Friday, July 01, 2022
10:42 AM (GMT +5)

Go Back   CSS Forums > CSS Optional subjects > Group I > Economics

Reply Share Thread: Submit Thread to Facebook Facebook     Submit Thread to Twitter Twitter     Submit Thread to Google+ Google+    
LinkBack Thread Tools Search this Thread
Old Wednesday, November 23, 2011
Join Date: Oct 2011
Posts: 30
Thanks: 1
Thanked 32 Times in 15 Posts
Jamshed Iqbal is on a distinguished road
Default Economic Terminology

• The “dismal science”, according to Thomas Carlyle, a 19th-century Scottish writer. It has been described in many ways, few of them flattering. The most concise, non-abusive, definition is the study of how society uses its scarce resources.
• Bigger is better. In many industries, as output increases, the AVERAGE cost of each unit produced falls. One reason is that overheads and other FIXED COSTS can be spread over more units of OUTPUT. However, getting bigger can also increase average costs (diseconomies of scale) because it is more difficult to manage a big operation, for instance.
• Getting the most out of the resources used. For a particular sort of efficiency often favoured by economists, see PARETO EFFICIENT.
• WAGES that are set at above the market clearing rate so as to encourage workers to increase their PRODUCTIVITY.
• You can’t beat the market. The efficient market hypothesis says that the PRICE of a financial ASSET reflects all the INFORMATION available and responds only to unexpected news. Thus prices can be regarded as optimal estimates of true investment value at all times. It is impossible for investors to predict whether the price will move up or down (future price movements are likely to follow a RANDOM WALK), so on AVERAGE an investor is unlikely to beat the market. This belief underpins ARBITRAGE PRICING THEORY, the CAPITAL ASSET PRICING MODEL and concepts such as BETA.
• The hypothesis had few critics among financial economists during the 1960s and 1970s, but it has come under increasing attack since then. The fact that financial prices were far more volatile than appeared to be justified by new information, and that financial bubbles sometimes formed, led economists to question the theory. BEHAVIOURAL ECONOMICS has challenged one of the main sources of market efficiency, the idea that all investors are fully rational HOMO ECONOMICUS. Some economists have noted the fact that information gathering is a costly process, so it is unlikely that all available information will be reflected in prices. Others have pointed to the fact that ARBITRAGE can become more costly, and thus less likely, the further away from fundamentals prices move. The efficient market hypothesis is now one of the most controversial and well-studied propositions in ECONOMICS, although no consensus has been reached on which markets, if any, are efficient. However, even if the ideal does not exist, the efficient market hypothesis is useful in judging the relative efficiency of one market compared with another.
• A measure of the responsiveness of one variable to changes in another. Economists have identified four main types.
• • PRICE ELASTICITY measures how much the quantity of SUPPLY of a good, or DEMAND for it, changes if its PRICE changes. If the percentage change in quantity is more than the percentage change in price, the good is price elastic; if it is less, the good is INELASTIC.
• • INCOME elasticity of demand measures how the quantity demanded changes when income increases.
• • Cross-elasticity shows how the demand for one good (say, coffee) changes when the price of another good (say, tea) changes. If they are SUBSTITUTE GOODS (tea and coffee) the cross-elasticity will be positive: an increase in the price of tea will increase demand for coffee. If they are COMPLEMENTARY GOODS (tea and teapots) the cross-elasticity will be negative. If they are unrelated (tea and oil) the cross-elasticity will be zero.
• • Elasticity of substitution describes how easily one input in the production process, such as LABOUR, can be substituted for another, such as machinery.
• Inside the economic model; the opposite of EXOGENOUS (see also GROWTH).
• People generally spend a smaller share of their BUDGET on food as their INCOME rises. Ernst Engel, a Russian statistician, first made this observation in 1857. The reason is that food is a necessity, which poor people have to buy. As people get richer they can afford better-quality food, so their food spending may increase, but they can also afford LUXURIES beyond the budgets of poor people. Hence the share of food in total spending falls as incomes grow.
• In a word, all that was wrong with American CAPITALISM at the start of the 21st century. Until late 2001, Enron, an energy company turned financial powerhouse based in Houston, Texas, had been one of the most admired firms in the United States and the world. It was praised for everything from pioneering energy trading via the internet to its innovative corporatate culture and its system of employment evaluation by peer review, which resulted in those that were not rated by their peers being fired. However, revelations of accounting fraud by the firm led to its BANKRUPTCY, prompting what was widely described as a crisis of confidence in American capitalism. This, as well as further scandals involving accounting fraud (WorldCom) and other dubious practices (many by Wall Street firms), resulted in efforts to reform coporate governance, the legal liability of company bosses, accounting, Wall Street research and REGULATION.
• One of the FACTORS OF PRODUCTION, along with LAND, LABOUR and CAPITAL. The creative juices of CAPITALISM; the ANIMAL SPIRITS of the ENTREPRENEUR.
• The life and soul of the capitalist party. Somebody who has the idea and ENTERPRISE to mix together the other FACTORS OF PRODUCTION to produce something valuable. An entrepreneur must be willing to take a RISK in pursuit of a PROFIT.
• Some people think CAPITALISM is wholly bad for the environment as it is based on consuming scarce resources. They want less CONSUMPTION and greater reliance on renewable resources. They oppose FREE TRADE because they favour self-sufficiency (AUTARKY), or at least so-called FAIR TRADE, and because they believe it encourages poorer countries to destroy their natural resources in order to get rich quick. Although few professional economists would share these views, in recent years many attempts have been made to incorporate environmental concerns within mainstream economics.
• The traditional measure of GDP incorporates only those things that are paid for; this may include things that reduce the overall quality of life, including harming the environment. For instance, cleaning up an oil spill will increase GDP if people are paid for the clean-up. Attempts have been made to devise an alternative environmentally friendly measure of NATIONAL INCOME, but so far progress has been limited. At the very least, traditional economists increasingly agree that maximising GDP growth does not necessarily equal maximising social WELFARE.
• Much of the damage done to the environment may be a result of externalities. An EXTERNALITY can arise when people engaged in economic activity do not have to take into account the full costs of what they are doing. For instance, car drivers do not have to bear the full cost of making their contribution to global warming, even though their actions may one day impose a huge financial burden on society. One way to reduce externalities is to tax them, say, through a fuel tax. Another is prohibition, say, limiting car drivers to one gallon of fuel per week. This could result in black markets, however. Allowing trade in pollution rights may encourage “efficient pollution”, with the pollution permits ending up in the hands of those for which pollution has the greatest economic upside. As this would still allow some environmental destruction, it might be unpopular with extreme greens.
• There may be a case for international eco markets. For instance, people in rich countries might pay people in poor countries to stop doing activities that do environmental damage outside the poor countries, or that rich people disapprove of, such as chopping down the rain forests. Choices on environmental policy, notably on measures to reduce the threat of global warming, involve costs today with benefits delayed until the distant future. How are these choices to be made? Traditional COST-BENEFIT ANALYSIS does not help much. In measuring costs and benefits in the far distant future, two main things seem to intervene and spoil the conventional calculations. One is uncertainty. We know nothing about what the state of the world will be in 2200. The other is how much people today are willing to pay in order to raise the welfare of others who are so remote that they can barely be imagined, yet who seem likely to be much better off materially than people today. Some economists take the view that the welfare of each future generation should be given the same weight in the analysis as the welfare of today’s. This implies that a much lower DISCOUNT RATE should be used than the one appropriate for short-term projects. Another option is to use a high discount rate for costs and benefits arising during the first 30 or so years, then a lower rate or rates for more distant periods. Many studies by economists and psychologists have found that people do in fact discount the distant future at lower rates than they apply to the near future.
• When SUPPLY and DEMAND are in balance. At the equilibrium PRICE, the quantity that buyers are willing to buy exactly matches the quantity that sellers are willing to sell. So everybody is satisfied, unlike when there is DISEQUILIBRIUM. In CLASSICAL ECONOMICS, it is assumed that markets always tend towards equilibrium and return to it in the event that something causes a temporary disequilibrium. GENERAL EQUILIBRIUM is when supply and demand are balanced simultaneously in all the markets in an economy. KEYNES questioned whether the economy always moved to equilibrium, for instance, to ensure FULL EMPLOYMENT.
• There are two definitions in ECONOMICS.
• 1 The capital of a firm, after deducting any liabilities to outsiders other than shareholders, who are typically the legal owners of the firm’s equity. This ownership right is the reason SHARES are also known as equities.
• 2 Fairness. Dividing up the economic pie. Economists have been particularly interested in this with regard to how systems of TAXATION work. They have examined whether taxes treat fairly people with the same ability to pay (HORIZONTAL EQUITY) and people with different abilities to pay (VERTICAL EQUITY).
• The fairness of other aspects of how the gains from economic activity are distributed through society have also been debated by economists, especially those interested in WELFARE ECONOMICS. Some economists start with the presumption that the free-market outcome is inherently inequitable, and that equity (sharing out the pie) must be traded off against EFFICIENCY (maximising the size of the pie). Others argue that it is inequitable to take money away from someone who has created economic value to give to people who have been less skilled or industrious.
• The extra reward investors get for buying a SHARE over what they get for holding a less risky ASSET, such as a government BOND. Modern financial theory assumes that the premium will be just big enough on AVERAGE to compensate the investor for the extra RISK. However, studies have found that the average equity premium over many years has been much larger than appears to be justified by the average riskiness of shares. To solve this so-called equity premium puzzle, some economists have suggested that investors may have greater risk aversion towards shares than traditional theory assumes. Some claim that the past equity premium was mismeasured, or reflected an unrepresentative sample of share PRICES. Others suggest that the high premium is evidence that the EFFICIENT MARKET HYPOTHESIS does not apply to the stockmarket. Some economists think that the premium fell to more easily explained levels during the 1990s. Nobody really knows which, if any, of these interpretations is right.
• The main currency of the EUROPEAN UNION, launched in January 1999 and in general circulation since 2002 (see ECONOMIC AND MONETARY UNION).

• The economy comprising all the countries that have adopted the EURO. There is much debate among economists about whether the euro zone is in fact an OPTIMAL CURRENCY AREA.
• A deposit in dollars held in a BANK outside the United States. Such deposits are often set up to avoid taxes and currency exchange costs. They are frequently lent out and have become an important method of CREDIT CREATION.
• The CENTRAL BANK of the EUROPEAN UNION, responsible since January 1999 for setting the official short-term INTEREST RATE in countries using the EURO as their domestic currency. In this role, the European Central Bank (ECB) replaced national central banks such as Germany’s Bundesbank, which became local branches of the ECB.
• A club of European countries. Initially a six-country TRADE AREA established by the 1957 Treaty of Rome and known as the European Economic Community, it has become an increasingly political union. In 1999 a single currency, the EURO, was launched in 11 of the then 15 member countries. Viewed as a single entity, the EU has a bigger economy than the United States. In 2002, a further 10 countries were invited to join the EU in 2004, increasing its membership to 25 countries, with more countries likely to follow later.
• A Darwinian approach to ECONOMICS, sometimes called institutional economics. Following the tradition of SCHUMPETER, it views the economy as an evolving system and places a strong emphasis on dynamics, changing structures (including technologies, institutions, beliefs and behaviour) and DISEQUILIBRIUM processes (such as INNOVATION, selection and imitation).
• Getting more money from an economic INVESTMENT than you needed to justify investing. In PERFECT COMPETITION, the FACTORS OF PRODUCTION earn only normal RETURNS, that is, the minimum amount of WAGES, PROFIT, INTEREST or RENT needed to secure their use in the economic activity in question, rather than in an alternative. Excess returns can only be earned for more than a short period when there is MARKET FAILURE, especially MONOPOLY, because otherwise the existence of excess returns would quickly attract COMPETITION, which would drive down returns until they were normal.
• Limits on the amount of foreign currency that can be taken into a country, or of domestic currency that can be taken abroad.
• The PRICE at which one currency can be converted into another. Over the years, economists and politicians have often changed their minds about whether it is a good idea to try to hold a country’s exchange rate steady, rather than let it be decided by MARKET FORCES. For two decades after the second world war, many of the major currencies were fixed under the BRETTON WOODS agreement. During the following two decades, the number of currencies allowed to float increased, although in the late 1990s a number of European currencies were permanently fixed under ECONOMIC AND MONETARY UNION and some other countries established a CURRENCY BOARD.
• When CAPITAL can flow easily around the world, countries cannot fix their exchange rate and at the same time maintain an independent MONETARY POLICY. They must choose between the confidence and stability provided by a fixed exchange rate and the control over INTEREST RATE policy offered by a floating exchange rate. On the face of it, in a world of capital MOBILITY a more flexible exchange rate seems the best bet. A floating currency will force FIRMS and investors to HEDGE against fluctuations, not lull them into a false sense of stability. It should make foreign BANKS more circumspect about lending. At the same time it gives policymakers the option of devising their own monetary policy. But floating exchange rates have a big drawback: when moving from one EQUILIBRIUM to another, currencies can overshoot and become highly unstable, especially if large amounts of capital flow in or out of a country. This instability has real economic costs.
• To get the best of both worlds, many emerging economies have tried a hybrid approach, loosely tying their exchange rate either to a single foreign currency, such as the dollar, or to a basket of currencies. But the currency crises of the late 1990s, and the failure of Argentina's currency board, led many economists to conclude that, if not a currency union such as the EURO, the best policy may be to have a freely floating exchange rate.
• Outside the model. For instance, in traditional NEO-CLASSICAL ECONOMICS, models of GROWTH rely on an exogenous factor. To keep growing, an economy needs continual infusions of technological progress. Yet this is a force that the neo-classical model makes no attempt to explain. The rate of technological progress comes from outside the model; it is simply assumed by the economic modellers. In other words, it is exogenous. New growth theory tries to calculate the rate of technological progress inside the economic model by mapping its relationship to factors such as HUMAN CAPITAL, free markets, COMPETITION and GOVERNMENT expenditure. Thus, in these models, growth is ENDOGENOUS.
• What people assume about the future, especially when they make decisions. Economists debate whether poeple have irrational or RATIONAL EXPECTATIONS, or ADAPTIVE EXPECTATIONS that change to reflect learning from past mistakes.
• The CAPITAL GAIN plus INCOME that investors think they will earn by making an INVESTMENT, at the time they invest.
• A tax on what people spend, rather than what they earn or their wealth. Economists often regard it as more efficient than other taxes because it may discourage productive economic activity less; it is not the creating of INCOME and wealth that is taxed, but the spending of it. It can be a form of INDIRECT TAXATION, added to the PRICE of a good or service when it is sold, or DIRECT TAXATION, levied on people’s income minus their SAVINGS over a year.
• Loans to boost EXPORTS. In many countries these are subsidised by a GOVERNMENT keen to encourage exports. Typically, the CREDIT comes in two forms: loans to foreign buyers of domestic produce; and guarantees on loans made by BANKS to domestic companies so they can produce the exports that should pay off the loan. This effectively insures producers against non-payment. When governments compete aggressively with export credits to win business for domestic FIRMS the sums involved can become large. The economic benefit of export credits is unclear at the best of times. This may be because they are largely motivated by political goals.
• Sales abroad. Exports grew steadily as a share of world OUTPUT during the second half of the 20th century. Yet by some measures this share was no higher than at the end of the 19th century, before FREE TRADE fell victim to a political backlash.
• An economic side-effect. Externalities are costs or benefits arising from an economic activity that affect somebody other than the people engaged in the economic activity and are not reflected fully in PRICES. For instance, smoke pumped out by a factory may impose clean-up costs on nearby residents; bees kept to produce honey may pollinate plants belonging to a nearby farmer, thus boosting his crop. Because these costs and benefits do not form part of the calculations of the people deciding whether to go ahead with the economic activity they are a form of MARKET FAILURE, since the amount of the activity carried out if left to the free market will be an inefficient use of resources. If the externality is beneficial, the market will provide too little; if it is a cost, the market will supply too much.
• One potential solution is REGULATION: a ban, say. Another, when the externality is negative, is a tax on the activity or, if the externality is positive, a SUBSIDY. But the most efficient solution to externalities is to require them to be included in the costings of those engaged in the economic activity, so there is self-regulation. For instance, the externality of pollution can be solved by creating PROPERTY RIGHTS over clean air, entitling their owner to a fee if they are infringed by a factory pumping out smoke. According to the Coase theorem (named after a Nobel prize-winning economist, Ronald Coase), it does not matter who has ownership, so long as property rights are fully allocated and completely free trade of all property rights is possible.

• A measure of OUTPUT reflecting the costs of the FACTORS OF PRODUCTION used, rather than market prices, which may differ because of INDIRECT TAX and subsidy (see GDP).
• The ingredients of economic activity: LAND, LABOUR, CAPITAL and ENTERPRISE.
• The PRICES charged by producers to wholesalers and retailers. Because these prices are eventually passed on to the end customer, changes in factory prices, also known as producer prices, can be a LEADING INDICATOR of CONSUMER PRICE INFLATION.
• Many politicians and NGOs argue that FREE TRADE is not enough; it should also be fair. On the face of it, fairness is self-evidently a good thing. However, fairness, in trade as in beauty, lies in the eye of the beholder. Frederic Bastiat, a 19th-century French satirist, once observed that the sun offered unfair COMPETITION to candle makers. If windows could be boarded up during the day, he argued, more jobs could be created making candles. American trade UNIONS complain that Mexicans' lower wages, say, give them an unfair advantage. Mexicans say they cannot compete fairly against more productive American counterparts. Both sides are wrong. Mexicans are paid less than Americans largely because they are, in general, less productive. There is nothing unfair about that; indeed, it helps to make trade mutually beneficial. The mutual benefits of trade also disprove the fair traders' other complaint, that free trade harms poor countries. (See COMPARATIVE ADVANTAGE.)
• America's CENTRAL BANK. Set up in 1913, and popularly known as the Fed, the system divides the United States into 12 Federal Reserve districts, each with its own regional Federal Reserve bank. These are overseen by the Federal Reserve Board, consisting of seven governors based in Washington, DC. MONETARY POLICY is decided by its Federal Open Market Committee.
• A place in which an above-average amount of financial business takes place. The big ones are New York, London, Tokyo and Frankfurt. Small ones such as Dublin, Bermuda, Luxembourg and the Cayman Islands also play an important part in the global financial system. GLOBALISATION and the increase in electronic trading has raised concerns about whether there will be as much need for financial centres in the 21st century as there was in the 19th and 20th centuries. So far, the evidence suggests that the biggest, at least, will remain important.
• Certificate of ownership of a financial ASSET, such as a BOND or a SHARE.
• A middleman. An individual or institution that brings together investors (the source of funds) and users of funds (such as borrowers). May be increasingly at risk of DISINTERMEDIATION.
• The FIRMS and institutions that together make it possible for MONEY to make the world go round. This includes financial markets, SECURITIES exchanges, BANKS, pension funds, mutual funds, insurers, national regulators, such as the Securities and Exchange Commission (SEC) in the United States, CENTRAL BANKS, governments and multinational institutions, such as the IMF and WORLD BANK.
• A favourite GOVERNMENT policy in the KEYNESIAN-dominated 1950s and 1960s, involving frequent adjustments to FISCAL POLICY and/or MONETARY POLICY to alter the level of DEMAND to keep the economy growing at a steady rate. The trouble was and is, partly because of the inadequacies of economic FORECASTING, that these frequent adjustments were and are often mistaken, making the economy's GROWTH path more, rather than less, erratic. In the 1990s, fine tuning was increasingly shunned by CENTRAL BANKS and governments, which stopped trying to manage short-term demand and instead aimed to pursue long-term macroeconomic goals, which required fewer adjustments to policy. Or so they claimed. In practice, there continued to be some attempted fine tuning.
• For many years, economists had little interest in what happened inside firms, preferring instead to examine the workings of the different sorts of industries in which firms operate, ranging from PERFECT COMPETITION to MONOPOLY. Since the 1960s, however, sophisticated economic theories of how firms work have been developed. These have examined why firms grow at different rates and tried to model the normal life cycle of a company, from fast-growing start-up to lumbering mature business. The aim is to explain when it pays to conduct an activity within a firm and when it pays to externalise it through short- or long-term arrangements with outsiders, be they individuals, exchanges or other companies. The theories also look at the economic consequences of the different incentives influencing individuals working within companies, tackling issues such as pay, AGENCY COSTS and corporate governance structures.
• The early bird gets the worm. GAME THEORY shows that being the first to enter a market or to introduce an INNOVATION can be a huge advantage, not just because the first firm in can erect BARRIERS TO ENTRY, but also because potential rivals may be discouraged from committing the resources necessary to compete successfully. However, this advantage may sometimes be cancelled out by the benefits enjoyed by followers, such as the chance to avoid--and learn from--the mistakes made by the first mover. (See INCUMBENT ADVANTAGE.)
• A nice little earner for the state. Fiscal drag is the tendency of revenue from TAXATION to rise as a share of GDP in a growing economy. Tax allowances, progressive tax rates and the threshold above which a particular rate of tax applies usually remain constant or are changed only gradually. By contrast, when the economy grows, INCOME, spending and corporate PROFIT rise. So the tax-take increases too, without any need for government action. This helps slow the rate of increase in DEMAND, reducing the pace of GROWTH, making it less likely to result in higher INFLATION. Thus fiscal drag is an automatic stabiliser, as it acts naturally to keep demand stable.
• When the net effect of TAXATION and PUBLIC SPENDING is neutral, neither stimulating nor dampening DEMAND. The term can be used to describe the overall stance of FISCAL POLICY: a balanced BUDGET is neutral, as total tax revenue equals total public spending. It can also refer more narrowly to the combined impact of new measures introduced in an annual budget: the budget can be fiscally neutral if any new taxes equal any new spending, even if the overall stance of the budget either boosts or slows demand.
• One of the two instruments of MACROECONOMIC POLICY; MONETARY POLICY's side-kick. It comprises PUBLIC SPENDING and TAXATION, and any other GOVERNMENT income or assistance to the private sector (such as tax breaks). It can be used to influence the level of demand in the economy, usually with the twin goals of getting UNEMPLOYMENT as low as possible without triggering excessive INFLATION. At times it has been deployed to manage short-term demand through FINE TUNING, although since the end of the KEYNESIAN era it has more often been targeted on long-term goals, with monetary policy more often used for shorter-term adjustments.
• For a government, there are two main issues in setting fiscal policy: what should be the overall stance of policy, and what form should its individual parts take?
• Some economists and policymakers argue for a BALANCED BUDGET. Others say that a persistent DEFICIT (public spending exceeding revenue) is acceptable provided, in accordance with the GOLDEN RULE, the deficit is used for INVESTMENT (in INFRASTRUCTURE, say) rather than CONSUMPTION. However, there may be a danger that public-sector investment will result in the CROWDING OUT of more productive private investment. Whatever the overall stance on average over an economic cycle, most economists agree that fiscal policy should be counter-cyclical, aiming to automatically stabilise demand by increasing public spending relative to revenue when the economy is struggling and increasing taxes relative to spending towards the top of the cycle. For instance, social (WELFARE) handouts from the state usually increase during tough times, and fiscal drag boosts government revenue when the economy is growing.
• As for the bits and pieces making up fiscal policy, one debate is about how high public spending should be relative to gdp. In the United States and many Asian countries, public spending is less than 30% of GDP; in European countries, such as Germany and Sweden, it has been as high as 40-50%. Some economic studies suggest that lower public spending relative to GDP results in higher rates of GROWTH, though this conclusion is controversial. Certainly, over the years, much public spending has been highly inefficient.
• Another issue is the form that taxation should take, especially the split between DIRECT TAXATION and INDIRECT TAXATION and between capital, income and expenditure tax.
• Production costs that do not change when the quantity of OUTPUT produced changes, for instance, the cost of renting an office or factory space. Contrast with VARIABLE COSTS.
• Going public. When SHARES in a company are sold to the public for the first time through an initial public offering. The number of shares sold by the original private investors is called the "float". Also, when a BOND issue is sold in the FINANCIAL MARKETS.
• Best guesses about the future. Despite complex economic theories and cutting-edge ECONOMETRICS, the forecasts economists make are often badly wrong. Indeed, following economic forecasts has been likened to driving a car blindfolded, following directions given by a person who is looking out of the back window. Some of the inaccuracies in forecasts reflect badly designed models; often, the problem is that the future actually is unpredictable. Maybe it would be better to take the advice of Sam Goldwyn, a movie mogul, "Never prophesy, especially about the future."
• Investing directly in production in another country, either by buying a company there or establishing new operations of an existing business. This is done mostly by companies as opposed to financial institutions, which prefer indirect INVESTMENT abroad such as buying small parcels of a country's supply of SHARES or BONDS. Foreign direct investment (FDI) grew rapidly during the 1990s before slowing a bit, along with the global economy, in the early years of the 21st century. Most of this investment went from one OECD country to another, but the share going to developing countries, especially in Asia, increased steadily.
• There was a time when economists considered fdi as a substitute for trade. Building factories in foreign countries was one way of jumping TARIFF barriers. Now economists typically regard FDI and trade as complementary. For example, a firm can use a factory in one country to supply neighbouring markets. Some investments, especially in SERVICES industries, are essential prerequisites for selling to foreigners. Who would buy a Big Mac in London if it had to be sent from New York?
• Governments used to be highly suspicious of FDI, often regarding it as corporate imperialism. Nowadays they are more likely to court it. They hope that investors will create jobs, and bring expertise and technology that will be passed on to local FIRMS and workers, helping to sharpen up their whole economy. Furthermore, unlike financial investors, multinationals generally invest directly in plant and equipment. Since it is hard to uproot a chemicals factory, these investments, once made, are far more enduring than the flows of HOT MONEY that whisk in and out of emerging markets (see DEVELOPING COUNTRIES).
• MERGERS AND ACQUISITIONS are a significant form of FDI. For instance, in 1997, more than 90% of FDI into the United States took the form of mergers rather than of setting up new subsidiaries and opening factories.
• There's no such thing. See OPPORTUNITY COST.
• Getting the benefit of a good or service without paying for it, not necessarily illegally. This may be possible because certain types of goods and services are actually hard to charge for--a firework display, for instance. Another way to look at this may be that the good or service has a positive EXTERNALITY. However, there can sometimes be a free-rider problem, if the number of people willing to pay for the good or service is not enough to cover the cost of providing it. In this case, the good or service might not be produced, even though it would be beneficial for the economy as a whole to have it. PUBLIC GOODS are often at risk of free riding; in their case, the problem can be overcome by financing the good by imposing a tax on the entire population.
• The ability of people to undertake economic transactions with people in other countries free from any restraints imposed by governments or other regulators. Measured by the volume of IMPORTS and EXPORTS, world trade has become increasingly free in the years since the second world war. A fall in barriers to trade, as a result of the GENERAL AGREEMENT ON TARIFFS AND TRADE and its successor, the WORLD TRADE ORGANISATION, has helped stimulate this GROWTH. The volume of world merchandise trade at the start of the 21st century was about 17 times what it was in 1950, and the world's total OUTPUT was not even six times as big. The ratio of world exports to GDP had more than doubled since 1950. Of this, trade in manufactured goods was worth three times the value of trade in SERVICES, although the share of services trade was growing fast.
• For economists, the benefits of free trade are explained by the theory of comparative advantage, with each country doing those things in which it is comparatively more efficient. As long as each country specialises in products in which it has a COMPARATIVE ADVANTAGE, trade will be mutually beneficial. Some critics of free trade argue that trade with DEVELOPING COUNTRIES, where wages are usually lower and working hours longer than in developed countries, is unfair and will wipe out jobs in high-wage countries. They want AUTARKY or FAIR TRADE.
• Real-world trade patterns sometimes seem to challenge the theory of comparative advantage (see NEW TRADE THEORY). Most trade occurs between countries that do not have huge cost differences. The biggest trading partner of the United States, for instance, is Canada. Well over half the exports from France, Germany and Italy go to other EUROPEAN UNION countries. Moreover, these countries sell similar things to each other: cars made in France are exported to Germany, and German cars go to France. The main reason seems to be cross-border differences in consumer tastes. But the agricultural exports of Australia, say, or Saudi Arabia's reliance on oil, do clearly stem from their particular stock of natural resources. Also poorer countries often have more unskilled labour, so they export simple manufactures such as clothing.
• That part of the jobless total caused by people simply changing jobs and taking their time about it, because they are spending time on JOB SEARCH or are taking a break before starting with a new employer. There is likely to be some frictional unemployment even when there is technically FULL EMPLOYMENT, because most people change jobs from time to time.
• Loved and loathed; perhaps the most influential economist of his generation. He won the NOBEL PRIZE FOR ECONOMICS in 1976, one of many CHICAGO SCHOOL economists to receive that honour. He has been recognised for his achievements in the study of CONSUMPTION, monetary history and theory, and for demonstrating how complex policies aimed at economic STABILISATION can be.
• A fierce advocate of free markets, Mr Friedman argued for MONETARISM at a time when KEYNESIAN policies were dominant. Unusually, his work is readily accessible to the layman. He argues that the problems of INFLATION and short-run UNEMPLOYMENT would be solved if the Federal Reserve had to increase the MONEY SUPPLY at a constant rate.
• Like ADAM SMITH and FRIEDRICH HAYEK, who inspired him, Mr Friedman praises the free market not just for its economic EFFICIENCY but also for its moral strength. For him, freedom--economic, political and civil--is an end in itself, not a means to an end. It is what makes life worthwhile. He has said he would prefer to live in a free country, even if it did not provide a higher standard of living, than a country run by an alternative regime. However, the likelihood of a free country being poorer than an unfree one strikes him as implausible; the economic as well as the moral superiority of free markets is, he has declared, "now proven".
• An adviser to Richard Nixon, he was disappointed when the president went against the spirit of monetarism in 1971 by asking him to urge the chairman of the Fed to increase the money supply more rapidly. The 1980s economic policies of Margaret Thatcher and General Pinochet were inspired--and defended--by Mr Friedman. However, in 2003, he admitted that one of those policies, the targeting of the money supply, had "not been a success" and that he doubted he would "as of today push it as hard as I once did".

• G7, G8, G10, G21, G22, G26
• "I don't want to belong to any club that will accept me as a member," quipped Groucho Marx. But the world's politicians are desperate to join the economic clubs that are the Group of Seven (G7), G8, G10 and so on. Being a member shows that, economically speaking, your country matters. Alas, beyond making politicians feel good, there has not been much evidence in recent years that they do anything useful, apart from letting GOVERNMENT officials and journalists talk to each other about economics and politics, usually in beautiful locations with lots of fine food and drink on hand.
• In 1975, six countries, the world's leading capitalist countries, ranked by GDP, were represented in France at the first annual summit meeting: the United States, the UK, Germany, Japan and Italy, as well as the host country. The following year they were joined by Canada and, in 1977, by representatives of the EUROPEAN UNION, although the group continued to be known as the G7. At the 1989 summit, 15 developing countries were also represented, although this did not give birth to the G22, which was not set up until 1998 and swiftly grew into G26. At the 1991 G7 summit, a meeting was held with the Soviet Union, a practice that continued (with Russia) in later years. In 1998, although it was not one of the world's eight richest countries, Russia became a full member of the G8. Meetings of the IMF are attended by the GIO, which includes 11 countries--the original members of the G7 as well as representatives of Switzerland, Belgium, Sweden and the Netherlands. In 2003, 21 developing countries, representing half of the world's population and two-thirds of its farmers, formed the G21 to lobby for more FREE TRADE in agriculture.
• How to win at Twister? No, but maybe at monopoly. Game theory is a technique for analysing how people, firms and governments should behave in strategic situations (in which they must interact with each other), and in deciding what to do must take into account what others are likely to do and how others might respond to what they do. For instance, COMPETITION between two firms can be analysed as a game in which firms play to achieve a long-term COMPETITIVE ADVANTAGE (perhaps even a MONOPOLY). The theory helps each firm to develop its optimal strategy for, say, pricing its products and deciding how much to produce; it can help the firm to anticipate in advance what its competitor will do and shows how best to respond if the competitor does something unexpected. It is particularly useful for understanding behaviour in MONOPOLISTIC COMPETITION.
• In game theory, which can be used to describe anything from wage negotiations to arms races, a dominant strategy is one that will deliver the best results for the player, regardless of what anybody else does. One finding of game theory is that there may be a large FIRST-MOVER ADVANTAGE for companies that beat their rivals into a new market or come up with an INNOVATION. One special case identified by the theory is the ZERO-SUM GAME, where players see that the total winnings are fixed; for some to do well, others must lose. Far better is the positive-sum game, in which competitive interaction has the potential to make all the players richer. Another problem analysed by game theorists is the PRISONERS' DILEMMA. (See also NASH EQUILIBRIUM.)
• Gross domestic product, a measure of economic activity in a country. It is calculated by adding the total value of a country's annual OUTPUT of goods and services. GDP = private consumption + INVESTMENT + PUBLIC SPENDING + the change in inventories + (EXPORTS - IMPORTS). It is usually valued at market prices; by subtracting indirect tax and adding any government SUBSIDY, however, GDP can be calculated at FACTOR COST. This measure more accurately reveals the income paid to FACTORS OF PRODUCTION. Adding income earned by domestic residents from their investments abroad, and subtracting income paid from the country to investors abroad, gives the country's gross national product (GNP).
• The effect of INFLATION can be eliminated by measuring GDP GROWTH in constant real prices. However, some economists argue that hitting a nominal gdp target should be the main goal of MACROECONOMIC POLICY. This is because it would remind policymakers to take into account the effect of their decisions on inflation, as well as on growth. GDP can be calculated in three ways. The income method adds the income of residents (individuals and firms) derived from the production of goods and SERVICES. The OUTPUT method adds the value of output from the different sectors of the economy. The expenditure method totals spending on goods and services produced by residents, before allowing for DEPRECIATION and CAPITAL consumption. As one person's output is another person's income, which in turn becomes expenditure, these three measures ought to be identical. They rarely are because of statistical imperfections. Furthermore, the output and income measures exclude unreported economic activity that takes place in the BLACK ECONOMY but that may be captured by the expenditure measure.
• GDP is disliked as an objective of economic policy by some because it is not a perfect measure of WELFARE. It does not include aspects of the good life such as some leisure activities. Nor does it include economically valuable activities that are not paid for, such as parents teaching their children to read. But it does include some things that lower the quality of life, such as activities that damage the environment.
• A company's DEBT expressed as a percentage of its equity; also known as leverage. (See also CAPITAL STRUCTURE and LEVERAGED BUY-OUT.)
• Or GATT, the vehicle for promoting international FREE TRADE, through a series of rounds of negotiations between the governments of trading countries. The first GATT round began in 1945. The last led to the establishment of the WORLD TRADE ORGANISATION in 1995.
• Economic perfection. This is when DEMAND and SUPPLY are in balance (the market is in EQUILIBRIUM) for each and every good and service in the economy. Nobody thinks that real-world economies can ever be that perfect; at best there is "partial equilibrium". But most economists think that general equilibrium is something worth aspiring to.
• A relatively new way of analysing FISCAL POLICY by identifying the financial costs and benefits of GOVERNMENT policies to people of different ages, now living or yet to be born. Fiscal policy can distribute resources between different generations, sometimes deliberately and often inadvertently. At any moment in time, one generation may be in work and paying taxes that support other generations (those at school or retired) that are not working. Over its lifetime, one generation's mix of taxes paid and benefits received may differ sharply from that of another generation. Politicians are often tempted to ignore the needs of future generations (who, clearly, cannot vote at the time) in order to win the support of current generations, for instance by borrowing heavily to fund current spending. More fundamentally, because it incorporates all the tax and spending, current and future, to which a government is committed, generational accounting is a much better guide to whether fiscal policy is sustainable than measures such as the BUDGET deficit, which looks only at taxes and spending in the current year.
• Named after Robert Giffen (1837-1910), a good for which DEMAND increases as its PRICE rises. But such goods may not exist in the real world.
• Shorthand for gilt-edged SECURITIES, meaning a safe bet, at least as far as receiving INTEREST and avoiding default goes. The price of gilts can vary considerably over time, however, creating a degree of RISK for investors. Usually the term is applied only to GOVERNMENT BONDS.
• An INEQUALITY indicator. The Gini coefficient measures the inequality of INCOME distribution within a country. It varies from zero, which indicates perfect equality, with every household earning exactly the same, to one, which implies absolute inequality, with a single household earning a country's entire income. Latin America is the world's most unequal region, with a Gini coefficient of around 0.5; in rich countries the figure is closer to 0.3.
• PUBLIC GOODS that cannot be provided by one country acting alone but only by the joint efforts of many (strictly, all) countries. Some economists, along with global institutions such as the UN, reckon that such goods include international law and law enforcement, a stable global FINANCIAL SYSTEM, an open trading system, health, peace and enviromental sustainability.
• A buzz word that refers to the trend for people, firms and governments around the world to become increasingly dependent on and integrated with each other. This can be a source of tremendous opportunity, as new markets, workers, business partners, goods and SERVICES and jobs become available, but also of competitive threat, which may undermine economic activities that were viable before globalisation.
• The term first surfaced during the 1980s to characterise huge changes that were taking place in the international economy, notably the GROWTH in international trade and in flows of CAPITAL around the world. Globalisation has also been used to describe growing INCOME INEQUALITY between the world's rich and poor; the growing power of multinational companies relative to national GOVERNMENT; and the spread of CAPITALISM into former communist countries. Usually, the term is synonymous with international integration, the spread of free markets and policies of LIBERALISATION and FREE TRADE. The process is not the result simply of economic forces. The decisions of policymakers have also played an important part, although not all governments have embraced the change warmly.
• The driving force of globalisation has been multinational companies, which since the 1970s have constantly, and often successfully, lobbied governments to make it easier for them to put their skills and capital to work in previously protected national markets. Firms enjoying some national protection, and their (often unionised) workers, have been some of the main opponents of globalisation, along with advocates of FAIR TRADE.
• Despite all the talk of globalisation during the 1990s, in some respects the world economy was more integrated in the late 19th century. The labour market was certainly more global. For example, the flow of people out of Europe, 300,000 people a year in the mid-19th century, reached 1m a year after 1900. Now governments are much fussier about immigration, and people are no longer free to migrate as they wish. As for CAPITAL MARKETS, only in the 1990s did international capital flows, relative to the size of the world economy, recover to the levels of the few decades before the first world war.
• This early globalised economy did not last for long, however. Between the two world wars, the flows of trade, capital and people collapsed to a trickle. Even before the first world war, governments started to put up the shutters against migrants and IMPORTS. Could such a backlash against globalisation happen again?
• Short for gross national income, a term now used instead of GNP in national accounts.
• Short for gross national product, another measure of a country's economic performance. It is calculated by adding to GDP the INCOME earned by residents from investments abroad, less the corresponding income sent home by foreigners who are living in the country.
• For much of human history gold has been an important ingredient of economic activity. But its importance declined during the 20th century and may continue to shrink in future. The GOLD STANDARD, which fixed EXCHANGE RATES to the value of gold during the 19th and early 20th centuries, has been long abandoned. CENTRAL BANKS, which in 2000 still owned 30,000 tonnes, over one-quarter of all the gold ever mined, no longer feel the need to have large RESERVES of the metal to support the value of their currency. It does not pay them any interest, though they may earn a little by lending it to bullion dealers. So they have started to sell.
• Governments and investors have traditionally held gold as a HEDGE against INFLATION and to provide security at times of international crisis. But its role as a store of value has been tarnished. During the 1980s and 1990s, the value of gold generally failed to keep pace with inflation. The LIQUIDITY of gold is also less than that of a foreign currency so it cannot as easily be used for foreign exchange intervention in defence of a currency under attack. In short, gold is no longer a monetary ASSET. It has become just another COMMODITY, although so-called gold-bugs still believe that should inflation ever soar again, gold will once more become the thing to have.
• A monetary system in which a country backs its currency with a reserve of GOLD, and allows currency holders to exchange their notes and coins for gold. For many years up to 1914, most of the world's leading currencies had their EXCHANGE RATE determined by the gold standard. The economic disruption resulting from the first world war led the combatants to abandon the link to gold. The UK (with others) returned to the gold standard in 1925, before quitting it for good in 1931. The widespread use of the gold standard ended during 1930-33 as a result of global DEPRESSION and large cuts in international lending. The United States left the gold standard in 1933 and partially returned to it in 1934. After the second world war, a limited form of gold standard continued but only directly applied to the dollar; other major currencies had their exchange rates fixed to the dollar under the BRETTON WOODS arrangements. The dollar was finally cut loose from the gold standard in 1971.
• Over the economic cycle, a GOVERNMENT should borrow only to invest and not to finance current spending. This rule is certainly a prudent approach to FISCAL POLICY, provided that governments are honest in describing spending as INVESTMENT, that they invest in appropriate things and do so efficiently, and that they are careful to avoid crowding out superior private investment. But there are other fiscal policy options that may make as much sense. See, for example, BALANCED BUDGET.
• There are few more hotly debated topics in ECONOMICS than what role the state should play in the economy. Plenty of economists provided intellectual support for state intervention during the era of big government, particularly from the 1930s to the 1980s. KEYNESIANS argued that the state should manage the amount of DEMAND in the economy to maintain FULL EMPLOYMENT. Others advocated a COMMAND ECONOMY, in which the government would decide price levels, oversee the allocation of scarce resources and run the most important parts of the economy (the "commanding heights") or, in communist countries, the entire economy. The role of the state increased at the expense of market forces. Economists provided plenty of examples of MARKET FAILURE that seemed to justify this.
• Since the 1950s, there has been growing evidence that government intervention can also be flawed, and can often impose even greater costs on an economy than market failure. One reason is that when a government acts, it usually does so as a MONOPOLY, with all the attendant economic inefficiencies this implies.
• In practice, policies of Keynesian DEMAND management often resulted in INFLATION, and thus lost much of their credibility. There was growing concern that public INVESTMENT was CROWDING OUT superior private investment, and that other public spending on things such as health care, education and pensions was similarly discouraging private provision. Government management of commercial enterprises was often seen to be inefficient and, starting in the 1980s, NATIONALISATION gave way to PRIVATISATION. Even when the state was not directly responsible for economic activity, but instead set the rules governing private behaviour, there was evidence of REGULATORY FAILURE. High rates of TAXATION started to discourage people and companies from undertaking economic activities that would, without the tax, have been profitable; wealth creation suffered.
• Most economists agree that there is a need for some government role in the economy. A market economy can function only if there is an adequate legal system, and, in particular, clearly defined, enforceable PROPERTY RIGHTS. The legal system is probably an example of what economists call a PUBLIC GOOD (although the existence in many countries and industries of some self-REGULATION shows it is not always so).
• Although politicians in many countries spent most of the period since 1980 talking about the need to reduce the role of the state in the economy, and in many cases introduced policies of privatisation, DEREGULATION and LIBERALISATION to help this happen, public spending has continued to increase as a share of GDP. Within the OECD, public spending accounted for a larger slice of GDP in 2002 than in 1990, which was in turn higher than in 1980. Indeed, it has risen during every decade since the start of the 20th century. One reason was that governments had to honour spending commitments on pensions and health care made by previous generations of politicians.
• See BONDS and GILTS.
• Spending by national and local GOVERNMENT and some government-backed institutions. See FISCAL POLICY, GOLDEN RULE and BUDGET.
• The most famous of all CENTRAL BANK bosses, so far. A former jazz musician turned economist, he became chairman of the board of governors of America's Federal Reserve in 1987, shortly before Wall Street crashed. In 2003, he was reappointed until 2005. He won admirers for delivering MONETARY POLICY that helped to bring down INFLATION and create the conditions for strong economic growth. Some people considered him the nearest thing CAPITALISM had to God. In 1996, he famously wondered aloud whether rising SHARE prices were the result of "irrational exuberance". Economists debate whether history will judge him a failure because he did not prevent the growth of a huge BUBBLE in America's economy.
• Bad MONEY drives out good. One of the oldest laws in ECONOMICS, named after Sir Thomas Gresham, an adviser to Queen Elizabeth I of England. He observed that when a currency has been debased and a new one is introduced to replace it, the new one will be hoarded and effectively taken out of circulation, while the old one will continue to be used for transactions, to be got rid of as fast as possible.
• See GDP.
• See GNP.
• What economic activity is all about, but how can it be made to happen? Economists have plenty of theories, but none of them has all the answers.
• ADAM SMITH attributed growth to the INVISIBLE HAND, a view shared by most followers of CLASSICAL ECONOMICS. NEO-CLASSICAL ECONOMICS had a different theory of growth, devised by Robert Solow during the 1950s. This argued that a sustained increase in investment increases an economy's growth rate only temporarily: the ratio of CAPITAL to LABOUR goes up, the MARGINAL product of capital declines and the economy moves back to a long-term growth path. OUTPUT will then increase at the same rate as the growth in the workforce (quality-adjusted, in later versions) plus a factor to reflect improvements in PRODUCTIVITY.
• This theory predicts specific relationships among some basic economic statistics. Yet some of these predictions fail to fit the facts. For example, INCOME disparities between countries are greater than the differences in their SAVINGS rates would suggest. Moreover, although the model says that economic growth ultimately depends on the rate of technological change, it fails to explain exactly what determines this rate. Technological change is treated as EXOGENOUS.
• Some economists argued that doing this ignored the main engine of growth. They developed a new growth theory, in which improvements in productivity were ENDOGENOUS, meaning that they were the result of things taking place within the economic model being used and not merely assumed to happen, as in the neo-classical models. Endogenous growth was due, in particular, to technological INNOVATION and investments in HUMAN CAPITAL. In looking for explanations for differences in rates of growth, including between rich and DEVELOPING COUNTRIES, the new growth theory concentrates on what the incentives are in an economy to create additional human capital and to invent new products.
• Factors determining these incentives include GOVERNMENT policies. Countries with broadly free-market policies, in particular FREE TRADE and the maintenance of secure PROPERTY RIGHTS, typically have higher growth rates. Open economies have grown much faster on average than closed economies. Higher PUBLIC SPENDING relative to GDP is generally associated with slower growth. Also bad for growth are high INFLATION and political instability.
• As countries grew richer during the 20th century annual growth rates declined, as a result of DIMINISHING RETURNS to capital. By 1990, most developed countries reckoned to have long-term trend growth rates of 2-2.5% a year. However, during the 1990s, growth rates started to rise, especially in the United States. Some economists said this was the result of the birth of a NEW ECONOMY based on a revolution in productivity, largely because of rapid technological innovation but also (perhaps directly stemming from the spread of new technology) to increases in the value of human capital.
• MONEY you can trust. A hard currency is expected to retain its value, or even benefit from APPRECIATION, against softer currencies. This makes it a popular choice for people involved in international transactions. The dollar, D-MARK, sterling and the Swiss franc each became a hard currency, if only some of the time, during the 20th century.
• An ancient system of moving MONEY based on TRUST. It predates western BANK practices. Although it is now more associated with the Middle East, a version of hawala existed in China in the second half of the Tang dynasty (618-907), known as fei qian, or flying money. In hawala, no money moves physically between locations; nowadays it is transferred by means of a telephone call or fax between dealers in different countries. No legal contracts are involved, and recipients are given only a code number or simple token, such as a low-value banknote torn in half, to prove that money is due. Over time, transactions in opposite directions cancel each other out, so physical movement is minimised. Trust is the only CAPITAL that the dealers have. With it, the users of hawala have a worldwide money-transmission service that is cheap, fast and free of bureaucracy.
• From a GOVERNMENT's point of view, however, informal money networks are threatening, since they lie outside official channels that are regulated and taxed. They fear they are used by criminals, including terrorists. Although this is probably true, by far the main users of hawala networks are overseas workers, who do not trust official money transfer methods or cannot afford them, remitting earnings to their families.
• An influential economist of the Austrian school, who won the NOBEL PRIZE FOR ECONOMICS in 1974 for his theory of the BUSINESS CYCLE many years after this body of work seemed to have been disproved by KEYNES. Born in 1899, Hayek attended his home-town University of Vienna after the first world war. He was attracted to SOCIALISM until he read a pioneering Austrian economist, Ludwig von Mises, on the subject, after which, he said, “the world was never the same again”.
• Hayek argued that the business cycle originated from expanded CREDIT CREATION by BANKS, which was followed by FIRMS and people making mistaken CAPITAL investments in producing things for which the market turns out to be smaller (or larger) than expected. But after an initially enthusiastic reception, the Austrian business-cycle theory lost out in policy debates to Keynes's General Theory. After the second world war, Hayek was a leading member of the CHICAGO SCHOOL along with Milton FRIEDMAN, among others.
• Hayek was a noted proponent of the free-market system and a critic of state planning. His 1944 book, The Road to Serfdom, anticipated the demise of command economies that sought to suppress PRICE signals. This prediction came from his belief in the limits of human reason and has faith in the superior ability of CAPITALISM to make efficient use of limited INFORMATION and to learn by trial and error. His views, which echo Adam SMITH’s INVISIBLE HAND, are said to have inspired the free-market economic reforms undertaken in the 1980s by Margaret Thatcher and Ronald Reagan. He died in 1992.
• Reducing your risks. Hedging involves deliberately taking on a new RISK that offsets an existing one, such as your exposure to an adverse change in an EXCHANGE RATE, INTEREST RATE or COMMODITY PRICE. Imagine, for example, that you are British and you are to be paid $1m in three months’ time. You are worried that the dollar may have fallen in value by then, thus reducing the number of pounds you will be able to convert the $1m into. You can hedge away that currency risk by buying $1m of pounds at the current exchange rate (in effect) in the futures market. Hedging is most often done by commodity producers and traders, financial institutions and, increasingly, by non-financial FIRMS.
• It used to be fashionable for firms to hedge by following a policy of DIVERSIFICATION. More recently, firms have hedged using financial instruments and DERIVATIVES. Another popular strategy is to use “natural” hedges wherever possible. For example, if a company is setting up a factory in a particular country, it might finance it by borrowing in the currency of that country. An extension of this idea is operational hedging, for example, relocating production facilities to get a better match of costs in a given currency to revenue.
• Hedging sounds prudent, but some economists reckon that firms should not do it because it reduces their value to shareholders. In the 1950s, two economists, Merton Miller (1923–2000) and Franco Modigliani, argued that firms make MONEY only if they make good investments, the kind that increase their operating cashflow. Whether these investments are financed through DEBT, EQUITY or retained earnings is irrelevant. Different methods of financing simply determine how a firm’s value is divided between its various sorts of investors (for example, shareholders or bondholders), not the value itself. This surprising insight helped win each of them a Nobel prize. If they are right, there are big implications for hedging. If methods of financing and the character of financial risks do not matter, managing them is pointless. It cannot add to the firm’s value; on the contrary, as hedging does not come free, doing it might actually lower that value. Moreover, argued Messrs Miller and Modigliani, if investors want to avoid the financial risks attached to holding SHARES in a firm, they can diversify their portfolio of shareholdings. Firms need not manage their financial risks; investors can do it for themselves. Few managers agree.
• These bogey-men of the FINANCIAL MARKETS are often blamed, usually unfairly, when things go wrong. There is no simple definition of a hedge fund (few of them actually HEDGE). But they all aim to maximise their absolute returns rather than relative ones; that is, they concentrate on making as much MONEY as possible, not (like many mutual funds) simply on outperforming an index. Although they are often accused of disrupting financial markets by their SPECULATION, their willingness to bet against the herd of other investors may push security prices closer to their true fundamental values, not away.
• A warning signal of possible MONOPOLY. ANTITRUST economists often gauge the COMPETITIVENESS of an industry by measuring the extent to which its OUTPUT is concentrated among a few FIRMS. One such measure is a
• Herfindahl-Hirschman index. To calculate it, take the market share of each firm in the industry, square it, then add them all up. If there are 100 equal-sized firms (a market with close to PERFECT COMPETITION) the index is 100. If there are four equal-sized firms (possible OLIGOPOLY) it will be 2,500. The higher the Herfindahl number, the more concentrated is MARKET POWER.
• The main virtue of the Herfindahl is its simplicity. But it has two unfortunate shortcomings. It relies on defining correctly the industry or market for which the degree of competitiveness is open to question. This is rarely simple and can be a matter of fierce debate. Even when the scope of the market is clear, the relation between the Her findahl and market power is not. When there is a CONTESTABLE MARKET, even a firm with a Herfindahl of 10,000 (the classic definition of a monopoly) may behave as if it was in a perfectly competitive market.
• One way to keep TAXATION fair. Horizontal equity means that people with a similar ability to pay taxes should pay the same amount. (See EQUITY and VERTICAL EQUITY.)
• Merging with another firm just like yours, for example, two biscuit makers becoming one. Contrast with VERTICAL INTEGRATION, which is merging with a firm at a different stage in the SUPPLY chain. Horizontal integration often raises ANTITRUST concerns, as the combined firm will have a larger market share than either firm did before merging.
• money that is held in one currency but is liable to switch to another currency at a moment’s notice in search of the highest available RETURNS, thereby causing the first currency’s EXCHANGE RATE to plummet. It is often used to describe the money invested in currency markets by speculators.
• When they go through the roof it is usually a warning sign that an economy is overheating. House prices often rise after INTEREST RATE reductions, which lower mortgage payments and thus give buyers the ability to fund a larger amount of borrowing and so offer a higher price for their new home. Strangely, people often regard house-price INFLATION as good news, even though it creates as many losers as gainers. They argue that rising house prices help to boost consumer confidence, and are part of the WEALTH EFFECT: as house prices rise, people feel wealthier and so spend more. However, against this must be set a negative wealth effect. An increase in house prices makes many people worse off, such as first-time buyers and anyone planning to trade up to a better property.
• As long as people think that their house is a vehicle for SPECULATION, rather than merely accommodation, it seems inevitable that prices will be volatile, prone to a boom-bust cycle. As house prices rise, profits are made, tempting more speculative buyers into the market; eventually, they start to pay too much, interest rates rise, DEMAND falls and prices plunge. People have also invested in housing as a HEDGE against INFLATION: house prices generally rise when other prices rise, whereas the real value of mortgage DEBT is eroded by inflation. However, when mortgage interest rates are variable (as they generally are in the UK) rather than fixed (as in the United States), they may rise painfully during times of high inflation as a result of MACROECONOMIC POLICY efforts to slow the pace of economic GROWTH.
• One of the reasons why the United States has long-term fixed mortgage rates is the financing provided by GOVERNMENT-sponsored agencies such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, nicknamed, respectively, Fannie Mae and Freddie Mac. Economists increasingly debate their role, especially as they have grown into some of the world's largest lenders. Supporters claim that, as well as reducing macroeconomic VOLATILITY, they make housing more affordable, particularly for poorer people, and that other governments should play a similar role in the mortgage market. Critics say they have become a huge potential risk in the global financial system by creating a MORAL HAZARD through the controversial but widespread belief that if they were to get into difficulties the government would bail them out and, thus, their financial counterparties.
• The stuff that enables people to earn a living. Human capital can be increased by investing in education, training and health care. Economists increasingly argue that the accumulation of human as well as physical CAPITAL (plant and machinery) is a crucial ingredient of economic GROWTH, particularly in the NEW ECONOMY. Even so, this conclusion is largely a matter of theory and faith, rather than the result of detailed empirical analysis. Economists have made little progress in solving the tricky problem of how to measure human capital, even within the same country over time, let alone for comparisons between countries. Levels of spending on, say, education are not necessarily a good indicator of how much human capital an education system is creating; indeed, some economists argue that higher education spending may be a consequence of a country becoming wealthy rather than a cause. Never the less, even modest estimates of the stock of human capital in most countries suggests that it would pay to greatly increase INVESTMENT in medical technologies that would extend the working lives of most people. The non-economic benefits would be worth having, too.
• The “good life” guide. Calculated since 1990 by the United Nations Development Programme, the Human Development Index quantifies a country’s development in terms of such things as education, length of life and clean water, as well as INCOME. Since the mid-1970s, the quality of life for humans throughout the world has improved enormously overall. America's human development index rose by around one-tenth between 1975 and 2001, for example. More spectacularly, during the same period, China's rose by around 40% and Indonesia's by nearly 50%. Even so, in 2001, some 54 countries were poorer than in 1990, and in 34, mostly in Africa and the former Soviet Union, life expectancy had fallen, reversing an impressive long-term trend, largely because of the HIV/AIDS epidemic and crime. Some 21 countries had a lower overall human development index in 2003 than in 1990.
• Very, very bad. Although people debate when, precisely, very rapid INFLATION turns into hyper-inflation (a 100% or more increase in PRICES a year, perhaps?) nobody questions that it wreaks huge economic damage. After the first world war, German prices at one point were rising at a rate of 23,000% a year before the country’s economic system collapsed, creating a political opportunity grasped by the Nazis. In former Yugoslavia in 1993, prices rose by around 20% a day. Typically, hyper-inflation quickly leads to a complete loss of confidence in a country’s currency, and causes people to search for other forms of MONEY that are a better store of value. These may include physical ASSETS, GOLD and foreign currency. Hyper-inflation might be easier to live with if it was stable, as people could plan on the basis that prices would rise at a fast but predictable rate. However, there are no examples of stable hyper-inflation, precisely because it occurs only when there is a crisis of confidence across the economy, with all the behavioural unpredictability this implies.
• Earmarking taxes for a specific purpose. It may be a clever way to get around public hostility to paying more in TAXATION. If people are told that a specific share of their INCOME TAX will go to some popular cause, say education or health, they may be more willing to cough up. At the very least they may be forced to make more informed decisions about the trade-offs between taxes and public SERVICES. There is a downside, however. Hypothecated taxes may tie the hands of a GOVERNMENT at times when the hypothecated revenue could be spent to better effect elsewhere in the public sector. Conversely, and perhaps more likely, hypothecated taxes may prove to be less hypothecated than the public is led to believe. Civil servants, doubtless under pressure from their political bosses, can usually find ways to fudge the definition of the specific purpose for which a tax is hypothecated, letting government regain control over how the MONEY is spent.
• Lagging; slow to respond. Traditionally, economists believed that high UNEMPLOYMENT was a cyclical phenomenon. Eventually, unemployment would cause people to lower their wage demands, and so new job opportunities would arise and unemployment would fall. More recently, however, economists have suggested that some unemployed people, especially the long-term jobless, can display hysteresis. They find it hard, perhaps impossible, to return to work, even when jobs become available. For instance, unemployed workers may gradually lose the motivation, self-confidence or the self-discipline, needed to get to the workplace and fulfil job requirements. Or their skills may become outdated and redundant. State benefits for the jobless may contribute to this hysteresis by making it easier from them to stay out of work.
Reply With Quote
The Following User Says Thank You to Jamshed Iqbal For This Useful Post:
rooshni (Wednesday, February 01, 2012)

Thread Tools Search this Thread
Search this Thread:

Advanced Search

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are On
Pingbacks are On
Refbacks are On

Similar Threads
Thread Thread Starter Forum Replies Last Post
development of pakistan press since 1947 Janeeta Journalism & Mass Communication 15 Tuesday, May 05, 2020 03:04 AM
Economic cost of terrorism in pakistan redmax Pakistan Affairs 0 Tuesday, January 04, 2011 01:56 AM
European Union Aarwaa Current Affairs Notes 0 Sunday, April 20, 2008 10:34 PM
The Globalization of World Politics: Revision guide 3eBaylis & Smith: hellowahab International Relations 0 Wednesday, October 17, 2007 03:13 PM
Economics an overview Naseer Ahmed Chandio Economics 0 Wednesday, December 13, 2006 08:40 AM

CSS Forum on Facebook Follow CSS Forum on Twitter

Disclaimer: All messages made available as part of this discussion group (including any bulletin boards and chat rooms) and any opinions, advice, statements or other information contained in any messages posted or transmitted by any third party are the responsibility of the author of that message and not of (unless is specifically identified as the author of the message). The fact that a particular message is posted on or transmitted using this web site does not mean that CSSForum has endorsed that message in any way or verified the accuracy, completeness or usefulness of any message. We encourage visitors to the forum to report any objectionable message in site feedback. This forum is not monitored 24/7.

Sponsors: ArgusVision   vBulletin, Copyright ©2000 - 2022, Jelsoft Enterprises Ltd.