Economics Dictionary (A to Z) - Page 3

Faraz_1984 · #21 Tuesday, August 05, 2008

J-CURVE
The shape of the trend of a country’s trade balance following a dEVALUATION. A lower EXCHANGE RATE initially means cheaper EXPORTS and more expensive IMPORTS, making the current account worse (a bigger dEFICIT or smaller surplus). After a while, though, the volume of exports will start to rise because of their lower PRICE to foreign buyers, and domestic consumers will buy fewer of the costlier imports. Eventually, the trade balance will improve on what it was before the devaluation. If there is a currency APPRECIATION there may be an inverted J-curve.
JOB SEARCH
The time taken to find a new job. Because some people will devote all their time to this search, there will always be some FRICTIONAL UNEMPLOYMENT, even when there is otherwise FULL EMPLOYMENT.
JOINT SUPPLY
Some products or production processes have more than one use. For instance, cows can both provide milk and be eaten. If farmers increase the number of cows they own in response to an increase in DEMAND for milk, they are also likely to increase, a little later, the supply of meat, causing beef prices to fall

Faraz_1984 · #22 Tuesday, August 05, 2008

KEYNES, JOHN MAYNARD
A much quoted, great British economist, not famous for holding the same opinion for long. Born in 1883, he studied at Cambridge but came to reject much of the CLASSICAL ECONOMICS and NEO-CLASSICAL ECONOMICS associated with that university. Keynes helped set up the BRETTON WOODS framework, but he is best known for his General Theory of Employment, Interest and Money, published in 1936 in the depths of the Great Depression. This invented modern MACROECONOMICS. It argued that economies could sometimes be stable (in EQUILIBRIUM) even when they did not have FULL EMPLOYMENT, but that a GOVERNMENT could remedy this under-employment problem by increasing PUBLIC SPENDING and/or reducing TAXATION, thereby increasing the level of aggregate DEMAND in the economy. Many politicians picked up on these ideas. As President Richard Nixon observed in 1971, “We are all Keynesians now.” However, it is much debated whether Keynes would have supported the way many of them put his thoughts into practice.
Keynes identified the economic importance of ANIMAL SPIRITS. Making and losing fortunes in the ¬FINANCIAL MARKETS led him to refer to the “casino CAPITALISM” of the stockmarket. He also noted that “there is nothing so dangerous as the pursuit of a rational INVESTMENT policy in an irrational world”. He had an amusingly accurate view of the impact and transmission of economic ideas: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” As for the frequency with which his opinions would evolve: “When the facts change, I change my mind – what do you do, sir?” “In the long run we are all dead,” he said. For him, the long run was 1946.
KEYNESIAN
A branch of ECONOMICS, based, often loosely, on the ideas of KEYNES, characterised by a belief in active GOVERNMENT and suspicion of market outcomes. It was dominant in the 30 years following the second world war, and especially during the 1960s, when FISCAL POLICY became bigger-spending and looser in most developed countries as policymakers tried to kill off the BUSINESS CYCLE. During the 1970s, widely blamed for the rise in INFLATION, Keynesian policies gradually gave way to monetarism and microeconomic policies that owed much to the NEO-CLASSICAL ECONOMICS that Keynes had at times opposed. Even so, the idea that PUBLIC SPENDING and TAXATION have a crucial role to play in managing DEMAND, in order to move towards FULL EMPLOYMENT, remained at the heart of MACROECONOMIC POLICY in most countries, even after the monetarist and supply-side revolution of the 1980s and 1990s. Recently, a school of new, more pro-market Keynesian economists has emerged, believing that most markets work, but sometimes only slowly.
KLEPTOCRACY
Corrupt, thieving GOVERNMENT, in which the politicians and bureaucrats in charge use the powers of the state to feather their own nests. Russia in the years immediately after the fall of COMMUNISM was a clear-cut example, with Mafia-friendly GOVERNMENT members allocating themselves valuable SHARES during the PRIVATISATION of state-owned companies, accepting bribes from foreign businesses, not collecting taxes from “helpful” companies and siphoning off INTERNATIONAL AID into their personal OFFSHORE BANK accounts.
KONDRATIEFF WAVE
A 50 year-long BUSINESS CYCLE, named after Nikolai Kondratieff, a Russian economist. He claimed to have identified cycles of economic activity lasting half a century or more in his 1925 book, The Long Waves in Economic Life. Because this implied that CAPITALISM was, ultimately, a stable system, in contrast to the Marxist view that it was self-destructively unstable, he ended up in one of Stalin’s prisons, where he died. Alas, there is little hard evidence to support Kondratieff’s conclusion.

Faraz_1984 · #23 Tuesday, August 05, 2008

LABOUR
One of the FACTORS OF PRODUCTION, with LAND, CAPITAL and ENTERPRISE. Among the things that determine the supply of labour are the number of able people in the POPULATION, their willingness to work, labour laws and regulations, and the health of the economy and FIRMS. DEMAND for labour is also affected by the health of the economy and firms, labour laws and regulations, as well as the PRICE and supply of other factors of production.
In a perfect market, WAGES (the price of labour) would be determined by SUPPLY and demand. But the labour market is often far from perfect. Wages can be less flexible than other prices; in particular, they rarely fall even when demand for labour declines or supply increases. This wage rigidity can be a cause of UNEMPLOYMENT.
LABOUR INTENSIVE
A production process that involves comparatively large amounts of LABOUR; the opposite of CAPITAL INTENSIVE.
LABOUR MARKET FLEXIBILITY
A flexible LABOUR market is one in which it is easy and inexpensive for FIRMS to vary the amount of labour they use, including by changing the hours worked by each employee and by changing the number of employees. This often means minimal REGULATION of the terms of employment (no MINIMUM WAGE, say) and weak (or no) trade UNIONS. Such flexibility is characterised by its opponents as giving firms all the power, allowing them to fire employees at a moment’s notice and leaving workers feeling insecure.
Opponents of labour market flexibility claim that labour laws that make workers feel more secure encourage employees to invest in acquiring skills that enable them to do their current job better but that could not be taken with them to another firm if they were let go. Supporters claim that it improves economic EFFICIENCY by leaving it to MARKET FORCES to decide the terms of employment. Broadly speaking, the evidence is that greater flexibility is associated with lower rates of UNEMPLOYMENT and higher GDP per head.
LABOUR THEORY OF VALUE
The notion that the value of any good or service depends on how much LABOUR it uses up. First suggested by ADAM SMITH, it took a central place in the philosophy of KARL MARX. Some neo-classical economists disagreed with this theory, arguing that the PRICE of something was independent of how much labour went into producing it and was instead determined solely by SUPPLY and DEMAND.
LAFFER CURVE
Legend has it that in November 1974 Arthur Laffer, a young economist, drew a curve on a napkin in a Washington bar, linking AVERAGE tax rates to total tax revenue. Initially, higher tax rates would increase revenue, but at some point further increases in tax rates would cause revenue to fall, for instance by discouraging people from working. The curve became an icon of supply-side ECONOMICS. Some economists said that it proved that most governments could raise more revenue by cutting tax rates, an argument that was often cited in the 1980s by the tax-cutting governments of Ronald Reagan and Margaret Thatcher. Other economists reckoned that most countries were still at a point on the curve at which raising tax rates would increase revenue. The lack of empirical evidence meant that nobody could really be sure where the United States and other countries were on the Laffer curve. However, after the Reagan administration cut tax rates revenue fell at first. American tax rates were already low compared with some countries, especially in continental Europe, and it remains possible that these countries are at a point on the Laffer curve where cutting tax rates would pay.
LAGGING INDICATORS
Old news. Some economic statistics move weeks or months after changes in the BUSINESS CYCLE or INFLATION. They may not be a reliable guide to the current state of an economy or its future path. Contrast with LEADING INDICATORS.
LAISSEZ-FAIRE
Let-it-be ECONOMICS: the belief that an economy functions best when there is no interference by GOVERNMENT. It can be traced to the 18th-century French physiocrats, who believed in government according to the natural order and opposed MERCANTILISM. ADAM SMITH and others turned it into a central tenet of CLASSICAL ECONOMICS, as it allowed the INVISIBLE HAND to operate efficiently. (But even they saw a need for some limited government role in the economy.) In the 19th century, it inspired the British political movement that secured the repeal of the Corn Laws and promoted FREE TRADE, and gave birth to The Economist in 1843. In the 20th century, laissez-faire was often seen as synonymous with supporting MONOPOLY and allowing the BUSINESS CYCLE to boom and bust, and it came off second best against KEYNESIAN policies of interventionist government. However, mounting evidence of the inefficiency of state intervention inspired the free market policies of Ronald Reagan and Margaret Thatcher in the 1980s, both of whom stressed the importance of laissez-faire.
LAND
One of the FACTORS OF PRODUCTION, along with LABOUR, CAPITAL and ENTERPRISE. Pending colonisation of the moon, it is in fairly fixed SUPPLY. Marginal increases are possible by reclaiming land from the sea and cutting down forests (which may impose large economic costs by damaging the environment), but the expansion of deserts may slightly reduce the amount of usable land. Owners earn MONEY from land by charging RENT.
LAND TAX
Henry George, a 19th-century American eco¬nomist, believed that taxes should be levied only on the value of LAND, not on LABOUR or CAPITAL. This “single tax”, he asserted in his book, PROGRESS AND POVERTY, would end UNEMPLOYMENT, POVERTY, INFLATION and INEQUALITY. Many countries levy some tax on land or property values, although George’s single tax has never been fully implemented. This is mainly because of fears that it would drive down land PRICES too much or discourage efforts to improve the quality (that is, the economic value) of land. George addressed this concern by arguing that the tax should be levied only against the value of “unimproved” land. Certainly, a land tax has obvious advantages: it is simple and cheap to levy; evasion is all but impossible; and it penalises owners who do not put their land to work.
LAW AND ECONOMICS
Laws can be an important source of economic ¬EFFICIENCY – or inefficiency. Early economists such as ADAM SMITH often wrote about the economic impact of legal matters. But ECONOMICS subsequently focused more narrowly on things monetary and commercial. It was only in the 1940s and 1950s, at the University of Chicago Law School, that the discipline of law and economics was born. It is now a substantial branch of economics and has had an impact beyond the ivory towers.
The "economics" of law and economics is firmly in the LIBERAL ECONOMICS camp, favouring free markets and arguing that REGULATION often does more harm than good. It stresses the economic value of having clear, enforceable PROPERTY RIGHTS, and of ensuring that these can be bought and sold. It has encouraged many ANTITRUST policy¬makers to focus on maximising consumer WELFARE, rather than, say, protecting small FIRMS or opposing big ones just because they are big. It has also ventured into broader sociological issues, for instance, analysing the economic causes of criminality and how to structure legal incentives to reduce crime. (See also EVOLUTIONARY ECONOMICS.)
LBO
See LEVERAGED BUY-OUT.
LEADING INDICATORS
Economic crystal balls. Also known as cyclical ¬indicators, these are groups of statistics that point to the future direction of the economy and the BUSINESS CYCLE. Certain economic variables, fairly consistently, precede changes in GDP and certain others precede changes in INFLATION. In some countries, statisticians combine the various different leading indicators into an overall leading index of economic GROWTH or inflation. However, there is not necessarily any causal relationship between the leading indicators and what they are predicting, which is why, like other crystal balls, they are fallible. Contrast with LAGGING INDICATORS.

Faraz_1984 · #24 Tuesday, August 05, 2008

LENDER OF LAST RESORT
One of the main functions of a CENTRAL BANK. When financially troubled BANKS need cash and nobody else will lend to them, a central bank may do so, perhaps with strings attached, or even by taking control of the troubled bank, closing it or finding it a new owner. This role of the central bank makes CREDIT CREATION easier by increasing confidence in the banking system and minimising the RISK of a bank run by reassuring depositors that their MONEY is safe. However, it also creates a potential MORAL HAZARD: that banks will lend more recklessly because they know they will be bailed out if things go wrong.
LEVERAGE
See GEARING.
LEVERAGED BUY-OUT
Buying a company using borrowed MONEY to pay most of the purchase PRICE. The DEBT is secured against the ASSETS of the company being acquired. The INTEREST will be paid out of the company’s future cashflow. Leveraged buy-outs (LBOs) became popular in the United States during the 1980s, as public DEBT markets grew rapidly and opened up to borrowers that would not previously have been able to raise loans worth millions of dollars to pursue what was often an unwilling target. Although some LBOs ended up with the borrower going bust, in most cases the need to meet demanding interest bills drove the new managers to run the firm more efficiently than their predecessors. For this reason, some economists see LBOs as a way of tackling AGENCY COSTS associated with corporate governance.
LIBERAL ECONOMICS
LAISSEZ-FAIRE CAPITALISM by another name.
LIBERALISATION
A policy of promoting LIBERAL ECONOMICS by limiting the role of GOVERNMENT to the things it can do to help the market economy work efficiently. This can include PRIVATISATION and DEREGULATION.
LIBOR
Short for London interbank offered rate, the rate of INTEREST that top-quality BANKS charge each other for loans. As a result, it is often used by banks as a base for calculating the INTEREST RATE they charge on other loans. LIBOR is a floating rate, changing all the time.
LIFE
Human life is priceless. But this has not stopped economists trying to put a financial value on it. One reason is to help FIRMS and policymakers to make better decisions on how much to spend on costly safety measures designed to reduce the loss of life. Another is to help insurers and courts judge how much compensation to pay in the event of, say, a fatal accident.
One way to value a life is to calculate a person’s HUMAN CAPITAL by working out how much he or she would earn were they to survive to a ripe old age. This could result in very different sums being paid to victims of the same accident. After an air crash, probably more MONEY would go to the family of a first-class passenger than to that of someone flying economy. This may not seem fair. Nor would using this method to decide what to spend on safety measures, as it would mean much higher expenditure on avoiding the death of, say, an investment banker than on saving the life of a teacher or coal miner. It would also imply spending more on safety measures for young people and being positively reckless with the lives of retired people.
Another approach is to analyse the risks that people are voluntarily willing to take, and how much they require to be paid for taking them. Taking into account differences in WAGES for high death-risk and low death-risk jobs, and allowing for differences in education, experience, and so on, it is possible to calculate roughly what value people put on their own lives. In industrialised countries, most studies using this method come up with a value of $5m–10m.
LIFE-CYCLE HYPOTHESIS
An attempt to explain the way that people split their INCOME between spending and saving, and the way that they borrow. Over their lifetime, a typical person’s income varies by far more than how much they spend. On AVERAGE, young people have low incomes but big spending commitments: on investing in their HUMAN CAPITAL through education and training, building a family, buying a home, and so on. So they do not save much and often borrow heavily. As they get older their income generally rises, they pay off their mortgage, the children leave home and they prepare for retirement, so they sharply increase their saving and INVESTMENT. In retirement, their income is largely or entirely from state benefits and the saving and investment they did when working; they spend most or all of their income, and, by selling off ASSETS, often spend more than their income.
Broadly speaking, this theory is supported by the data, though some economists argue that young people do not spend as much as they should on, say, being educated, because lenders are reluctant to extend CREDIT to them. One puzzle is that people often have substantial assets left when they die. Some economists say this is because they want to leave a generous inheritance for their relatives; others say that people are simply far too optimistic about how long they will live. (See also PERMANENT INCOME HYPOTHESIS and RELATIVE INCOME HYPOTHESIS.)
LIQUIDITY
How easily an ASSET can be spent, if so desired. Cash is wholly liquid. The liquidity of other assets is usually less; how much less may be measured by the ease with which they can be exchanged for cash (that is, liquidated). Public FINANCIAL MARKETS try to maximise the liquidity of assets such as BONDS and EQUITIES by providing a central meeting place (the exchange) in which would-be buyers and sellers can easily find each other. Financial market makers (middlemen such as investment BANKS) can also increase liquidity by using some of their CAPITAL to buy SECURITIES from those who want to sell, when there is no other buyer offering a decent PRICE. They do this in the expectation that if they hold the asset for a while they will be able to find somebody to buy it. Typically, the higher the volume of trades happening in a marketplace, the greater is its liquidity. Moreover, highly liquid markets attract more liquidity-seeking traders, further increasing liquidity. In a similar way, there can be vicious cycles in which liquidity dries up. The amount of liquidity in financial markets can vary enormously from one moment to the next, and can sometimes evaporate entirely, especially if market makers become too RISK AVERSE to put their capital at risk in this way.
LIQUIDITY PREFERENCE
The proportion of their ASSETS that FIRMS and in¬dividuals choose to hold in varying degrees of ¬LIQUIDITY. The more cash they have, the greater is their desire for liquidity.
LIQUIDITY TRAP
When MONETARY POLICY becomes impotent. Cutting the rate of INTEREST is supposed to be the escape route from economic RECESSION: boosting the MONEY SUPPLY, increasing DEMAND and thus reducing UNEMPLOYMENT. But KEYNES argued that sometimes cutting the rate of interest, even to zero, would not help. People, BANKS and FIRMS could become so RISK AVERSE that they preferred the LIQUIDITY of cash to offering CREDIT or using the credit that is on offer. In such circumstances, the economy would be trapped in recession, despite the best efforts of monetary policymakers.
KEYNESIANs reckon that in the 1930s the economies of both the United States and the UK were caught in a liquidity trap. In the late 1990s, the Japanese economy suffered a similar fate. But MONETARISM has no place for liquidity traps. Monetarists pin the blame for the Great DEPRESSION and Japan’s more recent troubles on other factors and reckon that ways could have been found to make monetary policy work.
LOCK-IN
See PATH DEPENDENCE.
LONG RUN
When we are all dead, according to KEYNES. Un¬impressed by the thrust of CLASSICAL ECONOMICS, which said that economies have a long-run tendency to settle in EQUILIBRIUM at FULL EMPLOYMENT, he wanted economists to try to explain why in the short run economies are so often in DISEQUILIBRIUM, or in equilibrium at high levels of UNEMPLOYMENT.
LUMP OF LABOUR FALLACY
One of the best-known fallacies in ECONOMICS is the notion that there is a fixed amount of work to be done – a lump of LABOUR – which can be shared out in different ways to create fewer or more jobs. For instance, suppose that everybody worked 10% fewer hours. FIRMS would need to hire more workers. Hey presto, UNEMPLOYMENT would shrink.
In 1891, an economist, D.F. Schloss, described such thinking as the lump of labour fallacy because, in reality, the amount of work to be done is not fixed. GOVERNMENT-imposed restrictions on the amount of work people may do can actually reduce the EFFICIENCY of the labour market, thereby increasing UNEMPLOYMENT. Shorter hours will create more jobs only if weekly pay is also cut (which workers are likely to resist) otherwise costs per unit of output will rise. Not all labour costs vary with the number of hours worked. FIXED COSTS, such as recruitment and training, can be substantial, so it will cost a firm more to hire two part-time workers than one full-timer. Thus a cut in the working week may raise AVERAGE costs per unit of OUTPUT and cause firms to buy fewer total hours of labour. A better way to reduce unemployment may be to stimulate DEMAND and so increase output; another is to make the labour market more flexible, not less.

Faraz_1984 · #25 Tuesday, August 05, 2008

LUMP-SUM TAX
A tax that is the same amount for everybody, regardless of INCOME or wealth. Some economists argue that this is the most efficient form of TAXATION, as it does not distort incentives and thus it has no DEADWEIGHT COST. This is because each person knows that whatever they do they will have to pay the same amount. It is also cheap to administer, as there is no complex process of measuring each person’s INCOME and ASSETS in order to calculate their tax bill. However, because rich and poor people pay the same, the tax may be perceived as unfair – as Margaret Thatcher found out when she introduced a lump-sum “poll tax”, a decision that was later to play a large part in her ousting as British prime minister.
LUXURIES
Goods and SERVICES that have a high ELASTICITY of DEMAND. When the PRICE of, say, a Caribbean holiday rises, the number of vacations demanded falls sharply. Likewise, demand for Caribbean holidays rises significantly as AVERAGE INCOME increases, certainly by more than demand for many NORMAL GOODS. Contrast this with necessities, such as milk or bread, which people usually demand in quite similar quantities whatever their income and whatever the price.

Faraz_1984 · #26 Tuesday, August 05, 2008

MACROECONOMIC POLICY
Top-down policy by GOVERNMENT and CENTRAL BANKS, usually intended to maximise GROWTH while keeping down INFLATION and UNEMPLOYMENT. The main instruments of macroeconomic policy are changes in the rate of INTEREST and MONEY SUPPLY, known as MONETARY POLICY, and changes in TAXATION and PUBLIC SPENDING, known as FISCAL POLICY. The fact that unemployment and inflation often rise sharply, and that growth often slows or GDP falls, may be evidence of poorly executed macro¬economic policy. However, BUSINESS CYCLES may simply be an unavoidable fact of economic life that macroeconomic policy, however well conducted, can never be sure of conquering.
MACROECONOMICS
The big picture: analysing economy-wide phenomena such as GROWTH, INFLATION and UNEMPLOYMENT. Contrast with MICROECONOMICS, the study of the behaviour of individual markets, workers, households and FIRMS. Although economists generally separate themselves into distinct macro and micro camps, macroeconomic phenomena are the product of all the microeconomic activity in an economy. The precise relationship between macro and micro is not particularly well understood, which has often made it difficult for a GOVERNMENT to deliver well-run MACROECONOMIC POLICY.
MANUFACTURING
Making things like cars or frozen food has shrunk in importance in most developed countries during the past half century as SERVICES have grown. In the United States and the UK, the proportion of workers in manufacturing has shrunk since 1900 from around 40% to barely 20%. More than two-thirds of OUTPUT in OECD countries, and up to four-fifths of employment, is now in the services sector. At the same time, manufacturing has grown in importance in DEVELOPING COUNTRIES.
Many people think that manufacturing somehow matters more than any other economic activity and is in some way superior to surfing the Internet or cutting somebody’s hair. This is prob¬ably nothing more than nostalgia for times past when making things in factories was what real men did, just as 150 years ago growing things in fields was what real men did. Mostly, the shift from manufacturing to services (as with the earlier shift from agriculture to manufacturing) reflects progress into jobs that create more UTILITY, this time for real women as well as real men, which may explain why it is happening first in richer countries.
MARGINAL
The difference made by one extra unit of something. Marginal revenue is the extra revenue earned by selling one more unit of something. The marginal PRICE is how much extra a consumer must pay to buy one extra unit. Marginal UTILITY is how much extra utility a person gets from consuming (or doing) an extra unit of something. The marginal product of LABOUR is how much extra OUTPUT a firm would get by employing an extra worker, or by getting an existing worker to put in an extra hour on the job. The marginal PROPENSITY to consume (or to save) measures by how much a household’s CONSUMPTION (SAVINGS) would increase if its INCOME rose by, say, $1. The marginal tax rate measures how much extra tax you would have to pay if you earned an extra dollar.
The marginal cost (or whatever) can be very different from the AVERAGE cost (or whatever), which simply divides total costs (or whatever) by the total number of units produced (or whatever). A common finding in MICROECONOMICS is that small incremental changes can matter enormously. In general, thinking “at the margin” often leads to better economic decision making than thinking about the averages.
ALFRED MARSHALL, the father of NEO-CLASSICAL ECONOMICS, based many of his theories of economic behaviour on marginal rather than average behaviour. For instance, given certain plausible assumptions, a profit-maximising firm will increase production up to the point where marginal revenue equals marginal cost. This is because if marginal revenue exceeded marginal cost, the firm could increase its PROFIT by producing an extra unit of output. Alternatively, if marginal cost exceeded marginal revenue, the firm could increase its profit by producing fewer units of output.
In all walks of life, a basic rule of rational economic decision making is: do something only if the marginal utility you get from it exceeds the marginal cost of doing it.
MARKET CAPITALISATION
The market value of a company’s SHARES: the quoted share PRICE multiplied by the total number of shares that the company has issued.
MARKET FAILURE
When a market left to itself does not allocate resources efficiently. Interventionist politicians usually allege market failure to justify their interventions. Economists have identified four main sorts or causes of market failure.
• The abuse of MARKET POWER, which can occur whenever a single buyer or seller can exert significant influence over PRICES or OUTPUT (see MONOPOLY and MONOPSONY).
• EXTERNALITIES – when the market does not take into account the impact of an economic activity on outsiders. For example, the market may ignore the costs imposed on outsiders by a firm polluting the environment.
• PUBLIC GOODS, such as national defence. How much defence would be provided if it were left to the market?
• Where there is incomplete or ASYMMETRIC INFORMATION or uncertainty.
Abuse of market power is best tackled through ANTITRUST policy. Externalities can be reduced through REGULATION, a tax or subsidy, or by using property rights to force the market to take into account the WELFARE of all who are affected by an economic activity. The SUPPLY of public goods can be ensured by compelling everybody to pay for them through the tax system.
MARKET FORCES
Shorthand for the pressures from buyers and sellers in a market, rather than those coming from a GOVERNMENT planner or from REGULATION.
MARKET POWER
When one buyer or seller in a market has the ability to exert significant influence over the quantity of goods and SERVICES traded or the PRICE at which they are sold. Market power does not exist when there is PERFECT COMPETITION, but it does when there is a MONOPOLY, MONOPSONY or OLIGOPOLY.

Faraz_1984 · #27 Tuesday, August 05, 2008

MARSHALL PLAN
Probably the most successful programme of INTERNATIONAL AID and NATION BUILDING in history. It was named after General George Marshall, an American secretary of state, who at the end of the second world war proposed giving aid to Western Europe to rebuild its war-torn economies. North America gave around 1% of its GDP in total between 1948 and 1952; most of it came from the United States and the rest from Canada. The Americans left it to the Europeans to work out the details on allocating aid, which may be why, according to most economic analyses, it achieved more success than latter day aid programmes in which most of the decisions on how the MONEY is spent are made by the donors. The main institution through which aid was administered was the Organisation for European Economic Co-operation (OEEC), which in 1961 became the OECD. Nowadays, whenever there is a proposal for the international community to rebuild an economy damaged by war, such as Iraq's in 2003, you are sure to hear the phrase “new Marshall Plan”.
MARSHALL, ALFRED
A British economist (1842–1924), who developed some of the most important concepts in MICRO¬ECONOMICS. In his best-known work, Principles of Economics, he retained the emphasis on the importance of costs, which was standard in CLASSICAL ECONOMICS. But he added to it, helping to create NEO-CLASSICAL ECONOMICS, by explaining that the OUTPUT and PRICE of a product are determined by both SUPPLY and DEMAND, and that MARGINAL costs and benefits are crucial. He was the first economist to explain that demand falls as price increases, and that therefore the DEMAND CURVE slopes downwards from left to right. He was also first with the concept of PRICE ELASTICITY of demand and CONSUMER SURPLUS.
MARX, KARL
Much followed, and much misunderstood, German economist (1818–83). His two best-known works were the Communist Manifesto, written in 1848 with Friedrich Engels, and Das Kapital, in four volumes published between 1867 and 1910. Most of his economic assumptions were drawn from orthodox CLASSICAL ECONOMICS, but he used them to reach highly unorthodox conclusions. Although claimed and blamed as the inspiration of some of the most virulently anti-market governments the world has ever seen, he was not wholly against CAPITALISM. Indeed, he praised it for rescuing millions of people from “the idiocy of rural life”. Even so, he thought it was doomed. A shortage of DEMAND would concentrate economic power and wealth in ever fewer hands, producing an ever-larger and more miserable proletariat. This would eventually rise up, creating a “dictatorship of the proletariat” and leading eventually to a “withering away” of the state. Marx thought that this version of history was inevitable. So far, history has proved him wrong, largely because capitalism has delivered a much better deal to the masses than he believed it would.
MEAN
See AVERAGE.
MEAN REVERSION
The tendency for subsequent observations of a random variable to be closer to its mean than the current observation. For example, if the current number is 7, the average is 5, and there is mean reversion, then the next observation is likelier to be 6 than 8.
MEDIAN
See AVERAGE.
MEDIUM TERM
Somewhere between SHORT-TERMISM, which is bad, and the LONG RUN, lies the hallowed ground of the medium term – far enough away to discourage myopic behaviour by decision makers but close enough to be meaningful. But not many governments say exactly how long they think the medium term is.
MENU COSTS
How much it costs to change PRICES. Just as a restaurant has to print a new menu when it changes the price of its food, so many other FIRMS face a substantial outlay each time they cut or raise what they charge. Such menu costs mean that firms may be reluctant to change their prices every time there is a shift in the balance of SUPPLY and DEMAND, so there will be STICKY PRICES and the market for their OUTPUT will be in DISEQUILIBRIUM. The Internet may sharply reduce menu costs as it allows prices to be changed at the click of a mouse, which may improve EFFICIENCY by keeping markets more often in EQUILIBRIUM.
MERCANTILISM
The conventional economic wisdom of the 17th century that made a partial come-back in recent years. Mercantilists feared that MONEY would become too scarce to sustain high levels of OUTPUT and employment; their favoured solution was cheap money (low INTEREST rates). In a forerunner to the 20th-century debate between KEYNESIANS and MONETARISTS, they were opposed by advocates of CLASSICAL ECONOMICS, who argued that cheap and plentiful money could result in INFLATION. The original mercantilists, such as John Law, a Scots financier (and convicted murderer), believed that a country’s economic prosperity and political power came from its stocks of precious metals. To maximise these stocks they argued against FREE TRADE, favouring protectionist policies designed to minimise IMPORTS and maximise EXPORTS, creating a TRADE SURPLUS that could be used to acquire more precious metal. This was contested for the classicists by ADAM SMITH and David Hume, who argued that a country’s wealth came not from its stock of precious metals but rather from its stocks of productive resources (LAND, LABOUR, CAPITAL, and so on) and how efficiently they are used. Free trade increased EFFICIENCY by allowing countries to specialise in things in which they have a COMPARATIVE ADVANTAGE.
MERGERS AND ACQUISITIONS
When two businesses join together, either by merging or by one company taking over the other. There are three sorts of mergers between FIRMS: HORIZONTAL INTEGRATION, in which two similar firms tie the knot; VERTICAL INTEGRATION, in which two firms at different stages in the SUPPLY chain get together; and DIVERSIFICATION, when two companies with nothing in common jump into bed. These can be a voluntary marriage of equals; a voluntary takeover of one firm by another; or a hostile takeover, in which the management of the target firm resists the advances of the buyer but is eventually forced to accept a deal by its current owners. For reasons that are not at all clear, merger activity generally happens in waves. One possible explanation is that when SHARE PRICES are low, many firms have a MARKET CAPITALISATION that is low relative to the value of their ASSETS. This makes them attractive to buyers (see TOBIN). In theory, the different sorts of mergers have different sorts of potential benefits. However, the damning lesson of merger waves stretching back over the past 50 years is that, with one big ex ception – the spate of LEVERAGED BUY-OUTS in the United States during the 1980s – they have often failed to deliver benefits that justify the costs.

Faraz_1984 · #28 Tuesday, August 05, 2008

MICROECONOMICS
The study of the individual pieces that together make an economy. Contrast with MACROECONOMICS, the study of economy-wide phenomena such as GROWTH, INFLATION and UNEMPLOYMENT. Microeconomics considers issues such as how households reach decisions about CONSUMPTION and SAVING, how FIRMS set a PRICE for their OUTPUT, whether PRIVATISATION improves EFFICIENCY, whether a particular market has enough COMPETITION in it and how the market for LABOUR works.
MINIMUM WAGE
A minimum rate of pay that FIRMS are legally obliged to pay their workers. Most industrial countries have a minimum wage, although certain sorts of workers are often exempted, such as young people or part-timers. Most economists reckon that a minimum wage, if it is doing what it is meant to do, will lead to higher UNEMPLOYMENT than there would be without it. The main justification offered by politicians for having a minimum wage is that the wage that would be decided by buyers and sellers in a free market would be so low that it would be immoral for people to work for it. So the minimum wage should be above the market-clearing wage, in which case fewer workers would be demanded at that wage than would be hired at the market wage. How many fewer will depend on how far the minimum wage is above the market wage.
Some economists have challenged this simple SUPPLY and DEMAND model. Several empirical studies have suggested that a minimum wage moderately above the free-market wage would not harm employment much and could (in rare circumstances) potentially raise it. These studies are not widely accepted among economists. Whatever it does for those in work, a minimum wage cannot help the majority of the very poorest people in most countries, who typically have no job in which to earn a minimum wage.
MISERY INDEX
The sum of a country’s INFLATION and UNEMPLOYMENT rates. The higher the score, the greater is the economic misery.
MIXED ECONOMY
A market economy in which both private-sector FIRMS and firms owned by GOVERNMENT take part in economic activity. The proportions of public and private enterprise in the mix vary a great deal among countries. Since the 1980s, the public role in most mixed economies declined as NATIONALISATION gave way to PRIVATISATION.
MOBILITY
The easier it is for the FACTORS OF PRODUCTION to move to where they are most valuable, the more efficient the allocation of the world’s scarce resources is likely to be and the faster GDP will grow. Apart from continental drift, LAND is immobile. CAPITAL has long been extremely mobile within countries, and, with the rise of GLOBALISATION, it is now able to move easily around the world. ENTERPRISE is mobile, although to what extent depends on the particular ENTREPRENEUR. Some members of the LABOUR market zoom around the world to work; others will not move to the next town.
CAPITAL CONTROLS are the main obstacle to capital mobility, and these have been mostly removed or reduced since 1980. The sources of labour immobility are more numerous and complex, including immigration controls, transport costs, language barriers and a reluctance to move away from family or friends. Workers are far more mobile within the United States than they are within the EUROPEAN UNION or within individual EU countries. Some economists reckon that the willingness of workers to move to where the work is helps to explain the stronger economic performance and lower UNEMPLOYMENT of the United States.
Can you sometimes have too much mobility? Certainly, some DEVELOPING COUNTRIES have suffered from HOT MONEY rushing into and then out of their markets.
In general, the possibility that a factor of production may suddenly move elsewhere can create serious economic problems. For instance, an employer may think twice about investing in training an employee if it fears that the employee may suddenly take a job with another firm. Similarly, entrepreneurs are unlikely to take the RISK of pursuing a new idea if they fear that their capital may disappear at any moment, hence the importance of having access to long-term capital, such as by issuing BONDS and EQUITIES.
MODE
See AVERAGE.
MODELLING
When economists make a number of simplified assumptions about how the economy, or some part of it, behaves, and then see what this implies in various different scenarios. MILTON FRIEDMAN argued that economic models should not be judged on the basis of the validity of their assumptions, but on the accuracy of their predictions. An expert billiards player, he said, may not know the laws of physics, but acts as if he knows such laws. So his behaviour could be predicted accurately with a model that assumes he knows the laws of physics. Likewise, the behaviour of people making economic decisions may be accurately predicted by a model that assumes their goal is, say, PROFIT MAXIMISATION, even if they are not actually conscious of this being their goal. The more complex the thing being modelled, the harder it is to get right. Economic FORECASTING has a poor overall track record. The more micro¬economic the thing being modelled, the more likely it is that a model can be designed that will deliver accurate predictions.
MODERN PORTFOLIO THEORY
One of the most important and influential economic theories about finance and INVESTMENT. Modern portfolio theory is based upon the simple idea that DIVERSIFICATION can produce the same TOTAL RETURNS for less RISK. Combining many financial ASSETS in a portfolio is less risky than putting all your investment eggs in one basket. The theory has four basic premises.
• Investors are RISK AVERSE.
• SECURITIES are traded in efficient markets.
• Risk should be analysed in terms of an investor’s overall portfolio, rather than by looking at individual assets.
• For every level of risk, there is an optimal portfolio of assets that will have the highest EXPECTED RETURNS.
All of this seems comparatively straightforward now, except perhaps the bit about efficient markets. But it was shocking when it was put forward in the early 1950s by Harry Markowitz, who later won the Nobel prize for it. According to Mr Markowitz, when he explained his theory to the high priests of the CHICAGO SCHOOL, “MILTON FRIEDMAN argued that portfolio theory was not economics”. It is now. (See ARBITRAGE PRICING THEORY, CAPITAL ASSET PRICING MODEL and BLACK-SCHOLES.)
MONETARISM
Control the MONEY SUPPLY, and the rest of the economy will take care of itself. A school of economic thought that developed in opposition to post-1945 KEYNESIAN policies of DEMAND management, echoing earlier debates between MERCANTILISM and CLASSICAL ECONOMICS. Monetarism is based on the belief that INFLATION has its roots in the GOVERNMENT printing too much MONEY. It is closely associated with Milton MILTON FRIEDMAN, who argued, based on the QUANTITY THEORY OF MONEY, that government should keep the MONEY SUPPLY fairly steady, expanding it slightly each year mainly to allow for the natural GROWTH of the economy. If it did this, MARKET FORCES would efficiently solve the problems of INFLATION, UNEMPLOYMENT and RECESSION. Monetarism had its heyday in the early 1980s, when economists, governments and investors pounced eagerly on every new money-supply statistic, particularly in the United States and the UK.
Many CENTRAL BANKS had set formal targets for money-supply growth, so every wiggle in the data was scrutinised for clues to the next move in the rate of INTEREST. Since then, the notion that faster money-supply growth automatically causes higher inflation has fallen out of favour. The money supply is useful as a policy target only if the relationship between money and nominal GDP, and hence inflation, is stable and predictable. The way the money supply affects PRICES and OUTPUT depends on how fast it circulates through the economy. The trouble is that its VELOCITY OF CIRCULATION can suddenly change. During the 1980s, the link between different measures of the money supply and inflation proved to be less clear than monetarist theories had suggested, and most central banks stopped setting binding monetary targets. Instead, many have adopted explicit inflation targets.

Faraz_1984 · #29 Tuesday, August 05, 2008

MONETARY NEUTRALITY
Changes in the MONEY SUPPLY have no effect on real economic variables such as OUTPUT, real INTEREST rates and UNEMPLOYMENT. If the CENTRAL BANK doubles the money supply, the PRICE level will double too. Twice as many dollars means half as much bang for the buck. This theory, a core belief of CLASSICAL ECONOMICS, was first put forward in the 18th century by David Hume. He set out the classical dichotomy that economic variables come in two varieties, nominal and real, and that the things that influence nominal variables do not necessarily affect the real economy. Today few economists think that pure monetary neutrality exists in the real world, at least in the short run. Inflation does affect the real economy because, for instance, there may be STICKY PRICES or MONEY ILLUSION.
MONETARY POLICY
What a CENTRAL BANK does to control the MONEY SUPPLY, and thereby manage DEMAND. Monetary policy involves OPEN-MARKET OPERATIONS, RESERVE REQUIREMENTS and changing the short-term rate of INTEREST (the DISCOUNT RATE). It is one of the two main tools of MACROECONOMIC POLICY, the side-kick of FISCAL POLICY, and is easier said than done well. (See MONETARISM.)
MONEY
Makes the world go round and comes in many forms, from shells and beads to GOLD coins to plastic or paper. It is better than BARTER in enabling an economy’s scarce resources to be allocated efficiently. Money has three main qualities:
• as a medium of exchange, buyers can give it to sellers to pay for goods and services;
• as a unit of account, it can be used to add up apples and oranges in some common value;
• as a store of value, it can be used to transfer purchasing power into the future.
A farmer who exchanges fruit for money can spend that money in the future; if he holds on to his fruit it might rot and no longer be useful for paying for something. INFLATION undermines the usefulness of money as a store of value, in particular, and also as a unit of account for comparing values at different points in time. HYPER-INFLATION may destroy confidence in a particular form of money even as a medium of exchange. Measures of LIQUIDITY describe how easily an ASSET can be exchanged for money (the easier this is, the more liquid is the asset).
MONEY ILLUSION
When people are misled by INFLATION into thinking that they are getting richer, when in fact the value of MONEY is declining. Whether, and how much, people are fooled by inflation is much debated by economists. Money illusion, a phrase coined by KEYNES, is used by some economists to argue that a small amount of inflation may not be a bad thing and could even be beneficial, helping to “grease the wheels” of the economy. Because of money illusion, workers like to see their nominal WAGES rise, giving them the illusion that their circumstances are improving, even though in real (inflation-adjusted) terms they may be no better off. During periods of high inflation double-digit pay rises (as well as, say, big increases in the value of their homes) can make people feel richer even if they are not really better off. When inflation is low, GROWTH in real incomes may hardly register.
MONEY MARKETS
Any market where MONEY and other liquid ASSETS (such as TREASURY BILLS) can be lent and borrowed for between a few hours and a few months. Contrast with CAPITAL MARKETS, where longer-term CAPITAL changes hands.
MONEY SUPPLY
The amount of MONEY available in an economy. In the heyday of MONETARISM in the early 1980s, economists pounced upon the monthly (in some countries, even weekly) MONEY-SUPPLY numbers for clues about future INFLATION. CENTRAL BANKS aim to manage DEMAND by controlling the SUPPLY of money through OPEN-MARKET OPERATIONS, RESERVE REQUIREMENTS and changing the rate of INTEREST (to be exact, the DISCOUNT RATE).
One difficulty for policymakers lies in how to measure the relevant money supply. There are several different methods, reflecting the different LIQUIDITY of various sorts of MONEY. Notes and coins are completely liquid; some BANK deposits cannot be withdrawn until after a waiting period. M3 (M4 in the UK) is known as broad money, and consists of cash, current account deposits in banks and other financial institutions, SAVINGS deposits and time-restricted deposits. M1 is known as narrow money, and consists mainly of cash in circulation and current account deposits. M0 (in the UK) is the most liquid measure, including only cash in circulation, cash in banks’ tills and banks’ operational deposits held at the Bank of England.
Although it is a poor predictor of inflation, monetary growth can be a handy LEADING INDICATOR of economic activity. In many countries, there is a clear link between the growth of the real broad-money supply and that of real GDP.
MONOPOLISTIC COMPETITION
Somewhere between PERFECT COMPETITION and MONOPOLY, also known as imperfect competition. It describes many real-world markets. Perfectly competitive markets are extremely rare, and few FIRMS enjoy a pure monopoly; OLIGOPOLY is more common. In monopolistic competition, there are fewer firms than in a perfectly competitive market and each can differentiate its products from the rest somewhat, perhaps by ADVERTISING or through small differences in design. These small differences form BARRIERS TO ENTRY. As a result, firms can earn some excess profits, although not as much as a pure monopoly, without a new entrant being able to reduce PRICES through COMPETITION. Prices are higher and OUTPUT lower than under perfect competition.
MONOPOLY
When the production of a good or service with no close substitutes is carried out by a single firm with the MARKET POWER to decide the PRICE of its OUTPUT. Contrast with PERFECT COMPETITION, in which no single firm can affect the price of what it produces. Typically, a monopoly will produce less, at a higher price, than would be the case for the entire market under perfect competition. It decides its price by calculating the quantity of output at which its MARGINAL revenue would equal its marginal cost, and then sets whatever price would enable it to sell exactly that quantity.
In practice, few monopolies are absolute, and their power to set prices or limit SUPPLY is constrained by some actual or potential near-competitors (see MONOPOLISTIC COMPETITION). An extreme case of this occurs when a single firm dominates a market but has no pricing power because it is in a CONTESTABLE MARKET; that is if it does not operate efficiently, a more efficient rival firm will take its entire market away. ANTITRUST policy can curb monopoly power by encouraging COMPETITION or, when there is a NATURAL MONOPOLY and thus competition would be inefficient, through REGULATION of prices. Furthermore, the mere possibility of ¬antitrust action may encourage a monopoly to self-regulate its behaviour, simply to avoid the trouble an investigation would bring.
MONOPSONY
A market dominated by a single buyer. A monopsonist has the MARKET POWER to set the PRICE of whatever it is buying (from raw materials to LABOUR). Under PERFECT COMPETITION, by contrast, no individual buyer is big enough to affect the market price of anything.
MORAL HAZARD
One of two main sorts of MARKET FAILURE often associated with the provision of INSURANCE. The other is ADVERSE SELECTION. Moral hazard means that people with insurance may take greater risks than they would do without it because they know they are protected, so the insurer may get more claims than it bargained for. (See also DEPOSIT INSURANCE, LENDER OF LAST RESORT, IMF and WORLD BANK.)

Faraz_1984 · #30 Tuesday, August 05, 2008

MOST-FAVOURED NATION
Equal treatment, at least, in international trade. If country A grants country B the status of most-favoured nation, it means that B’s EXPORTS will face TARIFF that are no higher (and also no lower) than those applied to any other country that A calls a most-favoured nation. This will be the most favourable tariff treatment available to IMPORTS.
Most-favoured nation treatment is one of the most important building blocks of the international trading system. The WORLD TRADE ORGANISATION requires member countries to accord the most favourable tariff and regulatory treatment given to the product of any one member to the “like products” of all other members. Before the general agreement on tariffs and trade, there was often a most-favoured nation clause in bilateral trade agreements, which helped the world move towards FREE TRADE. In the 1930s, however, there was a backlash against this, and most-favoured nations were treated less favourably. This shift pushed the world economy towards division into regional TRADE AREAS. In the United States, most-favoured nation status has to be re-ratified periodically by Congress.
MULTIPLIER
Shorthand for the way in which a change in spending produces an even larger change in INCOME. For instance, suppose a GOVERNMENT loosens FISCAL POLICY, increasing net PUBLIC SPENDING by pumping an extra $10 billion into education. This has an immediate effect by increasing the income of teachers and of people who sell educational supplies or build or maintain schools. These people will in turn spend some of their extra money, putting more cash into the pockets of others, who spend some of it, and so on.
In theory, this process could continue indefinitely, in which case the multiplier would have an infinite value. In practice, most people save some of their extra income rather than spend it. How much they spend will depend on their MARGINAL PROPENSITY to consume. The value of the multiplier can be calculated by this formula:
multiplier = 1 / (1 – marginal propensity to consume)
If the marginal propensity to consume is 0.5 (50 cents of an extra dollar), the multiplier is 2. In practice, it is often hard to measure the multiplier effect, or to predict how it will respond to, say, changes in MONETARY POLICY or fiscal policy.

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