The economics you need

T H E E C O N O M I C S YO U NE E D This short book offers a rigorous yet user-friendly introductory guide for students who need to grasp the essential concepts of economics quickly It provides a serious, clearly understandable, and systematic account of the key elements of economics, with a focus on theory and principles The Economics You Need provides the ideal introduction for students approaching economics from other academic disciplines, as it uses only a limited amount of economics jargon, and is constructed so that several chapters can be read independently of the others This book is structured around the premise that a set of theoretical steps are necessary for understanding economics as a way of thinking, rather than as a set of solutions It also encourages the reader to consider alternatives to common assumptions, to acknowledge the need for value judgements and to foster fresh thinking in an imperfect world This engaging primer will be essential reading not only for students of economics, but also for students with a background in disciplines such as politics, law, international relations, and business studies Enrico Colombatto is Professor of Economics at the University of Turin, Italy, where he teaches ‘Foundations of Policymaking’, ‘International Economics’, and ‘Growth and Development’ He is the head of research at IREF (Institut de Recherches Économiques et Fiscales, Luxembourg) and a Senior Fellow at GIS (Geopolitical Information Service, Liechtenstein) This page intentionally left blank TH E E CON O M IC S Y O U N EE D Enrico Colombatto First published 2016 by Routledge Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2016 Enrico Colombatto The right of Enrico Colombatto to be identified as author of this work has been asserted in accordance with the Copyright, Designs and Patent Act 1988 All rights reserved No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Names: Colombatto, Enrico, author Title: The economics you need / Enrico Colombatto Description: Abingdon, Oxon ; New York, NY : Routledge, 2016 Identifiers: LCCN 2015040251 (print) | LCCN 2015042933 (ebook) | ISBN 9781138963108 (hardback) | ISBN 9781138963115 (pbk.) | ISBN 9781315658988 (ebook) Subjects: LCSH: Economics Classification: LCC HB171 C764 2016 (print) | LCC HB171 (ebook) | DDC 330 dc23 LC record available at http://lccn.loc.gov/2015040251 ISBN: 978-1-138-96310-8 (hbk) ISBN: 978-1-138-96311-5 (pbk) ISBN: 978-1-315-65898-8 (ebk) Typeset in Bembo by Saxon Graphics Ltd, Derby C ONTE NT S List of figures Acknowledgements Introduction The economic way of thinking 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 ix xi xiii On the nature of economics and the importance of methodology From economics to policy-making Methodological individualism and the micro–macro divide Time: statics, dynamics and uncertainty Failures: social justice, transaction costs, externalities Exchange, opportunity costs and surplus 11 Free lunches and the surplus 14 Summing up 16 The economics of consumption 2.1 Price takers, price makers and market power 18 2.2 Why does the demand curve slope downward? 19 2.3 Demand curves are imaginary and partial 21 2.4 When the demand curve moves 22 2.5 Preliminary conclusions 24 2.6 Intertemporal consumption and the rate of interest 25 2.7 Tampering with the future 27 2.8 From the demand curve to the consumer’s surplus 28 2.9 The cost of living 32 2.10 A word on happiness 36 18 CONTENTS The economics of production and growth 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 38 What can the economics of production tell us? 38 Production functions, technologies and productivity 38 Some words of caution 41 From traditional production theorising to growth 43 The world of the firm: owners and managers 44 Productive entrepreneurs: who are they and what they need? 46 The alternatives: planners, bureaucrats and non-profit organisations 48 The consequences for growth 51 Cost theorising and supply curves 55 4.1 4.2 4.3 4.4 4.5 4.6 Total costs and cost-efficiency 55 Fixed, sunk and variable costs 58 Average costs 60 Marginal costs and supply curves 63 Cost efficiency and supply 66 Supply curves for the industry and competitive price setting: the short run 67 4.7 Supply curves for the industry: the long run 70 4.8 Do externalities justify tampering with supply curves? 71 Competition and its enemies 74 5.1 Where prices come from? 74 5.2 On competition as usually understood 77 5.3 Ideal output and the fair sharing of the surplus 78 5.4 Antitrust intervention 80 5.5 An introduction to free competition 82 5.6 Three categories of barriers 83 5.7 Fair profits and rightful profits 84 5.8 Profits, quasi-rents and normative rents 86 5.9 Rent-seeking 87 5.10 Rent-seeking: how much does it cost and why can’t we get rid of it? 88 5.11 So, what have we learned? 89 Taxation and regulation 91 6.1 On the role of government 91 6.2 On tax targeting, tax collecting and tax paying 91 6.3 The irrelevance of tax collection 92 vi CONTENTS 6.4 An extension to non-competitive contexts 94 6.5 The social losses of taxation in the goods markets 95 6.6 Efficient taxation and elasticities 98 6.7 An extension to the labour market 100 6.8 On efficiency, retroactive taxation and legal monopolies 101 6.9 On proportional, progressive and regressive taxation 102 6.10 On regulation: what you see … 104 6.11 … and what you don’t see 106 Money and banking 109 7.1 On the birth and nature of commodity money 109 7.2 From commodity money to banknotes and cheques 110 7.3 Modern banking and bank credit 111 7.4 The relationship between credit and basic money 114 7.5 Getting closer to the real world: monetary aggregates 116 7.6 Getting closer to the real world: central banking 117 7.7 Getting closer to the real world: fiat money 117 7.8 On the economics of fiat money 118 7.9 The nature of monetary policy and the economics of inflation 119 7.10 A note on the rate of interest 120 International trade 8.1 8.2 8.3 8.4 8.5 8.6 8.7 123 The benefits from trade 123 Why people fear free trade? 125 Who trades what? The theory of comparative costs 127 Agglomeration 128 The role of institutions 129 Intra-industry trade in manufactured goods 131 Trade patterns and trade statistics revisited 132 Exchange rates 134 9.1 9.2 9.3 9.4 9.5 An introduction to exchange rates 134 Simple exchange-rate economics: the gold standard 135 Devaluation under a gold standard: the short run 135 Devaluation under a gold standard: the long run 136 Deflation, trade imbalances and capital movements under a gold standard 137 9.6 Paper money and flexible-exchange rates 138 vii CONTENTS 9.7 Competitive devaluations, capital movements and the strength of a currency 140 9.8 Paper money and flexible-exchange rates: forward markets 141 9.9 Paper money and flexible-exchange rates: arbitrageurs at work (I) 143 9.10 Paper money and flexible-exchange rates: arbitrageurs at work (II) 145 9.11 Fixed-exchange rates 148 9.12 Currency boards 150 9.13 Monetary unions 151 10 On growth, poverty and crises 154 10.1 Basic concepts 154 10.2 What we mean by growth? The issues of measurement and aggregation 155 10.3 What makes the difference between stagnation and growth? Innovation! 158 10.4 Technological progress: science and engineering 159 10.5 Skills, entrepreneurship and investments: why institutions matter 160 10.6 Preliminary conclusions: what have we learned about growth? 162 10.7 What about poverty? 164 10.8 Business cycles, booms and crises 166 10.9 Final remarks 169 Glossary Index 172 181 viii FIGURE S 1.1 1.2 1.3 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 5.1 5.2 6.1 6.2 6.3 6.4 9.1 9.2 Alicia would like to sell Y and buy X Bob would like to sell X and buy Y Alicia and Bob exchange The demand curve The demand region Movements of the demand curve Movements along/of the demand curve Consumer’s surplus Consumer’s surplus Changes in consumer’s surplus Changes in consumer’s surplus The production function The production–possibility frontier The total-cost curve Average cost curves Average costs Marginal costs The supply curve of the firm Desirable supply Industry supply curve: the short run Competitive equilibrium Shifts in the supply curve Long-run changes in industry supply Subsidised supply Pricing under perfect competition (a) and monopoly (b) The perfectly competitive industry Equilibrium after a tax on a good or service (a) and (b) Taxes in the labour market The deadweight loss of taxation The role of the elasticities (a) and (b) The effects of a devaluation The exchange rate and the money supply 13 14 14 20 22 23 24 29 30 34 36 39 53 56 61 62 64 65 66 68 69 70 71 72 76 78 93 95 96 99 137 139 O N G ROW T H , P OV E RT Y A N D C R I S E S progress took off, and entrepreneurs could transform opportunities into (material) wealth The Scientific and the Industrial Revolutions are the labels that have been given to the periods in which these tipping points were reached Since then, scientific advance and technological progress have been virtually unstoppable However, the extent to which these opportunities are exploited is another matter Some authors argue that we should ignore such opportunities and go for zero or negative growth, a suggestion that does not clarify whether technological and entrepreneurial advances should be discouraged, or whether their outcomes should be offset by more stringent limitations regarding work efforts Others suggest that we should take advantage of these growth and innovation possibilities in order to enhance redistribution and/or the production of desirable goods and services Finally, a third group of commentators simply claims that we should let individuals decide on their own, rather than plan in advance what to with the new opportunities made available by progress Despite these disagreements about how to exploit progress, it is undeniable that since the early nineteenth century, the world has been facing huge opportunities to grow: some of them have been exploited, some of them have been wasted, and some of them have been forsaken in order to enhance other goals We go no further than that At the same time, history has also shown that efforts to go beyond the constraints set by science, technology and institutions are futile and possibly counterproductive As we have mentioned earlier, the history of poverty gives witness to the fact that growth cannot be decreed by law or centralised planning There are no substitutes for legal contexts that enhance economic freedom while at the same time defusing social tensions and stabilising the political context Certainly, education and investment are critical, but they often risk being futile or short-lived, unless the suitable incentive structure is in place Following from these last remarks, one can perhaps draw attention to the four main insights we have tried to offer in these pages and, more generally, in this entire book The first regards the very nature and purpose of economic investigation Economics is a way of reasoning, rather than a recipe for obtaining precise answers and exact solutions Economics is thus a method through which the analyst develops consistent mental constructions that allow us to study human behaviour and choice under scarcity As we have seen, and this is the second point, economists are ill-equipped to make claims about the desirability of goals and outcomes As a matter of fact, offering value judgements about outputs belongs to realms of philosophy, political philosophy and perhaps political opportunism, rather than of economics The third argument concerns forecasting Regardless of some people’s hopes, pretensions and expectations, the predictive power of economics is limited It can develop scenarios, but it is no crystal ball Economists can predict how people are likely to behave given a set of preliminary assumptions or – better said – economists can develop the implications of those assumptions In this light, economics is probably closer to an exercise in tautology than in prediction 170 O N G ROW T H , P OV E RT Y A N D C R I S E S Consequences follow First, one should always pay attention to making the right assumptions And in order to make the right assumptions, one should continue to observe how people formulate and change their preferences, how techniques evolve, and how the legal context (institutions) affects and directs individuals’ actions Thus, the ‘perfect economist’ is one who can read the world around him and translate what he sees into behavioural patterns Furthermore, one should never forget that the history of economic growth is in fact the history of the acquisition of knowledge and of how humankind progresses through uncertainty Under these conditions, predictions about the future must necessarily be made with great prudence It is probably fair to say that human nature changes very slowly, if at all Yet, institutions evolve continuously, new goods and services see the light every day, and new technologies make their way into the world of production by the hour Certainly, it would be foolish to believe that one can forecast the future as if the future were frozen Finally, the wise economist should also abstain from reaching hasty judgements Sometimes, decisions that appear less than optimal or unwise in a short-run perspective turn out to be understandable or rational once the presence of uncertainty is taken into account – where uncertainty includes ‘lack of knowledge’, ‘perception of risk’ and also ‘propensity to take risks’ This book has probably disappointed those who believe that by learning good economics, one acquires more accurate predictive skills or defines the notion of ‘good society’ with scientific precision Once again, the difference between a good and a bad economist is not a matter of forecasting accuracy or faith in scientism Rather, the distinction lies between those who believe that they can predict (or control), and those who try to make use of the appropriate tools in order to describe and explain what they see Of course, this does not rule out the possibility of articulating opinions, personal judgements and proposals about policy-making Yet, this is not the role of an economist; rather, it is a different exercise, one that each reader will pursue according to his moral standards, ideological preferences, and understanding of the nature and goals of a community Recommended readings Diamond, J (1997), Guns, Germs and Steel, New York and London: Norton Maddison, A (2005), ‘Measuring and interpreting world economic performance 1500– 2001’, Review of Income and Wealth, 51 (1), March: 1–35 Pomeranz, K (2000), The Great Divergence, Princeton and Oxford: Princeton University Press Mokyr, J (1990), The Lever of Riches, New York: Oxford University Press Clark, G (2007), A Farewell to Alms, Princeton and Oxford: Princeton University Press Bauer, P (1991), The Development Frontier, Hemel Hampstead: Harvester Wheatsheaf Olson, M (1996), ‘Big bills left on the sidewalk: why some nations are rich, and others poor’, Journal of Economic Perspectives, 10 (2), spring: 3–24 171 GLOSSAR Y Altruism Defines an individual who acts in order to benefit other people The actor obtains no material benefit for his altruistic actions, but is often rewarded by the beneficiary’s gratitude and/or by the awareness of having done something deontologically appropriate Appreciation see depreciation Bargaining power see price-making Black economy see underground economy Cartel see oligopoly Competition A market context characterised by the absence of legal barriers to entry This context can also be defined as free competition According to the mainstream view, competition is perfect when all firms are price takers (they would lose all their buyers if they raised their price above the perfectly competitive price) and profits tend to zero Competition is fair when the producers’ performance is not affected by conditions beyond their control (e.g regulation), or when these conditions exist and also apply to their rivals Competitiveness Corresponds to the ability of a firm to meet the buyers’ preferences and make a profit Cost This term usually means total costs, and it identifies the sum paid to the owners of all the production factors used in production The difference between total revenues and total costs (including the remuneration of risk taking and time preference) is profit Total costs include fixed costs (which are independent of the quantity produced) and variable costs (which vary with the amount of output) Moreover, average costs define the cost per unit of output, and marginal costs define the increase in total cost caused by the production of the last unit of output Credit multiplier Determines the amount of credit that the banking system can generate with one monetary unit It depends on the reserve ratio, which defines the fraction of the deposits that banks can lend; and on the currency– deposit ratio, which defines how much of the money outstanding is deposited with the commercial banks Currency board An exchange-rate regime, according to which a governmental authority (the central bank) commits itself to issuing an 172 G L O S S A RY amount of domestic currency no greater than the amount of another currency (the standard) it holds in its vaults or in liquid assets, converted at a fixed parity Currency–deposit ratio Defines how an individual allocates his cash balances In particular, it is the ratio between the currency one keeps for transaction purposes, and the currency one deposits on a bank account Deadweight loss The welfare loss provoked by price distortions: for example, when the economy is characterised by rent-seeking, when agents operate on the base of wrong information, or in the presence of tariffs and taxes Deflation see inflation Depreciation Applies to a flexible-exchange-rate regime, and describes a situation in which the price of a given currency drops with respect to other currencies The term appreciation refers to the opposite case Devaluation Defines a change in the fixed-exchange rate (under a papermoney standard) or in the gold parity (in a gold standard) In particular, a devaluation describes a situation in which the authorities lower the price of the domestic currency in terms of a foreign currency (or a unit of gold) A revaluation refers to the opposite case (an increase in the price of the domestic currency) Dynamics see statics Economies of scale A synonym for ‘decreasing average costs’ The presence of economies of scale indicates a situation in which the cost of producing each unit of output is smaller, the larger the number of units produced Efficiency When it is productive efficiency, it identifies a situation in which one obtains the maximum output of that good, given the resources available; or in which one succeeds in minimising the use of inputs, given the production target sought Cost-efficiency designates the combination of inputs that minimises the cost of production Allocative efficiency refers to the welfare-maximising use of output by an economy When the term efficiency applies to fiscal matters, the expression efficient tax refers to a tax as a consequence of which economic agents not change their behaviour Elasticity The ratio between the proportional changes in two variables, one causing the other The cause appears at the denominator, while the effect appears at the numerator Entrepreneurs Those who have intuitions/insights, and operate to transform those insights into operational projects The first owner of a firm is necessarily an entrepreneur But most owners are not Entrepreneurs fall into two categories: productive entrepreneurs, who create new wealth, and wasteful entrepreneurs, who use their skills to create and appropriate privileges (see also rent-seeking) Equilibrium When referring to an individual, equilibrium describes a situation in which the agent has no incentive to change his behaviour When referring to a market, it identifies a situation in which, at a given 173 G L O S S A RY price, buyers and sellers not want to change the quantities they are buying and selling, respectively Externality (negative) The damage suffered by an individual as a result of somebody else’s actions, and for which the victim obtains no compensation Negative externalities are a synonym for ‘undesirable consequences’, and in many cases originate from violations of property rights Externality (positive) The unintentional gain that one agent’s action generates to the benefit of other individuals Positive externalities are a synonym for ‘desirable consequences’ Failures Occur when a desirable outcome fails to materialise Market failures refer to undesirable/unsatisfactory outcomes generated by more individuals engaging in voluntary transactions The expression institutional failures refers to situations in which the undesirable outcome is provoked by bad laws and/or poor contract-enforcing mechanisms Fiat money Defines the irredeemable monetary instruments created by a governmental authority Firm An organisation run by one or more agents: it employs different inputs and is devoted to the production of goods and services A typical firm includes entrepreneurs, who contribute innovative insights; owners, who take strategic decisions, are entitled to appropriate the profits and suffer the losses; and managers, who act within the limits set by the owners Forward markets see spot markets Free lunch A synonym for unintentionally acquired surplus (a free ride) It can refer to the benefits generated by past technological discoveries or by somebody else’s activities (see also positive externalities) A free lunch differs from a surplus, in that the surplus is generated by one’s purposeful activities (exchange), while a free lunch consists in the enjoyment of an unintentional gift Free market Defines the set of unregulated, spontaneous, voluntary exchanges and activities carried out by individuals who act according to their preferences, as long as they respect private property and contracts, and abstain from exercising physical violence and cheating A market economy is actually a free-market economy; otherwise it would be a planned or regulated economy Free ride see free lunch Gold parity Defines how many monetary units (dollars, francs, etc.) correspond to one unit of gold (e.g an ounce or a gram) Gross domestic product (GDP) it is the market value of all the goods and services produced by the private sector of an economy within a given time period, plus the cost of production of the goods and services produced by the public sector (in the same time period) If not specified otherwise, the chosen time interval is one year Inflation The proportional change in the price of a representative basket of goods and services When the change takes a negative sign, inflation is 174 G L O S S A RY called deflation An inflationary policy denotes an increase in the money supply that is likely to produce inflation Inter-industry trade Defines a pattern of international trade, in which one country exports a given set of goods and services, and imports good and service belonging to different commodity sectors This pattern contrasts with intra-industry trade, a trade pattern following which a country exports and imports goods and services belonging to the same category Legal tender Characterises a monetary system based on paper money, which the government accepts as a means of payment Forced legal tender includes monopoly power on money printing, the obligation to accept the banknotes and coins issued by the central bank as a means of payment, and the introduction of barriers to entry against competing means of payment Lump-sum tax A tax, the amount of which does not vary with the size/ value of the tax base Macroeconomics Refers to the economic phenomena that characterise large groups of individuals considered as one global actor Managers see firm Marginal utility The amount of satisfaction produced (lost) by the last unit of a good or service acquired (given away) Market failures see failures Market power An ambiguous term, which is sometimes used as a synonym for surplus, and sometimes means price-making Market rate of interest see rate of interest Market see free market Merit goods Identifies the set of goods and services that it is believed all individuals should be able to consume, regardless of their income and wealth Typical merit goods are considered to be health and education Today, a significant share of public expenditure is justified by the production of merit goods (not to be confused with public goods) Methodological individualism Defines a vision that argues that the economic actor is always the individual, rather than a collective body In this light, economic analysis should focus on the individual, while the behaviour of the aggregate consists of the sum of individuals’ actions Microeconomics Refers to the study of the economic behaviour (and the interaction) of (among) individual agents Monetary base Under a commodity standard, it is a synonym for ‘money supply’ (commodity money plus banknotes, in circulation or in the banks’ vault) Under fiat money, it corresponds to the amount of banknotes in circulation (i.e held by the public), plus the reserves in the banks’ vaults (including the central bank’s) Money (or money supply) Defines all the assets generally accepted as a means of exchange In particular, the expressions commodity money and basic money relate to a context in which the means of exchange is a physical good (e.g gold) By contrast, the expression money in circulation 175 G L O S S A RY refers to the outstanding money supply, i.e the money supply held by the public Money multiplier Defines the amount of money generated by one unit of basic money Under a commodity standard and a 100 per cent reserve ratio, the money supply is equivalent to the amount of commodity money (the money multiplier is 1) Monopoly Identifies an industry featuring only one producer, the output of which has no close substitutes A natural monopoly depicts a context in which economies of scale are so large that the best way to minimise average cost is to have only one producer Natural rate of interest see rate of interest Oligopoly Relates to an industry characterised by a small number of firms When oligopolistic firms collude rather than compete, such a group of firms becomes a cartel Opportunity costs The costs of choosing in a world characterised by scarcity In other words, they are the sacrifice one must incur in order to acquire a given good or service Owners see firm Price-making Defines a situation in which the economic agent exploits his bargaining skills and succeeds in appropriating at least part of the surplus that his counterpart was originally trying to keep for himself This expression is a synonym for bargaining power Price-taking Defines a situation in which the economic agent (e.g., a buyer) has no bargaining power and, therefore, cannot change the price charged by his contractual counterpart (e.g., a seller) Production function A mathematical formula that defines the maximum amount of output produced with given amounts of inputs, which are combined according to the techniques offered by the existing technology Production–possibility frontier Defines a locus of points, which corresponds to the maximum amount of output of one commodity, given the production of the other commodities, given a fixed amount of inputs, and given that no wastages occur (full employment and efficient techniques) Productivity Defines the relationship between output and the inputs utilised in the production process In particular, the average productivity of an input identifies the ratio between total output and the total amount of that input; the marginal productivity of an input corresponds to the output produced by the last unit of that input employed in the production process Total factor productivity (TFP) defines the change in output that does not depend not on the variations in the quantity of inputs TFP is frequently used to define the role of technological change Profit see surplus Public goods Defines goods and services characterised by two properties: (1) non-excludability (producers are not able to prevent consumers from using the good, even if they don’t pay) and (2) non-rivalry (consumption 176 G L O S S A RY by individual A does not reduce the quantity of the good/service available to other individuals) For example, many would maintain that national defence is a public good The notion of public good should not be confused with that of merit good.  Pure rate of interest see rate of interest Quasi rent see rent Rate of interest Includes the remuneration of the lender’s rate of time preference (impatience), of the expected loss of purchasing power of the currency involved in the transaction, of the risk that the borrower might default The market rate of interest is a synonym for rate of interest The natural rate of interest is the rate of interest at which the borrowers’ decisions and expectations are consistent with the lenders’ In other words, it is the rate of interest that emerges when the agents involved are immune to systematic misperceptions and miscalculations The pure rate of interest is the remuneration of the financial resources required to realise a project, net of the loss in purchasing power featured by the monetary unit and with no bankruptcy in sight Rate of time preference The reward an individual seeks in order to postpone consumption to the future When negative, it describes a situation in which the individual actually prefers future consumption to present consumption Rent Usually a synonym for profits (or unfair profits) and defines the difference between revenues and costs When this difference is guaranteed by legal privileges (e.g an import tariff or a production licence), rents are actually normative rents When this difference can be eroded by competition, rents are quasi rents Rent-seeking The set of actions that aim at creating, appropriating, and exploiting privileges established and enforced by a governmental institution Reserve ratio The portion of the depositors’ money that commercial banks not invest/lend and keep in their vaults or at the central bank Revaluation see devaluation Risk Describes a situation is which the individual is aware that given events can occur, and knows the probability associated to each of them Savings Defines the difference between current income and current expenditure Social justice Relates to compliance with a vision of society characterised by a predetermined set of desirable features (e.g., free education, the absence of poverty) In theory, each individual can have his own distinct notion(s) of social justice Spot markets Defines situations in which the contract and the actual transaction are simultaneous By contrast, forward markets characterise transactions that will take place in the future, but the terms of which are defined today Statics Relates to analyses which focus on a given moment in time (as in a snapshot), with no regard for the past or the future (as in a movie) 177 G L O S S A RY Comparative statics defines an exercise in which the observer compares two static situations (snapshot A and snapshot B), in which A has been affected by changes and has become B By contrast, dynamic analysis describes how one moves from A to B Within the context of economic policy-making, the notion of statics refers to simulations that consider only the short-term, direct consequences of intervention, while the notion of dynamics also takes into account long-term indirect results Subjectivism Claims that each individual has his own perceptions and preferences, which only the individual can evaluate and that, therefore, escape objective measurement Surplus The gain one enjoys from an activity, a gain that has involved no sacrifices for the beneficiary Surplus is also defined as net benefit It is known as profit when it is measurable in monetary terms and applies to a firm In particular, a firm’s profit is the difference between total revenues and total costs (including the remuneration of time preference and risktaking) When the surplus originates from activities carried out by somebody else, the surplus is called free lunch Tax The amount of money that an agent must give to the government in order to finance public expenditure at large, rather than to buy specific good and services Taxation is progressive when the ratio between the tax revenues and the tax base increases with the tax base (e.g income, consumption) It is regressive when this ratio decreases as the tax base increases, and it is proportional when the ratio is constant regardless of tax base A tax is retroactive when it applies to the taxpayers’ past tax base, and the tax is introduced only after the tax base has materialised Technique Applies to the economics of production and defines how given quantities of inputs can be combined and transformed into given units of output A technique is inefficient when there exists a combination that uses fewer inputs and generates the same amount of output, or when the same amount of inputs can be combined in a different way and produce more output Technology The set of all the efficient techniques available Total factor productivity see productivity Transaction costs The costs incurred in order to complete a transaction, but that not imply a transfer of resources from the buyer to the seller of the good or service exchanged For example, they include the cost of acquiring information and of contract enforcement Transformation curve Synonym for production–possibility frontier Uncertainty Ignorance of the set of events that can occur in the future (e.g a new source of energy that might be available in twenty years from now), or about the probability with which a known event can occur (e.g an earthquake) 178 G L O S S A RY Underground economy Identifies transactions in violation of the existing legislation, either because the object of the transaction is illegal (e.g., drug dealing), or because at least one party flouts the required procedures (e.g untruthful declaration for tax purposes) This term is generally used as a synonym for black economy or informal economy Utilitarianism In economics, it is a vision of policy-making, according to which the policy-maker maximises the happiness of the greatest portion of a community Utilitarianism is a variety of consequentialism, following which the moral worth of a policy is judged by its consequences Value added The difference between the market value of what the firm produces, and the market value of what the firm buys outside (e.g., raw materials, semi-manufactured goods, energy) Wealth Cumulated past savings 179 This page intentionally left blank INDE X Agglomeration 128–9 Aggregation 32, 154, 157 Allocation 49, 101, 121; misallocation 88, 95 Altruism xv, 3, 8, 18, 51 Anti-trust 4, 80–1, 85, 90, 105 Arbitrage 144–7 Banknotes see Money Banks 110–21, 167–8; banking 7, 84, 105, 111–13, 117 Bargaining power 18–19, 60–1, 75, 79, 81, 105 Barriers 83, 88–9; (barriers to) entry 75, 87, 118; trade (barriers) 7, 23, 81, 123, 126 Boom xiv, 26, 86, 113, 119, 166–7, 169 Bureaucracy 48–51, 53, 97, 108, 129–31, 165; bureaucrats 3, 87, 106–7 Business cycle xv, 91, 120, 166–9 Capital inflows 150 Capital movements 137–8, 141, 148, 150 Cartels 80–1, 88 Central bank 28, 116–19, 121–2, 168; central banking and exchange rates 138–40, 148–51 Cheque see Money Common good 83, 87, 103–4, 106–7; (common good and) policymaking 2–3, 11, 16, 48 Comparative advantage see Comparative costs Comparative costs 127–8 Competition 82, 88, 124, 129; fair 84; free 69, 77, 83–4, 90; perfect 75, 78–9, 82–4, 89–90; restricted 82–3; trade and 126, 132–3 Competitiveness 60, 73, 126 Costs: average 60, 74–5, 123; cost of living 32–3; exchange 101, 109; fixed 58–62, 74–5, 123–4; institutional 109; marginal 60, 63–6, 74, 94; opportunity xiv, 11–12, 18–20, 26–7; opportunity costs and production 44, 52; opportunity costs and international trade 127; organization and monitoring 61; opportunity costs and taxation 104; sunk 58–9, 63, 132; total 56–7, 60–6; transaction 8–9; variable 59–61 Crisis 26, 28, 86, 166, 169 Culture 1, 51, 128, 165 Currency boards see Exchange rates Currency-deposit ratio see Money Demand: curve 20–4; region 21–2; rigid 76 181 INDEX Deposit: deposit insurance 105; transferable deposits 110–11 Desirability 2, 7–8, 10, 16, 48, 73; (desirable outcomes and) competition 77–9, 82–4, 89–90; (desirable outcomes and) regulation 105–7; (desirable outcomes and) taxation 96–7, 102 Devaluations see Exchange rates Division of labour see Specialisation Dominant position, abuse of 81–2 Dynamics 134, 138, 141, 147–8; managed floating 140; monetary unions 134, 148, 151–2 Externalities 9–10, 49–50, 71–2 Extrapolation Economics 5, 16, 82, 170; institutional 8; law and Economies of scale 62, 123–4, 131 Education 101, 129–30, 162 Efficiency: allocative 98, 100; cost 55–7, 66, 76, 87; dynamic 58; production 38, 59, 87; social 79; static 58, 79, 88; taxation and 98–102, 106; trade and 125, 128 Elasticity 98–102 Employment 95, 100–1, 126, 152, 156, 167 Engineering 160–2 Entrepreneurship xiii, 47, 50, 88, 128, 130, 162, 169–70: entrepreneurs 41–2, 46–7, 74–5, 77, 85–6, 161 Equilibrium 21, 74, 122, 154; (equilibrium) price 69, 92–6, 98, 142–3 Exchange xiv, 1, 5, 9–13, 15–16, 48, 80: consumption and 18, 31; cost of 101, 109; money and 114–15, 120 Exchange rates 6: appreciations and depreciations 147; competitive depreciation 140–1; convertibility 150; currency boards 134, 148–52; devaluations and revaluations 135–7, 150–2; dirty floating 140; fixed 134, 138, 148–52; flexible Failures 2, 7, 9, 106, 154; institutional 9; market 7, 48; planning 49 Fairness 15, 48, 83–5, 102–3, 106 Firm 44–7, 50, 77 Flexibility 41, 58–9, 67, 130–1 Forward exchange rate see Market Free lunch 14–15, 169 Free market 7–8, 15–16, 31, 48, 51–2, 85, 89 Free riding 10, 72–3 Free trade 53, 125–7, 132 GDP 30–1, 155–8, 166 Gold parity see Standard Governance, corporate 45 Growth 43, 48, 51, 53, 154–61, 168–71: competition and 78, 86; international trade and 124–5, 132 Happiness 2, 29–30, 32–3, 36–7, 119–20, 156–7 Illusions 167–8 Industry 67–8 Infant industries 125 Inflation 27, 120, 122, 136–7, 149 Information 1, 6, 105, 143, 156–8, 165–7: and competition 74; and consumption 21, 24–5, 33; and costs 57; and production 40, 42–3 Innovation 15, 126, 158–62: competition and 80, 88, 124, 132; product 24, 124; production and 47, 49, 74–5, 152 Institutions 70–1, 130–3, 159, 161, 171: change 152; context 10, 41, 43, 107, 129, 132, 161–5 182 INDEX Interest groups 87, 90, 106–7, 161 Interest rate see Rate of interest Non-profit organizations 51 Oligopoly 80 Owners 15, 101, 110, 126: and competition 77, 82–5; and production 44–9, 51–2, 57, 59, 72; and rent-seeking 87–8 Judiciary 3, 9, 81, 107, 129; growth and the judiciary 45–7, 53, 155, 162 Justice, social Labour 94; labour market 100 Legal tender see Money Liberalisation 89 Licenses 58, 75, 80–1, 87, 123 Loss: deadweight 97–9; welfare 97 Macro-economics Managers 45–6, 77 Mark-up 63, 75–6, 86, 100 Market: forward 142–8; spot 141–8 Market power 18, 89, 129 Market value 30–1, 35, 42, 92, 155 Measurement 154 Mercantilism 123, 125 Methodological individualism 3–5, 16–17 Micro-economics 3–4 Monetary cooperation 149 Monetary policy 7, 26–8, 53, 119–20, 122, 141, 143, 148–53 Monetary unions see Exchange rates Money: banknotes 110–11, 114–19, 149; basic 112–16; cheque 111, 116; in circulation 115, 121–2; commodity 109–13, 117–19; currency-deposit ratio 112–13; debasement 110; fiat 117–21; legal tender 117–18; paper 111, 117–20, 138; reserve ratio 112–15, 117, 120–1; supply 114–17, 119, 138 Monopoly 75–7, 79–82: legal monopoly 101–2; (monopoly) power 117–18, 129 Multiplier: credit 112–13, 119, 121; money 114–15, 117, 121 Paternalism 83 Planning 49–50, 66, 170 Policy-making 2–3, 5, 16, 28, 105 Pollution 96, 102 Poverty 11, 47, 51, 154, 165, 170 Price: caps 80, 105; discrimination 76–7; elasticity 25, 98 Price maker 18, 105 Price taker 18–19, 67, 75–6 Pricing 74; fair pricing 81, 89 Privileges 81, 86–9, 106–7, 126–7 Procurement, public 107 Production 43; function 38–41; production-possibility frontier 52–3, 87 Productivity 12, 40–2, 51, 152–3, 167; average 40; growth and 155; marginal 40; total factor 42 Profit 13, 31, 45, 84–6; competition and 75–7, 81; exchange rates and 147; fair 84; rightful 84 Property rights 7, 10–11, 48, 72, 161 Protection 75: protectionism 123, 125–7, 133 Purchasing power 11, 85, 124; consumption and 27, 31–6; exchange rates and 134, 136, 141; growth and 155–8; money and 114, 118–21; production and 51; taxation and 97, 99–100, 104 Rate of interest 27–8, 83, 112–13, 121–2, 144–8, 169 Rate of time preference 26–8, 36, 121 183 INDEX Recovery 167 Redistribution Regulation 7, 15–16, 46–53, 100–1, 104–8, 150: banking and 7, 113–14, 116–21; cost of 58–9, 66–7, 79–80, 83–4; deregulation 45; growth and 161–3, 165; price 30–1; trade and 125–6, 130–1, 133 Rents 77, 88: quasi-rents 86–7, 165; normative rents 86–7; rent-seeking 46, 49, 77, 87–90, 165 Reserve ratio see Money Revaluation see Exchange rates Revenues 76 Revolution: industrial 162, 170; scientific 162, 170; technological 160, 162 Risk 77, 117, 121, 131, 167–8, 171: aversion 59, 67, 145; entrepreneurial 15, 49, 80; exchange-rate 142, 144; taking 85–6, 113, 161 Safe-deposit box 112–13 Savings 25–6 Scarcity xiii, 2, 6, 12, 52 Science 159–60; scientific progress 159, 162, 170 Social choice Social security 94–5, 100–1 Sovereignty: consumer’s 75, 126; monetary 149, 151–3 Specialisation 11–12, 127–32; inter-sectoral 131; intra-industry 131 Speculators 148 Spot exchange rate see Market Standard: gold 110–11, 134, 136–7, 148, 151; gold parity 111, 135–6; living 156 Statics 5, 78 Subjectivism 12; subjective value 21, 29, 31, 33, 35 Supply curves 63–70 Surplus 13, 15, 18–19, 29–30, 35, 66: competition and 76, 79–81; marginal 29; taxation and 96, 99, 104 Tariffs 123 Tax: burden 92–5, 99–100, 102, 104; capitation 102; collection 91, 97; growth and 155, 165; income 95, 100–1; paying 91; progressive 101, 104, 130; proportional 103; regressive 103–4; retroactive 102; targeting 91, 104; trade and 125, 130, 133; value added tax (VAT) 92 Taxation 50, 73, 85, 90–1, 118 Technique 38–42, 55, 58 Technology 38–41: technological change 124; technological progress xiii, 159, 162, 169–70 TFP (total factor productivity) see Productivity Time 6; see also Rate of time preference Tolerance 159, 162 Trade: free 123; imbalances 137–8 Transfers 95, 97, 101 Typical agent: consumer 38; firm 38; individual 33 Uncertainty 6–7, 17, 59–60, 122, 131, 171 Unemployment see Employment Utilitarianism 3, 105 Utility 2, 12, 15, 32, 35, 56; marginal utility 19, 34, 94 Value 12; see also Market value Wages: wage rate 94, 150 Welfare 16, 30–1, 34–6, 49, 72–3, 155–7: social 82, 88; taxation and 96–7, 102, 106 184 ... buying a book, rather than going to the theatre, the opportunity cost of the book (X) is the pleasure Alicia would have enjoyed by going to the theatre (Y) Obviously, however, the notion of opportunity... between economics and policy-making pertains to the difference between the analysis of individual voluntary action (economics) and the study of the consequences of rule-making in the name of the. .. crucial, however, the future is not just the extension of the present, based on the information available at present The notion of time – and thus the difference between the present and the future –