• RENT-SEEKING
• Cutting yourself a bigger slice of the cake rather than making the cake bigger. Trying to make more money without producing more for customers. Classic examples of rent-seeking, a phrase coined by an economist, Gordon Tullock, include:
• • a protection racket, in which the gang takes a cut from the shopkeeper’s PROFIT;
• • a CARTEL of FIRMS agreeing to raise PRICES;
• • a UNION demanding higher WAGES without offering any increase in PRODUCTIVITY;
• • lobbying the GOVERNMENT for tax, spending or regulatory policies that benefit the lobbyists at the expense of taxpayers or consumers or some other rivals.
• Whether legal or illegal, as they do not create any value, rent-seeking activities can impose large costs on an economy.
• REPLACEMENT COST
• What it would cost today to replace a FIRM’s existing ASSETS.
• REPLACEMENT RATE
• The fertility rate required in a country to keep its population steady. In rich countries, this is usually reckoned to be 2.1 children per woman, the extra 0.1 reflecting the likelihood that some children will die before their parents. In poorer countries with higher infant mortality, the replacement rate may be much higher. In may countries, since the early 1990s the fertility rate has fallen below the replacement rate. There has been much debate about why, and much agreement that, if this trend continues, those countries may face long-term problems such as a relatively growing proportion of retired older people having to be supported by a relatively shrinking proportion of younger people.
• REPO
• An agreement in which one party sells a security to another party and agrees to buy it back on a specified date for a specified PRICE. CENTRAL BANKS deal in short-term repos to provide LIQUIDITY to the FINANCIAL SYSTEM, buying SECURITIES from BANKS with cash on the condition that the banks will repurchase them a few weeks later.
• REQUIRED RETURN
• The minimum EXPECTED RETURN you require from an INVESTMENT to be willing to go ahead with it.
• RESCHEDULING
• Changing the payment schedule for a DEBT by agreement between borrower and lender. This is usually done when the borrower is struggling to make payments under the original schedule. Rescheduling can involve reducing INTEREST ¬payments but extending the period over which they are collected; putting back the date of repayment of the loan; reducing interest payments but increasing the amount that has to be repaid eventually; and so on. The rescheduling may or may not require the lender to bear some financial loss. The rescheduling may or may not require the lender to bear some financial loss. The rescheduling of loans to countries usually takes place through the PARIS CLUB and London Club.
• RESERVATION WAGE
• The lowest WAGE for which a person will work.
• RESERVE CURRENCY
• A foreign currency held by a GOVERNMENT or CENTRAL BANK as part of a country’s RESERVES. Outside the United States the dollar is the most widely used reserve currency. Everywhere the EURO is increasingly widely used.
• RESERVE RATIO
• The fraction of its deposits that a BANK holds as RESERVES.
• RESERVE REQUIREMENTS
• Regulations governing the minimum amount of RESERVES that a BANK must hold against deposits.
• RESERVES
• MONEY in the hand, available to be used to meet planned future payments or if some other need arises. FIRMS may put their reserves in a BANK, as a deposit. For a bank, reserves are those deposits it retains rather than lending them out.
• RESIDUAL RISK
• When you buy an ASSET you become exposed to a bundle of different RISKs. Many of these risks are not unique to the asset you own but reflect broader possibilities, such as that the stockmarket average will rise or fall, that INTEREST rates will be cut or increased, or that the GROWTH rate will change in an entire economy or industry. Residual risk, also known as alpha, is what is left after you take out all the other shared risk exposures. Exposure to this risk can be reduced by DIVERSIFICATION. Contrast with SYSTEMATIC RISK.
• RESTRICTIVE PRACTICE
• A general term for anything done by a firm, or FIRMS, to inhibit COMPETITION. Generally against the law. (See ANTITRUST and CARTEL.)
• RETURNS
• The rewards for doing business. Returns usually refer to PROFIT and can be measured in various ways (see RATE OF RETURN and TOTAL RETURNS).
• REVEALED PREFERENCE
• An example of a popular joke among economists: two economists see a Ferrari. “I want one of those,” says the first. “Obviously not,” replies the other. To get a smile out of this it is necessary (but not, alas, sufficient) to know about revealed preference. This is the notion that what you want is revealed by what you do, not by what you say. Actions speak louder than words. If the economist had really wanted a Ferrari he would have tried to buy one, if he did not own one already.
• Economists have three main approaches to modelling DEMAND and how it will change if PRICES or INCOMES change.
• • The cardinal approach involves asking consumers to say how much UTILITY they get from consuming a particular good, aggregating this across all goods and SERVICES, and calculating how demand would change on the assumption that people will consume the combination of things that maximises their total utility.
• • The ordinal approach does not require consumers to say how much utility they get in absolute terms from consuming a particular good. Instead, it asks them to indicate the relative utility they get from consuming one item compared with another, that is, to say if they prefer one basket of goods to another, or are indifferent between them.
• • The third approach is revealed preference. To model demand it is only necessary to be able to compare an individual’s CONSUMPTION decisions in situations with different prices and/or incomes and to assume that consumers are consistent in their decisions over time (that is, if they prefer wine to beer in one period they will still prefer wine in the next).
• RICARDIAN EQUIVALENCE
• The controversial idea, suggested by David RICARDO, that GOVERNMENT deficits do not affect the overall level of DEMAND in an economy. This is because taxpayers know that any DEFICIT has to be repaid later, and so increase their SAVINGS in anticipation of a tax bill. Thus government attempts to stimulate an economy by increasing PUBLIC SPENDING and/or cutting taxes will be rendered impotent by the private-sector reaction.
• RICARDO, DAVID
• The third of 17 children of a wealthy banker, David Ricardo (1772–1823) was disinherited at the age of 21 after he married a Quaker against the wishes of his parents. He became a stockbroker and did so well that he retired at 42 to concentrate on writing and politics.
• A friend of fellow classical economists Thomas Malthus and Jean-Baptiste Say (see SAY'S LAW), he developed many economic theories that are still in use today. The most influential was COMPARATIVE ADVANTAGE, the theory underpinning the case for FREE TRADE. In his 1817 book, The Principles of Political Economy and Taxation, he outlined a theory of distribution of output in an economy. In this he argued that the allocation of factors of production to any area of economic activity is determined by the level of economic RENT that can be earned from it. As this gradually falls because of DIMINISHING RETURNS, CAPITAL and other resources shift to more profitable projects. He examined the split between WAGES and PROFIT, arguing that “there can be no rise in the value of LABOUR without a fall of profits”. He also claimed that changes in the GOVERNMENT DEFICIT did not affect the level of DEMAND in the economy (RICARDIAN EQUIVALENCE).
• RISK
• The chance of things not turning out as expected. Risk taking lies at the heart of CAPITALISM and is responsible for a large part of the GROWTH of an economy. In general, economists assume that people are willing to be exposed to increased risks only if, on AVERAGE, they can expect to earn higher returns than if they had less exposure to risk. How much higher these EXPECTED RETURNS need to be depends partly on the PROBABILITY of an undesirable outcome and partly on whether the risk taker is RISK AVERSE, RISK NEUTRAL or RISK SEEKING.
• During the second half of the 20th century, economists greatly improved their understanding of risk and developed theories of RISK MANAGEMENT, which suggest when it makes sense to use INSURANCE, DIVERSIFICATION or HEDGING to change risk exposures.
• In FINANCIAL MARKETS the most commonly used measure of risk is the volatility (or STANDARD DEVIATION) of the PRICE of, or more appropriately the TOTAL RETURNS on, an ASSET. Often added to the risk profile are other statistical measures such as skewness and the possibility of extreme changes on rare occasions. (See STRESS TESTING, SCENARIO ANALYSIS and VALUE AT RISK.)
• RISK AVERSE
• Someone who thinks RISK is a four-letter word. Risk-averse investors are those who, when faced with two investments with the same EXPECTED RETURN but two different risks, prefer the one with the lower risk.
• RISK MANAGEMENT
• The process of bearing the RISK you want to bear, and minimising your exposure to the risk you do not want. This can be done in several ways: not doing things that carry a particular risk; HEDGING; DIVERSIFICATION; and buying INSURANCE.
• RISK NEUTRAL
• Someone who is insensitive to RISK. Risk-neutral investors are indifferent between an INVESTMENT with a certain outcome and a risky investment with the same EXPECTED RETURNS but an uncertain outcome. Such people are few and far between.
• RISK PREMIUM
• The extra RETURN that investors require to hold a risky ASSET instead of a risk-free one; the difference between the EXPECTED RETURNS from a risky INVESTMENT and the risk-free rate. (See EQUITY RISK PREMIUM.)
• RISK SEEKING
• Someone who cannot get enough RISK. ¬Risk-seeking investors prefer an INVESTMENT with an uncertain outcome to one with the same EXPECTED RETURNS and certainty that it will deliver them.
• RISK-FREE RATE
• The RATE OF RETURN earned on a risk-free ASSET. This is a crucial component of MODERN PORTFOLIO THEORY, which assumes the existence of both risky and risk-free assets. The risk-free asset is usually assumed to be a GOVERNMENT BOND, and the risk-free rate is the YIELD on that bond, although in fact even a Treasury is not entirely without risk. In modern portfolio theory, the risk-free rate is lower than the EXPECTED RETURN on the risky asset, because the issuer of the risky asset has to offer RISK AVERSE investors the expectation of a higher return to persuade them to forgo the risk-free asset.