.
between them. One such form of interaction
would be population movement. Others green pound. The exchange rate for the
would be car travel or air travel. A general pound sterling used for converting agricul-
form of the gravity model would be, tural prices agreed under the COMMON AGRI-
CULTURAL POLICY in terms of the EUROPEAN
CURRENCY UNIT into domestic UK prices.
For most of the time since the UK entered
the EUROPEAN COMMUNITY the value of the
where 1ц is the amount of interaction be-
tween places / and ;, Л is a constant, P is green pound has exceeded the market rate
some measure of significance such as popu- owing to the depreciation of the pound. By
lation or income level, D is the distance and converting the agreed food prices at this
x, у and z are parameters. Thus migration higher (green pound) rate, food prices in the
between / and / might be represented as a UK have been lower than they would have
been had the market rate been used. So
function of the population of each centre
likewise have been the incomes of UK
and the distance between them. Despite its
farmers. Despite devaluations of the green
common use, the approach has been criti-
pound from time to time it has usually
cized as lacking firm foundation in economic
remained above the market rate.
theory.
The divergence between the green rate
and the market rate has made necessary
the payment of monetary compensatory
'Great Leap Forward'. The name given to amounts. A French farmer, selling a unit of
the development policy launched in China at his product in the UK at the CAP price
the end of 1957, which was intended to determined by the green rate, would find on
speed the development process by a 20 to 30 converting his sterling receipts into francs at
per cent industrial growth rate. The basis the market rate that the price was below the
was a simultaneous development in all types guaranteed price expressed in francs. To
of industry and agriculture, although the em- make good the difference a monetary com-
phasis was on heavy industry where the pensatory amount is paid to him from EC
scarce available capital was used and else- funds.
where there was large scale substitution of From April 1987 a new 'green' ECU was
labour for capital, and highly LABOUR- defined and tied to the strongest currency
INTENSIVE techniques were implemented in within the EC. A corrective coefficient (the
small industries and agriculture. The success highest percentage revaluation under any
of this venture has been very difficult to currency realignment) was also introduced;
assess because of other events which were this is applied to the central EUROPEAN MONE-
occurring simultaneously. People's com- TARY SYSTEM rate for a currency and used to
munes had been established in 1958 and adjust farm prices in each country, so as to
although they helped to get rural labour in- leave the farm price level unchanged in the
volved they removed much of the incentive strongest currency country. Thus a revalua-
to work by taking away private land owning tion of a currency would leave farm prices
and disrupting family life. Technical experts unchanged in the revaluing country while
who were not given the respect due to them the prices in the other countries would adjust
as party officials took control. Between 1959 upwards. The greater stability in exchange
and 1961, various natural disasters occurred rates in the late 1980s has reduced the need
and Soviet experts left in 1960. Many of for monetary compensatory amounts, while
these other occurrences, although not re- green currencies themselves would become
lated to the implementation of labour- redundant in the event of European mone-
intensive techniques, blur an accurate tary union.
assessment; and it is not possible to assume
that the economic slump which followed was green revolution. A term applied to the
a result of the policy. However one clear major increase in agricultural productivity
lesson was learnt, in that extensive use of obtained in developing countries by the
Group of 77 17'
the international monetary system, acceler- because of the stimulus to productivity that
ate the transfer of technology and economic come from ECONOMIES OF GROWTH whose
aid and extend national sovereignty over source is higher turnover and capacity utiliz-
natural resources so as to redistribute wealth ation. However, it is intuitively plausible to
in favour of developing countries. argue that dynamic supply and demand
constraints prevent the continuance of this
growth-gap unemployment. Long-run positive relationship. On the supply side
DEMAND-DEFICIENT UNEMPLOYMENT. The organization difficulties are likely to set in at
growth in the productive capacity of the higher rates of growth, while on the demand
economy through time is insufficient to pro- side DIMINISHING RETURNS will eventually set
vide jobs for all those who wish to work. The in with respect to demand creation expendi-
production techniques adopted are 'too capi- tures. Such an argument implies a bell-
tal intensive' and this is therefore one form shaped function with profitability initially an
Of TECHNOLOGICAL UNEMPLOYMENT. increasing function of the growth rate, but
then beyond some point DISECONOMIES OF
growth path. This is the pattern of change GROWTH begin to 'dominate' and profitability
of a variable overtime; the variable is a becomes negatively related to growth. (See
measure of development, usually per capita also GROWTH THEORIES OF THE FIRM.)
income or consumption and the growth path
represents its actual, or predicted pattern of growth-stock paradox. Refers to a situ-
change overtime. Development strategies ation where because the current DISCOUNT
will result in different paths; if large amounts RATE is less than a firm's expected constant
of capital are being invested in the capital- annual growth rate of dividend payments,
goods industry, the growth path will rise the share valuation will tend to infinity. This
slowly until such time as these industries are can be shown formally under STEADY-STATE
well established enough for further indus- GROWTH conditions with no uncertainty: the
trial development in consumer goods to take price of a share will under such conditions be
place when the growth path may rise equal to the NET PRESENT VALUE of the
sharply. (See ROSTOW MODEL, TECHNOLOGY, expected dividend payments. If the dividend
CHOICE OF.) payment per share D grows at the constant
annual rate of gD then given a discount rate
growth pole. A group or cluster of indus- /, the capitalized value of the expected divi-
tries centred on and linked with one or more dend payments will be
PROPULSIVE INDUSTRIES which form a centre
of growth and dynamism in an economy. D
Sp =
The concept was introduced by the French ~ gD
economist Perroux who thought of the where Sp is the share price and gD is treated
growth pole as involving a close set of mar- as negative INTEREST. If however gD s* / then
ket relationships but not necessarily geo- there will be no convergence and Sp will
graphical concentration of the industries. tend to infinity. This special case, the
However, the theory has been widely ap- growth-stock paradox, is conventionally
plied in REGIONAL ECONOMICS both as an ruled out since any tendency for Sp to tend
explanation of the geographical clustering of to infinity will cause the discount rate, in
particular industries and as a policy model reflecting the OPPORTUNITY COST of capital, to
for stimulating economic growth in rise in order to restore EQUILIBRIUM.
DEPRESSED AREAS or underdeveloped regions
of an economy. growth theories of the firm. Due to the
pioneering work of E.T. Penrose (The
growth-profitability function. Refers to Theory of the Growth of the Firm, Black-
the maximum PROFIT RATE which a firm can well, Oxford, 1959) and R.L. Marris (The
sustain at different rates of growth. The Economic Theory of 'Managerial Capital-
rationale concerning the nature of this FUNC- ism, Macmillan, London, 1964) growth
TION is normally put as follows: at low theories are a branch of the MANAGERIAL
growth rates positive increments in that rate THEORIES OF THE FIRM, considered appropri-
are likely to generate an increased profit rate ate to a CORPORATE ECONOMY within which
growth-valuation function 1
can sustain at different rates of growth and is guaranteed week. Payments made to
a common feature of GROWTH THEORIES OF workers who through no fault of their own
THE FIRM. Reflecting the growth-profitability find that they are on SHORT-TIME WORKING
relationship this function is likely to be bell- Such an eventuality is most likely to arise
shaped. Assuming STEADY-STATE GROWTH because of a strike elsewhere, a breakdown
conditions, initial positive increments in the in production or a reduction in demand for
growth rate stimulate GROWTH ECONOMIES the output of the industry concerned. These
producing a higher profit rate thus leading, arrangements apply to MANUAL WORKERS in
for a given DIVIDEND-PAYOUT RATIO, to a the main because salaries are usually
larger initial dividend payment and faster whether or not there is work.
expected growth of that payment. This has a
positive effect on the valuation ratio.
Beyond that rate of growth at which growth guidelines.
diseconomies have set in and are 'dominant', See INCOMES POLICY.
the consequent fall in the profit rate
depresses the initial dividend payment and
prevents the continuance of a positive
relationship between growth and the valu- guidepost following behaviour.
ation ratio. (See also GROWTH-PROFITABILITY See NORM FOLLOWING BEHAVIOUR.
FUNCTION.)
G7. guideposts.
See GROUP OF SEVEN. See INCOMES POLICY.
н
Haavelmo, Trygve (1911- ). Norwegian Theory (1961) and Money in the Inte
economist who was awarded the Nobel Prize national Economy (1965).
for Economics in 1989 for his work on the
foundations of econometrics.
habit-creating demand function.
His most significant contributions were
DEMAND FUNCTION for non-durable goo(
made in his Harvard University thesis, sub-
which reflects the fact that demand in ai
sequently published as 'The Probability
one period may be influenced by the cum
дрргоасп in Econometrics 1 , Econometrica
lated purchases of the good in the past. Tl
Vol. 12, H8pp (1944). In this work he
higher this past 'stock' (it is not a stock in tl
showed how the formulation of economic
strict sense since past goods will not \
theories in probabilistic terms made it poss-
extant) the greater will be the influence
ible to use statistical inference methods to
past consumption on demand in the curre
draw rigorous conclusions about underlying
period.
relations from 'the random sample' of
empirical observations.This permitted the
derivation of economic models, their testing Halesbury Committee. The UK Gover
and their use in forecasting. His thesis also ment's Committee of Inquiry set up to gi
contained advances in dealing with the prob- advice on organizing a system of DECIMJ
lem of interdependence in economic vari- COINAGE. It was set up in 1961 and report
ables, for he suggested methods for in 1963.
specifying, identifying and estimating econ-
omic relations, when interdependence is
present. His techniques have been adopted hammered. Prior to the Big Bang of 19
and developed by other econometricians. when a stockbroking firm was unable
Apart from his work in econometric meet its liabilities to a client or other stoc
theory Haavelmo also made important con- broker, its right to trade on the market w
suspended. On the London STOCK EXCHAN
tributions to the theory of investment and
the theory of economic growth. His major this suspension was announced after silen
publications apart from his thesis are A had been called by beating a wooden hai
Study in the Theorv of Economic Evolution mer. Hence the suspended firm was said
(1954) and A Study in the Theory of be 'hammered'. In similar conditions
Investment (1960). would now be suspended by the Securit]
and Investments Board. |
Haberler, Gottfried (1900- ). Austrian-born
American economist, best known for his hard-core unemployed. Those amonj
work in international trade. In his Theory of the REGISTERED UNEMPLOYED who find it <
International Trade (1936) he provided an tremely difficult to obtain a job because
alternative demonstration of THE GAINS FROM their mental and physical condition, th
TRADE in terms of the opportunity cost of attitude toward work or their age. It 1
Producing goods as seen in the goods fore- been argued that these may form an irredi
gone. This freed the case of trade from the ible minimum number of unemployed I
R
EAL COSTS of the approach of RICARDO. His this ignores both the fact that devoti
°ther major early work was Prosperity and greater resources to these groups might
°epression (1935) which surveyed the litera- duce the undesirable characteristics and i
t e on business cycles. His other major fact that attitudes towards work are the
w
orks are International Trade and Econ- selves likely to be a function of the level
O)
nic Development (1959), an authoritative unemployment. {See also the UNEMPLOYMI
Monograph A Survey of International Trade RATE.)
182 hard currency
1954 applied his INPUT-OUTPUT technique to lity changes was pioneered by Zvi Griliches
examine the structure of US foreign trade. and has found applications in the analysis of
He examined the factor composition of US housing demand and environmental
exports and of US imports, as they would be economics.
produced in the US if the US had to produce
them domestically, and came to the surpris- hedonism. The philosophy which states
ing conclusion that US exports were labour that human behaviour ought to be guided by
intensive and import substitutes were capital the search for pleasure. As a philosophy,
intensive. Since on any definition the US is however, hedonism is typically modified by
capital abundant, the finding appeared to concepts of duty, obligation, etc. As a school
refute the Heckscher-Ohlin model and now of positive thought it simply states that
goes under the name of the Leontief people do behave as pleasure-seekers, not
paradox. that they ought to.
displays CONSTANT RETURNS TO SCALE since are generally wary of the relative improve-
a, say, doubling of all INPUTS will lead to a ment Of the BALANCE OF PAYMENTS and
doubling of output. (See also EULER'S strengthening of the EXCHANGE RATE due to
THEOREM.) inflows of hot money as the inflow can be
very transient. (See FOREIGN EXCHANGE MAR-
homogeneous product. When the commo- KET, ARBITRAGE SPECULATION.)
dities or services supplied by economic
agents in a given market have attribute com- Hotelling's Rule. A rule for the optima]
binations which are identical in the eyes of use of non-renewable natural resources
buyers, the product is said to be homo- established by H. Hotelling in 1931 ('The
geneous. Economics of Exhaustible Resources',
Journal of Political Economy, Vol. 39, pp.
homogeneous production functions. 137-175). The rule, which still has a central
See PRODUCTION FUNCTIONS. place in the economics of natural resources,
states that for the time path of extraction to
homoscedasticity. A property of the VARI- be optimal net price (selling price minus ex-
ANCE Of the DISTURBANCE TERM of REGRESSION traction cost) of a unit of resource left in the
equations whereby it remains constant over- ground must rise at a rate equal to the inter-
all observations. This is one of the required est rate. The reasoning is as follows. A re-
properties for the ordinary least squares esti- source owner has the choice of either
mator to be the BEST LINEAR SQUARES extracting a unit of resource and investing
ESTIMATE. the receipts at the going rate of interest or of
leaving the unit in the ground. He will only
horizontal equity. Fairness or justice in be content with the latter course of action, if
the treatment of individuals in similar cir- the net price rises by as much as the rate of
cumstances. In general, the principle that interest, so that both courses of action yield
like-individuals should be treated in a like the same return. The rule may be alterna-
manner where economic arrangements are tively stated as the condition that the PRES-
concerned. The concept is most frequently ENT VALUE of a unit of the resource must be
used with regard to tax and income, thus the same irrespective of when it is extracted.
horizontal equity is held to be attained if The rule holds for producers in a competi-
individuals with the same income face the tive situations and for society, but not for
same TAX BURDEN. However, it may be ap- situations of IMPERFECT COMPETITION. (See
plied in other areas, for example with regard
to the benefits of public expenditure hori- NON-RENEWABLE RESOURCE.)
zontal equity may be said to require that
individuals with similar income or NEED housing benefit. See BEVERIDGE REPORT.
should receive the same benefit. In using the
concept we must be clear which character- human capital. The essence of human
istics are employed in defining 'similar', gen- capital is that investments are made in hu-
erally income is the relevant variable but man resources so as to improve their produc-
other characteristics might be thought rel- tivity. Costs are incurred in the expectation
evant - such as health. (See also EQUITY, of future benefits; hence, the term invest-
ment in human resources'. Like all invest-
VERTICAL EQUITY.)
ments, the key question becomes: are they
horizontal integration. Horizontal integra- economically worthwhile? The answer to
tion is said to take place when two FIRMS at this question depends on whether or not
the same stage of the production process benefits exceed costs by a sufficient amount,
merge to form a single business organiz- and the standard INVESTMENT CRITERIA apply-
ation. (See MERGER.) There is thus a direct analogy between
investment in human capital and investment
hot money. If a country has a favourable in physical capital, although there are differ-
RATE OF INTEREST, it will attract money from ences. In particular, human capital is not
abroad which would however be moved out collateral because it cannot be sold-
again if interest rates subsequently became Moreover, an individual cannot spread or
more favourable elsewhere. Governments diversify his risk in the manner that owners
hyperb<
f physical capital can. These factors apart, for sweeping reform of the Ameria
the parallel between human and physical cial services industry with extensive
apital is a close one; for example, human lation. Among its proposals were,
capital like physical capital is subject to 1. Removal of upper limits on
DEPRECIATION. interest rates
The concept of man investing in himself 2. Provision for the payment oi
has a very wide application. It covers not on demand deposits
only investments in formal schooling and 3. Elimination of distinctions
post-school training (see ON-THE-JOB TRAIN- commercial banks and savings a
ING), but also home investments in the form institutions
of family care in the pre-school years, the 4. Provision for multiple brand
acquisition of improved health, and invest- both intrastate and interstate
ments in labour market information via job 5. Combination of all regulat
search. supervisory Federal functions wit
Human capital theory underpins many of agency.
the important developments in modern The proposals of the Hunt Con
economics and provides one of the main were not adopted at the time of
explanations for wage and salary differen- lease, but they served as the basis
tials by age and occupation, the uneven inci- extensive banking reforms which cu
dence of unemployment by skill, the job in the Deregulation and Monetary
regulatory practices of trade unions and so Act of 1980 and the Garn-St
on, as well as contributing to policy decisions Depository Institutions Act of 19
on, say, the allocation of resources to DEREGULATION AND MONETARY CON'
schooling and training vis-a-vis other claims OF I 9 8 O . )
on resources. See Becker, G., Human
Capital, National Bureau of Economic Hunt Report. The findings of i
Research (1964). Royal Commission set up to invest
problems of those geographical re
Hume, David (1711-76). A major Scottish Britain said to be intermediate bet^
philosopher. Hume's contributions to politi- most prosperous areas of the cou
cal economy are largely contained in chap- the DEPRESSED AREAS which were ii
ters of his Political Discourses (1752). He of benefits from REGIONAL POLICY
emphasized (following LOCKE) that the quan- Royal Commission on the Intermedia
tity of money in a country has no effect on Cmnd. 3998, London, 1969). The <
the real wealth of that country, and held a sion argued that these intermediate
QUANTITY THEORY OF MONEY. He improved on
areas were disadvantaged compa:
Locke in as much as he denied that a country both the prosperous areas and the
could have a permanent trade surplus or MENT AREAS, they thus recommen
deficit. The PRICE-SPECIE MECHANISM ensured substantial government support si
that international trade was always bal- made available for such areas. Alth
anced. His theory of interest is one of supply report led to the establishment, in
and demand. The demand for loans is partly 'intermediate areas' which receivec
influenced by business expectations, and ment support for industrial INVEST*
thus the rate of profit and rate of interest are levels of support were not as high
closely related. which the commission had propoj
He saw social science methodology as ASSISTED AREAS.)
la
rgely a branch of applied psychology. This
Philosophy and his views on self-interest and
fhe desire for accumulation as the motivat- hyperbola. The graph of a functi
ing forces of economic activity had a major form
influence on A. SMITH and later economists.
У = a + bX'c
Commission. The President's Com- where с is a positive constant. Such
mission on Financial Structure and Regula- are often used to represent DEMANI
ll
°n issued its report in 1972, calling because of compatible theoretical
190 hyperinflation
ties. In particular, the special case of the concerned with determining whether an
rectangular hyperbola whose equation is EXPLANATORY VARIABLE (or Set of explanatory
variables), has any causal influence on the
x
Y = bX~ = | DEPENDENT VARIABLE in a REGRESSION
equation. The Null Hypothesis is that there
will, if Y is quantity and X is price, yield a is no influence. The test statistic calculated
demand curve having a constant price elas- is normally the T-STATISTIC, which, if great-
ticity of demand equal to minus one. er than the critical value from the т-
DISTRIBUTION , allows the rejection of the
hyperinflation. A position of rapidly hypothesis of no influence, in favour of the
hypothesis that there is some causal effect.
accelerating INFLATION. Under conditions of
(See STATISTICAL INFERENCE, ONE TAIL TESTS.)
hyperinflation prices rise ten or even a
hundred-fold in a single month. Examples of
such inflations are rare but have been experi-
hysteresis. A term used by scientists to
enced in Germany in the early 1920s and in
describe the circumstance in which the EQUI-
China around the period of the Second
LIBRIUM of a system depends on the history
World War. The exact boundary between
of that system. In economics it is most com-
inflation and hyperinflation is difficult to
monly used in considering the NATURAL RATE
define.
OF UNEMPLOYMENT, where the equilibrium is
said to be path-dependent, i.e. it depends on
hypothesis testing. A general term de- the actual history or path of unemployment.
scriptive of procedures for the statistical Hysteresis may result from INSIDER-OUTSIDER
determination of the validity of an hypoth- effects or from a rise in the proportion of
esis. The tests normally involve the calcu- long term unemployment in total employ-
lation of TEST STATISTICS to discriminate ment, where the long term unemployed are
between competing hypotheses. Under one regarded as having withdrawn from the
of the hypotheses (the NULL HYPOTHESIS) this labour force, either for psychological
statistic will follow a certain distribution, reasons or for the lack of relevant skills.
so that if the value of the test statistic lies Under such circumstances unemployment
outside certain CRITICAL VALUES of the distri- will fail to exert downward pressure on
bution (determined by the LEVEL OF SIGNIFI- wages, and any rise in wages can result in a
CANCE of the test), the Null Hypothesis is further rise in unemployment. See Cross,
rejected in favour of the alternative R., Unemployment, Hysteresis and the
hypothesis. Natural Rate Hypothesis, Blackwell, Oxford
Normally, in economics, the tests are (1988).
I
IBRD- unity, and whose off-diagonal elemei
See INTERNATIONAL BANK FOR RECONSTRUC-
all zero.
TION AND DEVELOPMENT.
idiosyncratic exchange. The unique
of the tasks and therefore the skills с
ICFC. Industrial and Commercial Finance
worker provides workers and em]
Corporation. (See FINANCE FOR INDUSTRY.)
with some degree of discretion in the
of wages. Almost every job is idiosy
IDA. involving some firm-specific skill;
SPECIFIC TRAINING.) Because of th
See INTERNATIONAL DEVELOPMENT ASSOCIA-
notion of a competitive labour markei
TION.
on demand and supply for each job d<
apply. Most jobs are, then, unique ai
identification problem. An econometric an external market. As a result of \
problem which arises in the estimation of the training, workers already in a firm h|
parameters of SIMULTANEOUS EQUATIONS. advantage over outsiders and in a
The difficulty occurs when it is impossible to possess a degree of MONOPOLY powe
distinguish from the data which equation is their jobs. At the same time, the emp
being estimated. For instance, both supply potential control over a worker also
curves and demand curves may be specified because the worker's specific trail
with quantity as the DEPENDENT VARIABLE, most worthwhile to his current em]
and price as the EXPLANATORY VARIABLE. The There results a situation akin to BIL
data may be the result of a series of supply/ MONOPOLY, coupled with BOUNDED I
demand equilibria, so that simply estimating ALITY since workers are in a position
an equation involving quantity and price will feet their monopoly over the knowk
not necessarily result in the determination of technology because that technology
either a supply curve or a demand curve. In part unwritten and in part derived fn
order to distinguish between equations, their provements that the workforce itseli
specifications must include factors which will duces.
identify which is which. If there are just
An important purpose of the IN
sufficient of these factors then the equation
LABOUR MARKET is to neutralize the in
is said to be just identified. If there are too
bilateral monopoly problem so that
few it is underidentified (or unidentified),
not absorb the resources of the firm
and if too many, then it is overidentified.
detriment of both workers and manag
The rules of the internal labour mar
thus designed to suppress the oppori
identity. An equation which is true by
for individual parties to long-rui
definition, or which serves to define a vari-
optimize by regularizing the idios>
able. Thus, for instance, NATIONAL INCOME is
trading relation. In particular, the inc
defined as the sum of CONSUMPTION and
contact is replaced by the collective 1
^VESTMENT expenditures by the relation
that is written in non-precise terms
Y = C+I which wage rates attach mainly 1
rather than to workers. Promotions a
where the triple bar sign conventionally training that are rewarded by the i
denotes an identity. wage structure mean that the тк
EARNINGS of incumbent workers are
^entity matrix. Commonly denoted I. A their current wage. The firm is reluc
MA whose diagonal elements are all capture the discrepancy in case this <
191
192 idle balances
ages labour mobility and also discourages imaginary number. A number involving
workers from acquiring the knowledge that the square-root of minus one, convention-
is required to advance along the promotion ally denoted /. (See also COMPLEX NUMBER.)
ladder.
The model of idiosyncratic exchange pro- IMF.
vides a variant of contract theory (see 'NEW- See INTERNATIONAL MONETARY FUND.
NEW' MICROECONOMICS and IMPLICIT CON-
TRACTS.) T h e parties to idiosyncratic, or non- imitative growth. An aspect of FIRM
standardized, exchange have as we have growth by DIVERSIFICATION, referring to that
seen an incentive to regularize the trading growth stimulated by the introduction of
relation. This requires the setting up of a products whose ATTRIBUTES are such that
governance or regulatory structure to har- consumers do not perceive the product to be
monize that relation. The more elaborate new; that is they do not arouse and satisfy
that governance structure (i.e. the greater some LATENT NEED. The impact of imitative
the degree of idiosyncracy) the slower will growth will be felt on a small number of
be the labour market to respond to underly- PRODUCERS. (See DIFFERENTIATED GROWTH.)
ing changes in aggregate demand because of
the longer-run nature of institutional com- immiserizing growth. The possible but im-
mitments. Long and variable price lags will probable case where an increase in economic
arise and an apparent non-responsiveness of output within a country leads via repercus-
wages, with quantity rather than price bear- sions through trade to a situation where its
ing the brunt of interim adjustments. ECONOMIC WELFARE is diminished. The
Idiosyncratic exchange thus alters the mech- circumstances which could bring this about
anics of inflation: the effects of an inflation- are growth biased towards the export com-
ary disturbance are more spread out. modity, for which foreign demand is price
Contractual arrangements do, however, INELASTIC, and a high MARGINAL PROPENSITY
adjust in response to higher and more vari- TO IMPORT. The growth in real output induces
able rates of inflation. In other words, the a demand for more imports. To earn the
model is still rational but only after recon- extra FOREIGN EXCHANGE to pay for them the
tracting occurs. Firms and workers do not export commodity in the face of a price in-
have all of the necessary information on elastic demand has to be sold at so low a
future states of the world available to them price that the TERMS OF TRADE deteriorate to
when they establish their contractual and such an extent that this wipes out the gain
institutional arrangements but they will from the extra output.
adapt those arrangements, after a lag, in
response to a changing market environment. impact analysis. A general name given to
techniques which attempt to measure the
idle balances. Money that is withdrawn effect on a regional or local economy of a
from circulation and held as a store of given change in economic activity. For
wealth, KEYNES identified a speculative example, one might undertake an impact
demand for money and argued that money analysis of the effect of the location of a new
would be held in idle balances because of industry in a region. Generally, impact
uncertainty as to'the future price of financial analysis is based on some form of the RE-
ASSETS which represented the principal GIONAL MULTIPLIER - either of the conven-
alternative form of holding WEALTH. (See tional Keynesian type or the ECONOMIC BASE
MONEY, DEMAND FOR.) MULTIPLIER. In its more sophisticated forms,
impact analysis may employ INPUT-OUTPUT
illiquidity. Lack of LIQUIDITY in a specific techniques or a full ECONOMETRIC MODEL of
ASSET, or in a PORTFOLIO of assets held by a the regional economy.
transactor. Being the obverse of liquidity the
condition is always a relative one, since impact multiplier. The immediate effect
almost all assets vary in degree of liquidity. on an ENDOGENOUS variable of a change in
an EXOGENOUS variable, as opposed to the
ILO. total or long-run effect of such a change. In
See INTERNATIONAL LABOUR OFFICE. MACROECONOMICS it is the MULTIPLIER effect
implicit contra<
of a change in one of the components of other hand, the heterogeneous and <
AGGREGATE DEMAND in the period immedi- nature of housing as a commodity
ately following the change. In ECONOMETRIC conditions (1) and (4), while though
MODELS impact multipliers are the estimated ship rights can be transferred the con
PARAMETERS on exogenous variables in the itself cannot be moved thus breaking
RED
U C E D FORM.
imperialism. According to Mai
impact of taxation. This simply refers to socialist thought, a foreign polic)
the person, company or transaction on seeks political and economic conti
which a TAX is levied. Someone is respon- backward areas to guarantee the
sible for handing the levy over to the tax country an outlet for idle savings and
authorities. This is thus referring essentially manufactured goods in exchange f
to the legal situation. The eventual incidence tegic raw materials. Most Marxist or
of the tax could be quite different. An indi- thought holds that a closed capitalii
vidual or organization will attempt to pass omy must suffer from a chronic defiq
on the burden to someone else. Whether he EFFECTIVE DEMAND, which Can Only
will be able to do so depends on a complex rected by the opening of foreign mai
set of factors. (Sec INCIDENCE OF TAXATION.)
unemployment. The policy may achieve sig- pass on the increased burden
nificant increases in industrial output for a prices, on final consumers. In th
feW years but after that the rate of growth is EQUILIBRIUM analysis of the efi
limited to the growth in internal demand for income tax it can be shown that if
industrial products which can be imported, of labour is reduced as a result of 1
protection has often been found to be ex- if as a consequence the output of
cessive with a protected industry occasion- economy is reduced then part of
ally producing a negative VALUE-ADDED at will be on the owners of CAPITAL a
world prices. There is political pressure on question of the incidence of a PROI
the governments of developing countries to been a particularly controversial с
maintain production at high levels even if it nomists. Economic theory is nol
is not strictly necessary. This can happen if elusive on the likely outcome
productivity increases in the years after an extensive empirical evidence ha
infant industry has been established through vided convincing evidence to sup
'LEARNING BY DOING'. the view that it is mostly boi
owners of capital or is passed
import tariff. sumers or suppliers of INPUTS.
See TARIFFS.
income. The amount of funds
Impossibility Theorem. services received by an individi
See SOCIAL WELFARE FUNCTION. ation or economy in a given ti
(See EARNINGS, NATIONAL INCOME
impure public good.
See MIXED GOOD. income, circular flow of.
See CIRCULAR FLOW OF INCOME.
imputed rent. The rent notionally paid by
the firm to itself for the use of the land it income consumption curve. Tr
occupies. (See IMPLICIT COST.) of the consumer's INDIFFERENCE
his BUDGET LINE defines the
inactive money. EQUILIBRIUM. If income is variei
See IDLE BALANCES. the budget line moves outwards i
fashion, new equilibria will be i
incentive payment systems. The locus of all such equilibria is
See PAYMENT-BY-RESULTS. consumption curve. If the curve
wards in COMMODITY SPACE it indicates that where Qt is the quantity demanded of good
both goods (measured on the axes) are NOR- i, Y is income and the symbol A refers to a
MAL GOODS. If it slopes backwards or down- change in the variable in question. (See
wards one of the goods is an INFERIOR GOOD. ENGEL CURVE.)
(See diagram.) The income consumption
curve is widely referred to as an ENGEL income-expenditure model. A simple KEY-
CURVE, although some writers distinguish the NESIAN one sector model which shows the
two. determination of the EQUILIBRIUM LEVEL OF
NATIONAL INCOME. Under the assumptions of
a fixed CAPITAL STOCK, LABOUR FORCE and
income determination.
See INCOME-EXPENDITURE MODEL.
technology and rigid wages and prices and,
therefore, expectations, it details the static
equilibrium in which the supply of REAL
income differentials. The difference in NATIONAL OUTPUT equals the quantity of
income levels between different people; national output people wish to buy. In the
these can be due to types of job, i.e. skill model the volume of AGGREGATE EXPENDI-
differentials or geographical location in that TURE determines the volume of output and
some areas have higher wage levels than the associated level of employment: the
others, or there may be differences between model concentrates exclusively on the
urban and rural wage levels. This is a demand side of the macro-economy. There
particularly marked phenomenon in less is no reason why the equilibrium that is
developed countries, because in general, eventually established will be associated
development plans, introduction of new with full employment, on the contrary this
techniques and high-wage type occupations simple representation of the Keynesian sys-
are situated in urban areas, while the agri- tem seeks to demonstrate the possibility of
cultural sector is often left behind, using an UNEMPLOYMENT EQUILIBRIUM. The equilib-
primitive methods for subsistence farming; rium level of national income is established
in addition payment may be made in kind, in where WITHDRAWALS equal INJECTIONS and
foodstuffs, seeds, clothing which is difficult this may occur at less than full employment.
to quantify in money terms and will give the Under these circumstances the Keynesian
rural sector an appearance of 'earning' less prescription is for a rise in GOVERNMENT
than it actually does. (See DISTRIBUTION.) EXPENDITURE which when magnified by the
actions of the MULTIPLIER will result in a level
of national income and output just sufficient
income effect. A change in the price of a
to ensure full-employment. Graphically
good will reduce or increase the consumer's
equilibrium is shown as the point at which
real income. In response to this change
in real income we can expect the consumer t h e AGGREGATE EXPENDITURE f u n c t i o n CUtS
to buy less (more) of all goods including the 45° line as below. This diagram is also
the one which has changed in price. This is known as the Samuelson Cross after
the income effect of a price change. (See SAMUELSON who first suggested the diagram-
SUBSTITUTION EFFECT, PRICE EFFECT, SLUTSKY matic approach.
EQUATION.) , This simple approach can however, be cri-
ticized on a number of counts. First, it con-
centrates on the demand side of the
income elasticity of demand. A measure economy assuming that the appropriate
of the responsiveness of the quantity supply will be forthcoming at any level of
demanded of any GOOD to a change in the
expenditure. Second, money plays no role in
level of income of the persons demanding
the model; prices are determined exogen-
the good. To avoid the measure being sensi-
ously. The model in fact concentrates exclus-
tive to the units used, the measure is ex-
ively on the goods market and it is the IS-LM
pressed as:
DIAGRAM which integrates this with the
Income Elasticity of Demand = money market.
government can exert direct control over ted that it 'double taxes' savings. Income
wage levels. It is suggested they fall unduly which is saved will have tax paid on it. If that
on public employees. income is invested tax will also be payable
Incomes policies have suffered from a on the interest or dividend. An income tax
number of other shortcomings. It is argued does in fact discriminate against saving and
that they merely defer rather than cancel in favour of consumption. The argument
large wage increases, because once the that an income tax discourages work effort
policy is 'off employees attempt to catch up is not clear-cut. There is a SUBSTITUTION
lost ground. Moreover where the norm re- EFFECT adverse to work effort and an INCOME
lates tO basic WAGE RATES, EARNINGS DRIFT EFFECT encouraging extra work. The net re-
has risen to compensate for this in some sult depends on the relative strengths of
sectors. This causes feelings of resentment these opposing forces. Empirical work has
on the part of those who remain restrained. not given convincing evidence that the net
Incomes policies tend to ossify the WAGE effect is significantly adverse, though it may
STRUCTURE and prevent differential rates of be for certain groups such as married women
change of money wages from allocating and people paying the very top marginal
labour between sectors. For all these reasons rates. The argument that income tax reduces
incomes policies have been the subject of the volume of investment is not foolproof
severe criticism. either. Income taxation may well reduce the
The administration of incomes policies in total return on investment but the effect on
the UK has usually been undertaken by the incremental projects is not so clear-cut. The
government although on the occasion of the existence of loss-offsetting arrangements
voluntary norm known as the social contract means that the government shares in the
the policy was administered by the TUC and losses as well as in the gains from new proj-
government. In Sweden both unions and ects. The net effect on risk-taking is uncer-
management have policed the policy without tain, depending on the attitude of investors
active government participation, while in the to risk and on the range of assets available to
USA administration has largely been by them. {See ALLOWANCES AND EXPENSES FOR
government. In the USA voluntary norms INCOME TAX, CORPORATION TAX.)
known as guidelines or guideposts operated
income terms of trade.
in the 1960s while more recently informal
See TERMS OF TRADE.
government pressure to moderate pay has
been employed. See Elliott, R.F. and income velocity of circulation. The
Fallick, J.L., Incomes Policies, Inflation and measure of the velocity of circulation of
Relative Pay, George Allen and Unwin money which stems from the Cambridge
(1981). analysis {see QUANTITY THEORY OF MONEY), in
which average cash balances are related to
income support. the level of income in a given period. The
See BEVERIDGE REPORT. equation is
M = kPY
income tax. This is the most important
single tax in the UK and plays an important where M is the quantity of money, P rep-
role in the fiscal regimes of all Western resents the price level, Y stands for real
countries. In the UK it is levied on TAXABLE income and к for the fraction of NOMINAL
INCOME of individuals at PROGRESSIVE rates. INCOME held as cash balances. If the terms
These have undergone many changes in are rearranged,
recent years as have the ALLOWANCES which
determine taxable income. Income is widely M_
recognized as being a suitable base for taxa- к= PY
tion on EQUITY grounds though there are
many problems with the definition of taxable and refers therefore to the proportional re-
income and some economists suggest that an lationship between balances and national
EXPENDITURE TAX is superior. Critics of income. This differs from the transactions
income tax argue that it can have significant velocity in the equation of exchange
disincentive effects. Thus it has been sugges- MV = PT,
index number problem
product at current prices to exceed the value then his UTILITY from X is the same as his
of current product at current prices, and utility from Y.
at the same time the value of current prod-
uct at base year prices to be greater than the indifference curve. A curve showing the
value of base year product at base year locus of combinations of the amounts of two
prices. In other words, in this instance, two GOODS, say X and Y, such that the individual
different methods of aggregation, namely is indifferent between any combination on
the PAASCHE INDEX and the LASPEYRES INDEX that curve. An indifference curve is usually
indicate different answers. See Diewert, assumed to be CONVEX (see diagram). (See
W.E., 'Index Numbers', The New Palgrave- INDIFFERENCE MAP.)
A Dictionary of Economics, Macmillan,
London (1987), Vol. 2, pp. 767-780.
be unable to withstand foreign com- ANCES may then not permit the recov*
tition during its infancy. Protection is capital costs in real terms. Similarly,
reued for until the potential COMPARATIVE inflation can give an artificial boost to p
nvANTAGE of the industry is realized and from STOCK APPRECIATION . If such profi
free trade accepted. The case was usually taxes a company which has to repla
made out for tariff protection, but it is nowa- stock at the higher price level is pena
days recognized that an infant industry rep- Several different approaches to a soluti
resents a domestic distortion, where the the problem have been suggested. Th<
M
ARGINAL PRODUCT of factors is lower than rent purchasing power method retain
elsewhere in the economy. This requires a toric cost notions but expresses accoui
domestic remedy, e.g. a subsidy; the imposi- terms of 'purchasing units' employi
tion of a TARIFF would add a foreign trade RETAIL PRICE INDEX. The Sandilands <
distortion to the domestic one. mittee which examined the whole subji
the UK recommended the use of
inference. accounting whereby assets were t<
See STATISTICAL INFERENCE. measured by reference to their value an
cost. The use of replacement cost accou
inferior good. A good for which the whereby assets are revalued from histo
INCOME EFFECT is negative, that is, as income current costs was recommended. Ther
rises CETERIS PARIBUS the quantity of the been much controversy about the de
good demanded falls. If demand rises as procedures that should be adopted. Ev
income rises the good is termed a NORMAL ally a consensus was reached with
GOOD, GIFFEN GOODS are a special case of publication of STATEMENT OF STANI
inferior goods where the negative income ACCOUNTING PRACTICE 16 entitled 'Cu
effect resulting from a fall in the price of the Cost Accounting' in 1980. Three a«
good is strong enough to outweigh the sub- ments to trading profits calculated on ;
stitution effect of the price fall. As a result toric basis are required to arrive at cu
demand falls when the price of the good cost operating profit. The first is th<
falls. PRECIATION adjustment which allows fo
impact of price changes when determ
infinite memory. A property of a DIFFER- the charge against revenue for the pa
ENCE STATIONARY PROCESS. fixed assets consumed in the period,
inflation. A sustained rise in the general second is the cost of sales adjustment \
price level. The proportionate rate of in- allows for the impact of price changes '
determining the charge against revenu
crease in the general price level per unit of
stock consumed in the period. The th
time. For theories of the causes of inflation
the monetary working capital adjust
See DEMAND-PULL and COST-PUSH INFLATION.
which represents the amount of addit
inflation, suppressed. This occurs if price (or reduced) finance needed for mon
controls are holding down prices when gen- working capital as a result of changes i
eral inflationary tendencies are present in input prices of goods and services empl
in the business.
the economy. (See INFLATION.)
with the associated upward pressure on of money balances will find their real pur-
prices. chasing power diminished in a manner anal-
This was initially advanced to explain the ogous to an increase in, for example, income
inflation of the 1940s and 1950s; the first real taxes. (See INFLATION SUBSIDY, FISCAL DRAG,
inflation since the publication of the General SEIGNORAGE.)
Theory of Employment, Interest and Money.
However the treatment neglects the role of informal sector. This refers to the large
money either in bringing inflation under volume of self-employed in a developing
control or in exacerbating an upward spiral country who are engaged in small-scale
of wages and prices. The model may be labour-intensive work such as tailoring, food
preparation, trading, shoe-repairing, etc.
Expenditure These people are often regarded as unem-
ployed or underemployed as they cannot be
included in national employment statistics,
but they are often highly productive and
make a significant contribution to national
income. Their work in general is character-
ized by a low CAPITAL-OUTPUT RATIO, that is
the ratio of the level of equipment, or capital
relative to output, and a low capital-labour
ratio; that is the ratio of the levels of factor
inputs of capital equipment to labour. (See
UNDEREMPLOYMENT.)
information.
See PERFECT INFORMATION.
omy, usually the agricultural and industrial borrowing. The funds dealt in are in large
sectors, work together efficiently, and are sums - generally not less than a quarter
mutually interdependent. As part of the million pounds - and they are lent, unse-
development process, this situation is cured, at terms which may be 'overnight' or
usually coincident with the achievement of 'at call', or for fixed periods. The market
sustained growth. which is served by a number of firms of
money BROKERS, is used by the banks and
integrated time series. A TIME SERIES, other institutions to adjust their short-run
which needs to be differenced 'd' times {see LIQUIDITY positions, or to obtain funds for
DIFFERENCING) before the resultant series is on-lending.
stationary, is said to be an integrated time
series of order d and is written I(d). If d = 1 intercept. In a LINEAR FUNCTION, the con-
the series is said to have a unit root and the stant term, i.e. that term which does not
undifferenced series is called a RANDOM contain any INDEPENDENT VARIABLES. For in-
WALK. See Harvey, A.C., The Econometric stance, in the function
Analysis of Time Series, 2nd edition, Philip
Allen (1990). Y = a + bX
a is the intercept, so called because the
integration. Denoted by the symbol J . graph of the function crosses (or intercepts)
The reverse process to differentiation {see the Y axis when Y is equal to a (i.e. when
DERIVATIVE.) By integrating a MARGINAL X = O). In a simple linear CONSUMPTION
function we can obtain the corresponding FUNCTION, the intercept can be interpreted as
total function. Thus for instance, autonomous consumption, i.e. consumption
which would take place even if income were
TC = fMCdQ
zero.
where TC is total cost (the integral)
MC is marginal cost (the integrand),
interdependent utility. If one individual's
and
UTILITY is affected by the quantities of goods
Q is quantity, i.e. the variable we are
and services consumed by other individuals
integrating with respect to.
we have the case of interdependent utility.
Such effects arise from envy or altruism.
intended inventory investment. The delib- Traditionally, WELFARE ECONOMICS is based
erate build-up of stocks. The deliberate run- on an assumption of independent UTILITY
down of stocks is intended inventory disin- FUNCTIONS; under this assumption the utility
vestment. {See INVENTORIES.) of individuals depends only upon their own
consumption of goods and services. {See
intensive margin. The case of decreasing EXTERNALITIES.)
physical returns to capital or labour applied
to a fixed quantity of land. Often accredited Interdistrict Settlement Account (or Fund).
to David RICARDO, this theory states that if to A special clearinghouse account used to
a given piece of land equal increments of accommodate transfers of funds among the
labour (or capital) are applied the incre- 12 District Banks of the FEDERAL RESERVE
ments in the output of the crop produced SYSTEM. The Fund offices are located in
will at some point reach a maximum and Washington, DC. For example, if a Cleve-
thereafter continuously decline. {See DIMI- land bank (A) receives a cheque drawn on a
NISHING RETURNS.) New York Bank (B), bank A sends it to the
Cleveland Federal Reserve Bank which cre-
Inter-Bank Market. One of a group of dits the account of Bank A and then sends
interrelated MONEY MARKETS in London. It the cheque on to the New York Federal
developed in the 1960s actually as a market Reserve Bank. The Cleveland Federal
in which the ПОП-CLEARING BANKS lent to one Reserve Bank receives a credit in its account
another, but it has since become a general with the interdistrict Settlement Fund. The
money market used by the whole range of New York Federal Reserve Bank debits the
financial institutions both for lending and Federal Reserve account of Bank В and
Intermediate Technology Development Group 21
ceives a debit in its own interdistrict USA). While most western governmen
Settlement Fund account. involve both local and national tax systen
(FISCAL FEDERALISM), intergovernment
interest. grants or 'grants-in-aid' from national
See RATE OF INTEREST. local governments have grown in impoi
ance. Indeed, in the UK most of the incon
interest equalization tax. In the early of local governments is provided by tl
1960s, the US was experiencing continuing national government through the RATE SU
balance of payments deficits in large PORT GRANT. (See GRANT.)
measure because of significant net capital
outflows. The interest equalization tax was interlocking directorates. Refers to a sit
an attempt to stem that outflow by placing a ation in which one or more person(s) sit <
tax on acquisition of foreign bonds and equi- the board of directors of two or more coi
ties by American residents. The tax was panies. Where these firms have similar pro
designed to make the after-tax yields on for- uct lines, such conditions can be conduci
eign securities equal to yields on comparable to collusive activities.
American issues. However, the tax was only
on securities from Western Europe, Japan, intermediate areas.
Australia, South Africa, and New Zealand. See HUNT REPORT, ASSISTED AREAS.
Canada and the rest of the world were
exempt. The tax was very effective in reduc- intermediate good. A good which is us
ing capital outflows directly to the countries at some point in the production process
included in the tax, but total capital out- other goods, rather than final consumptic
flows were not decreased dramatically. Common examples are steel and wood. II
Furthermore, Canada, Mexico and Latin quite possible for some goods to be be
America in general, soon began to serve as intermediate and FINAL GOOD, as is the a
centres for borrowing and relending, making with coal for instance which is used both \
them conduits for the flow of US capital to the purposes of producing electricity a
those nations affected by the tax. The tax steel, as well as directly for domestic heati
was repealed in 1974. purposes.
International Bank for Reconstruction and three affiliated organizations; the INTER-
Development. An international develop- NATIONAL FINANCE CORPORATION, the INTER-
m e n
t bank established in 1945, along with NATIONAL DEVELOPMENT ASSOCIATION and the
t h e INTERNATIONAL MONETARY FUND ( I M F ) , Multilateral Investment Guarantee Agency
by Articles of Agreement signed at the established in 1956, 1960 and 1988
United Nations Monetary and Financial respectively.
Conference held at BRETTON WOODS, New
Hampshire in July 1944. The Bank, com- international cartel. An agreement among
monly referred to as the World Bank, producers, when their number is small, to
became a specialized agency of the United apportion the world market in a particular
Nations in 1947. Initially the Bank was con- good among themselves to obtain profits
cerned with raising and allocating capital above the competitive level and in times of
resources for postwar reconstruction in depression to avoid cut-throat competition.
Europe. However, following the establish- The interwar period was the hey-day of car-
ment Of the EUROPEAN RECOVERY PROGRAMME tels, when they covered machine tools, elec-
in 1948, the main objective of the Bank has trical machinery, dyestuffs, chemicals and
been to assist the economic development of other goods. A cartel tends to be inherently
member countries by providing loans where unstable, since it is in the interest of any one
private capital is not available on reasonable member to break the rules, provided other
terms to help finance investment projects. members abide by them. OPEC is the out-
Loans generally have a grace period of five standing current example of a cartel.
years and are repayable over fifteen years or international clearing union.
less. They are made to developing countries See KEYNES PLAN.
at more advanced stages of growth. Loans
are given to, or guaranteed by, govern- international commodity agreements.
ments. In the 1980s the Bank devoted more Agreements made between producer and
of its resources to support adjustment and consumer countries, but occasionally only
policy reform to promote future growth and on the part of producers, in an attempt to
equilibrium on the balance of payments. The secure price stability for primary commodi-
Bank finances its activities by members' con- ties. Consumers and producers may agree to
tributions (in 1990 there were 153 mem- purchase and supply respectively certain
bers), calculated according to their quotas in quantities at set prices, while in those involv-
the IMF, borrowing in world capital markets ing only producers the schemes usually in-
and selling portions of its loans. The Bank's volve quotas, and occasionally buffer stocks,
lending rate is reviewed at quarterly inter- to control the level of supply. There have,
vals and is based upon the average weighted for example, been agreements for wheat,
cost, by amount and maturity, of capital sugar, coffee, tin and olive oil.
funds borrowed by the Bank in the preced-
ing year. The Bank also provides and co- International Development Association
ordinates a wide range of technical assist- (IDA). A specialized agency of the
ance for member countries. It conducts United Nations, established in 1960 as an
project feasibility and evaluation studies and affiliate of the INTERNATIONAL BANK FOR RE-
acts as executing agency for a number of CONSTRUCTION AND DEVELOPMENT ОГ World
development projects financed by the Bank. It provides capital to governments for
UNITED NATIONS DEVELOPMENT PROGRAMME. development projects in member countries
J
n addition, the Bank collaborates with nu- on more favourable terms than those offered
merous international and regional develop- by private capital markets or the World
ment agencies. The Bank also administers Bank. Its loans are concentrated on very
the Economic Development Institute, a staff poor countries, i.e. those with per capita
college which provides training for govern- incomes of $480 or less (in 1987 dollars).
ment officials of member countries who Forty countries qualify under this criterion.
ar
e directly involved with the evaluation Most of the association's loans are for
an
d implementation of development pro- periods of 40 to 50 years, with a 10 year
grammes The Bank's lending and technical initial grace repayment period and are inter-
assistance activities are complemented by est free, although a small service charge
* r ...iciiiauuiiai development (Jo-operation Agency
jd to be related to the level and growth experience a new inflow of foreign exchange
f world trade. However the availability and thus an addition to the domestic money
°f international lending facilities, either supply. It may attempt to neutralize or steril-
trough bodies such as the INTERNATIONAL ize the impact of such inflows by the sale of
ONETARY FUND (IMF) or through the EURO- BONDS to the public to reduce their cash
markets
CURRENCY ' g reat ly affects the inter- balances, but again there are limits to this
national liquidity situation since such facili- process. The continued sale of bonds will
ties are a means of redistributing the push down the price and raise the interest
available stock of international means of rate which in turn will increase the net in-
vment. when
wh the th demands
d d ariseri bbecause flows on capital account. Thus in the deficit
fv l country there will tend to be a net outflow of
of a loss of confidence in a particular cur- money reducing the inflationary pressure
rency, liquidity may have to be mobilized on while the surplus country will experience a
an international scale, and provided in a way net inflow and hence inflation. In this man-
analogous to that given by a CENTRAL BANK ner inflation rates will tend to equality and
acting as LENDER OF LAST RESORT. equilibrium of the balance of payments be
international monetarism. A school restored.
of thought which holds that changes in In the case of floating exchange rates, a
the world MONEY SUPPLY are the principal rapid expansion of the domestic money
source of inflationary and deflationary press- supply will lead directly to depreciation of
ure in the international economy. Thus rapid the currency. Domestic residents will seek to
monetary expansion by either a large coun- reduce their holdings of cash and restore the
try relative to the rest of the world or simul- value of cash balances within their portfolios
taneously by a number of small countries by purchasing foreign commodities and
will result in inflationary pressure through- securities. Conversely the countries with a
out the world under a FIXED EXCHANGE RATE rate of growth of the money supply less than
regime. In a world of fixed exchange rates, the rate of growth of income will seek to
flows of international reserves add to and increase their cash balances to enable them
reduce the domestic money supply of surplus to finance their increased volume of trans-
and deficit countries respectively, and thus actions. The country will thus experience a
there is a tendency for a uniform rate of net inflow of funds as the residents of this
price inflation to emerge throughout the country increase their exports or their sales
world. It follows that in a world of fixed of foreign securities in an attempt to increase
exchange rates the rate of price inflation in a their cash balances. Thus a country with a
small open economy cannot be independent rapid growth of real income and a slow
of the world rate of inflation. growth of domestic money supply will ex-
In a world of fixed exchange rates the perience an appreciation of its currency due
following mechanism is postulated: excess to the tendencies toward a surplus on either
growth in the money supply of a particular capital or current account. (See MONETARISM,
country results in excess cash balances and SPECIE FLOW MECHANISM.)
the subsequent attempt to bring this back
into the desired ratio within the country's International Monetary Fund (IMF). The
portfolio, leads to the purchase of both International Monetary Fund was estab-
domestically and foreign produced commo- lished in December 1945 following ratifica-
dities and securities. Thus a deficit on either tion of the Articles of Agreement of the
°r both current and capital account will Fund, formulated at the United Nations
emerge which will have to be financed by Monetary and Financial Conference held at
borrowing abroad and running down foreign BRETTON WOODS, New Hampshire in 1944.
exchange reserves. The magnitude of the The fund became a specialized agency of the
reserves and the borrowing facilities places a United Nations in 1947. The purposes of the
hmit on the extent to which the country can fund are to encourage international mone-
continue to increase the money supply and tary co-operation, facilitate the expansion
thus the domestic price level. Conversely a and balanced growth of INTERNATIONAL
country with a BALANCE OF PAYMENTS surplus TRADE, assist member countries in correcting
° n either capital or current account will BALANCE OF PAYMENTS deficits and promote
216 International Monetary Fund
FOREIGN EXCHANGE stability. The 'Bretton UK and the US along with Switzerland ( a n
Woods System', or international monetary associate member of the fund), undertook to
system established by the fund, was based provide up to $6900 million in their own
upon a policy of FIXED EXCHANGE RATES, the currencies if required by the fund. These
elimination of exchange restrictions, CUR- General Arrangements to Borrow were
RENCY CONVERTIBILITY and the development reformed in 1983 and renewed for 5 further
of a multilateral system of international pay- years from 1988. Until 1983 only the Group
ments. Exchange rates were based upon a of Ten plus Switzerland could borrow under
par value system which required member the scheme, but this right was extended to
countries to constrain fluctuations in their other members of the IMF and the funds
exchange rates within a margin of plus or available were increased to SDR 17 billion
minus one per cent round a par value ex- This increase together with the increase in
pressed in terms of US dollars, which in turn quotas in 1984 was necessary to permit the
were directly convertible into gold at a fixed IMF to come to grips with the debt problems
rate. However, following the 1971 decision of the developing countries. These countries
of the US to suspend the convertibility of had borrowed heavily from commercial
dollars into gold, the ministers and CENTRAL banks in the 1970s and largely because of the
BANK governors of the Group of Ten (see oil price hike of 1975-80 and the collapse of
below) met in December 1971 at the primary product prices in the early 1980s
Smithsonian Institute in Washington DC (the result of the world recession) they were
and ratified the 'Smithsonian Agreement' unable to service their debts. The Fund
which resulted in a 10 per cent devaluation working closely with the IBRD has played a
of the dollar and a realignment of exchange crucial role in a series of ad hoc rescue pack-
rates, including wider margins of fluctuation ages, as the two institutions were in a unique
in lieu of par values. This adjusted par value position of being able to provide finance in
system was largely abandoned when, follow- support of adjustment programmes in debtor
ing another dollar devaluation in 1973, the countries and act as a catalyst for other pri-
EUROPEAN COMMUNITY member countries vate and official lenders.
introduced a joint system of floating their A number of credit regulations, known as
currencies against the dollar. In 1972, fol- tranche policies, control members' access to
lowing the initial collapse of the Bretton the fund's general resources. In general, the
Woods System of exchange rates, the fund tranche policies limit purchases of foreign
established a Committee on Reform of the currencies by a member to some multiple of
International Monetary System and Related its quota but this figure can be as much as
Issues which issued a set of recommen- 440 per cent for countries which can avail
dations eventually adopted in 1976 by the themselves of all the existing facilities.
Jamaica Agreement (see below). Access to the various facilities is only
The fund relies upon members' contri- granted to countries, which have accepted
butions and borrowing arrangements to certain conditions laid down by the fund
finance its operations. Member contri- with respect to appropriate policies towards
butions, payable in SDRs (see below), other the balance of payments, growth and
members' currencies or its own currency, are employment creation, financial stability,
determined by a qubta system which assigns structural reform and restrictions on trade
each member a quota related to its NATIONAL and payments. These terms, which have to
INCOME, MONETARY RESERVES, ratio of EX- be accepted by a borrower, are known as
PORTS to national income and other econ- conditionality. In addition to the normal
omic indicators. A membeis' quota, which is stand-by facilities, the fund has established a
periodically reviewed and revised, also compensatory scheme for financing tempor-
determines its drawing rights on the funds ary export fluctuations, a BUFFER STOCK
under both regular and special facilities, its financing facility, an extended facility which
allocation of SDRs and its voting power. In provides medium term financing for up to
1962 an agreement was concluded whereby 4 years to enable members to overcome
the Group of Ten: Belgium, Canada, structural balance of payments difficulties,
France, the Federal Republic of Germany, a structural adjustment facility and an
Italy, Japan, the Netherlands, Sweden, the enhanced structural adjustment facility-
international trade
/The latter 2 facilities are designed to help Apart from making loans the other
low income countries improve their growth function of the IMF is the surveillance с
prospects.) exchange rate policies of members ii
Against a background of inadequate attempt to secure consistency in mj
growth in gold production in the early 1960s economic policies at the world level. T]
discussions took place on how to augment done by engaging in annual or bienniai
international LIQUIDITY. At the IMF meeting cussions with members.
at Rio de Janeiro in 1967 a draft outline for a Executive authority for the Fund's <
scheme of Special Drawing Rights (SDRs) ations is vested in a Board of Govei
was produced. In 1969 the members of IMF composed of two representatives from
agreed to an amendment in the fund's articles member country. Daily activities of the
to permit the fund to operate a Special are conducted by a permanent staff unde
Drawing Fund in addition to its General supervision of the Managing Director
Fund and the first allocation of SDRs took Board of Executive Directors. See de \|
place in 1970, with subsequent allocations in M.G., The International Monetary Fuf\
1971, 1972, 1979, 1980 and 1981. The SDR is vols., IMF, Washington (1985).
an accounting creation without any backing,
which, subject to a variety of conditions, international payments system. A ge
debtor countries may use to settle debts. term referring to the way in which i
Debtors run down their drawing rights, while national financial transactions are ca
creditors' balances are increased. The SDR out, that is payments between residen
has also been adopted by other international different countries who hold different <
and regional financial institutions. Initially estic currencies. The term covers the d
the value of the SDR was equivalent to that of ent systems of EXCHANGE RATES, EXCH.
the US dollar. However, following the CONTROL and questions concerned with n
emergence of floating exchange rates in 1973, NATIONAL LIQUIDITY.
the value of the SDR was based upon a
weighted basket of 16 currencies, where the International Standard Industrial Classi
weights reflect the importance of members' tion (ISIC). An industrial classificatic
currencies according to the relative share of economic activity which is designec
their economy in the volume of world ex- promote international comparability in
ports. In 1981, the basket of currencies used istics compiled and published by the Ui
to determine the value of the SDR was Nations. The classification is essential
changed to include only the US dollar, the compromise between the systems of in
West German Deutschmark, the French trial classification employed by coun
franc, the Japanese yen and the UK pound throughout the world. (See STANDARD IN
sterling as these were the currencies of the TRIAL CLASSIFICATION.)
five members having the largest volume of
exports between 1975 and 1979. The fund has international trade. Trade between nal
also distributed SDRs according to the above in goods and services. The essential di
Quota system in order to supplement the ence between internal trade and ii
reserve assets of member countries. SDRs national or foreign trade is that the Ii
have not been as successful as their protago- involves the use of different currencies ai
nists had hoped as they play only a very minor subject to additional regulations such as
role in the total of international settlements. IFFS, QUOTAS a n d EXCHANGE CONTROLS.
The fund's Articles of Agreement were sub- International trade is held to take p
stantially revised following the 'Jamaica because of cost differences between nal
Agreement' concluded at Kingston, Jamaica or because of the absolute non-availabili
m May 1976. The agreement reduced the role goods or services in countries. Internati
°f gold in the international monetary system, trade leads to GAINS FROM TRADE. The th
a
cknowledged the system of 'floating' Of COMPARATIVE ADVANTAGE shoWS t h a t
e
*change rates, revised the valuation and difference required in costs between nat
Possible uses of the SDR and authorized the is not an absolute advantage but a comp
sa
le of the fund's gold reserves for the benefit tive advantage, based on a difference in
°f developing member countries. structure among countries.
218 International Trade Organization
inventory cycle. Fluctuations in the level rate. The former is known as the
of output caused by changes in INVENTORY ENT VALUE criterion and the lat
holdings. Demand for output arises from MARGINAL EFFICIENCY OF INVESTMEf*
sales of output and from inventory holding
by firms. Sales can be (partly) met from a investment criteria (for D
rundown of inventories such that output is COUNTRIES). Criteria proposed о
depressed; likewise output is boosted if base the allocation of investible '
1
INVENTORY INVESTMENT is in progress. Many Capital is in very scarce supply in c
1
firms try to maintain a constant inventory to countries and so it is important
f
sales ratio which implies that changes in available supply be allocated in
sales lead to greater changes in output as the efficient manner to obtain develoi
constant ratio is maintained. jectives. Many criteria have been*
by economists. These are often
1
inventory investment. The accumulation tory. Sometimes the contradiction
of inventories when production exceeds cause different development /
actual sales. If production is less than sales assumed by different authors. -
inventory DISINVESTMENT takes place. Often assumptions are made about the
such investment is unanticipated and acts as which should be reflected in the
a buffer between output and uncertain sales. investment undertaken. Thus one'
may be to maximize the total о
inverse function rule. A rule for the deter- head at the end of a specified ti/
mination of the DERIVATIVE of a function (say 10 years). This objective wouj
where the variable with respect to which we a different ordering of investment
wish to differentiate is expressed as the de- situation where the goals were to^
pendent variable, it states that output and consumption over
shorter period. The first objective
quire an allocation of investible
which have a low priority to consu
the short term compared to th<1
dXIdY' Special consideration of investme£
so that if we have the function in developing countries is also nee1
cause markets are so imperfect t(
X = a + bY , market prices (both goods and la.
greatly out of line with SOCIAL OP
we can determine that COSTS or SHADOW PRICES. Use c1
values may give wrong indicatio]
relative social values of goods and1
production and lead to a misalk
resources. In developing countries 3
bution of income could be si$
investment. The term is most commonly altered by a set of new projects. =
used to describe the flow of expenditures may be so pronounced that it is f
devoted to increasing or maintaining the real some economists that distribute
CAPITAL STOCK. In fact a more accurate defi- siderations require to be explicitly
nition, which clearly encompasses the when proposed projects are exam
above, is that investment is the flow of SOCIAL MARGINAL PRODUCTIVITY
expenditures devoted to projects producing LITTLE-MIRRLEES METHOD, UNID(
goods which are not intended for immediate LINES.)
consumption. These investment projects
та
У take the form of adding to both physical investment grants. Funds made
an
d HUMAN CAPITAL as well as INVENTORIES. by government or other agencies fc
nvestment is a flow, the volume of which is pose of encouraging FIRMS to makej
aet
errnined by all those projects which yield tures on the acquisition of physica^
Positive NET PRESENT VALUE, or an INTER- These grants are generally р к
AL
RATE OF RETURN greater than the interest the form of a fixed percentage of
220 investment trust
iso-cost curve. A curve or line showing the iso-profit curves. The locus of combi-
combinations of any two inputs that can be nations of two or more independent vari-
bought with a fixed sum of money. It is ables of the PROFIT FUNCTION which yield an
analogous with the consumer's BUDGET LINE, equal profit. This is a commonly used con-
but relates to the firm's purchase of inputs. cept in OLIGOPOLY theory.
The tangency of the iso-cost curve with the
ISO-PRODUCT CURVE defines the least-cost
combination of inputs for the production of isoquant.
a given level of output. The iso-cost curve is See ISO-PRODUCT CURVE.
also known as the iso-outlay line (curve).
(See COST MINIMIZATION.)
iso-revenue line (curve). The locus of
iso-outlay line (also known as iso-outlay combinations of OUTPUT and marketing
curve). outlays which yield a given level of TOTAL
See ISO-COST CURVE.
REVENUE. Thus for instance, the general
functional form of an iso-revenue curve
iso-product curve (also known as producers' comprising output and ADVERTISING outlay
combinations will be
indifference curve, or isoquant). An iso-
product curve traces out the combinations of (1) TR = / ( Q , f l )
any two or more INPUTS which give rise to
the same level of OUTPUT. These combi- where TR is the given level of total revenue,
nations must be the most efficient ones - i.e. Q is output and a is units of advertising. This
any point on an iso-product curve shows the function will then trace out those combi-
minimum quantities of the inputs needed to nations of a and Q which yield TR. Totally
differentiating (1) gives
produce the given output. Iso-product
curves are typically drawn as being convex to
the origin because of the assumed substituta- (2) = 0
bility of inputs (Curve 2 in the diagram). dx da
Where inputs are complementary the iso- and manipulating to solve for
product curve will be a perfect 'L' shape
(Curve 1). Where they are perfect substi- da
tutes the iso-product curves will be straight dx
lines. (See PROCESS, ELASTICITY OF INPUT
yields:
SUBSTITUTION.)
(3) da dTR/dx
dx dTR/da
Capital (3) states that the slope of an iso-revenue
curve, i.e. the rate at which output can be
substituted for units of advertising in order
to maintain TR = TR, is given by the ratio
of the marginal revenue product of output to
the marginal revenue product of advertising.
224
job search channel;
laces in a labour queue; that employers use the job evaluation. The wage rates f.
c
screening devices to hire workers based remaining non-market jobs can then b
upon their presumed adaptability and traina- ted into the structure and different
bility {see SCREENING HYPOTHESIS); and that tween current pay levels and evaluate
a
ll training is acquired on-the-job, so that levels met by upgrading or downgf
the labour market is a market for training (while maintaining 'personal' wage vi
slots. {See INTERNAL LABOUR MARKET.) the old level) as appropriate. Note thl
evaluation is a subjective process, th"
'ob creation. Action in the widest sense to cess of which depends on its concor(
reduce the stock of unemployment in re- with what the market would dictate. '
cession, either by reducing the flow of
redundancies or by increasing the rate of job search. The process of gathering
outflow from the ranks of the unemployed. mation about the existence of job vac
Job creation may be either direct or indirect and the wage rates attaching to each va'
in form. By direct job creation is meant the in the labour market. Even in a wo1
provision of jobs in the public sector. This HOMOGENEOUS commodities there wil
method is favoured by those of DUAL LABOUR mally exist some dispersion of prices. С
MARKET persuasion and by those who see in perfect information is costlessly provic"
the very directness ol the measures the pro- market participants will there be a
spect of a 'bigger bang' per fiscal pound. price. The labour market is charactd
Indirect job creation, on the other hand, neither by job/worker homogeneity nfl
operates via the subsidization of the private perfect information. Thus there will be1]
sector. Private sector employers may be dispersion and because of this it wii
given subsidies to preserve employment (i.e. workers to search the market for a :
defer redundancies). It has been claimed offer, The more an individual searchr
that job subsidies can reduce the budget greater the probability that he will loca"
deficit and dampen the rate of inflation at highest-paying job offer obtaii1
the same time as they promote or maintain although the search process will Q]
employment. However, each of these claims diminishing returns, because there are '
has been strongly countered and there is no options to examine. The search for job !
consensus on the efficacy of the measures in mation is costly with the chief cost bein1
question. A similar conclusion follows in the of time. It is often assumed that the 4
case of public sector job creation. process is most efficient when the worj
unemployed. From this arises the noti
job duplication. This occurs when an indi- search unemployment. Here, the cc
vidual has more than one form of employ- search is the income foregone from err1
ment at the same time and therefore is not ment less any unemployment be'
dependent on only one source of income. It received. The costs represent an inves
is particularly prevalent in underdeveloped on which a return in the form of a I
countries especially in the INFORMAL SECTOR. wage offer is expected. Not all wage '
will be identified: the worker will(
job evaluation. A process whereby the searching when it seems that the bene
various elements of a job - such as different additional search are probably not wor
skills, acquired knowledge, responsibility, costs of additional search. An actual о
and physical working conditions - are each ceived change in the costs and benei,
rated and an overall rating for the job ob- search will thus have an effect on the of
tained. Points are accorded to the various duration of search and hence upon
Job factors and these points are aggregated unemployment and wage dispersion.
flowing the weighting of each component.
v
he differences in the weighted totals for job search channels. The methods thi
different jobs are then used to determine which jobs are identified and/or obte
relative wages. The process is, however, re- They are classified as either 'fonrn
**ted to the market rates ruling for certain 'informal'. Formal methods include
е
У jobs. From these KEY RATES a curve, or public employment service, private errf
EG
RESSION line, is obtained relating pay to ment agencies and trade union netw
226 job shopping
Informal methods comprise employee refer- joint products. Examples of joint products
rals and gate applications. Informal search are wool and mutton, gas and coke, petrol
activities are not only the most common, and heavier oils.
they are also the most effective job search
methods for BLUE-COLLAR WORKERS (effec-
tiveness here being defined as the change in joint profit maximization. The maximiz-
the probability of finding a job when the ation of the combined profits of an existing
particular search activity is used, rather than group of FIRMS. This is a feature which can
cost-effective). characterize OLIGOPOLISTIC market struc-
tures, where firms mutually recognize their
job shopping. A tendency among younger interdependence and are thus motivated to
workers, and in particular teenagers, to overcome rivalry and adopt goals such as
search for suitable employment on a trial joint profit maximization.
and error basis. Job shoppers tend to move Joint profit maximization requires the
from one job to another, finding out in a group of firms to find that industry output
rather expensive way what kind of work they level at which industry MARGINAL COST and
like. MARGINAL REVENUE are equal. Each indi-
vidual firm's output level is found by equat-
Johnson, Harry Gordon (1923-77). Canad- ing industry marginal revenue with the firm's
ian economist appointed to the chair in marginal cost. If there is variance in the cost
economic theory at Manchester in 1956. He conditions facing each individual firm, then
taught at Chicago, the London School of this requires each firm adopting an output
Economics and in Geneva. He was editor at level which they would not have adopted if
various times of Economica, Journal of acting independently. To induce allegiance
Political Economy and the Journal of Inter- to the goal of joint profit maximization SIDE
national Economics. A prodigious writer, his PAYMENTS between the firms in the oligopoly
best known works include: International will be necessary. (See CARTELS.)
Trade and Economic Growth; Studies in
Pure Theory (1958); Further Essays in joint stock company. Joint stock com-
Monetary Economics (1972); Inflation and panies developed out of the requirements by
the Monetarist Controversy (1972); and many undertakings for large amounts of
Economics and Society (1975). FINANCIAL CAPITAL. A distinctive feature of
A member of the CHICAGO SCHOOL, in these business units is their issue of financial
addition to original contributions in the field capital in the form of SHARES which are of
Of BALANCE OF PAYMENTS, TARIFFS, a n d f a c t o r small denomination, thus allowing investors
payments, he synthesized much of the to purchase small or large sums as they
contemporary work on INTERNATIONAL ECON- please, DIVIDEND payments are made out of
OMICS and INTERNATIONAL MONETARY ECON- PROFITS and are distributed in proportion to
OMICS. the number of shares held. Regulation over
the establishment of joint stock companies
joint probability distributions. Probability is the responsibility of the registrar of
distributions which give the probability with Companies, who ensures that all legal
which two or nWe variables take on certain formalities are carried out. Joint stock com-
values (or fall within certain ranges) simul- panies are often referred to simply as limited
taneously. Included amongst their para- companies.
meters are the MEANS and VARIANCES of the
individual variables, and the COVARIANCES
between them. joint venture. A situation where both
public and private sectors work together in
joint products. Commodities which have an economic activity; this is particularly pr e '
the property that in production a change in valent in underdeveloped countries where
the rate of output of one brings about a capital is very scarce in the private sector
similar change in the other(s). Any change and government funds are often needed in
in supply and demand conditions will there- order to develop industry, or banking ser-
fore be transmitted between the markets of vices etc.
jus
the City. From 1911 he was editor of the given population with a particular tech-
Economic Journal. His early work which nology. This was in contrast to the prevailing
was of a more practical nature, e.g. the orthodox economic theory which attributed
return of the UK to the GOLD STANDARD high unemployment to excessive REAL WAGES
{Economic Consequences of Mr. Churchill and high INTEREST RATES. If money wages
(1925)), and the reform of the UK currency were reduced and thereby consumption cut,
{Tract on Monetary Reform (1923)), led to employment would increase (a) because
the production of a new theoretical frame- firms would take on more labour at a lower
work in which to analyse the problems of the price and (b) because increased SAVINGS
day, and formulate public policy towards would lead to greater INVESTMENT. In the
them {Treatise on Money (1930) and espe- General Theory Keynes argued that far from
cially General Theory of Employment, increasing employment a wage cut, by
Interest and Money (1936)). Keynes con- depressing demand, would increase unem-
tinued to play a part in the formulation of ployment. The level of employment was not
government policy being a member of the determined by the level of real wages, but
MACMILLAN COMMITTEE on Finance and rather by the level of aggregate demand
Industry (1930) which highlighted the diffi- which in turn largely depended on the level
culties of small firms trying to raise capital of investment in the economy. Moreover a
(MACMILLAN GAP). He was also a major con- fall in the rate of interest might have little
tributor to the BRETTON WOODS Conference effect on the level of investment especially in
(1944) which set up the INTERNATIONAL times of depression. The reasoning behind
MONETARY FUND. He analysed the problem of such statements and the conclusion that
inflation in the pamphlet How to Pay for the SAY'S LAW is inoperative in a capitalist econ-
War (1940). A director of the BANK OF ENG- omy is as follows: the level of output and
LAND, he was created Lord Keynes of Tilton employment at a given wage rate and popu-
in 1942. The General Theory is undoubtedly lation depends on (1) the MARGINAL PROPEN-
Keynes' most significant work, and is SITY TO CONSUME, (2) the MARGINAL
regarded by many as a turning point in the EFFICIENCY OF CAPITAL, ( 3 ) t h e QUANTITY OF
course of the history of economic thought. MONEY a n d ( 4 ) LIQUIDITY PREFERENCE. T h e
Such a claim rests on four main contri- effective demand in the economy acts
butions: (1) a reformulation of contempor- through the propensity to consume and the
ary monetary theory emphasizing the rate of new investment to set a ceiling on the
difference between a monetary economy level of economic activity. Keynes assumes
and a BARTER economy, (2) the creation of an that aggregate consumption is a relatively
aggregative GENERAL EQUILIBRIUM model of fixed proportion of aggregate expenditure -
the economy which is simple, capable of the CONSUMPTION FUNCTION. Given that con-
manipulation and of empirical formulation, sumption will adjust to any level of income
and, at the same time, is relevant to prob- the level of employment is determined by
lems of economic policy, and from these (3) the other components of aggregate expendi-
an explanation of why a competitive capita- ture (in Keynes' model the only other com-
list economy does not automatically main- ponent is investment). There exists an
tain a level of full employment, and (4) equilibrium level of employment at every
thereby stimulating a* revolution in the orth- level of investment. Full employment occurs
odox thoughts on the role of government in at a unique level of investment and unless
such an economy. The policy problem which there is some mechanism to ensure the 'cor-
occupied Keynes in the 1930s was that of rect' level of investment full employment
mass UNEMPLOYMENT. This led him to focus will not come about automatically. The orth-
his attention (in the General Theory) on odox view was that investment adjusts to the
what determined the level of output rather full employment level automatically via the
than the question of what determined the rate of interest. Any deficiency in invest-
general price level (which was the major ment is considered to be an excess of the
concern of contemporary economic theory). supply funds over the demand for those
Keynes stressed the mechanism of EFFEC-
TIVE DEMAND. This mechanism determined funds. The rate of interest is the price of
LOANABLE FUNDS and like any other price
the level of employment in an economy of a
will equate supply and demand in this case
ill
Keynesian economics
sserting a tendency towards equality of sav- the formulation of the new ecom
• 2 s (the supply of funds) and investment problem of determining the level of e
[the demand for funds). The labour market omic activity, (2) the use of a nati
similarly cannot show a prolonged tendency income-expenditure approach to descri
of disequilibrium as real wages (the price of the economy, and (3) demand manager
labour) will tend to adjust the supply and by political and monetary authorities,
demand for labour. acceptance has generated the subject are
A major difference between Keynes and contemporary MACROECONOMICS. Its ge
his predecessors is the explanation of the ality has been questioned in recent years
determinants of the rate of interest. For the reformulation of the Keynesian sys
Keynes the level of investment is determined by J.R. HICKS and others has tended tc
by the relation between expected marginal duce Keynes' contribution to a special
yields of assets and their marginal costs of of NEOCLASSICAL equilibrium with i
production (the MARGINAL EFFICIENCY OF money wages and a LIQUIDITY TRAP. '
CAPITAL). standard interpretation or NEOCLASSJ
Expectations of future yields by entre- SYNTHESIS has itself been subject to s<
preneurs are related to their confidence in criticism especially by those who emphz
the state of the economy. The rate of inter- the part played by uncertainty and tim
est plays a secondary role in determining the Keynes' analysis. (See KEYNESIAN ECONO
inducements to invest. Unlike contemporary MONETARISM, GENERAL EQUILIBRIUM.)
economists Keynes regarded the level of Moggridge, D.E., Keynes, 2nd e
investment as the major determinant of the Macmillan, London (1980).
level of income, and the lack of a straight-
forward automatic adjustment mechanism Keynes effect. A change in the dem
through the rate of interest was a major for commodities as a result of a change id
feature of his under-full-employment equi- general price level. For example, a fall in
librium system. For Keynes the rate of inter- general price level will increase the quar
est was a monetary phenomenon determined of real money balances and therefore rr
by the demand and supply for stocks of money will be available for specula
bonds and money. The role of money as a purposes. As a result the price of bonds
hedge against an uncertain future allowed rise and the interest rate fall which in 1
Keynes to postulate a liquidity preference will stimulate a rise in investment and
theory of the rate of interest which empha- increase in the demand for commodit
sized the distinction between decisions to Clearly a rise in the general price level
save and decisions to invest. The possible set in motion an opposite sequence
inequality between planned savings and events. This indirect change in the dem
planned investment allows changes in invest- for commodities for investment should
ment to determine changes in the level of distinguished from the direct effects с
output and employment. In Keynes' system change in the general price level on
the equality of savings and investments is demand for commodities for consumptioi
achieved by changes in the level of aggregate described by the direct real balance effi
income and not by changes in the rate of The Keynes effect is illustrated by a shif
interest. the LM curve in the IS-LM DIAGRAM while
Keynes demonstrated that autonomous direct real balance effect manifests itself
expenditure such as government spending a shift in the is CURVE. (See REAL BALAI
would increase aggregate income by a EFFECT.)
greater amount through the MULTIPLIER
mechanism and thus provided the analytical Keynesian cross.
Stl
m u l u s for DEMAND MANAGEMENT by t h e See INCOME-EXPENDITURE MODEL.
state. He saw an increasing role for the
government in this respect as he expected Keynesian economics. A term used to
n
e inducements to invest to decline in the scribe macroeconomic theories of the le
future. of economic activity using the techniq
The Keynesian system has led to: (1) the developed by J.M. KEYNES. The meth
ё O w t h
of macroeconomic models based on ology of Keynesian economics may
232 Keynesian growth theory
distinguished from NEO-CLASSICAL ECON- the view that transitory shocks do not
OMICS by its concern with aggregate behav- have permanent effects on real magnitudes
iour, especially the income generating effect such as output and employment, while
of total expenditure and the emphasis placed Keynesians would consider such shocks to
on the investment component in determin- have permanent effects. This runs counter to
ing the level of activity. The development of the view that classical and Keynesian macro-
Keynesian taeory has centred around three economics are converging, a view particu-
related topics: (1) the stability of a market larly popular in the US, but the persistence
system and particularly its ability to maintain of high unemployment and the apparent
full employment, (2) the role of money in failure of the NCM, RE and RBC theories
such a system and (3) the long term dy- to explain it have reinforced Keynesian
namics of the market economy. economists in their view that there is a
The standard exposition of the Keynesian fundamental difference between their analy-
system attributes the possible instability of sis and that of those schools within neo-
the system to rigidity in wages and the exist- clasical economics. See Blanchard, O. and
ence of a LIQUIDITY TRAP. The latter pheno- Fischer, S., Lectures on Macroeconomics,
menon and an interest inelasticity of invest- MIT Press, Massachusetts (1989).
ment were sufficient to recommend the
adoption of fiscal policy as opposed to mone- Keynesian growth theory.
tary policy. This so-called NEO-CLASSICAL See HARROD-DOMAR GROWTH MODEL.
SYNTHESIS formulated as the IS-LM model,
and the passive role of money have been Keynes Plan. The UK TREASURY proposals
questioned not only by post-Keynesians who for the establishment of an International
stress the DISEQUILIBRIUM nature of a model Clearing Union which received consider-
where decisions are made under conditions ation at the United Nations Monetary and
of uncertainty, but also by the CHICAGO Financial Conference convened at BRETTON
SCHOOL which claims that monetary policy is WOODS, New Hampshire in 1944. As JOHN
the only effective way of changing the level MAYNARD KEYNES was primarily responsible
of activity and prices. A number of eco- for their formulation, these proposals were
nomists have used the Keynesian aggregates collectively referred to as the Keynes Plan.
as a basis for a dynamic theory of growth. The proposals recommended the creation of
Following R.F. HARROD, the CAMBRIDGE an international means of payment called
SCHOOL use investment functions which BANCOR which would be used to clear inter-
imply that investment determines savings to national debts on a multilateral basis be-
generate models of accumulation. While tween the members of the International
neo-classical economists have adopted the Clearing Union. Members experiencing
new classical model (NCM), rational expec- temporary balance of payments deficits
tations (RE) and more recently the real could obtain bancors, up to a credit quota or
business cycle (RBC) as an approach to overdraft limit, from the clearing union with
macroeconomic problems, Keynesians have which to settle their international debts. The
been less clear in their objectives. They have overdraft limits would increase automati-
adopted different definitions of equilibrium, cally as each member country increased its
such as path dependent or hysteretic equili- volume of imports and exports. Although
bria and non-competitive aspects of the the value of the bancor was initially linked to
economic system, to explain why high unem- gold, it was anticipated that it would eventu-
ployment is so persistent. The dominant ally replace gold as a means of financing
analysis of the economic system has tended international payments. In order to discour-
to pass to the NCM and RBC schools with age persistent credit or debit balances, the
Keynesian economists seeking to distance plan also recommended that INTEREST should
themselves from this neo-classical domi- be paid on both credit and debit balances
nance. While macroeconomics continues to held by the union. In contrast to the bancor
be the most unsettled area of economics, credit quotas, the number of bancors held by
Keynesians would take the view that the a surplus country was unlimited, or limited
most important issue is that of neutrality, only by the sum of member country credit
with the NCM and RBC economists taking quotas, as they were obligated to accept
Klein, Lawreiu
bancor cheques. This aspect of the plan, change in cost conditions which
which potentially could have resulted in a take the new marginal cost curve
situation whereby the US was the sole sur- the discontinuity in the margina
S
j u s member in the Clearing Union, was curve, leaves price unchanged.
^porously opposed by the US delegation at
the Conference. The Keynes Plan was
eventually rejected by the Conference which
price
instead established the INTERNATIONAL MONE-
TARY FUND (IMF) following the proposals set
out by the US or WHITE PLAN. The idea of a
bancor, however, has to some extent re-
emerged within the framework of the IMF in
the form of SPECIAL DRAWING RIGHTS ( S D R S ) .
associated with his name the best known and about the future causes the special reward of
most successful has been the Wharton profit. He was concerned to distinguish be-
Econometric Forecasting Model of the US tween insurable risk and uninsurable uncer-
economy, developed at the University of tainty. Only the latter was responsible for
Pennsylvania. pure profit. Profit as a reward for under-
Klein has specialized more on the appli- taking production in the face of uncertainty
cation of theoretical developments in econo- is therefore related to the rate of change of
metrics to applied work than on developing economic variables and the availability of
the theory of econometrics itself. His work entrepreneurs willing and able to make accu-
has shaped developments in the field and rate guesses about future conditions.
influenced model-building on a world-wide His other major publications include The
scale. Klein's unique achievement can be Economic Organization (1933), The Ethics
said in general terms to have been his trans- of Competition (1935), Freedom and Reform
lating of the broad KEYNESIAN model into (1947), Essays on the History and Methods
statistical terms. His two best known books of Economics (1956), and Intelligence and
are The Keynesian Revolution (1947) and his Democratic Action (1960). A founder of the
Textbook of Econometrics (1953). CHICAGO SCHOOL of 'liberal' economists,
Knight has had considerable influence on
knife edge. In GROWTH THEORY, an ob- members of that tradition but although he
stacle to steady growth where the WAR- was critical of state power, he was sceptical
RANTED RATE OF GROWTH is unstable, apart of the ability of a free enterprise to function
from the further problem of whether or not efficiently and in an ethically satisfactory
the warranted rate is equal to the NATURAL manner. He was particularly critical of the
RATE OF GROWTH. The role of EXPECTATIONS implications of free enterprise for the distri-
about the future level of output is central to bution of income.
the knife edge problem: if the expected rate
of growth of income is below the warranted Kondratieff, Nikolai D. (1892-?). A
rate then ENTREPRENEURS will invest too Russian economist who did notable work in
little, causing a fall in AGGREGATE DEMAND agricultural economics and in the develop-
and an increase in EXCESS CAPACITY causing a ment of economic planning in the USSR. In
further fall in the expected rate of growth of 1925 he published The Long Waves in
income. Economic Life, for which he is best known.
He identified long cycles from the end of the
Knight, Frank (1895-1973). American 1780s to 1844-51, from 1844-51 to 1890-96
economist; Knight was appointed Professor and an upswing from 1890-96 to 1914-20.
of Economics at Chicago in 1928. He made He held that the existence of long waves was
important contributions to the ethics and 'at least very probable' but offered no
METHODOLOGY of economics as well as the systematic theory, merely outlining certain
definition and interpretation of SOCIAL COST. relevant factors. Subsequent work has
His most celebrated contribution to econ- suggested that the waves identified may be
omics was Risk Uncertainty and Profit due to the statistical techniques used by
(1921). A disciple of J.B. CLARK, he was Kondratieff. His attempts to analyse econ-
concerned to show that, contrary to the omic conditions objectively brought him into
statements of Clark and Alfred MARSHALL, conflict with official Soviet policies. He was
profits could exist in a STATIONARY STATE. arrested in 1930, never brought to open trial
The followers of Marshall argued that profits and died in prison at an unknown date.
only appear as the income of entrepreneurs
in conditions of change. In a stationary econ- Koopmans, Tjalling (1910-85). American
omy factors receive only WAGES, INTEREST economist born in the Netherlands.
and RENT. Profits are a reward for the talent Koopmans was Professor of Economics at
of the entrepreneur in organizing the pro- Chicago (1948-55), Director of the Cowles
ductive process to changed conditions. Foundation (1961-67) and Professor of
Knight argued that it was not change as such Economics at Harvard (1960-61). Credited
which gave rise to profit but that devia- with the independent development of LINEAR
tion from expected conditions. Uncertainty PROGRAMMING, Koopmans linked linear
it
Kuznets, Sin
e
vious values of one or more of the INDE- MONOPOLY and outlawing r
P ND E N T VARIABLES. {See DISTRIBUTED LAGS.) practices. The doctrine has t
cized for its ideological over
Lagrangean technique. A method for daily its implication for ec
lying CONSTRAINED OPTIMIZATION prob- The apparent inability of a fr<
ш
1 ms which the CONSTRAINTS written as omy in the twentieth cent
PLI'CIT FUNCTIONS are incorporated along
IM
many important social goa
with the OBJECTIVE FUNCTION to form a new employment and stable grow
equation called the 'Lagrangean' If +the
Tf u
~ abandonment of laissez-f
problem is, say, to maximize policy. The KEYNESIAN revoli
of international trade, and
у = /№,x 2 ), income distribution have cai
subject to the constraint nomists to urge the use of \
state planning in order t
g(XltX2) = 0, broader social aims are mei
the Lagrangean is hand an increasing number
stresses the advantages of
L = f(Xlt X2) f
X2) economy based on private
The maximization of L with respect to Xx, unrestricted industrial actioi
X2 and X will yield the values of Xx and X2 of economic activity. (
which maximize Y, while still satisfying the LIBERALISM.)
constraint. The term X is called a 'Lagran-
gean multiplier'. land. A term used in ecoi
not only that part of the eai
laissez-faire. A doctrine that the economic covered by sea, but also al
affairs of society are best guided by the de- resources such as forests,
cisions of individuals to the virtual exclusion sources of the sea, soil ferti
of collective authority. The idea has its basis can be used in the process
in the writings of the PHYSIOCRATS, but its Land is therefore convention
analytic foundations lie in the work of Adam a separate FACTOR OF PRODUC
SMITH and the CLASSICAL SCHOOL.
Adam Smith argued that individuals act- land intensive. A process
ing purely out of self interest will be a pro- production Л is said to be n
gressive force for the maximization of the sive than an equivalent proa
total wealth of a nation. The role of the B, if the ratio of land to oi
authorities, given this aim, should be per- PRODUCTION used is greater ii
missive, creating a legal defensive apparatus
sufficient to allow individual action. land reform and tenure.
Interference with the free working of this generally referring to the
natural order will reduce the growth of obtaining increases in prosp^
wealth and misdirect resources. areas (usually in DEVELOP]
The theme was extended by the NEO- through changes in the institj
CLASSICAL writers to include not just freedom ments in the agricultural sei
°f production and accumulation but also wide variety of such arrange
freedom of choice in consumption. The eral are inimical to progr
model of PERFECT COMPETITION provided ownership of land is extrerr
further analytic evidence that free compe- with each family having onl
tition and unrestricted expression of con- land. New equipment and
sumer preferences maximize the economic not be economic propositioi
welfare of society. The doctrine in this form farms. Output per acre ma]
Presupposes that collective action will be on larger farms simply beci
beneficial if in addition to providing the cannot afford the inputs r
asic requirements of legal property owner- crease productivity. At the
t
ni
P and national defence it will also act there are cases where the o\
0
maintain competition by breaking up is concentrated among a fev
of whom owns an enormous acreage. This KEYNESIAN ECONOMICS (Price Flexibility an^
may also inhibit the growth in output per Full Employment, 1944), despite regardin
acre. The landlord may be interested only in Keynesian economics as a special case Of
the rent which he can obtain from the tenant Walrasian economics. (See WALRAS )
farmers. He may be unwilling to invest in Although he made significant contributions
drainage, fencing, irrigation and ditching in numerous fields (e.g. WELFARE ECONOMICS
schemes which could possibly lead to large UTILITY FUNCTIONS, STABILITY conditions), he
increases in output per acre. The tenant is remembered most for his part in the
farmers may be unwilling to incur such debate in the 1930s on whether rational
expenditure on land which does not belong economic calculation could take place in a
to them, or they may not be able to afford PLANNED ECONOMY. He argued this was poss-
such investments. There is a considerable ible, for the prices which were required as
amount of statistical evidence to suggest that indices of scarcity could be calculated out-
on very large farms output per acre is often side the MARKET SYSTEM without any necess-
less than in rather smaller holdings. In cur- ary act of exchange, though in practice to
rent circumstances where the objectives are obtain his system of prices Lange requires
generally to increase output, probably with the creation of an institution, which is an
an employment constraint, there is a pre- analogue of a market. His Political Econ-
sumption that owner-occupied farms of a omy, though incomplete (English translation
size at least sufficient to permit the improve- 1963) is the first major synthesis of MARXIST
ments referred to above are optimal. (See ECONOMICS.
LAND TAX.)
Laspeyres price index. A base year weight-
land tax. A tax based on land values or ed PRICE INDEX. If expenditure in year 1 is
size of land holdings. It has been proposed
by some economists as a device for mobiliz-
ing any surplus from agriculture and for
encouraging productivity growth. The ex- for n goods then the price increase in year 2
perience of Japan in the nineteenth century can be calculated by taking year 2 prices and
is cited as an example in favour of this tax. weighting them by year 1 quantities. That is,
The tax could be formulated in such a way expenditure in year 2 is calculated at year 2
that it encouraged farmers to cultivate land prices but with reference to year 1 quan-
more intensively (e.g. if the tax were based tities. This expenditure would be
on potential productivity per acre if culti- I = 11
learning (or learning by doing). An ex- return for an agreed fixed charge which is
planation of TECHNICAL PROGRESS (as seen in generally paid in periodic instalments.
declining labour inputs per unit of output) in Leasing has long been a common practice
terms of experience in carrying out an oper- with land and buildings though in the recent
ation. Increases in efficiency arise from fam- past other ASSETS such as machinery, aircraft
iliarity with the technique, i.e. as a result of and motor cars have been available for
experience, where experience is measured as lease. For companies, the main advantage of
the sum of all past outputs. The improve- leasing is as a method of avoiding large CAPI-
ments in labour productivity are irreversible, TAL EXPENDITURES. It is also a less risky
so that per unit labour input does not in- method of finance on the part of lenders, as
crease when the scale of output is reduced. they continue to own the tangible asset.
The process of productivity increase is Many banks have now formed their own
thought to be subject to DIMINISHING RE- leasing companies and will lease equipment
TURNS through time. to firms to whom they may well not lend
The classic example of learning by doing money.
was in the US airframe industry during the
Second World War, where a doubling of least cost method of production.
cumulative airframe output was accomp- See COST MINIMIZATION.
anied by an average reduction in direct
labour requirements of about 20 per cent. least squares. A general term descriptive
of the basis of a family of econometric ESTI-
learning curve. A relationship showing an MATION techniques. The objective of the esti-
increase in cumulative average output per mators based on the principle is to minimize
man and the cumulative number of units of the sum of the squares of the vertical dis-
output produced, usually in some manu- tances between the observed data points,
facturing industry. For a typical learning and the REGRESSION line. Examples of this
type of estimator include ORDINARY LEAST
curve, see diagram below.
SQUARES, TWO STAGE LEAST SQUARES a n d
GENERALIZED LEAST SQUARES.
Cumulative
average Le Chatelier principle. A mathematical
output per man principle with wide applications in econ-
per week omics, dealing with the effects of CON-
STRAINTS on maximising behaviour. For
example, it can be used to explain why LONG-
RUN demands have greater ELASTICITY than
those in the SHORT RUN as a lengthening of
the time span allows new factors to be varied
resulting in greater changes in the factor
whose price has changed, no matter whether
the factors which vary are complementary or
competitive with the one subject to a price
change.
r at very short notice; unless the banks can awarded the Nobel Prize in
.. a l l idate assets, which are mostly non- Science in 1973.
liquid, the system would be in danger of
collapsing. This can be averted by the cen- Leontief inverse. In INPUT-OUT
tral bank, or exceptionally another public sis, the inverse of the IDENTITY МЛ
agency, supporting the banking system by the TECHNOLOGY MATRIX common!
providing its own liabilities, by loans or pur-
chases of appropriate assets. The BANK OF
ENGLAND, the pioneer in this role, came to This matrix multiplied by a giver
channel such assistance through the DIS- final demands gives the total outp
COUNT HOUSES, charging BANK RATE for it. ments from each sector of the e
From 1971 to 1981 such assistance was given produce those levels of final der
at MINIMUM LENDING RATE. In similar circum- INPUT-OUTPUT.)
stances other central banks deal directly with
the commercial banks. In the UK, up to the
Leontief paradox.
1970s, the lender of last resort had come to
See HECKSCHER-OHLIN APPROACH
be used more or less routinely as part of
NATIONAL TRADE.
MONETARY MANAGEMENT. It was one of the
modes by which the Bank of England
smoothed out the effects of the large flows of Lerner, Abba P. (1903-83).
funds between the public and private sectors Russia and educated in Englanc
on the liquidity of the whole banking system. demic life was spent in various uni
Under the new monetary control arrange- the USA. His early work consiste
ments introduced progressively from 1980 grammatic exposition and ext
onwards (and completed in August 1981) the Marshallian price theory to includ
Bank now makes much wider and more imperfect competition by Joan ROI
active use of open market operations to per- CHAMBERLIN. The work centrec
form this smoothing function. Although the search for an adequate concept of
papers setting out the arrangements make power and a defence of egalitaria
no reference to it, the need for a traditional the law of diminishing marginal i
lender of last resort type operation could still major work is The Economics с
arise in a financial crisis, as indeed it did in (1944) which makes extensive
the 'secondary bank crisis' of 1973-6. (See Marshallian analysis to make out
MARKET SOCIALISM. He also sets oi
LIFEBOAT, LIQUIDITY.)
ditions under which a change in a
EXCHANGE RATE would improve it
Leontief, Wassily W. (1906- ). Born in the
USSR, Leontief became Professor of OF TRADE. The condition is often
Economics at Harvard in 1946. His major MARSHALL-LERNER CONDITION. In 8
work is an analysis of the interdependencies this early work, Lerner was an
within an economic system, and particularly porter, and indeed defender, of
the production sector, using a technique economics.
which he called INPUT-OUTPUT analysis. In
such works as Studies in the Structure of Lerner case. The situation an
the American Economy (1953) and Input- LERNER in TARIFF theory where п
Output Economics (1966) he extended the tion of a tariff on an import, for w
interactive models of QUESNAY and others estic demand is very price INELASI
lr
*to an advanced mathematical construction in worse TERMS OF TRADE be
which showed the relationships between increased demand for the product.
e
Parts of an economic system. Leontief MUM TARIFF.)
na
s applied the technique to the economy
°t the USA, providing interesting results in Lerner index. An indicator of
n e
fields of international trade and the power that is defined as
conomics of natural resources. The tech-
4 " e has become the basis for planning in price — marginal cost
ап
У non-market economies. Leontief was price
244 less developed countries
When PERFECT COMPETITION exists price Lewis, Sir W. Arthur (1919-91). West
equals marginal cost; therefore the index Indian economist and joint winner with
assumes a value of zero. When price exceeds Theodore Schultz of the Nobel Prize fOr
marginal cost, the Lerner index becomes Economics in 1979. Educated at the London
positive and varies between zero and unity. School of Economics, Sir Arthur Lewis held
The closer the index to unity the greater the chairs of economics at the Universities of
degree of monopoly power is said to be pos- Manchester and Princeton.
sessed by the firm. Note that the index is a His main concern was with public policy
measure of actual conduct and does not and with the economics of underdeveloped
measure the potential for monopoly behav- countries and the Lewis model of develop-
iour on the part of the firm. ment, which assumes a dual economy with
an expanding modern sector, in which pro-
less developed countries. fits are reinvested, and which absorbs un-
See DEVELOPING COUNTRIES. limited supplies of labour from the
traditional agrarian sector, is widely
letter of credit. A document issued by a accepted. His major work is the Theory of
BANK on behalf of a customer which guaran- Economic Growth (1955), which presents a
tees payment by the bank of CHEQUES drawn readily accessible synthesis of work on
by the customer, or more commonly today development to that date. In Development
of BILLS drawn on that customer by parties Planning; The Essentials of Economic Policy
from whom he has bought goods. Letters of (1966) he provides a guide to the practi-
credit are used largely in association with tioner on how to devise and assess an econ-
BILLS OF EXCHANGE, to which they give added omic plan. His other publications are
security in the financing of foreign trade. Economic Survey, 1918-1935 (1949), which
l reviews and analyses the events and policies
il of that period, Overhead Costs (1949) and
level of significance. A concept used in
i HYPOTHESIS TESTING to determine the CRITI- Principles of Economic Planning (1949).
i CAL VALUE against which to compare the TEST (See LEWIS-FEI-RANIS MODEL.)
STATISTIC. A test at, say, the five per cent
significance level involves choosing the criti- Lewis-Fei-Ranis model. An economic
cal values such that under the NULL HYPOTH- model of unemployment in DEVELOPING
ESIS there is a five per cent probability of the COUNTRIES which was put forward by A.
test statistic falling outside them. For LEWIS in 1954 and 1958 and then formalized
example, a parameter estimate in a RE- by Fei and Ranis in 1964. The model high-
GRESSION analysis is said to be significantly lights the need to distinguish the agricultural
different from zero at the five per cent level, and industrial sectors in the dual economy -
if its test statistic (usually a T-STATISTIC) is i.e. one characterized by two separate sec-
above or below the values of the т- tors such as agriculture and industry - and
DISTRIBUTION outside of which there is 0.05 the problem of labour movements between
probability that a t-statistic will lie. (See STA- them. The agricultural sector, at SUBSIS-
TISTICAL INFERENCE.) TENCE level, has surplus labour which moves
gradually into the modern industrial sector.
leverage. An indicator of the relationship The labour absorption of the industrial sec-
i between long-term debt and capital tor depends on the rate of CAPITAL ACCUMU-
!i I employed. It is measured by the ratio, long- LATION and hence profit levels, which are by
1
III, ' term DEBT -г- total CAPITAL employed. The assumption, reinvested. Lewis originally
i denominator includes all fixed interest secur- held the industrial wage level as a constant,
ities. This measure considers that the more being related to the subsistence income
relevant issue concerning CAPITAL STRUCTURE levels in the agricultural sector. Full employ-
is the proportion of capital employed rep- ment is finally reached when all the surplus
resented by long-term debt. AH capital is labour from the agricultural areas has been
invested in a company's activities and it is absorbed into industry.
not meaningful to say that any one operation This model made a major contribution Ш
was financed by any particular class of funds. its emphasis on the rural-urban problem and
(See GEARING, CAPITAL STRUCTURE.) that of labour transfer but empirical work
has undermined two of its precepts. First, in licensed deposit takers. Under the
general, there is little unemployment in rural Banking Act of 1979, a class of institut
areas, yet it is widespread in industrial areas. which are licensed to carry on the busine;
Second, industrial wages, far from being DEPOSIT taking. The Act, which is frame
constant, are rising continually in relation to establish a system of regulation and cor
those in rural areas. to protect the depositing public, effecti
restricts the business of deposit taking to
lexicographic preferences. The prefer- classes of institutions, 'recognized ba
and 'licensed deposit takers'. The latter
ences of an individual who strictly prefers
deposit taking institutions which meet
o ne bundle of goods to another, so long as it
tain conditions in regard to the scale of t
contains more of a particular good and
net assets and the conduct of their busii
regardless of the amounts of other goods in
but which do not provide the range of b
the bundle.
ing services broadly denoted by the t<
RETAIL a n d WHOLESALE BANKING. Such 1
liabilities. Any claims, actual or potential, tutions may not describe themselve
on an individual or institution. The term 'banks', though under the new arrangem
usually refers to financial liabilities of which for monetary control established in Ail
the commonest form is a DEBT of any kind. 1981 they are defined as forming part о
Thus bank deposits, which are bankers' monetary sector for statistical purposes
debts, are commonly referred to as 'deposit are subject to the same CASH RATIO req
liabilities'. Some liabilities are contingent, ment as recognized banks.
i.e. result in actual claims only in specified
circumstances. A guarantee issued on behalf 'Lifeboat'» The colloquialism for the t
of a borrower, e.g. by a bank, is a contingent ation mounted in December 1973 Щ
liability of the guarantor: it only becomes an BANK OF ENGLAND, With the help ol
actual claim if the borrower fails to meet his London and Scottish CLEARING BANK;
obligations. deal with the so-called secondary bar
crisis which broke in that month. The
ONDARY BANKS concerned were la
liberalism.
deposit-taking FINANCE HOUSES which
See ECONOMIC LIBERALISM.
grown in numbers and size in the late
and early 1970s, aided by the quantii
LIBOR. The London Interbank Offer restrictions on lending applied (before
Rate; a rate - a different rate according to to the clearing banks and larger fii
circumstances - at which funds can be bor- houses. In the 1970s these institutions, i
rowed in particular currencies, amounts and ing funds largely from the MONEY MA
maturities, in the EUROCURRENCY MARKET. but also from depositors, lent heavil
Such a rate is used as the base for deter- property development. Tightening mon
mining the lending rate charged by banks policy in 1973 created liquidity probleri
engaged in medium-term lending of these houses, as money market funds
Eurocurrencies for a variety of purposes, the withdrawn; but these subsequently m
development of North Sea oilfields being a into insolvency problems as the rise in
notable example. Since the periods for erty values, halted in 1973, turned int
which currencies can be borrowed rarely ex- lapse in 1974. In order at first to p
ceed two years, a bank (e.g. a CONSORTIUM individual depositors, but later as the
B
ANK) making a four-year loan must borrow deepened, to avert the threat to the
a
t short term, 'rolling over' the borrowings financial system, the Bank of En
On effect reborrowing) at intervals during organized the 'Lifeboat' operation -
l
he course of the loan. The RATE OF INTEREST tively a joint lending operation - to pr
charged on such loans is set at a margin over those institutions which seemed capa
tn
e LIBOR for the particular amount, term eventual solvency or reconstruction,
a
nd currency composition of the funds bor- peak in 1975 over 20 companies w<
rowed, and so may vary at each borrowing receipt of support, which totalled £13C
term with movements of LIBOR. lion. (See LENDER OF LAST RESORT.)
246 life-cycle hypothesis
linear expenditure systems. In linear linear nature of the function involved, and
expenditure systems the DEMAND FUNCTIONS the fact that the constraints are in general
are expressed for groups of goods rather inequalities, it is not possible to use standard
than for individual goods. Substitutability optimization methods (such as LAGRANGEAN
within the group is significant but is zero TECHNIQUES), SO that special solution pro-
between the groups. The demand functions cedures are generally used. One such
for the groups may then be added to secure a method commonly used is the SIMPLEX algor-
total expenditure function. The implied util- ithm. Linear programming is also related to
ity function is additive (see ADDITIVE UTILITY USeS Of DUALITY, t o SENSITIVITY ANALYSIS a n d
FUNCTION) and has the form to activity analysis.
= £/. + + Uk
liquid asset.
where /, j and к refer to groups of commodi- See LIQUIDITY.
ties. Expenditure on a group of commodities
tends to be composed of subsistence and liquidation. This is the process whereby
supernumerary elements (see SUBSISTENCE the existence of a company is terminated, its
EXPENDITURE, SUPERNUMERARY EXPENDI- property having been realized and distrib-
TURE.) uted among its creditors and in the event of a
surplus, among its members. Where the
linear function. A mathematical relation- company is insolvent, the process resembles
ship in which the variables appear as addi- BANKRUPTCY, but it may also be used in the
tive elements, with no multiplicative or case of solvent companies as, for instance, in
exponential components. The general form certain types of MERGER or reconstruction.
of a linear function is thus given by
a2X2 anXn = b, liquidity. The quality in ASSETS of 'near-
ness' to free spending power, MONEY is by
where X, are variables and the a, and b are definition completely liquid. Other assets
constants. The function is so called because vary in degree of liquidity, depending on
the graph of such a FUNCTION (and in particu- whether they meet two, not wholly consist-
lar for only two variables) is a straight line. ent, criteria. An asset is the more liquid the
more readily - in terms of time and other
linearly homogeneous. transactions costs involved - it may be con-
See HOMOGENEOUS FUNCTIONS.
verted into money. The second character-
linear probability model (also known as istic of liquidity, emphasized more strongly
PROBIT MODEL.) A model in which the DE- in recent times, is degree of freedom from
PENDENT VARIABLE is a DUMMY or BINARY vari- the risk of fluctuation in capital value (in
able, and is expressed as a LINEAR FUNCTION monetary terms). By the convertibility cri-
of one or more INDEPENDENT VARIABLES. The terion a deposit withdrawable at short notice
model is so called since its predictions, given may be only fractionally more liquid than a
values of the independent variables, can five-year GILT-EDGED stock which is readily
be interpreted as the probability with which saleable in a highly organized market. But
the dependent variable will assume the by the criterion of capital risk, the stock is
value unity. Such models are useful in the decidedly less liquid than a deposit, or for
analysis of qualitative phenomena. (See that matter, than a short-term bill.
LOGIT ANALYSIS.)
liquidity preference.
linear programming. A technique for the See MONEY, DEMAND FOR.
formalization and analysis of CONSTRAINED
OPTIMIZATION problems in which the OBJEC- liquidity ratio. Before the introduction
TIVE FUNCTION is a LINEAR FUNCTION, and is to in 1971 of the monetary control arrange-
be maximized or minimized subject to a ments summarized in the Bank of England
number of linear INEQUALITY constraints. paper Competition and Credit Control,
The method is very useful in such problems control over bank lending was partly exer-
as the determination of the optimal allo- cised by requiring banks to observe a desig-
cation of scarce resources. Because of the nated minimum ratio between their liquid
Little-Mirrlees method
sSETS
_ defined as cash, money lent at call and therefore no effect on investment,
n d short notice to the DISCOUNT MARKET, hence AGGREGATE DEMAND. When origi
nd bills - and their total deposit liabilities. suggested by Keynes in the General Th
The doctrine that the liquidity ratio had this appeared to be an important qu
superseded the CASH RATIO as the operative cation of the effectiveness of mon<
controlling ratio in British banking became policy. However in practice there ij
generally accepted in the 1950s, and was empirical evidence to support the exist
based on the facts of the greatly increased of a liquidity trap. Furthermore while
volume of TREASURY BILLS, the MONETARY hypothesis rests on the view that ex
AUTHORITIES' policy of stabilizing the tations are regressive it offers no theoi
Treasury Bill rate, and the institutional precisely how these are formed. {See KE1
arrangements by which the DISCOUNT MARKET EFFECT, PIGOU EFFECT, REAL BALANCE EFFJ
guaranteed the uptake of all Bills issued.
Accordingly the banks were required to ob-
serve a minimum liquidity ratio of 30 per listed securities. The name given to SE
cent, later reduced to 28 per cent. (See ITIES that are traded on the UK s'
EXCHANGE. Listed companies have to a
MONEY MULTIPLIER, FUNDING.)
the terms of the Listing Agreement, w
has rulings on disclosure of new acquisiti
liquidity trap. A situation in which an in-
new operations abroad, or any change ii
crease in the MONEY SUPPLY does not result in
company likely to affect its share pr
a fall in the interest rate but merely in an
Listing is valued by both companies
addition to IDLE BALANCES: the interest ELAS-
shareholders. It gives publicity and ii
TICITY OF DEMAND for money becomes infi-
mation about the company and also т а к
nite. Under normal conditions an increase in
easier for the company to borrow capita
the money supply, resulting in excess cash
balances, would cause an increase in BOND
prices, as individuals sought to acquire assets Little-Mirrlees method. A technique
in exchange for money, and a corresponding project evaluation in DEVELOPING COUNT
fall in interest rates. In the situation de- which has received widespread attent
scribed by KEYNES as a liquidity trap, indi- The authors lay emphasis on the distort
viduals believe that bond prices are too high in both the product and factor market
and will therefore fall, and correspondingly starting points to their methodology. T
that interest rates are too low and must rise. approach is essentially a COST-BEN
They therefore believe that to buy bonds ANALYSIS where adjustments are made
would be to invite a CAPITAL LOSS, and as a product and factor prices and to inte
result they hold only money. As a result an rates. Their numeraire is social uncommil
increase in the money supply merely in- income in the hands of the governnj
creases idle balances and leaves the INTEREST measured in terms of convertible FOR^
RATE unaffected. EXCHANGE. They argue that all costs
Individuals' views on the level of bond benefits of projects have a BALANCE OF I
prices may be summarized in terms of their MENTS effect and that foreign excha
views about the interest rate. Keynes' theory values are likely to be a more accurate
hypothesizes that each individual has a view flection of relative social costs and ben<
about the long-run EQUILIBRIUM interest rate of different goods and services in a devel
and that there corresponds to this a critical ing country. The authors argue that an a<
rate below which the individual holds only tional unit of consumption is less value
jttoney and above which he holds only than an extra unit of investment. Additic
bonds. Clearly if everyone is holding money consumption from a project does, howe^
as they are in the liquidity trap then the have some social value. This extra consul
current interest rate must be below the low- tion has to be evaluated in terms of
est critical rate of the population. The impli- numeraire. It is because saving is less t!
cations of the liquidity trap are that socially optimal that an extra unit of govc
MONETARY POLICY is ineffective under these ment income is thought to be more valus
circumstances. An increase in the money than an extra unit of private consumpti
supply will have no effect on the interest rate The SHADOW PRICE of labour for use in
250 LM curve
demand to hold it - this being a functional consequence of the pecuniary and psyi
ariable of the rate of interest. In EQUILIB- logical costs of extensive travel to w
RIUM the two theories come to the same These costs act to sub-divide spatiall
thing; but this does not mean, as has at times labour force that is already stratified occi
been argued, that they are interchangeable. tionally; they tend to restrict the labour i
It is fair to say that most exponents of the ket to that which is accessible from a g
loanable funds theory see the 'real' factors - residence. This holds true for lower 1
savings, as determined by 'thrift', and invest- occupational groups at least.
ment, as influenced by the MARGINAL PRO- Changes in the structures of employn
DUCTIVITY OF CAPITAL - as determining the within a market and the pattern and lev<
long-run level of the rate of interest, with rewards offered and changes in trans
financial and monetary forces being respon- facilities indicate that a perfectly demarci
sible for short-term movements in the rate local labour market area will rarely
and in the economic system. Nevertheless, found. Such changes in the structure of с
the two theories can usefully be regarded as and rewards will affect both the shape
complementary models, to be combined extent of employee work preference ar
with more complex modern analyses of the If the complex of costs and DISUTILITIES
behaviour of interest rates, e.g. the PORT- individuals of the journey to work were
FOLIO BALANCE approach. ceived and evaluated equally, and if
constituted the only variable betv
loan capital. alternative employments, it would be p
See DEBENTURES. ible to derive the labour catchment агег
employers offering given wages and
loan stock. work preference zones of workers livin
See DEBENTURES, FINANCIAL CAPITAL. given areas. Yet, empirical problems as
this would only account for but one <
local authorities' market. A wholesale
myriad of forces influencing job choice.
MONEY MARKET in London, closely linked
with the INTERBANK, EUROCURRENCY and
In practice, the definition of a local lab
FINANCE HOUSES MARKETS, in which short-
market is established on the assumption
term loans are placed, through firms of its key characteristic is that the bulk of
money BROKERS, with local authorities. The area's population habitually seek emp
market first developed in the late 1950s ment there and that local employers rec
when the local authorities were encouraged most of their labour from that area. Joui
to resort to the CAPITAL MARKET, but when to work statistics form the basis of this cl
high long-term rates also encouraged them spatial definition or delineation.
to borrow short. Banks and other financial
institutions are prominent lenders in the
market; but at times it has also attracted local multiplier.
large sums from abroad. See REGIONAL MULTIPLIER.
i sis of the theory of industrial location well as extending Weber's theory thi
аП
carried o u t by Alfred Weber at the be- considering demand and by analysin
^ning
o f t his сепШг
У (
See
-
C J Friedricn
> development of location patterns as a
^Alfred Weber's Theory of the Location of cess of 'trial and error', Losch develop
I dustries, Chicago University Press, Chi- elaborate theory of the pattern of locati
1929). Weber considered the problem economic activity in an economy. Lose
0
g
°f a firm, again in perfect competition, gan by assuming a country to consist of
°hoosing its location given that its market is plain with evenly spread population,
at one point while raw materials' sources are raw materials (this can be contrasted
at other points. As in the theory of perfect Weber's model). In essence, Losch's e
competition, firms are profit maximizers, nation of the pattern of location of
and if production costs are assumed to be the industry is the outcome of the influen
same everywhere, the location decision re- transfer costs and ECONOMIES OF SCALE.
duces to finding the point at which transfer theory can be viewed as a developme
costs are at a minimum. In the simplest ver- C.H. CHAMBERLIN'S theory of MONOPOJ
sion of the model we have one market place COMPETITION. Losch's theory also
and one raw material source; the following resented the first attempt at a GENERAL ]
results are provided i / Weber's approach: LIBRIUM approach to location theory. \
1. If production of the good in question is earlier approaches had considered onl)
'weight losing', i.e. the good is less heavy (or firm or activity at a time (i.e. they
bulky, or perishable) than the raw materials PARTIAL EQUILIBRIUM approaches), L
from which it is manufactured, then the firm sought to analyse the whole pattern of d
will locate near the raw material source. omic activity. Losch's approach has
(INPUT ORIENTATION.) developed further by many economists,
2. If the production process is 'weight ably in W. Isard, Location and the S
gaining', the good being bulkier, heavier or Economy, MIT Press, Cambridge, L
more perishable than its raw materials, then 1956.
the firm will locate near the market, (MARKET The economic forces determining
ORIENTATION.) spatial pattern of towns were first anal
3. Generally, the firm will locate either at by W. Christaller (see С Baskin (ti
the market or the raw material source, and lator), Central Places in Southern Germ
not at any intermediate point. This is so Prentice Hall, New York, 1966). Chri
because an intermediate location would in- ler's theory, known generally as cei
volve extra costs of loading and unloading place theory, bears some relation to Losi
(terminal costs), and by involving shorter but is less sophisticated in terms of econc
journeys would lose LONG-HAUL ECONOMIES. theory and is concerned with the provi
More complex versions of Weber's model of services and the location pattern of i
involve multiple markets, multiple sources ket towns rather than with industry.
of raw materials, spatial variation in costs While most models of location theory
(notably costs of LABOUR) and the possibility concerned with analysing EQUILIBRIUM 1
Of AGGLOMERATION ECONOMIES. tion patterns and are based on the stam
An important criticism of the Weberian economic assumptions of profit maxin
approach is that its assumption of perfect tion and UTILITY maximization, alterna
competition leads to a neglect of the influ- approaches do exist. Some economists r
ence of location on the demand for a firm's argued that the dynamic processes of 1<
output. The possibility exists that a firm's tion will tend to DISEQUILIBRIUM in that e<
location may give it some degree of MONO- omic activity will tend to become more
POLY power, and thus that an approach more concentrated at certain locati<
based on the theory of IMPERFECT COMPE- These patterns are usually predicted w
TITION would be more appropriate. The CUMULATIVE CAUSATION MODELS are app
analysis of demand influences on industrial to location questions and are also sugge;
1Q4ntiOn W a s f i r s t u n d e r t a k e n in the early by the analysis of GROWTH POLE the*
IIt н\ Ь у A u e u s t u s Losch. (See his (trans- Other economists have, in analysing in<
ited) The Economics of Location, Yale trial location, rejected the assumption
university Press, New Haven, 1954). As profit maximization. In this way devel
254 locking-in effect
ments in location theory have been related logarithmic form it is also the basis of LOGIT
to developments in the theory of the firm ANALYSIS.
where alternatives to profit maximization
have been analysed. In particular, some eco-
logit analysis. A development of the
nomists have sought to apply the BEHAV-
LINEAR PROBABILITY MODEL in w h i c h the
IOURAL THEORY OF THE FIRM to location issues.
values of the DEPENDENT VARIABLE are con-
(See LOCATIONAL INTERDEPENDENCE.)
strained to lie within the 0-1 probability
limits by the use of the specification
locking-in effect. The effect by which a
holder of an asset is deterred from selling it Ln = a+b
because of a fall in its market value and the -Pi
consequent loss that would be incurred.
Typically, it may affect holders of GILT- where Pt is the probability of the dependent
EDGED or other fixed-interest SECURITIES variable taking the value 1,
when a marked rise in interest rates causes a (1 — Pi) is the probability of the
fall in the market prices of these stocks. dependent variable taking the value
0,
Xt is the independent variable, and
lockout. Closure of the workplace by the
a and b are constants.
employer in an attempt to compel the
employees to accede to the terms of employ- Note that LnX, represents the natural LOG-
ment desired by the management. ARITHM of X. (See also LOGISTIC FUNCTION.)
to individuals Л, В and С from two possible industrial co-operation through the tra
policies of technology, development of new ii
trial partnerships and increased EC pr
Policy investment in ACP countries. The cor
Voter X У tion also provided for financial and tech
assistance to be distributed, generally i
A -1 -1 form of grants and soft loans financed b
+5 -3 EUROPEAN DEVELOPMENT FUND a n d t h e I
вС -3 +5 PEAN INVESTMENT BANK, tO the
countries. The second Lome Conve
On a simple majority neither policy would was concluded in 1979 by the Eurc
be adopted. However if В supports С on Community and 58 ACP countries. ТЫ
oolicy Y in exchange for Cs support on convention introduced new areas о
policy X, both make a net gain of 2. Thus an operation regarding migrant labour, ii
incentive exists for them to exchange in ment protection, energy policy, agricu
logrolling. Note, however, that individual A development and the stabilization of e
loses as a result of the practice. If individual earnings for mineral producers (SYS
A's losses were larger than the gains of В scheme). The third Convention came
and С it might be argued that the logrolling force in March 1985 and extended the ]
caused a social loss. In general, logrolling sions of the second Convention, empi
can enable one group of voters to set up ing EC assistance to the ACP coui
policies which benefit them at the expense of sectoral programmes, furthered comm
other voters; thus it has been argued that co-operation between the EC and
logrolling may lead to over-expansion of states, increased STABEX transfers, ai
public expenditure. Logrolling can provide a vised the SYSMIN scheme. This Convc
solution to the so-called PARADOX OF VOTING. also contained specific provisions relat
shipping, fisheries and greater incentiv
Lombard Street. The street in the heart of investment. A fourth Convention was «
the banking and financial quarter of the City in December 1989 with the trade pro\
of London. The name originated with the effective in 1990 and the remainder in
bankers from northern Italy who were In 1990 there were 69 ACP countries
prominent in mediaeval times. It is fre- were party to the Convention.
quently used colloquially to denote the
London MONEY MARKET, as in the title of London Money Market.
Walter BAGEHOT'S renowned book. See MONEY MARKET.
Lome Convention. A trade and economic long cycle theory. A prolonged per
co-operation convention signed in 1975 at relatively prosperous times followed
Lome, the capital of Togo, by the EUROPEAN period of hard times of similar dui
COMMUNITY (EC) member countries and 46 often called the KONDRATIEFF cycle,
African, Caribbean and Pacific (ACP) tends much beyond the periodicity
developing countries. It replaced and ex- TRADE CYCLE, a full cycle being conside
tended the earlier YAOUNDE CONVENTIONS of about 50 years in length. Some econ
association which existed between the EC considered that PRICE and INTEREST
and the Associated African and Malagasy movements alone were involved, wi
states. The Convention's trade provisions Kondratieff a price and not an (
nave resulted in the EC granting duty-free phenomenon. Long cycles may Ы
access on a non-reciprocal basis to all ACP sidered as long-run cumulative move
ex
ports of manufactured goods and tropical one view is that they are caused by
agricultural produce. An export revenue related to high government expenditi
stabilization scheme, STABEX, was estab- armaments during prosperous times,
lished to guarantee ACP countries a specific ence on long cycles is inconclusive.
vel of income on selected commodity ex-
rea fht e d н°
t h e E C A
8 r e e m e n t w a s a l *° long-dated securities. SECURITIES
o n
measures designed to encourage form of DEBT rather than EQUITIES - e.j
256 long-haul economies
EDGED stock or DEBENTURES - which have a would be more sensible to use plant 1 than
long term to their maturity (i.e. repayment) plant 2 since the average cost of producing
dates, usually more than 10 years. Long- Xx is lower. At X2, however, it is better to
dated securities and the dealings in them are use plant 2. Each of the overlapping sections
frequently referred to, collectively, as the of the short-run average cost (SRAC) curves
'long end of the market'. may therefore be 'deleted', leaving a cost
curve which is seen to be an 'envelope' of the
long-haul economies. The tendency for points on the short-run average cost curves
transport costs to rise less than in proportion which correspond to the lowest possible
to distance travelled. Thus where long-haul short-run costs for a given level of output.
economies are present the AVERAGE COST per The 'bumpy' shape of the curve shown is due
unit distance travelled is a decreasing func-
tion of distance. These economies arise prin-
cipally because any mode of transport will Cost
involve certain costs which are fixed and
uninfluenced by the distance of the journey. SRAC,
The fixed costs consist of the terminal costs
of movement - i.e. those involved at each SRAC, SRAC
end of the journey, such as loading and
unloading a cargo. Given these fixed costs,
doubling (say) the length of a journey will
not double its total cost.
long-term capital, CAPITAL in financial (i.e. loss function. A DISUTILITY function which
monetary) form which if borrowed on DEBT a policy-maker is assumed to minimize. A
terms, has a long term to maturity, usually loss function usually contains the squared
over ten years; or which alternatively is difference between the actual and desired
raised by an EQUITY issue and hence is not value of each target variable multiplied by a
repayable at all, other than on the winding WEIGHT associated with that variable. For
up of the company. example a loss function to be minimized may
take the form:
Lorenz curve. A construct used in the cal-
L = a,(M - w*)2 + a2(P~ P*)2
culation of measures of inequality. Using
income as our example, the Lorenz curve where u* and P* are desired rates of unem-
plots cumulative percentages of total income ployment and price inflation respectively
received against cumulative percentages of while u and P are actual levels. ax and a2 are
income recipients, starting with the smallest weights whose relative size gives the ranking
income recipient, as in the diagram. A point assigned by the policy-maker. The minimiz-
on the curve gives the percentage of the ation of a loss function enables a trade off to
Population that account for a given percent- be made between the targets (i.e. u* and
a g e of tot
al income. The Lorenz curve would P*). It owes much to the work of the Dutch
assume the characteristic of the 45° line economists Jan TINBERGEN and Henri Theil.
^nown in the diagrams if all income recipi-
of tv, 6qUal s h a r e s i e
' - w h e r e 10 P e r c e n t loss leader pricing. The practice of diversi-
tne
Population had a 10 per cent share, 20 fied firms who offer some portion of their
!^r cent had a 20 per cent share, and so on. product range at prices below cost, in the
extent to which the measured Lorenz belief that this will encourage sales of
258 loss-offsetting provisions
other higher profit margin products. This is LUS. An adjective used to describe RESI-
common amongst retailers who use 'loss DUALS which are Linear, Unbiased and pos-
leaders' to attract customers, who then may sess a Scalar COVARIANCE MATRIX. They
buy high profit margin goods as a matter of include RECURSIVE RESIDUALS and those
convenience or impulse. generated from regression models using the
Householder Transformations, BLUS RESI-
loss-offsetting provisions. Generally refers
DUALS are of the LUS class but possess
to the arrangement whereby losses from a
properties of uniqueness.
project can be offset against income from
other sources. It is very significant when ana-
lysing the effects of income taxation on
investment. Such taxation by itself reduces luxury (also known as 'elitist' good). Not a
the return from a project but if loss offsetting widely used term in modern economics, but
arrangements exist the government shares in if used, is taken to refer to a GOOD with an
INCOME ELASTICITY OF DEMAND greater than
the gains as well as in the losses and the
mean expected return from a new project unity such that, as income rises, the good
may not be reduced. accounts for an increasing proportion of the
consumer's income.
low-level equilibrium trap.
See POPULATION POLICY, POPULATION.
luxury taxes. Raising taxes for govern-
low wage trade.
ment funds can be very problematic in less
See DYNAMIC THEORIES OF COMPARATIVE AD-
developed countries; many people are self-
VANTAGE.
employed or paid in kind and cannot be
Lucas critique. A criticism of the use of an made liable for INCOME TAX. An attempt to
ECONOMETRIC MODEL for evaluating the out- tax luxury goods is often evaded as corrup-
come of policy decisions as the estimated tion can be widespread. One effective
PARAMETERS implicitly contain policy effects. method can often be via CUSTOMS duties
Thus changing the POLICY INSTRUMENTS will especially if most luxuries are imported.
also change the parameters of the model Import taxes on foreign cars can be as high
either negating the effect of the policy or as 300 per cent. Nevertheless, there is often
making its effect unpredictable. The critique tax evasion even in the case of customs
is closely associated with the RATIONAL duties and another method suggested is to
EXPECTATIONS aspect of the NEW CLASSICAL estimate a level of tax on luxury spending by
MACROECONOMICS. See Lucas, R.E., 'Econo- observing an individual's CONSPICUOUS CON-
metric policy evaluation: A critique', in K. SUMPTION. This system too is open to corrup-
Brunner and A.H. Meltzer (eds), The tion because of the necessary level of
Phillips Curve and Labour Markets, Supple- discretion on the part of the officials.
ment to the Journal of Monetary Economics However, in general most less developed
(1976). countries attempt to tax luxuries.
M
Macm Committee. The UK trade' pricing on retailers who did n<
Committee of Inquiry set up in 1929 as the pricing agreements as well as those w
'Committee on Finance and Industry', under sign such agreements. It closed a loopl
the chairmanship of H.P. (later Lord) the MILLER-TYDINGS ACT OF 1937, thus
Macmillan, KC, to examine the banking and ing individual states to pass and enforc
financial system, in its internal and inter- mandating manufacturer's price floors
national operations, and to make recom- retailers as long as one retailer signed
mendations on how the system could trade price agreement. (See FAIR
promote 'the development of trade and com- LAW.)
merce and the employment of labour'. The
Committee, whose members included J.M. macroeconomics. The study of the I
(later Lord) KEYIVS and Ernest Bevin, iour of the economy as a whole. The|
reported in 1931. Its Report (Cmnd 3897) is omy is disaggregated into what are be
a major document on the structure and oper- to be broadly homogeneous categori
ation of the monetary system and of MONE- the determinants of the behaviour of c
TARY POLICY, at that time; on the working of these aggregates is integrated to pro
the international GOLD STANDARD, to which model of the whole economy. Increasi
the UK returned in 1925; and on the role of relies on deductions from microeco^
monetary factors in the economic depression about the determinants of the behavi
of the time. It recommended the mainten- each aggregate variable but in so doii
ance of the gold standard, together with an elements of the macro system may be
active and internationally co-ordinated use looked. (See PARADOX OF THRIFT.) Esse
of monetary policy to combat cyclical insta- macroeconomics dates from KEYNES a
bility of output and employment. In its principal aggregates studied are
examination of how the system served the suggested by him. See Parkin, M. and
financial needs of industry, the Report ident- R., Modern Macroeconomics, 2nd e<
ified two 'gaps' in the institutional provision Philip Allan, London, 1988.
of finance: first, a need for a combination of
large-scale finance and what are now termed majority rule. A form of COLL
'corporate financial services' - advice and CHOICE or SOCIAL DECISION RULE in whi
assistance with share issues, mergers, capital proposal obtaining the support of mor
restructuring etc.; and second, the provision half of the 'voters' is chosen. Alt
of long-term capital for small and medium- widely used, majority rule can give i
sized companies, in amounts too small for a the PARADOX OF VOTING and leads to
public issue of shares. It is the latter which is sistent choices.
normally referred to as 'the Macmillan gap'.
In 1946 the FINANCE CORPORATION FOR
malleable capital. An assumption
INDUSTRY (FCI) and the INDUSTRIAL AND
the nature of physical CAPITAL much u
COMMERCIAL FINANCE CORPORATION ( I C F C ) NEO-CLASSICAL ECONOMICS, which il
(now INVESTORS IN INDUSTRY) were estab- that the materials incorporated into
"sned to fill the two gaps. ticular machine may be instantly an
tlessly changed into a different machin
'Macmillan gap'. effect of this concept, in NEO-CLA
6e
MCMILLAN COMMITTEE. GROWTH THEORY for example, is to i
unimportant the question of EXPECT
ire Act. A 1952 amendment to the and their impact on the CAPITAL STOCI
f e d e r a l Trade Commission Act, the 'wrong' investment can instantly anc
f ^u Act was designed to enforce 'fair lessly be changed into the 'correct
259
•us, i\cv. iiioinas Kooert
nitalism have been identified by A.A. growth theory of the firm. {See also CORPOR-
wLAr and
and G.C. Means, R.L. Marris and ATE CAPITALISM.)
. GALBRAITH
managerial utility function. This relation-
ship specified the arguments upon which the
jpiagerial discretion. The ability of a cor-
preference ordering of firms' managers
oration's managers to pursue objectives
depends. Variables commonly used are
which they themselves deem beneficial. The
growth, staff outlay, VALUATION RATIO and
extent to which this discretionary behaviour
managerial involvements. {See MANAGERIAL
can be sustained will be determined by how
THEORIES OF THE FIRM.)
competitive product and capital markets are.
managing director. A person appointed as
managerial revolution. A label associated a director of a limited company who takes
with the Galbraithian idea that economic chief responsibility for the day-to-day run-
power has passed from capital to the owners ning of the company's activities. In general
of technical expertise, i.e. the managerial managing directors have a shareholding
class. This is due to the alleged inelastic within the company.
supply of managers relative to that of capi-
tal. (feTECHNO-STRUCTURE.) Manoilescu argument. A version, devel-
oped by the economist of that name, of the
managerial slack. INFANT INDUSTRY argument which rests on
See X-EFFICIENCY.
the empirical observation that the average
wage in the manufacturing sector in an
underdeveloped country exceeds that in the
managerial theories of the firm. Theories agricultural sector although labour producti-
which have been developed from a belief vity may be similar. The manufacturing
that contemporary CAPITALISM is character- industry is at a disadvantage vis-a-vis im-
ized by the dominance within the production ports and the argument is that it should be
sector of large corporations, where owner- compensated by a TARIFF on manufactured
ship and control is separated between share- goods.
holders and managers respectively. It can
then be argued that given imperfect capital manpower policy. An attempt to improve
markets and uncompetitive product mar- the functioning of the labour market, and, if
kets, managers will have the scope to pursue possible, the trade-off between unemploy-
objectives other than PROFIT MAXIMIZATION. ment and inflation. Two main forms of man-
Managerial theories of the firm have gen- power policy may be distinguished. The first
erally made use of managerial UTILITY FUNC- accepts the existing characteristics of supply
TIONS to formalize the objectives pursued. and demand and aims for better 'matches'
When maximized subject to given specified between workers and jobs by improving
constraints, predictions on firm behaviour placement efforts and by counselling
can be derived. Thus for example, a specifi- workers looking for jobs and employers
cation representative of GROWTH THEORIES OF looking for workers. Programmes of this
THE FIRM is one in which managers are kind may also include schemes for increasing
assumed to maximize a utility function the mobility of workers. The second form
whose arguments are growth and the firm's attempts to influence the pattern of the
VALUATION RATIO. This is maximized subject supply of labour by upgrading skills and
to a constraint imposed by the capital mar- abilities. There is also a third form, which
ket, which states that the firm's valuation seeks to influence the composition of
ratl
° must achieve a value greater than or demand by establishing measures to increase
equal to the valuation ratio set by the most the number of employment opportunities,
dangerous RAIDER FIRM, this being based on especially by opening up good jobs for DIS-
the policy it would pursue if successful. ADVANTAGED WORKERS. {See JOB CREATION.)
rhe major managerial theories of the
rcn are W. Baumol's SALES MAXIMIZATION manual workers. Employees engaged in
"YPOTHESIS, O.E. Williamson's MANAGERIAL physical work and who are paid a wage.
°ISCRETION model of the firm and R. Marris's Frequently used interchangeably with BLUE-
margin
COLLAR WORKERS. The opposite of NON- point at which the demand curve cuts the
M A N U A L WORKERS. marginal cost curve. The market conditions
prevailing in perfect competition ensure
margin. In economics, 'at the margin' marginal cost pricing since average and mar-
means at the point where the last unit is ginal revenue are the same. Hence the
produced or consumed. requirement for profit-maximization, that
marginal cost be equal to the marginal reve-
marginal. A marginal unit is the extra unit nue, means that price equals marginal cost
of something, as with MARGINAL COST, MAR- Under IMPERFECT COMPETITION, however
GINAL UTILITY etc. profits will not be maximized with price
equal to marginal cost since average revenue
marginal analysis. will exceed marginal revenue. Hence
See NEO-CLASSICAL ECONOMICS. marginal cost pricing under imperfect
competition will only come about through
marginal cost. The extra cost of producing some form of regulation or taxation. In the
an extra unit of output. Algebraically it is PUBLIC SECTOR, NATIONALIZED INDUSTRIES a r e
written recommended to use marginal cost pricing,
the rationale being that it maximizes econ-
omic welfare, for then buyers put a valuation
M C =
AX on the last unit consumed, which is just
equal to the resource cost of the last unit
where A means 'a small change in', C is total produced, a condition necessary for the opti-
cost and X is output. In the SHORT RUN the mal allocation of resources.
marginal cost curve slopes upwards due to
the operation of the LAW OF DIMINISHING marginal damage cost. The extra cost of
RETURNS. Note also that marginal cost can- damage done, usually by pollution, from an
not be affected by the level of FIXED COSTS. extra unit of the nuisance-creating activity.
Quite simply, if an extra unit of output is (See DAMAGE COST.)
produced fixed costs do not change and
hence extra fixed costs must be zero. It fol- marginal disutility. The extra DISUTILITY
lows that marginal cost is determined by resulting from a small change in some
VARIABLE COSTS only. In the LONG RUN mar- variable.
ginal costs may rise, fall or stay constant marginal efficiency of capital. That unique
depending on the presence of ECONOMIES or RATE OF DISCOUNT which would make the
DISECONOMIES OF SCALE. (See LONG-RUN MAR-
PRESENT VALUE of the expected net returns
GINAL COST, LONG-RUN AVERAGE COST.)
from a CAPITAL ASSET just equal to its supply
price when there is no rise in the supply price
marginal cost of funds schedule. The of the asset. The term originates with KEYNES
schedule detailing the true cost of financial and is sometimes known incorrectly as the
capital to the enterprise. In an imperfect INTERNAL RATE OF RETURN. T h i s l a t t e r COn-
capital market the true cost will exceed the cept is distinct in that it takes specific
INTEREST RATE. Firms can raise money to account of the fact that the supply price of
finance investment/rom many sources and capital assets will rise in the short run as all
the cost of finance will vary with the source. firms simultaneously seek to increase the
The least expensive source of finance may be size of their CAPITAL STOCK. (See MARGINAL
the firms retained profits or its depreciation EFFICIENCY OF CAPITAL SCHEDULE, MARGINAL
fund. More expensive will be a RIGHTS ISSUE EFFICIENCY OF INVESTMENT SCHEDULE,
or new issue of EQUITIES or borrowing on
INVESTMENT.)
fixed interest.
marginal efficiency of capital schedule.
marginal cost pricing. A pricing practice The schedule detailing the long-run equilib-
pursued by private firms or public corpor- rium relationship between the desired CAPI-
ations in which price is made equal to MAR- TAL STOCK and the INTEREST RATE. At all
GINAL COST. Given continuous revenue and points along this schedule the MARGINAL
cost curves, this implies setting price at the EFFICIENCY OF CAPITAL is just equal to the
marginal product
ar ginal rate of tax the greater is the SUBSTI- which would otherwise have sold at the
\J T ION EFFECT likely to be. Thus very high higher price. Marginal revenue is an import-
T
argi na l rates of income tax could encour- ant concept in the analysis of the firm. A
people to take more leisure or possibly necessary condition of profit maximizing
undertake less risky investments. In the equilibrium is that marginal revenue be
TJK marginal income tax rates were very equal to MARGINAL COST.
high in the 1960s and 1970s reaching 83 per
ent for earned income and 98 per cent for marginal revenue product. The MARGINAL
UNEARNED INCOME. Though these high rates PHYSICAL PRODUCT multiplied by the MAR-
have been widely criticized conclusive GINAL REVENUE from the sale of the extra
em pincal evidence that they have had very unit of output from the employment of the
significant disincentive effects is not avail- extra unit of input. Under PERFECT COMPE-
able. Marginal rates of tax are now very high TITION price equals marginal revenue, so that
for operators of North Sea oil fields. The we can write
combined take of royalty, PETROLEUM REVE- MRP = MPP • P
NUE TAX and CORPORATION TAX on an incre-
mental barrel from a reasonably profitable where MPP is marginal physical product and
field can reach over 80 per cent. P is price. Under IMPERFECT COMPETITION,
however, price does not equal marginal
marginal rate of technical substitution. The revenue and it is necessary to modify the
marginal rate of technical substitution of two equation to:
inputs, for example, of LABOUR for CAPITAL is MRP = MPP • MR
the amount of labour that needs to be substi-
tuted for a very small reduction in the where MR is the marginal revenue associ-
amount of capital employed in order to ated with the sale of the extra units of
maintain the level of output. Its value is output.
eaual to the ratio of the MARGINAL PRODUCT
of capital to the marginal product of labour marginal user cost. In the economics of
and is equal to the slope of the production NATURAL RESOURCES the net benefit (the
ISOQUANT.
valuation of a unit of resource, i.e. its price
less its costs of extraction) denied to a future
marginal rate of transformation. The generation through the use of a unit of a
numerical value of the slope of the PRO- finite resource by the current generation. To
DUCTION POSSIBILITY FRONTIER. The marginal
determine the optimal rate of use of the
rate of transforming good A into good B is resource through time the present gener-
the fall in the rate of output of good A which ation must equate selling price with the sum
permits an additional unit of good B to be of marginal extraction cost plus marginal
produced. It is equal to the ratio of the user cost. This condition is identical to
HOTELLING'S RULE, since the net price of a
MARGINAL COST of good B to the marginal
cost of good A. resource in a future generation is identical to
marginal user cost.
marginal revenue. The change in total marginal utility. The extra utility obtained
revenue arising from the sale of an addi- from an extra unit of any GOOD. Mathematic-
tional unit of output. In PERFECT COMPETITION ally expressed as
m
arginal revenue will equal price because
the FIRM faces an infinitely elastic DEMAND
CURVE, i.e. it can sell any amount of output
at the prevailing market price. Within mar- where U is utility, X is the amount of a good,
ket structures such as IMPERFECT COMPE-
and 'A' is a 'small change in'.
TITION, the firm faces a downward sloping
demand curve and thus in order to sell an marginal utility of income.
ad
.ditional u n i t o f o u t P u t , it must reduce the See MARGINAL UTILITY OF MONEY.
n
P ce on all the output it sells. Marginal
rev
enue will then be equal to the new price marginal utility of money. The rate at
ln
us the fall in revenue on those units which an individual's UTILITY increases as his
266 margin requirement
personal budget (income) is expanded by express concern about the reactions of other
one unit (£1, $1 etc.). When consumers max- producers to any change in the price, output
imize utility it will be the case that the mar- or quality of their own product. Finally, j t
ginal utility of each good purchased will has been suggested that the type of market
equal its price multiplied by the marginal should be classified by the extent to which
utility of money. Strictly speaking, the term new producers can secure entry into a given
is better defined as the MARGINAL UTILITY OF market. This seems reasonable where the
INCOME since money as money has particular BARRIERS TO ENTRY are based on product
attributes which affect the utility it may pro- differences between existing and new firms,
vide to someone holding it. MARSHALL but less reasonable if the barriers are based
assumed the marginal utility of money was on deliberate policies by existing firms to
constant - i.e. did not change as the prices of prevent entry - e.g. by engaging in price
goods in an individual's 'shopping basket' reductions below new firms' average costs of
changed. This was held to be reasonable as production, legal manoeuvres etc.
long as the items in question formed a small
proportion of the consumer's budget. Other- market demand curve. The aggregation of
wise it is not. a set of individual DEMAND CURVES for a
good. Thus, if at price px individual 1 would
buy 10 units of good X, individual 2 would
margin requirement. The percentage of
buy 15 units and individual 3 would buy 4
market value of a security that the purchaser
units, the market demand curve would show
can borrow when buying the security. The
that 10 -f 15 + 4 = 29 units would be bought
security itself serves as collateral for the
at price px. This kind of aggregation is gener-
loan. In the US investors can buy common
ally valid for PRIVATE GOODS, but not if there
and preferred stocks, convertible bonds, and
is some form of interdependence between
execute short sales 'on margin'. The
individuals' demand curves. For some types
Securities and Exchange Act of 1934 gave
of interdependence see SNOB EFFECT, VEBLEN
the Federal Reserve the power to set the
EFFECT. Nor is this form of aggregation appli-
margin requirements for these three types of
cable to PUBLIC GOODS since, by definition,
transactions with Regulations G,T and U.
the provision of a given quantity of a public
Since 1974, purchasers have been allowed to
good to any one individual entails that quan-
borrow up to 50 percent of the market value
tity being simultaneously given to all other
of the security in making any of these three
individuals.
types of security transaction.
resources and production are made on the held to provide a case for collective or go
basis of prices generated by voluntary ernment action to improve ALLOCATF
xchanges between producers, consumers, EFFICIENCY. (See PARETO OPTIMUM, PUBL
workers and owners of FACTORS OF PRO- GOODS, WELFARE ECONOMICS.)
DUCTION. Decision making in such an econ-
omy i decentralized
d t l i d - ii.e. decisions
d i i ae
are market forces. Pressures produced by tl
free play of market supply and demam
m ade independently by groups and indi- which induce adjustment in prices and/<
viduals in the economy rather than by cen- quantities traded.
tral planners. Market economies usually also
involve a system of private ownership of the
market imperfection. Any deviation froi
means of production - i.e. they are 'capita-
the conditions necessary for PERFECT COMPI
list' or 'free enterprise' economies. However
TITION. This should be distinguished froi
market economies can function, to some ex-
MARKET FAILURE, which is the inability of
tent, under social ownership. (See PLANNED
ECONOMY, MARKET SOCIALISM.)
private market to provide certain goods i
sufficient quantities if at all. (See IMPERFEC
market failure. The inability of a system of MARKET.)
private MARKETS to provide certain goods
either at all or at the most desirable or 'opti- marketing. A term used to cover thos
mal' level. In general, market failure arises activities of firms associated with the sale
because of (1) NON-EXCLUDABILITY and/or and distribution of product(s). Broadl
(2) NON-RIVAL CONSUMPTION of 'd g o o d . speaking it covers such activities as sale
Non-excludability means that individuals promotion, advertising and market research
who have not paid for a good cannot be i.e. all activities which promote and organizi
prevented from enjoying its benefits. For the sale of products to the purchaser.
example, everyone benefits from clean air
whether they have contributed to an anti- marketing boards. These have been set uj
pollution programme or not. In this case in a number of African countries, fo
individuals will not pay for a good which example, Nigeria and Ghana, and they serv<
they can obtain at no cost. The market sys- various purposes. They give small farmers <
tem of exchange cannot operate. If a good is stable and secure market for their produce
non-rival, its consumption by one person and because the goods are then marketed or
does not preclude its enjoyment by anyone a large scale on international markets, the
else. Again, the pleasures of breathing clean authorities have a better basis for bargaining
air are non-rival. In this case, charging a for a fair price. Sometimes the marketing
price which prevents people from using the boards will pay farmers a price greater than
good is undesirable since the good could the current world price in order to subsidize
be made available at no cost to someone their activities. However this system is also
who would benefit from it. In this case the used to provide revenue for the government
market system would not allow for the opti- as a form of forced savings on the part of the
mal level of consumption. In reality we also growers as they are often paid below the
observe goods whose consumption is partly market price. This is usually done as an
rival and partly non-rival. For example, if I attempt to raise capital where the level of
am inoculated against disease I obtain a pur- voluntary savings and investment is very
j % personal benefit but I also provide a low.
benefit to everyone else in the community by The disadvantages are that the system
reducing the risk of infection. This is a case does not create much incentive for small
jrt a beneficial EXTERNALITY being produced farmers unless they are sure that they will
y my consumption. In the presence of receive the benefits from this revenue. As an
ex
ternalities markets may fail to produce the example, one of the marketing boards in
optimal level of output - though some eco- Ghana provided funds to build a hall of
omists argue that the problem may be over- residence for the University of Ghana, near
me by private bargaining (see COASE'S Accra. A further problem with the system is
THEOREM.) the high incidence of smuggling; in central
The existence of market failure is usually Ghana a great deal of cocoa is smuggled
268 market maker
across the borders by small farmers who can production can be socially owned and basic
receive nearly double the price in Togo or decisions and directions of development may
Ivory Coast. be centrally planned but otherwise the oper-
Marketing boards in the UK such as the ation of the economy may be left to MARKET
Milk and Egg Marketing Boards perform FORCES.
a somewhat different role as their tasks Although this type of organization has
include: maintaining standards of quality; been adopted in Yugoslavia and theoreti-
giving farmers government-subsidized prices cally expounded by such economists as Ota
for their products and a guaranteed buyer. Sik it is opposed in socialist countries by the
influential economists who advocate the use
market maker. The name given in the of PLANOMETRICS and computer aided central
London STOCK EXCHANGE since 1986 to a firm planning. (See SOCIALISM, PLANNED ECON-
which makes a market in a range of SECURI- OMIES.)
TIES by always being prepared to buy or sell
these securities. In 1991 there were 27 such Markov Process. A process which relates
firms. the current value of a variable to its own
previous values, and a random error term. A
market orientation. A tendency for pro- simple example is the First Order Markov
ducers to locate their factories near the mar- Process which is defined as
kets in which the products will be sold rather
Xt = aX^ + e,
than (say) near a raw material source. In
LOCATION THEORY a market orientation is where Xt is the variable concerned, and e,
generally explained on the grounds that pro- is the error term. (See AUTOREGRESSION, UNIT
duction is 'weight gaining' - i.e. weight per ROOTS.)
unit of output is greater than the weight per
unit of raw materials which have to be Markowitz, Harry (1927- ). American
moved to the factory - because of the addi- economist, who was a joint winner (with M.
tion of some local or generally available MILLER and W.F. SHARPE) of the Nobel Prize
input - consequently costs of movement will for Economics in 1990.
be minimized by locating production near His important work, carried out in the
the market thus minimizing the transpor- 1950s, established the foundations of
tation of the relatively heavy output. An modern PORTFOLIO theory. His original
alternative explanation of market orien- theory of portfolio selection was developed
tation would be the advantage, in terms of as a NORMATIVE model for investment
information, of close contact with the mar- managers. His major contribution was to de-
ket. {See INPUT ORIENTATION.) velop a rigorously formulated, operational
theory of portfolio selection under UNCER-
market power. The ability of a single, or TAINTY. Markowitz showed that under cer-
group of buyer(s) or seller(s) to influence the tain given conditions an investor's portfolio
price of the product or service in which it is choice reduced to balancing the expected
trading. A perfectly competitive market in return on the portfolio with its VARIANCE.
EQUILIBRIUM ensures the complete absence The complicated choice among many assets
of market power. with varying attributes is rendered in prin-
ciple as a two-dimensional problem, known
market share. The proportion of total as MEAN-VARIANCE ANALYSIS. Markowitz's
market sales accounted for by one firm. It major publications include the following"
has been argued that the maintenance of Portfolio Selection: Efficient Diversification
market share is an important objective of Investments, Wiley (1959), and Mean-
of firms in OLIGOPOLISTIC market structures. Variance Analysis in Portfolio Choice and
Capital Markets, Blackwell (1987).
market socialism. A socialist economic
system which leaves the day-to-day running mark-up. That portion of price which the
of the economy to the market mechanism. seller adds onto AVERAGE VARIABLE COSTS i'1
Oscar LANGE originally put forward the order to cover overheads and yield a net
in the 1930s that the means of profit margin.
Marshall, Alfred 269
Marshall, Alfred (1842-1924). British this is that the DEMAND SCHEDULE for all
economist who spent most of his academic individuals will be negatively sloped in
life as Professor of Economics at Cambridge general.
(1885-1908). A mathematician by training, Marshall introduced the concept of ELAS-
Marshall limited the use of mathematics in TICITY of demand to describe the responsive-
his published works. Although a pioneer of ness of quantity demanded to a change in
marginal analysis Marshall never totally price. Marshall was also concerned to com-
abandoned his link with English classical pare intergroup utilities both through time
economic thought. In contrast with Stanley and in a static framework. The former led
JEVONS and the AUSTRIAN SCHOOL, he empha- him to develop a theory of TIME PREFERENCE
sized the costs of production as much as the based on marginal utility; and the latter to a
UTILITY of consumption in his theory of discussion of the concept of CONSUMER'S SUR-
VALUE. To the extent that Marshall used a PLUS. Marshall was aware of the limitations
'real cost' theory of value based on the DIS- which the assumptions imposed on his
UTILITY of labour together with the waiting demand theory.
required for saving, he emphasized, like the Marshall envisaged equilibrium in a mar-
CLASSICAL SCHOOL, the ultimate importance ket as the result of price formation arising
of accumulation, rather than the efficiency from the point of intersection of the down-
aspect of resource allocation stressed by ward sloping demand curve, and a supply
Leon WALRAS, Jevons, and the Austrians. schedule. The supply schedule shows the
Marshall's analysis of allocation, although price at which individual firms are willing to
static, was not as restrictive as the GENERAL supply the commodity.
EQUILIBRIUM, stationary, and perfectly com- The value of a commodity is determined
petitive models of the LAUSANNE SCHOOL. by the forces of demand and supply acting
Instead he favoured partial analysis of mar- like two blades of a pair of scissors. Behind
kets with particular emphasis on the long- demand is marginal utility determining the
run development of industries in a less than demand price of buyers; behind supply is
perfectly competitive setting. marginal effort and sacrifice determining
The fundamental idea of Marshall's work supply price of sellers. This view although
is the power of DEMAND and SUPPLY to gener- similar to the Austrian School version is dis-
ate equilibrium prices in markets. Marshall tinguished by Marshall's conception of the
was as critical of the classical school as he cost of production. Marshall distinguishes
was of the Austrians, claiming that both had between 'real cost of production' and
a one-sided view of price determination. He 'expenses of production'. The former con-
stressed that demand and costs of pro- sists of the disutility of labour, and the sacri-
duction each play an important role in the fice or waiting involved in providing capital.
determination of equilibrium values. Mar- He argued that the market valuation of two
shall envisaged price determination as the unequal real costs (expenses of production)
outcome of the interaction of market might be the same. Actual prices may not
demand and market supply. reflect the real costs of production.
Marshall derived the law of a downward Marshall was well aware of the limitations
sloping DEMAND CURVE from the hypothesis which a static framework placed on his
(a) that individuals obtain utility from com- analysis. He emphasized the changes in pro-
modities at a declining rate (falling MAR- duction and consumption decisions which
GINAL UTILITY) and (b) that the MARGINAL may occur over time. Principally he dis-
UTILITY OF INCOME does not vary. The indi- tinguished between the different time
vidual is in equilibrium when the utility periods over which the forces tending to
gained from consuming one more unit of a establish equilibrium are operative. He con-
commodity is just equal to the loss of utility sidered: (a) a period where all supplies are
^volved in spending money on that commo- fixed and prices correspond to market
dl
ty- Given equilibrium, a fall in price of the values; (b) the short period when productive
c
°nimodity will induce the individual to pur- elements are free to vary and supply can be
chase more of that commodity since utility increased up to the point of maximum
Ppr unit of expenditure will be increased. capacity feasible with the current capital
h e conclusion which Marshall drew from stock; and (c) the long period when all
270 Marshall Aid
determinants of supply are free to vary given with the American Economic Co-operation
the existing technology. Lastly, and (d) Administration.
Marshall seems to have considered the very
long period where technology is a variable. Marshallian demand curve. The most
In the short and long periods prices tend widely used DEMAND CURVE in which the re-
towards what Marshall calls normal values sponsiveness of quantity demanded to price
and the earnings of factors tend towards incorporates both the INCOME EFFECT and the
their real costs of production. The use of SUBSTITUTION EFFECT. This is in contrast to
time in Marshall's analysis allowed him not the compensated demand curve where
only to apply theory to concrete problems income effects are netted out. Note, how-
where constraints on adjustment operate, ever, that the income effect is zero if INDIF-
but also to formulate a theory of income FERENCE CURVES are parallel which is how
distribution which differed from the MAR- some authors interpret Marshall's intentions
GINAL PRODUCTIVITY theory insofar as the in some of his writings. {See ADDITIVE UTILITY
availability of factors is a variable through FUNCTIONS.)
time, and the quantity supplied is deter-
mined by price. In the short run, for Marshall-Lerner condition. A DEVALUA-
example, the incomes of many factors are in TION of the CURRENCY may under certain con-
the nature of RENT or what Marshall calls ditions improve the BALANCE OF PAYMENTS.
QUASI-RENT. The Marshall-Lerner condition is one such
Marshall stands as a bridge between classi- condition. It is generally expected that the
cal economic theory with its emphasis on the devaluation will increase the value of ex-
costs of production overtime, the neo- ports and decrease the value of imports.
classical subjective price theory of Jevons, However, it is still possible for the devalua-
and the general equilibrium theory of tion to be successful even if it leads to
Walras based on a purely static theory of increased imports or decreased exports, as
value. Marshall's major works include: The long as this is outweighed by a favourable
Pure Theory of Foreign Trade (1879), The export effect or import effect. Formally the
Principles of Economics (1890), Industry Marshall-Lerner condition states that, on
and Trade (1919), and Money, Credit and the assumption of high price ELASTICITIES of
Commerce (1923). Not only did Marshall's Supply, a CURRENCY DEPRECIATION Or DEVALU-
work have a considerable influence on econ- ATION will improve the balance of payments
omic policy (and it continues to do so) but it on current account, if the sum of the elastici-
also greatly influenced a generation of ties of domestic demand for imports plus
British economists. foreign demand for exports exceeds unity.
For Hegel the idea was paramount and lation to labour (VARIABLE CAPITAL), SI
would eventually influence society, to Marx the rate of surplus value, and by assurr
the mode of production of the material the RATE OF PROFIT, will fall, becaus
means of existence conditioned the whole exploitable component of total capit;
process of social, political and intellectual clines as a proportion of the whole
life. This historical materialism he used to further assumes that TECHNICAL PRO
explain his theory of social evolution. He will be LABOUR-SAVING, so that workei
argued that continuous change in the be displaced and forced to join the re
methods of production and exchange cause army of the unemployed, whose pre
the existing social relations and political imposes a downward pressure on the
structure, appropriate to an earlier material Increasing competition among capi
base, to become outmoded, irrational and leads to concentration through the tak
unjust, so that an epoch of social revolution of the weaker by the stronger, and t
is inevitable. Marx identified four stages polarization of the system into a fev
through which the relations of production capitalists and a mass of miserable woi
and society had passed, namely primitive The situation is exacerbated by the bu:
COMMUNISM, slavery, feudalism and CAPITAL- cycle. Finally as structural maladjusti
ISM. mount the system collapses, giving wj
It was as the next stage of this evolution- itially to SOCIALISM and finally to com
ary process that Marx set out in Capital to ism.
discover the laws of motion of capitalism Marx's predictions for capitalism ha\
[Capital, vol. 1 (1867), vol. 2 (1885) and vol. yet been fulfilled. The rate of profi
3 (1894)]. Volumes 2 and 3 were edited by remained remarkably stable over th(
Engels. Capitalism is characterized by two century and real wages have risen,
antagonistic classes, the capitalist bourgeois reasons for the failure of the prediction;
class, which owns the means of production, depend on the validity of several ci
and the propertyless proletariat, which has assumptions which Marx makes, e.g.
emerged from the ranks of the landless labour is the only input into produ
labourers and small artisans. Although which can be exploited; that as capita
apparently free and equal before the law, man rises, output per man rises more sli
the proletariat is in a weak economic re- so that surplus value per man, the soui
lationship vis-a-vis the owners of CAPITAL profit, also grows more slowly: that tech
and is required to offer itself as wage LABOUR progress is labour-saving. On the other
in order to survive. Marx, setting out from he has been successful in his predicts
the LABOUR THEORY OF VALUE, which also increased concentration in industry,
provides him with a system of prices (see success of Marxism as a political doc
TRANSFORMATION PROBLEM), argues that probably owes more to the moral ind
workers are paid their labour values, i.e. the tion that it arouses from its assumptic
amount needed to buy the subsistence goods the exploitation of labour than it does
to keep the population constant, but they the detail of its economic argument.
are made to work more hours than are Marx's achievements, though they m<
necessary to produce these goods, so that false in detail, were immense. In his Hi
SURPLUS VALUE accrues to the capitalist. By of Economic Analysis (1954) Schumj
their nature and for fear of losing out to has written that Marx's economic inter
other capitalists in competition, capitalists ation of history, historical materialism,
accumulate the surplus value in the form of resents a 'powerful analytic achievem
machines and the hire of additional labour. and that his 'all-comprehensive system
Marx assumes that while it is possible to 'grand vision of an imminent evolutic
exploit labour by not paying it the full the economy process . . . constitutes M
amount of its output, it is not possible to claim to greatness as an economic anal)
exploit machinery, which simply adds to cur- Marx's other major works in econc
rent output, the same amount as it de- are Theories of Surplus Value (3
Preciates - hence its title of CONSTANT 1905-10) and Grundrisse: Foundations c
CAPITAL. As accumulation proceeds he Critique of Political Economy (1973, En
r
gues that constant capital will rise in re- edition).
272 Marxist economics
X 1
1
2
2
5 ©
3 4
5
The Growing Economy (196£
Controlled Economy (1971); /
Economy (1975), Demand
(1983) (with Vines D. and
J.M.) and Alternative Systems
2 1 2 1 ® and of Workers' Renumeradon
most celebrated work is in the fi
3 5 © 6 5 NATIONAL TRADE theory and
problems of STABILIZATION poli
ECONOMIES is the main focus of
4 1 ® 4 7 his earlier work and particulai
ditions for the existence of a bs
domestic economy and in fo
maximin actions. He highlighted the po:
conflicts between a balance on ei
select the highest of these. In the matrix and the balance of domestic
shown above, S is a state of nature (prob-
ability unknown), C is a course of action and DEMAND a n d AGGREGATE SUPP]
the entries in the 'cells' are the pay-offs. To FIXED EXCHANGE RATE S y s t e m . 1
use the maximin principle we circle the mini- responsible for the analysis of
mum pay-offs from each course of action. economics of CUSTOMS UNIONS
Then we select the highest minimum pay- under conditions where perfect
off- This is 4 and entails that we would select will not lead to the potential ma?i
course of action 3. welfare.
where the X, are individual sample obser- preferences are distributed among the popu-
vations and n is the number of observations lation as shown below.
in the sample. The population mean is de-
fined as the EXPECTED VALUE of the variable.
No of Voters
means-tested benefits. Benefits that may
only be paid if the claimant's income is less
than a certain value. The major means-
tested social benefits in the UK are income
support, family credit, free school meals,
rent and community charge rebates, and free
medicines/dental and optical treatment. (See
BEVERIDGE REPORT, POVERTY TRAP.)
speaking, retain connections with, or are off- thought. The former asks questions of a nor-
shoots of, trading enterprises. mative type whereas the latter confines
analysis to propositions capable of verifi-
merger. An amalgamation of two firms cation by reference to facts. In the second
where the respective shareholders agree to sense we may identify schools of thought
combine their equity capital to form a single which ask different types of questions thus
new company. Agreement between the shar- using different 'methods' in the sense of
eholders involves the receipt of shares in the using different tools of analysis. For
new company in exchange for shares in the example, the HISTORICAL SCHOOL or the CLAS-
old companies at some suitably determined SICAL SCHOOL were often concerned with
rate. (See TAKEOVER BID.) economic laws which governed the progress
of society through time. On the other hand
merit bad. A commodity, the consump- NEO-CLASSICAL economists tend to ask ques-
tion of which it is argued should be discour- tions about the allocation of existing re-
aged or prevented even though individuals sources, thus using a different set of
choose to consume it. In such cases it is theories, concepts and tools. Similarly the
claimed that through ignorance or inability, KEYNESIAN revolution emphasizes method-
the individual is not the best judge of his or ologies using MACROECONOMIC concepts. See
her welfare. Examples of commodities Blaug, M., The Methodology of Economics,
which have been treated as merit bads in- Cambridge University Press (1980).
clude alcohol and drugs and a long list of
works of literature. It is not clear who, if Metzler case. The situation in TARIFF
anyone, should determine which commodi- theory analysed by the economist of that
ties are merit bads or on what principles. name, where the imposition of a tariff on an
(See MERIT GOOD.) import improves the TERMS OF TRADE to such
an extent that not only the external terms of
merit good. A good the consumption of trade improve but even the domestic terms
which is deemed to be intrinsically desirable. of trade inclusive of tariff. This can happen
In the case of such goods it is argued that where the supplier of the import has a very
CONSUMER SOVEREIGNTY does not hold and inelastic demand for the export product of
that if consumers are unwilling to purchase the protecting country and to obtain the
'adequate 7 quantities of such goods they revenue to buy this product it has to cut the
should be compelled or encouraged to do so. price of its export product considerably. (See
This argument is sometimes deployed in OPTIMUM TARIFF.)
defence of compulsory education or 'free'
tax-financed health services. Many eco- M-form enterprise. A common type of
nomists would reject this reasoning but in internal organization adopted by large cor-
any case there is a difficulty in determining porations in response to MANAGERIAL SLACK.
who is to decide which goods are merit Responsibility for production activities is
goods. A variant of this argument is that decentralized by the formation of operating
individuals willingly delegate to govern- divisions, each of which possess their own
ments or professional agencies decisions on managerial structures. Decisions on capital
certain matters (such as health care) which allocation are centralized, in that they a re
they do not feel competent to assess. The undertaken by higher level executives in the
corollary of this concept is that the consump- head office. These higher level executives
tion of MERIT BADS should be discouraged. generally have an equity stake in the corpor-
ation, and therefore have an incentive to use
methodology. A term often very loosely their control over the flow of capital to
used in economics to describe the way in sanction those operating divisions whose
which economists proceed in their analysis profitability is unsatisfactory. (See U-FORM
of a problem. It is often also used to describe ENTERPRISE.)
the set of problems which a group of eco-
nomists are prepared to analyse. In its first microeconomics. The term used to de-
sense we may compare the NORMATIVE ECON- scribe those parts of economic anal>s|s
OMICS and POSITIVE ECONOMICS schools of whose concern is the behaviour of individ'
Mill, John Stuart 2'
on which Alfre MARSHALL built his theory of that dividend policy does not affect the value
prices. Mill used the concept of demand and of the firm in equilibrium. (An additional f j
supply in the field of international trade as a of dividend reduces the firm's value by £l ? SQ
modification of Ricardo's theory of COM- that the firm's shares will be worth £1 less in
PARATIVE COST. The concept of RECIPROCAL aggregate.)
DEMAND between countries allowed a deter- Much subsequent research in corporate
minate solution to the terms of trade ratio finance has been devoted to an analysis of
which the real cost theory of Ricardo could the implications of relaxing some of the sim-
not. By admitting the forces of demand and plifying assumptions, e.g. the effects of taxes
supply into value theory Mill opened the and of bankruptcies.
way for a neo-classical theory of value. Miller's main contributions, made with
Both the Principles, and the earlier Essay Modigliani, in addition to that cited above
on Some Unsettled Questions of Political are 'Dividend Policy, Growth and the
Economy (published in 1844 but written in Valuation of Shares', Journal of Business
1829) show Mill to be the last in the line of (1961), and 'Some Estimates of the Cost of
major British philosopher economists in the Capital in the Electric Utility Industry',
tradition of Adam Smith. Pure economics American Economic Review (1966).
for Mill was meaningless and the study of
economics was only part of the whole discip- Miller-Tydings Act of 1937. The fair-
line of moral and social philosophy. Only trade' law which established a US manufac-
after Mill do economists begin to answer turer's right to set minimum retail prices for
practical questions in terms of economic brand names and trade-marked goods. This
premises alone. His wider social views are law allowed individual states to pass laws
perhaps most evident in his description of requiring all retailers to sell such goods at or
the STATIONARY STATE. Unlike Smith and above the manufacturer's minimum price
Malthus, Mill looked forward to the coming provided at least one retailer signed an
of a society in which the struggle for survival agreement with the manufacturer. In 1951,
has ended and people can enjoy the fruits of the Supreme Court ruled that such agree-
past ABSTINENCE. ments were not binding on those retailers
who did not sign the agreement. This loop-
Miller, Merton (1923- ). An American hole was closed by the MCGUIRE ACT of 1952.
economist, who was a joint winner (with H. Congress declared all such laws null and void
Markowitz and W.F. Sharpe) of the Nobel in 1972. (See FAIR TRADE LAW AND MCGUIRE
Prize for Economics in 1990 for his contri- ACT.).
butions to the modern theory of corporate
finance. minimax regret. In DECISION THEORY a rule
In a celebrated article written jointly with for making decisions under UNCERTAINTY.
MODIGLIANI, 'The Cost of Capital, Corporate Given various states of nature and various
Finance and the Theory of Investment1, courses of action that could be taken, the
American Economic Review (1958), Miller minimax regret principle dictates that we
showed that in a perfect CAPITAL MARKET the select measures of 'regret' - i.e. the differ-
firm's CAPITAL STRUCTURE does not affect the ence between an actual PAY-OFF and what the
firm's maricet value and the overall cost of pay-off would have been if the correct strat-
capital (i.e. financial LEVERAGE is irrelevant egy had been chosen. Borrowing the data in
to the cost of capital). In such circumstances the matrix shown under MAXIMIN, first con-
the firm should maximize its net wealth and struct a regret matrix. This appears as shown
leave shareholder preference for different in the diagram.
degrees of RISK to be achieved by share- For example, if state of nature 2 occurs
holders' obtaining the leverage they desire in and we choose course of action 2 we make a
their personal PORTFOLIO decisions. Crucial gain of 2. But had we chosen course of
to the validity of the argument is that per- action 1 the gain would have been 5, so the
sons have access to the capital market on the 'regret' is 5 - 2 = 3.
same terms as firms. Miller (and Modigliani) Now we seek to minimize the maximum
are also credited with deriving under highly regrets. The maximum regrets are circled in
simplified assumptions another proposition the regret matrix. The minimum of these is
minimum wage lej
1 1 0
© 2 minimum lending rate. The t
October 1971 replaced 'BANK
2 2 3 5 © name for the rate at which
ENGLAND will give assistance
rediscounting bills to DISCC
3 0 © 0 2
forced by shortage of funds
MARKET to go to the Bank as LI
4 2
© 2 0 RESORT. As one measure to inc:
and flexibility in the financh
principal object of the revis
minimax regret monetary control introduce(
Minimum Lending Rate was
given by action 3 with a loss of 2. Minimax
rent short-term interest rates
regret is thus a 'cautious' principle and
them, though with provision i
ensures that, if the worst happens, we make
the link and fixing the rate by
'the best of a bad job'.
decision when policy required
onwards a number of sucl
minimum efficient scale. That size of plant occurred, and in May 1978 tl
or firm at which LONG-RUN AVERAGE COSTS was terminated, the Rate be
are at a minimum. This may not be a unique Bank rate, by policy decisic
size. Empirical evidence from statistical cost 1981 as part of wider changes i
analysis suggests that L-shaped long-run ism of monetary control Mini
average cost curves are quite common. In Rate was discontinued, thoi
such cases there will be a range of plant or provisions for its use in an er
firm sizes which are of a minimum efficient Bank of England now conduci
scale. MANAGEMENT operations throi
ket sales and purchases of
selected with reference to a
minimum employment target. In develop- bond embracing one or more i
ment plans of less developed countries rates. (See COMPETITION, CREDI
employment targets are often set. There are
various approaches to this; they can be set
on an aggregate, sectoral, or project level. minimum wage legislation.
At the aggregate level there are two resent an attempt to improve
methods: the target is achieved as a by- living of workers by setting
product after fixing the level of investment hourly wage rates that can be
and capital-intensity of enterprises. A more T h e MARGINAL PRODUCTIVITY I
direct method is to realize the constraints on that the effects of such legist
employment targets of investment and reduce the equilibrium level j
choice of techniques and to adjust them in covered industries, CETEIJ
w
>thin the limits available to achieve higher ideal circumstances, however
employment targets. wage is set so as to increase
Many development plans look at the prob- and the level of employment
em
of employment targets at the sectoral monopsonistic exploitation,
ev
el and set targets for net investment minimum wage legislation ha«
Per worker in the different sectors. almost all cases to have had ai
^ndustry-oriented plans have also been used upon employment, particular
o try and include minimum employment agers. This demonstrates tl
rgets especially in small-scale industries. formulating a specific wage
ad u
tcj f J stment at project level often helps exploitation without causi
avour
hav Jabour-intensive techniques which ment. Two-tier minimum v
e
a major contribution to make to might protect teenage emp
280 minority control
agers might then be hired at a rate below the demand for the good and the ^
general minimum for a limited period of externality produced by the good. This j s
time during which they could be trained and illustrated in the diagram below where we
their productivity raised to normal levels. have two persons A and B, both of whom
have a private demand for good X. In addi-
minority control. Refers to the ability of tion we assume that A's consumption of ^
an individual or organization to gain effec- benefits B (assume the effects are one-way
tive control over a COMPANY, despite possess- i.e. non-reciprocal). The private demand
ing less than 51 per cent of the ordinary schedules of A and B are indicated as O
voting stock of that company. This can occur and DB. These are added horizontally to
in circumstances where there are dispersed give DM, the market demand schedule which
and inert stockholders, which facilitates the shows the total amount which will be pur-
use of proxy machinery by the minority chased by individuals, acting independently
group to gain control over a majority of the at each price. This addition is indicated in
voting shares. Proxy machinery enables the the left-hand diagram below.
owners of voting shares in a firm to exercise In the case of a mixed good we must add
the right of choosing whom to nominate as a to DM, DE - which indicates Z?'s demand for
proxy at annual board meetings. consumption by A. DE is added to DM not
horizontally but vertically (as with Public
mint. The place where money in coin form Goods) since each unit consumed by A con-
is made. Since earliest times the state has fers a benefit on both A and B; the total
benefit of v4's consumption of each unit
controlled the minting of money. (See
being indicated by adding the price A will
COINAGE.)
pay for that unit to the price B would offer
for A's consumption of that unit. This is
mis-specification. indicated in the right-hand diagram with
See SPECIFICATION ERROR. total demand given as Ds. If S is the supply
curve, we observe that a private market
mixed estimation. ESTIMATION which in- would lead to a production and consumption
volves the use of EXTRANEOUS INFORMATION. level of Qx which is less than the optimal
(See BAYESIAN TECHNIQUES, RESTRICTED LEAST level Q2- A case thus exists for collective
SQUARES.) action to enable Q2 to be reached.
A problem arises with constructing the
mixed good. Goods, the benefit of con- demand schedules DE and thus DM in that
suming which is neither confined solely to individuals may not reveal their true
one individual nor available equally to demands for consumption by others. Where
everyone. A mixed good thus lies between private demands are concerned, individuals
the polar extremes of a PRIVATE GOOD the indicate their preferences by purchasing the
consumption of which is RIVAL (i.e. one per- goods. However, this mechanism does not
son's consumption precludes anyone else operate where consumption by others is con-
benefiting from the same unit) and a PUBLIC cerned. Consequently DF and DM a r e
GOOD which is NON-RIVAL in consumption PSEUDO-DEMAND SCHEDULES, C o n s t r u c t e d Oil
(the benefits of*the good are equally avail- the unrealistic assumption that individuals
able to everyone), containing elements of reveal their preferences through some form
both. For example, inoculation against dis- of voting.
ease is a mixed good since it benefits the Another example of a mixed good arises
community at large (by reducing risks of when the use of some facility is non-rival
illness) as well as the individual though the only up to a certain level of consumption.
benefits are not equally distributed. In such For example, a public park may eventually
a case, private consumption confers a ben- become so full that the entrance of an extra
eficial EXTERNALITY on the rest of the com- person reduces the benefit obtained by
munity. In order to estimate the best or others. With this type of good there are said
'optimal' level of production of a public to be CONGESTION COSTS. The economic
good we must construct a DEMAND SCHEDULE theory of CLUBS analyses this type of good-
which includes the effects of both individual Some public goods may only confer benefits
modern sectc
Pj
\
\
\ \
0 Q1 Q2
within a restricted geographical area. Such range of values) which occurs with
goods are relevant to discussions of local frequency.
government or FISCAL FEDERALISM.
Mixed goods are certainly more common
than pure public goods and possibly more model. A formal or informal fra
common than private goods - thus their of analysis which seeks to abstract f
analysis is of great importance. The term complexities of the real world those
impure public good is sometimes used to teristics of an economic system wl
describe mixed goods. crucial for an understanding of the
ioural, institutional, and technical
ships which underlie that systei
mixed market economy. A system which intention is to facilitate the explan
combines competitive private enterprise economic phenomena, and for thi
with some degree of central control. While ation of economic forecasts.
the allocation of resources between alternate
uses is largely determined by individual
actions through the price mechanism, the modern quantity theory of money.
authorities play some role in determining the See MONETARISM and MONEY, THE
level of aggregate output by means of MONE- FOR.
TARY and FISCAL POLICIES, and in determining
the distribution of income by means of pro-
gressive taxation and welfare legislation. In modern sector. Another name
some cases the government may take control industrial sector, or sometimes the
01
sectors of the economy by nationalizing ment sector, which is often used w
certain industries. Such a blend of private ence to less developed countries w
ar
>a public control characterizes most of the legacy from the colonial era was tl
industrialized capitalist world. (See MARKET comprising plantations, mines, oil f
refineries and now includes othei
ECONOMY, MARKET SOCIALISM.)
intensive industry sponsored by
ments as well as multinational corp
. A measure of the central tendency Wage levels are often high althoug
a
vana
b l e . The mode (or modal range) of widespread unemployment. (See
m
Ple of observations is that value (or LEWIS-FEI-RANIS MODEL.)
mode of production
mode of production. MARX'S term for so- of the United States 1867-1960 (with A.J
ciety's economic base, which he believed Schwartz) did much to revive intellectual
exerted the most powerful influence in interest in these issues. The work Of
determining social institutions and social and Friedman and his associates in the late 195os
religious thought. The mode of production and early 1960s stimulated new controversy
was further subdivided into the MATERIAL on the role of money in the modern econ*
FORCES OF PRODUCTION a n d t h e SOCIAL RE- omy and the 'monetarist revolution' can in
LATIONS OF PRODUCTION. fact be attributed to this. That monetarism
was considered important must also b e
Modigliani, Franco (1918- ). Italian-born attributed to the failure of the Keynesian
US economist who was awarded the Nobel orthodoxy to explain the emergence of high
Prize for Economics in 1985 mainly for his and sustained levels of unemployment and
work on the consumption function, where inflation in many Western industrial
his major innovation has been the LIFE-CYCLE countries in the late 1960s. In its earliest
HYPOTHESIS. Modigliani has also made phase monetarism rested on an elaboration
significant contributions to capital theory, in of the simple QUANTITY THEORY OF MONEY
particular the cost of capital in the which had explained the determination of
MODIGLIANI-MILLER THEORY. (See CAPITAL the general price level in CLASSICAL ECON-
STRUCTURE.) OMICS. Thus it argued that in the long run
changes in the money stock influenced the
Modigliani-Miller theory of cost of capital. value of nominal variables but had minimal
See CAPITAL STRUCTURE. effect on the quantity of output or employ-
ment. The central propositions of monetar-
modulus. ism as it emerged in the late 1960s could be
See ABSOLUTE VALUE. summarized as follows.
First, the demand for money function was
moments. A term generally descriptive of
more stable and better defined statistically
the summary STATISTICS which serve to
than many of the components of aggregate
characterize the shape and position of either
demand. This implied that the INCOME VE-
a PROBABILITY DISTRIBUTION, or a data
LOCITY OF CIRCULATION in the quantity theory
sample. The nth moment of a variable X
of money was relatively stable although it
about a given constant 'a is defined as
was now admitted that this was a function of
Mn = / Jx - a)" -f(X)dX , several other economic variables, one of
which was the interest rate.
where f(X) is its PROBABILITY DENSITY FUNC- Second, the unique properties of money
TION. Common examples include the MEAN, were emphasized. It was argued that money
which is the first moment about zero, and was a commodity which was substitutable for
the VARIANCE, which is the second moment a wide range of other commodities and
about the mean. financial assets. As a result monetary policy
would have a direct impact on aggregate
monetarism. A school of economic demand in contrast to Keynesian analysis
thought which argues that disturbances which emphasized that the initial impact
within the monetary sector aie the principal would fall on financial assets with only a
cause of instability in the economy. The weak and uncertain impact on aggregate
term 'monetarism' was introduced by Karl demand.
Brunner in 1968 and is most commonly The direct link hypothesized by monetar-
employed to describe the school of thought ists is often called the REAL BALANCE EFFECT.
which argues that changes in the level of Linked to the notion of real balances, (i.e.
aggregate money income are due essentially Private Money holdings divided by a general
to prior money stock changes. Such a view is price index) is the idea of an 'optimal' or
frequently attributed to FRIEDMAN whose 'desired' level of real money balances.
seminal contribution on 'The Quantity Exactly how this desired level of money bal-
Theory of Money - A Restatement' in M. ance is determined is one of the theoretical
Friedman (ed) Studies in the Quantity weaknesses of the monetarist position, but
Theory of Money and A Monetary History it follows from this that if an individual's
monetary authorities 283
Idings of money are increased through payments surplus). This result appears in-
NETARY POLICY, then the individual will tuitively plausible as it suggests why fast
M
ttempt to bring actual and desired money growing economies (e.g. Japan, Germany)
balances into line by spending the excess have balance of payments surpluses while
e y Such efforts will however raise the slow growing economies have chronic defi-
rice level and thus lower real balances. It is cits (e.g. the UK, the USA). The three
lear therefore that even if it is assumed that weaknesses in the monetarist approach may
the MONEY SUPPLY is controlled in some sense be considered to be:
(as monetarists do) the real money supply is 1. its failure to provide a theory explaining
decided by the actions of all the decision why people should hold money at all. It is
makers in the economy. The real money not sufficient merely to observe that they do
supply is therefore ENDOGENOUS and is hold it (see F. Hahn, 'Professor Friedman's
brought into line with the demand for real views on Money', Economica, 1971);
balances by changes in the price level. The 2. the problem of a satisfactory definition
implication is of a strong positive link from of money and therefore of the precise nature
the size and rate of change of the nominal of the transmission mechanism;
money stock to the price level. Nonetheless 3. the fact that once some substitution
monetarists acknowledge that changes in the between money and financial assets is
money stock can affect output and employ- allowed for, and short run impacts on output
ment in the short run. are admitted, then distinctions between
One of the more important aspects of monetarist and Keynesian views become a
modern monetarism is its concern with matter of degree and less of substance.
dynamics and the role of EXPECTATIONS. The revival of interest in monetarism dur-
Expectations are now recognized to be of ing the 1970s did much to clarify the issues
great importance in determining the path of that divided monetarists and their critics.
prices and output, RATIONAL EXPECTATIONS in Thus it emerged that the early attempts to
particular have become associated with ex- summarize the position of monetarists and
treme monetarist views. If this particular their critics within the framework of the is-
hypothesis is correct then the future for any LM analysis was inappropriate, and that the
stabilization policy is bleak, for firms and real debate between monetarists and non-
households will soon learn to interpret econ- monetarists had little to do with the relative
omic events with the result that they will potency of monetary and fiscal policy -
perfectly anticipate government action and Friedman had acknowledged that fiscal
take action in advance to offset this. The policy could affect real output in the short
implication is that only unanticipated policy run and the price level in the long run, as
moves will have any effect on real output, early as 1966. The chief area of disagree-
even in the short run. This stands in stark ment concerned the principal source of in-
contrast to Keynesian type policies which stability in the economy. Monetarists argued
make no allowance for private sector antici- that the private economy is basically stable
pation of government action. and that fixed policy rules are necessary to
Monetarist ideas also extend to the case of insulate the economy against ill-conceived
the OPEN ECONOMY. Unlike the Keynesian and badly timed government actions which
view which emphasizes that balance of are the principal source of instability, while
payments theory is a problem in the market non-monetarists argued that the principal
tor goods, monetarists see it as a theory of source of instability is to be found in the
reserve changes, closely linked analytically private sector. The latter emphasize the in-
t0
the GOLD STANDARD. A balance of pay- stability of private investment decisions in
ments surplus will CETERIS PARIBUS lead to an particular and generally support an active
inflow of money and thus an increase in the government counter-cyclical policy in order
HIGH POWERED MONEY base. This follows to achieve stability. (See MONEY, THE
trom the argument that the demand for DEMAND FOR.)
money will grow in line with income growth
a n d tni
s demand may be met by either the monetary authorities. A general term
government increasing the money stock or denoting the agency or agencies responsible
"rough an inflow of money (i.e. a balance of for the oversight of the monetary system and
284 monetary base
the execution of MONETARY POLICY and and private sectors of the economy
EXCHANGE RATE policy. The agency con- Beginning in 1980 the Bank moved from a
cerned in most cases is the CENTRAL BANK system combining purchases and sales of
which may act with varying degrees of con- bills at its own initiative, conducted with the
sultation with the department of government DISCOUNT HOUSES and certain large BANKS
- in the UK and the US, the Treasury - with LENDER-OF-LAST-RESORT loans to the dis-
concerned with the formulation of such poli- count houses (through the 'discount win-
cies. (See MONETARY MANAGEMENT.) dow') to a system placing greater emphasis
on truly open-market operations in bills at
monetary base. A term often used inter- rates which the Bank determines with regard
changeably With HIGH-POWERED MONEY tO to an 'unpublished bond'. These operations
denote those assets, largely public sector and the rates at which they are conducted
monetary and short-term liabilities, which in now give more weight than formerly to mar-
the traditional theory of CREDIT CREATION are ket factors, though discretionary interest
held to determine the total supply of money rate policy has been extensively used in the
through a CREDIT (or money) MULTIPLIER. 1980s. This change in monetary manage-
The term can be used in a more distinct ment operations led to a wider set of changes
sense to designate any group of assets which in monetary control, involving the suspen-
the monetary authorities might seek to con- sion Of MINIMUM LENDING RATE, and the
trol, either rigorously in the short-term or in revision of the reserve requirements for
a looser, long-term way, with the object of banks and other institutions, announced in
controlling some chosen money aggregate. August 1981. Full UK membership of the
Whether or not such control is possible with- EXCHANGE RATE MECHANISM ( E R M ) of the
out considerable structural changes in EUROPEAN MONETARY SYSTEM in 1 9 9 0 with its
money and security markets, or without obligation to maintain the exchange rate
causing undesirable instability of interest with other currencies in the ERM implies
rates, is a matter of debate. At present, no that UK monetary policy will have to accom-
monetary authority appears to aim at any- modate to the need to sustain this rate. (See
thing approaching a tight, short-term control CASH RATIO, DEBT MANAGEMENT, FUNDING,
of a monetary base. In the UK the monetary MONEY MARKET.)
control arrangements introduced in August
1981 did not constitute a move to monetary monetary policy. That branch of economic
base control although they were stated to be policy which attempts to achieve the broad
'consistent with' such a move should it later objects of policy - stability of employment
be decided on. Since joining the EXCHANGE and prices, economic growth, and balance in
RATE MECHANISM of t h e EUROPEAN MONETARY external payments - through control of the
SYSTEM in 1990 maintaining the exchange monetary system and by operating on such
rate of sterling against those of other curren- monetary magnitudes as the SUPPLY OF
cies has replaced monetary control. MONEY, the level and structure of INTEREST
RATES and other conditions affecting the
monetary management. This term is availability of CREDIT. Like other arms of
sometimes used in a very broad sense to policy, monetary policy operates ultimately
embrace the whole range of modern MONE- through its influence on expenditure flows;
TARY POLICY. It is also used, in the UK con- but in the UK (and elsewhere) views on the
text, with an implicit emphasis on the more appropriate proximate means for doing this
narrowly technical aspects of day-to-day have changed during the last 20 years. In the
management of the London Money Market, 1960s and earlier, policy aimed to influence
the GILT-EDGED market and the level and spending through the level of interest rates,
structure of INTEREST RATES. Given the which determines whether funds for capita'
objectives of policy regarding interest rates expenditure are dear or cheap. At that time
and the control of the money supply current interest rate policy, regarded as only moder-
at any given time, the BANK OF ENGLAND ately effective, was frequently backed up W
operates routinely in the London Money direct controls - CREDIT CEILINGS and the like
Market to smooth out the effects of discon- - on BANK lending and HIRE PURCHASE
tinuous flows of funds between the public finance. In the 1970s, for a variety of reasons
money 285
f which the influence of MONETARISM is only one currency, which may be an existing one
relatively more weight has come to be or a new one. In the unification of the econo-
one
ttached to control of monetary aggregates, mies of East and West Germany in 1990 the
a
e the MONEY SUPPLY in one or other of its West German currency, the Deutsche Mark,
definitions. In fact this is a matter of empha- replaced the East Mark. The Delors Report
s since, given the size and growth of the on future EC monetary arrangements envis-
TjiC NATIONAL DEBT, interest rate policy is a ages a new common currency. Parties to a
vital ingredient of controlling growth in the monetary union lose certain policy instru-
money supply. But where the RADCLIFFE ments, namely MONETARY POLICY and
COMMITTEE, for example, in 1959, saw DEBT EXCHANGE RATE policy. Against that the de-
MANAGEMENT as a means of influencing inter- gree of UNCERTAINTY in international trade
est rates and ultimately capital expenditure, and finance with other parties to the union is
modern policy sees interest rates policy diminished, since exchange rate variations
(and, increasingly, EXCHANGE RATE policy) can no longer raise problems.
as vital to debt management and control of
the money supply. Since 1971, quantitative
monetization of debt. The process where-
credit controls have been abandoned and,
by government debt is repaid on maturity, or
until recently, MINIMUM LENDING RATE (now
is for policy reasons 'bought in' without a
itself suspended) was not used positively, as
counterbalancing issue of new non-monetary
the former BANK RATE was, to influence
debt, so that the MONEY SUPPLY increases.
short-term interest rates. Generally, the
This situation may arise in consequence of
significance attached to monetary policy,
difficulties of DEBT MANAGEMENT, or as a
compared with FISCAL POLICY, is much higher
result of a policy to stabilize interest rates
now than in the 1950s and 1960s, but this is
which imposes on the government obli-
within a more modest view of the possi-
gations to buy in all its own debt offered to
bilities of short-term control of aggregate
it, at a constant price. It may also arise as a
demand. Finally, a persisting concern in UK
direct consequence of paying off the
monetary policy has been its use to meet
NATIONAL DEBT as part of a political pro-
external policy needs. Interest rate policy, in
gramme, which disapproves of public
particular, is used to influence flows of short-
indebtedness.)
term funds to and from London, in the inter-
ests of the short-term BALANCE OF PAYMENTS
position and with full UK membership of the money. Anything which is widely accept-
EXCHANGE RATE MECHANISM ( E R M ) of the able in exchange for goods, or in settling
EUROPEAN MONETARY SYSTEM maintaining the debts, not for itself but because it can be
exchange rate relative to other ERM curren- similarly passed on, has the character of
cies is now the dominant concern of mone- money since it serves the primary function of
tary policy. (See COMPETITION AND CREDIT money, i.e. a means of payment. As a means
CONTROL, CENTRAL BANK, OPEN MARKET OPER- of payment money is an entity which is trans-
ATIONS.) See Artis, M. and Lewis, M . , ferred when a payment is made; as such it
Money in Britain, Philip Allan, London acts as a MEDIUM OF EXCHANGE, a function
(1991). essential to any economy other than the
most primitive. The term 'money' is also
monetary theory. This term refers to the used in the sense of 'money (or unit) of
branch of MACROECONOMICS which studies account': this denotes a system of abstract
money in all its aspects, how it affects the accounting units in which values are ex-
national economy and what part it plays. It pressed or debts defined. Practically such a
covers issues such as MONEY SUPPLY, the system is a necessary precondition of a price
demand for money, INFLATION, CENTRAL system since it reduces RELATIVE VALUES to a
AN
KS, BRANCH BANKING, CREDIT CREATION manageable number of money prices. In
an
d financial institutions. (See MONETARISM, modern monetary systems the principal
M
ONEY, THE DEMAND FOR, QUANTITY THEORY means of payment are DEBT instruments,
0F
MONEY.) namely BANKNOTES and BANK DEPOSITS.
Monetary union. A situation where two or Besides serving as exchange media, such
m r
° e national CURRENCIES are replaced by means of payment are held as part of the
286 money, the demand for
holder's stock of ASSETS, i.e. they act as cautionary reasons, Lj, was determined by
'stores of value'. the individual's level of income, Y. Thus j n
Keynesian theory the demand for money
money, the demand for. The demand for a function Md, is:
commodity which performs the role of both
a medium of exchange and a store of value. Md = L](Y) + L2(r)
In general it must be recognized that MONEY The individual's preference for liquidity
is not demanded for itself but for the fact money, therefore arises because of his
that it can be used to purchase other goods uncertainty about the exact point in time
and services. The precise nature of the when he will need money - the precaution-
demand for money has in recent years be- ary motive - and his uncertainty about
come a central issue in modern macroecono- future interest rates - the speculative
mics due largely to the development of motive. Liquidity preference in the
MONETARISM. Keynesian analysis is therefore largely a
Two broad schools of thought on this issue function of uncertainty.
may be identified; the Keynesian and the In contrast to the above, classical mone-
Modern Quantity Theories. tary theory as reflected in the Cambridge
The Keynesian view argued that three Cash Balance Approach had argued that in-
motives give rise to a demand for money. dividuals would demand money for trans-
First, individuals will demand money to actions purposes only. Monetary holdings
finance their daily purchases of goods and would be maintained at the minimum
services, the transactions motive; second, in- required for transaction purposes and thus
dividuals will demand money as a con- any form of hoarding, the building up of idle
tingency against unforeseen expenditures, cash balances, was 'abnormal'. The demand
the precautionary motive; and third, indi- for money, Md, would therefore be some
viduals will hold money as a store of wealth, constant proportion, k, of his income, Y,
the speculative motive. In particular they which when taken together with the average
will hold money for speculative purposes be- price level, P, would determine the volume
cause they are unsure about the returns from of transactions he could undertake. Thus
the alternative financial assets in which they
could hold their wealth, i.e. BONDS. The re- Md = kPY
turns from holding bonds comprise the inter- Modern MONETARISM essentially rep-
est payments and the possibility of a capital resents no more than a sophisticated version
gain or loss. If the expected capital loss is of classical monetary theory. The demand
greater than the interest payments the net for money to finance transactions is now
return is negative and the individual con- viewed as being stably related to a few key
cerned will hold no bonds, only money. variables. Monetarists argue that the
Bond prices are inversely related to the demand for money is no longer a function
interest rate and therefore, if an individual solely of the interest rate and income, but
expects a sharp rise in the interest rate, this that the rate of return on a much wider
is the same as expecting a corresponding spectrum of physical and financial assets will
sharp fall in bond prices and again he will influence an individual's demand for money.
hold only money. In aggregate Keynes sup- Individuals will act in such a way as to ensure
posed that individuals held a wide variety of that the rate of return at the margin is equal
different views about the future level of across the complete range of physical and
interest rates and therefore as the current financial assets that they could purchase.
rate of interest fell more and more people Thus money is seen as being a substitute for
would expect that eventually it would rise all other assets and the demand for money is
again - the price of bonds fall - and there- therefore a function of the rates of return on
fore more people would hold only money. In all these. In contrast, of course, money was
this manner, Keynes argued that in aggre- seen as a substitute for financial assets only
gate the demand for money for speculative in the Keynesian system and thus it was the
purposes, L2, would be inversely related to rate of return on these, the interest rate, that
the interest rate, r. In contrast the amount of influenced the demand for money. In prac-
money demanded for transactions and pre- tice, however, if the rate of return across all
money market 287
hysical and financial assets moves to equa- seven days' notice and longer. (See LIQUI-
nv then the interest rate will clearly serve as DITY, MONEY MARKET.)
a p p r ° P r i a t e P r o x v f° r t n e s e - Thus the
a
odern quantity theory of the demand for money balances (also known as nominal bal-
o n ey can be represented in similar fashion
ances). The amount of MONEY held on
JJ that of Keynes. Namely average by individuals in the form of FIAT
MONEY and/or BANK DEPOSITS. (See MONEY
SUPPLY.) At EQUILIBRIUM, money balances
• y = f(y>r)
are that amount of money which will remain
where unspent, but which represents lateni
demand for commodities and/or financial
assets. (See IDLE BALANCES.) Money balance*
are often measured in real terms as REAI
represents the demand for REAL MONEY BAL- MONEY BALANCES. (See MONETARISM.)
ANCES, y income, and r the interest rate.
Nonetheless even though both schools use money illusion. An individual is said to b<
this functional form in empirical work the 'suffering from' money illusion if he reacts t(
underlying theories are very different. changes in values specified in monetar
Monetarists maintain that the demand for terms rather than in real terms. Income cai
money function is better determined statisti- be expressed in purely money values or thi
cally than either the consumption or invest- can be deflated by the current rate of INFLA
ment function and this explains their TION which will give an indication of REA
preference for MONETARY POLICY rather than INCOME, which is a more accurate indicatio:
FISCAL POLICY. The monetarist prescription is of the real purchasing power of income.
to allow the MONEY SUPPLY to grow at a
constant rate equal approximately to the money market. A term used in at lea<
growth in output (the money supply rule). three senses, to be judged by the context. I
But in fact recent empirical work has re- its narrowest and most specific sense
vealed great instability in both the demand appears as 'the London Money Market
for money function and the major com- when it signifies the market in short tern
ponents Of the AGGREGATE DEMAND function secured, loans, most of then 'at call' (i.<
and thus it is certainly not clear that mone- recallable immediately), in which the bo
tary policy is to be preferred to fiscal. On the rowers are the London DISCOUNT HOUSES an
contrary the money supply rule will under a small number of money brokers and ma
these conditions lead to large and unpredic- ket makers, and the lenders are principal
table changes in individuals' holdings of the commercial banks, though they incluc
money and thus to large and unpredictable other financial institutions and some comp
changes in expenditure. nies. In London the terms 'Money Marke
and 'Discount Market' are used more or le
money at call. In UK official statistics, this interchangeably, indicating that even in tr
denotes loans made by banks mostly to the narrow sense the money market is to 1
London DISCOUNT MARKET, on terms which regarded as embracing the market in bills,
allow recall at any time of the working day. which the Discount Houses are predon
^uch loans, which are secured against bills nant. Secondly, the term is used to dene
and other securities, were between 1971 and any market in highly liquid assets which
^ 8 1 classed as 'eligible assets' for the pur- supported by an identifiable and active set
Pose of calculation of the RESERVE ASSETS operators. In London it embraces the gro
^ T I O . Prior to 1975 the term 'money at call of closely interrelated markets in whi
and short notice' was used, as the item then sterling is lent, unsecured, at terms rangi
nc uded loans to the Discount Market sub- from overnight to several months' noti<
da / e C a 1 1 a t v a r y m § Periods up to seven This group includes the INTERBANK MARK
e
lent' § e n e r a l l y short-term money is LOCAL AUTHORITY MARKETS, and the marl
r w i t h o u t securit in sterling CERTIFICATES OF DEPOSIT. Fine
instit ° Y> by a variety of
ra . utlOns > in various markets, on terms the term is occasionally met in the literati
§ m g from 'overnight' and 'call', up to of monetary theory, where it may re
2«« money multiplier
simply to the market in loanable funds in the of interest-bearing sterling bank deposit
most general and undifferentiated sense. along with private sector holdings of retail
building society shares and deposits and
money multiplier. National Savings Bank ordinary accounts
1. See CREDIT MULTIPLIER. The broad definitions include other cat
2. coefficient on the real money supply in egories of money, e.g. wholesale interest-
the reduced form equation for income in a bearing deposits and money market assets
macroeconomic model, the IS-LM model such as bills. Thus M4 includes notes and
results in a reduced form equation for in- coin in circulation with the public, private-
come of sector interest bearing and non-interest
bearing sterling bank deposits (retail and
wholesale), private-sector sterling time de-
Y = A+ £
posits, private-sector holdings of sterling
bank certificates of deposit, private-sector
where A is autonomous expenditure, holdings of building society shares and de-
posits and of sterling certificates of deposit
— real money supply, and
minus building society holdings of bank de-
Y income. posits, bank certificates of deposit and notes
In this equation (3 is the 'money multiplier', and coin. While M4 relates only to deposits
which indicates by how much an increase in in sterling, the next definition, M4c, contains
the real money supply changes the equilib- the same categories as M4 but includes also
rium level of income, with fiscal policy held bank and building society deposits in foreign
constant. currencies. The final definition, M5, adds to
Confusion often arises between meanings M4 holdings by the private sector (excluding
1 and 2, but most authors use the term in the building societies) of money market instru-
sense of meaning 1. (See MULTIPLIER, FISCAL ments (bank, Treasury and local authority
MULTIPLIER.) bills), certificates of tax deposit and various
National Savings instruments.
In the USA the categories are as follows.
money price.
Ml is currency, demand deposits and
See PRICE.
other chequeable deposits. M2 is Ml plus
overnight repurchase agreements and
money stock. Another name for the Eurodollars, Money Market Mutual Fund
MONEY SUPPLY. Balances and Money Market Deposit
Accounts. M3 is M2 plus term repurchase
money supply. The amount of money in agreements, term Eurodollars and insti-
an economy; there are various definitions tution only Money Market Mutual Fund
which are related to the number of LIQUID balances. (See MONETARISM, KEYNESIAN
ASSETS included as MONEY. In the UK (since ECONOMICS, MONETARY POLICY, NEW-
1989) figures for five definitions of the ORTHODOXY, NEO-ORTHODOXY, RADCLIFFE
money supply are published; two are narrow REPORT.)
money definitions relating to the use of
money as a medium.of exchange and three money terms. The expression of the
are broad money definitions, which values of a good in nominal money terms -
acknowledge the additional use of money as i.e. including changes in the general level of
a store of value. The narrowest money defi- prices. (See MONEY ILLUSION.)
nition is MO, which includes notes and coins
(both in circulation and in bank tills) and the monoculture. The practice of cultivating
operational balances which the banks hold at only one type of crop in any area which
the Bank of England. M2 excludes the occurred in England before the agrarian
money held by the banks in their tills and at revolution and is still prevalent in tropical
the Bank of England but adds to the notes areas. Its disadvantages are that it makes the
and coins in circulation all private sector crop very susceptible to disease and pests,
non-interest-bearing sterling sight bank and gradually renders the soil more and
deposits plus private-sector retail holdings more infertile unlike the practice of crop
Monopolies and Restrictive Practices
rotation which restores goodness to the soil Commission may investigate proposed
because of the different types of plant. It is well as existing mergers. Responsibility
not only primitive subsistence farmers who acting upon the Commission's recomm
have suffered from the problems affecting dation rests with the appropriate minis
jnonoculture; the cotton, cocoa, rubber and who may seek statutory orders to rem<
banana industries on small farms and plan- the situation. Companies, however, do
tations alike have been affected by blights. have to notify a dominant market position
intention to merge as it is the responsibi
Monopolies and Mergers Act 1965. Con- of the authorities to identify such situatic
tained two important developments in UK which in turn they are in no obligation
competition policy. Firstly, large MERGERS refer to the Commission.
were made liable to investigation by the then
named Monopolies Commission. The Act Monopolies and Restrictive Practices (
set out criteria determining those mergers quiry and Control) Act 1948. Marked I
liable to investigation; these were, any introduction of a UK competition pol
mergers involving the transfer of £15 million with the creation of the Monopolies a
or more of gross ASSETS or which would Restrictive Practices Commission. T
establish a MONOPOLY, then defined as a 25 Board of Trade could refer to this Co
per cent market share. Investigations of mission any case where a firm supplied oi
mergers by the Commission put the onus of third or more of the UK market in a good,
proof on the Commission to show that a where two or more persons conducted th
merger is against the public interest. The business in a manner deemed detrimental
relevant Secretary of State has the right of competition. References to the Commissi!
veto over Monopolies Commission's recom- took the form of establishing whether
mendations in any referred merger case. MONOPOLY existed, or passing judgement i
The second major development empow- whether the conduct of a particular busim
ered the Monopolies Commission to inquire practice was in the public interei
into references concerning the supply of ser- Responsibility for taking action on ti
vices as well as goods. Furthermore, the recommendations arising from these rek
Commission could also undertake general ences lay with the relevant Secretary
inquiries into practices likely to restrict com- State. The pragmatic approach embodied
petition but not registerable under the RE- this 1948 Act has remained an importa
STRICTIVE TRADE PRACTICES ACT 1956. (See feature of UK competition policy. (S
RESTRICTIVE TRADE PRACTICES ACT 1 9 6 8 , FAIR RESTRICTIVE TRADE PRACTICES ACT 1 9 5 6 , MON
TRADING ACT 1 9 7 3 , COMPETITION ACT I 9 8 0 . ) POLIES AND MERGERS ACT 1 9 6 5 , RESTRICTS
TRADE PRACTICES ACT 1 9 6 8 , FAIR TRADING A!
Monopolies and Mergers Commission. The 1 9 7 3 , COMPETITION ACT I 9 8 0 . )
Director General of Fair Trading and the
Secretary of State for Trade and Industry monopolistic competition. A theory orig
can refer MONOPOLIES and MERGERS for inves- nated by E.H. Chamberlin (The Theory <
tigation by the Monopolies and Mergers Monopolistic Competition, Harvard Unive
Commission, an independent administrative sity Press, 1933) and J. ROBINSON (77
tribunal established in 1973 replacing the Economics of Imperfect Competition
earlier Monopolies Commission set up in Macmillan, 1933). Development of th
1948. It deals primarily with cases where model of market behaviour was stimulate
°ne company, or two or more acting in com- by a belief that actual MARKET STRUCTURI
mon, supplies 25 per cent or more of a par- did not appear to correspond with either (
ticular good or service, local monopolies those postulated by the two polar cases (
which prevent, restrict or distort compe- PERFECT COMPETITION Or MONOPOLY. Th
tition and monopolies in public sector indus- monopolistically competitive industry is on
tries. Mergers may be referred to the in which there are a large number of firrr
Commission by the Secretary of State for producing similar but not identical product;
Trade and Industry if they result in or inten- The introduction of PRODUCT DIFFERE!1*
sify a monopoly or if the total value of gross TIATION gives firms an element of MONOPOL
as
sets acquired exceeds £15 million. The POWER in that each firm faces a negativel
290 monopolistic competition
onopoty power. The ability of a firm or moral hazard. The effect of certain t
roup of firms to influence the market price of insurance systems in causing a diverg
^f the commodity or service it sells. The between the private MARGINAL COST of s
following are conditions which can give rise action and the marginal SOCIAL COST of
t 0 some degree of monopoly power. (1) action thus resulting in an allocation o
MINIMUM EFFICIENT SCALE OF PLANT is SO l a r g e sources which is not OPTIMAL. For examp
in relation to market size that only one firm person may be insured against illness in
can operate efficiently. (2) PRODUCT DIFFER- a manner that the cost to him of consul
ENTIATION. (3) BARRIERS TO ENTRY which put more medical care is less than the co:
potential entrants at a cost disadvantage to society. Consequently he may increase
established firms. (4) PATENT RIGHTS which use of medical facilities beyond the soc
give exclusive use to a technique of pro- optimal level. This in turn would lead ii
duction. (5) High transport costs which en- ance companies to recalculate premiums
courage local monopolies. (See increase the cost to all consumers. The p
MONOPOLISTIC COMPETITION, MONOPOLY, IM- lem of moral hazard leading to overus
PERFECT COMPETITION.) facilities arises in both private insurance
terns and in state controlled agencies su<
monopoly profit.
the British National Health Service.
See SUPER-NORMAL PROFITS.
mortgage. A legal arrangement in wh
monopsony. In the strict sense a monop- form of ownership of some ASSET is r
sonist is the sole buyer of a FACTOR OF PRO- over or conveyed to the lender of func
DUCTION; the classic example is provided by the debtor as a guarantee or security ag
the one company town. More generally, the loan. When the loan is paid ownei
monopsony refers to situations of reduced reverts to the debtor. The debtor ret
alternative in the labour market. This may within limits set by the mortgage agreen
result from the limited job search of workers control over the asset and may (for exan
and not simply from limited numbers of po- sell it in order to repay the loan. This foi
tential employers. Whatever the cause, the agreement is very common in the pure
buyer confronts an upward sloping aggre- of housing by individuals and in the agi
gate labour supply curve. In consequence, tural sector.
his decision to purchase more labour has
some effect on the wage level. The monop- most favoured nation clause. A clau:
sonistic employer realizes that the marginal an international trade agreement v
cost and the average cost (i.e. the wage) of states that contracting parties to the aj
an additional worker differ and because of ment are bound to grant to each other t
this disparity he hires less labour and pays ment as favourable as they extend to
this labour a lower wage than would occur in other country regarding the applicatic
competitive circumstances. IMPORT and EXPORT duties and other I
regulations. (See GENERAL AGREEMENT
Monte Carlo method. A technique for dis- TARIFFS AND TRADE.)
covering the small sample properties of eco-
nometric ESTIMATORS. A hypothetical moving average. A method of smooi
economic model with known PARAMETERS is out fluctuations in data. An n period me
used to generate artificial data with known average is calculated from a time serk
characteristics, and the estimator is used to first calculating the simple average oi
estimate the parameters of the model. By first n observations, then calculating
comparing these estimates with the actual average of the 2nd to the (n + l) t h , the
Parameter values, information about the 3rd to the (n + 2) th , and so on. The
Performance of an estimator under specific nique is often used to eliminate sea:
c
°nditions can be gained. components (or other intra-annual
ation) from data, for which a 12-mont
g 4-quarter) moving average would
UNDEREMPLOYED WORKERS. needed. (See FILTER, SEASONAL ADJUSTM]
multicollinearity
stage. Clearly the extent of the eventual in- Analysis and the Principle of Acceler
crease in income is determined by how much Review of Economics and Statistics,
income is passed on at each stage, i.e. by the although HARROD (The Trade Cycle, (
MARGINAL PROPENSITY TO CONSUME of the par- University Press, Oxford, 1936) develi
ties to this sequence of events. Hence the model along similar lines some years e
size of the multiplier is found by According to the accelerator principl
amount of capital is proportional i
1 amount of consumption. Thus
1 - marginal propensity to consume
Kt = vCt
or, because the sum of marginal propensity
to consume and the marginal propensity to where Kt is the amount of capital rei
withdrawn income must equal unity, the in period t;
multiplier must be equal to 1 -f marginal Ct is consumption; and
propensity to withdraw income. Clearly the v is a constant.
larger the propensity to withdraw income Now as consumption rises, the rei
the smaller the value of the multiplier, so capital stock increases corresponding!
that in an OPEN ECONOMY in which the pro- hence INVESTMENT is required. The rei
pensity to import, tax and save is high, the ship may be expressed as follows:
multiplier will decline. The concept is
Keynesian and suggests that the idle re- It = K[ — Kt-\
sources that are employed to increase = vC, - vCt-X
income by some multiple of the original in-
jection are immediately forthcoming, at an = v(Cr-C,_,) I
e x o g e n o u s | y determined price. The multi-
The principle of accelerator-multiplier
plier is an essential feature of the simple
action can be shown using a simple w
INCOME-EXPENDITURE MODEL. (See REGIONAL example. In the table above it is ass
MULTIPLIER.)
that there is some EXOGENOUS investm
MARGINAL PROPENSITY TO CONSUME, C,
multiplier-accelerator interaction. An and the accelerator coefficient, v, of 1.
a
Pproach to the explanation of fluctuations that C, = cYhI, and C + / + G = Y.
*n the level of economic activity - the TRADE The data in this table reveal a ser
C CLE
^ - which rests on interactions between fluctuations in income although these c
Jhe MULTIPLIER and the ACCELERATOR. The seen to be damped; i.e. eventually in
asj
c analysis combining the Keynesian will settle down at that level determin
CONSUMPTION FUNCTION and the accelerator the multiplier, which in this case is
Pnncipie to produce a self-generating million. But the table is only meant
yclical mechanism was provided by SAMUEL- illustrative. In fact, mathematical an
0N
('Interaction between the Multiplier of this question shows that a damped
294 multiproduct firm
(progressively smaller deviations in income point for most subsequent work on open
around the equilibrium value) is only one economy MACROECONOMICS and in exchange
possibility. There are other alternatives, de- rate determination.
pending upon the precise relationship be-
tween v and c. Thus if the assumed values of mutually exclusive projects. Refers to a
v and c were 0.5 and 0.9 respectively then situation where two or more projects cannot
there would be no cycle at all: income would all be executed because they all require an
simply rise toward the multiplier value of input which can only be utilized on one proj-
£1000 million. Alternatively, given values of ect. For example, a piece of land could be
v and c of 2.0 and 0.6 respectively the devi- used for an office block or a block of flats but
ation in income around the equilibrium not both. In this situation it is necessary to
value would become progressively greater rank the projects. Generally ranking by NET
through time - an exploding cycle. Again, PRESENT VALUE will produce the maximum
one would observe exploding growth for return to the owners unless there is a capital
values of v and c of 3.0 and 0.8 respectively. constraint.
The simple accelerator-multiplier model is
often used to explain 3-year BUSINESS CYCLES
in the economy, INVENTORY changes in par- MV = PT. The equation of exchange of
ticular are thought to correspond fairly t h e QUANTITY THEORY OF MONEY.
closely to this simple sketch of accelerator-
multiplier interaction. Myrdal, Gunnar K. (1898-1987). Swedish
economist, politician and international civil
multiproduct firm. An enterprise which servant, Myrdal consistently challenged
combines factors of production to produce a orthodox economic thought on a wide range
range of products. With such firms the con- of topics.
cepts of a physical volume of total output In The Political Element in the Develop-
and unique price are less applicable. ment of Economic Theory (1929) he criti-
cized the orthodoxy of the day which he
multisector growth model. A model used claimed had turned the doctrine of utility
in GROWTH THEORY which allows for many from its logical conclusion of egalitarianism
types of good. It is an extension of the prob- into a defence of the status quo. Such a
lems considered in GENERAL EQUILIBRIUM defence is rooted in the innate conservatism
continued into growth theory. Considerable of the economic profession. Myrdal had
mathematical competence is needed to been critical of the development of sophisti-
understand such models fully. A TWO SECTOR cated mathematical economics which he saw
GROWTH MODEL may be considered as the
as superficial and largely irrelevant, justifi-
first step from the ONE SECTOR GROWTH able only as an attempt on the part of eco-
MODEL to the multisector case. nomists to withdraw from analysing real
problems.
multivariate analysis. An analysis (nor-
mally of a statistical nature) which involves Myrdal's approach to the analysis of
more than two variables. (See BIVARIATE 'economic' problems is perhaps best charac-
ANALYSIS.) m
terized by his An American Dilemma; The
Negro Problem (1944). In this work he com-
Mundell-Fleming model. A model, devel- bines economic equilibrium models and dy-
oped independently by these two eco- namic analysis of cumulative processes
nomists, which shows that the expansionary which follow from disturbances. Myrdal
effect of policy variables, FISCAL POLICY and attempts to widen the scope of economics by
MONETARY POLICY, varies according to the drawing attention to the interdependence of
EXCHANGE RATE regime assumed. On the economic and social factors such as edu-
assumption of the perfect mobility of capital, cation and health. He shows how a cumulat-
monetary policy is shown to be ineffective ive process of deterioration can arise and is
with a fixed exchange rate and fiscal policy critical of attempts to determine the ultimate
with a flexible exchange rate. This con- causes of any economic situation. He prefers
clusion is an example of the ASSIGNMENT a theory of cumulative causation which in
PROBLEM. The model has been the starting this case may be described as vicious circles
Myrdal, Gunnar K. 29
of poverty, discrimination and poor educa- pressed the view that institutional factors ai
tion. more important than market relations in th
From the 1950s, Myrdal became increas- determination of economic events. Myrdj
•naly associated with the theory of economic also made contributions to 'pure' economi
development. The Asian Drama (1968) is theory, and his early work, particular]
perhaps his best known work in this area, Monetary Equilibrium (1931) developed th
and describes the vicious circle of poverty, economics of Knut WICKSELL and anticipate
ill-health, lack of education and underem- much of the later work of J.M. KEYNES. I
ployment which occurs in underdeveloped this context Myrdal was responsible for th
countries. In all his works he consistently formulation of the concepts EX ANTE and E
stressed the need to take a broad view of POST. He used these ideas to discuss aggn
economic research and to attach great im- gate investment decisions and their relatioi
portance to political, institutional, demo- ship to equilibrium national output in whs
graphic, educational and health factors. He became known as Keynesian manner.
argued in contrast to the prevailing ortho- His other important works include: A
doxy that economic aid from the developed International Economy: Problems and Prol
countries to the Third World is not in the pects (1956); Economic Theory and Unde
latter's long term interests. It is safer, he Developed Regions (1957); Challenge
claimed, for poorer countries to develop in- Affluence (1963) and Against the Strea,
dependently of the rich since the policies of (1973).
the West place restrictions on the develop- Myrdal was awarded the Nobel Prize
ment of those countries. Indeed, Myrdal be- Economic Science (with F.A. von HAYEK)
lieved that they inhibit that development for 1974 for his attempts to broaden the scope
their own interests. economic science. (See INSTITUTION^
In this area and in others Myrdal ex- ECONOMICS.)
N
naive accelerator. mean 'public sector debt', that is to include
See ACCELERATOR PRINCIPLE. the obligations of other public bodies that
borrow, e.g. local authorities and nationa-
Nash solution. In GAME THEORY this applies lized industries. For many purposes, e.g
under certain conditions to the solution of when considering problems of DEBT MANAGE-
co-operative two-person games. The players MENT, this broader total is more significant
collusively co-ordinate their strategies where since the securities of other public bodies are
failure to do so would result in both being close substitutes for GILT-EDGED stock for
worse off, in that both would receive a lower many PORTFOLIO holders. Whichever total is
pay off (the THREAT PAYOFF) than is possible in view, the distinction between the gross
with collusion. and net amounts outstanding is important,
since considerable amounts of central gov-
national accounts. The compilation of ernment and other public debt are held
accounts to derive estimates of the NATIONAL within the public sector.
INCOME.
296
national income 297
national income does not simply aggregate Quarterly Review which contains predictions
all incomes. It aggregates only those of resi- for the UK and world economies.
dents of the nation, corporate and indi-
vidual, which derive directly from the National Insurance Contributions. A form
current production of goods and services. It of tax on labour, levied in the UK on both
aggregates the incomes of FACTORS OF PRO- employers and employees. Contributions
DUCTION, factor incomes and excludes all levied are generally related to incomes
incomes which cannot be regarded as pay- though there are variations in payments de-
ment for current services to production pendent upon employment status (fOr
(TRANSFER INCOMES). The sum of all factor example, as between employed and self-
incomes gives total domestic income which employed) and entitlement to benefits. The
once adjusted for STOCK APPRECIATION gives payments are earmarked to finance pay-
gross domestic product at factor cost. If we ments of National Insurance benefits but
then add on NET PROPERTY INCOME FROM they do not provide the full revenue
ABROAD we have obtained one measure of required for this purpose. (See BEVERIDGE
gross national income, or, as it is more com- REPORT, NATIONAL INSURANCE FUND.)
monly known, gross national product.
The expenditure approach aggregates
consumption and investment expenditures National Insurance Fund. A fund into
to obtain total domestic expenditure at mar- Which NATIONAL INSURANCE CONTRIBUTIONS
ket prices. It aggregates only the value of are paid and from which Social Security
final purchases and excludes all expenditures benefits are paid out. Although the National
on INTERMEDIATE GOODS. However, since Insurance Contributions are the main source
final expenditures at market price include of revenue for this fund they are not suf-
both the effects of taxes and subsidies and ficient to meet its expenditures thus
our expenditures on IMPORTS while excluding 'topping-up' payments are made from gen-
the value of our EXPORTS, all these have to be eral government revenue. This fund is an
taken into account before we obtain gross insurance fund in name only since its reve-
national product by this method. nue does not meet its payments, the level of
Finally, the output approach aggregates payments is not determined by the earnings
the sum of the VALUES ADDED at each stage
of the fund and contributions are not based
of production by the industries and pro- on any actuarial assessment of risk. The fic-
ductive enterprises in the country. The sum tion of the fund is perhaps maintained in
of these values added gives gross domestic order to remove the stigma of 'charity' from
product at factor cost which after a similar National Insurance benefits. (See BEVERIDGE
REPORT.)
adjustment to include net property income
from abroad gives gross national product.
Thus the three approaches give rise to National Labor Relations Act. The
estimates of gross national product which 'Wagner Act' was passed by the US Con-
once adjusted to take account of CAPITAL gress in 1935. It was the culmination of a
CONSUMPTION provides the measure of long history increasing Federal government
national income or more accurately net pressure to endorse the principle of COLLEC-
national income or net national product. A TIVE BARGAINING. The Congress ordered
typical account is shown above. The figures employers to stop interfering with unions
are hypothetical. attempting to organize employees. The cen-
tral message of the act is summed up in the
statement, 'Employees shall have the right
National Institute for Economic and Social to self-organization, to form, join, or assist
Research. An independent, British non- labor organizations, to bargain collectively
profit organization founded in 1938 to in- through representatives of their own
crease knowledge of social and economic choosing, and to engage in concerted activi-
conditions of contemporary society. It is ties for the purpose of collective bargaining
financed mainly by grants from charitable or other mutual aid or protection.' The
foundations, government agencies and busi- Wagner Act established the National Labor
ness. It publishes books and an influential Relations Board to monitor and adjudicate
natural prici
natural rate of growth. The rate of growth power because of their location, wind if j t
of the effective labour force in the HARROD- can be usefully harnessed as a source of
DOMAR GROWTH MODEL. With a FIXED COEF- power, rainfall etc. Some of these are non-
FICIENTS PRODUCTION FUNCTION the natural renewable and some will always continue
rate is the maximum sustainable rate of however much they are utilized. (See NON-
growth of real income. The natural rate RENEWABLE RESOURCES.) See Pearce, D.\y
(G/v) is composed of the rate of growth of and Turner, R.K., Economics of Natural
population (n) plus LABOUR-AUGMENTING Resources and the Environment, Harvester
TECHNICAL PROGRESS (X) (also known as Wheatsheaf, London (1990).
HARROD-NEUTRAL TECHNICAL PROGRESS). T h u s
Li,
neo-classical growth theory 3U1
tourism, catering and banking. The classifi- the domestic economy by overseas residents.
cation has its basis in the Marxian distinction (See NATIONAL INCOME.)
between productive and unproductive work.
(See PRODUCTION SPHERE AND BUDGETARY neutrality of money. This theorem states
SPHERE.) that via the operation of the REAL BALANCE
EFFECT in the MONEY MARKET, there will be an
net national income. equal proportionate increase in EQUILIBRIUM
See NATIONAL INCOME. money prices for a given increase in the
MONEY SUPPLY .
HHnet national product.
See NATIONAL INCOME. neutralizing monetary flows.
See INTERNATIONAL MONETARISM.
net present value. The sum that results
when the DISCOUNTED value of the expected 'new classical macroeconomics'. Essen-
costs of an investment are deducted from the tially a restatement in a more rigorous form
discounted value of the expected returns. of orthodox CLASSICAL ECONOMICS. This re-
That is, the DISCOUNT RATE is r, the return in statement rests on the notion of RATIONAL
year 1 is /?/, the return in year 2 is R2 and so EXPECTATIONS combined with a NATURAL
on, and the cost in year 1 is Cj and so on, RATE OF UNEMPLOYMENT which emerges as
then the net present value is given by the a result of efficient market clearing.
formula: Accordingly it is argued that the economy
will settle at the natural rate and attempts to
R, - C, disturb this equilibrium, say to reduce unem-
NPV
= ? ployment below the natural rate, will be
If the NPV is positive the project in question fully anticipated and neutralized by econ-
is potentially worth undertaking. The pre- omic agents. Any attempt to stabilize output
cise rule for acceptance or rejection, how- or employment below or above the natural
ever, will depend on the method of ranking rate by FISCAL and MONETARY POLICY will
all available options which have positive net prove ineffectual and will not alter the value
present values and this can require the use of of real variables in either the long or the
PROGRAMMING techniques. In macroecono- short run. The essence of this view is cap-
mics, the net present value approach can be tured in the proposition that there is no
found in the CLASSICAL approach to invest- trade-off between inflation and unemploy-
ment appraisal originated by Irving FISHER. ment even in the short run, i.e. that both the
In contrast, KEYNES adopted the MARGINAL short-run AGGREGATE SUPPLY CURVE and the
EFFICIENCY OF CAPITAL approach which essen- short-run PHILLIPS CURVE are vertical. While
tially begins in the same way but does not correctly viewed as a development of MONE-
require the adoption of a discount rate for TARISM this 'school' nonetheless departs from
the purposes of discounting. Rather it asks the arguments of mainstream monetarists,
what rate of discount will equate the two such as FRIEDMAN, for the latter concede that
discounted streams of returns and costs. The demand management policies will probably
result then has to be compared with some result in deviations in output and employ-
ment from the natural rate in the short run.
RATE OF INTEREST. (See MARGINAL EFFICIENCY
The new classical macroeconomics purports
OF INVESTMENT.)
to show the futility of Keynesian demand
management policies and instead focuses
net profits. That portion of total profits attention on SUPPLY-SIDE ECONOMICS.
which remains after the deduction of taxa-
tion payments and depreciation provisions.
New Economic Policy. A term used to
net property income from abroad. The describe the workings of the economic sys-
difference between PROFITS, DIVIDENDS and tem in the USSR in the 1920s.
INTEREST received on assets held overseas by
domestic residents and profits, dividends new industrial state. Associated with the
and interest paid abroad on ASSETS held in work of J.K. GALBRAITH, who argues that
'new-new' microeconomics
odern developed capitalist economies have 'new microeconomics'. The name givei
xperienced a shift in economic and political a body of economic literature which
ovver away from the owners of capital to sought to identify the microeconomics
vvnat he calls the TECHNOSTRUCTURE. The macroeconomics; specifically, to provid
technostructure uses corporate planning - firm microeconomic rationale of the me
• e industrial strategies such as innovation, anisms underlying the aggregate relations
acquisition and merger - in the pursuit of between price changes and unemploym
goals such as growth, prestige and power. (Phelps, E.S. et al., The Microecono,
The implication is that producer sovereignty Foundations of Inflation and Unemployn,
has replaced CONSUMER SOVEREIGNTY in mar- Theory, New York, Norton, 1970). The r
kets as the driving force in determining the microeconomics builds upon the NATU.
allocation of resources. RATE OF UNEMPLOYMENT hypothesis, j
abandons the notion of fully and costlei
informed market participants. Beyond
new inflation. The notion that the current
ploring the implications of the natural i
inflation that western economies have
hypothesis (e.g. accelerating inflation wh
experienced since the Second World War is
the actual rate of unemployment lies bel
of a different nature or origin to previous
the natural rate and accelerating deflati
inflations in history. The basic argument
after some point, where unemployment!
here is that trade union PUSHFULNESS consti-
ceeds the natural rate), the new microeco
tutes the 'vital parameter' or 'motive force'
mics seeks to explain the existence o
of the current inflation.
positive natural rate of unemployment
the negative short-run PHILLIPS CURVE
new issues market. The primary market, lation between wage/price change j
not very clearly defined, in which newly unemployment. The new microeconon
created SECURITIES, or securities not pre- models are not identical, but all attrib
viously listed and hence not traded on the output changes to price 'surprises'. Th
STOCK EXCHANGE, are sold: by open offer to unanticipated increases in aggregate derm
the public at large, to existing shareholders lead to unanticipated inflation; prices
in the case of 'rights issues', or to selected wages begin rising faster than agents bell
individuals and institutions in the private they are rising elsewhere in the econoi
'placing' of the securities of private compa- This perceived increase in the relative w
nies or of unquoted public companies. The or price faced by the particular agent le
core of the market consists of the financial to an increase in output and employmer
institutions and operators engaged in some the usual supply response to a CETERIS P^
way in floating new issues. These include the BUS price increase. However, once age
ISSUING HOUSES, ISSUING BROKERS and the discover the rise in prices and wages to
financial institutions, e.g. INSURANCE COM- quite general and not specific to their p
PANIES, PENSIONS FUNDS and investment ticular markets, output and employment *
trusts, which sub-underwrite new issues, i.e. return to their previous levels. (See 'NI
guarantee to buy any part of an issue not NEW' MICROECONOMICS.)
taken up by the public or by existing share-
holders in the case of rights issues. A new 'new-new' microeconomics. The na
issue is not always made to raise fresh given to model building exercises wh
finance for the issuer: it may consist of the attempt to explain wage and price contra
sale of existing shares on the conversion of a in terms of microeconomic optimizing
private to a public COMPANY, or simply rep- haviour. The existence of wage and pi
resent the capitalization of existing reserves. contracts means that prices will react si
J
t should also be noted that the initial (pri- gishly to underlying changes in aggreg
mary) sale of a security previously unlisted demand and that the latter will predo
on the stock exchange does not take place on nantly induce quantity changes in the sh
h e fl
°or of the exchange, even when the run. The causal sequence is from change;
security is to be 'quoted' on the exchange, aggregate demand to changes in output i
but
it may be 'placed' with buyers by the employment which then lead to changes
stockbrokers to the issue. price and wage inflation.
The new-new microeconomics is com- a valid account of how the quantity of bank
monly contrasted with the new micro- deposits - the major component of the
economics, which attributes output or quan- money stock - is determined. The roots of
tity adjustments to price 'surprises'. The this view lie in the theoretical contributions
new-new microeconomics developed partly of John G. Gurley and Edward Shaw in their
in response to perceived limitations of the Money in the Theory of Finance (Baltimore,
new microeconomics and, in particular, the 1960) and in the development of the PORTFO-
alleged failure of the latter to provide an LIO BALANCE APPROACH to monetary analysis
explanation of layoffs (here viewed as an at the hands of Professor James Tobin and
involuntary phenomenon) and the counter the Yale School of monetary economists.
factual prediction of a pro-cyclical behaviour Essentially, this view denies the uniqueness
of QUITS. Recent developments have indi- of the banks as credit and money-creating
cated these criticisms to be less damaging institutions, a proposition central to the cre-
than first thought and so the new-new micro- dit multiplier approach. The credit multip-
economics is best regarded as an extension lier theory (in its simpler forms) takes a
of rather than a replacement for the new supply-based, mechanistic approach to cre-
microeconomics. By introducing the institu- dit creation, portraying a system in which
tional features of labour and product mar- the volume of bank deposits is determined
kets it is possible to extend the predictive by the size of a monetary base of HIGH POW-
reach of the latter. Two principal variants of ERED MONEY in conjunction with the main-
the new-new microeconomics exist in the tenance by various operators of certain
form Of IDIOSYNCRATIC EXCHANGE and IM- conventional or legally-determined ratios
PLICIT CONTRACT models. (e.g. the banks' reserve ratios). Again in its
simpler versions, the theory postulates that
new-orthodoxy. The movement away society must hold the quantity of bank de-
from the orthodox view that the authorities posits which the total operations of the sys-
were unable to control the MONEY SUPPLY. tem create. In contrast, the 'New View'
The new-orthodoxy, led by Sayers and the takes a demand-based approach, asserting
RADCLIFFE COMMITTEE, said that through try- that society is as free to determine its hold-
ing to stabilize interest rates, the authorities ings of bank deposits as its holdings of, say,
had in fact decided not to control the money BUILDING SOCIETY deposits, and that its de-
base. They argued that the significant ratio cision here is part of a total portfolio choice.
of the banking system to be controlled was In effect this view sees the quantity of bank
the LIQUID ASSETS ratio and not the CASH deposits (and hence money) as determined
RATIO, and that the control of the bank-cash like that of all other DEBT claims by a mixture
base would not amount to control of the of exogenous (external) and endogenous
amount of bank deposits, and that the (internally operating) factors.
banks' liquid assets would also have to be
controlled. (See RADCLIFFE REPORT, MONE-
New York Stock Exchange. The main
TARY BASE, MONEY SUPPLY, MONETARY POL-
STOCK MARKET in the US listing over 1000
ICY.)
securities.
new quantity theory of money.
nominal. An adjective which describes the
See QUANTITY THEORY OF MONE*.
measurement of an economic magnitude in
new view of investment. The view of current prices. The opposite of REAL.
investment in VINTAGE GROWTH MODELS
which noted that EMBODIED TECHNICAL PRO- nominal balances.
GRESS lowered the average age of the CAPITAL See MONEY BALANCES.
STOCK and increased the proportion of that
stock which incorporated new technology. nominal value. The stated or face value of
a SECURITY, to be distinguished from its mar-
'new view' on money supply. The doctrine ket value.
of the nature and creation of money which
largely rejects the traditional theory of credit nominal yield. In the case of an ordinary
creation and the CREDIT MULTIPLIER, as share the declared dividend expressed as a
non-manual workers 307
physical labour who are paid a salary. The resources are oil, coal, gas and metals such
opposite of MANUAL workers. (See WHITE- as tin, mercury, aluminium etc.
COLLAR WORKER.)
non-rival consumption. When one indi-
non-nested hypotheses. In the REGRESSION vidual's consumption of a good in no way
MODEL two hypotheses are non-nested, if the diminishes the supply of that good to other
EXPLANATORY VARIABLES under one hypoth- individuals, the good is said to be non-rival
esis are not a subset of the explanatory vari- in consumption. There is no OPPORTUNITY
ables in the other. COST of consumption of such a good.
For example in the two hypotheses Non-rivalness is a characteristic of PUBLIC
GOODS. An example of a good which is non-
Ho- y = + "o rival in consumption is a broadcast television
signal; one person's use of that signal does
y=
not diminish its availability to other indi-
where M0 and ux are assumed to be WHITE viduals. Economists generally argue that
NOISE under Ho and Hi respectively, Hi is goods which are non-rival should be pro-
not nested in Ho nor vice versa, as x{ is not vided at zero price for MARGINAL or in-
included in the equation under Hi and x2 is cremental units, on the grounds that if an
not included in the equation under H(). additional unit of consumption can be pro-
Often the comparison of two economic vided at zero cost then that consumption
theories involves the testing of non-nested should not be prevented by the charging of a
hypotheses; examples of test procedures are price.
the J-TEST and the more general ENCOMPASS-
ING TEST. non-tariff barriers. Restraints on INTER-
NATIONAL TRADE such as QUOTAS, domestic
non-pecuniary goals. Those objectives government purchasing policies and safety
pursued by individuals or organizations and technical standards, which give advan-
which are not directly measurable in mone- tages to domestic producers over foreign
tary units. Objectives such as prestige, producers.
power, professional excellence and status
have this property and are commonly non-uniqueness. In PARTIAL and GENERAL
referred to within MANAGERIAL THEORIES OF EQUILIBRIUM theory, a situation in which
THE FIRM. more than one equilibrium price exists. {See
EQUILIBRIUM.)
hour paid for. They are made up of exter- normal cost pricing. A hypothesis that
nally imposed cost elements and internally process of price fixing is based on the cos
created elements. The former comprise sta- some notional output level rather than UJ
tutory unemployment insurance and social actual current costs or excess demand. Tl
security payments; the latter include pay for when output and costs fluctuate in respo
time not worked, contractual or voluntary to cyclical or other factors, price will noi
payments to insurance schemes, and benefits adjusted. If, on the other hand, the cost
in kind and other expenses of a social nature producing the 'normal' level of oui
and outlays on vocational trainings. Both change (due to, say, a rising trend in I
elements may be thought of as the FRINGE labour costs) then prices will change accc
BENEFITS accruing to workers, although it is ingly. Much controversy surrounds
often conventional to exclude the value of hypothesis, principally because wages
paid leave (vacations, holidays and sick major element in cost changes) are usu
leave) from fringe benefit calculations since found to be responsive to excess dem
these may be viewed as constituting part of inter alia. Thus, excess demand for lab
earnings - in this case 'earnings per hour at may very well affect the long-run cost tr
work'. There was a sharp growth in non- and hence prices. (See CUSTOMER MARKET;
labour wage costs in the 1970s. By 1976, for
example, private pension plans and insur-
normal distribution. A symmetric, b
ance schemes, employers' contributions to
shaped probability distribution, having
social security schemes, and payroll taxes
parameters its MEAN and VARIANCE. The J
had reached more than 30 per cent of total
ticular case in which the mean is zero, j
wage and salary earnings in France, Italy,
variance is unity is referred to as
the Netherlands and Swede'n (the corre-
Standard Normal Distribution, whose v
sponding figures for the UK and US being 14
able is usually denoted as 'Z'. The non
per cent and 15.5 per cent respectively). For
distribution is often used to describe
manufacturing industry, the share of non-
behaviour of the error term in regress
wage labour costs (to include pay for time
analysis, and allows the calculation of
not worked) stood at 50 per cent or above in
USUal TEST-STATISTICS ( i . e . T-STATISTICS,
France, Germany, Italy, Belgium, the
STATISTICS, etc.). (See CENTRAL U
Netherlands and Sweden (21.5 per cent and
THEOREM.)
31.75 per cent in the UK and US respect-
ively). In part, this growth resulted from
changes in legislation concerning social normal equations. The set of simultane
security and other welfare contributions equations which is solved to obtain LE
imposed on employers, but attempts by SQUARES estimates of the PARAMETERS i:
trade unions to bargain for non-wage bene- REGRESSION analysis, involving the sumg
fits also played a role partly because of the squares, and cross-products of the varial
high marginal tax-rates applying to wages. In in the regression equation. The non
addition, the rising share also reflected de- equations themselves are derived as the
liberate policy on the part of firms to in- suit of minimizing the sum of squared en
crease the productivity of the labour force with respect to the parameter values.
and to ensure an employment pattern which
is more consistent with expected develop- normal good. A good whose demanc
ments in product demand. In the 1980s non- reduced as income falls. For normal gooc
wage labour costs began to decline as a pro- price fall gives rise to an increase in i
portion of total labour costs as the growth in income such that the INCOME EFFECT alw
non-wage items slowed. has the same sign (with respect to the pi
change) as the SUBSTITUTION EFFECT: both
norm. The normal rate of increase in pay negative. Where income and substitut
which is specified at times of INCOMES POLICY. effects have different signs the reaction t
*\ statutory or voluntary pay ceiling which price change is determined by the relai
effectively becomes the normal rate of in- absolute size of the two effects such that
crease in pay, during periods "of INCOMES good may be an INFERIOR GOOD in which c
POLICY. demand will still rise as price falls but
310 normal profits
rise will be smaller than in the case of a we disagree with the value judgements
normal good. If, however, the income effect involved.
is very powerful demand may fall as price
falls - the condition for a GIFFEN GOOD. norm following behaviour. The argument
Normal goods are also known as 'superior' that during a period of INCOMES POLICY when
goods. a statutory or voluntary NORM exists this
effectively becomes the target for all wage
normal profits. That minimum amount of settlements, it becomes the going rate. If it j s
profit which a firm must acquire in order to also enforced as an effective PAY CEILING, in
induce the firm to remain in operation. This which case none can exceed it but all or most
is where all OPPORTUNITY COSTS are just achieve this size of wage settlement, it effec-
covered by total revenue and therefore cor- tively narrows the dispersion of wage settle-
responds to a zero level of profits. (See ments. Norm following also implies a
SUPER-NORMAL PROFITS.) reduction in the responsiveness of wage
changes to excess demand and may there-
normal unemployment rate. fore alter the basic PHILLIPS CURVE relation-
See NATURAL RATE OF UNEMPLOYMENT. ship; effectively it will pivot the Phillips
curve in a horizontal direction.
normal variable. A RANDOM VARIABLE
which has a NORMAL DISTRIBUTION. (See CEN-
notional demand.
TRAL LIMIT THEOREM.)
See EFFECTIVE DEMAND.
311
312 offer for sale
forces of RECIPROCAL DEMAND. On the dia- HOUSE, and then offered for sale to the
gram British exportable goods are measured public. Under the UK Companies Acts and
on the vertical axis and American on the STOCK EXCHANGE requirements (where a
horizontal. Any point on an offer curve indi- Stock Exchange quotation is required) the
cates the quantity of its exportable goods offer must be made in the form of a prospec-
which a country is prepared to offer to attain tus published in at least two daily papers.
a certain quantity of the other's goods, e.g. (See NEW ISSUES MARKET.)
at Z on the British curve, the British offer
OC of their goods to obtain OD of Office of Fair Trading. A UK government
America's goods. At only one point is the agency, headed by the Director General of
quantity which the Americans are prepared Fair Trading, which is responsible for a
to offer equal to the quantity demanded by variety of anti-trust functions. The Office
the British, and the quantity which the administers the Fair Trading Act, 1973,
British are prepared to offer equal to the which regulates MONOPOLIES and MERGERS,
quantity demanded by the Americans. This the Restrictive Trade Practices Act, 1973,
is P where the offer curves intersect, estab- which regulates restrictive trade practices
lishing equilibrium terms of trade given by and resale price maintenance and the Com-
the slope of line OP. OB British goods petition Act, 1980, which regulates anti-
exchange for OA American goods, so that competitive practices. Although the Secre-
the terms of trade for the British are tary of State for Trade and Industry has
similar powers, it is usually the Director
OA General who identifies cases of firm domi-
OB nance or complex monopoly for referral to
t h e MONOPOLIES AND MERGERS COMMISSION.
and for the Americans
Thus, although it has no powers of adjudica-
OB tion or enforcement, the Office is primarily
OA ' responsible for the policing of competition
and the initiation of appropriate proceedings
if an anti-trust violation is detected.
British American
exportable curve Office of Management and Budget (OMB).
goods //^British First established as the US Bureau of the
p curve Budget in 1921, the OMB is part of the
executive office of the President and assists
the President in preparing a coordinated
federal budget to submit to Congress. It also
scrutinizes each federal agency's expendi-
ture requests and provides allotments on a
quarterly basis.
nportunity cost. Perhaps the most funda- opportunity cost of money holdings. 1
ental concept in economics, the oppor- is usually reflected in the market RATE
tunity c o s t o f a n a c t i o n i s t n e v a m e of the INTEREST, in that the OPPORTUNITY COST
foregone alternative action. Opportunity holding money is the rate of interest fc
oS t can only arise in a world where the gone which would have been earned had
o u r C es available to meet wants are limited money been put into interest-bearing ass
o that all wants cannot be satisfied. If re- as opposed to being held as cash. (See OPP
ources were limitless no action would be at TUNITY COST, RATE OF INTEREST.)
the expense of any other - all could be
undertaken - and the opportunity cost of opportunity wage. The wage that could
any single action, the value of the 'next best' earned in an individual's 'next best' empl
alternative, would be zero. Clearly, in a real ment. The highest wage that is foregone
world of scarcity opportunity cost is positive. remaining in the present job.
Strictly, cost in economics always refers to
opportunity cost and hence accountant and optimal.
economist may well define the cost of an See OPTIMUM.
action quite differently. For the accountant
what matters are the money outlays on the optimal capacity. That output which d
various resources required to produce a responds to the minimum point of the A
product. For the economist, those money AGE TOTAL COST schedule.
prices may themselves be an inaccurate re-
flection of the opportunity cost of the re- optimal distribution. The best' or rri
sources if for some reason markets have desirable distribution of (generally) inco
failed to reflect the value of those resources or wealth between the individuals comp
in their highest value alternative use. ing a society or community. Definition of
Additionally, the economist will tend to look optimal distribution requires some crite
at all the benefits sacrificed by taking an upon which distributions may be judgi
action. If he is concerned with a private thus the definition of an optimal distributi
financial decision he may, for example, wish is inherently a VALUE JUDGEMENT. (See L
to look at the foregone profits on the TRIBUTIVE JUSTICE.)
alternative project, whereas the accountant
would typically not do this. If the eco- optimal level of pollution. That level
nomist's concern is wider, as in (social) COST- pollution at which the extra cost of aba
BENEFIT ANALYSIS, the foregone benefits may ment is just equal to the extra cost of 1
include many other items such as the value damage done by the pollution. To abj
of amenity that may have been produced by further would be to incur ABATEMENT coj
the alternative programme, and so on. in excess of the benefits secured by the
Although the terminology varies, it is there- duction in damage. Typically, then, the o{
fore useful to speak of 'private' opportunity mal level of pollution will not be zero. It is
cost in cases where one is looking at the fact the term used in environmental ec<
foregone private benefits of an action; and omics for the optimal level of EXTERNALIT
social opportunity cost where one looks at
the much wider range of foregone benefits. optimum. The 'best' situation or state
(See IMPLICIT COST.) affairs. To achieve an optimum is to 'ot
mize' and a situation which is an optimun
°Pportunity cost approach to international said to be 'optimal'. Much of economics
trade. This approach views the cost of concerned with analysing how groups or
Producing a particular good not as a certain dividuals may achieve 'optimal' arranj
jjniount of real costs but as the goods which ments. For example, the choices made
jj av e to be foregone to obtain this good. consumers are analysed in terms of attemj
rovided opportunity cost ratios differ to obtain the optimal pattern of consun
etvveen countries, it is possible for gains to tion. Definition of what is optimal does,
e course, involve judgements concerning wl
obtained from trade, in the manner
es is or should be desirable. Generally, it
cribed in the theory of COMPARATIVE
^VANTAGE. assumed that the satisfaction of individi
316 optimum optimorum
desires is the objective of the economic sys- PUT OPTION; to buy, a CALL OPTION and to buy
tem. In attempting to attain an optimum we or sell, a double option. These are often
are usually constrained by the fundamental referred to in the abbreviated form of p u t s
scarcity of goods and resources - individuals and calls. (See STOCK EXCHANGE, FUTURES
are constrained by their income - thus we MARKET, FUTURES.)
speak of 'constrained optimum', the best
that can be achieved in view of existing option value. The value to a consumer of
limits. Where we are faced with more than retaining the option to consume a good. It j s
one objective, we sometimes speak of an the difference between the maximum pay-
'optimum optimorum' - the best of the best ment the consumer is willing to make and
situations. This simply means that a number the EXPECTED VALUE of actually consuming
of arrangements may be judged equally the good. Another concept of option value
desirable in terms of one criterion (say has been introduced in the context of de-
efficiency) while the application of a second cisions which involve irreversible conse-
criterion (say a 'just' distribution of income) quences. Quasi option value is the increase
indicates the best overall arrangement. (See in expected net benefits as a result of making
PARETO OPTIMUM.) a decision after UNCERTAINTY is resolved, in-
stead of making a decision before the uncer-
optimum optimorum. tainty is resolved.
See OPTIMUM.
ordering. A listing of events, goods, pro-
optimum plant size. That size of plant at jects etc. such that the most preferred
which long-run average costs are at a appears at the top of the list, the next most
minimum. preferred second, and so on.
optimum tariff. The name given to the
tariff which maximizes the WELFARE or UTI- ordinalism. The doctrine which states that
LITY enjoyed by a nation. Unless the foreign UTILITY levels can only be ranked in ordinal
terms. (See ORDINAL UTILITY.)
price ELASTICITY of supply of a good or ser-
vice is infinite, it is normally possible for a
country to improve its TERMS OF TRADE by ordinal utility. In any ORDERING of goods
imposing a tariff on the import of the good, etc., that with the highest UTILITY is ranked
for the fall in demand for the imported good above the good with the next highest utility
will cause a fall in the world price of the and so on. This ranking or ordering is ordi-
good. The country imposing the tariff con- nal if it is not possible to say by how much
ducts a smaller volume of trade but on more utility differs between the first and second
favourable terms. The optimum is where the ranked good and, say, the second and third
gain from the better terms of trade is offset ranked good. Ordinal utility is the corner-
by the losses from the smaller volume of stone of neo-classical CONSUMER DEMAND
trade. A tax on the export of a good from THEORY. (See CARDINAL UTILITY.)
the country has the same effect on welfare,
where foreign demand for the good is price ordinary least squares (OLS). The most
inelastic. The majdr difficulty likely to be commonly used method of estimating the
encountered in imposing the optimum tariff parameters in a linear REGRESSION equation.
or export tax is the danger of retaliation. The procedure is to minimize the sum of the
squares of the vertical distances between the
option. A contract allowing the other data points and the estimated regression like
party to buy or sell COMMODITIES or SECURI- (or plane), i.e. to minimize the sum ot
TIES within a given time period at an agreed squared RESIDUALS. This can be shown to
PRICE. It represents a type of speculation in result in the general formula (in matrix nota-
that if the price changes significantly, a tion):
buyer may well be buying at an agreed price
P = (X'X)~lX'Y.
which is well below the current trading price;
he will gain if the difference is greater than where 3 is the VECTOR of parameter
the cost of the option. A contract to sell is a estimates,
Organization for European Economic Co-operation
Paper money. General term for money in paradox of voting. The possibility that the
tn
e form of banknotes. Under a GOLD STAN- system of simple MAJORITY RULE voting may
DARD these are convertible into gold coin or fail to give an unambiguous choice between
u
'lion; otherwise they are inconvertible alternatives. Consider the table below which
(though modern Scottish banknotes are con- illustrates the preferences between issues
vertible into Bank of England notes). The X, Y and Z of a community composed of A ,B
err
n is occasionally used as a term of disap- and C.
probation for the money, in whatever form, If issues are considered in pairs, a majority
Modern, inconvertible systems. vote would choose X above Y and Y above Z
but Z above X; this pattern of choice is said
pa
Per profit. When an asset increases in to be INTRANSITIVE. If voting is allowed to
a Ue
' in nominal terms, this is called paper continue without limit a process of cycling is
321
3/./. parameter
Individuals SUCh a s APPROVAL VOTING, t h e BORDA COUNT
rank A B C EXHAUSTIVE VOTING a n d POINT VOTING. In ^
majority rule system the problem of cycling
1 X Z Y may be overcome by LOGROLLING or vote
2 Y X Z trading. The paradox was first discussed by
3 Z Y X the Marquis de Condorcet and lies at the
heart of K.J. ARROW'S analysis of the im-
possibility Of a SOCIAL WELFARE FUNCTION
generated as one policy defeats another in (See SOCIAL DECISION RULE.)
an unending cycle. If however, some limit is
placed on the voting process, the problem of parameter. A quantity which remains con-
path dependency arises in that the alterna- stant in a given context. Thus, for instance,
tive chosen will depend upon the order in in the equation
which alternatives are considered. In the
Y = a + bX
where .Yand y are variables, and a and b are
constants, a and b are the parameters of the
equation.
.yjll be made by them (see also COASE'S rules are that (1) the MARGINAL RATE OF SUB-
THEOREM), however such agreements may, in STITUTION IN CONSUMPTION (the rate at which
practice, be difficult to arrange. Sen himself a consumer can exchange one good for
has argued that personal liberty should take another without being made better or worse
priority over the Pareto rule. The theorem off) between any two commodities must be
raises problems for the theory of COLLECTIVE the same for all consumers (2) the MARGINAL
CHOICE which have not yet been resolved. RATE OF TECHNICAL SUBSTITUTION (the rate at
which one factor can be substituted for
Pareto, Vilfredo (1848-1923). An Italian another while maintaining output levels) be-
economist with extensive training in math- tween any two FACTORS OF PRODUCTION must
ematics, physical sciences and engineering, be the same wherever those factors are used
pareto was the successor of Leon WALRAS to ( 3 ) t h e MARGINAL RATE OF TRANSFORMATION
the Chair of Economics at the University of (the rate at which the economy as a whole
Lausanne in 1892. His interest in the appli- must forego the production of any one good
cation of mathematics and statistics to econ- to increase output of another) for any two
omics led him to extend the mathematical goods must equal the marginal rate of substi-
conditions for the general equilibrium sys- tution in consumption of those two goods.
tem of Walras thereby establishing a definite
LAUSANNE SCHOOL. In Cours D'Economique Pareto criterion.
Politique (1896-9) he set out what he con- See PARETO OPTIMUM.
ceived to be the mathematical conditions of
a general equilibrium system based on the Pareto improvement. A reallocation of re-
general interdependence of all economic sources which makes at least one person
quantities. In addition to stressing the for- better off without making anyone worse off.
mal nature of a positive economic science (See PARETO OPTIMUM.)
purged of all ethical elements, Pareto also
rejected socialism on normative grounds and Pareto non-comparability. If when choos-
justified the inequality of income on the ing between two states of society some indi-
basis of a supposed constancy of income dis- viduals prefer one and some the other, the
tribution across countries and through time two states are said to be Pareto non-
(Pareto's Law). comparable. In order to be able to attempt a
In the Manual of Political Economy ranking of such Pareto non-comparable
(1906) Pareto rejected both the concept of states some economists introduced the
cardinal utility and the usefulness of com- notion of COMPENSATION TESTS.
paring interpersonal utilities. His examin-
ation of the optimum conditions of exchange Pareto-optimal redistribution. Transfers of
made use of indifference curves first intro- income or wealth from one individual to
duced by F. EDGEWORTH. A Pareto optimum another which increase the UTILITY or satis-
is a welfare maximum defined as a position faction of both donor and recipient, thus
from which it is impossible to improve any- bringing about a PARETO IMPROVEMENT.
one's welfare by altering production or Pareto-optimal redistribution is possible if
exchange without impairing someone else's one individual experiences some benefit
welfare. No interpersonal comparisons are from giving to another individual - say as a
needed if there exists only one such result of humanitarian sentiment. (Dona-
°ptimum. However, if more than one such tions to charity are an example of this type of
°ptimum exists it becomes impossible to redistribution), WELFARE ECONOMICS is tra-
e
valuate any movement from one equilib- ditionally based on the PARETO PRINCIPLE
rium point to another. Pareto's analysis which requires a change to make at least one
formed the basis for WELFARE ECONOMICS and person better off and no-one worse off be-
the COMPENSATION TESTS of N. KALDOR and J. fore it may be regarded as an improvement.
HICKS. (See KALDOR-HICKS TEST.) Consequently issues of REDISTRIBUTION,
which generally involve one group gaining at
o conditions. A set of rules devised in the expense of another, have been difficult
ARE ECONOMICS which if fulfilled will to analyse in the context of welfare econ-
rise to a PARETO OPTIMUM. Briefly, these omics. Pareto-optimal redistribution can,
324 Pareto optimum
however, be analysed in that framework. maintain this parity. (See COMMODITY CREDIT
Nevertheless, many economists would re- CORPORATION for a discussion of the agency
gard the Pareto-optimal analysis as being far empowered to carry out the programmes.)
too restrictive an approach to issues of DIS-
TRIBUTIVE JUSTICE. par rate of exchange. The expression of
EXCHANGE RATES in terms of GOLD or US
Pareto optimum. When the economy's re- dollars. (See INTERNATIONAL MONETARY
sources and output are allocated in such a FUND.)
way that no reallocation can make anyone
better off without making at least one other partial adjustment. A process by which be-
person worse off then a Pareto optimum is haviour is adjusted imperfectly towards
said to exist. The concept was proposed by some desired level, usually defined by the
and is named after Vilfredo PARETO. A real- relationship
location of resources which makes at least Xt-Xt.x = l(X*t-Xt-x) + ut
one person better off while making no-one
worse off is said to be a Pareto improve- where Xt represents the current level of the
ment. Much Of WELFARE ECONOMICS is COn- variable,
cerned with analysing conditions under Xr_i represents its value one period
which a Pareto optimum may be achieved. ago,
Despite its analytical importance, the Pareto X, represents the current desired
criterion is highly restrictive since it provides level of the variable,
no guidance to choice between alternatives u, is a STOCHASTIC disturbance term,
which involve one person becoming better and
off at the expense of another. Since almost / is the reaction coefficient, and that 0
any economic policy will act to someone's
disadvantage, this is a serious restiiction. In Note that if / is close to unity, adjustment is
order to overcome this, some economists almost perfect, whereas if / is close to zero,
have sought to supplement the Pareto cri- very little adjustment takes place. For eco-
terion with criteria based on DISTRIBUTIONAL nometric purposes, the desired component
EQUITY while others have considered the use X? is usually specified in terms of some
Of COMPENSATION TESTS. observable variable(s), and the equation will
contain a lagged ENDOGENOUS VARIABLE. (See
Pareto-relevant externality. also KOYCK TRANSFORMATION.)
See EXTERNALITIES.
partial derivative. In functions involving
Paris Club. The name given to the forum, two or more INDEPENDENT VARIABLES, the
where creditor countries negotiate with deb- DERIVATIVE with respect to one of the vari-
tor countries over the rescheduling of official ables, treating all other independent vari-
debts. The club has no fixed membership ables as constants. The partial derivative has
and no institutional structure and is open to the same interpretation as the simple deriva-
all creditors, who accept its practices and tive, and bears the same MARGINAL to total
procedures. relationship as the latter. Thus, for instance,
the first partial derivative of the PRODUCTION
parity price system. A system of price sup- FUNCTION
ports for US agriculture first established with
the Agricultural Adjustment Act of 1933. Q = f(K, L)
The intent was to maintain agricultural with respect to capital, is interpreted as the
prices and farm incomes in the same ratio to MARGINAL PRODUCT of capital. The partial
non-farm prices and incomes as prevailed in derivatives of the function
the years 1910-1914. As a result, farmers'
purchasing power would be stabilized.
Various programmes, including agricultural are commonly denoted
loans, soil bank programmes, and govern-
ment purchases of agricultural surplus have
been used since 1933 in an effort to
pay ceilii
may come to be regarded as the NORM or the such peaks in demand and although some
going rate. may have additional occupations as trades-
men or small manufacturers of handicrafts
pay freeze. etc., there are many who have little to do for
See INCOMES POLICY. the rest of the year. (See HIDDEN UN-
EMPLOYMENT.)
payment-by-results, (also known as incen-
tive payment systems) Systems of payment pecuniary external economy. Describes a
under which the worker is paid according to situation where the profits of a firm depend
the volume of output he or the work group not only on its own inputs and outputs but
or plant of which he is part produces. also on the inputs and outputs of other firms.
These should not be confused with non-
payments, balance of. pecuniary Or TECHNOLOGICAL EXTERNAL
See BALANCE OF PAYMENTS. EFFECTS which describe interdependences
between production and/or utility functions.
pay-off. The net benefit that occurs when a
particular course of action is taken. The pay-
off in a gambling situation is obviously the peg.
See EXCHANGE RATES.
sum won if the bet pays-off.
peak period labour demand. The level of pension fund. With the rapid growth in
demand for labour at its highest point, this employees' pension schemes in recent
term usually refers to agricultural employ- decades, the pension funds of the larger
ment, which is cyclical by nature with peaks public and private sector employers have
occurring especially at harvest time. There become nv.ijor financial institutions, invest-
are various methods of coping with this; one ing large sums annually. Apart from a min-
is when harvest time coincides with vaca- ority of highly publicized forays into art
tions for students and school-children who collections, the great bulk of the funds'
can then be employed temporarily. In devel- assets are marketable SECURITIES - about half
oping countries where this does not always of them company securities and especially
happen, there are some groups of migrant EQUITIES - and property. Because of the long-
workers who move about finding work term nature of their obligations pensions
where there is a high demand. However, it is funds have a preference for long-term assets,
often the case that the rural sector has to but they deal in all sections of the capital and
support the number of people required by money markets. Like some other institutions
perfect competition 327
Such conditions imply that both MARGINAL be thought of as the income an individual
REVENUE and AVERAGE REVENUE are equal to expects to derive from his work and his hold-
price. Thus firms are PRICE TAKERS and can ings of wealth during his lifetime. The
sell as much as they are capable of producing hypothesis suggests that the individual con-
at the prevailing market price. Given u- sumes a constant proportion of the present
SHAPED COST CURVES a unique SHORT RUN value of the income flow from his work and
profit maximizing level of output exists wealth while maintaining his holdings of
where MARGINAL COST equals marginal reve- wealth intact. It is most significantly in this
nue with marginal costs increasing at this latter respect that it differs from the LIFE-
point. Since the demand curve facing each CYCLE HYPOTHESIS. This theory, proposed by
firm is horizontal this condition implies that M. FRIEDMAN in A Theory of the Consump-
marginal cost equals price. tion Function (Princeton University Press,
In the short run the profit maximizing con- Princeton, NJ, 1957), attempts to explain
dition can be satisfied at an output level such the empirical evidence on the specification
that AVERAGE COST lies above, equal to or of the CONSUMPTION FUNCTION by hypothesiz-
below average revenue, so that losses, NOR- ing that individuals consume a constant pro-
MAL PROFITS or SUPER-NORMAL PROFITS can be portion of their PERMANENT INCOME. In
achieved. Free entry and exit ensure that the practice it suggests the actual income they
long run EQUILIBRIUM output level is such receive in any period, their measured
that each surviving firm earns normal pro- income, can differ from this and this discrep-
fits, with price equal to the minimum aver- ancy accounts for the conflicting evidence on
age cost of production. (See PROFIT the form of the consumption function.
MAXIMIZATION.) Both measured income and measured
consumption, the theory suggests, contain a
perfect information. The possession by permanent and a transitory element.
MARKET participants in a competitive econ- Permanent income and consumption consti-
omy of complete knowledge and foresight tute the anticipated and planned elements of
with regard to the array of present and income and consumption respectively, while
future prices as well as the location of goods the transitory elements are the WINDFALL
and services. Any divergence from such cir- GAINS or losses of income and the unantici-
cumstances can be regarded as a state of pated changes in consumption. Over the
imperfect information and is commonly long-run individuals will consume a constant
cited as a source of MARKET IMPERFECTION, proportion of their permanent income,
(SEE ASYMMETRIC INFORMATION.) which the theory suggests is proxied by
measured income and this therefore explains
the empirical evidence on the specification
perfect markets.
Of t h e LONG-RUN CONSUMPTION FUNCTION.
See PERFECT COMPETITION.
In contrast to the long-run a large number
of households will be experiencing a nega-
permanent consumption. The average tive transitory component of income over
level of consumption that the individual or the TRADE CYCLE and since their consumption
household plans to carry out over a period of is related to their permanent income their
years. (See PERMANENT INCOME HYPOTHESIS.) average propensity to consume will increase
thus giving rise to the SHORT-RUN CONSUMP-
permanent income. (also known as nor- TION FUNCTION revealed by the evidence.
mal income and average expected income) Similarly cross-section evidence will reveal
The average income that the individual or that among the group with the highest
household expects to receive over a period measured incomes there are a greater than
of years while retaining his wealth intact. average proportion of individuals with posi-
(See PERMANENT INCOME HYPOTHESIS.) tive transitory components and therefore a
low average propensity to consume, while
permanent income hypothesis. The hypo- conversely at the lowest income levels there
thesis that the consumption of the individual will be a greater than average proportion of
(or household) depends on his (or its) PER- those with negative transitory incomes.
MANENT INCOME. Permanent income may Since individuals seek to consume a constant
petroleum reveni
tax was set at 45 per cent and it is levied on a the postwar period however money and
field-by-field basis. Further special allow- wages proved to be inflexible in a downward
ances are the safeguard and tapering provi- direction and as a result the curve for this
sions. The first states that in any year when period lies above the horizontal axis. From
gross profits are less than 30 per cent of the other Lxis it is clear that there will always
accumulated capital expenditure PRT be- be some rate of unemployment whatever the
comes zero. The second states that in any rate of w ^ e inflation.
one year the maximum amount of PRT pay-
able is 80 per cent of the excess of gross Rate of change
profit above 30 per cent of accumulated capi- of money wage
tal expenditure.
Numerous changes have been made to the
tax since its introduction. In 1979 the rate
was increased to 60 per cent, the capital
expenditure allowance reduced to 135 per
cent, and the oil allowance cut to 5 million
1861 1948
tonnes with no more than a half million
tonnes being allowed in any one year. In
1980 the rate was raised to 70 per cent. In
1981 the extra 35 per cent allowance was
restricted to expenditure prior to field pay-
back. The safeguard provisions became
applicable only with one and a half times the Unemployment
payback period. In 1982 the rate was rate
increased to 75 per cent and an advance PRT
introduced. In 1983 exploration relief was
permitted against PRT from all fields, and
the advance PRT was set to be phased out by Phillips curve
the end of 1986. As an incentive to field
development the oil allowance was increased A theoretical underpinning for this statis-
to 10 million tonnes on new fields. The tax tical association was later provided by
take is now considerably lower on new fields Lipsey (1960) who suggested that the rate of
than on old ones. money wage change would be a function of
In 1988 for new onshore fields and those in the degree of excess demand in the labour
the Southern Basin the royalty was abol- market: the unemployment rate was to be
ished and the volume allowance reduced to interpreted as a (negative) index of excess
the equivalent of 2.5 million tonnes with no demand in the labour market. The Phillips
more than 250,000 tonnes being available in curve was interpreted by many to mean that
any one year. there was a long-run TRADE-OFF between the
rates of WAGE INFLATION and the level of
Phillips curve. The statistical observation unemployment. Phillips calculations seemed
by A.W. Phillips (1958) that there was an to suggest that stable prices would be
inverse relationship ^between the rate of ensured by running the economy at an
change of money WAGE RATES and the UNEM- unemployment rate of about 2.5 per cent. At
PLOYMENT RATE in the UK over the period this level of unemployment money wages
1861-1957. That is: would rise by 2 per cent per annum but since
this would be just offset by the rate of
AW, = f(U), growth of PRODUCTIVITY there would be no
where AW is the change in money wage rates inflation of the general price level.
and U the unemployment rate in period /. The fundamental weakness of the Phillips
Prior to 1948 wages were flexible in both curve is seen by many to be its emphasis on
an upward and downward direction and money wages. Critics would argue that it is
therefore the Phillips curve, illustrated be- the real wage which is the subject of the
low, intercepted the horizontal axis at a rate wage bargain. Consequently any trade-off
of unemployment in excess of 6 per cent. In between money wages and unemployment
Pigovian tax
after the tax has been introduced the private decision makers at each level of the econ-
costs as perceived by the externality- omic process. The rigidities and inertia in
generating party, are equal to the SOCIAL the system may be exacerbated by the large
COSTS of the activity. organizations required and the consequent
element of BUREAUCRACY. Manifestations of
pivot effect hypothesis. The argument that such tendencies may be the existence of per-
INCOMES POLICY not only creates SHIFT sistent shortages of some goods combined
EFFECTS in the wage adjustment process but with surpluses of others. Even with proper
may also change the slope of the Phillips and efficient co-ordination, planning may
curve or, more technically, the magnitude of still be insensitive to the wishes of
response of the rate of change in wages to its consumers.
determinants. Various forms of socialist planned econo-
mies exist or have existed in the former COM-
placing. A method of making a new issue ECON countries, China, and elsewhere. They
Of SECURITIES, EQUITIES Or DEBENTURES, b y ranged from the highly centralized bureauc-
which the securities are first acquired by an ratic model of the USSR to a planning model
ISSUING HOUSE, and then 'placed' with, i.e. which reduces the role of the planner to
sold by private arrangement to, institutions, determining certain key proportions in the
private investors, and also JOBBERS on the economy. In the latter case the planner may
London STOCK EXCHANGE. In the case of be only concerned with the proportion of
securities for which a quotation is sought, national income going to consumption and
the STOCK EXCHANGE imposes certain restric- investment or the distribution of investment
tions on placings, e.g. as to maximum size. between industries. The former model relied
Unquoted securities may be the subject of on a system of planning and management by
'private placings'. {See NEW ISSUES MARKET.) directives on physical inputs used and physi-
cal outputs produced determined by a
planned economy. An economy where national plan based on the BALANCE PRIN-
crucial economic processes are determined CIPLE. The more decentralized models use
to a large extent not by market forces, but by the market mechanism to allocate resources,
an economic planning body which im- to a large extent relying on a substantial
plements society's major economic goals. In private sector. Often called MARKET SOCIA-
such a system the greater part of production LISM the state reserves the right to control
activity is determined by obligatory input prices and the level of investment by means
and output targets generated by vertical sig- of monetary and fiscal policy.
nals from an administrative hierarchical The problem of centralized planning and
body. The advantages of such a system over particularly the satisfaction of consumer
the pure MARKET ECONOMY include the re- preferences resulted in two new approaches
duction of unco-ordinated economic activity to planning in the former COMECON
which may lead to an inefficient utilization of countries. First, the more extensive use of
available resources and the production of computer aided planning or PLANOMETRICS;
undesirable commodities. A planned econ- and second, the use of decentralized market
omy may be able to solve the problems of forces and price signals to allow flexibility
unemployment and idle capacity, and reduce into the process while at the same time main-
the creation of pollution and over- taining the essence of state socialism - con-
differentiation of products. A . planned trol over the means of production and
underdeveloped economy may experience distribution. The revolutions in Eastern
faster growth than would be the case if it Europe in the late 1980s and early 1990s
were not able to concentrate resources in arose partly from a lack of political and
certain key sectors and insulate itself from other freedoms but also from the dissatisfac-
world market forces. , tion with the failure of the planned systems
On the other hand a centralized planning to deliver goods. The result in most econo-
system may lead to inefficiencies in resource mies has been a move to adopting capitalist
allocation generated by the necessity of co- institutions and methods so that privatiza-
ordinating the large number of components tion, the use of the market and prices, de-
of plans in action and the independent regulation and liberalization have been
point voting 33:
pollution rights. The idea that certificates a specific area, such as a particular country
should be issued which give the owner a or a town or city.
'right to pollute' in a given environment, say population explosion. The name given to
a river. The object would be for potential
the ever increasing growth rates of popu-
polluters (or, for that matter, conserva- lation in the world, especially in DEVELOPING
tionists) to buy the certificates. This they will COUNTRIES. Population grew fairly slowly
do as long as the price of a certificate allow- until about 1800 when it has been estimated
ing them to 'emit' a given amount of pollu- there were just over 1 billion people in the
tion is less than the ABATEMENT COST for that world as a whole. However, by 1930 it had
amount of pollution - i.e. the cost of avoid- doubled to 2 billion and projections of 8
ing the pollution in the first place. The total billion by the year 2000 were forecast and
supply of certificates will be fixed by some much publicized, with many expressing
authority, say an environmental agency. If doubts as to whether the world could sup-
the agency wishes to raise the environmental port such a level. In 1988 the world popu-
standard it can buy certificates itself, or re- lation was calculated to be 5.1 billion with an
strict their supply, thus raising the price and estimated growth rate of 1.7 per cent per
making it more profitable for polluters to year between 1985-90, a rate lower than that
install abatement equipment. In the same that of the 1970s. The growth rates vary
way, conservationists can buy the certifi- between regions, being greatest in less
cates, thus rstricting supply and raising the developed areas and least in developed re-
price. Again, environmental quality would gions; between 1985 and 1990 while the
be improved. For details see J.H. Dales, growth rate was highest in Africa at 3.0 per
Pollution, Property and Prices (Toronto, cent it was least in Western Europe at 0.1
1968). per cent.
polynomial. An equation by which, in gen- Various reasons are advanced to account
eral, several terms in an INDEPENDENT VARI- for the decline in growth rates, including
ABLE are raised to various powers. The increasing affluence on the one hand and
degree of the polynomial is the highest rising costs of living on the other: both may
power to which the independent variable is cause people to have smaller families. In
raised. Thus a third degree polynomial is addition, the increasing emancipation of
women who pursue careers for longer before
Y = a + bX + cX2 + dX3 having children leads them to have smaller
i.e. a CUBIC equation. families in order to continue with their car-
eers. In less developed countries where
polynomial lag. growth rates have been highest, family plan-
See ALMON LAG. ning programmes are beginning to be suc-
cessful. The problem remains formidable,
pooled data. Data of this type are formed however, and is perhaps the most serious
when (a) CROSS SECTION and (b) TIME SERIES obstacle to world economic development.
DATA are merged into the same data set, (See POPULATION POLICY.)
usually when there is not sufficient data of
type (a) or (b) alone, to estimate the PARA- population policy. A government may set
METERS of a model due to insufficient DE- up a specific policy in respect of the level of
GREES OF FREEDOM. the population it governs. This is more com-
mon in developing countries where the ratio
Population. of population to necessary resources for sur-
}- In a statistical sense, the entire set of vival causes much concern. Policy measures
objects about which we require information, which are usually designed to control the
°r with which we are dealing. This can in- increase of the population usually involve
clude population in the demographic sense, education programmes on the subject of
bu
t it can also mean, for instance all of the birth-control, widespread advertising, mar-
cars m the UK, or all of the light bulbs in a keting and distribution of contraceptives,
Clt
y- A sample is a subset of its 'parent' and offering free sterilization operations.
Population. The problem can also be tackled from a
The total number of people who live in social angle, i.e. raising the minimum age of
336 population trap
marriage and raising the economic status of be achieved by technical progress. A combi-
women. However it seems that one of the nation of fertility control and technical
most effective methods of population con- change is obviously a safer policy still.
trol is increasing affluence as birthrates tend Empirical evidence for the existence of
to decline as incomes increase. (See POPU- population traps is not substantial.
LATION TRAP.)
portfolio. The set of assets held by an indi-
population trap, (also known as 'low level vidual or institution. It generally refers to
equilibrium trap') An economy with a very financial (including monetary) assets, but
low level of income per head may well find there is in principle no need to regard it as
that the rate of growth of population exceeds excluding real assets.
the rate of growth of real income. If so, this
is equivalent to saying that the real income portfolio balance approach. An approach
per head will decline. Only where the to monetary analysis which emphasizes the
significance of decisions by asset-holders
about the composition of their PORTFOLIOS.
Growth in One major variant of this approach postu-
population^)
lates that while all holders require some
Growth in diversity in their assets, they differ for per-
income
sonal or institutional reasons in their basic
preferences between different types of assets
- e.g. between long-term and short-term,
fixed yield and variable yield assets.
However it is assumed that at least some
holders can be tempted to substitute some
less preferred for some more preferred
assets by the incentive of an increased differ-
ential return on the former. Expectational
effects complicate the analysis, but leaving
these aside, such a model offers one expla-
nation of the structure of INTEREST RATES,
and provides the monetary authorities with a
population trap working hypothesis for operating on interest
rates, either to influence capital investment
income growth exceeds the population or to control the growth of the money
growth can real incomes per head actually supply. The approach, which descends
increase. In the diagram, the rate of growth directly from KEYNES' General Theory, has
of income is greater than the rate of growth been developed most extensively by the
of population up to point T, but after T the 'Yale School' of economists, led by
situation is reversed and incomes grow less Professor James Tobin. However, a portfo-
fast than population. As such the economy lio balance model is a common theoretical
moves back to point T as per capita incomes basis of the main contending schools of
decline. Efforts to mcve away from T are monetary thought, monetarist and non-
thus doomed to failure because of the effect monetarist (see MONETARISM.) The differ-
on population growth being more pro- ences between them are empirical, e.g. in
nounced than the income growth. T is thus their assumptions about the substitutability
the 'low level equilibrium' or the 'population between money and other assets in asset-
trap' from which the economy cannot in- holders' portfolios.
itially escape. Only if it is possible to 'jump'
to point K can the process of raising per portfolio balance approach to the balance
capita incomes on a sustained basis be of payments/exchange rate. A variant of
achieved. This suggests either measures of the monetary approach to the BALANCE OF
control over birth rates in the developing PAYMENTS, which assumes that assets are
economy, or a means of shifting the growth imperfect substitutes. This has import-
of income curve upwards. The latter might ant implications for the effectiveness of
post- Keynesian economics
MONETARY a n d FISCAL POLICY. (See INTER- of the validity of the assumptions mad<
NATIONAL MONETARISM.) the construction of an economic model. 1
is, if the model predicts accurately it d
portfolio diversification. not matter whether the assumptions
See DIVERSIFIER. thought to be 'true' or 'realistic'.
economy would achieve steady state growth. potential Pareto improvement. A poten-
Following the lead of P. SRAFFA writers such tial Pareto improvement exists when the
as Garegnani examine the long run tenden- gainers from a change are hypothetically
cies of a capitalist economy to share the able to compensate those who lose, so that it
surplus product between labour and capital is possible for no-one to be any worse off
and the contradictions which that involves. after the change and for at least one person
These contradictions create the uncertainty to be better off. (See also COMPENSATION
which prevent an economy growing at a TESTS, PARETO IMPROVEMENT.)
steady state with expectations continually
fulfilled. poverty. Poverty can be viewed as an ab-
Post-Keynesian economics, although not a solute or a relative concept. The absolute
complete coherent body of theory, presents poverty approach defines minimum levels of
a challenge to the orthodox approach to income required to sustain life: for example,
equilibrium theories of price, employment estimating minimum dietary needs and how
and economic growth. these can be most cheaply met. The relative
poverty approach defines poverty relative to
posterior distribution. That probability appropriate comparator groups. Thus while
distribution for a variable or STATISTIC which an individual may have more than enough
results from the combination.of the PRIOR income to sustain life, if it is very low com-
DISTRIBUTION with sample information in pared to the rest of the community the indi-
BAYESIAN TECHNIQUES. vidual would be viewed as being in poverty.
As a society grows richer so the income level
postwar credits. A form of compulsory defining poverty rises.
saving introduced in the UK during the
Second World War, in the 1941 budget. The poverty trap. The existence of many im-
idea was suggested by KEYNES in his 1940 portant MEANS-TESTED BENEFITS means that
pamphlet, 'How to Pay for the War'; he saw the low paid can face an effective marginal
it as a way of spreading the consumption, tax rate - i.e. the rate of tax on an extra unit
inevitably postponed during wartime, equi- of income - far in excess of the 34 per cent
tably among all classes, and as a potential rate of INCOME TAX and NATIONAL INSURANCE
stimulus to expenditure in a postwar slump. contributions faced by most employees. As
But the scheme was introduced on a much earnings rise entitlement to benefit is either
smaller scale than Keynes had wanted, and reduced or removed altogether, according to
played only a minor part in war finance. income level and often also family size. Thus
it is quite possible for a low paid worker to
potential entry. For a particular industry, face an effective marginal tax rate of over
the possibility of new competition from firms 100 per cent, and quite common for him to
who are not currently producing competing suffer an overall effective deduction of over
products. The inducement to entry is the 50 per cent of a pay rise. The range of
potential profit to be earned subsequent to incomes over which this happens defines the
entry. For established firms potential entry is 'poverty trap'.
a threat to their future stream of profits, and
this can be expected to influence their con- power function. A function in which the
duct over such policy variables as pricing and INDEPENDENT VARIABLE is raised to some
output. (See LIMIT PRICING.) power, for instance
Y = aXn
potential national income.
See FULL EMPLOYMENT NATIONAL INCOME. where a and n are constants.
The locus of such equilibria is the price con- same consumer different pricej
sumption curve. Typically, the price con- units of the same good. In thi
sumption curve will show the demand for the former, where each group of
cheaper good rising as its price falls. If, how- different price elasticity of den
ever, demand falls as a result of the price can, by equalizing the marg
fall, the price consumption curve will curve generated by each group, earn
back on itself (see diagram). Such a situation of profits than would be the casj
w ill arise if the cheaper good is a GIFFEN price were to be charged. Prec
GOOD. the successful operation of this
discrimination are (1) the abili
identify different segments oi
according to price ELASTICITY
Price consumption curve for Good X if X is a and (2) the prevention of res
Giffen good customers who can buy at low
resell to those who buy at highe
form of arbitrage would lead t
gence of prices charged to ei
buyers.
Price consumption In the case of the second f
curve discrimination, perfect operati
volve the firm appropriating
SUMER SURPLUS that each con
have got if buying at a constant
achieved by setting the price
equal to the maximum amount
vidual would be willing to pay.
that individual's demand curvd
price consumption curves firm acquires from the customer
sumer surplus from intra-margif
Quite clearly, this form of pi
nation requires exact knowle^
price control. Generally associated with buyer's demand curve and is the|
the fixing of prices by government statutory employed as described above.)
order. In the UK price controls have been mon is the two-part tariff ope
used during wartime where supply difficul- and electricity suppliers, where ]
ties would have led to exceptionally large only take place after a rent is
price increases. By restricting prices con- right to be supplied. This ren
siderably below their equilibrium level, a appropriates some of the consul
system of rationing becomes necessary.
Since the Second World War price controls price/earnings ratio (P/E ratio),
have been used as part of anti-inflationary of the price of an ORDINAR
policy, though it is widely recognized that EARNINGS per ordinary share. C
these controls are not by themselves a cure market companies which inv(
for inflationary conditions. group reckon will produce incr
will be priced at a higher P/E
price-cost margin. Empirical measures of those whose profits are an
the PROFIT MARGIN where accounting data are stagnate. The calculation of the i
used and therefore the economic definition plicated under the imputation fi
of profit cannot be directly observed. PORATION TAX where ADVANCE C
TAX (ACT) sometimes cannot be
price discrimination. There are two major against corporation tax. In cal<
forms of price discrimination: firstly, the P/E ratio two definitions of earni
practice employed by firms of charging possible. One is based on a 'n
different prices to different groups of basis. The other is based on tl
buyers, and secondly, that of charging the paid and calculates 'net earr
342 price effect
I
taking into account the excess ACT. This is price fixing agreement. An agreement
I) !]: the basis employed by the newspaper the between two or more producers to sell at
Financial Times. predetermined prices, generally for the pur-
it pose of exercising market power. In the US,
price effect. The change in the demand for any price fixing agreement that restricts the
a good that comes about because of a change seller from setting his price individually, or
in the price of that good. It is composed of the quantity to be produced, is automatically
the INCOME EFFECT and the SUBSTITUTION deemed illegal under the SHERMAN ACT. Price
EFFECT. (See SLUTSKY EQUATION.) fixing agreements include contracts that:
1. limit output to stabilize prices;
price elasticity of demand. The responsive- 2. set maximum prices to be charged in a
ness of the quantity demanded of a good to market;
its own price. To avoid the measure of elas- 3. set uniform discount rates; and
ticity being sensitive to the units in which 4. set uniform base prices.
quantities and prices are measured, the elas- (See COLLUSION.)
ticity of demand is expressed as the percent-
age change in demand that occurs in price index. An INDEX NUMBER showing
response to a percentage change in price. how prices of a 'bundle' of goods have
That is: changed from one period to the next.
Typically, such an index will not be a simple
average of prices, but each price will be
Price Elasticity of Demand =
weighted by the proportion of total expendi-
• 100 ture taken up by the good in question. This
(A/yp,) • 100 weighting may vary depending on which
period is chosen for the analysis of expendi-
ture. (See PAASCHE PRICE INDEX, LASPEYRES
A& Pi PRICE INDEX.)
Qi ' AP,
price leadership. The situation in an
where A is a symbol for 'change in', P, and industry where one firm takes the initiative
Q, are the price and quantity of good /. If A in making price changes and the other firms
is very small the resulting measure is known then follow. Three forms of price leadership
as the point elasticity of demand. If A is can be identified: dominant firm, barometric
significantly large the measure obtained is and collusive price leadership. The first,
one of the responsiveness of demand to this dominant firm price leadership, occurs
change in price and is generally known as the within industries dominated by one large
arc elasticity of demand. Note that if the firm which sets price as a MONOPOLIST after
LAW OF DEMAND operates, a fall in price will due account is made for supply from the
result in a rise in demand, so that Pz would competitive fringe of small firms at each
be negative and Qt would be positive. The price. This fringe of firms are individually so
elasticity estimate would then have a minus small as to accept the price set by the domi-
in front of it, i.e. a negative sign. In the nant firm. Barometric price leadership is dis-
economic literature tm's minus sign is often tinguished by change in the identity of the
omitted and care should be taken in the leader. Whether or not the price initiative is
event that an elasticity is used in any math- followed depends upon how closely the
ematical manipulation to remember this. change reflects market conditions common
Note also that the ratio to all. Collusive price leadership character-
izes oligopolistic markets (see OLIGOPOLY) in
which the few established firms have similar
market shares as well as demand and cost
is the inverse of the slope of the demand conditions. With such features price initia-
curve. The fact that the formula for elasticity tives by any one firm will reflect the wishes
has an additional expression indicates that of the others, and their implicit acceptance
the slope of the demand curve and the elas- comprises the collusive element of this form
ticity are not the same thing. of leadership.
price theory |
price mechanism. Used with reference to such that its activities can bring no influ
the free market system and the way in which to bear on the prevailing market price.
prices act as automatic signals which coordi-
nate the actions of individual decision mak- price theory. The theories included in
ing units. By means of this role, the price body of thought can be grouped under 1
system provides a mechanism whereby main headings: those concerned with
changes in demand and supply conditions determination of individual prices, thos
can affect the ALLOCATIVE EFFICIENCY of lating to changes in the aggregate price
resources. and those applying to the allocation o
sources. The price determination the>
price-push. The name given to a type of can be classified by the market structui
INFLATION, similar to cost-push where ENTRE- which they pertain. In a competitive indi
PRENEURS are blamed for causing inflation by firms act as PRICE TAKERS, i.e. the pri«
charging unnecessarily high prices in order which they can sell their product is di
to make large PROFITS. {See COST-PUSH mined by the interaction of the mi
INFLATION.) DEMAND CURVE and the market SUPPLY C\
of which they are an insignificant part. T
price revolution. The name given to the is a large set of theories which apply to
influx of gold and silver from the newly dis- competitive markets. These firms' den
covered countries in America during the fif- curves have a common feature in that
teenth and sixteenth centuries which caused are downward-sloping and thus all firms
prices to quadruple. This is considered to be in principle act as PRICE SETTERS or \
one of the initial causes of the rise of CAPITA- makers. The most simple and possibly i
LISM and beginnings of the industrial revolu- widely used of these is the theory of M<
tion in the Western World as these high POLY, where the profit maximizing mom
prices were an incentive for SPECULATION, list faces the market demand cu
accumulation of CAPITAL and establishment Monopolists are sometimes able to prai
of new industries. PRICE DISCRIMINATION, a variation on
monopoly theme is the case where there
single buyer - MONOPSONY. When a si
price setter. A firm operating in a non- seller and a single buyer confront
competitive market faces a downward- another we have a situation of BILATI
sloping demand curve for its product and MONOPOLY and the price and output outc
thus has some discretion to choose the price is indeterminate.
at which it sells, rather than having to be a
There are many hypotheses relatin;
PRICE TAKER.
markets in which there are a small nun
of firms, termed OLIGOPOLY, the special
price specie mechanism. of which with two sellers is known as i
See SPECIE FLOW MECHANISM. POLY. The characteristic of oligopolistic i
kets is that the firms involved recognize t
price support scheme. A method of arti- mutual interdependence. This can resul
ficially raising the price of a good in the the firms forming a collusive oligopoly
market. This will give rise to a situation in practicing pricing policies such as LIMIT F
which supply exceeds demand and would ING Or ENTRY-FORESTALLING PRICING wl
therefore normally result in the government are designed to keep other firms out of
agency responsible for the support having to market. These industries are freque
Purchase the excess supplies itself. This is characterized by price rigidity, one sug
the simple explanation for 'commodity ted cause of which is the KINKED DEM,
mountains', excess supplies of commodities CURVE. A l s o FULL COST PRICING Or COST-F
(food, minerals etc.) which result from price PRICING can lead to all firms changing t
support schemes. prices at the same time, when they are fa
by common cost increases. In some mark
price taker. An economic agent whose size particularly, if there is a dominant fi
ls
sufficiently insignificant in relation to the PRICE LEADERSHIP emerges. The remaii
Sl
ze of the market in which it operates, major market form is that of MONOPOLI
344 primary goods
COMPETITION where there are many sellers principal-agent problem. This refers to the
but each seller faces a downward-sloping situation in the theory of the firm where the
demand curve for his distinct product. The interests of managers and shareholders
only macroeconomic aspect of the theory of differ. The principle (i.e. the shareholder)
price is the determination of changes in the has interests in the performance of the firm
aggregate price level. (See INFLATION.) but appoints an agent (i.e. the manager) to
act in his place. The principal cannot fully
primary goods. As defined in the theory of control what the agent does; this often leads
justice developed by John Rawls, these to the above problem.
goods are the basic rights, freedoms, income
and wealth which are available for distri- prior distribution. The PROBABILITY DISTRI-
bution in a society. Rawls' concept of DIS- BUTION for a variable or STATISTIC which
TRIBUTIVE JUSTICE is framed in terms of the characterizes the A PRIORI information to be
distribution of these goods between indi- combined with sample information in BAYE-
viduals. (See RAWLSIAN JUSTICE.) SIAN TECHNIQUES.
primary market. Some assets when sold for prisoner's dilemma. This term arises from
the first time are not sold in the market in a consideration of the decision problems of
which they are subsequently traded. The lat- arrested criminals who are the subject of
ter is called a secondary market, and the separate interrogation. Each criminal knows
former may be termed a primary market. An that if no-one confesses and informs on his
example is presented by the NEW ISSUES MAR- co-partners in crime, he will get off scot-free
KET, which is the primary market, and the or at least with a modest sentence. However,
STOCK EXCHANGE which is the secondary mar- if one partner confesses, and the others do
ket for (quoted) SECURITIES. not, he will go free while the others receive
severe sentences. If all confess, then all will
be sentenced but less severely than if only
primary money. Another term for base one confesses. The incentive here, for the
money or HIGH POWERED MONEY, i.e. the rational actor, concerned only with his own
MONEY issued by the monetary authorities. survival, is to confess and let the others suf-
fer the consequences. But, as all will be
primary securities. A term introduced by motivated to act in this way, they end up
John G. Gurley and Edward S. Shaw in their with an outcome that is worse for all than if
Money in a Theory of Finance (1960) and they had been able to make a binding agree-
signifying all forms of debt, marketable or ment among themselves that no-one con-
otherwise, issued by 'ultimate borrowers', fesses. (See GAME THEORY.) This model shows
i.e. borrowers who require finance to how rational behaviour at the micro-level
acquire real assets. They are distinguished leads to an apparently irrational macro
from 'indirect securities' which are the debt outcome.
and claims issued by individuals and insti-
tutions - notably FINANCIAL INTERMEDIARIES -
private company.
in order to acquire and hold primary
See COMPANY.
securities. •
private good. A good which displays rival-
primary workers. Those individuals who ness (see RIVAL) in consumption and where
remain in the labour force either as EXCLUSION may be practised by both pro-
employed or unemployed irrespective of ducer and consumer. The first condition
short-run changes in wages and market con- means that one person's consumption of the
ditions. Male heads of households are the good reduces the quantity available to
archetypal primary worker. (See SECONDARY others. Exclusion by the producer means
WORKERS.) that the producer can restrict use of the
product to those consumers who are willing
principal. The sum of money paid to the to pay for it while exclusion by the consumer
holder of a BOND upon MATURITY to ex- means that the consumer is not forced to
tinguish the liability. consume the good. Where goods display
these characteristics, free EXCHANGE is poss- amounting to as much as 20 per
ible and MARKETS can operate. In the ab- value of some enterprises, to i
sence of the possibility of exclusion markets while in other cases employees of
cannot operate while the absence of rival- have received free shares equa
ness is held to imply that the good should be cent of the value of the compan
provided at zero price. cases large state companies have
mercialized', i.e. turned into J
privatization. The policy of converting companies owned 100 per ce
public ownership of an asset to private Treasury, with two thirds of
ownership or of permitting the performance appointed by the government a
of a certain activity, hitherto carried out by maining third by workers' counci
the department of a public organization, by
a private sector business. Into the former probability. A number lying be
category come in the UK the sale of local- and unity (sometimes expressed
authority owned houses to the sitting tenants centage) which indicates the c
and the issue of more than 50 per cent of the which an event will occur. A us<
shares in former government-owned compa- interpreting probability is as the 1
nies, e.g. British Telecom, British Gas and tive frequency as the number o
the water and electricity companies, while comes infinite. Thus, for insi
into the latter come the transfer of one-time number of heads obtained in toss
public sector services such as refuse collec- divided by the number of times
tion or the laundering of National Health tossed will approach the pro
Service linen. The major argument advanced obtaining a head as the numbe
for privatization is that of increased approaches infinity. (See PROBABI
efficiency, but as many of the former natio- BUTION, JOINT PROBABILITY DISTRIB
nalized industries are natural monopolies it
has been necessary to establish regulators,
such as OFWAT, OFTEL and OFGAS to probability density function, j
supervise price-setting and commercial describing the shape of a PROBABI
policy in respectively the water, telecommu- BUTION, which when integrated be
nications and gas industries. See Vickers, J. tain limits gives the probability
and Yarrow G., Privatization, The MIT its variable(s) take on values bet
Press (1988). limits.
sometimes called, an activity ray. The point uses less labour and capital than point E.
4K+ 2L will then define another such point, Facets will therefore slope down from left to
and so on. In short, each process reflects a right for cases where some substitution is
specific capital/labour ratio $ if the inputs in possible, which establishes a prima facie case
question are capital and labour. The number for the convexity of iso-product curves.
of processes available to produce a given
output may be limited because of INDIVISI- process innovation. A change in the re-
BILITY in the inputs. The diagram below lationship between factor input proportions
shows a situation in which there are five such used by a firm to produce a given level of
processes only. The linear segmented curves output. This can occur in two ways. It may
joining equal output points are ISO-PRODUCT result from a change in relative factor input
CURVES although they do not exhibit the fam- prices which induce the firm to adopt a new
iliar 'smoothness' and curvature of the typi- minimum cost technique on its existing
cal textbook curve. This is because such isoquant. This form of process innovation
smoothness can only come about by assum- involves no research and development
ing that labour and capital can be substituted expenditure as the technology remains
for each other in extremely divisible units. unchanged. Alternatively, isoquants may
Once indivisibility exists the picture will look shift in toward the origin as a consequence of
more like the one shown below. Points be- technological change thus leading the firm to
tween processes and on iso-product curves adopt a new process of production. Once
do have an economic meaning. This is be- this innovation has diffused to other firms, it
cause it is possible to produce, say, the first is known as TECHNICAL PROGRESS.
500 units of output with process C and the
next with process B. This would in fact be
illustrated by point G which lies on a 'facet' producers' co-operatives. An amalgama-
of the iso-product curve. tion of individual firms who attempt to even
This analysis may also be used to indicate out the supply of their common product, in
why an iso-product curve cannot 'bend spite of variations in production. The aim is
outwards'. Suppose it does, as in the second to avoid undue fluctuations in prices and
diagram, then, considering only the three therefore incomes. Producers' co-operatives
processes shown, points D, E and F all indi- are common in the agricultural sectors of an
cate combinations that would produce an economy, where unplanned variations in
equal output. But point E is clearly ineffici- production can occur as a consequence of
ent since we can draw a facet from D to F factors such as unexpected climatic
and observe a point G on process B which conditions.
iso-product curves
production frontier 347
decreasing, the frontier could equally well reduces to k-f(L, K) so that multiplying in-
be a straight line (constant returns to scale in puts by a constant k simply increases output
both X and Y) or curve inwards (increasing by the same proportion.
returns to scale). Examples of linearly homogeneous pro-
duction functions are the COBB-DOUGLAS PRO-
production function. The relationship be- DUCTION FUNCTION and the CONSTANT
tween the OUTPUT of a good and the inputs ELASTICITY OF SUBSTITUTION ( C E S ) PRO-
(FACTORS OF PRODUCTION) required to make DUCTION FUNCTION. If n is greater than 1 the
that good. In formal notation the production production function exhibits increasing RE-
function has the general form: TURNS TO SCALE. If n is lower than 1 decreas-
ing RETURNS TO SCALE prevail. (See iso-
Q = f (L, /C, f, etc.)
PRODUCT CURVE.)
where Q is output, L is labour, K is capital, t
is 'technical progress' and where the ' e t c ' production possibility curve.
indicates that other inputs may also be rel- See PRODUCTION FRONTIER.
evant (raw materials, for example). While
typically used in the context of the theory of production sphere and budgetary sphere.
the FIRM, it is possible to speak of a nation's A classification of employment used in socia-
output being dependent upon the various list countries and (still) in some East
resources used to produce that output. Such European countries. The production sphere
a production function is termed an AGGRE- includes all employment in agriculture, for-
GATE PRODUCTION FUNCTION, and has the estry and fishing, in industry, in construc-
same general form as that indicated above tion, in transport, in trade, in the so-called
save that Q would now be the GROSS productive services and in the private sector.
NATIONAL (or domestic) PRODUCT and K, L The budgetary sphere comprises employ-
etc. would refer to the whole capital stock of ment in administration, the armed services,
the nation, the entire workforce etc. the police, courts, state schools, research
Whether aggregate production functions are institutes, the state health services, customs
meaningful depends on the view taken on officers etc. The criterion for inclusion in the
whether it is sensible or not to speak of a budgetary sphere is that the employee is
measured stock of capital. paid either from the state, or some form of
Production functions may take many local authority, budget. (See NET MATERIAL
specific algebraic forms. Typically, eco- PRODUCT)
nomists work with homogeneous production
functions. A production function is homo- productivity. Output per unit of input
geneous of degree n if when inputs are mul- employed. Increases in productivity come
tiplied by some constant, say, k, the about from increased efficiency on the part
resulting output is a multiple of kn times the of capital or labour. It is essential to measure
original output. That is, for a production productivity in terms of real output, but
function: often impossible to separate capital produc-
tivity from labour productivity. In common
Q = f(L,/C) use, the term is generally confined to labour
then if and only if productivity. (See AVERAGE PRODUCT.)
Revenue
which therefore does not correspond to this
cost Total cost economic definition of profits. (See NORMAL
profit PROFIT, SUPERNORMAL PROFIT.)
Total
revenue
profits-push inflation. A variant of COST-
PUSH INFLATION, which attributes the origins
of the inflationary process to capitalists who
seek an enhanced share of the NATIONAL
INCOME. Prices are thus said to be pushed up
by oligopolistic producers who have a degree
of market power that gives them consider-
able flexibility in the setting of prices, par-
ticularly in the short run. (See OLIGOPOLY.)
programme budgeting.
See OUTPUT BUDGETING.
output
programming methods. A generic name
profit maximization for a set of optimization techniques, usually
involving iterative solution methods. An
maximizing output. At this point the slopes example is LINEAR PROGRAMMING.
of the two curves are equal. The slope of the
total revenue curve is MARGINAL REVENUE progressive tax. Generally referring to a
(MR) and the slope of the total cost curve is situation where the proportion of income
MARGINAL COST (MC). Thus, profit maximiz- taken in tax (the tax rate) rises with income
ation requires that or spending power. Most income tax systems
MC = MR . in Western countries are progressive. This is
achieved by a system of rising MARGINAL
To see why this is so, consider what would RATES OF TAX with increments of income.
happen if MC > MR. In this case the costs of It is possible to have a progressive EXPEN-
producing extra output are greater than the DITURE TAX where the rate of tax rises with
revenue obtained and hence profits are increments to consumption expenditure.
lower than need be. If MR > MC opportuni- There is some empirical evidence that the
ties exist for increasing profits by expanding UK value added tax (VAT) is actually pro-
output. Profit-maximization may not, how- gressive: people with higher incomes tend to
ever, describe the motives of many firms. increase their spending on items subject to
(See SALES MAXIMIZATION HYPOTHESIS, MANA- the tax to such an extent that the payments
GERIAL THEORIES OF THE FIRM.) become a bigger proportion of income.
Economists and politicians who have an ega-
profit motive. Is said to pertain where PRO- litarian philosophy tend to favour progress-
FIT provides the spur which conditions firms' ive taxes.
organization of production activities. (See
PROFIT MAXIMIZATION.) • project appraisal.
See CAPITAL BUDGETING, DISCOUNTED CASH
profit rate. PROFIT expressed as a pro- FLOW, NET PRESENT VALUE, RATE OF RETURN.
portion of the book value of capital assets.
proletariat. A class of persons which owns
profits. The difference between the reve- little or no property. The distinguishing
nue generated from the sale of output and characteristic of such a group is the necessity
the full OPPORTUNITY COSTS of the factors for them to sell their labour services in re-
used in the production of that output. turn for wages. In Marxist theory the prole-
Included within costs are the premium tariat are the exploited class which will
charged for risk taking and the costs of using eventually overthrow the capitalist BOUR-
the owner's CAPITAL. These are not included GEOISIE by social revolution and create a
as costs in the accountants' measure of profit communist economy.
public expenditure 351
property rights. These rights pertain to the proxy variable. A variable used in RE-
permissible use of resources, goods and ser- GRESSION analysis to replace or 'stand in
vices. Ownership of an asset consists of the for' another theoretically more satisfactory
following rights: to use that asset, to change variable in cases where either data are not
its form and substance and to transfer all available on the latter, or the latter is
rights through sale. Ownership of an asset is unobservable (e.g. 'desired' levels of con-
not unfettered because some restrictions are sumption Or PERMANENT INCOME.) (See
generally imposed by private contract or INSTRUMENTAL VARIABLE.)
law.
proportional tax. There are two defi- pseudo-demand schedule. A functional re-
nitions. First, where the proportion of lationship indicating the amount an indi-
income taken in tax stays the same as income vidual would be willing to pay for successive
increases, there is a constant MARGINAL RATE units of a PUBLIC GOOD or for successive units
OF TAX which equals the effective or average of consumption of the good by some other
rate. A second definition is that a tax is individual (as a result of the existence of a
proportional if the rate remains constant as beneficial EXTERNALITY.) This type of sched-
the TAX BASE rises. On the latter definition an ule, when drawn, resembles the normal
AD VALOREM sales tax on a commodity would DEMAND CURVE. However it is not a true
be a proportional tax. Note, however, that demand curve. Whereas private demand
the consumption of the commodity and con- for a good can be estimated by observing
sequently the tax paid may not increase with individuals' purchases in the market, this
the income of the taxpayer, so that the ratio mechanism is not available in the case of
of tax paid to income would fall. public goods or externalities. Consequently
pseudo-demand schedules are drawn on the
propulsive industries. A group of key unrealistic assumption that individuals fully
industries whose interaction and expansion reveal their preferences through political
can provide a stimulus to growth in an econ- channels such as voting. Although useful in
omy. These industries form the nucleus of theory, these schedules are extremely diffi-
the GROWTH POLE concept introduced by cult to estimate in practice since people may
the French economist Perroux. Propulsive wish to conceal their preferences. (See FREE
industries are said to have certain character- RIDER.)
istics, principally technological sophistica-
tion, strong links with the other industries
forming the 'pole' and expanding demand public choice. A branch of economics con-
for their products. The development of these cerned with the application of economics to
industries is held to affect the rest of the the analysis of 'non-market' decision mak-
economy both by generating demand for the ing. It may also be regarded as an economic
products of other industries as inputs and, analysis of politics. (See COLLECTIVE CHOICE,
through imitation, by stimulating innovation ECONOMIC THEORY OF POLITICS, SOCIAL DE-
and technical progress. CISION RULE.)
mainly privately supplied in the USA. The government ownership or through legal
extent of nationalization will also determine regulation, which is the practice in the USA
the size of the public sector. and UK.
exchange rate is mixed. It has done badly in of PERFECT COMPETITION. F.H. Knight a
the recent era of volatile exchange rates. that pure profit would exist because i
Purchasing power parity is often used in certainty concerning the future. Pro<
international comparisons of living stan- or ENTREPRENEURS would be forced tc
dards, for exchange rates, heavily influenced RISKS in making decisions concerning o
by capital flows, can distort per capita GNP earning higher than anticipated returns
figures, when converted into one common 'extra' return constituting pure profit.
currency. (See BALANCE OF PAYMENTS.) See
Officer, C.H., 'The purchasing power parity put option.
theory of exchange rates: a review article', See OPTIONS.
IMF Staff Papers, xxiii (1976), 1-60.
putty-clay. An aspect of the PRODI
purchase tax. A type of SALES TAX. It
FUNCTION which allows substitution of 1
existed in the UK before the introduction of
for capital and vice versa before
VALUE-ADDED TAX in 1973. It was an AD
investment is carried out but once ma<
VALOREM tax levied on particular goods at
are installed the CAPITAL-LABOUR RATK
the wholesale level. The rate can be varied not be varied. Thus EX ANTE capital is '
among products. In the UK so-called luxury but EX POST it becomes hard baked
goods were taxed at higher rates than more Putty-clay models are seen as a compr
basic commodities. It was argued that it was between perfect substitutability (]
difficult to extend this type of tax to a very PUTTY) and rigidly FIXED PROPOI
wide range of consumer expenditure includ- (CLAY-CLAY).
ing services. This constituted one of the
reasons for the introduction of value-added
tax. putty-putty. An aspect of the PRODI
FUNCTION in GROWTH THEORY w h i c h i
pure competition. capital to be continuously reshaped bo
See PERFECT COMPETITION. fore (EX ANTE) and after (EX POST) i
ment has taken place. Thus capital is si
pure profit. A residual sum left over when 'putty' both before and after actual i
we have subtracted from the revenue gener- ment such that the CAPITAL-LABOUR
ated by some activity all of the opportunity may be continuously varied. (See i
costs of production, the normal PROFIT CLAY, CLAY-CLAY.)
required to keep the producer in business.
Economists have debated the issues of pyramiding.
whether pure profit can exist in a state See HOLDING COMPANY.
Q
quadratic equation. An equation which According to Fisher Ms is determined inde-
involves the square of a variable as the pendently of the other three variables, T is
highest power. given, while V is considered to have a con-
stant EQUILIBRIUM value to which it will re-
quadratic utility function. A UTILITY FUNC- turn after any shock or disturbance. The
TION whose algebraic form is that of a QUAD- price level P is then determined by the inter-
RATIC EQUATION. Most typically applied to action of the other three.
PORTFOLIO analysis in which such a function is In particular if it is hypothesized that T*
required if the investor in a portfolio is to be and the equilibrium value of V* are con-
assumed to be influenced only by the MEAN stants then the equilibrium price level is de-
and VARIANCE of the PROBABILITY DISTRI-
termined by the quantity of money, yielding
BUTION of returns. the quantity theory of money
= PT* (2)
qualitative choice models. These are
The demand for money (Md) will be a con-
models developed to deal with discrete re-
stant fraction (k) of the value of transactions
sponse data, such as the decision whether or
not to buy a car, to change jobs, or to go to Md = kP•T (3)
university, for example. They are usually
formulated in terms of the REGRESSION and assuming demand equals supply
MODEL where the dependent variable is dis- Md = Ms (4)
crete (i.e. equals unity if the consumer buys
a car, equals zero otherwise). They are it is possible to obtain
widely applied in labour economics, con-
sumer theory and in financial models. Ms- = MSV* = PT"
k (5)
quantity theory of money. A theory of the Such a view implies that the economy will
DEMAND FOR MONEY which formed the most always tend to FULL EMPLOYMENT NATIONAL
important component of macroeconomic INCOME and the STABILITY of V* arises from
analysis before Keynes' General Theory of the technological and institutional frame-
Employment, Interest and Money (1936). work.
This same theory is now enjoying a revival in
more sophisticated forms. (B) CAMBRIDGE CASH BALANCE APPROACH.
Before the Keynesian revolution the This approach is much associated with MAR-
quantity theory had two mayi forms, each SHALL and PIGOU (in particular A.C. Pigou
summarized as follows: 'The Value of Money' Quarterly Journal of
Economics, 1917). Starting with the same
(A) Irving FISHER: The Purchasing Power equation as Fisher (see (1)) the Cambridge
of Money (Macmillan, New York: 1911). economists took a rather different theoreti-
This analysis started with a simple IDENT- cal route to a similar form of the demand for
ITY, the equation of exchange money function (3). Fisher was concerned
with the quantity of money an economy
M*V = PT (1) needs to carry out a given volume of trans-
s actions while the Cambridge economists
where M is the quantity of money
V is the velocity of circulation of each were concerned with what volume of money
unit of money an individual would wish to hold given that
P is the price level transactions must be carried out. The Fisher
T is the volume of transactions. approach was therefore macroeconomic
356
quartile 357
while the Marshall-Pigou model was micro- place) he proceeded to analyse the factors
economic in flavour. The microeconomic which determined how much money they
analysis emphasized the convenience of held.
money, the larger the number of trans- To Friedman, money is an asset yielding a
actions an individual incurs the more money flow of money services to the holder. He
he will want to hold as MONEY BALANCES. In assumes a diminishing MARGINAL RATE OF
the Fisherian model the individual ended up SUBSTITUTION between money and goods.
holding money balances which he required Thus the more money an individual has in
because of the institutional and technologi- relation to a fixed bundle of goods the more
cal nature of the economy. In other words likely he is to spend some money on further
the Fisherian individual would not choose to goods to equate the MARGINAL UTILITIES
hold money for its own sake, it merely has rendered.
current net value. This hypothesis has very important impli-
Pigou in particular after assuming that cations as it suggests substitution between
the individual's WEALTH, transactions and money and goods and thus a very large
income are stably related to one another in direct impact on AGGREGATE DEMAND for ex-
the short run, argued that the NOMINAL cessive growth (or decline) in money bal-
demand for money (Md) is a constant pro- ances, unlike the Keynesian notion that IDLE
portion (k) of the nominal income of that BALANCES will be spent on financial assets
individual not commodities. This may be stated as
Md = kPY (6)
and assuming equilibrium
where W is total wealth, WH is human
Ms = Md . wealth (for he considered this a very illiquid
Comparing (3) with (6) it can be seen that form of wealth), r is the interest rate, p is the
after aggregation over all individuals in the price level, and Md is nominal balances. The
superscript V indicates EXPECTATIONS.
economy in the Cambridge case
Friedman actually considers three interest
rates - the expected rate of return on
- = MSV = PY money, the expected rate of return on fixed
k (8) value SECURITIES and the expected RATE OF
where V represents the INCOME VELOCITY OF RETURN On EQUITIES.
CIRCULATION. The Fisher approach empha- The sophisticated quantity theory, now
sized the role of the institutional framework surrounded by a battery of related hypoth-
while the Cambridge economists were more eses {see RATIONAL EXPECTATIONS, NATURAL
concerned with the RATE OF INTEREST and RATE OF UNEMPLOYMENT), has become im-
expectations of its future value. portant for macroeconomic policy makers.
Keynes in 1936 developed the ideas of In this approach any category of expendi-
Marshall and Pigou in his LIQUIDITY PREFER- tures is considered as a substitute for money,
ENCE schedule and SPECULATIVE DEMAND for such that any change in the MONEY SUPPLY
money. Marshall and Pigou had an implicit (especially any expansion) will bring about
role for the interest rate while Keynes made DISEQUILIBRIUM in money markets (Ms ^Md)
it explicit. With the Fisher model it is easier at current prices, with disequilibrating spil-
to conclude that the interest rate has no role lover effects on demand and prices in almost
to play in the demand for money. any market. There are also important impli-
Milton FRIEDMAN (in 'The Quantity cations for FISCAL POLICY, in particular an
Theory of Money, A Restatement' in M. expansionary policy will raise either the
Friedman (ed), Studies in the Quantity money supply or the supply of government
Theory of Money, Chicago, 1956) saw mone- securities or both. This will raise the level of
tary theory as an extension of the general wealth and thus increase the demand for
theory of demand much in the line of the money reducing the MULTIPLIER effect of the
Cambridge School. Taking as given the fact original fiscal changes. (See MONETARISM.)
that individuals do hold money (i.e. he did
not explain why they hold it in the first quartile. A means of location of sample
358 quasi-option value
data or distributions. The lower quartile is single tax (l'impot unique) on agriculture.
that value below which 25 per cent of the His advocacy of free trade and unrestricted
observations on the variable concerned lie. competition had an influence on the British
The upper quartile is that value above which CLASSICAL ECONOMICS and especially ADAM
25 per cent of the observations lie. (See also SMITH.
DECILE, PERCENTILE, INTERQUARTILE RANGE.)
y = -
V
R
R2. See COEFFICIENT OF DETERMINATION. anarchism and libertarianism. The writers
are often referred to as 'The New Left'.
Radcliffe Committee. The 'Committee on Radical thought is of very diverse nature
the Working of the Monetary System' set up but has certain common tenets, namely the
in 1957 under the chairmanship of a lawyer. belief that most economic and social prob-
Lord Radcliffe, and which reported in 1959 lems stem from the private CAPITALIST econ-
(Report, Cmnd. 827). The Committee, omy, that this economy must be destroyed
which included two distinguished eco- before amelioration of the human condition
nomists, Professor (now Sir) Alec Cairn- will be possible on a large scale, and that
cross and Professor R.S. Sayers, produced a orthodox economic theory is inadequate for
wide-ranging and authoritative survey of the explaining social reality and is no more than
money and financial system. Its approach an apologia for capitalism. Radical writing is
and findings reflected the trend of thought, interdisciplinary in approach and refrains
in the ascendant at that time, that the mone- from the use of advanced techniques so that
tary system - including its core institutions, it can be understood by the intelligent
the banks - had to be viewed within the layman.
wider setting of financial institutions and Several topics are extensively treated and
markets. The Committee rejected the tradi- recur in radical writing. One of the most
tional view of the banks as occupying a common is inequality of income, capital and
unique position as creators of money, and power. The analysis of inequality is ex-
they concluded that the object of monetary tended beyond that between capitalist and
policy should be to influence or control not worker to the proliferating intra-class differ-
the 'supply of money' but the 'state of liqui- entials, which run in a continuous spectrum
dity' of the economy, a broad concept taking from the unskilled to the managerial elite. It
in both the amounts of liquid assets available is argued that while inequality may be a
and the operation and expectations of the necessary consequence of scarcity, in ad-
markets and institutions which created or vanced economies there is no longer any
handled them. In the Committee's view the reason for scarcity, which is a manufacture
'centrepiece' of monetary policy should be of advanced capitalism, e.g. through adver-
the structure of interest rates, not the supply tising, so that there is no longer any need for
of money; but in any case they saw monetary excessive inequality. Radical economists
measures as forming only one, by no means argue for a reasonable minimum income for
dominant, part of a general policy that in- all, often as an entitlement without the need
cluded fiscal policy and direct controls. The for work, and for a substantial number of
Committee's recommendations were necessities free of charge.
influential in the early 1960s and while the According to radical economics all forms
increasing emphasis on controlling money of alienation have a common root in the
supply since the late 1960s cuts across the SOCIAL RELATIONS OF PRODUCTION under capi-
Radcliffe philosophy, the practical operation talism. The worker not only loses control of
of monetary policy in the UK has departed what he produces, but what he produces
much less from the Radcliffe view than comes to gain control of him. The massive
appears on the surface. (See 'NEW VIEW' OF forces of industry, which he as an individual
MONEY SUPPLY.) helps to build, come to dominate his life.
SPECIALIZATION and DIVISION OF LABOUR ren-
radical economics. The generic name for der work boring, so that instead of reaffirm-
writing in a socialist or Marxist tradition, ing himself in his work the worker mortifies
relating in the main to MARXISM but adopting his mind and body. Human beings become
and using other sources of ideas such as estranged from each other in work and in
360
R and D 361
their social organization. Despite growth in removal of which would help big business,
material production the quality of life is held will be dealt with and not those whose treat-
to deteriorate, since production and society ment would harm big business. Any action
are so organized that man is unable to fulfil which appears to be directed against busi-
himself. This frustration is a potential source ness such as anti-monopoly policy is to be
of social conflict. Orthodox economics it is interpreted as insignificant in relation to the
argued takes too limited a view of man. problem or as a subterfuge to throw people
Two rival explanations are offered for the off their guard. Likewise in its stabilizing
possible breakdown of capitalism. One role the state will absorb surplus in a politi-
views capitalism as generating such a poten- cally feasible manner, military expenditure
tial surplus of output over necessary con- being particularly appropriate since its level,
sumption that it will prove impossible to and the rate of profit on contracts can be
absorb all the surplus. Surplus which cannot concealed. In its redistributive role, state
be absorbed will not be produced, so that social expenditures will be set at the level
long run depression is regarded as inevi- which does not blunt incentives in the econ-
table. Military expenditure has played a cru- omy and which is the minimum necessary to
cial role in the absorption of surplus so far, prevent unrest.
and hence it is regarded as doubtful whether Radical economists regard orthodox eco-
capitalism can maintain a high level of nomists as unscientific, since the latter use
employment without this prop. The other aggregates which do not directly refer to
hypothesis is that the profitability of modern people and their actions in macroeconomics,
capitalism is being undermined as organized while in microeconomics the social origins of
labour succeeds in increasing its share of utilities and preferences are ignored because
output, so that the incentive to invest may class analysis is entirely absent. If the analy-
diminish with consequent large scale unem- sis were scientific it would be possible, for
ployment. example, to identify directly the causes of
Radical economics also concerns itself inflation or unemployment, which orthodox
with the development problems of poor economists find difficulty in doing. See
countries, whose failure to develop is Sawyer, Malcolm C, The Challenge of
explained in terms of economic IMPERIALISM Radical Political Economy, Harvester
and neo-colonialism, in which the. MULTI- Wheatsheaf, London (1989).
NATIONAL CORPORATION plays a crucial role.
The development of a dual economy with
the multinational corporation making little raider firm. A company which has the po-
positive impact on the traditional economy, tential to establish itself as a TAKEOVER threat
the failure to train local personnel, the repa- to another company.
triation of profits and the exhaustion in
many cases of the underdeveloped country's Ramsey pricing. Widely used in the theory
natural resources, all leave the underdeve- of environmental EXTERNALITIES, a rule
loped country worse-off after the event, so which it may be necessary to apply to all
that there is the development of underdeve- prices in an economy, when at least one
lopment. It is also maintained that resources good is a non-depletable PUBLIC GOOD.
are misallocated under capitalism: too many Where the provision of such a good cannot
are devoted to goods for consumption by the be financed through taxation because the
u
pper and middle classes and to military amount is too great to be raised by lump-
goods and too few to PUBLIC GOODS, SOCIAL sum taxes, all prices are required to depart
COSTS are also ignored, so that there is pollu-
from underlying MARGINAL COSTS under con-
tion, congestion, over-population "and re- ditions of optimality. See Baumol, W.J. and
source exhaustion. There is clearly a case for Oates, W.E., The Theory of Environmental
state intervention, but the radical theory of Policy, 2nd edition, Cambridge University
the state suggests that there will only be Press (1988).
intervention where the end result defends or
facilitates the operation of the capitalist state
and promotes the interests of the bourgeoi- R and D.
sie. Only those external diseconomies, the See RESEARCH AND DEVELOPMENT.
362 random coefficient models
ratchet effect. tend to stabilize the interest rate and that the
See RELATIVE INCOME HYPOTHESIS. rate thus established could differ from the
rate of return on physical assets. In turn this
rate capping. A procedure whereby the might lead to a shortfall in investment and i
UK Secretary of State for the Environment deficiency in aggregate demand. In this man
limits the rates increases of individual local ner Keynes integrated the real and monetary
authorities. It can be viewed as an alterna- sectors of the economy in contrast to th<
tive to more traditional methods of control- CLASSICAL DICHOTOMY. Later HICKS estab
ling local authority spending, such as the lished via the IS-LM DIAGRAM that the rate o
manipulation of the RATE SUPPORT GRANT. interest was both a real and monetar
phenomenon. Most recently MONETARIST
rate of commodity substitution. have argued, once again, that the rate o
See MARGINAL RATE OF SUBSTITUTION. interest is a real phenomenon and, in com
mon with classical economists, that the rat
rate of interest. The price of money ser- of return on physical and financial assets wi
vices. While financial markets exhibit a tend to equality in the long run.
range of rates of interest the theory of the
rate of interest explains the determinants of rate of return. A general concept referrin
the 'pure' rate of interest which is the price to the EARNINGS from the INVESTMENT C
that would have to be paid to borrow money CAPITAL, where the earnings are expressed 2
in order to undertake a completely riskless a proportion of the outlay. The term is at
enterprise, KEYNES argued that the rate of plied to a wide variety of situations in ecoi
interest was a monetary phenomenon ref- omics. It can refer to the earnings from th
lecting the supply and DEMAND FOR MONEY. investment of physical capital, money capiti
Supply was determined EXOGENOUSLY while and also to the return to investment in HI
the demand for money reflected the MAN CAPITAL. The term is most frequent
speculative, precautionary and transaction applied to the rewards from capital expend
demands for money. Money acted as a store ture by businesses. The definition emplo;
of wealth but the OPPORTUNITY COST of hold- ed unfortunately varies among user
ing wealth in this form was the rate of return Accountants and businessmen have tr
that could be earned on other financial ditionally had a different definition con
assets, ARBITRAGE in financial markets pared to economists, but there is now
ensured that the RATES OF RETURN across all tendency for the economist's definition
financial assets tended to equality and the become more widely accepted. The trac
unique rate thus established represented the tional approach of businessmen and accou
market rate of interest. tants is to define the term as the ratio
In contrast to Keynes, classical economists PROFIT to capital employed. Profits ha
had regarded the rate of interest as a real been defined in various ways for this pi
Phenomenon. The rate of interest was deter- pose, but the most sensible is net prof
mined by the forces of productivity - the after TAXATION and DEPRECIATION . Profits c
demand for funds for investment purposes - refer to the initial year's profits or to t
a
nd thrift, the supply of savings. A positive average over the lifetime of the project. T
rate of TIME PREFERENCE described an upward initial year's profits may be quite unrepi
sloping savings schedule and a diminishing sentative and average profit is clearly me
marginal product of capital described a sensible. Capital has been defined as eitr
downward sloping investment demand the initial capital expenditure on a proj<
schedule. The intersection of those two including working capital, or average capi
schedules determined the rate of interest, employed over the project's lifetime. T
ar
»d thus the interest rate could be regarded latter definition is superior. The profits i
as
a real phenomenon. ure expressed as a percentage of the capi
In the classical system the rates of return figure gives the rate of return on capi
°n physical and financial assets would tend employed. It is compared with the fin
to
equality and establish a unique market COST OF CAPITAL.
ra
te of interest. In contrast Keynes argued Economists do not find the above cone
that speculation in the BOND market would very helpful in assessing the rewards
364 rate of surplus value
capital investment. The approach does not every hour he labours creating the value
take into account the timing of the cash equivalent of his own subsistence.
flows. A project which generates a given
total income a number of years earlier than a rate of time preference.
second project is obviously more attractive: See TIME PREFERENCE.
the funds can be reinvested to earn further
income. For this reason economists prefer rates. A TAX based on the rateable value
the concept known as the internal rate of of land and buildings which was replaced in
return. This concept explicitly takes into the UK in the late 1980s by the community
account the timing of the cash flows from a charge. Rateable values were based on
project. It is the DISCOUNT RATE which makes annual rental values. The amount of rates
the NET PRESENT VALUE of a project equal to which a taxpayer had to pay was determined
zero. It is conventionally known as the sol- by multiplying the rateable value of the
ution for r in the following equation: property by the 'rate poundage'. This was
determined by the local authority. It was
c = v; calculated by dividing the yield of a 'penny
r)1 rate' (i.e. the yield of one penny in each
pound of total rateable value) in the area
where C refers to the initial capital expendi- into the total amount required. If the expen-
ture in the initial time period and V refers to diture to be met from rates was £300,000 and
the net cash flow from the project in any year the yield of a penny rate was £6000 then the
of its life. If the solution for r is 10 per cent rate poundage would be 50p.
this indicates that the capital expenditure
can be recovered and a 10 per cent return on A number of reliefs were available from
the outstanding balance of the capital rates. Agriculture had been derated for a
attained over its lifetime. The internal rate long time. Rate rebates were later intro-
of return is compared with the company's duced for households. The amount of rebate
cost of capital in order to determine whether was related to the ratepayer's income and his
a proposed project should be accepted or family commitments. The cost of these was
not. This method of appraising projects also largely covered by the RATE SUPPORT GRANT.
has some drawbacks. It does not give an The existence of rebates made the system
indication of the amount of wealth gener- leSS REGRESSIVE.
ated from a project. (This is better indicated The LAYFIELD REPORT on Local Govern-
by use of the NET PRESENT VALUE method). ment Finance recommended that capital
Further, there are sometimes multiple rates values replace rental values as the basis for
of return. These may occur when there is rates. The Layfield Committee also recom-
more than one change of sign in the pattern mended that local income from rates be sup-
of net cash flows over the lifetime of the plemented by a local income tax but
project. The internal rate of return is some- successive UK Governments have had no
times known as the DISCOUNTED CASH FLOW sympathy with this idea.
yield and the investor's ^ield. When the COMMUNITY CHARGE was intro-
1 The calculated rate of return is not a pre- duced for persons a uniform business rate
I ' was introduced for businesses. Whereas pre-
cise measure of the return to capital in a
business as it is not really possible to separ- viously the rate poundage paid by firms
ate out the returns to each factor of pro- varied from one local authority to another,
duction. (See NET PRESENT VALUE.) the uniform rate means that all firms in the
country pay the same rate poundage, though
this varies between Scotland and England
and Wales.
rate of surplus value. In the Marxian
scheme the ratio which SURPLUS VALUE bears rate support grant. A mechanism for
to VARIABLE CAPITAL. Marx regarded this as transferring funds from the national govern-
an expression for the degree of exploitation ment to local authorities in the UK. This
of labour by capital, for the rate of surplus inter-governmental grant now forms the
value indicates how many hours the worker main source of income for British local gov-
labours creating profit for the capitalist for ernments. The amount of grant allocated to
Rawlsian justice 36
imagined to enter into an agreement, or function of the two firms allows us to trace
SOCIAL CONTRACT, about the nature of society the output path of the industry.
while behind a 'veil of ignorance' which pre-
vents them from knowing what position (in real balance effect. Generally employed
terms of sex, race, ability and so on) they to describe the situation where there is a
will occupy in that society. Rawls argues that change in the demand for commodities as
if placed in this 'original position' individuals a result of a change in the quantity of REAL
would choose a set of institutions for the MONEY BALANCES. More accurately the direct
society with the following characteristics: real balance effect as detailed by Patinkin,
1. Each individual would enjoy equal and earlier known as the PIGOU EFFECT, is
rights to the maximum amount of personal the increase in the demand for commodities
freedom compatible with the freedoms of for consumption as a result of portfolio
other individuals. adjustments by individuals following a
2. All inequalities in society would (a) change in real money balances. This results
be derived from positions open to free in a shift in the IS curve in the IS-LM DIA-
competition; (b) be justified only in so far GRAM. This direct real balance effect should
as the inequalities operated to everyone's not be confused with the indirect KEYNES
advantage. EFFECT which shifts the LM curve, although
It is the second characteristic, which in practice the term real balance effect is
Rawls calls the 'difference principle' which often used to describe both effects. (See
has been of greatest interest to economists. WEALTH EFFECT.)
Under the difference principle, inequalities
would only be acceptable to the extent that real cost approach to international trade.
they provided incentives to work and pro- The Ricardian theory of COMPARATIVE
duce. Further, the difference principle also ADVANTAGE is based on a real cost approach.
imposes the requirement that the inequali- Real cost was initially the exertion of labour
ties must enable the least well-off person in in making a commodity, but it was sub-
society to be made as well-off as possible. sequently extended to the use of capital,
Note that Rawls considers the terms 'well- since the formation of capital involves absti-
off, 'better-off and inequality in terms not nence from present consumption. The
of UTILITY but of PRIMARY GOODS which can be approach maintains that it is in differences in
defined as rights, freedoms, opportunities, real costs that comparative advantage lies.
income and wealth. Land, however, enters into the production
The adoption of the difference principle of traded goods, but it is not possible to
by individuals in the original position may regard the use of land as involving a real
be explained in terms of the MAXIMIN strat- cost. Because of this deficiency the real cost
egy in GAME THEORY; adoption of the prin- approach has been largely superseded by
ciple ensures each individual of the greatest t h e OPPORTUNITY COST APPROACH TO INTER-
protection possible against the risk of being NATIONAL TRADE.
the poorest member of society.
real money balances. The value of money
holdings measured in terms of the quantity
R, D and D. Research, Development and
of goods and services they command.
Demonstration. (See RESEARCH AND DEVE-
LOPMENT.)
real national output. The value of total
output - NATIONAL INCOME - measured in
reaction functions. Specifies for any one 'constant prices' - i.e. with the general rate
firm the optimum value for a choice variable of INFLATION deducted so as to record the
given the value chosen by competitors. real command over resources.
Reaction functions are commonly used in
oligopoly theory: for instance, in a duopoly real wages. Wage rates or wage earnings
within which each firm chooses that output that are measured in terms of the goods and
level which maximizes profit, and assumes services they can buy. Theoretically they are
the output level of the other to remain con- measured by the slope of the BUDGET CON-
stant in response to that choice, the reaction STRAINT relating hours of leisure to the
redeemable preference shares
amounts of market goods for which hours Reciprocal Trade Agreements Act of V
can be exchanged in the market. In practice, (RTA). The Smoot-Hawley Tariffs
they are obtained by dividing, or 'deflating', 1930 imposed such high import duties t
nominal wage rates or wage earnings by the US international trade was virtually elii
RETAIL PRICE INDEX. nated. The President and the Congr
recognised the connection between high i
receiver. A receiver is a person appointed port TARIFFS and reduced ability to exp<
to take over the property of a debtor, and to and pushed for lower tariff rates. The Rl
receive the income from that property with a reduced tariffs by 50 per cent across t
view to paying off the debt. Receivers are board. It also provided for bilateral agn
often appointed in respect of the property ments to further reduce rates, using
of LIMITED COMPANIES. They are usually unconditional most favoured nation form;
appointed by a secured creditor of the com- Prior to the RTA, average import duties
pany, or the court, on the request of such a the US were 51.4 per cent. By 1962, actio
creditor. A secured creditor is someone who under the RTA had reduced average tar
is owed money by the company which is in rates to 11.1 per cent. By 1990 industri
debt and he has taken a security over all or tariffs averaged 5 per cent.
part of the company's assets in order to pro-
tect his own interests. Although receivers recognition lag. The period which elaps<
originally simply collected rents and profits, between the time a potentially destabilizir
it is now usually for a person to be appointed disturbance occurs and the time it is recoj
receiver and manager and it is his function to nized as such by policy makers. Also a con
realize the assets comprised within the credi- ponent of INSIDE LAG.
tor's security with a view to paying off the
secured creditor and thereafter returning recontract. An arrangement by whic
any surplus to the company. buyers or sellers can change the amount o
offer if that particular set of prices does no
recession. The CONTRACTIONARY PHASE of
clear the market; the amounts will then b<
the TRADE CYCLE which follows a peak and changed according to whether there is ai
ends with the trough. The term recession is excess-demand or excess-supply situation
generally reserved for the mild version of (See TATONNEMENT.)
this phase, unlike the SLUMP which is a
severe version. If the underlying growth rate recursive model. A model in which tfa
of output (or income) is sufficiently positive, current values of one set of variables deter-
a recession may be marked by a fall in the mine the current value of another, whereas
growth rate with no absolute fall in output. previous (or lagged) values of the latter
determine the current values of the former.
A simple example of a recursive model is
reciprocal. A quantity raised to the power
of minus one. Thus, the reciprocal of 2 is ~, Y, = a + bXt
redeemable securities. This can mean genous variables appear on the right hand
either SECURITIES that will be redeemed - side of the equations. (See STRUCTURAL FORM,
repaid - at a certain date, or securities that INDIRECT LEAST SQUARES.)
can be redeemed at the option of the
borrower. redundancies. Involuntary job losses due
to a reduction in manpower requirements on
redemption date. The date at or by which the part of firms. Such reductions may in-
securities which are redeemable, but not at volve either the complete closure of plants
the borrower's option, must be repaid. or the scaling down of the size of the work-
force in a plant. While some employees will
redemption yield. An investor who buys a have been declared redundant through
dated stock at a price below its nominal no fault or choice of their own, where sub-
value will if he holds to redemption make a stantial SEVERANCE PAY is offered some
capital gain, in addition to the annual inter- employees may elect to be declared redun-
est payable on the stock. The redemption dant. Redundancies are one element in
yield, which may be calculated gross or net DISCHARGES.
of CAPITAL GAINS TAX, is therefore the yield
on the current value of the stock adjusted redundancy payments.
upwards to take account of the discounted See SEVERANCE PAY.
value of the ultimate capital gain.
re-export. A good imported from one
redistribution. The process of altering the country, which is not consumed within the
existing distribution of (usually) income or importing country but is instead sent to a
wealth in a society. Redistribution may be third country.
the result of a deliberate policy to transfer
income between individuals or may be an regional development grant. Payments
'accidental' effect of a policy. Examples of formerly made by the British government to
deliberately redistributive policy include firms undertaking new manufacturing
high levels of INCOME TAX on high earners INVESTMENT in those regions designated as
and INCOME MAINTENANCE policies which pro- DEVELOPMENT AREAS and SPECIAL DEVELOP-
vide payments to the poor. Such policies MENT AREAS. This grant was introduced in
may be said to represent an attempt to the Industry Act 1972 and was available for
achieve DISTRIBUTIVE JUSTICE or to attain the expenditure on plant, machinery and build-
'best' or 'optimal' distribution of income. On ings. Unlike pre-existing forms of assistance
the other hand, a policy such as providing it was available to all manufacturing firms
free university education may have unin- undertaking new investment and not only to
tended effects on the distribution of wealth. those firms in the process of moving into an
In general we may distinguish between area. Regional development grants were
redistribution 'in-cash' where individuals phased out from March 1988. (See ASSISTED
have money taken from or given to them and AREAS, REGIONAL POLICY.)
IN-KIND REDISTRIBUTION where individuals
are provided with goods and services free or regional economics. Regional economics
at a subsidized price. Economists have ana- is that branch of economic analysis which is
lysed redistribution in a POSITIVE sense - ana- concerned with the spatial distribution of
lysing the effects of various distributive economic activity and spatial variation in
policies - and in a NORMATIVE sense - con- levels of economic performance. The subject
sidering the problem of distributive justice. can be split in the usual way into macroeco-
The last-mentioned area remains extremely nomic and microeconomic topics. In re-
controversial involving, as it does, many gional macroeconomics, the analysis is
VALUE JUDGEMENTS. usually carried out in terms of the compara-
tive economic performance of a number of
reduced form (RF). The form of a set of regions within a national economy but each
SIMULTANEOUS EQUATIONS in which the ENDO- region is regarded as being, in economic
GENOUS VARIABLES are expressed as functions terms, homogeneous - that is no attention is
of only EXOGENOUS VARIABLES, i.e. no endo- given to variations within each region.
regional multiplier 3<
to an area smaller than one to which the workers classified according to the region in
term region would be applied. which they are employed. The pure regional
As an alternative to the Keynesian money wage differential which remains after
approach of estimating INJECTIONS and WITH- all adjustments for the different occu-
DRAWALS, the ECONOMIC BASE MULTIPLIER Cal- pational, industrial, sexual and racial mix of
culates the expansion in total employment different regions may be due to differences
resulting from an expansion in employment in the cost-of-living between regions or to
in basic industries on the grounds that a disequilibrium phenomena such as relative
fixed relation exists between basic and total shortages or surpluses of labour and capital
employment. Estimates of base multipliers in various regions. Barriers to mobility may
often produce results rather greater than result in substantial regional differences in
those of Keynesian multipliers but it should the short run but in the long run these should
be borne in mind that the base multiplier is disappear. (See REGIONAL WAGE STRUCTURE
concerned with changes over fairly long and WAGE DIFFERENTIALS.)
periods while the Keynesian multiplier is
concerned with short-run changes. regional wage structure. The ranking of
The regional multiplier may be further the average levels of pay of groups of
extended by including the possible effects of workers classified according to the region in
a growth in regional income on investment which they are employed. (See WAGE STRUC-
(as in the ACCELERATOR model) and on in- TURE, REGIONAL WAGE DIFFERENTIALS.)
movement of new firms. Inclusion of these
registered unemployed. Also known as
effects yields what has been termed the
the claimant count, the total in the UK of all
'supermultiplier'.
persons who are registered as claiming bene-
regional policy. A form of government fit at Unemployment Offices. This infor-
economic policy which is aimed at altering mation is available cheaply and quickly as a
the regional pattern of economic activity or by-product of administrative procedures.
economic performance. Policies will be Turnover on the register is extremely
influenced by what policy-makers consider high. At a time when unemployment in the
to be the desirable pattern of regional econ- UK was around 1.4 million almost 0.4 mil-
omic performance and what they consider to lion joined or re-joined the register every
be the most effective way of altering that month. Since the total number on the regis-
pattern. Most generally regional policy has ter at this time remained roughly constant it
been directed to improving the economic is clear that a similar number left the register
performance and status of DEPRESSED AREAS each month. The pool of registered unem-
and narrowing the gap in performance be- ployed may therefore increase either as a
tween regions. While economic performance result of more people joining the register or
can be measured by various indices such as because fewer people leave. If the outflow
growth or income levels, British Regional falls the average duration of unemployment
Policy can be seen as mainly a response to will correspondingly rise.
differences in UNEMPLOYMENT RATES between This method of counting the unemployed
regions. The main forms which such policy is only one approach and it suffers from the
takes include encouraging the movement of disadvantage that it fails to capture all those
industry into areas of high unemployment, unemployed who have no entitlement to
encouraging the movement of workers out benefit. The alternative approach of a
of these areas, supporting firms operating in sample survey of households to discover all
depressed areas and generating income by those unemployed but actively seeking work
raising PUBLIC EXPENDITURE in depressed is also used in the UK and is the principal
areas. Substantial controversy surrounds the method used in the US. (See also UNEMPLOY-
question of the effectiveness of such policies. MENT, HARD-CORE UNEMPLOYED.)
For a review of the issues see H. Armstrong
and J. Taylor, Regional Economic Policy, regressand. The DEPENDENT VARIABLE in a
Philip Allan, Oxford (1978). REGRESSION analysis.
its average propensity to consume will re- relativities. The term used to describe the
main unchanged. It can therefore be shown differences between the average levels of
that if the income distribution remains pay of groups of workers in the same occu-
unchanged in the long run the average pro- pation, who are covered by different pay
pensity to consume will remain constant as negotiating groups. While frequently con-
income increases. This aspect of the theory sidered distinct from WAGE DIFFERENTIALS
explains the evidence on the form of the they are essentially a specific sub-group of
LONG-RUN CONSUMPTION FUNCTION. Further these.
as we move up the income distribution we
find a lower average propensity to consume renewable resource. Any resource which
at higher levels of income as suggested by is capable of being replenished, in part or
the CROSS-SECTION evidence. Effectively whole, by 'natural' means. Examples would
therefore a series of cross-section consump- be fish, timber, animal populations. How-
tion functions, one for each period of time, ever, replenishment may be difficult if
is shifting upwards producing a single long- the resource is subject to a long gestation
run consumption function with a constant period (30-50 years for trees) or if persistent
average propensity to consume. over-exploitation is practised (as with many
The second part of the hypothesis explains species of whales). In short, renewability
the specification of the SHORT-RUN CONSUMP- does not imply that the resource cannot be
TION FUNCTION. It suggests that households exterminated.
find it easier to adjust to rising incomes than
falling incomes; there is a 'ratchet effect'.
Therefore as incomes decline in the re- rent.
cession households seek to maintain their See ECONOMIC RENT.
standard of living and their consumption
falls by less than their income. It follows that rent gradient. A relationship employed in
at lower levels of income, during the reces- URBAN ECONOMICS which expresses the rent
sionary phase of the TRADE CYCLE, the aver- paid for use of a unit of land as a function of
age propensity to consume rises, as the distance from some reference point - usually
evidence on the short-run consumption func- the city or town centre. Most, though not all,
tion suggests. analyses of urban location patterns indicate
Thus the relative income hypothesis that a negative rent gradient will exist - i.e.
reconciles the conflicting evidence on the rents will fall as we move away from the
form of the consumption function. However central point. The rent gradient is usually
it suggests that: seen as the outcome of competitive bidding
1. increases in the full employment level by the alternative users of each site. (See
of income always produce a proportional BID-RENT FUNCTION, ACCESS/SPACE TRADE-OFF
increase in consumption. This is unlikely MODEL.)
with exceptionally large or unexpected in-
creases in income; and
2. consumer behaviour is irreversible. rentiers. Owners of capital who derive all
Thus a fall in income will lead to dissaving as or most of their income from this source, but
consumption is maintained, regardless of the who choose to exert no effective control
duration of the fall in income. In fact con- over its use.
sumption is slowly reversible over time.
Indeed empirical evidence has revealed re- rent seeking. The use of real resources in
cessions in which consumption actually rose. an attempt to appropriate a surplus in the
These shortcomings of the relative income form of a rent. An industry may use re-
hypothesis are taken account of in the sub- sources to lobby a government to impose a
sequent LIFE-CYCLE HYPOTHESIS and PERMA- restriction such as a TARIFF on an imported
NENT INCOME HYPOTHESIS. (See ABSOLUTE good, so that the factors of productions in
INCOME HYPOTHESIS.) the industry earn payments in excess of
their TRANSFER EARNINGS as a result of the
relative price. higher market price for the good, which
See PRICE. they produce. Consumers suffer two losses
research and development 37
from rent seeking; the loss of CONSUMERS' be held on deposit with the Federal Reservd
SURPLUS from the higher price and the loss of or in the form of vault cash. Non-member)
output from the resources devoted to rent- institutions keep their reserves in the form ofj
seeking. Resources may subsequently be deposits with member banks or in vault cash.
devoted to rent protection. In international (In 1980, 38 per cent of all commercial banks
economics a related, though different, were members of the Federal Reserve
concept has been developed with the name, System, but they held 70 per cent of all bank
directly unproductive profit-seeking (DUP). assets). The Deregulation and Monetary
See Rowley, C.K., Tollison, R.D. and Control Act of 1980 and the Garn-St
Tullock, G., The Political Economy of Rent- Germain Depository Institutions Act of 1982
Seeking, Kluwer Academic Publishers, have mandated that all depository insti-
Boston (1988). tutions, whether or not they belong to the
Federal Reserve system, are subject to the
replacement cost. same reserve requirements. As of August
See HISTORICAL COST. 1991, institutions with deposits of $41.1 mil-
lion or less must hold 3 per cent of their
replacement cost accounting. A method of chequeable accounts in reserve and those
accounting which adjusts for price changes with over $41.1 million must hold 12 per cent
by calculating profit as the difference be- of their chequeable accounts in reserve. (See
tween the selling price of a good and its EXCESS RESERVES, FREE RESERVES, RESERVE
replacement cost on date of sale. RATIOS.
replacement ratio. The ratio of total net Resale Prices Act 1964. UK legislation
income (income plus benefits net of tax and which prohibited resale price maintenance
housing outlays, allowing for rent and rate by an individual firm. The Restrictive
rebates) when unemployed to that when Practices Court can exempt certain classes of
working. This ratio has been shown to ex- goods from prohibition if the agreement is
ceed unity in certain cases and this has led to deemed to have beneficial effects for con-
a great deal of popular speculation about the sumer welfare. (See RESTRICTIVE TRADE PRAC-
disincentive effects of unemployment and TICES ACT I956.)
other benefits on the desire to work.
research and development (R and D).
representative firm. A firm characteristic Activity devoted to increasing scientific or
of the industry or sector of the economy technical knowledge and applying that
being analysed. knowledge to the creation of new products
and means of production as well as to the
repressed inflation. A situation where a improvement of existing products and pro-
price freeze is controlling the rate of change duction processes. When research and
of prices without affecting the underlying development is extended to the manufacture
inflationary tendencies. (See INCOMES POLICY, of a prototype commercial product the term
INFLATION.) 'research development and demonstration'
is used to describe the whole sequence. R
required reserves. In US banking, and D is important both to FIRMS and to
depository institutions are required to main- governments - in the latter case particularly
tain a certain percentage of the liabilities for military purposes. Economists are par-
they issue (basically, chequing, saving, and ticularly interested in R and D as a cause of
certificate of deposit accounts) as idle bal- TECHNICAL PROGRESS, INNOVATION a n d ECON-
ances. For institutions which belong to the OMIC GROWTH. (See PROCESS INNOVATION,
FEDERAL RESERVE SYSTEM, such balances may PRODUCT INNOVATION.)
374 reservation wage
reservation wage. The worker searching reserve base. The quantity in the financial
the LABOUR MARKET for a job will have some system of those assets which, either practi-
idea of the wage he desires or merits, based cally or legally, may constitute the reserves
on his previous wage and wage offers that of the banking system, and which in the
are known in some expectational sense. He traditional theory of the CREDIT MULTIPLIER
can thus be viewed as setting a minimum form the multiplicand on which that multip-
standard for jobs he will find acceptable. lier operates to determine the total quantity
This is known as the reservation wage. His of bank deposit money. (See HIGH-POWERED
OPTIMAL strategy is to accept any job that MONEY.)
pays above this critical value and reject all
offers below this value. It may well be the
case that the reservation wage is set at too reserve currency. The name given to a
high a level, say during a cyclical down turn, foreign CURRENCY which a government is
and in this case it is likely gradually to be prepared to hold as part of its foreign
revised downwards as the search process exchange reserves; this is used to finance
lengthens, so as to be more consistent with international trade. There are four necessary
offers received. attributes that such a currency must possess.
First, it must have a stable value; second, it
must belong to a country which plays a sig-
nificant part in world trade; third, there must
reserve assets ratio. The minimum ratio be a viable FOREIGN EXCHANGE MARKET in
which, between 1971 and 1981, all BANKS which the currency can be exchanged; and
operating in the UK, as well as the larger finally, it must have free CONVERTIBILITY. The
FINANCE HOUSES, had to maintain between dollar, and the pound, although less used
defined 'eligible assets' and similarly defined more recently due to speculation about their
'eligible liabilities'. This ratio, originally long term stability, and the Deutsche-mark
termed the 'eligible assets ratio', and set at and Swiss franc, are often used as reserve
12.5 per cent for the banks and 10 per cent currencies. (See FOREIGN EXCHANGE MARKET,
for the finance houses, was introduced in
INTERNATIONAL LIQUIDITY, STERLING AREA.)
September 1971 under the revised credit
control arrangements proposed in the BANK
OF ENGLAND'S consultative document, 'Com- reserve ratio. The ratio of an asset, or
petition and Credit Control' of May 1971. group of assets, held as a reserve, to some
'Eligible assets' comprised a variety of short- total of liabilities or commitments, and that
term assets, including TREASURY BILLS and is in some degree an object of operating
similar ELIGIBLE PAPER, MONEY AT CALL and policy of the institutions concerned. The
GILT-EDGED securities with one year or less to term arises commonly in regard to banks and
run. 'Eligible liabilities' were, broadly, all other deposit-taking institutions which, be-
deposits denominated in sterling with a cause of the LIQUIDITY of their deposit liabili-
maturity of two years or less, minus certain ties have long recognized the need to
offsets, e.g. a proportion of cheques in maintain a part of their asset portfolios in
course of collection. The* reserve assets similarly liquid assets. In banking this came
ratio, which replaced the CASH and LIQUIDITY to be expressed in certain working rules of
RATIO requirements applicable under pre- ratios between liquid assets - e.g. CASH,
vious monetary control arrangements, was BILLS, MONEY AT CALL - and outstanding de-
itself discontinued in August 1981, under the posits. Later, CENTRAL BANKS came to recog-
revised arrangements introduced then. nize the importance of the banks
Under the new arrangements all banks and maintaining predictable reserve ratios,
LICENSED DEPOSIT TAKERS are required to partly to ensure soundness, but more espe-
maintain a non-operational balance of de- cially to enhance the effectiveness of OPEN
posits at the Bank of England equal to 0.5 MARKET OPERATIONS as instruments of MONE-
per cent of a slightly redefined 'eligible liabi- TARY POLICY. In most systems the banks and
lities' total; above that they are free to deter- other financial institutions are required by
mine their holdings of all types of reserves law to observe specified minimum reserve
by their own prudential criteria. (See MONE- ratios. (See CASH RATIO, ELIGIBLE ASSETS
TARY MANAGEMENT, MONETARY POLICY.) RATIO, LIQUIDITY RATIO.)
reswitching 375
residual. The difference between an actual i.e. the members of the agreement, to justify
data point and the value indicated by an the maintenance of the agreement.
estimated equation. Thus the residual for
a ny observation is given by Restrictive Trade Practices Act 1968. The
ei = Yt - Y, major feature of this legislation was a provi-
sion relaxing the compulsory registration of
where Yt is the actual value of the DEPEN- agreements required by the RESTRICTIVE
DENT VARIABLE, and TRADE PRACTICES ACT 1956. This provision
Yt is the estimated value of the de- empowered the Board of Trade to exempt
pendent variable from the RE- agreements designed to improve efficiency
GRESSION equation, given the actual or to create productive capacity, as long as
values of the INDEPENDENT VARI- the agreement is on balance in the national
ABLES. interest.
The method of LEAST SQUARES is an esti-
mation technique which 'chooses' the para- reswitching (also known as double switch-
meter values so as to minimize the sum of ing). In the CAPITAL CONTROVERSY the
the squared values of the residuals (residual notion that a technique of production aban-
sum of squares). doned when the rate of profit is low may be
introduced when the rate of profit rises to
restricted least squares (RLS). A method
of estimating the parameters of an equation
in which a priori information is taken into wage
account. For instance, in a COBB-DOUGLAS rate
PRODUCTION FUNCTION we may wish to
impose the restriction of CONSTANT RETURNS w
TO SCALE by constraining the sums of the
estimates of the exponents of the factor
inputs to be equal to one. The procedure is
based on ORDINARY LEAST SQUARES, but re-
sults in better estimates in the sense that
their variances are smaller than those which
would be obtained by unrestricted tech-
niques. (See BAYESIAN TECHNIQUE.)
more profitable to readopt Ta, which returns to scale. The rate at which output
amounts to switching back to the technique changes as the quantities of all inputs are
abandoned when the rate of profit first rose varied. If, for example, inputs are multiplied
above r7. Hence the name 'reswitching'. The by a factor of 2 and output goes up by the
possibility of reswitching raises serious
theoretical problems for wide areas of Capital
neoclassical economics, in particular the
AGGREGATE PRODUCTION FUNCTION a n d t h e
MARGINAL PRODUCTIVITY theory of distribu-
tion.
the LAW OF DIMINISHING RETURNS and the success in creating an 'engine of analysis'
differential fertility of agricultural land. and for his method of procedure as for his
Ricardo accepted a MALTHUSIAN view of substantive conclusions, for he was the first
population so that an unlimited supply of to use the technique of building simple ana-
labour would be forthcoming at the subsis- lytical models on heroic assumptions for
tence wage. As the population increased direct application to significant problems.
more food had to be found to sustain it. This
implied extending cultivation to less fertile right-to-work laws. In the US, where the
land where the MARGINAL PRODUCT of labour term originated, the CLOSED SHOP is illegal
and capital was lower than on present agri- and individual states are free to prohibit the
cultural land, and the more intensive culti- enforcement of a UNION SHOP clause. This
vation of currently used land. The marginal prohibition is known as a right-to-work law.
land coming into cultivation was a free gift of Such laws have nothing to do with the right
nature and required no rent payment. to a job; rather, they deal with the right not
Superior land, since it was more productive to join unions as a condition of employment.
would confer an advantage on-any farmer, In the US some 19 states currently have
so that competition for such land resulted in right-to-work laws. Crude estimates indicate
the payment of rent to landlords. Profit was that unions presently under a union shop
the residue of product after paying rent, arrangement would lose from 6 to 15 per
which would vary differentially according to cent of their membership if a right-to-work
the fertility of land, and the fixed, subsis- law were passed.
tence wage. As population grew the use of
even less fertile land would lead to no sur- rights issue. An issue of shares offered,
plus after paying the wage, and rent plus usually on favourable terms, to existing
wages would exhaust the product on intra- shareholders of a COMPANY on a proportio-
marginal land. In the absence of profits nate basis. Shareholders who do not wish to
accumulation would cease. An involved take up the offer can normally sell the right
argument on rather special assumptions also at a price related to the premium value of
ensured zero profits in manufacturing. the offer.
The short-run solution to the dilemma lay
in foreign trade and the import of cheap, risk. A context in which an event occurs
foreign grain. This led Ricardo to argue with some PROBABILITY or where the size of
against the CORN LAWS and to develop his the event has a PROBABILITY DISTRIBUTION.
doctrine of COMPARATIVE COSTS to demon- Thus, the return on an investment may be
strate that FREE TRADE would- benefit all 'risky' in that it has a 1 in 10 (0.1 probability)
countries party to it. Although the argument chance of being a loss, a 5 in 10 chance of
was conducted in terms of goods, Ricardo being of a particular size and a 4 in 10 chance
saw the implications of the doctrine for wage of being larger still. Risk should not, how-
and price levels, namely that if foreign pay- ever, be confused with probability since it is
ments were to be in long-run balance, the an amalgam of both this probability and the
more efficient country would need to have size of the event. If the 1 in 10 chance of a
higher money and real wages. loss is one of making a very big loss indeed,
Ricardo devoted much of his energies to this can be a more risky event than one
an unsuccessful search for an invariable where the probable gains are exactly the
measure of value, which he hoped to find in same but the risk of loss, while still 1 in 10, is
the LABOUR THEORY. This problem has been much smaller. Attitudes to risk vary, depen-
treated afresh by SRAFFA. In the end Ricardo ding very much on the psychological make-
was said to be a proponent of no more than up of the risk-taker and the probable out-
an empirical labour theory of value, for he comes. (See RISK-AVERSION.)
saw the logical difficulties in explaining value
in terms of labour inputs but he nevertheless risk aversion. The expectation of investors
used it to explain value on the grounds that of a higher expected return as compensation
labour costs were quantitatively the major for an increase in risk. A risk averter can be
proportion of costs and prices. a DIVERSIFIER and spread his PORTFOLIO over
Ricardo is remembered as much for his different assets or a 'plunger' and invest
Robinson, Joan V.
wholly in BONDS or money. A 'risk lover', non-rival include the use of knowledge
however, accepts a higher level of risk for a sunshine. It is frequently argued, notabl
given expected return. If an individual is WELFARE ECONOMICS and the theorems
'risk neutral' he would be indifferent be- PARETO OPTIMALITY that goods which are r
tween whether or not he accepted 'fair' rival in consumption should be providei
INSURANCE. Most individuals are generally zero price. (See PUBLIC GOOD.)
held to be risk averters. (See MONEY, THE
DEMAND FOR.) Robbins, Lionel (1898-1984). British <
nomist and influential figure, Li<
risk capital. Traditionally this refers to the Robbins was Professor of Economics at
capital invested in a business where the London School of Economics from 1
owner accepts the risk that the company may until 1961. During this period Robbins hj
go bankrupt. Companies may have several major influence on both students and j
types of FINANCIAL CAPITAL of varying de- ernment. Robbins was the leader of a re\|
grees of risk. Debenture holders have a prior in 'liberal' economic thought. He stre:
claim and accept the least risk. Preference the necessity for a conceptual and prac
shareholders have the next claim and ordin- separation of NORMATIVE and POSITIVE e<
ary shareholders the last claim and so the omics. Economists in Robbins' view o»
greatest risk. If profits grow the ordinary not to make value judgements in econcj
shareholders make corresponding gains as analysis.
they have claim to the residual income after In An Essay on the Nature
the fixed interest and preference share divi- Significance of Economic Science (19
dends have been paid. Capital invested in Robbins stressed the aspect of scarcity ii
government securities was traditionally economic behaviour. The dominant cha^
regarded as being a riskless investment, but teristic of human behaviour which is relei
rapid inflation has introduced a different for the economist is that of decision ma]
form of risk to such investment. (See FINAN- subject to constraints. Robbins' fait
CIAL CAPITAL.) maxim summarizes this view and has
come a standard definition of the scop
risk premium. economics: 'The science which stu
1. An addition to the 'pure' DISCOUNT RATE human behaviour as a relationship betv
in order to take account of the uncertainty ends and scarce means which have alte
associated with the future benefits or reve- tive uses.'
nue from a project. Its use implies that the
Apart from the Essay Robbins' most <
risks involved increase at a compound rate
brated works include: The Economic I
with time, which is unlikely to be the case.
of Class Conflict and Other Essayi
Only if risk consists solely of the possibility
Political Economy (1939); The Econc
that the project may fail at any time, the
Causes of War (1939); The Econc
probability of failure in different periods
Problem in Peace and War (1947);
being equal and naturally independent, is a
Theory of Economic Policy in En\
risk premium appropriate.
Classical Political Economy (1952); Re
2. In an uncertain world, that part of the Torrens and the Evolution of Clas
return to CAPITAL which compensates the Economics (1958); The Theory of Econc
owners of capital for the risk involved in its Development in the History of Econc
use in business ventures. Thought (1968); and The Evolution
risk-spreading. Modern Economic Theory (1970).
See INSURANCE.
Robinson, Joan V. (1903-1983). Br
rival. Where one individual's consumption economist and one of the most influei
of a good reduces the quantity available to economic theorists of the post-Keyne
others then that good is said to display rival- period. Professor Robinson taught at
ness or to be rival in consumption. Rivalness University of Cambridge from 1931
Js a characteristic of PRIVATE GOODS which Her first major contribution was a crit
are thus scarce and require a process of and reformulation of the traditional thi
allocation. Examples of goods which are of value based on the notion of PER
380 Robinson-Pat man Act
prepared to give financial support to new can only be raised by increasing the c
ideas. of roundaboutness.
3. The take-off- this stage is characterized
by growth as the normal, steady state, rather royalty. In the UK a tax paid to th
than only appearing in short bursts of sud- Government by organizations expl
den activity. In general, the ratio of SAVINGS minerals as all mineral rights are vesi
a n d INVESTMENT tO NATIONAL INCOME will rise the Crown. For North Sea oil it was lev
to at least ten per cent during this afage. As a rate of 12.5 per cent of the wellhead
well as this growth, there are two more under the first four licensing rounds a
characteristics of the third stage. There has 12.5 per cent of the landed or tax value
to be at least one significant manufacturing the fifth round onwards. Royalties
sector with a high growth rate; and a frame- abolished for new oil fields in the Ct
work, either political or social, which will and Northern sectors of the North S
support the expansion of the modern sector. 1983 and for onshore fields and those i
Rostow also defined the take-off as an indus- Southern Gas Basin in 1988.
trial revolution. Traditionally a royalty is the share a
4. The drive to maturity - this is the stage ing to the landlord from the exploitatioi
between take-off and maturity which is basi- resource in his property. In the USA mi
cally a long period of continued progress, rights are often vested in private hand?
with the level of investment rising as high as the royalty is thus not thought of as a tj
20 per cent of national income. In general is a very blunt instrument to use as a d<
this stage lasts 60 years. to extract ECONOMIC RENTS from the ex
5. The stage of high mass consumption - tation of a resource. Being based on j
this stage is the longest. Rostow considers output values it takes no account of i
that it took the USA about 100 years to and so its presence could make the ex
move from maturity to the level of this final tation of a mineral uneconomic. Similarl
stage. It is characterized by an affluent popu- MARGINAL COSTS are likely to rise over tin
lation and by mass production of sophisti- a reservoir or mine as more deposits
cated consumer goods and services. exploited, an orthodox royalty could lea
oil fields or mines being prematurely al
roundaboutness. The term used to define doned. In many countries more sopr
more time-consuming and usually more pro- cated forms of taxation usually basec|
ductive methods of production. Fish can be profits are becoming more importan
caught directly but inefficiently by hand. If a devices for taxing natural resources.
fisherman were to spend some time con-
structing a rod, he would be more successful royalties.
in catching fish as a result of this roundabout See COMPENSATION RULES.
process. A still greater time spent making a
n
et, a yet more roundabout process, would RPI.
lead to even greater catches. An increase in See RETAIL PRICE INDEX.
roundaboutness is also described as a length- rule-of-thumb. A simple formula or |
ening of the period of production. cedure which provides the basis for decis
The notion of, and the greater producti- making by economic agents. It can
vity of, roundaboutness is a central tenet of argued that under conditions of imperi
the AUSTRIAN SCHOOL in its discussion of CAPI- information and uncertainty resort to roi
TAL. This notion or its synonym, the average and ready rules is unavoidable. (See FI
period of production, is criticized on the COST PRICING, AVERAGE COST PRICING.)
grounds that since it involves measuring
capital as an amalgam of magnitude of input Rybczynski theorem. Theorem, dei
and duration of input, it is not possible to oped by the economist of that name, to
obtain a unique measure for roundabout- effect that if in the HECKSCHER-OHLIN frar
ness. Furthermore it is not empirically work one of the two factors of productioi
necessary that every increase in roundabout- increased, to maintain constant commoc
ness, if it could be measured, should lead to and factor prices it is necessary for i
increased productivity, or that productivity output of the good intensive in the use of 1
382 Rybczynski theorem
increased factor to expand and for the out- can be done in the face of the expansion of
put of the other good, intensive in the use of one factor by increasing the output of the
the constant factor, to decrease. The reason- industry using the factor intensively and
ing runs as follows. For commodity prices to by contracting the output of the other indus-
remain constant, factor prices must remain try, which releases the constant factor in a
constant. Factor prices can remain constant higher proportion, making it available for
only if the ratio in which factors are used use with the increased factor in the expand-
in the two industries, remains constant. This ing industry.
sackings. DISCHARGES from employment sales tax. A tax levied on a market trans
for cause. Employees who have lost their job action. There are many types of sales taxe:
through some fault of their own. One ele- but they may be divided between thos<
ment in LABOUR TURNOVER. which apply to a large range of expenditure
and those which apply to the sale of <
St Louis model. A small linear econo- specific good or service. Thus a VALUE
metric model of the US Economy developed ADDED TAX, a retail sales tax, a TURNOVER TA>
at the Federal Reserve Bank of St Louis to and an comprehensive EXPENDITURE TAX are
counter the trend to larger and more non- examples of general sales taxes, CUSTOMS,
linear models developed elsewhere from the EXCISE and PROTECTIVE DUTIES are examples
original Tinbergen and Klein-Goldberger of taxes on specific goods. (See INDIRECT
models of the US economy (such as the TAXES.)
Brookings model, the Wharton model, etc.).
salvage value (also known as scrap value).
When considering CAPITAL BUDGETING, the
St Petersburg paradox.
value of the capital assets at the end of the
See BERNOULLI HYPOTHESIS.
project life has to be taken into account.
salary. The remuneration of almost all sample. Any set of observations or
non-manual and some manual employees in measurements of a particular variable,
exchange for the supply of labour services. which does not include all possible obser-
Frequently payment is made at intervals of vations. (See RANDOM SAMPLE.)
one month and, in contrast to manual
workers' wages, does not vary with the num- Samuel son, Paul A. (1915- ). American
ber of hours worked or the intensity of effort economist, professor at the Massachusetts
during those hours provided some minimal Institute of Technology, and winner of the
contractual obligation is honoured. Nobel Prize in Economics in 1970 for raising
the general analytical and methodological
sales maximization hypothesis. Due to level of economic science with the aid of
W.J. Baumol (Business Behaviour, Value mathematical tools.
and Growth, New York, Macmillan, 1959) Samuelson's work, which encompasses
the hypothesis is in the spirit of MANAGERIAL almost the entire field of economics, has
THEORIES OF THE FIRM. Baumol's model con- appeared mostly in article form in journals.
siders the maximization of total sales REVE- In DYNAMIC ECONOMICS he has investigated
NUE subject to a profit constraint as typical of how an economic system behaves outside
an oligopoly. The profit constraint is speci- EQUILIBRIUM and how an economy develops
fied as that minimum profit level necessary from period to period in a chain of develop-
to secure shareholder acquiescence. If this ment phases. He has specified the conditions
CONSTRAINED MAXIMIZATION problem is to be under which an economic system is stable,
solved by choice of output level alone, then conditions which often coincide with the
it can be shown that with increasing MAR- requirements for static stability. The inti-
GINAL COSTS, price will be lower and output mate, formal dependence between compara-
higher than would otherwise be the case if tive statics and dynamics Samuelson called
the firm chose a profit maximizing level of the Correspondence Principle. In his 'Inter-
output. Once ADVERTISING is also included as action between the Multiplier Analysis and
a CHOICE VARIABLE either advertising or out- the Principle of Acceleration' (Review of
put must be higher than profit maximizing Economic Statistics, 1939) he analysed the
levels, but not necessarily both. process, which has become a mainstay of
384 Samuelson test
TRADE CYCLE analysis. In the debate on capi- POSSIBILITY CURVE for the second bundle lies
tal and growth in the 1960s with Cambridge, entirely outwith that of the first.
England, he upheld the NEO-CLASSICAL con-
cept of capital but without complete success satiation (also known as saturation). The
as became evident in the controversy over phenomenon of 'having enough' of a GOOD.
RESWITCHING. Samuelson has also elaborated More formally, the UTILITY attached to an
the conditions for economic efficiency over- extra unit of the good beyond its satiation
time, in particular in his TURNPIKE theorem, level is zero or negative, i.e. it creates zero
which defines conditions for maximal utility or DISUTILITY.
growth.
In CONSUMER DEMAND THEORY his ap- satisficing behaviour. Conduct aimed at
proach has been the opposite to that most achieving satisfactory ASPIRATION LEVELS of
commonly adopted, i.e. the development of the objectives of decision-making and which
theorems about consumer behaviour based may not therefore involve maximizing any-
on deductive methods, for he has defined thing (e.g. profits). The concept of satisfic-
preferences on the basis of observed behav- ing behaviour is an integral feature of
iour or 'REVEALED PREFERENCES' as they are BEHAVIOURAL THEORIES OF THE FIRM.
called. In WELFARE ECONOMICS he has estab-
lished the SAMUELSON TESTS as criteria for savings. All income not spent on goods
judging whether welfare will be improved by and services which are used for current con-
some change; all other criteria are but sumption. Both firms and households save.
special cases of his tests. (See PERSONAL SAVINGS, COMPANY SAVINGS.)
In INTERNATIONAL ECONOMICS Samuelson
has made many definitive contributions. savings and loan associations. Corporations
With Stolper he developed the theorem organized either as mutual or capital stock
which bears their name and which states that institutions to accept savings from the public
FREE TRADE reduces the income of the scarce and to invest their funds primarily in mort-
factor of production. He has gone on from gages. (See FEDERAL HOME LOAN BANK
this to elucidate in a HECKSCHER-OHLIN SYSTEM.)
framework the conditions necessary for FAC-
TOR PRICE EQUALIZATION. His treatment of savings function. The schedule detailing
t h e TRANSFER PROBLEM a n d Of t h e GAINS FROM the relationship between aggregate savings
TRADE are both rigorous and classic state- (S) and income (Y) i.e. S = S(Y). Savings
ments of the current position. may be related to either NATIONAL or DISPOS-
In PUBLIC FINANCE his pure theory of ABLE INCOME. The precise properties of the
public expenditure, which attempts to deter- savings function are the inverse of those of
mine the optimal allocation of resources in CONSUMPTION FUNCTION, since Y = C + S.
the presence of both PRIVATE and PUBLIC
GOODS, is a seminal work. savings-investment approach to the balance
Despite being a prolific writer Samuelson of payments. The savings-investment
has written, as opposed to edited, just two approach to BALANCE OF PAYMENTS equilib-
books, which are The Foundations of rium concentrates on the KEYNESIAN re-
Economic Analysis (1948) and a very suc- lationship between SAVINGS and INVESTMENT
cessful introductory text, Economics (1945), to explain the position of the current account
now in its fourteenth edition. of the balance of payments, for the differ-
ence between the exports of goods and ser-
vices, X, and imports of goods and services,
Samuelson test. According to this test one M, is the counterpart of the difference be-
situation is potentially superior in welfare tween aggregate domestic savings, S, and
terms to another if for every distribution of aggregate domestic investment, /, i.e. X —
the commodity bundle in the first situation M = S - I. For the current balance to
there exists some distribution of the second improve S must rise in relation to /.
commodity bundle in which at least one
person is better-off and nobody is worse- Say, Jean-Baptiste (1767-1832). French
off. This implies that the POINT UTILITY businessman turned economist, Say was
schooling functions 385
education, particularly that of the mother, (1947), that capitalism would give way to
may be said to increase the ability to learn socialism not because of its failures (as MARX
and possibly also increase the 'taste' for edu- argued) but because of its success. The capi-
cation. Greater ability increases the demand talist unit of production will become ex-
for education, ceteris paribus. Family size tremely large, will be run by de facto
and family income enter on the costs side; bureaucrats, divorced from the owners and
the larger the family size and the smaller the with no interest in the ownership, will lose
family income, the greater are the costs of its raison d'etre and its apologists, and will
education, ceteris paribus. Interestingly, be taken over by the state. His final work,
differences in educational levels among incomplete at the time of his death was a
males appear to be largely a function of monumental and outstanding History of
demand factors whereas for females cost Economic Analysis (1954).
constraints appear more important. For
further reading see Mincer, J, (1979) scientific tariff. A TARIFF or tariff struc-
Schooling, Experience and Earnings, ture, which achieves the policy ends, often
NBER, New York. non-economic such as national indepen-
dence or military preparedness, at minimum
Schultz, Theodore W. (1902- ). American cost to society. This is done by minimizing
economist and professor at the University of the cost of achieving each amount of benefit
Chicago, he was joint winner of the 1979 by adjusting the structure of tariff rates in
Nobel Prize in Economics. His major work order to equalize the ratio of marginal bene-
has been in the field of agricultural econ- fit to marginal cost in each industry pro-
omics but he is also known as a pioneer in tected and of maximizing the benefits of
the field of HUMAN CAPITAL. protection by selecting the general level of pro-
tection at which the marginal value of bene-
Schumpeter, Joseph A. (1883-1950). fit equals the marginal cost of protection.
Born and educated in Vienna, Schumpeter
was more a disciple of WALRAS than of the Scitovsky paradox. The paradox arises if a
AUSTRIAN SCHOOL. Though at times during move from allocation A to allocation B rep-
his life he had been a lawyer, a finance resents a POTENTIAL PARETO IMPROVEMENT but
minister and a banker, he is best known as that those who do lose in the move would
an academic scholar of very wide interests in gain sufficiently from a return to A to enable
the social sciences. His major chairs were at them to bribe the gainers to move back to
Bonn and at Harvard from 1932 until his the original allocation. The underlying cause
death. of the paradox is that the relative valuations
He was a pioneer of TRADE CYCLE analysis of a bundle of goods will depend on the way
(Business Cycles, 1939) and of ECONOMIC in which the bundle is distributed. (See also
DEVELOPMENT (Theory of Economic SCITOVSKY REVERSAL CRITERION.)
Development, 1912), in both of which the
entrepreneur plays the leading role. The Scitovsky reversal criterion. Scitovsky
entrepreneur is responsible for the inno- noted that the application of the KALDOR-
vation, which may be, fry example, a new HICKS TEST might lead one to view state B as
product, a new technique, a new market or a preferred to state A but once in state B,
new method of organization. His action is application of the test might show A to be
then imitated, so that innovations come in better than B. In order to avoid this possi-
clusters and cause the boom: the depression bility Scitovsky introduced his reversal cri-
is a process of adaptation to changed con- terion which essentially requires the move to
ditions introduced in the boom. Schumpeter B to pass the Kaldor-Hicks test but the move
is also remembered for his theory of interest, back to A to fail the test.
for he argued that the rate of interest would
be zero in the absence of systematic TIME screening hypothesis. The argument that
PREFERENCE and a dynamic mechanism in the education has little direct productivity-
economy. increasing effect; rather, education acts pri-
A writer of great vision, he argued in marily as a filter, or screening device, to
his Capitalism, Socialism and Democracy identify pre-existing talents of intelligence,
! till
secular supply curve
perseverance and motivation that employers lapse of the property boom in 1974, a n
find attractive. Thus the function of edu- ber of these institutions got into difficul
cation is not viewed as conferring skill and In this phase, known as the 'secondary b;
therefore productivity and higher wages on ing crisis', some houses collapsed, ot
the worker, but rather to certify his 'traina- were propped up by the 'LIFEBOAT' opera
bility', productivity being almost exclusively initiated by the BANK OF ENGLAND. It sh<
acquired on-the-job. On this view, the social be noted that the term 'secondary bank'
returns to education lie considerably below been used differently to denote all rei
the private returns. nized banks, other than the clearing
savings banks, operating in the UK.
scrip issue.
See BONUS ISSUE. secondary market. j
See PRIMARY MARKET. [
SDR. Special Drawing Right. (See INTER-
NATIONAL MONETARY FUND.) secondary workers. Those groups w
attachment to the labour force is less per)
search costs. nent than those of PRIMARY WORKERS. TJ
See JOB SEARCH. include married women, teenagers and oj
workers (65 years of age or above). SJ
search unemployment. groups are likely to have highly-valued |
See JOB SEARCH. tions outside of the labour market relativ^
the wage they can earn in market wd
seasonal adjustment. A name of any pro- Thus married women with children tend
cedure by which seasonal influences are have high-valued options in the home; t
taken into account, or (more usually) nagers have the alternative of educatio
removed from data. The most common activities; and older workers may plaa
method is the calculation of MOVING AVER- high value on leisure.
AGES. (See FILTER, DUMMY VARIABLE.)
second-best. The second-best theore
seasonal unemployment. Unemployment formulated by R.G. Lipsey and |
that results from the seasonal pattern of Lancaster, states that if one of the conditic
work in certain industries. The agricultural, for PARETO OPTIMALITY cannot be fulfill
construction and tourist industries have all then the best attainable situation (i
traditionally exhibited a marked seasonal second-best optimum) can, in general, o
pattern in employment - an element of be achieved by departing from all the otl
STRUCTURAL UNEMPLOYMENT. Paretian conditions.
the curve can be viewed as horizontal. In this the SEC. In addition to regulatory powers,
'Malthusian' range (see IRON LAW OF WAGES), the SEC influences the securities industry by
each member of the population must work investigations, both of specific improprieties
to live. As countries begin to industrialize (e.g., trading based on confidential infor-
the curve bends backward; within this real mation) and of general practices in which no
income range consumption patterns tend not impropriety is involved (e.g., commission
to change so that the family need send fewer charges). The investigations and consequent
of its members to market-place to achieve publicity impel more efficient self-regulation
customary consumption levels. The curve on market organizations such as the New
next enters a forward rising zone as expec- York Stock Exchange.
tations are revised upward with further
industrial development. In the penultimate Securities and Investment Board (SIB)
stage, the supply curve appears more or less See BIG BANG.
vertical. Earlier retirement and greater
access to full-time education depress partici- securitization. An alternative term to DIS-
pation rates but this movement is almost INTERMEDIATION, it describes the direct
exactly offset by rising levels of female par- financing of a company's monetary needs via
ticipation, reflecting a decline in the amount the capital market and the use of instru-
of time it is economical for the wife to ments SUCh as BILLS OF EXCHANGE, ACCEPT-
devote to the production of home goods. ANCES and bond issues in the place of
Finally the curve is assumed to-bend back- borrowing from commercial banks. While
ward again to reflect the leisure revolution the original stimulus to disintermediation
attendant upon major technological ad- was to avoid monetary regulation, the more
vances. We do not appear yet to have recent forces include the world-wide liberali-
entered this segment of the secular supply zation and deregulation of financial services
curve, which might thus be termed the 'nir- and the availability of sophisticated elec-
vana' zone. tronic processing, which has made it possible
to introduce and monitor complicated new
secular trend (also known as the TREND.) financial transactions. Though commercial
The word 'secular' indicates that it is the banks have lost on-balance sheet business,
trend computed for a long run of DATA. they have increased their off-balance sheet
business by acting more like merchant or
secured loan stock. investment banks.
See FINANCIAL CAPITAL. The term has also acquired a more specific
meaning, particularly in the USA, where it
securities. A loose term embracing a wide describes the sale by banks of poorly per-
range of financial ASSETS, e.g. gilt-edged forming debt, especially that of developing
stock, EQUITIES and DEBENTURES. Short-term debtor countries, for whatever can be ob-
assets like bills are sometimes included, but tained in the market. A bank loan is trans-
the word tends to refer to longer-term formed into a security.
assets.
seignorage. Historically, and as applied to
Securities and Exchange Commission money, this was a levy on metals brought to
(SEC). An independent agency of the US a MINT for coining, to cover the cost of mint-
government set up in 1934 which acts as the ing and provide a revenue to the ruler who
chief regulator of the SECURITIES industry. claimed it as a prerogative. In recent mone-
There are five commissioners, usually securi- tary literature the term has been revived and
ties law specialists, and a staff of about 1500. applied to the net revenue derived by any
Before an issue of securities may be offered money-issuing body, e.g. a note-issuing
for public sale, the SEC examines a required authority. It is applied more especially to a
registration statement giving complete infor- country whose currency is held by foreigners
mation on the securities and on the financial for trading or reserve purposes. In this case
and managerial conditions of the issuing the seignorage amounts to the return on the
company. Brokers, dealers, and stock extra assets, real or financial, which the
exchanges are also required to register with country is enabled to acquire because of the
separability of preferences
external holdings of its currency, less the the part of the working populatic
interest paid on the assets in which the for- Malthus had claimed. A rise in living
eigners invest their holdings, and less any dards provides an automatic check o
extra administrative costs arising from the growth of population as each generatio
international role of its money. proves its living standards at the exper
child-rearing.
self-liquidating. A loan or other financial Senior was an exponent of the subje
transaction which has a low risk and a built- theory of value and attempted to recc
in procedure for ending the loan and clear- Ricardian value theory with utility ana
ing the debt, for example, HIRE PURCHASE or He adopted a cost of production theo
bridging loans given by banks to enable an value which included the cost of ca
individual to purchase a new house while in under the term ABSTINENCE. In Senior's
the process of selling the previous one. abstinence refers to the sacrifice mad
creating new capital. Saving is necessar
self-liquidating advances. A traditional this creation, but saving is only made j
precept of British banking has been that ible by abstention from current consump
'self-liquidating' forms of credit are the of income. The cost of such abstention
safest type of lending for a banker. These tributes to the value of a commodity, IN
are advances (including bills discounted) EST is seen as the reward for abstaining f
made to finance trading and production that consumption. Senior's major wori
operations which, in the normal course of economics was An Outline of the Scienc
business, will result in sales and hence pro- Political Economy (1836).
duce the means of repaying the advances.
The doctrine contains a fallacy of compo- seniority practices. Methods of regula
sition: the self-liquidating character of one promotion, demotion and lay-off withi
advance usually depends on the making of a unit of a firm according to the seniority
further advance at a later point in the chain the worker. Seniority rights can be viewei
of production or distribution. Thus the tota- beneficial to management and not simpl;
lity of such credit cannot be self-liquidating. unions and workers. The interests of the
parties conflict only to the extent that sen
self-regulating organizations (SROs) ity and ability are uncorrelated. And
See BIG BANG . cause experience with an employer
valuable, the correlation is often high. Thl
semi log. A method of illustrating econ- is then to some extent a natural senio
omic variables which change over time. For system built on PROFIT MAXIMIZATI
example, if income growth is constant, data Moreover, the use of 'objective', negotia
may be plotted as a straight line on graph decision rules reduces uncertainty in ind
paper which has the logarithm of income on trial relations and lessens strike frequency
the vertical scale and time on the horizontal 1
scale. sensitivity analysis. Sensitivity analysis I
volves changing the PARAMETERS of a <j
Senior, Nassau W. (1790-1864). An cision problem and studying how this aff&
English economist, Senior was twice the outcome. It is particularly associat
Drummond Professor of Political Economy with COST-BENEFIT ANALYSIS, where the m<
at Oxford. He was both an academic and common form is the use of alternative d
a
public servant. Senior modified the count rates. The purpose of the analysis is
Malthusian theory of population. Population identify the important assumptions up<
growth could occur without reducing the which the analysis is based - those to whi>
population to subsistence level since each the outcome is sensitive.
generation had a desire to improve its stan-
dard of living. The desire to move up the separability of preferences. In consum
scale of consumption from what Senior theory the partitioning of commodities into
called 'necessities' through 'decencies' to number of groups such that consum*
'luxuries' would allow income growth, and preferences within each group can be treate
there was no need for 'moral restraint' on independently of the other groups. j
390 separation of ownership from control
For example if four commodities X\,x2,x3 equation. Nth order serial correlation is the
and x4 are arguments in the utility function correlation of the current value of the RESI-
but x\ and x2 are separable from x3 and x4 DUAL with its value N periods ago. First
then the utility function can be written as order serial correlation therefore implies
u = u(xu x2,x3,x4) that the residual follows a first order MARKOV
PROCESS of the form
= v[ul(xl,x2), u2(x3,x4)] (1)
This is called weak separability. The number
of goods in each group may vary and some where et is the residual
vt is a STOCHASTIC disturbance, and
may contain one or many goods.
Separability allows two-stage budgeting p is the autocorrelation coefficient.
where the consumer initially allocates The term autocorrelation usually denotes
expenditure to groups of goods (i.e. heating, the version of the problem which occurs in
food, transport) before deciding at the CROSS-SECTION rather than TIME-SERIES data,
second stage what kind of heating or what in which the residual for one observation is
foods to buy. Linked to weak separability is correlated with those for other observations.
the notion of implicit or quasi separability The major consequence of the problem is
where the prices in the corresponding cost that the ORDINARY LEAST SQUARES estimator
function are separated into groups instead of is not the BEST LINEAR UNBIASED ESTIMATOR in
the quantities in the direct utility function as that it does not yield estimates with mini-
above. mum VARIANCE. The estimates of the para-
An empirically useful assumption is that meter variances will also be biased
of strong or additive separability. Then the downwards. If serial correlation is found to
function (1) above is written as the ADDITIVE exist, therefore, special econometric pro-
UTILITY FUNCTION. cedures should be employed to correct for
the problem. (See also DURBIN-WATSON, DUR-
BIN H-TEST, VON NEUMANN RATIO, GENERA-
= F[Ul{xux2), u2(x3,x4)] LIZED LEAST SQUARES.)
As t approaches infinity this geometric pro- to $50,000 in 1955 and to $1,000,000 for
gression converges to corporations in 1974.
D shift effect hypothesis. The argument that
INCOMES POLICY might have the effect of
With STEADY-STATE growth conditions the shifting the PHILLIPS CURVE to the left, thus
dividend will grow at a constant rate gD. generating a lower rate of wage and/or price
This can be treated as a negative discount inflation for given values of their determi-
rate and thus the share price expression is nants - principally the level of unemploy-
ment. Tests of the hypothesis conventionally
D use a SIMULATION approach or shift DUMMY
P VARIABLES.
i-gD •
takes no account of linkages between the become short-dated simply with the passage
industries of a region and that, for example, of time.
a fast growing industry may promote growth
in other industries in the region which supply short run. The time period in the pro-
inputs to it. Second, it must be recognized duction process during which the fixed FAC-
that industrial classifications are to some de- TORS OF PRODUCTION cannot be changed, but
gree arbitrary and we cannot be sure that the the level of utilization of variable factors can
industry which we have called A in one re- be altered. The concept was introduced by
gion is identical to what we have called A in Alfred MARSHALL.
the nation at large. Third, shift-share analy-
sis offers no explanation of the 'residual' or
'unexplained' fraction of growth. short-run average cost.
See AVERAGE COST.
shirking model.
See EFFICIENCY WAGE THEORY. short-run consumption function. The
functional relationship between consump-
shock effect. An argument analogous to tion and income over the period of the TRADE
that employed in the ECONOMY OF HIGH CYCLE. Studies of year on year changes in
WAGES. In this case, it is argued that a sud- income and consumption for periods of up to
den increase in wages will increase the pro- 10 years or so found a close relation between
ductivity of management by eliminating the two. Generally years with lower than
sources of slack or X-EFFICIENCY that are said average levels of income tended to be years
to exist in most companies. Faced by a threat of lower than average consumption and vice
to the organization, management will im- versa. These studies found:
prove its utilization of labour input and, as a 1. MARGINAL PROPENSITY TO CONSUME <
result of innovations in technique or organi- 1, but typically greater than that found in
zational method, labour's MARGINAL PHYSI- cross section studies;
CAL PRODUCT will increase. However, 2. marginal propensity to consume <
managerial slack is likely to be a function of average propensity to consume and there-
market power, and here the incentive to fore an average propensity to consume
increase the efficiency of input utilization is which declines as income rises;
arguably much reduced. Moreover,
3. the marginal propensity to consume
although the shock effect is much espoused
was a constant.
by union bargainers, the argument requires
These suggested a straight-line CONSUMP-
there to be repeated waves of improved
TION FUNCTION with a positive intercept, that
methods consequent upon annual wage
is
increases.
C = a + bY
shop steward. An appointed or elected These findings support all but one of the
representative of a workgroup who furthers propositions of Keynes' ABSOLUTE INCOME
the interests of employees in a plant or shop HYPOTHESIS on the shape of the consumption
in matters such as pay and conditions of function - they do not reveal a declining
employment. Usually the task is unpaid marginal propensity to consume with rising
although itself conducted during working income. {See CONSUMPTION FUNCTION, LONG-
hours without loss of pay. In most cases shop R U N CONSUMPTION FUNCTION, CROSS-SECTION
stewards are official representatives of the CONSUMPTION FUNCTION.)
union although their exact status and duties
are often ill-defined.
short-run marginal cost.
short-dated securities. Debt securities, See MARGINAL COST.
e.g. DEBENTURES or GILT-EDGED, which have
only a short period to run, usually not more short-time working. Refers to workers
than five years, to their REDEMPTION DATES. who are working fewer hours than the STAN-
Such securities may have been issued with DARD WORKING WEEK specified in their labour
a near maturity date, or they may have contract. (See GUARANTEED WEEK.)
394 SIC
be used to gain UNBIASED estimates of the sinking fund. The regular setting aside oj
parameters of a simultaneous equation (see funds with the purpose of repaying debt, oi
B EST LINEAR UNBIASED ESTIMATOR), and for the DEPRECIATION of CAPITAL equipment.
special econometric procedures must be The sinking fund method of depreciation
employed. (See INDIRECT LEAST SQUARES, ensures that the full capital invested in a
jWO STAGE LEAST SQUARES, THREE STAGE project is recovered at the end of a project's
LEAST SQUARES, FULL INFORMATION MAXIMUM life. The aggregate annual provisions are less
LIKELIHOOD.) than the total amount of initial CAPITAL
EXPENDITURE to be recovered since the
single equation estimator (SE). An ESTI- annual provisions can be invested in the
MATOR which is used to gain parameter esti- periods between being set aside and the end
mates of only one equation at a time in a of the project's life.
SIMULTANEOUS EQUATION system, and which
effectively ignores the CORRELATION of RESI- Sismondi, Jean (1773-1842). Swiss-born
DUALS between equations. An example is economist. In his first work, De la richesse
TWO STAGE LEAST SQUARES. (See LIMITED IN- commerciale (1803), he showed himself to be
FORMATION, SYSTEMS ESTIMATOR.) a follower of Adam SMITH, stressing the har-
mony of interests, the necessity of LAISSEZ-
FAIRE and the folly of government inter-
Single European Act (SEA). This agree- ference. Sixteen years later in Nouveaux
ment within the framework of the EUROPEAN principes d' economie politique (1819), he
COMMUNITY (EC) became operative on 1st had become disillusioned with laissez-faire
July 1987. The SEA intended that policy for he stressed the evils which flowed from
development within the EC should have the unrestrained competition, especially the
objective of a single market in place by the overproduction of goods and services, which
end of 1992, with the free movement of he attributed directly to DIVISION OF LABOUR
capital, labour, services and goods replacing and large scale production. He argued that
the unco-ordinated arrangements existing up when working for himself a man knows
to 1987. The SEA also strengthened areas of when enough has been produced: when
policy and introduced others, in particular working for others he cannot know this.
environmental issues, health and safety at Laissez-faire leads to suffering, so that gov-
work and economic and social cohesion with ernment intervention must take place to,
the aims of ensuring the full participation of regulate and moderate the pace of the pur-
the weaker members. Foreign policy co- suit of wealth. Sismondi attacked inventions'
operation was also included with a special which displaced existing processes of pro-
secretariat in Brussels. Majority voting will duction and supported only those which
facilitate decisions on the internal market catered for an extended demand. His work
and the other issues covered but unanimous represented less a body of doctrine than a
voting has been retained for some areas of voice of protest, which influenced later
decision-making. The SEA means that the socialist writers.
institutions of the EC will become increas-
ingly involved in matters regarded with some
sensitivity by member states, but the expec- situation utility possibility frontier. The
envelope of a set of POINT UTILITY POSSIBILITY
tation is that the benefits of a full internal
market will outweigh any costs. CURVES. Sometimes known as the welfare
frontier, it is the locus of overall PARETO
OPTIMA and shows the maximum possible
singular matrix. A MATRIX whose DETERMI- level of utility for one individual for different
NANT is equal to zero, because of LINEAR given utility levels for other individuals.
DEPENDENCE, between some of its rows or
columns, i.e. a matrix whose RANK is not size distribution of firms. A FREQUENCY
equal to its size. Such a matrix has no in- DISTRIBUTION where firms belonging to one
verse. If the matrix of coefficients of a set of industry or sector of the economy are classi-
SIMULTANEOUS EQUATIONS is singular, then it fied according to size. Size can be measured
is impossible to find a unique solution to that using a variety of indicators including sales,
s
et of equations. VALUE-ADDED, total assets and employment.
396 skewed distribution
His Inquiry into the Nature and Causes of PUBLIC FINANCE, including a discussion of his
the Wealth of Nations (1776) was the first full famous canons of taxation.
scale treatise in economics, covering pro- Though SCHUMPETER in his History of
duction and distribution theory, reviewing Economic Analysis (1954) has written that
the past in the light of these principles and '. . . The Wealth of Nations does not contain
concluding with policy applications. His a single analytic idea, principle, or method
main preoccupation was with economic that was entirely new in 1776' it was never-
growth, and the engine of growth he found theless a great achievement, since the time
in the DIVISION OF LABOUR, which leads to had come for the type of co-ordination of
increased output, TECHNICAL PROGRESS and which Smith was capable. Smith's major
even CAPITAL ACCUMULATION. Division of theoretical achievement was to take the first
labour implies the need to exchange and is steps towards a theory of the optimal
limited by the extent of the market. efficient allocation of resources under con-
Exchange takes place because each man is ditions of free competition. It is said that
prompted by self-interest in his desire for the before Smith there was economic discussion
goods of others. The other element promot- and that after Smith people discussed econ-
ing growth is capital accumulation, for which omics. (See CLASSICAL ECONOMICS.)
Smith makes parsimony the basis. For
growth to succeed the social, institutional snake.
and legal framework must be correct and See EUROPEAN MONETARY SYSTEM.
Smith argues for 'the obvious and simple
system of natural liberty', where each man, snob effect. The effect whereby as the
in promoting his own interest, is led price of a good falls and some sections of the
(through a harmony of interests) to promote community expand their demand for the
those of society, though he does not intend good, other sections or individuals reduce
this. Smith is in fact relying upon a system of their demand in order to differentiate them-
free competition, which has its own powers selves from the general trend. That is, they
of regulation and which economists have tend to do the opposite to the general trend.
recognized can lead to an optimal allocation The effect is that the MARKET DEMAND CURVE
of resources. Smith has shown himself aware may exhibit a steeper slope than would
of this principle in his description of an opti- otherwise be predicted from a straight-
mal investment pattern for a country. forward aggregation of individual demand
Though he argued for LAISSEZ-FAIRE, Smith curves.
recognized the need for state intervention,
e.g. a tariff for infant industries and for the social benefit. The sum of the gains or
three functions of the state - security, justice benefits deriving from an activity or project
and certain public works. to whomsoever they accrue. These are the
Apart from his model of growth, Smith relevant benefits for inclusion in COST-
also examined microeconomic issues, PRICES BENEFIT ANALYSIS but should not include
he argued were determined by costs of pro- TRANSFER PAYMENTS. Occasionally used in a
duction, RENT was price determined, rather second sense to describe what might be
than price determining. He offered a com- called external benefits, i.e. the benefits to
pendium of theories to explain WAGES, in- others rather than to the individual who pre-
cluding a SUBSISTENCE theory and.had many, dominantly enjoys the private benefit.
still pertinent, remarks to make on the net
advantages of different occupations to social choice.
different people, PROFITS, Smith thought, See PUBLIC CHOICE.
would fall through time owing to compe-
tition and the increasing difficulty of finding social contract. A unanimous agreement
profitable outlets. (usually of a hypothetical or imaginary
He also examined different systems of nature) between all of the individuals com-
political economy and attacked the MERCAN- posing a society concerning the basic prin-
TILISTS and the PHYSIOCRATS and made a ciples upon which that society will operate.
strong case for foreign trade. Finally, more This concept was employed in eighteenth
than one-quarter of the book is devoted to and nineteenth century explanations of the
398 social cost
existence of nation states, but had fallen out cation, crime, housing and welfare services.
of favour till revised and reintroduced in the An alternative usage of the term is that of
justice theory of John Rawls. Rawls' concept certain RADICAL ECONOMISTS who describe
of DISTRIBUTIVE JUSTICE rests upon a form of their work regardless of subject area as
social contract. This use of the term should social economics.
not be confused with its application to a
temporary agreement between British TRADE Social Fund.
UNIONS and the Labour government of See BEVERIDGE REPORT.
1974-79 - which is discussed under INCOMES
POLICY. (See RAWLSIAN JUSTICE.) socialism. A term used to describe the
general doctrine that the ownership and con-
social cost. The social cost of a given out- trol of the means of production - capital and
put is defined as the sum of money which is land - should be held by the community as a
just adequate when paid as compensation to whole and administered in the interests of
restore to their original utility levels all who all. For Karl MARX socialism is an intermedi-
lose as a result of the production of the ate stage in the inevitable transformation of
output. The social cost is the OPPORTUNITY CAPITALISM into COMMUNISM. The socialist
COST to society (i.e. to all individuals in so- state is characterized by the dictatorship of
ciety) rather than just to one firm or indi- the PROLETARIAT and existence of scarcity.
vidual. One of the major reasons why social While in this sense socialism is a lower form
costs differ from the observed private costs is of communism, for many socialists it rep-
due to the existence of EXTERNALITIES or EX- resents a programme of social reform which
TERNAL COSTS. essentially maintains the capitalist structure.
For many, however, socialism is synony-
social decision rule. A procedure or mous with a PLANNED ECONOMY. In this
method of making choices between alterna- sense, a number of general characteristics of
tives which must be made by or on behalf of a socialist economy may be distinguished:
a group of individuals rather than a single (1) the concentration of power in the
individual. Thus a social decision rule is Communist Party representing the proletar-
required for choices concerning PUBLIC iat, (2) social ownership of the means of
GOODS or other elements of COLLECTIVE production, (3) central economic planning
CHOICE. (See SOCIAL WELFARE FUNCTION, PAR- and (4) the elimination of incomes from
ADOX OF VOTING.) property (rent, interest and profit). To the
extent that these characteristics exist in both
social discount rate. This is the rate used the MIXED MARKET ECONOMY and the planned
to discount collective or public investments. economy they may be broadly described as
There are three broad approaches towards socialist.
the determination of the social discount rate,
one of which emphasizes the SOCIAL TIME socially necessary labour.
PREFERENCE RATE, another the SOCIAL OPPOR- See LABOUR THEORY OF VALUE.
TUNITY COST OF CAPITAL and the third which
represents a synthesis of these two. The social marginal productivity criterion.
social time preference rate is not equal to the This criterion states that the total net contri-
social opportunity cost rate because of im- butions of a unit of investment to output
perfections in the capital market and be- should be considered when allocating re-
cause individuals' collective behaviour sources and not simply the part which
towards the future differs from their behav- accrues to private investors. The social mar-
iour as individuals. (See TEST DISCOUNT ginal productivity of capital should be
RATE.) equated in its various possible uses if re-
sources are to be allocated efficiently. Critics
social economics. The application of NEO- of the criterion have said that it does not
CLASSICAL economic theory to social policy. take sufficient account of the changes in the
The term 'social' is interpreted as widely or labour and managerial skills, in the volume
as narrowly as the individual author chooses, of saving, in the rate of population growth
although it usually encompasses health, edu- following from an investment in the present
social returns to education 399
period. It is also argued that where the may be faced with a choice between a num-
OPPORTUNITY COST of labour is zero the cri- ber of alternative situations all of which are
terion is subject to the same criticisms ap- PARETO OPTIMAL (i.e. in each situation we can
plied tO the CAPITAL TURNOVER CRITERION. only make anyone better-off by making
Some of these criticisms, especially those someone else worse-off). By introducing a
concerning the indirect effects of investment SOCIAL WELFARE FUNCTION, which represents
now, really result from the assumption of the welfare of society at large as some func-
different development objectives. {See MAR- tion of the welfare of the individuals forming
GINAL PER CAPITA REINVESTMENT QUOTIENT that society, we are able to choose the best
CRITERION.) of all the Pareto optimal situations - the
social optimum. In the diagram below, we
social opportunity cost of capital. It is have a two-person community. The line u-u
argued that the correct way to evaluate represents, in terms of each individual's UTI-
public sector investments is through con- LITY or well-being the various, alternative
sideration of the OPPORTUNITY COST to society Pareto optimal points possible while the w-w
of diverting resources from marginal private lines represent combinations of individual
sector projects to public sector ones. utility which give rise to equal levels of social
However, this does not imply that the appro- welfare. Higher w-w lines indicate higher
priate SOCIAL DISCOUNT RATE is the INTERNAL levels of social welfare. The point S is the
highest attainable level of social welfare and
RATE OF RETURN on marginal private projects
thus is the social optimum. Although the
because of the existence, for example, of
social optimum concept is usually employed
taxation and risk premia. It is suggested that
in Paretian welfare economics, it could be
the marginal rate of return on private invest-
formulated in terms of some other set of
ment when suitably adjusted generates an objectives.
appropriate discount rate.
social relations of production. The term
social optimum. That allocation of a so- used by MARX to define the social relation-
ciety's resources, pattern of production and ships between humans, which arise from a
distribution of output which is the 'best' particular set of MATERIAL FORCES OF PRO-
attainable according to some stated set of DUCTION. The most important relationship is
objectives. The concept is most usually that among the classes following frorr
employed in WELFARE ECONOMICS where we ownership of the means of production anc
determining the division of the total prod
uct. As the material forces of production
Utility of A change with economic development, thej
may come into conflict with the social rd
lations and give rise to the need for a social
revolution.
have been not inconsiderable, particularly Press, Oxford, 1957) that 'welfare' is an ethi-
where educational investment comes from cal concept since to define something as con-
funds that might otherwise have been used tributing to welfare is to make a VALUE
for consumption. Given the empirical elusi- JUDGEMENT about whether that thing is good
veness of such social benefits to schooling, or bad. Alternatively it has been argued that
however, estimates in this area can never be welfare should be equated with the satisfac-
more than an educated guess. (See ABILITY tion of individual preferences and regarded
AND EARNINGS, SCREENING HYPOTHESIS.) as a 'technical' term. On the whole, Little's
argument is the more widely accepted and
definitions of social welfare are usually
social time preference rate. Society's rate
regarded as VALUE JUDGEMENTS.
of time preference represents the rate at
which society is willing to trade consumption
between different time periods. If the rate social welfare function. A statement of a
was 10 per cent this would imply that an society's objectives in which the level of
additional unit of consumption in year 0 is SOCIAL WELFARE or well-being is represented
worth 1.1 additional units in year one. as a function of the way in which resources
Conversely, 1 unit in year one is worth are allocated. In the form in which this con-
cept was introduced by A. Bergson, social
welfare is generally made a function of the
1-1 levels of UTILITY of the individuals forming
the society. However, other variables can be
units now, since included. In this form the social welfare
function is essentially arbitrary since it is
imposed from outside the analysis and we
1-1 are provided with no guidance as to how it is
units will, at 10 per cent, cumulate to to be formulated. One might imagine it as
being decided upon by legislators, civil ser-
vants or in I.M.D. Little's phrase an 'ethical
1-1 X
' superman' (see his Critique of Welfare
Economics, 2nd edn, Oxford University
unit in year one. It is commonly argued, Press, Oxford, 1957). This concept has
although not universally agreed, that the proved to be useful in purely theoretical
social time preference rate is the appropriate analysis, permitting definition of the SOCIAL
SOCIAL DISCOUNT RATE. The social time OPTIMUM - the 'best' allocation of society's
preference rate is not equal to the market resources.
RATE OF INTEREST since individuals might not
K.J. ARROW has analysed the process by
express all their preferences concerning the
which a social welfare function may be for-
future in the market (particularly because of
mulated, arguing that a social welfare func-
imperfect capital markets). Also their
tion is only a valid concept if it is derived
preferences expressed as individuals might
from the preferences of the individuals com-
not be the same as their preferences when
posing the society. Arrow's analysis, pro-
they see themselves as part of society.
vided fully in his Social Choice and
Individual Values (2nd edn, Wiley, New
social welfare. The well-being of the York 1963), rests on the view that a social
society or community at large. In defining welfare function is equivalent to a DECISION
social welfare we face two sets of problems. RULE or 'constitution'. He then considers
The first problem concerns the 'social' whether a rule may be formulated which
aspect. In general, social welfare is seen fulfils certain 'reasonable' (sic) criteria.
as some aggregation of the welfare of These criteria are
individual members of a society - this raises 1. collective rationality - the social welfare
the question of how the aggregation is to function will indicate a choice between
be achieved. The second problem relates alternatives on the basis of any given pattern
to the concept of 'welfare'. I.M.D. Little of individual preferences concerning the
has argued (see his Critique of Welfare alternatives available;
Economics, 2nd edn, Oxford University 2. the PARETO PRINCIPLE; if every individual
spatial price discrimination 401
consumer, irrespective of location, the same on interest rates, might conflict with other
'delivered price', consumers at greater dis- policy aims. In effect, special deposits are an
tances will be paying less than the FOB price alternative to varying the RESERVE RATIO
plus transfer costs while consumers located requirement, a measure which most other
near the producer will be paying more than CENTRAL BANKS employ. Despite the fact that
this sum. Consequently, the practice discri- the only present requirement of UK banks is
minates in favour of consumers at great dis- that they maintain balances at the Bank of
tances and against those located near the England equal to 0.5 per cent of deposits
consumer. The practice of the producer and that control of the MONEY SUPPLY has
bearing some of the transfer costs is known been through interest rates, the Bank of
as 'freight absorption'. As with conventional England has retained the right to call for
'price discrimination' this policy is only poss- special deposits. (See DEBT MANAGEMENT.)
ible where the producer has some MONOPOLY
power and is only a profitable strategy if the Special Development Areas. Regions of
more distant consumers have a higher PRICE the UK within which firms were eligible until
ELASTICITY OF DEMAND for the "product than 1984 for the highest levels of government
the nearer consumers. (See BASING-POINT support available as part of REGIONAL POLICY.
SYSTEM.) These areas were established in 1967 orig-
inally in predominantly coal-mining areas of
Spearman's rank correlation. Scotland, Northern England and Wales as a
See RANK CORRELATION. response to very high local rates of unem-
ployment. At that time, the government
Special Areas. The first form of ASSISTED support available in these areas was signifi-
AREA to be established in the UK. Under the cantly higher than in the ordinary DEVELOP-
Special Areas Acts of 1934 and 1937 and the MENT AREAS but that difference was
Special Areas Reconstruction Act of 1936, subsequently reduced, and the boundaries of
various forms of assistance, including loans the areas were redrawn. The designation of
and subsidies for firms and the establishment Special Development Area came to an end
of trading estates, were made available in in 1984 when the various ASSISTED AREAS
these areas. The creation of the Special were regrouped and reclassified into two cat-
Areas in Scotland, Wales and Northern egories, Development Areas and
England was a response to high levels of Intermediate Areas, with revised but still
local unemployment and represents the first differing levels of financial assistance. (See
major step in UK REGIONAL POLICY. ASSISTED AREAS.)
economy under investigation has a mix of increasing use first of PAPER MONEY and thei
industry which differs from that of the nation of BANK DEPOSITS, appeared to strengthei
of which it forms a part. The coefficient is the theory, since a loss of gold due to ai
expressed as external deficit would reduce the cash re
serves of the banking system and so, accord
2 I Saj - San | ing to the theory of the CREDIT MULTIPLIER
(the two vertical lines indicate absolute induce a multiple contraction in the tota
values, i.e. ignoring positive or negative money supply. As an account of how tin
signs) where Saj is the share of industry a in gold standard worked, historically, tru
total industrial activity of region /, while San specie flow theory has come in for som<
is the share of industry a in total national criticism and modification, notably in th<
industrial activity. A region with an indus- light of Keynesian income and employmen
trial mix exactly matching that of the nation analysis: this showed that where a balance o
would have a coefficient of zero. The greater payments deficit (for example) was causec
the value of the coefficient the greater the by a decline in exports, or a switch of dom
extent to which the region's economic struc- estic expenditures towards imports, then
ture diverges from the national average and would be a contractionary effect on incom<
thus the more 'specialized' it is. (See CON- and employment, which would in turn re
CENTRATION, COEFFICIENT OF.) duce import demand, thus tending to mov(
the balance of payments in a favourabl*
specie. Precious metal in coined form. direction. However, though this process
(See MINT.) could be expected to operate more directly
and rapidly than the specie flow mechanism
specie flow mechanism. According to the the theory also showed that the inducec
traditional theory of the operation of the effects of the income and employmeni
GOLD STANDARD, a corrective mechanism by change would not proceed far enough tc
which deficits and surpluses in BALANCE OF remove the deficit on their own.
PAYMENTS would tend to be eliminated by An analysis similar to the specie flow
induced flows of gold. Thus the theory held mechanism has been developed from mone-
that a deficit country would experience a loss tarist analysis and is known as INTER-
of gold: its adverse payments position would NATIONAL MONETARISM.
cause its EXCHANGE RATE to depreciate to the I
'gold export point', i.e. that rate at which, specie points. Those levels of th(
given the gold values of the various curren- EXCHANGE RATE of a currency which is on <
cies adhering to the gold standard, it became GOLD STANDARD at which it becomes profi
profitable to purchase gold with the depre- table to move gold into or out of the
ciated currency and export it to other centres country. One of the consequences of
for conversion into their currencies. In the country adhering to an international golc
earliest formulation of the specie flow mech- standard is that if the exchange rate of it!
anism, by David HUME, the drain of gold currency depreciates by a small amount be
produced a simple decline in the deficit low its gold parity (i.e. the exchange value
country's quantity of money which in turn determined by its gold value), it become?
caused its general level of prices to fall rela- profitable to convert the currency into golc
tive to the price levels of other countries. and export this to other centres for conver-
This change in relative price levels, by mak- sion into their currencies (the profit being
ing the country's exports more competitive derived either from their using these curren-
abroad and its imports less competitive at cies to meet foreign debts, or by reconvert-
home, caused the country's BALANCE OF ing them into the original currency at its
TRADE to move 'favourably', i.e. towards a depreciated rate). The exchange rate at
surplus of exports over imports, and this which this takes place is known as the 'gold
improved the country's balance of pay- export point'. Similarly, there is a level
ments. Theoretically, this improvement above the gold parity at which it is profitable
would continue until the balance of pay- to move gold into the country, known as the
ments was once more in balance. The devel- 'gold import point'. The margin between
opment of modern monetary systems, with these points is determined by the small
404 specification error
differences between the buying and selling and thus making a PROFIT if prices or
prices of gold, normally maintained by the EXCHANGE RATES have changed. Speculators
CENTRAL BANK of a country on the gold stan- unlike hedgers are risk-lovers and maintain
dard, and by the costs of transporting gold open positions. Whereas a hedger maintains
between financial centres. (See SPECIE FLOW a closed position by matching a future ASSET
MECHANISM.) against a future LIABILITY, a speculator will
hold only the asset or liability, hoping that at
specification error. An econometric prob- the time the contract matures, events will
lem in which the form of the relationship to have moved in his favour. (See ARBITRAGE,
be estimated is wrongly specified, either EXCHANGE RATES, BEARS, BULLS, EXPEC-
through an incorrect form of function (e.g. TATIONS, HEDGING, RISK AVERSION.)
LINEAR instead of NON-LINEAR) or through
the omission of relevant variables, or in- speculative balances.
clusion of irrelevant variables. If the specifi- See MONEY, THE DEMAND FOR.
cation error involves anything other than the
inclusion of irrelevant variables, all esti- speculative boom. INVESTMENT in highly
mation techniques will result in biased para- risky projects but with high expected RATES
meter estimates. OF RETURN or CAPITAL GAIN in a period of
rapid economic expansion or BOOM. Such
specific tax. Generally, a tax imposed on investment is usually encouraged by naive
each unit of output of a good and not on the EXPECTATIONS that the boom will continue
value of output. (See AD VALOREM TAX.) indefinitely or at least long enough to enable
the original investor to sell his investment to
specific training. Training which produces another even less risk averse speculator and
skills which raise a worker's PRODUCTIVITY in by the availability of cheap bank borrowing.
only the firm providing the training. Such Such behaviour was notable in the boom
skills are to be distinguished from the trans- which preceded the great SLUMP which began
ferable skills produced by GENERAL TRAIN- in 1929 in the US.
ING. Neither workers nor firms have the
incentive to bear the full costs of specific speculative demand for money.
training, while the worker remains free to See MONEY, THE DEMAND FOR.
quit the job or the firm to dismiss the
worker. Accordingly the costs of specific speculative motive for holding money.
training are believed to be borne by both the See MONEY, THE DEMAND FOR.
firm and the worker. Specific skills can result
in IDIOSYNCRATIC EXCHANGE and are one speculative unemployment. An element
cause of the distinction made in INSIDER- Of FRICTIONAL UNEMPLOYMENT. M o r e aCCU-
OUTSIDER models. rately described as speculative UNDEREM-
PLOYMENT, it is suggested it arises as a result
spectral analysis. A technique by which of a fall in the real wage which is regarded as
the cyclical properties of a variable can be temporary. This will lead some workers to
established from TIME,SERIES data. This in- reduce their present supply of hours in
volves the estimation of a 'power spectrum' favour of offering more hours at the higher
which plots the strength of the component in rate expected to govern in the future. This
the data with a given frequency, against that may be regarded as temporal redistribution
frequency. A peak (or high value) in the of the hours of work the employees will offer
power spectrum for a certain frequency over their lifetimes in response to a tempor-
implies that there is a strong element in the ary fall in the real wage. (See PRECAUTION-
data with that frequency, for instance a peak ARY, SEARCH UNEMPLOYMENT.)
at a frequency of one cycle in five years may
indicate a strong business cycle influence in spillover.
the data. See EXTERNALITIES.
speculation. The practice of buying or sell- spillover hypothesis. The notion that im-
ing with the motive of then selling or buying portant wage settlements set a pattern which
Sraffa, Piero
demand does not enter into his system and Stackelberg. It is an extension of the COUR.
prices are determined on the basis of costs of NOT DUOPOLY MODEL incorporating the idea
production. of a 'sophisticated' duopolist who recognizes
that the competitor acts on the Cournot
stability. Generally used in the context of assumptions. The 'sophisticated' duopolist
PARTIAL Or GENERAL EQUILIBRIUM S y s t e m s tO will act like a monopolist incorporating the
refer to the extent to which an EQUILIBRIUM rival's predicted decisions into his consider-
price or set of prices will be secured despite ations becoming in effect a PRICE LEADER
any 'shocks' to the system which temporarily choosing the price which maximizes profits
move price away from its equilibrium level. subject to the known reaction of the rival
firm. Stable EQUILIBRIUM will be achieved as
stabilization. A NORMATIVE approach to in the Cournot model except that the
fluctuations in the level of economic activity. 'sophisticated' duopolist will have higher
The implicit assumption is that cycles or profits and the 'naive' duopolist will have
other irregularities in the time path of econ- lower profits. If both firms become 'sophisti-
omic variables should be smoothed out, by cated' then disequilibrium will result with
the use of policy instruments to achieve the necessity for collusion if a price war,
desirable values of policy TARGETS. Alterna- damaging to the profits of each duopolist, is
tively targets may be implied by the specifi- to be avoided.
cation Of a SOCIAL WELFARE FUNCTION,
OBJECTIVE FUNCTION Or LOSS FUNCTION, f r o m stag. A STOCK EXCHANGE colloquialism for
which strategies and decision rules may be someone who applies for a new issue of
derived to optimize the function. Such an SECURITIES in the expectation they will im-
approach to macroeconomics, in particular, mediately rise to a premium on the issue
follows naturally from the KEYNESIAN revolu- price, and can be sold at a profit before the
tion, with its advocacy of intervention to issue price has to be met.
attain certain objectives or targets such as
FULL EMPLOYMENT a n d ECONOMIC GROWTH, stages of growth.
using instruments such as FISCAL and MONE- See ROSTOW MODEL.
TARY POLICY.
The approach passes over the aggregation stagflation. Periods of recession and rising
problem of shifting from individual prefer- unemployment coupled with positive rates
ences to an aggregate social welfare func- of price INFLATION.
tion, which is usually explicitly specified
mathematically. J. TINBERGEN and H. Theil stamp duty. An old form of TAX first intro-
are considered originators of modern stabil- duced in the UK in 1694. Many kinds of
ization theory. legal and commercial documents are
required to be stamped to denote payment
stabilization function. The role of govern- of duty. Sometimes the duty is specific and in
ment in manipulating FISCAL and MONETARY others AD VALOREM depending on the value
POLICIES for the purpose of maintaining a of the property transferred and the amount
high and even level of economic activity. of consideration. The rates current in 1986
This function is one of the three economic are 0.5 per cent on the transfer of shares, 1
functions of government in a market econ- per cent on real estate above an exempt limit
omy identified by, among others, R.A. of £30,000 and 1.5 per cent on initial conver-
Musgrave. While some economists would sion of UK shares into AMERICAN DEPOSITORY
argue that the stabilization function requires RECEIPTS.
an active policy, others, notably the MONE-
TARISTS, claim that government should seek standard commodity. A construct used
merely to avoid causing disturbances to the by P. SRAFFA to understand the relationship
economy. (See ALLOCATION FUNCTION, DISTRI- between relative prices and the distribution
BUTION FUNCTION, DEMAND MANAGEMENT.) of income between wages and profits. The
standard commodity is a composite com-
Stackelberg's duopoly model. A model of modity constructed such that its price does
a two firm market developed by H. von not change when there are changes in the
standard working week 407
than paying out cash. In order to do this, a situation where there was no ready marke
firm must transfer funds from net profits to SAVING and INVESTMENT should be higher as
its capital account. r e s u l t . GOVERNMENT SECURITIES, ORDINA]
SHARES, PREFERENCE SHARES a n d DEBENTUR
stock exchange. A market in which the can all be quoted on a stock market. (S
SECURITIES issued by central government, STOCK EXCHANGE.)
local government bodies and PUBLIC COMPA-
NIES, other than BILLS and similar short-term stock option. The right to buy a giv<
instruments, are traded. Stock exchanges SECURITY (a 'call'), or to sell it (a 'put'), ai
are really associations of dealers in securi- determined price, over a period of tim
ties, i.e. in the UK STOCKBROKERS and MAR- usually three months, on the STO
KET MAKERS (formerly JOBBERS). In the UK EXCHANGE. The transactor taking out an c
until 1986 no firm could be both a stock- tion pays a price for it. Trading in sto
broker and marker maker, but now dual options is a form of forward dealing whi
capacity is permitted, though the operations may be undertaken as a speculation or a:
must be kept rigidly apart. On the London HEDGE against the risk of an unfavourai
Stock Exchange members no longer transact price movement. |
business on the 'floor' but deal with each
other by electronic communication. stocks.
Conditions of membership and codes of See INVENTORIES.
practice are regulated by the SECURITIES AND
INVESTMENTS BOARD and its subsidiary (self) Stolper-Samuelson Theorem. Using
regulatory bodies. Similarly, companies and HECKSCHER-OHLIN framework Stolper i
other security-issuing bodies have to meet SAMUELSON have shown that on certain
specific requirements if their issues are to be strictive assumptions international tr;
'listed' (or 'quoted') on an exchange. The necessarily lowers the real wage of the sea
existence of such a market is a vital con- FACTOR OF PRODUCTION without it be
dition of the provision of finance on the scale necessary to specify its pattern of consul
needed in a modern mixed economy, since it tion. A corollary to this proposition is 1
provides a SECONDARY MARKET in which protection necessarily raises the real wag<
ownership of claims created in the raising of the scarce factor.
finance can be transferred. The existence of
this facility encourages the holding of such Stone, Sir Richard (1913-91). Bri
claims, and hence the provision of financial economist; awarded the 1984 Nobel P
capital. (See NEW ISSUES MARKET.) in Economics for his pioneering resei
into the development of systems of NATIO
stock market. An institution where STOCKS ACCOUNTS, both in terms of their theorei
and SHARES are traded. They exist in all underpinning and their practical app
advanced Western countries. The arrange- tion. His early work, with J.E. MEADE,
ments for trading differ from one country to inspired by KEYNESIAN macroeconc
another. For example the Stock Exchange in analysis and led to the publication of
the UK has a system of MARKET MAKERS and first White Paper on NATIONAL INCOME
STOCKBROKERS who are respectively whole- expenditure for the UK in 1941.
salers and retailers in stocks and shares, a represented the breakthrough of a
feature which not all stock markets h ve. methodology, and the principles wo
The economic significance of a stock market out at that time have shaped nati
results from the increased marketability accounting practices in most countrie
resulting from a stock exchange share quo- the world. Apart from the period oi
tation. Investors know that they can quickly Second World War, Stone spent almo;
realize their holdings. In general this means his working life at Cambridge Univei
that companies wishing to raise EQUITY or where he was a Professor from 1955 to '
loan CAPITAL from the public can do so more His last major research was empirica
easily and cheaply as investors will be pre- search into growth in the Cambridge Gr
pared to purchase stocks with a ready mar- Project. His major publications are Nat
ket at a lower required return compared to a Income and Expenditure (1944) with
412 'stop-go'
example, in the case of an EXTERNAL ECON- will be replaced by 'piecewise linear' curves.
OMY, (3) to keep prices of certain goods low (See diagram.) For substitutes the CROSS
or stable, for example, as part of an anti- ELASTICITY OF DEMAND will be positive.
inflation policy. A further use of subsidies
is by multi-product firms engaging in CROSS- substitution effect. The effect on the
SUBSIDIZATION. demand for a good of a change in price of
that good assuming real income is held
subsistence. The minimum level of con- constant. The substitution effect is always
sumption necessary for existence. The con- negative, that is, as price rises the quant-
cept was used by the CLASSICAL ECONOMISTS
ity demanded falls and vice versa. Two
to explain the long run level of wages.
Wages were constrained to be at subsistence
level by population growth. (See MALTHUS.)
subsistence wage.
See IRON LAW OF WAGES.
and customary barriers to the efficient allo- associated with different techniques are
cation of resources such as the restrictive straight lines such that the GRAND FACTOR
practices of unions. The policy prescriptions PRICE FRONTIER does not entail the reintro-
that flow from this analysis typically take the duction of a previously abandoned tech-
form of lowering tax rates and introducing nique for changes in the rate of profit
measures designed to increase the degree of (i.e. as long as RES WITCHING does not occur).
competition in labour and product markets. (See P. Samuelson 'Parable and Realism in
Supply-side economics gained particular Capital Theory: The Surrogate Production
prominence in the early nineteen eighties Function', Review of Economic Studies,
with the election in the USA of a conserva- 1962).
tive government under President Reagan;
thus on occasions these ideas have been survivor technique. A statistical method
labelled 'Reaganomics'. They represent a re- of identifying the MINIMUM EFFICIENT SCALE
turn to orthodox CLASSICAL ECONOMICS and
OF PLANT OR FIRM, which is based on the
its recent more formal statement the NEW rationale that in competitive markets those
CLASSICAL MACROECONOMICS. See Bartlett,
plants/firms which survive the best in the
B., and Roth, T.P., eds, The Supply-Side
market place are those with minimum costs.
Solution, London, Macmillan (1984).
It thus follows that if a certain size of plant
or firm is accounting for an increasing pro-
surplus unit. Any economic unit whose portion of total industry output, this size lies
ASSETS are greater than its LIABILITIES, and is within the optimum size range and is there-
therefore willing to lend money, extend cre- fore of minimum efficient scale. The re-
dit, or purchase financial instruments. (See liability of estimates using this technique are
DEFICIT UNITS.) dependent upon the existence of competitive
conditions. This assumption has been one
surplus value. MARX applies the LABOUR source of criticism of this method. (See
THEORY OF VALUE to labour, in the sense that STATISTICAL COST ANALYSIS.)
the value of the total labour force (worker
and family) is equal to the number of hours
of labour necessary to produce the goods to sustainable development. The maximiz-
maintain the labour force intact. If a capita- ation of the net benefits of ECONOMIC DEVEL-
list hires a worker he must pay him a sum OPMENT, subject to maintaining the services
which will supply the worker and his family and quality of NATURAL RESOURCES over
with these necessary goods for the period of time. By the latter, environmental eco-
the hire, but because of the power situation nomists, who introduced the concept in the
in capitalism the worker is required to work 1980s, mean using renewable natural re-
for more hours than are necessary to pro- sources at rates below their regenerative ca-
duce these wage goods, and "the capitalist is pacity and non-renewable resources with
able to appropriate this surplus, which in the optimum efficiency, taking account in the
Marxian system is the sole source of PROFIT. latter of the substitution of TECHNOLOGICAL
PROGRESS for natural resources.
surrogate production function. In the
debate surrounding the CAPITAL CONTRO- swap arrangements. A method of improv-
VERSY a concept of the PRODUCTION FUNCTION ing LIQUIDITY arrangements developed in the
which implied some substitution between 1960s by swapping currencies. The CENTRAL
labour and capital in the long run was intro- BANKS of two countries would credit each
duced with the aim of allowing the use of other with an equivalent amount of the
derived demand functions for factors of pro- other's currency such that either government
duction in econometric work. These demand could draw on this extra FOREIGN EXCHANGE
functions would be derived 'as if (hence the reserve if necessary. It is usually for a speci-
name 'surrogate') the production function fied period of time, after which the trans-
existed. The difficulty arose because of the actions would be reversed at the original rate
non-malleability of capital (see MALLEABLE of exchange. (See INTERNATIONAL LIQUIDITY,
CAPITAL). The surrogate function is allow- INTERNATIONAL MONETARY FUND, EXCHANGE
able provided the FACTOR PRICE FRONTIERS RATE, BALANCE OF PAYMENTS.)
418 Sweezy, Paul
Sweezy, Paul (1910- ). American Marxist other major works include: Socialist Cuba:
economist, he co-founded the Monthly Anatomy of a Revolution (1960, with Leo
Review. He is best known for his work in Huberman); Socialism in Cuba (1966);
interpreting and presenting the economic Modern Capitalism and Other Essays (1972).
theory of Karl MARX in a manner which
allows comparison with modern economic
theory. The Theory of Capitalist Develop- systems estimator (also known as full infor-
ment (1942) is generally regarded as a stan- mation estimator). An ESTIMATOR which is
dard textbook in Marxian economics. used to gain estimates of all of the PARA-
Sweezy has been responsible for a treatment METERS in a simultaneous equation system at
of Marx which stresses the importance of the the same time, and which is used to gain
Keynesian concept of aggregate demand, estimates of all the parameters in a SIMUL-
arguing that both Marx and Keynes analysed TANEOUS EQUATION system at the same time,
the occurrence of unemployment in essen- and which takes into account any CORRE-
tially the same way. Monopoly Capital: an LATION between the RESIDUALS of different
Essay on the American Economic and Social equations. This type of estimator usually re-
Order (1966, with Paul BARAN) is a reinter- sults in better estimates (in the sense that
pretation of Marxian economic theory in the they have lower VARIANCES) than SINGLE
light of twentieth century developments in EQUATION Or LIMITED INFORMATION ESTI-
the world economy. Baran and Sweezy sub- MATORS, b u t are much m o r e expensive com-
stitute a law of rising ECONOMIC SURPLUS as a putationally. Examples include THREE STAGE
proportion of total output for the old LEAST SQUARES a n d FULL INFORMATION MAXI-
Marxist law of the falling rate of profit. His MUM LIKELIHOOD.
Taft-Hartley Act. A 1947 amendment of two previously independent compani
to the NATIONAL LABOUR RELATIONS ACT merger is usually used to cover those am
(Wagner Act), the Taft-Hartley Act was gamations which are agreed on a voluntj
designed to limit the power of unions. The basis between respective firms' sharehold
Wagner Act contained the key statement and directors.
'Employees shall have the right to self-
organisation . . .'. The Taft-Hartley Act
added the phrase, 'and shall also have the takeover bid. An attempt by an in
right to refrain from any or all of such activi- vidual, group or company to acquire s
ties'. While the Wagner Act clearly pre- ficient VOTING SHARES for control of anotl
vented businesses from interfering with company. Bids made by a PUBLIC COM?A
union activity, the Taft-Hartley Act had the for the VOTING SHARES of another public cc
effect of preventing unions from pressuring pany are usually made on the basis of c
rent STOCK MARKET VALUATIONS. The RAI
employees to join. It also provided some
additional restrictions on union activity, FIRM generally makes these bids in the fc
specifically prohibiting secondary boycotts of an offer of a proportionate number o
and certain kinds of picketing. One of its own shares, a cash payment per share c
most important provisions gave the Federal combination of both.
government the power to enjoin a union The motives underlying take-over bids
from striking if the industry was 'vital to varied. Commonly stated reasons are: i
national security'. Such injunctions allowed NOMIES OF SCALE, DIVERSIFICATION, t h e aC<
for a maximum 80-day 'cooling off period sition of larger financial resources
after which a strike could begin if manage- greater MARKET POWER. (See MERGER.)
ment and labour were unable to reach a
COLLECTIVE BARGAINING agreement. Taft-
tangible assets. Physical assets such
Hartley injunctions have been used spar-
plant and machinery, which are
ingly, but their threat has clearly led to les-
tinguished from intangible assets such as
sening use of strikes as bargaining tools in
value of a patent or a firm's GOODWILL.
vital industries. (See BARGAINING UNIT.)
take-home pay. Disposable income; gross- tap issue. The system by which GILT-ED
earned income less tax and national insur- stocks are continuously available for ]
ance contributions which are deducted at chase from the government broker in
source. London STOCK EXCHANGE. Issues of
stocks are made discontinuously, nomir
take-off. for sale on specified days. Stock not take
See ROSTOW MODEL. by the public on the date of issue, usua
large proportion of the amount on offe
takeover. The acquisition by a 'RAIDER' absorbed into the Issue Department oi
FIRM of more than 51 per cent of the voting BANK OF ENGLAND, which in effect un
shares of another company. The take-over writes all issues of gilt-edged. The sto(
process involves the raider company making then sold off in the market by the go\
a
bid to the shareholders of the 'VICTIM' COM- ment broker, 'through the tap', as m2
PANY; this can take the form of cash, loan conditions permit and at rates and p
stock or a new issue of shares in exchange consistent with official policy, TREA
for the shares of the victim company. BILLS are also issued through a tap, but
Though both MERGER and takeover are to government departments and ce
terms used with reference to the fusion public agencies. j
419
420 targets
important under a PROGRESSIVE income tax ation is liable for VAT on the selling prii
and means that a person receiving his but is allowed as a tax credit the amount
income at irregular intervals would pay more VAT which has been paid on purchases
tax than someone receiving the same income inputs. A common case arises with MUL
on a regular basis. In practice averaging pro- NATIONAL COMPANIES. An internatiot
visions for people such as authors and artists organization based in the UK and operati
help to maintain HORIZONTAL EQUITY. overseas will find itself in the situation wht
The appropriate definition of income it is paying income tax to the government
should take into account all income whether an overseas country on its profits arisi
it results from market transactions or not. there. It will also be liable for corporati
Thus food grown and consumed by farmers tax in the UK on these same profits,
should be included. Imputed rent accruing prevent DOUBLE TAXATION the UK system
to an owner-occupier should be a part of taxation allows the income tax levied by
taxable income. overseas country to be credited against
Income should be defined in net terms. tax due in the UK. The net result is that
Thus the cost of acquiring an income should organization pays the higher of the
be allowed as a deduction. In practice the taxes.
appropriate costs are often a matter of
dispute. tax credit scheme. An INCOME MAINT
ANCE programme in which everyone is g
taxation. Compulsory levies on private anteed a minimum income, while ino
individuals and organizations made by above that level is taxed. When a cei
government to raise revenue to finance income level is reached, the tax paid wi
expenditure on PUBLIC GOODS and services, just equal to the guaranteed payment -
and to control the volume of private expen- is the 'break-even' income level. This tyj
diture in the economy. Taxes are classified in programme is formally identical with
various ways. Some are called DIRECT TAXES, NEGATIVE INCOME TAX though there
examples of which are INCOME TAX and differences of emphasis in presenta
WEALTH TAX. Others are called INDIRECT Both types of scheme are characterize
TAXES. These are taxes on transactions, espe- (1) a minimum guaranteed income, i
cially expenditure. Examples are EXCISE 'break-even' income level, (3) a tax ra
DUTIES and VALUE-ADDED tax. any two of these are known, the thin
ment may be calculated (so long as we
tax base. fine ourselves to a single PROPORTION A
See TAXABLE INCOME. rate). Thus a guaranteed minimum in
of £100 plus a break-even level of
tax burden. implies a tax on income (other than th<
See AVERAGE RATE OF TAX. dit') of ten per cent. Proposals for s
system were put forward in the UK 1
tax credit. This is a credit given directly 1970-74 Conservative government bu
against a tax: the tax payable is reduced never adopted. A negative income tc
by the amount of the credit. It can apply tern has been operated in New Jersey,
in several different situations. In some
countries (for example Kenya) personal tax disincentive. An INCOME TA>
income tax credits are given instead of cause work effort to be reduced. Its
personal allowances against gross income. ence makes leisure relatively more ;
When an income tax credit is raised all ive, as it is not subject to taxation,
tax-payers benefit equally unlike the situa- termed the SUBSTITUTION EFFECT of t
tion with personal allowances under a PRO- The tax will also encourage some
GRESSIVE INCOME TAX system where an work longer hours to earn a highe
increase would benefit high income earners income so that his net income is not i
and tax payers more than those in low tax- so much as a result of the tax. T
paying positions. Another example relates effects thus pull in different directi
to VALUE-ADDED TAX. Under the system general it may be argued that the
employed in the EC a tax-paying organiz- tution effect operates more stron
422 tax expenditure
higher the MARGINAL RATES OF TAX and the alleged to have made wage changes less re-
income effect may operate more strongly sponsive to business cycle conditions. On
with high average rates. Much empirical this argument, then, there is a significant
work has been done to discover the effects in tendency for nominal wage demands to be
practice. In general the disincentive effects raised to catch-up a past short-fall of real or
have not been found to be strong for the desired after-tax earnings compared with
majority of tax-payers. There is some evi- their 'normally expected' increase. Tax
dence that the effect may be significant for thresholds that are not inflation indexed will
married women, and also for some people in result in a growing claw-back of income to
the highest tax-paying brackets. the state and threaten the desired increase in
There has been a considerable debate net earnings. Nominal wage claims will be
about the effect of taxation on INVESTMENT. notched-up accordingly and the rate of wage
The view that income taxation reduces the inflation increased. This is a controversial
return to investment, and thus causes a dis- hypothesis.
incentive to investment has been found to be
too simple. When the uncertainty of the out- tax shifting. The phenomenon whereby
come of an investment and the fact that most those on whom taxes are levied are able to
income tax systems have LOSS-OFFSETTING pass the burden either partly or fully on to ;
PROVISIONS are taken into account, the exist- others. (See INCIDENCE OF TAX for a dis- !
ence of income tax may not reduce the mean cussion of the conditions under which shift-
expected return from an incremental proj- ing takes place.)
ect: the government becomes a partner
which shares in both the losses and the gains
from the new project. In fact, because of the tax yield. The revenue collected from a
risk-sharing, investment could actually be TAX. The relationship between collection
increased as a result of the tax. The outcome costs and revenue from a tax is often a mat-
depends on several factors, such as the atti- ter of discussion. The elasticity of the tax
tude of investors towards risk and the variety yield in response to a given increase in
of assets available to investors. income is often analysed, especially in less
developed countries where a growing tax
tax expenditure. A term used to describe yield is particularly important.
the various allowances which may be used to
reduce tax liability - generally liability to t-distribution (also known as STUDENT'S T-
income tax. Examples include tax relief on DISTRIBUTION). A PROBABILITY DISTRI-
payments of MORTGAGE interest and depen- BUTION often used in HYPOTHESIS TESTS in
dants allowances. Tax expenditures are so small samples, and where the VARIANCE of
called on the grounds that they should be the variable concerned has to be estimated
seen as analogous to direct payments or sub- from the data. It is a bell-shaped distri-
sidies provided by the government. This is bution, with MEAN equal to zero, the disper-
said to be so in three ways; first, the granting sion around the mean being dependent on
of a tax allowance increases the recipient's the DEGREES OF FREEDOM dictated by the
income just as a direct payment would have sample size. The T-STATISTIC (or t-ratio as it is
done, second, the existence of a tax allow- sometimes called) is the most commonly
ance will influence the pattern of expendi- used TEST STATISTIC in quantitative economic
ture and third, granting a tax allowance analysis; and is defined as the ratio of a
reduces government revenue and thus alters NORMAL VARIABLE to a Chi-square variable
the government's net deficit or surplus in the divided by degrees of freedom. In the case of
same way as would an increase in expendi- tests of significance of parameter estimates
ture. Thus it is argued that analysis of the in REGRESSION analysis, the calculation of the
effects of PUBLIC EXPENDITURE should include t-statistic involves dividing the estimate of
the effects of tax allowances. the parameter by its estimated STANDARD
ERROR. The distribution of the t-statistic ap-
tax-push inflation. This is related to proaches that of the standard NORMAL VARI-
workers' interests in maintaining after-tax ABLE as the number of degrees of freedom
real wage growth and is one of the factors approaches infinity.
technological unemployment
I ill
term structure of interest rates 425
recallable at any time. The term loan was measures the rate of exchange via commodi-
a n American concept, first introduced by a ties between a unit of factor service time
British bank in 1959, and since then gener- in one country and factor service time in
ally adopted by UK banks. another.
terms of trade. A relationship between the term structure of interest rates. The struc-
prices of exports and the prices of imports. ture or relationship between interest rates,
When the concept is not further qualified or more strictly the REDEMPTION YIELDS, on
reference is being made to the net barter SECURITIES of different terms to maturity
terms of trade, which is the quotient be- (i.e. repayment). Typically, but not in-
tween an index of export prices and an index variably, this structure - which can be
of import prices. This is also known as the exhibited in a yield curve (see diagram) - is
commodity terms of trade. On the assump- one in which shorter-term assets produce
tion that the value of exports equals the lower yields than longer-term assets, and
value of imports, the gross barter terms of this has sometimes been regarded as in some
trade can be found by dividing the quantity sense a natural pattern.
of imports by the quantity of exports. The classical or expectations theory of the
Countries are concerned about move- term structure of interest rates is concerned
ments in the terms of trade, since an im- with 'pure' interest rates and therefore with
provement (a rise) in the net barter terms of the structure of rates on government debt,
trade implies that a given quantity of exports since private debt is assumed to involve an
now commands a larger volume of imports, element of investor risk. It starts by recog-
so that prima facie the standard of living nizing that an individual wishing to buy a
could increase. A rise in the relative price of financial asset can always hold a succession
exports may, however, lead to a fall in of short BONDS rather than hold a single
demand, so that while a unit of exports com- long-dated bond over the entire investment
mands more imports, total exports decline period. Similarly an individual wanting to
and with them the capacity to import. This hold bonds over a short period, say for two
has led to the notion of income terms of years, can always buy and then sell, holding
trade, where the net barter terms of trade successively for one year in each case two
are weighted by the volume of exports. This long-dated bonds which will not reach
gives an indication of the purchasing power maturity during the period. Therefore, if all
of exports. individuals have similar expectations about
A deterioration in the net barter terms of the future yields on short bonds and the
trade because of, for example, lower export future prices at which they can sell a longer-
prices does not necessarily imply a reduced dated bond held over the same period -
standard of living, if the decline in price is since unlike the short bond this will not
due to increased productivity. If productivity come to maturity - the total returns across
in exports rose by 20 per cent and prices ail securities should be the same over any
declined by less than this, a given input of given period.
factors would still command more imports, The possibility of a capital loss from hold-
so that while some of the productivity gain ing longer dated securities will therefore
is shared with other countries, welfare still lead to a higher interest rate on these securi-
increases within the country. The concept ties in order to induce people to hold them.
used to express this idea is the single factor- On this view, therefore, the different inter-
ial terms of trade, which is the net barter est rates for securities of differing maturity
terms of trade multiplied by an index of dates is explained by EXPECTATIONS about the
productivity change in the export industries. future prices of securities. It would seem to
The final measure of the terms of trade is the suggest a smooth continuum of gradually
double factorial terms of trade, in which rising interest rates as we move along the
the net barter terms of trade are multiplied spectrum from short to long-dated securities
by the quotient between an index of pro- which have increasingly risky capital values.
ductivity change in the export industries Two KEYNESIAN theories of the term struc-
and productivity change in foreign factors ture stand in sharp contrast to this. First,
of production making imports. In effect it HICKS' liquidity premium theory argued that
426 test discount rate
PROBABILITY DISTRIBUTION, which under the exceeds the maximum limit the service
alternative hypothesis it does not. Should require to be duplicated. The technique
the value of the test statistic therefore fall be criticized for its reliance on strict phys
outside the CRITICAL VALUES of the distri- limits rather than consideration of the c
bution, it is deemed unlikely that the null of alternative levels of provision. <
hypothesis is true. Examples of test statistics THRESHOLD.)
include the T-STATISTIC, F-STATISTIC and
CURBIN-WATSON statistic. (See STATISTICAL threshold effect. An increase in the li
SIGNIFICANCE.) of taxation which a community is said tc
willing to pay resulting from some crisi;
threat effect. Where a non-union employer national emergency. It is argued that i
pays the union wage, or one approximating time of crisis, such as a war, the member
it, in an attempt to forestall the unionization a community will be willing to pay hi£
of his labour force. According to this taxation than would previously have b
hypothesis the direction of causation in wage regarded as acceptable and that once
inflation is from the union to the non-union 'threshold' has been crossed, the commu
sector. will still be prepared to pay the new tax 1<
even when the crisis is over. The ef
threat pay off. formed an important part of the explanai
(See NASH SOLUTIONS.) of PUBLIC EXPENDITURE growth advance*
A. Peacock and J. Wiseman, The Growl
three stage least squares (3 SLS or Th Public Expenditure in the United Kingc
SLS). A member of the LEAST SQUARES (London, Allen and Unwin, 1961). (See
family of ESTIMATORS applicable to the esti- PLACEMENT EFFECT.)
mation of the parameters of SIMULTANEOUS
EQUATIONS systems in which the DISTURBANCE threshold of a good. In regional or sp
TERMS may be correlated between equations. economics, the minimum population wl
(See FULL INFORMATION MAXIMUM LIKELI- can provide a market for some good or
HOOD.) vice. When the population of an area (s
as a town) is below the threshold, dem
threshold. The point beyond which there for the good will be so low that its provis
is some change in the behaviour of the econ- is not economically viable. The concep
omic agent, i.e. a threshold on price expec- relevant where there are ECONOMIES OF SC
tations means that expectations are not in the provision of a good: thus the AVER
revised constantly in the light of accumulat- COST of the goods falls as sales rise,
ing evidence of price changes but are revised threshold may be thought of as the size
at intervals once the rate of price change has market at which the AVERAGE REVENUE
exceeded a certain point. More recently the tained from sales of the good just eqi
term has been used to describe a particular average cost. This concept is sometimes u
form of INDEXATION of wage contracts which in explanations of the location of retail
operates only after inflation has exceeded service centres, in CENTRAL PLACE THEC
some prespecified level. and in regional planning. (See THRESHI
ANALYSIS.)
threshold analysis. A technique employed
ln
physical planning in determining the Thiinen, Johann Heinrich von (1783-18!
desirable size of communities and the provi- A German agricultural economist, '
sion of public services. The analysis rests on Thunen developed a theoretical me
the idea that there are INDIVISIBILITIES in the based on his own farming experience wr
Provision of public services such that there was designed to show the optimum local
exists a given minimum and maximum of a particular type of cultivation v
Population for which the provision of some special regard to distance from the centr<
Public or communal service is viable. If the demand. He was not only a pioneer in LC
Population of (say) a town is below the TION THEORY, b u t a l s o of MARGINAL ANALY
threshold for a given service, the service He set out a theory of RENT very similai
should not be provided, while if population that of RICARDO, and a theory of distribut
Tiebout model
based on MARGINAL PRODUCTIVITY. The appli- number of activities that do not fall easily
cation of marginal productivity theory to into this typology. One such activity is the
wages as well as capital, his use of differen- home preparation of food. Such activities
tial calculus and marginal reasoning to pro- can be termed non-market work. The im-
vide equilibrium solutions of economic portance of this extra classification is that it
variables, and his generic statement of the suggests that the supply of labour time must
LAW OF VARIABLE PROPORTIONS have allowed be treated as part of a more general analysis
him to be described as the founder of mar- of the allocation of time to a number of
ginal analysis. Alfred MARSHALL paid par- alternative uses.
ticular tribute to von Thiinen. His main The general theory of the allocation of
work is Der isolierte Staat in Beziehung auf time assumes that neither time nor consumer
Landwirtsschaft und Nationalokonomie (3 goods are consumed by themselves.
vols, 1826, 1850, 1860). Part I has been Accordingly, consumption decisions are
translated into English under the title Von made among alternative activities or outputs
Thunen's Isolated State, ed. P. Hall (1966). that require both goods inputs and time
inputs. This means that the total price of any
Tiebout model. An analysis of the provi- activity should be taken as the sum of its
sion of PUBLIC GOODS which argues that if market price plus the value of the time
certain public services are provided at the required to perform it. The individual's
level of local governments, individuals can supply of labour hours is thus determined
indicate their preferences concerning these simultaneously with consumption. Recog-
services and obtain a combination of public nition of this fact extends the predictive
services and taxes which corresponds with reach of the basic labour-leisure model. For
their preferences by moving between local example, higher real income could cause
government areas. The analysis requires that hours of work and leisure to increase be-
there be a large number of communities cause of a reduction in the time devoted to
offering different combinations of services non-market work.
and taxes, between which individuals can
choose. The model was first presented by time deposit. A deposit in a BANK which is
C M . Tiebout 'A pure theory of local gov- withdrawable only after a period of notice. It
ernment expenditures' Journal of Political originated in the US where in the FEDERAL
Economy, 1956. This analysis has both a RESERVE SYSTEM member banks are required
NORMATIVE aspect, in arguing that provision to maintain different minimum reserve rates
of public goods at the local level is desirable, against time and DEMAND DEPOSITS. In the
and a POSITIVE aspect in predicting that London clearing banks DEPOSIT ACCOUNT bal-
people will move in response to local taxes ances are time deposits being subject for-
and services. (See CLUBS, FISCAL FEDERAL- mally to seven days' notice of withdrawal
ISM.) (although in practice this is not often insisted
on). With the proliferation of different
tied loan. forms of deposits, e.g. for fixed periods or at
See TYING OF AID. longer than the traditional seven days no-
tice, as a term of general usage it is less
tight money. A phasa of monetary policy clearly defined than it was. However in the
when the supply of CREDIT is restricted and revision of British banking statistics in 1976
interest rates are high. The object of such a it was given a precise statistical meaning:
policy is to reduce the general level of briefly all deposits other than SIGHT DE-
demand, or restrain its growth, in the inter- POSITS, but including certain bills and other
ests of restraining a rise in prices or improv- financial instruments. (See WHOLESALE
ing an adverse BALANCE OF PAYMENTS (or BANKING.)
both). (See MONETARY POLICY.)
time preference. Individuals with a posi-
time, allocation of. The traditional labour- tive rate of time preference value units of
leisure model of the supply of hours assumes current consumption or income more highly
that all time is allocated either to mar- than those accruing in the future. For this
ket work or to leisure. Yet there are a reason in INVESTMENT APPRAISAL the stream
Todaro model
of future costs and benefits is DISCOUNTED to His major works are: Business Cycles
a PRESENT VALUE so that projects with differ- the USA, 1919-39 (1939), On the Theory
ent time profiles of costs and benefits can be Economic Policy (1952), Economic Pol
compared. A number of reasons have been Principles and Design (1956), Selet
suggested why individuals might have posi- Papers (1955), Shaping the World Econc
tive time preference rates. The 'risk of (1962), Central Planning (1964), Devel
death' argument points out that an indi- ment Planning (1968) and Income Distri
vidual may not survive in order to enjoy tion Analysis and Policies (1975).
future benefits, PIGOU suggested that pure
myopia or what he referred to as individuals Tobin, James (1918- ). American e
having a 'defective telescopic faculty' would nomist and Professor of Economics at Y
lead to present consumption being valued University; awarded the 1981 Nobel priz<
more highly than future consumption. If in- Economics for his work in 'the theory
dividuals themselves and future generations financial markets and their relation to c
are expected to be wealthier and it is held sumption and investment decisions, p
that there is diminishing marginal utility of duction, employment and prices'.
consumption, this also would lead indi- Tobin has built on the work of KEYNES J
viduals to discount future benefits. has probably done more to develop j
refine Keynesian ideas than any other ec
time series. A set of observations on the omist. His most significant work on PORTFC
values which a variable takes at different selection, in which he has stressed the tra
points of time (normally in successive off between risk and yield over a whole ra
periods). For instance, an annual time series of assets, including money, can be regan
on NATIONAL INCOME would involve obser- as re-establishing the intellectual respect;
vations on the value of the variable in suc- lity of Keynesian notions of LIQUIDITY PREI
cessive years. The most common time series ENCE. His GENERAL EQUILIBRIUM a p p r o
consist of annual, quarterly or monthly ob- and his emphasis on substitution over a rai
servations. (See CROSS-SECTION.) of assets makes him critical of the stress 1
on one asset, money, by MONETARISTS.
time varying parameter models. addition to explaining portfolio balai
See VARIABLE PARAMETER MODELS. Tobin has analysed the way in which chan
in financial assets, brought about by,
Tinbergen, Jan (1903-). Dutch economist example, changes in MONETARY or FIS<
and joint winner, with R. FRISCH, of the policy impinge upon the REAL variables in
Nobel Prize for Economics in 1969 for his economic system.
pioneering work in ECONOMETRICS. His most In the Keynesian tradition Tobin has a
celebrated early study was into cyclical paid much attention to rigidities in w;
fluctuations in the USA, in which he endeav- formation. Their existence, he argu
oured to specify quantitatively the import- undermines the RATIONAL EXPECTATIC
ance of different factors in business cycles in approach to macroeconomics. He belie
the USA. that changes in demand in commodity £
Another influential work of Tinbergen has labour markets are for this reason m<
been his Theory of Economic Policy (1952), likely to express themselves in changes
in which he demonstrated the need for as output and employment rather than
many policy variables as there are policy changes in the inflation rate. To avoid i
ends. Tinbergen is a practitioner as well as a waste associated with unemployment
theorist and as Head of the Central Planning argues that there is still a theoretical case
Bureau in the Hague he has been instrumen- DEMAND MANAGEMENT.
tal in constructing an econometric model for Almost all of Tobin's prolific output
forecasting and planning economic policy in work has taken the form of papers in jo
the Netherlands. Tinbergen has also con- nals or collections of essays rather tr
cerned himself with the problems of plan- books on a single subject.
ning in developing countries and as well as
giving advice, he has made significant contri- Todaro model. The best-known econoi
butions to the concept of 'SHADOW' PRICES. model of internal migration in DEVELOP)
430 token money
COUNTRIES. Its author, Michael Todaro, is an might still be a rational decision on a long-
American economist who has spent some term basis.
time working in Africa. The model sets out The root of the problem is the large differ-
to explain why the observed high rates of ence between earnings in the modern indus-
rural-urban migration found in most devel- trial sector and those in the rural areas.
oping countries is quite rational "from an Often the former are well above market
economic viewpoint. The determinant of the clearing levels for a variety of reasons. The
migration decision is the expected real long-term answer to the problem is to pro-
income difference between income in the duce a set of policies for both urban and
urban area and that in the rural area. The rural areas which reduces the real income
potential migrant first estimates the real differences between the two areas.
income which he would obtain in the urban
area for a job commensurate with his qualifi- token money. Any form of money the
cations. He next makes a subjective judge- value of which as means of payment rests on
ment of the probability of obtaining such a legal enactment, e.g. legal tender, or on con-
job. He then compares the expected income ventional acceptability, and which bears no
with that which he hopes to obtain in the relation to its intrinsic commodity value.
rural area. His migration decision is based Token money could at one time be con-
on the differences. For example, if the trasted with 'full bodied' money, e.g. the
expected rural income were £100 and the gold sovereign before 1914, the exchange
real income of an urban job which appears value of which was equal to the value of the
within his range of competence were £200, metal from which it was made.
that information by itself would not be suf-
ficient to make the migration decision. If the Tokyo Round. The seventh round of
subjective probability of obtaining the urban multilateral trade negotiations, conducted
job was 0.4 the expected income would be under the auspices of the GENERAL AGREE-
£80 and no migration would take place. If MENT ON TARIFFS AND TRADE (GATT) which
the probability were 0.8 the expected took place in Tokyo between 1973 and 1979.
income would be £160 and the worker would Unlike previous negotiating rounds, such as
migrate. The implications of this model are the KENNEDY ROUND, the Tokyo Round
far reaching. For example, if the govern- addressed the problem of both tariff and
ment of the country concerned were success- non-tariff barriers to trade. Most of the
ful in fostering industrial development in an member countries who participated in the
urban area employment would increase negotiations agreed to industrial tariff re-
there. The effect would be to increase the ductions averaging 25 to 30 per cent, to be
subjective probability of obtaining urban implemented in equal annual stages between
employment in the minds of rural inhabi- 1980 and 1987. Reductions in non-tariff
tants. Migration would increase and the trade barriers included an agreement on
eventual effect of the new industrial devel- public purchasing designed to increase
opment could be that urban unemployment opportunities for exporters to bid for gov-
becomes higher than the level ruling before ernment contracts, a reduction in technical
the new development too* place. There will trade barriers arising from product standards
be some level of urban unemployment and certification systems and the approval of
which produces equilibrium in the sense that a consistent method of customs valuation.
no further migration takes place. Poten-
tial migrants may take a long-term view in
total cost. The total cost of producing any
making their decision. They may consider given level of output. In the SHORT RUN total
that their chances of obtaining an urban costs can be divided into two parts: FIXED
job will be higher after a waiting period COSTS, i.e. those costs which do not vary with
of some months. Thus they will compare output (sometimes referred to as OVERHEAD
the PRESENT VALUE of the sum of expected
COSTS), and VARIABLE COSTS, i.e. those costs
urban earnings with the present value of which vary directly with output (sometimes
expected rural earnings. They may be referred to as DIRECT COSTS). In the short run
content to accept a low income in the output can only be changed by adjustment of
urban informal sector for some time. This the variable factor inputs. Thus the addition
trade cycle
t 0 total costs from any increase in output is after the actual transfer of the goods,
given by the cost of the extra variable INPUTS doing this the supplier rarely makes an <
required. plicit charge for the credit (although soi
In the LONG RUN all factors are variable. retailers now do this on CHARGE ACCOUNTS
The long-run total cost schedule of a profit form of trade credit to consumers); but
maximizing firm is then given by those factor implicit charge in the form of a discount
input combinations which minimize total early payment is very common, and t
C ost at all o u t p u t levels. (See COST MINIMIZ- amounts to a charge on extended crec
ATION, RETURNS TO SCALE, U-SHAPED COST Many businesses are both takers and givi
CURVES.) of trade credit, and it is a major chani
through which credit flows between sect<
total remuneration. The total pecuniary of the economy, and a significant source
benefits a worker receives from his employ- ELASTICITY in the financial system. Whetl
ment. Most frequently the term is employed or not trade credit, in nature and effec
to refer to the SALARY and FRINGE BENEFITS of presents a close parallel with BANK CREDIT,
WHITE-COLLAR WORKERS. some maintain, is a matter of debate.
total revenue. The total receipts from
sales of a product or series of products pro- trade cycle. (also known as the busin<
duced by a single firm or industry. (See AVER- cycle or the cycle). A fluctuation in the le1
AGE REVENUE.) of economic activity (usually proxied
national income) which forms a regular p
trade. The exchange of commodities be- tern, with an expansion of activity followi
tween individuals or groups either directly by a contraction succeeded by further expi
through BARTER or indirectly through a me- sion. Such cycles occur about the SECULAR
dium such as money. The benefits of trade long-run trend path of output. (,!
consist of an extension in the range of com- diagram).
modities available for consumption and
a specialization in productive activity.
Without trade the individual or group would output
be forced to meet all requirements from
their own resources. Voluntary trade allows
a DIVISION OF LABOUR such that all partici-
pants may benefit. (See INTERNATIONAL contraction
TRADE.)
The AMPLITUDE of the cycle is given by the function of the volume of economic activity.
height of a peak above the trend line or of a (See MONEY, THE DEMAND FOR.)
trough below it, such as distance BG. The
cycle may be divided into two PHASES (i) transactions motive for holding money.
EXPANSION phase and (ii) CONTRACTION phase See TRANSACTIONS DEMAND FOR MONEY TRANS-
where the contraction phase is usually ACTIONS BALANCES, MONEY, THE DEMAND FOR.
shorter than the expansion phase, and
may be convergent ('DAMPED'), divergent
('EXPLOSIVE') or constant in amplitude. transactions velocity of circulation.
Trade cycle theory is associated with HICKS, See INCOME VELOCITY OF CIRCULATION.
SCHUMPETER, Metzler and Goodwin amongst
others. (See MULTIPLIER-ACCELERATOR INTER-
transcendental logarithmic production func-
ACTION.) tion.
See TRANSLOG PRODUCTION FUNCTION.
trade-off. Conflict of policy objectives
with the result that one objective can be
transcendental production function. A
attained only at the cost of moving away
generalisation of the COBB-DOUGLAS PRO-
from another. The idea is most frequently
DUCTION FUNCTION of the form
employed in the context of the choice be-
tween higher wage inflation or higher unem- Q = ALa K? ea'1^'K
ployment. That is, we can only obtain some
additional employment, i.e. reduce unem- A > 0, and a', p ' *£ 0
ployment, at the cost of a higher rate of
change of wages. (See PHILLIPS CURVE.) where Q is output, K and L are capital and
labour INPUTS and a, 3 , a ' and (3' are con-
stants and e is the base of the natural logar-
traditional sectors. ithm. This function makes it possible for
See AGRICULTURAL SECTOR, DUALISM, THEORY
marginal products to rise before eventually
OP, INFORMAL SECTOR, LEWIS-FEI-RANIS
falling and permits both the elasticity of pro-
MODEL.
duction and the ELASTICITY OF INPUT SUBSTI-
TUTION to vary over the range of inputs. If a'
transactions approach. The name given to and p' vanish the above function reduces to
Newcomb and Fisher's version of the classi- the Cobb Douglas.
cal QUANTITY THEORY OF MONEY: MV = PT. Other generalisations of the Cobb
This differs from the Cambridge version M Douglas production function are the
— kPT'm that the VELOCITY OF CIRCULATION V CONSTANT ELASTICITY OF SUBSTITUTION
is included directly as opposed to its recipro- PRODUCTION FUNCTION (CES), the Zellner-
cal k which appears on the right-hand side in Revankar production function, the Nerlove-
the Cambridge equation. (See CAMBRIDGE Ringstad production function and the TRANS-
SCHOOL.) L O G PRODUCTION FUNCTION.
transfer costs. The costs involved in mov- and agriculture can be substanti
ing some object between two points. The increased. (See APPROPRIATE TECHNOLC
costs include not only the direct costs of APPROPRIATE PRODUCTS.)
movement which will vary with distance
moved (and thus may be called 'distance transfer payment. A payment made tc
costs'), but also all the costs of loading, individual (usually by a government be
unloading, handling and administration at which does not form part of any EXCHA
each end of the journey. This latter set of of goods or services. Examples of tran
costs may be referred to as terminal costs. payments include student grants and so
(See LONG-HAUL ECONOMIES.) security benefits. The making of tran
payments is part of the process of REDIS
transfer deed. Generally this refers to the BUTION of an economy's output. (See DIS
document by which the ownership of SECURI- BUTION FUNCTION, TRANSFER INCOMES.)
TIES is legally transferred from a seller to a
buyer, STAMP DUTY is levied on the transfer transfer pricing. The system of set!
though there are a number of exceptions to prices for transactions among subsidiarie:
the duty, particularly government securities. a MULTINATIONAL CORPORATION, where
prices are not subject to market deter
transfer earnings. nation. The prices are often deliberai
See ECONOMIC RENT. chosen so as to minimize tax or tariff t
dens on the corporation on a world sc
transfer incomes. Incomes which cannot e.g. costs may be overstated in subsidia
be regarded as payment for current services in a country with a high profits tax so t
to production and which therefore do not profits can be shifted to a subsidiary i
enter NATIONAL INCOME. Examples of trans- lower tax country.
fer incomes are retirement pensions or the
receipt of private gifts. Corresponding to transfer problem. The name given to
transfer incomes are transfer payments debate in international economics as
which are payments out of FACTOR INCOMES whether a country, which has to make
for which no goods or services are received unrequited payment to another country, e
in return. Examples of such payments are a reparations payment, suffers an excess
national insurance contributions or private secondary burden, i.e. a burden greater tr
gifts. Transfer incomes and payments should the magnitude of the payment, in order
not be confused with TRANSFER EARNINGS. effect the transfer by earning a correspoi
ing surplus on foreign payments. The c
transfer of technology. Technology is a rent position is that where there exi
main factor in the promotion of ECONOMIC SAVING in the KEYNESIAN sense, there will
GROWTH. Developing countries have to an excess burden, which will take one o
decide whether to develop their own techno- mixture of two forms, namely worse TER
logies or to import them from developed OF TRADE or an increase in the level
countries. Imported technology often comes unemployment.
via MULTINATIONAL CORPORATIONS based in I
Western countries and is often inappropriate transformation function.
for the FACTOR PROPORTIONS generally exist- See PRODUCTION FRONTIER.
ing in developing countries. Usually the
technology will be too CAPITAL-INTENSIVE for transformation problem. The problem
countries which have scarce capital and Marxian economics of deriving a unique \
abundant labour. Highly-skilled labour may of prices from values, i.e. labour inputs.
also be required to cooperate with this tech- Volume I of Capital, by virtue of his spec
nology. The transfer of inappropriate tech- assumptions of equality in all industries
nology can thus distort the pattern of the rate of PROFIT, of the CAPITAL-LABO
development. It can lead to the introduction RATIO and of the period of turnover, MA
of inappropriate products. Nevertheless if, was able to show that prices were pi
as does happen in some cases, the tech- portional to labour inputs. When, howev<
nology is modified productivity in industry the ratio of capital to labour or the period
434 transitivity of preferences
turnover varies between industries, the rate where Q is output, L and K are labour and
of profit, which it assumed remains equal capital a, a, (3, 7, 8 and e are constants. This
between industries because of the forces of function which is quadratic in the natural
capitalist competition, must be earned on all logarithms In of the variables reduces to the
capital locked up in an enterprise and not Cobb Douglas if the parameters 7, 8, and e
just on the capital used to hire labour. When are all zero, otherwise it has the property of
this happens, prices cease to be proportional non-unitary ELASTICITY OF SUBSTITUTION. This
to labour inputs. function is particularly useful and flexible in
In Volume III of Capital Marx attempted approximating a wide range of production
to derive prices of production, when the technologies in terms of input substitution
ratios of capital to labour differed. On the possibilities and as such is a very useful
basis of special assumptions (sum of SURPLUS approximation to almost any production
VALUES equals sum of profits, sum of prices function.
equals the sum of values and industries are
independent of each other) he was able to trans-shipment points. Locations at which
derive prices of production from values: transport changes from one type or mode to
industries with an above average (for the another (e.g. at a sea port there is a change
economy) capital to labour ratio had prices between land or river transport and sea
above values and those with a below average transport). These locations are also known
ratio had prices below values. Subsequent as points of modal interchange. Such loca-
work has attempted to derive prices from tions often become centres of manufactur-
values without use of these special assump- ing, or of the processing of raw materials.
tions. The current position is that it is poss- This phenomenon is explicable in terms of
ible to derive a unique set of prices three main influences:
corresponding to any set of values but to do 1. Trans-shipment points generally in-
so requires the adoption of one invariance volve not only a change of transport mode
postulate, which is the requirement that one but also a change in the number of routes
magnitude must be the same in value and (for example from one sea route to many
price terms, so that there exists a vehicle by road routes). If (say) a raw material is cheap
which the two systems can be linked to transport in bulk, but less economical to
together. Invariance postulates which have transport in small quantities the most advan-
been used are equality between the sum of tageous processing point may be where the
surplus values and the sum of profits or of load is broken up - at the trans-shipment
the sum of prices and the sum of values or of point - this advantage is reinforced if there
a commodity, whose price is the same as its are ECONOMIES OF SCALE in the processing
value. operation.
2. There may exist economies of scale
transitivity of preferences. which lead to reduction in the costs of hand-
See AXIOMS OF PREFERENCE. ling, loading and unloading (TERMINAL
COSTS) at trans-shipment points.
transitory consumption. An unanticipated 3. These points will, in any case, tend to
rise or fall in consumption. {See PERMANENT develop specialized facilities for handling
INCOME HYPOTHESIS.) and storing goods.
revenue and monitoring changes in the tax weekly amounts to the banks. The securities
system; it is responsible for repaying holders were in effect a form of compulsory borrow-
of maturing TREASURY BILLS and for offering ing from the banking system and by 1945
and deciding the mix of short-ternrand long- formed almost 40 per cent of the assets of
term FINANCIAL INSTRUMENTS constituting the the London CLEARING BANKS. Thereafter
federal debt. Its secretary serves as an econ- their issue was progressively reduced and
omic adviser to the President along with the they were phased out in 1953.
COUNCIL OF ECONOMIC ADVISERS and the
OFFICE OF MANAGEMENT AND BUDGET. (See
Treasury-Federal Reserve Accord. From
FEDERAL RESERVE SYSTEM.)
1942-51, the US FEDERAL RESERVE SYSTEM
supported US government bond prices in
Treasury bill. A short term borrowing me- order to facilitate Federal government bor-
dium of the UK government introduced in rowing. The Federal Reserve agreed to buy
1877 and at that time modelled on the all new Federal government bond issues at
COMMERCIAL BILL. Their original purpose was agreed prices, thus allowing the Treasury to
to serve purely seasonal needs for finance finance war and post-war debt at very low
but since the First World War they have interest rates. This meant, however, that the
been a permanent element in government Federal Reserve had given up its ability to
debt with very large amounts outstanding in control credit by changing the interest rate.
the years following the Second World War. Without the use of such monetary tools, the
Treasury bills have a term of 91 days (some Federal Reserve could do little to ameliorate
63-day bills are issued at certain times of the the rapid inflation of the late 1940s. As a
year), and they are sold by tender in weekly result, in 1952 the Federal Reserve and the
lots, with TAP ISSUES to government depart- Treasury came to an 'accord', an agreement
ments and other public agencies. Though the that freed the Federal Reserve from any
volume of non-public holdings is now much bond buying responsibility.
reduced from earlier levels, the Treasury bill
remains an important financial instrument,
with a significant role in the operation of Treasury note.
monetary management. By an arrangement See CURRENCY NOTE.
dating from the 1930s the weekly Bill tender
is effectively underwritten by the DISCOUNT Treasury view. A view held by the UK
HOUSES whose bids in total always cover the Treasury in the early part of the twentieth
amount on offer. This arrangement, backed century which considered that additional
by understandings with the CLEARING BANKS government expenditure would be offset by
and by the Discount Houses' access to the a reduction in private expenditure. This view
BANK OF ENGLAND a s LENDER OF LAST RESORT, was not adhered to by many UK economists
provides a means by which the government in the 1920s with the exception of Hawtrey;
can always obtain the funds it needs. it was at this time that KEYNES and PIGOU
In the US, a corresponding instrument were advocating government expenditure as
exists. US Treasury bills from the US a cure for the unemployment problem.
Department of Treasury are issued in three-,
six-, nine-, and twelve-month maturities
through the FEDERAL RESERVE banks. Treaty of Rome.
Although these securities are virtually risk- See EUROPEAN COMMUNITY.
less short-term investments, there is risk in
secondary market trading prior to maturity, trend (also known as time trend).
because prices fluctuate with changes in mar- 1. An underlying, long-run component in
ket interest rates. (See DEBT MANAGEMENT.) TIME-SERIES data, which is often calculated to
display the long-run direction of movement
Treasury Deposit Receipt (TDR). This of a variable. There are various methods by
wa
s a short-term (six-month) non- which the trend can be established, including
rnarketable security introduced by the UK REGRESSION analysis and MOVING AVERAGES.
Government in 1940 as an instrument of (See DETRENDING, FILTER.)
wartime finance, and sold in determined 2. A measure of the average level of an
436 trend stationary process
at previous stages in the production and dis- variables in the estimation of the O U
tribution process. The effect of this tax is ameters of the structural form. TSLS
thus to encourage VERTICAL INTEGRATION in member of the LEAST SQUARES family ol
industry and commerce as a reduction in the mators, and is a SINGLE EQUATION (or LII
number of times that a transaction takes INFORMATION) estimator. (See LIMITED H
place reduces the amount of tax payable. MATION MAXIMUM LIKELIHOOD, THREE S
The inefficiency of this type of tax has been LEAST SQUARES.)
realized and in recent years many countries
have changed over to a VALUE-ADDED TAX
which does not have these inefficiencies. tying contract. A condition of sail
quiring the buyer of a given product to
chase another (different) product, us
turnpike theorems. A class of propositions
complementary to the first product,
in GROWTH THEORY concerned with the close-
example, a seller of stapling machines r
ness of optimal growth paths to BALANCED
require buyers to purchase his staples
GROWTH at the highest rate. The name 'turn- condition of buying the machines. The
pike theorem' was given by R. Dorfman, P. tract may be the seller's means of leven
SAMUELSON and R. SOLOW in Linear Pro-
his MONOPOLY of the first product; of ex|
gramming and Economic Analysis, McGraw ing the interdependence of the two proc
Hill (1958). demand functions; of applying PRICE DI
MINATION among buyers with diffi
twelve-month rule. intensities of demand; of ensuring tha
See INCOMES POLICY.
reputation of the desired product is
damaged by buyers' use of inferior copi
two sector growth model. A model used in the product not desired; and of avoidin
GROWTH THEORY where the fundamental effects of PRICE CONTROL on the desired t
differences between CONSUMPTION and CAPI- uct (assuming no control on the produc
TAL goods are recognized, with one sector desired). These agreements may be ill
concerned with each of the two goods. with the usual application of the SHE$
Examples are the models of J.E. MEADE, and
ACT, t h e CLAYTON ACT, Or t h e FEDERAL TI
H. Uzawa. (See ONE SECTOR GROWTH MODEL,
COMMISSION ACT.
MULTISECTOR GROWTH MODELS.)
two stage least squares (TSLS or 2 SLS). type I/type II errors. The types of ei
An econometric procedure for the ESTI- which can be made in HYPOTHESIS TEST!
MATION of the STRUCTURAL FORM parameters type I error is the rejection of the r>
of SIMULTANEOUS EQUATION systems, which HYPOTHESIS when it is in fact true. A tyr.
avoids simultaneous equation bias. The error is the acceptance of the Null H;
technique involves the estimation of the thesis when it is false. The probabilit;
REDUCED FORM parameters by ORDINARY making these types of error is closely rel;
LEAST SQUARES (OLS). These are used to to the LEVEL OF SIGNIFICANCE of the test,
calculate estimates of the values of the ENDO- higher the level of significance the lower
GENOUS variables of the model, which are probability of making a type I error, and
subsequently used as INSTRUMENTAL VARI- higher is that of making a type II error,
ABLES for the actual explanatory endogenous vice versa.
u
U-form enterprise. A company in which probability of occurrence will not be known.
decision making is centralized around a In such circumstances it is necessary to
top board of executives whose functional resort to some rule based on the investor's
responsibilities are applied to all company attitude to the balance of gains and losses
products. This form of organization is com- in the event that a particular choice is
mon to small and medium-sized firms; large taken and a particular set of circumstances
firms adopting the U-form organization occur. (See DECISION THEORY, RISK.) See
tend to suffer control-loss. (See M-FORM McKenna, C.J. The Economics of Uncer-
ENTERPRISE.) tainty, Harvester Wheatsheaf, London
(1986).
unanimity rule. A procedure for COLLEC-
TIVE CHOICE which requires that before a unconvertible loan stock.
policy can be adopted it must be approved See FINANCIAL CAPITAL.
by all of the members of the community
affected by the decision. If this rule is uncovered interest parity. In a flexible
adopted we can be sure that any policy EXCHANGE RATE regime, when investors are
adopted will be a PARETO IMPROVEMENT. risk-neutral and do not cover themselves
However, in practice use of the rule would against exchange risk in the FORWARD MAR-
be difficult and time consuming. The use of KET, the requirement that the future spot
this rule is analogous to the VOLUNTARY- rate for a currency diverge from the present
EXCHANGE MODEL of public finance. (See spot rate (see SPOT MARKET) by an amount
SOCIAL DECISION RULE.) which exactly offsets the interest differential
in two countries. Thus if the rate of interest
unanticipated inflation. That proportion in the US exceeds that in the UK, the future
of the actual level of inflation which people spot-rate for the dollar would have to be at a
did not expect; actual minus EXPECTED discount to the present spot, so that a UK
INFLATION. If people expect the rate of infla- investor would believe that the extra yield he
tion to be five per cent per annum but in fact would get by lending to the US would be
inflation is ten per cent over that period the exactly offset by a capital loss in returning
unanticipated inflation rate is five per cent. from dollars to sterling at the future spot
rate. (See COVERED INTEREST PARITY.)
438
unemployment benefit
employed worker is thus one who values country's goods would be too cheap. '
income more highly and leisure less highly Japanese yen was allegedly undervaluec
than the typical worker or, in other words, the early 1980s, its undervaluation be
one whose MARGINAL RATE OF SUBSTITUTION maintained by large scale overseas lend
of income for leisure is less. An underem- (See REVALUATION, CURRENCY APPRECIATIO
ployed worker would prefer to work a larger
number of hours than that offered to him by underwriter. Someone who agrees to b
the standard working week. Indeed he a risk, or some part of it, in return fo
would be willing to offer more hours at a payment known as an INSURANCE PREMI
rate possibly substantially below the estab- ISSUING HOUSES also underwrite new iss
lished wage. Underemployed workers will of shares such that if the whole issue is
actively seek OVERTIME and if this is denied taken up by the public, the underwriters
them in sufficient quantities, they will seek left to take up the remainder of the issue
part-time work elsewhere in addition to their
principal job. This latter phenomenon is
known as moonlighting or multiple job hold- undistributed profits. That proportior
ing. The propensity to moonlight is a nega- total profit not distributed in the forrr
tive function of income and a positive dividend payments to owners of equity c
function of family size. Also, moonlighters tal or released in the form of tax payme
must have principal job schedules which per- These funds are an important source
mit them to take second jobs. Classic finance for corporate sector investn
examples are postal workers, milkmen and plans. (See DISTRIBUTED PROFITS.)
school teachers. In the US approximately
five per cent of all employees are moon- unearned income. A term which usu
lighters. In less-developed economies under- refers to any type of non-wage inco
employment of workers is commonplace. which could be in the form of PROFITS, IN:
EST or RENT. It is differentiated usually
underemployment. According to the DUAL taxation purposes as most 'earned' incc
LABOUR MARKET HYPOTHESIS, the secondary i.e. wage income is taxed at source,
labour market consists of many workers who unearned income often has to be deel
either already possess skills that would en- and taxed separately.
able them to function satisfactorily within
the primary market or who could be trained unemployment. The stock of all those
for skilled jobs at no more than the usual dividuals who are not in employment J
costs. Given the barriers to entering the pri- who are either in the process of moving j
mary sector, however, they are forced to new job or who are unable to find wort
take up unskilled secondary sector jobs and the prevailing real wage rate. The un<
are in this sense underemployed. (For a ployed may be classified by cause accord
different sense of underemployment, see to a modern Keynesian view (see FRICTION
UNDEREMPLOYED WORKERS.) STRUCTURAL, SEASONAL, DEMAND-DEFICIE
CYCLICAL GROWTH GAP a n d TECHNOLOGI
underidentification (also known as UNIDENT- UNEMPLOYMENT) or according to KEYNES'
IFICATION). See IDENTIFICATION PROBLEM. tinction between VOLUNTARY and INVOL
TARY UNEMPLOYMENT, or by characteri
according to a NEO-CLASSICAL view I
undervalued currency. In a fixed
SEARCH, PRECAUTIONARY a n d SPECULA1
EXCHANGE RATE system a currency whose
UNEMPLOYMENT, NATURAL RATE OF UNEMPL
parity leads to persistent BALANCE OF PAY-
MENTS surpluses. The price is below its free MENT.) See Nickell, S., 'Unemployment
market level and maintained at this level by Survey', Economic Journal, (1990), }
adding foreign currencies to reserves and 100, pp. 391-439.
sterilizing the domestic monetary expansion
which follows from a surplus. With flexible unemployment benefit. A payment m
rates the undervaluation would be seen in a to an individual who is unemployed. Th
departure from purchasing power parity: the payments are made from the NATIO
440 unemployment equilibrium
INSURANCE FUND and are related to the level in unemployment as revealed by either the
Of NATIONAL INSURANCE CONTRIBUTIONS m a d e REGISTERED UNEMPLOYED or by a survey of
by the individual, prior to UNEMPLOYMENT. households as a proportion of the labour
There are other forms of TRANSFER PAYMENT force. In the USA the same procedure is
made if an individual is not eligible for followed except that the armed forces are
unemployment benefit. The purpose of such omitted from the denominator.
payments is to ensure incomes do not fall A comparison of the unemployment rate
below SUBSISTENCE level during periods of with the estimated natural rate of unemploy-
unemployment. (See BEVERIDGE REPORT.) ment is frequently used as a measure of the
excess supply of labour.
unemployment equilibrium. The central
proposition of KEYNES' General Theory that unequal exchange. In its strict Marxian
even if wages and prices are fully flexible, as form the exchange of the products of devel-
assumed in classical theory, the economy oped economies at prices above their labour
will not always return to FULL EMPLOYMENT. values (see LABOUR THEORY OF VALUE and
Under the assumption of fixed wages and TRANSFORMATION PROBLEM) for the products
prices as incorporated in the INCOME- of less developed economies at prices below
EXPENDITURE MODEL and Hicks' IS-LM MODEL their labour values. On the assumption that
an unemployment 'equilibrium' could be the RATE OF PROFIT is to be equal on all
easily demonstrated, although as the NEO- capitals advanced, if prices were simply pro-
CLASSICAL SYNTHESIS has subsequently shown portional to labour inputs, then in countries
we can no longer consider this to be an with much capital per man the rate of profit
equilibrium position. However Keynes' would be lower than in less developed eco-
argument did not rest solely on fixed wages nomies where SURPLUS VALUE (the source of
and prices. He had also demonstrated that profit) has to be spread over a smaller total
even with flexible wages and prices INVOLUN- Of VARIABLE p l u s CONSTANT CAPITAL.
TARY UNEMPLOYMENT was possible. He Even within a Marxian framework the
suggested that both the LIQUIDITY TRAP and proposition is open to dispute, since the
INVESTMENT demand which was completely large quantity of labour (and the ensuing
interest inelastic resulted in an unemploy- surplus value) at work with an outmoded
ment equilibrium. In so doing he appeared technique of production in a less developed
to have driven a stake through the heart of country may not represent SOCIALLY NECESS-
classical theory which asserted the self- ARY LABOUR, while the high capital to labour
regulating properties of the market econ- ratio in a developed country may so raise
omy. Classical economists in fact countered surplus value that the going rate of profit
by arguing that the REAL BALANCE EFFECT could be earned without having prices ex-
would lead to greater expenditures out of ceed values. In a looser formulation unequal
rising real wealth as prices fall and this exchange has been defined as the deterio-
would arrest the downward spiral of prices ration in the TERMS OF TRADE between the
and wages and stimulate output and employ- products of less developed countries and
ment. However, as the subsequent debate those of developed, a matter on which the
a b o u t INSIDE MONEY AND OUTSIDE MONEY h a s statistical evidence is not unambiguous.
revealed these effects may be trivial. More
important seems to be the empirical evi- UNIDO guidelines. A technique of
dence against the liquidity trap and com- appraising projects in DEVELOPING COUNTRIES
pletely interest inelastic investment demand and an alternative to the LITTLE-MIRRLEES
and the fact that both these hypotheses rest method. It is essentially a COST-BENEFIT
on rather implausible assumptions about the ANALYSIS where the numeraire is present
manner in which individuals formulate consumption. The authors argue that the
EXPECTATIONS. social value of an incremental unit of INVEST-
MENT exceeds that from a unit of consump-
unemployment rate. In the UK the per- tion. They introduce an accounting price for
centage of the labour force without work investment to indicate its social worth in
and actively engaged in looking for work. terms of consumption in PRESENT VALUE
This is computed by expressing the number terms. The SHADOW WAGE RATE is related to
union/non-union differential 441
the MARGINAL PRODUCT of labour in its A further factor is the changing attitude of
alternative occupation and also incorporates governments.
an adjustment for the belief that SAVING and Union density in the UK and the US
investment are socially more valuable than approximated 42 per cent and 17 per cent
consumption. The shadow exchange rate is respectively at the end of the 1980s.
equal to the weighted average of the ratio of
domestic prices at which import and export union market power. The market power
markets are cleared and world prices at of trade unions is a function of the elasticity
official exchange rates. The SOCIAL DISCOUNT of DERIVED DEMAND for union labour. It is
RATE is employed to find the NET PRESENT plain that a union need have less fear for the
VALUE OF PROJECTS. The costs or benefits of employment consequence of a given wage
employing foreign resources are evaluated in claim if the elasticity of derived demand for
domestic currency. Thus there are several union labour is low, CETERIS PARIBUS. In this
differences in the UNIDO approach com- case, the union is said to possess more
pared to the Little-Mirrlees method but in power. It was MARSHALL who first categor-
practice there may not be many divergences ized the determinants of this elasticity. The
in the ranking of projects between methods. four Marshallian rules in question state that
(See INVESTMENT CRITERIA FOR DEVELOPING the union is likely to be better placed vis-a-
COUNTRIES, UNITED NATIONS INDUSTRIAL vis the employer in obtaining higher wages
DEVELOPMENT ORGANIZATION.) for a given grade of labour:
1. The less elastic is final demand for the
unintended inventory disinvestment. Run- product.
down of STOCKS due to an unexpected rise 2. The less easy it is to substitute other
in sales or fall in production. (See inputs for the grade in question.
INVENTORIES.) 3. The smaller is the grade's share in the
total expenses of production.
unintended inventory investment. Increase 4. The lower the elasticity of supply of co-
in stocks resulting from the failure of operant factors.
expected orders to materialize. (See INVEN- To these rules it is useful to add a fifth,
TORIES.) relating to the effectiveness of union control
over alternative supplies of labour to the
union density. The proportion of the grade in question. This effectiveness is a
labour force that is unionized. Union density function of UNION DENSITY. Higher union
varies widely across industries and between density alters the conditions described by
different countries as a result of differences rules 1 and 2 in a manner favourable to the
in the costs and benefits of unionisation. The union. Note that union market power may
key determinants of these costs and benefits be buttressed by union political power.
appear to be average establishment size, the
degree of product market CONCENTRATION union/non-union differential. This mea-
and the wage rate. The first variable enters sures the extent to which unions have raised
on the costs side of organization: it is less the wage of their membership relative to
costly to organize and maintain organization equivalent non-union labour. Calculation of
in industries with a few large visible plants this magnitude is complicated by a variety j
than in industries with a more atomistic of factors. First, when wages are raised \
!
employment structure. The two latter vari- employers have an incentive to screen job
ables enter on the benefits side of organiz- applicants more carefully and to take on
ation. Market concentration is a crude proxy only the more highly qualified. This adjust-
for monopoly power and thus implies a less ment could in principle iron out most differ-
elastic DERIVED DEMAND curve. Similarly, ences in terms of EFFICIENCY UNITS. Second,
higher wages indicate greater benefits to wages and union membership might be
organizing the industry. jointly determined - higher wages may en-
Changes in union density through time courage unionization as much as unions
have also been shown to be a positive func- cause higher wages. Third, and less import-
tion of the rate of inflation and a negative ant, the THREAT EFFECT may lead to an under-
function of the lagged level of membership. estimate of the differential. Studies which
442 union pushfulness
recognize these complications produce much RIDER problem and provides a more stable
reduced estimates (less than ten per cent) of industrial relations environment. Unions
the union/non-union differential. A middle also commonly claim that the union shop is
of the road position would put the differen- democratic; before the arrangement can be
tial in the range of 10 to 15 per cent. negotiated it is first necessary to gain the
Whatever estimate is chosen, the differential vote of a majority of the employees in the
moves counter-cyclically, possibly because bargaining unit. Arguments against basically
union wages are more rigid than non-union focus on the FORCED RIDER issue: the union
wages. shop is thus said to be unfair because it
compels workers against their will to join a
union pushfulness. The propensity of purely private organization in order to keep
unions to engage in a wage push, i.e. their their jobs. This deficiency has to be set
mood for militant action. The basic difficulty against the stabilization of the industrial re-
with this notion is that militancy or pushful- lations environment attendant upon reduced
ness is a subjective magnitude and is, there- membership raids by rival unions.
fore, empirically elusive. Two broad
approaches to pushfulness exist. The first is uniqueness. Generally used in the context
an economic approach based on the argu- of GENERAL EQUILIBRIUM theory to refer to
ment that there exist measurable magni- the existence of a unique set of market clear-
tudes, which are plausibly correlated with ing prices. (See EQUILIBRIUM.)
the subjective magnitude and which are,
therefore, employed as PROXY measures for
the underlying attitudinal variable. Two unit root tests. Tests used to determine
main types of proxy, union membership whether or not a TIME SERIES is DIFFERENCE
proxies and strike activity proxies, have STATIONARY. If a time series can be described
been used in ECONOMETRIC tests. Consider- by the model,
able controversy attaches to each, not least yt = a + p^ f _! + ut t = 1, . . ., T
because both union membership and strike
frequency are related to the level of econ- then testing for p = 1 is called testing for a
omic activity. Accordingly, an observed re- unit root. If p = 1 then the above series can
lation between either variable and the rate be written as
of change in wages may be a spurious CORRE-
Ay, = a + u, , where Ay, = yt — yt^\
LATION, reflecting the fact that the militancy
proxy variable and the rate of change in which is known as a RANDOM WALK or a
wages are jointly determined by economic difference stationary process. This is said to
forces. be a random walk win drift if a ¥^ 0.
The second approach has been to argue A large literature exists on this problem,
that union pushfulness is not an economic but the most commonly used tests are de-
phenomenon but rather a sociological rivatives Of the DICKEY-FULLER TEST. A
phenomenon. An array of sociological hypo- closely related problem is that of distinguish-
theses have been advanced, associated with ing between a TREND STATIONARY PROCESS
RELATIVE DEPRIVATION, *the dispersion of (TSP) and a DIFFERENCE STATIONARY PROCESS
power from the centre to the base in collec- (DSP).
tive bargaining, 'permissiveness' and so on.
United Nations Capital Development
union shop. An arrangement whereby a Fund. A special body created by the
worker must join the union within a speci- United Nations General Assembly in 1966 to
fied period of time after beginning employ- facilitate economic growth in developing
ment. The employer thus has complete countries by supplementing existing sources
discretion in his choice of labour. This of capital assistance with grants and loans;
arrangement would be termed a post-entry generally earmarked to finance small scale
closed shop in the UK. rural development projects which are unable
Arguments in favour of the union shop are to generate alternative financing due to
that the arrangement is necessary for the insufficient collateral or credit worthiness
survival of the union because of the FREE on the part of the applicant. (See UNITED
unit tax 4
Unit Trust. The term used in the UK for urbanization economies. Cost savings
an institution, resembling an INVESTMENT which arise when economic activities are
TRUST, which enables investors to spread concentrated in urban areas. These econo-
their risks by purchasing an interest in a mies, also known as economies of urban
PORTFOLIO OF SECURITIES. By buying 'units' in concentration, are a particular form of AGG-
such a trust the investor in effect acquires LOMERATION ECONOMIES. The existence of
ownership of the trust's securities in pro- urbanization economies helps to account for
portion to the number of units held. Unit the growth of urban industrial and commer-
trusts are run by managers, who include cial centres.
many of the major banks and insurance com-
panies and who usually run several trusts Uruguay round.
each specializing in particular ranges of See GENERAL AGREEMENT ON TARIFFS AND
securities. The managers are obliged to sell TRADE.
and buy back units freely at prices related to
the current market values of the underlying
securities: if sales exceed repurchases, the user cost of capital. The implicit rental
portfolio expands, so that unit trusts are value of CAPITAL SERVICES, or the price a FIRM
'open-ended 1 . should itself pay for the use of the CAPITAL
STOCK it owns or is considering acquiring. It
may also be considered as the price the firm
Unlisted Securities Market (USM). would pay if it rented capital goods to obtain
Launched in 1980 by the London STOCK capital services, just as in the case of labour.
EXCHANGE (by which it is regulated) the TAXATION and INTEREST RATE changes may be
USM is a less organized market than the considered to affect INVESTMENT through the
Stock Exchange. For companies, of which user cost of capital. This concept is much
over 200 now use it, it has less onerous associated with the NEO-CLASSICAL theory of
disclosure requirements and formalities, in- investment, in particular as seen by D.
cluding costs. Jorgenson and associates, and assumes a
PUTTY-PUTTY capital model, with factor sub-
unsecured loan stock. stitution equally possible before and after
See FINANCIAL CAPITAL. investment.
unvalidated inflation. An INFLATION rate
which is not accompanied by a similar rate of use value and exchange value. A distinc-
increase in the money supply. tion, which was the subject of discussion
from the time of ARISTOTLE up to MARX, be-
urban economics. That branch of econ- tween the UTILITY obtained from a good and
omics which applies the tools of economic its price, SMITH dealt with it in the paradox of
reasoning to the analysis of economic value. Water has a high use value but a low
activity in, and the economic problems of, exchange value, while the reverse holds for
cities and towns. Much of urban economics diamonds. The doctrine of MARGINAL UTILITY
is concerned with analysing the pattern of resolved the problem by explaining that
location of economic activities in and be- price (exchange value) is related to marginal
tween urban areas - thus it has strong links utility and not to total utility (use value).
with REGIONAL ECONOMICS and with LOCATION
THEORY. Other topics include the issues of U-shaped cost curves. Curves showing
optimum city size and analysis of the econ- how the average costs of a firm or industry
omic growth of towns and cities - this latter vary with the level of output. They are an
indicates a connection with regional macro- integral feature of the theory of PERFECT
economics. COMPETITION, where it is assumed that the
However, urban economics should not be long-run average cost curve of the firm in-
viewed as simply a form of regional econ- itially exhibits INCREASING RETURNS TO SCALE
omics since it also analyses topics such as which pertain up to the point of MINIMUM
problems of urban transport and urban EFFICIENT SCALE. Beyond this point DECREAS-
public services which are not comparable ING RETURNS TO SCALE set in as a consequence
with aspects of regional economics. of the existence of fixed factors such as high
utilitarianism
quality management, for instance, which goods he consumes and their amounts. M
gets over-utilized as output rises. Such a formally written as:
returns to scale pattern yields a U-shaped U = U(X,Y,Z . . .)
average cost function.
where X, Y and Z are the amounts of
utility. Widely construed in economics to goods in question.
be synonymous with 'welfare', ECONOMIC
WELFARE, satisfaction, and, occasionally, utilitarianism. Philosophical and polii
happiness. More strictly, however, to say term to describe the doctrines of BENT:
that someone derives utility from a good or and his followers, who took as their crite
event is to say that they prefer the good to for judging actions the principle of
exist rather than not to exist. To say that greatest happiness of the greatest num
they derive more utility from good X than While utilitarianism had a major influi
good y is simply to say that X is preferred to on reforms enacted by Parliament in the
y. For an argument that utility is a circular in the early nineteenth century, its impa<
concept see J. Robinson, Economic Philo- theoretical economic writings was not g
sophy, Penguin, Harmondsworth (1964), Of the CLASSICAL ECONOMISTS only John
p. 48. and his son, J.S. MILL, were utilitarian
the only significant theoretical contrib
utility function. A function stating that an was J.S. Mill's tax theory developed in
individual's UTILITY is dependent upon the of equal sacrifices of UTILITY.
vacancies. Employers' unsatisfied de- where D is the dividend payment per share
mands for additional employees. In the UK which grows at the constant annual rate g
vacancies for most MANUAL WORKERS and and i is the DISCOUNT RATE. Alternatively, we
some NON-MANUAL WORKERS are notified to may write
the public employment service and are sys-
tematically recorded. As a result monthly V =
statistics on the level of vacancies and the - g
VACANCY RATE are published. In contrast where r is the RETENTION RATIO and TT the
vacancies for professional and senior non- profit rate. Dividing through by K gives us
manual employees are most frequently the expression for V, the valuation ratio
advertised in the national press and pro-
fessional journals. They are not notified to V = (1 - r)ir
and recorded by the public employment ser- K i-g '
vice since this does not constitute the tradi-
tional channel of JOB SEARCH for this class of (See GROWTH THEORIES OF THE FIRM and
workers. Published vacancy statistics there- GROWTH VALUATION FUNCTION.)
fore under-record the level of vacancies out-
standing in the economy at any one time value, money, a standard of. One of the
although changes in vacancies probably pro- functions of MONEY is that it acts as a stan-
vide a reasonably accurate indication of dard of value. That is, it provides a system of
changes in the demand for extra employees. units of account in terms of which PRICES are
expressed, and deferred payments, e.g.
vacancy rate. An index of the demand for DEBTS, are defined.
labour at the prevailing wage rate. In the
UK this is computed by expressing those value, theory of. The intrinsic worth of a
VACANCIES notified to the public employment commodity. If defined in terms of money,
service as a proportion of vacancies plus the value determines PRICE. Since the time of
total number of employees in employment. ARISTOTLE onwards it has been traditional to
separate the concepts of use value and value
validated inflation. INFLATION which is in exchange. Value in use is not an intrinsic
allowed to persist because the government quality of a commodity, but its capacity to
allows the MONEY SUPPLY to expand at the satisfy human wants. Value in exchange is
same rate as inflation. the worth of commodity in terms of its ca-
pacity to be exchanged for another commo-
valuation curve. dity. The exchange ratios of two com-
See GROWTH-VALUATION FUNCTION. modities are the relative prices of those com-
modities if expressed in terms of a constant
valuation ratio. The ratio of the stock money commodity.
market valuation of the firm V to the book In CLASSICAL ECONOMICS the existence of
value of assets K. Given STEADY-STATE use value was a prerequisite for commodities
GROWTH conditions a firm's stock market to have value in exchange. A commodity
valuation will be equal to the NET PRESENT must possess UTILITY or usefulness in order
VALUE of expected dividend payments mul- for it to be produced or exchanged. The
tiplied by n, the current share issue size of exchange value of a commodity was deter-
the firm. We can write mined by the costs of producing that com-
modity - wages, profit and rent. Adam SMITH
nD explained the price of a commodity in these
V =
~8 terms arguing that the costs of production
446
value judgement 4
determine the 'natural price' of the commo- levied on value-added excluding the tax ps
dity around which actual prices fluctuate at previous stages in the production proo
according to variation in short-run demand. and so does not give an incentive to VERTIC
David RICARDO is often credited with advanc- INTEGRATION a s d o e s a TURNOVER TAX.
ing a LABOUR THEORY OF VALUE. The value of practice this type of tax is not actually bai
a commodity . . . depends on the relative on value-added. In the UK for example
quantity of labour which is necessary for its ports are not liable but imports are. Furth
production' although he recognized that a government expenditure on wages and sal
strict labour theory held only under certain ies is not part of the tax base. The VAT b
special assumptions. However, for Ricardo, does allow for CAPITAL EXPENDITURE, by i
value theory was not primarily a theory of mediately allowing for all new investm
relative prices but the key to the explanation and not just that part which replaces w<
of INCOME DISTRIBUTION. Ricardo was con- out capital. Further, certain services
cerned with the search for an invariant exempt because it was found difficult to
measure of absolute value. The late nine- them in practice. The UK VAT is best
teenth century neo-classical economists fo- scribed as a tax on consumption in the \
cused not on intrinsic value, but on the vate sector which leaves out some servi<
determinants of market price. In contrast to There are exempt goods such as finan
earlier writers they concentrated on the uti- services, education and health. With t\
lity of a commodity developing a theory of the trader does not charge his customer
exchange value. Price was determined by tax on his sale. He cannot however reel
MARGINAL UTILITY which was the source and any tax which he himself has paid
cause of exchange value. Alfred MARSHALL purchases of inputs. Transactions v
advanced the idea that market price was exempted because of the difficulty
determined by the interaction of DEMAND administering the tax. There are also z
and SUPPLY both of which were derived from rated goods. Here the trader does not chj
the principle of utility. The theory of value tax to his customer and in addition he
became a theory of the allocation of scarce reclaim any tax he has paid on his purch
resources to specific uses rather than a of inputs. Zero-rated items in the UK
search for intrinsic value. Modern theory has elude food, books and journals, coal,
furthered this line of thought substituting the and electricity, the construction of build
dual incentives of utility maximization for and medicines supplied on prescript
the consumer (demand) and PROFIT MAXIMIZ- Small traders whose turnover is less th<
ATION for the producer (supply) for the minimum value are exempt. For secc
single principle of utility. Only the followers hand goods the general rule is that tax is i
of Karl MARX who developed the labour on the full second-hand value. A main
theory of value into a theory of profit or ception is motor cars where the tax is pai
SURPLUS VALUE retain the separation of value the dealer's gross margin.
theory from the theory of price determina- The tax is administered in the UK I
tion. the other EC countries) by the indirect
tractive method. Thus tax at the full
value-added. The value of the firm's out- (currently 17.5 per cent) is charged
put minus the value of the inputs it pur- customer. The trader then reclaims th*
chases from other firms. Essentially it is the which he himself has paid on his purch
sum of the FACTOR INCOMES, the wages and of inputs from other traders.
profits, of the firm. (See NATIONAL INCOME.)
value judgement. A statement that ca
value-added tax (VAT). Conceptually this general, be reduced to the form 'X is \
is a tax based on the VALUE-ADDED in a (bad)'. In turn, such statements are anal
country. The thinking behind the tax is that in different ways by different philosop!
it is an equitable way to tax the value of Some would say 'X is good' means 'I lik
sales. It does not discriminate against any for others it means 'I like X and you sh
activity as do specific sales taxes such as like it too', and so on. The term value ji
EXCISE DUTIES or PURCHASE TAX and so is ment causes extensive confusion in <
more neutral in its impact. Further, the tax is omics. Common misconceptions are tha
448 value marginal physical product
synonymous with 'a matter of opinion', parameters vary over time they are called
whereas 'in my opinion it will rain tonight' is TIME VARYING PARAMETER models. One
a positive statement of predictive form and approach to this type of model is to assume
has no value judgement involved. there is a small number of different regimes
with an associated parameter change:
value marginal physical product. another and more general approach is that
See MARGINAL REVENUE PRODUCT. the variation is continuous. There are many
methods of estimating such models such as
variable capital. In the Marxian scheme that suggested by Hildreth and Houck (Jour-
that part of CAPITAL, represented by labour nal of the American Statistical Association,
power, which undergoes an alteration of 1968) or by using the KALMAN FILTER. If the
value in the production process. If the wage variation in the parameters is not systematic
necessary to buy the SUBSISTENCE goods to but STOCHASTIC then the models are called
keep the labour stock constant is £10 per p u r e RANDOM COEFFICIENT MODELS.
day, the capitalist will get back more than
the £10 he advances for this purpose, for the variance. A commonly used measure of
worker will produce an output or value the extent to which a random variable (or
equal to the £10 and an excess or SURPLUS STATISTIC) is dispersed about its MEAN value.
VALUE which accrues to the capitalist, so that It is defined as
the money advanced to buy labour power
varies (increases), whereas the money ad- a = J (Xi-Sy)2-f(X)-dX
vanced to buy machines (CONSTANT CAPITAL) — oo
undergoes no increase in value. where X is the variable,
|x is its mean, and
variable costs. Costs which vary with the f(X) is its probability density
level of OUTPUT - e.g. labour costs. In the function.
SHORT RUN some costs will be fixed and some
variable. In the LONG RUN, all costs are likely An estimate of the variance of a variable can
to be variable. be obtained from sample information by the
calculation of the sample variance, accord-
variable elasticity of substitution production ing to the formula
function (VES production function). This N —,
is a generalisation of the CONSTANT ELAS- 2
TICITY OF SUBSTITUTION PRODUCTION FUNCTION s = S N-1
i=\
which allows the elasticity of substitution to
vary with the ratio of the factor inputs. This where Xt is the ith observation on the vari-
function may be estimated by regressing the able X,
logarithm of output per unit labour on the A^is the sample mean, and
REAL WAGE and the capital to labour ratio. N i s the sample size.
variable labour costs. The costs of Note that the square root of the variance is
t h e STANDARD DEVIATION, Or STANDARD
employment that vary proportionately or
ERROR. (See RANGE, COVARIANCE.)
more than proportionately with hours
worked. The principal examples are hourly
wage rates and overtime/premium-time pay. variance-covariance matrix. The matrix of
But various NON-WAGE LABOUR COSTS will VARIANCES and COVARIANCES of a set of
also often have a variable as well as a fixed jointly distributed RANDOM VARIABLES, the
cost component. variances forming the diagonal elements,
while the covariance occupy the relevant
variable parameter models. Econometric rows and columns. In econometrics this term
models where the underlying population normally applies either to the matrix of vari-
parameters which are being estimated are ances and covariances of parameter esti-
assumed to be variables, unlike the situation mates, or to that of the values of the
in REGRESSION analysis where these para- stochastic DISTURBANCE TERM in a REGRESSION
meters are assumed to be fixed. If the equation.
vector autoregression 449
BOX-JENKINS forecasts using a full econo- higher paid. The distribution of benefits
metric model. from, say, free education might also be ana-
lysed in terms of vertical equity. Ultimately,
vehicle currency. In the major FOREIGN a concept of vertical equity must imply some
EXCHANGE trading centres most business is view of what constitutes a 'fair' distribution
conducted in a few major currencies, holders of income. (See EQUITY, HORIZONTAL EQUITY,
of other currencies converting them into one DISTRIBUTIONAL EQUITY.)
or other of these major currencies for carry-
ing out their transactions. Such major cur- vertical integration. A situation where the
rencies are termed vehicle currencies, and activities of a firm extend over more than
while a number of them are in active use, the one successive stage in the production pro-
US dollar remains the world's principal ve- cess of transforming raw materials into final
hicle currency. (See EXCHANGE RATE, EXTER- goods. Vertical integration can be par-
NAL RESERVES.) titioned into two types: backward inte-
gration, where a firm extends itself into a
veil of ignorance. previous stage of the production process and
See RAWLSIAN JUSTICE. forward integration, where a firm moves into
a succeeding stage of activity.
veil of money. Motives commonly adduced for such inte-
See CLASSICAL DICHOTOMY. gration are reduction in WORKING CAPITAL
requirements, elimination of prohibitory
velocity of circulation. The speed at which transaction costs, greater price competitive-
a given sum of money circulates in the econ- ness as a consequence of avoiding successive
omy - i.e. the average number of times a profit mark-ups and, in the case of forward
unit of money changes hands in a specified integration into retail outlets, the acquisition
time period. One version of the equation of of 'secure' markets.
exchange is
vertical merger. The amalgamation of two
MV = PT
firms which produce products belonging to
where M is the money flow, V the velocity of different stages of the same production pro-
circulation, P the general price level and T cess. (See MERGER, VERTICAL INTEGRATION.)
the level of transactions. On rearrangement
it becomes vertical Phillips curve. The hypothesis
that in the LONG RUN there is no TRADE-OFF
v - El between the rate of money wage change and
the level of unemployment as the PHILLIPS
(See QUANTITY THEORY OF MONEY, INCOME VE- CURVE originally suggested. In contrast to
LOCITY OF CIRCULATION.) Phillips' original hypothesis, FRIEDMAN
(1968) suggested that it is the REAL WAGE and
venture capital. not the money wage which is the focus of the
See RISK CAPITAL. wage bargain.
The hypothesis suggests that workers are
vertical equity. Justice or fairness in the concerned to protect the real value of their
treatment of individuals in different circum- wages and will, therefore, demand money
stances. In the field of taxation, vertical wage increases which compensate for the
equity is held to require that individual's tax expected rate of inflation. That is:
burdens should be related to income levels.
Thus vertical equity is often put forward ^W = F(V)t + XAPf
as an argument for PROGRESSIVE or PRO-
PORTIONAL TAX by which higher income where X = 1
earners pay more tax. It is usually argued AW is the change in money wage
that MARGINAL amounts of income have less rates,
significance at high than at low income U is the unemployment rate, and
levels, thus fairness in sharing the burden of AP e the expected change in prices, all
taxation requires higher taxation for the in period t.
voluntary-exchange model 451
(CONTINUITY). Quite simply, the consumer is 'no'. This contrasts with an economic v<
prepared to 'TRADE-OFF' risk for extra gain. where intensity of want is expressed throi
Now, assign some arbitrary number, say a higher WILLINGNESS TO PAY. (See ECONOI
100, to the best event, X, and another arbi- THEORY OF POLITICS.)
trary number, say 1, to the worst event, Z.
Consider the lottery p*X + (1 -p*)Z versus vote trading.
the certainty of Y. Then the UTILITY number See LOGROLLING.
to be attached to Y is (substituting the arbi-
trary values for X and Z): voting and non-voting shares. The own
p*-100 + (1 - p * ) = 99-p* + 1 . of a company's ordinary shares (see E(
TIES) generally have full voting rights at c<
If p* is determined, an exact number can be pany meetings. However, in the 1950s ;
found. The resulting utility index is there- 1960s 'A' ordinary shares were issued
fore CARDINAL. The theory then asserts that some companies in the UK. These contai
consumers will behave so as to maximize all the risks of other ordinary shares, but
their expected utility - i.e. the sum of the not have voting rights. They were issuec
individual utilities each weighted by their companies whose directors did not wis]
probability of occurrence. lose control of the organizations thrc
takeover bids. The issue of such shares
von Neumann ratio. Denoted generally been frowned upon. The owne
2 PREFERENCE SHARES, though regardec
|S , members of a company rather than c
tors, normally do not have voting right
A TEST STATISTIC calculated for the purpose cept where their dividends are in arrea
of detecting the presence of SERIAL CORRE- where an item of business affects
LATION of RESIDUALS in REGRESSION analysis, rights. Owners of DEBENTURES do not
according to the formula voting rights.
recipient's income or in the extent to which are a way of increasing CONSUMER SOVER-
the recipient's income may be added to the EIGNTY in areas like education and health
voucher and so on. It is suggested that they care.
w
difference. 'True' drift arises from inform- wage rates. The rate of payment an indi-
al arrangements between employers and vidual receives for the supply of each of the
workers to allow pay to rise or the required minimum number of hours specified in
labour input to fall and most frequently the WAGE CONTRACT. Often referred to as
occurs under PIECEWORK systems. (See EARN- basic hourly wage rates, they specify some
INGS DRIFT.) minimum level of remuneration the indi-
vidual can expect for each hour of the STAN-
wage fund. According to CLASSICAL econ- DARD WORKING WEEK. The total minimum
omic doctrine, a fund available for the pay- remuneration for the standard working week
ment of wages. At any given time the fund, is frequently referred to as basic pay or the
along with the given supply of labour, deter- weekly wage rate. The wage rate should be
mined the average wage. In the long run distinguished from EARNINGS which vary with
both the fund and supply of labour were the length and intensity of the input of
variable, since the fund could be augmented labour.
by savings while the supply of labour was
thought to be determined by some 'mini- wage restraint.
mum of existence'. While classical doctrine See INCOMES POLICY.
was clear that wages were advanced out of
capital, it failed to explain satisfactorily the wage round. The hypothesis that substan-
division of capital between the wage fund tial linkages exist between the settlements of
and physical capital. (See IRON LAW OF all negotiating groups in the economy and
WAGES.) that in consequence wage settlements con-
form to certain patterns each year. These
wage inflation. A rise in money wages patterns have variously been suggested to
over time. This may be due, but need not be, take the form of a bunching of settlements in
tO WAGE-PUSH INFLATION. certain months, an orderly and repetitive
sequence of settlements and a marked simi-
wage leadership. A situation where a larity in the size of all settlements. In prac-
single settlement or the general level of sett- tice, these patterns had seldom been
lements within a specific sector serves as a observed in the UK prior to the incomes
point of reference for all subsequent wage policies of the 1970s. These policies, how-
claims. (See LEADING SECTOR AND ever, appeared to concede the right to an
COMPARABILITY.) annual pay review for all employees with the
result that a fairly orderly sequence of settle-
wage-price spiral. The notion that wage ments throughout the year was established.
increases lead to price increases, via the in- Some economists have advocated compress-
crease in production costs, which in turn ing the wage round into a few weeks in an
feed through into wages, as workers seek to attempt to produce a coordinated wage
preserve the purchasing power of their policy. (See COMPARABILITY.)
wages, and so on. The interpretation of the
wage-price spiral as a mechanical sequence wages boards. Statutory bodies similar to
is intimately linked to the COST-PUSH view of WAGES COUNCILS but controlling the pay and
inflation. conditions of work in the agricultural
industry.
wage-push inflation. A variant of COST-
PUSH which attributes the origins of the infla- Wages Councils. Statutory bodies empow-
tionary process to trade union pressure in ered by the government to make proposals
the labour market. There are a number of about the pay and hours of work in certain
versions of the argument ranging from the industries in the UK. Established in 1909
exertion of trade union MONOPOLY power, and modified in 1945 these bodies were
through models of union bargaining power introduced into industries which were
based on objective economic variables (e.g. thought too weak to support voluntary COL-
the costs imposed on employers by strike LECTIVE BARGAINING in an attempt to elimin-
activity) to non-economic models of trade ate low pay. In the mid-1970s approximately
union militancy. one-fifth of all manual workers in the UK
wage theory 457
were covered by Wages Councils and WAGES in the analysis of wage determination.
BOARDS. In the main, these were concen- However, the predominance of neo-classical
trated in the retailing and distribution indus- labour theory has by no means been continu-
tries. Changes introduced in 1985 removed ous and was itself preceded by the CLASSICAL
workers under 21 from the protection of treatment. The cornerstone of the latter was
Wages Councils, while further changes in the MALTHUSIAN principle of the population
coverage have substantially reduced the im- and the concept of the WAGES FUND. The
portance of these bodies. classical economists firmly believed that
The Councils consist of an equal number wages tended to oscillate around their natu-
of representatives of employers' associations ral or subsistence level. This pessimistic view
and trade unions together with a number of of the long-term prospects for the working
independent members appointed by the gov- class led to the designation of economics as
ernment. The recommendations on pay and the 'dismal science'. The classical eco-
hours made by the Councils have the force nomists were aware that wages varied be-
of law and are policed by a Wages Council tween occupations and although their main
Inspectorate which visits workplaces to concern was to explain the general level of
ensure that they comply with the orders. labourers' wages and the movement of
While the WAGE RATES established by the labour's share in the national product with
Councils can differ from industry to population growth they did give attention to
industry, in practice they reveal a remark- these variations and much of their analysis of
able degree of similarity. They constitute an differentials remains valid today.
effective minimum rate in the industries Gradually the approach to the theory of
covered and, therefore, constitute the MINI- wages changed. Among later classical eco-
MUM WAGE LEGISLATION in the UK. (See FAIR nomists, especially J.S. MILL, the wages fund
WAGES.) doctrine fell into disrepute, although the
classical school continued to cling to the
wages freeze. Malthusian principle of population. The lat-
See INCOMES POLICY. ter half of the nineteenth century was
characterized by dissatisfaction with classical
analysis on two principal fronts. First, the
wages fund doctrine. development of Marxist theory provided a
See IRON LAW OF WAGES.
radical departure from the classical analysis,
particularly in respect of value theory. From
wage structure. The ranking of pay levels the manpower perspective of wage theory,
of different groups of workers classified however, the Marxist LABOUR THEORY OF
according to the industry or location in VALUE and the prediction that the wage rate
which they work or according to the occu- under capitalism tends toward the subsis-
pational or racial group to which they tence level were in fairly close conformity
belong. While the concept of WAGE DIFFER- with early classical analysis. Second, and
ENTIALS is concerned to measure the differ- more substantively, came the marginalist
ences in pay between groups on some revolution. Whereas the classical economists
common scale the notion of a wage structure viewed cost of production as the determi-
is concerned only with the relative ranking nant of product price, the early marginalists
of groups of workers. Since groups of viewed MARGINAL UTILITY, or demand, as the
workers who differ on one of the above determinant of price. The wage of labour
dimensions are unlikely to be the same in all was thought to be determined by the DE-
others, it is in practice extremely difficult to RIVED DEMAND for labour, represented by the
describe a ranking along any single dimen- value MARGINAL PRODUCT of labour. The
sion. Nonetheless the notion of a REGIONAL worker was paid out of a flow of revenue
WAGE STRUCTURE and of an INDUSTRIAL WAGE from the sale of goods he helped (in associ-
STRUCTURE still attract attention. (See OCCU- ation with capital - a distinct source of
PATIONAL WAGE STRUCTURE. value) to produce and not out of a fund.
Subsequent analysis, and in particular that
wage theory. NEO-CLASSICAL theory is of A. MARSHALL and his successors, showed
today the dominant scientific paradigm that wage determination was a product of
458 wage-wage spiral
an income stream (Y) using the interest rate wear and tear.
See DEPRECIATION.
Y
to = — . Weberian location theory.
r
See LOCATION THEORY.
This however raised the problem of INSIDE
MONEY, as those who had initially borrowed weighted average. An average in which
money by selling bonds would now feel cor- each of the observations is multiplied (or
respondingly worse off unless MONEY ILLU- 'weighted') by a factor before calculation,
SION is significant. and in which these factors sum to unity. It
Many economists consider the wealth can thus be defined by
effect to be theoretically valid but empiri-
cally weak. (See INSIDE MONEY.)
New Welfare Economics. The most import- sick and the unemployed. Many of the post-
ant departure of Paretian welfare economics war developments in the welfare state in the
from the Pigovian tradition was the rejection UK have been influenced by the BEVERIDGE
of the idea that UTILITY was cardinally and REPORT.
interpersonally measurable. As a result of
denying that it is possible to compare the well-behaved. A property of PRODUCTION
utility or welfare of one individual with that (and UTILITY) FUNCTIONS. It requires that
of another many pairs of social states cannot production (utility) is zero if one of the
be ranked. In order to extend the applica- inputs (commodities) is zero, that the MAR-
bility of the PARETO RULE, hypothetical COM- GINAL PRODUCT (utility) is always positive,
PENSATION TESTS have been introduced. In but diminishes smoothly with increasing
order to locate the optimum optimorum amounts of a given factor (commodity). This
some economists have proposed the use of a notion plays a crucial role in the NEO-
Bergsonian SOCIAL WELFARE FUNCTION. How- CLASSICAL theories of growth and distri-
ever, this requires that utility be cardinally bution (See CAPITAL-LABOUR SUBSTITUTION.)
and interpersonally measurable. For further
reading see Johansson, Per-Olov, An Wharton model. A seventy-six equation
Introduction to Modern Welfare Economics, econometric model of the US economy
Cambridge University Press, (1991). developed from the KLEIN-GOLDBERGER
MODEL (K-G) but different from it in four
main ways.
welfare function. For an individual, the
(1) It is estimated using quarterly data
relationship between his level of wellbeing,
where the K-G model uses annual data.
welfare or UTILITY and the things that con-
(2) It is primarily designed to be used to
tribute to it. Synonymous with UTILITY FUNC-
forecast economic activity in particular
TION. For society, the SOCIAL WELFARE
NATIONAL INCOME and the level of
FUNCTION is a relationship between the wel-
EMPLOYMENT.
fare of society as a whole and all the vari-
ables affecting the state of the economy and (3) It is disaggregated to a much greater
the 'quality of life'. A social welfare function degree and has a much better developed
can also be denned as a relationship between monetary sector.
SOCIAL WELFARE and the welfare (or utility) (4) Production is modelled using functions
of the individuals comprising that society. of the COBB-DOUGLAS type.
This meaning effectively requires some rule The Wharton model also includes a PHILLIPS
for saying how individuals' utilities are to be CURVE relationship. It was estimated using
combined - e.g. whether each individual's TWO STAGE LEAST SQUARES. The Wharton
utility is to be counted for what it is, or model has a reasonably good record for the
whether some should be 'weighted' to reflect accuracy of its forecasts outperforming both
some concept of fairness or distributive larger and smaller models.
justice.
whipsawing. A technique employed by
some unions to extract a concession from an
welfare state. The most general interpret- employer by threatening to strike while his
ation is a state in which the government competitors continue to operate, and, after
plays a positive role in the promotion of he has conceded, to attempt to force a
SOCIAL WELFARE. All activities of govern- second employer to grant the same or even
ment can thus be counted as part of the enhanced terms and conditions of employ-
welfare state in that it is likely to be claimed ment or face a strike. Employers may meet
that they promote social welfare. The term is this tactic by co-ordinating their COLLECTIVE
more specifically used to refer to the provi- BARGAINING activities and perhaps by nego-
sion of education, health-care and housing at tiating as a single group, STRIKE INSURANCE
zero or subsidized prices; the personal social may form a plank in this response.
services provided for the old, the handi-
capped and children in care; and the cash white-collar worker. Employees and
transfers to particular groups, such as, the employers who are not engaged in physical
Wicksell, Knut 463
work and who perform duties which appear - the INTERBANK, LOCAL AUTHORITY, CERTIFI-
to be functionally related to authority. The CATE OF DEPOSIT and EUROCURRENCY markets.
notion is vague and for practical purposes is The sums lent and borrowed in these mar-
usually interpreted to mean NON-MANUAL kets are large, not less than £lk million; they
WORKERS plus shop sales persons and shop are placed at various terms from 'overnight'
assistants. up to several months; and specialist money
brokers play an important part in them.
white noise. A description of variation Before 1971 the main institutions involved
which is purely RANDOM and contains no were the MERCHANT BANKS and the London
systematic elements. The ideal property of offices of foreign and British overseas banks.
the STOCHASTIC DISTURBANCE term in a RE- The British domestic banks, inhibited by
GRESSION equation is that it should be white credit policies, participated through sub-
noise. (See STATIONARITY.) sidiaries set up for the purpose. However,
with the freedom introduced by the 1971
White Plan. The US plan for an
credit control regime, the CLEARING BANKS
International Stabilization Fund, proposed
now participate directly in the wholesale
at the United Nations Monetary and
money markets. (See COMPETITION AND CRE-
Financial Conference held at BRETTON
DIT CONTROL, MONEY MARKET, RETAIL
WOODS, New Hampshire in 1944. The plan,
BANKING.)
commonly called the White Plan after its
chief author, Harry D. White of the US
Treasury, recommended that member coun- Wicksell, Knut (1851-1926). A Swedish
tries contribute currencies and gold to a cen- economist, Wicksell studied mathematics
tral reserve fund which would in turn be and philosophy. He was appointed to the
used to help finance short-term BALANCE OF Chair of Economics at the University of
PAYMENTS deficits experienced by members. Lund in 1904. His work provides a masterly
The main objective of the fund was to pro- exposition, synthesis and extension of the
vide a means of establishing stability and NEO-CLASSICAL theory of production and dis-
order in foreign exchange transactions so as tribution. This is contained largely in volume
to encourage the re-establishment and main- I of Lectures on Political Economy (1901).
tenance Of MULTILATERAL TRADE. Unlike the Wicksell bridged the gap between the AUS-
TRIAN SCHOOL and the LAUSAWNE SCHOOL. He
rival UK or KEYNES PLAN, the White Plan did formulated in a multi-sector model a version
not provide for the establishment of a new of the marginal productivity theory of capital
international means of payment or the ex- similar to that of BOHM-BAWERK and a theory
tension of credit facilities, especially auto- of wages and rent contingent on the mar-
matic and unlimited American credits to ginal products of labour and land. In this
members experiencing persistent balance of context he discussed the return to capital
payments difficulties. Although the Confer- and its relationship with the RATE OF INTER-
ence eventually established the INTER- EST. In contrast to contemporary theory he
NATIONAL MONETARY FUND along the lines
pointed out that in equilibrium the value of
suggested by the White Plan, the Fund has the marginal social product of capital as a
since evolved into an institution which re- whole would be less than the rate of interest.
sembles a compromise between the original This would be the case because the aggre-
UK and US proposals considered at Bretton gate effect of individual additions to the
Woods. stock of capital would be to raise the value of
the whole capital stock and thus lower the
wholesale. The intermediate stage in the
value of a marginal addition. This has be-
chain of distribution. Wholesalers specialize
come known as the WICKSELL EFFECT.
in the process of distribution, purchasing the
output of firms for re-sale and distribution to In the second volume of Lectures,
RETAILERS. Wicksell made important contributions to
monetary theory. This largely consists of a
wholesale banking. The large-scale deal- re-statement of the mechanism which links
ing in money deposits centred in the closely money to prices indirectly through the inter-
interrelated group of MONEY MARKETS which est rate and directly through what has be-
have developed strongly since the mid-1960s come known as the REAL BALANCE EFFECT. In
464 Wicksell effects
Interest and Prices (1898, but not translated Wicksell argued that an increase in the
into English until 1936), he suggested a new supply of capital (INVESTMENT) affects not
theory of interest and prices which only the price of new capital, but also alters
attempted to solve the classical QUANTITY the units in which the existing stock of capi-
THEORY dilemma over the relationship be- tal is valued. He argued that the net effect of
tween interest rates and prices. Wicksell a rise in wages and a fall in the RATE OF
explained the existence of high rates of inter- INTEREST is to raise the value of existing capi-
est in times of inflation by means of an analy- tal. This implies that the value of capital in
sis of the determinants of the MONEY SUPPLY two economies may differ according to the
under various monetary institutions. He level of wages and the rate of interest
argued that the control of the money supply although the stock of real capital is identical
by the monetary authorities may prevent the and the techniques in use are the same. This
swift restoration of monetary equilibrium effect has been termed the Price Wicksell
consequent upon a fall in the rate of interest. effect. The Real Wicksell effect refers to a
A self-generating inflation may be occa- change in techniques consequent upon a
sioned in a pure credit system where banks' change in the rate of interest. A negative
reserve limits do not present a check on Real Wicksell Effect is in fact what the CAM-
credit creation. Wicksell in this way ex- BRIDGE SCHOOL has called CAPITAL-REVERSING.
tended the classical QUANTITY THEORY OF A less CAPITAL-INTENSIVE technique may be
MONEY from a theory of the demand for chosen at a lower rate of interest. This is
money to a fuller explanation of the rela- contrary to neo-classical marginal producti-
tionship between the price level and the vity of capital theory which says that as the
determinants of monetary equilibrium. He rate of interest (the price of capital) falls
distinguished between the market or money more capital intensive techniques will be
rate of interest (subject to control by the chosen.
banking system) and the 'natural' or real
rate of interest (dependent upon the physical Wieser, Friedrich von (1851-1926). Aus-
productivity of capital). A money rate set trian economist, politician and member of
below the natural rate would, he said, push the AUSTRIAN SCHOOL. He further refined the
up prices by lowering the cost of investment. doctrine of MARGINAL UTILITY, introduced by
This would cause a shift upwards in the MENGER, but his major contribution lay in his
demand for capital goods in conditions of elaboration of the doctrine of 'imputation'
full employment pushing prices up further or 'attribution'. In the Austrian view goods
until the shortage of loanable funds had de- of the first order (consumer goods) obtain
pleted the gap between the market rate of value directly from an estimate of their mar-
interest and the natural rate. Wicksell, while ginal use. To all goods of a higher order
defending the quantity theory of money, (production goods) value is reflected back;
advocated active MONETARY POLICY. The role they have no value until a value is imputed
of the monetary authorities was to check to them. Wieser's theory is an analysis of the
investment, if it induced inflation, by in- working of this process of imputation.
creasing the BANK RATE. The cumulative pro- Wieser was also the first to see that the
cess of inflation has*much in common with general logic of economic behaviour of
the INFLATIONARY GAP of J . M . KEYNES. maximization of utility and minimization of
Indeed, G. MYRDAL and Lindahl, the intel- costs and attention to marginal rates yielded
lectual heirs of Wicksell, developed the dis- a theory of the socialist economy. His major
tinction between planned and realized works were Natural Value (1889) and Social
investment implicit in Wicksell's distinction Economics (1913).
between time periods of investment and
saving. wildcat strike. A STRIKE that is called by
local groups of union members, ostensibly
Wicksell effects. The Wicksell effect dem- without the authorization of the official
onstrates that contrary to the marginal pro- union leadership and in contravention of
ductivity theory of capital the real rate of established procedures. Such strikes may
interest in the economy may differ from receive the de facto support of the union
the aggregate MARGINAL PRODUCT of capital. leadership as a method of pressurizing the
window dressii
employer; most obviously when an author- any given time might not be favoui
ized strike would not have legal sanction and desirable levels of investment. Th<
might result in legal penalties. Equally, wild- eluded that at the time of their eni
cat strikes might be directed against the was 'the price of finance in rela
union leadership because of, say, dissatisfac- expected profitability which (was) th<
tion with wage settlement provisions, re- financial constraint on real investmer
moteness, and failure to consider and Committee emphasized the pervash
adequately represent the interests of particu- torting effects of high and variable i
lar groups within the union. inflation on the system, but also drev
tion to the way in which taxation ar
willingness to pay. The valuation placed trols imposed for monetary or pru
by an individual on a GOOD or SERVICE in reasons (e.g. on the BANKS) also affec
terms of money. Its use as an indicator of operation of financial institutions am
valuation is controversial in two respects. petition between them. The Con-
First, it will be constrained by ABILITY TO PAY made a number of recommendations
so that those with higher incomes will appear removal or amelioration of these infli
to value goods more highly than those with Like the MACMILLAN and RADCLIFFJ
lower incomes. This may contradict some MiTTEES before them, the Wilson Con
concept of fairness or justice. Secondly, it is found continuing difficulties in the pn
open to moral objection when the good in of finance for small firms and madt
question is the removal of a nuisance such as recommendations on this score. Othei
noise or pollution, since it might be argued recommendations included the dism
that it is unjust that the sufferer should have of the 'recommended rate system' of
to pay for the removal of the nuisance, when by the BUILDING SOCIETIES; the strengt
most people would expect that the sufferer of the system of supervisory arrangi
should be compensated by the wrong-doer. over the STOCK EXCHANGE and activitie
as takeovers, which affect the SEC
Wilson Committee. The 'Committee to market; and the setting up of a perr
Review the Functioning of Financial publicly accountable body to review '
Institutions' set up in 1977 by the Labour arrangements for the regulation of the
Administration, under the chairmanship of cial system' in the light of developi
Lord (Harold) Wilson, the former Prime cumstances. Finally, and not least
Minister, with a wide remit to enquire into Committee recommended against
the role and functioning of UK financial in- nationalization of any existing financial
stitutions and the provision of funds for tutions, though some members believe
industry and trade, and to recommend any there was a role for publicly-owned
changes considered to be required in the ance companies and a greater rol
arrangements for the supervision of these publicly-owned banks.
institutions. The Committee reported in
June 1980 (in two volumes, Report and windfall gain. An unanticipated adi
Appendices, Cmnd.7937) and its report pres- to income. (See TRANSITORY INCOME.)
ents a wide-ranging and authoritative de-
scription and analysis of the UK financial windfall loss. An unanticipated redi
system in the late 1970s. Among the reasons in income. (See TRANSITORY INCOME.)
for the setting up of the Committee was the
view, prevalent in some political circles, that winding up.
the performance of the economy, particu- See LIQUIDATION, RECEIVERS.
larly the level of investment and growth, was
being impaired by shortages of finance window dressing. In the UK, the prai
consequent on the conduct and operation of abandoned in 1946, by which the Lo
financial institutions and markets. One of CLEARING BANKS 'called' loans from
the major conclusions of the Committee was DISCOUNT MARKET on the days when
that the evidence did not support this con- made up their weekly (monthly after ]
tention, though they pointed out that the statements, in order to show a higher
price at which such finance was obtainable at position than on average they maintai
466 withdrawals
As the banks had different making-up days, criticized for lacking a rigorous theoretical
the money called by one bank was simply base. Economists have therefore revealed a
made good by others drawing down their considerable disparity of views as to the
cash positions on that day; thus in the aggre- appropriate criteria which should be satis-
gate statistics, as well as individually, the fied if an industry is to be considered work-
banks' CASH RATIO was overstated. In 1946 ably competitive. A representative set of
the banks agreed to make up their monthly criteria could be specified as follows: there
statements on the same day of the month, are sufficiently low BARRIERS TO ENTRY such
and also to maintain a daily cash ratio of that potential entrant firms can readily enter
eight per cent. Window dressing has by no the market in response to the attraction of
means disappeared: at certain times some SUPER-NORMAL PROFITS; there is a sufficiently
continental banks take MONEY MARKET funds large number of firms to ensure that each
for this purpose. competes independently, there is therefore
an absence of collusion and restrictive agree-
ments; well-informed customers choose
withdrawals (also known as leakages). rationally between alternative suppliers;
Any income that is not passed on in the firms exhibit patterns of performance con-
CIRCULAR FLOW OF INCOME, and therefore is
sistent with the preceding structure and
not available for spending on currently pro- conduct criteria; long-run profits will be
duced goods and services. In the simple reasonable in relation to the degree of risk in
INCOME-EXPENDITURE MODEL withdrawals are
the industry; surviving firms will be efficient
magnified by the actions of the MULTIPLIER and progressive with regard to product and
and result in a multiple CONTRACTION of process innovations; situations of excess ca-
NATIONAL INCOME. Withdrawals exert contra- pacity and insufficient reserve capacity will
dictory pressure on national income. The be avoided.
three broad categories that are usually con-
sidered are SAVINGS, TAXATION and IMPORTS.
(See INJECTIONS.)
workers' co-operative. An enterprise
whose share capital is owned by those who
are workers in the organization. The number
withholding tax. Generally a tax levied on of shares each cooperative member can hold
dividends and interest paid by a company to is limited. These features enable workers to
an overseas destination. Most Western exert control over the enterprise's activities
countries have such a tax. Frequently they and policies.
are a subject of discussion when double tax
agreements are being made. It is a special workers' participation.
form of INCOME TAX. Its existence can mean See INDUSTRIAL DEMOCRACY.
that there is a tax incentive for a company to
retain its profits in a country rather than working capital. This generally refers to
remit dividends overseas. the amount of current ASSETS which is
financed from long-term sources of finance.
workable competition*. The construction Gross working capital is alternatively de-
and refinement of the concept of workable fined as the sum of all current assets while
competition was brought about by the view net working capital is the amount by which
that the abstract model of PERFECT COMPE- current assets exceed current liabilities. The
TITION is an unattainable ideal which could size of working capital is an indicator of the
not provide an operational base for compe- LIQUIDITY and solvency of a company par-
tition policy. Workable competition is a set ticularly when related to other financial indi-
of relevant criteria which purport to provide cators in the form of financial ratios.
guidance on the competitive nature of
markets, and can thereby instruct the working capital ratio. This is found by
formulation and execution of competition dividing current liabilities into current
policy. These criteria are derived from the assets. It is a measure of a firm's LIQUIDITY.
STRUCTURE - CONDUCT - PERFORMANCE frame- If the ratio exceeds unity the company
work of analysis in industrial economics. can meet its current liabilities in full as
However, this framework is frequently they fall due. The ratio may frequently be
writing-down allowance
misleading, however, as the constituent fig- rate can be decomposed into INCOME
ures are taken from the balance sheet of the SUBSTITUTION EFFECTS although the dire
company. The data on the latter are only of the total effect cannot be determir
past values and do not represent the present. PRIORI but depends on whether the ne§
Neither is information presented about the income effect (assuming leisure to be a
timing of receipts and payments. (See QUICK mal good) outweighs the positive si
ASSETS RATIO.) tution effect.
working population. All those willing and work sharing. A means of maintc
able to work and either in employment or employment levels by reducing hou
registered as unemployed. In the UK this work per employee. Although work sr
total comprises employees in employment, was at one stage much favoured by
employers and the self-employed, the armed unions, it now appears that unions ]
forces and the REGISTERED UNEMPLOYED. (See layoffs as a means of accepting re<
LABOUR FORCE PARTICIPATION RATE.) labour costs in the cyclical down turn
resisting cuts in nominal wages. This
work in progress. Production that remains opment is explained in part by the <
uncompleted at the end of the accounting portionate influence of senior work*
period. union councils.
X-efficiency. A situation in which a firm's petitive pressures are weakened. The term
total costs are not minimized because the was originally applied to the manager-
actual output from given inputs is less than worker relationship but can be extended to
the maximum feasible level. This outcome is deal with the manager-owner relationship.
also termed a situation of 'technical ineffici- (See SEPARATION OF OWNERSHIP AND
ency'. X-efficiency is a direction function of CONTROL.)
monopoly or market power in which com-
468
V-efficiency. The effectiveness with which GAP, TERM STRUCTURE OF INTEREST RATES,
existing profitable market opportunities are INTEREST RATE, RATE OF RETURN.)
exploited. It is conceivable that the lack of
competitive market pressures induces a fail-
ure by firms to supply potential customers yield gap. The difference between an
who are willing to pay a price which yields a average YIELD on EQUITIES and a correspond-
profit. Thus though a firm may be minimiz- ing yield on long-dated fixed-interest SECURI-
ing the cost of producing a given output, and TIES. Traditionally equities were on the
therefore be X-EFFICIENT, it can be failing to upper side of this gap, reflecting the risk
maximize profits due to this slackness with element involved, but since the late 1950s a
regard to market opportunities. Though in 'reverse yield gap' has existed, with the divi-
principle this could be the case, Y-efficiency dend yield on equities falling below that of
and X-efficiency are likely to occur together debt securities. This was caused first by the
given their similar origins. expected growth element in equities, then
increasingly by the effect of inflation in rais-
yield. The annual return on a SECURITY ing the nominal yields on debt. If one takes
calculated as a percentage of its current mar- the earnings yield on equities, the reverse
ket price. In the case of EQUITIES, there is a yield gap is a more intermittent phenom-
distinction between earnings yield and DIVI- enon. (See TERM STRUCTURE OF INTEREST
DEND YIELD, the former being calculated on RATES.)
net profits and the latter on declared divi-
dends. The dividend yield is normally below
earnings yield because of retained profits. yield gap on securities.
(See FLAT YIELD, REDEMPTION YIELD, YIELD See TERM STRUCTURE OF INTEREST RATES.
469
Zellner-Giesel. The name of a procedure zero-rated goods.
specifically designed for the CONSISTENT ESTI- See VALUE-ADDED TAX.
MATION of the parameters of a DISTRIBUTED
LAG equation after a KOYCK TRANSFORMATION,
which takes into account the fact -that the
transformation may introduce SERIAL CORRE- Z variable.
LATION of the DISTURBANCE term. See NORMAL DISTRIBUTION.
A70
List of Acronyms
ACT Advance Corporation Tax GATT General Agreement on Tariffs and
ADR American Depository Receipt Trade
AFL-CIO American Federation of Labour/ GDP Gross Domestic Product
Congress of Industrial Unions GNMA Government National Mortgage
ARIMA Autoregressive Integrated Moving Association
Average GNP Gross National Product
ASE or AMEX American Stock GSP Generalized System of Preferences
Exchange G7 Group of Seven
ASEAN Association of South East Asian G10 Group of Ten
Nations IBRD International Bank for
BIS Bank for International Settlements Reconstruction and
BLUE Best Linear Unbiased Estimators Development
CAP Common Agricultural Policy IDA International Development
CBA Cost Benefit Analysis Association
CBI Confederation of British Industry IDC Industrial Development Certificate
CIF Cost, Insurance, Freight ILO International Labour Office
COLA Cost of Living Adjustment ILS Indirect Least Squares
COMECON Council for Mutual Economic IMF International Monetary Fund
Assistance ISIC International Standard Industrial
CSO Central Statistical Office Classification
DCE Domestic Credit Expansion IS-LM Investment/Saving-Liquidity/Money
DCF Discounted Cash Flow MLR Minimum Lending Rate
DIDMCA Depository Institutions MPC Marginal Propensity to Consume
Deregulation and Monetary MPP Marginal Physical Product
Control Act MPS Marginal Propensity to Save
D-W Durbin-Watson MRP Marginal Revenue Product
EC European Community MRS Marginal Rate of Substitution
ECGD Export Credits Guarantee MTFS Medium Term Financial Strategy
Department NAIRl Non-Accelerating Inflation Rate
ECSC European Coal and Steel of Unemployment
Community NEDC National Economic Development
ECU European Currency Unit Council
EEC European Economic Community NEDO National Economic Development
EFTA European Free Trade Association Office
EMS European Monetary System OAPE( Organisation of Arab Petroleum
EPU European Payments Union Exporting Countries
ERM Exchange Rate Mechanism (of the OECD Organisation for Economic
EMS) Co-operation and Development
FAO Food and Agricultural OFT Office of Fair Trading
Organisation OLS Ordinary Least Squares
FASB Financial Accounting Standards OPEC Organisation of Petroleum
Board Exporting Countries
FED Federal Reserve System PESC Public Expenditure Survey
FIML Full Information Maximum Committee
Likelihood PRT Petroleum Revenue Tax
FNMA Federal National Mortgage PSBR Public Sector Borrowing
Association Requirement
FOB Free on Board PSDR Public Sector Debt Repayment
FT-SE 100 Financial Times-Stock Exchange R&D Research and Development
100 Shares RPI Retail Price Index
GAB General Arrangements to Borrow SDR Special Drawing Right
471
472 List of Acronyms
USA Japan
474 Tables
Total
OECD
0. 1
-0..3
-0. 4
0. 2
-0.,4
-0..9
-0.,3
-0.3
-0.2
-0..7
-0 .7
-0 .2
-0 .4
-0 .4
-0 .5
-0.6