Ebook Essentials of economics (7th edition): Part 2

(BQ) Part 2 book Essentials of economics has contents: Aggregate demand and the national economy, aggregate supply and growth, banking, money and interest rates, inflation and unemployment, macroeconomic policy, globalisation and international trade, balance of payments and exchange rates.

Part c Macroeconomics Aggregate demand and the national economy 200 Aggregate supply and growth 231 10 Banking, money and interest rates 260 11 Inflation and unemployment 292 12 Macroeconomic policy 327 chapter aggregate demand and the national economy We turn now to macroeconomics This will be the subject for this third part of the book and most of the final part In particular, we will be examining five key topics The first is national output What determines the size of national output? What causes it to grow? Why growth rates fluctuate? Why economies sometimes surge ahead and at other times languish in recession? The second is employment and unemployment What causes unemployment? If people who are unemployed want jobs, and if consumers want more goods and services, then why does our economy fail to provide a job for everyone who wants one? The third is the issue of inflation Why is it that the general level of prices always seems to rise, and only rarely fall? Why is inflation a problem? But why, if prices fall, might that be a bad thing too? Why countries’ central banks, such as the Bank of England, set targets for the rate of inflation? And why is that target positive (e.g per cent) rather than zero? The fourth issue is the financial system We look at the role that financial institutions play in modern economies In doing so, we analyse the financial crisis of the late 2000s, the initial responses of policy makers to limit the adverse impact on economies and the subsequent responses to try to prevent a similar crisis reoccurring The final topic, which is the subject of the final part of the book, concerns a country’s economic relationships with other countries We look at international trade and investment and at the flows of foreign currencies around the world In this chapter, after a preliminary look at the range of macroeconomic issues, we then focus on the first of these issues: national output In doing this we identify the key purchasers of goods and services in the economy and the ways in which these purchasers are connected We analyse the potential determinants of their spending and so the factors that can influence the aggregate level of expenditure in the economy after studying this chapter, you should be able to answer the following questions: • • • • • • • What are the key macroeconomic issues faced by all countries? Who are the key groups of purchasers whose demands determine the total level of spending on a country’s goods and services? What are the various flows of incomes around the economy? What causes these flows to expand or contract? How we measure national output? What factors influence the level of spending by firms, households and government? What determines the level of national output at any one time? What is the effect on national income of an increase in spending? 8.1  Introduction to Macroeconomics  201 8.1 Introduction to Macroeconomics What issues does macroeconomics tackle? The first half of the book was concerned with microeconomics We saw how it focuses on individual parts of the economy and with the demand and supply of particular goods and services and resources The issues addressed by macroeconomists, by contrast, relate in one way or another to the total level of spending in the economy (aggregate demand) or the total level of output (aggregate supply) Many of these issues are ones on which elections are won or lost Is the economy growing and, if so, how rapidly? How can we avoid, or get out of, recessions? What causes unemployment and how can the rate be got down? Why is inflation a problem and what can be done to keep it a modest levels? What will happen to interest rates and if they were to change what would be their economic impact? How big a problem is government debt? Are banks lending too much or too little? If there were agreement about the answers to these questions, macroeconomics would be simpler – but less interesting! As it is, macroeconomics is often characterised by lively debate Economists can take different views on the importance of macroeconomic issues, their causes and the appropriate policy responses They can also disagree about how to analyse macroeconomic phenomena and, therefore, the actual approach to take in modelling macroeconomic relationships We shall be looking at these different views throughout this third part of the book This is not to suggest that economists always disagree and we will also identify some general points of agreement, at least among the majority of economists Problems of prediction.  Another factor in addressing these questions is the difficulty of forecasting what will happen It is relatively easy to explain things once they have happened Predicting what is going to happen is another matter Few economists – or anyone else – foresaw the global banking crisis, credit crunch and subsequent economic downturn of the late 2000s Even those who thought banks had too little capacity to absorb losses and were making too many risky loans, could not predict exactly when a crisis would occur The role of expectations.  A crucial element in macroeconomic activity is people’s expectations If people are optimistic about the future, consumers may be more inclined to spend and firms more inclined to invest If they are pessimistic, spending may fall But what drives these expectations? Again, this is a topic of lively debate Politics.  Then there is the political context Governments may be unwilling to take unpopular measures, especially when an election looms So, should they give responsibility for decisions to other bodies? In many countries, interest rates are not set by the government but by the central bank In the UK, for example, it is the Bank of England that sets interest rates at the monthly meetings of the Monetary Policy Committee So just what are the macroeconomic issues that we will be studying in the following chapters? We can group them under the following headings: economic growth, unemployment, inflation and the economic relationships with the rest of the world, the financial well-being of individuals, businesses and other organisations, governments and nations, and the relationship between the financial system and the economy We will be studying other issues too, such as consumer behaviour, finance and taxation, but these still link to these major macroeconomic issues and, more generally, to how economies function Key macroeconomic issues Economic growth To measure how quickly an economy is growing we need a KI means of measuring the value of a nation’s output The mea- p sure we use is gross domestic product (GDP) However, to compare changes in output from one year to the next we must eliminate those changes in GDP which simply result from changes in prices When we have done so, we can then analyse rates of economic growth Governments hope to achieve a high rate of economic growth over the long term: in other words, growth that is sustained over the years and is not just a temporary phenomenon They also try to achieve stable growth, avoiding both recessions and excessive shortterm growth that cannot be sustained In practice, however, this can often prove difficult to achieve, as recent history has shown Figure 8.1 shows how growth rates have fluctuated over the years for four economies.1 As you can see, in all four cases there has been considerable volatility in their growth rates Therefore, while we observe most economies around the world growing over the long term, growth is highly variable in the short term with periods, like the late 2000s, Definitions Gross domestic product (GDP)  The value of output produced within a country, typically over a 12-month period Rate of economic growth  The percentage increase in output between two moments of time, typically over a 12-month period Note that EU-15 stands for the 15 member countries of the EU prior to May 2004: Austria, Belgium, Denmark, Germany, Greece, Finland, France, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and the UK 202 Chapter 8 Aggregate demand and the national economy Figure 8.1  Growth rates in selected industrial economies, 1965–2016 12 10 Annual % change in real GDP -2 -4 -6 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Notes: 2015 and 2016 based on forecasts; EU-15 = the member countries of the European Union prior to May 2004 Source: Based on data in AMECO Database (European Commission, DGECFIN) when economies experience negative rates of growth and so contract The fact that growth fluctuates in this way is fundamental to our understanding of economies The inherent instability of economies is our next threshold concept Key Idea 30 TC 12 Economies suffer from inherent instability As a result, economic growth and other macroeconomic indicators tend to fluctuate This is Threshold Concept 12 It is a threshold concept because it is vital to recognise the fundamental instability in market economies Analysing the ups and downs of the ‘business cycle’ occupies many macroeconomists Unemployment Reducing unemployment is another major macroeconomic aim of governments, not only for the sake of the unemployed themselves, but also because it represents a waste of human resources and because unemployment benefits are a drain on government revenues Unemployment in the 1980s and early 1990s was significantly higher than in the previous three decades Then, in the late 1990s and early 2000s, it fell in some countries, such as the UK and USA However, with the global economic crisis of that late 2000s many countries experienced rising rates of unemployment This was exacerbated in the early 2010s by attempts, particularly across Europe, to reduce levels of government borrowing which depressed rates of economic growth These patterns are illustrated in Figure 8.2, which shows unemployment rates (as a percentage of the labour force) for the same four economies In the UK, in recent years, there has been a move towards more flexible contracts, with many people’s wages not keeping up with inflation and many working fewer hours than they would like This has helped to reduce the rate of unemployment, but has created a problem of underemployment Inflation By inflation we mean a general rise in prices throughout the economy Government policy here is to keep inflation both low and stable One of the most important reasons for this is that it will aid the process of economic decision making For example, businesses will be able to set prices and wage rates, and make investment decisions with far more confidence We have become used to low inflation rates and in some countries, like Japan, periods of deflation, with a general fall in prices Even though inflation rates rose in many countries in 2008 and then again in 2010–11, figures remained much lower than in the past; in 1975, UK inflation reached over 23 per cent Figure 8.3 illustrates annual rates of consumer price inflation (annual percentage change in consumer prices) in the same four economies Definitions Underemployment  When people work fewer hours than they would like at their current wage rate Inflation rate (annual)  The percentage increase in prices over a 12-month period 8.1  Introduction to Macroeconomics  203 Figure 8.2  Standardised unemployment rates in selected industrial economies, 1965–2016 14 Unemployment (percentage of workforce) 12 10 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Notes: Figures from 2014 based on forecasts; EU-15 = the member countries of the European Union prior to May 2004 Source: Based on data in AMECO Database (European Commission, DGECFIN) Figure 8.3  Inflation rates in selected industrial economies, 1965–2016 25 Annual rate of inflation (%) 20 15 10 –5 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Notes: (i) Based on the annual rate of increase in private final consumption expenditure deflator; (ii) Figures from 2014 based on forecasts; (iii) EU-15 = the member countries of the European Union prior to May 2004 Source: Based on data in AMECO Database (European Commission, DGECFIN) 2015 204 Chapter 8 Aggregate demand and the national economy In most developed countries, governments have a particular target for the rate of inflation In the UK the target for the growth of consumer prices is per cent The Bank of England then adjusts interest rates to try to keep inflation on target (we see how this works in Chapter 12) The balance of payments A country’s balance of payments account records all transactions between the residents of that country and the rest of the world These transactions enter as either debit items or credit items The debit items include all payments to other countries: these include the country’s purchases of imports, the spending on investment it makes abroad and the interest and dividends paid to people abroad who have invested in the country The credit items include all receipts from other countries: from the sales of exports, from inward investment expenditure and from interest and dividends earned from abroad The sale of exports and any other receipts from abroad earn foreign currency The purchase of imports or any other payments abroad use up foreign currency If we start to spend more foreign currency than we earn, one of two things must happen Both are likely to be a problem The balance of payments will go into deficit.  In other words, there will be a shortfall of foreign currencies The government will therefore have to borrow money from abroad, or draw on its foreign currency reserves to make up the shortfall This is a problem because, if it goes on too long, overseas debts will mount, along with the interest that must be paid; and/or reserves will begin to run low The exchange rate will fall.  The exchange rate is the rate at which one currency exchanges for another For example, the exchange rate of the pound into the dollar might be £1 $1.50 If the government does nothing to correct the balance of payments deficit, then the exchange rate must fall, for example to $1.45 or $1.40, or lower (We will show just why this is so in Chapter 14.) A falling exchange rate is a problem because it pushes up the price of imports and may fuel inflation Also, if the exchange rate fluctuates, this can cause great uncertainty for traders and can damage international trade and economic growth and expenditure These are measured as so much per period of time Thus a person’s weekly wages would be an income flow; and spending, whether by cash, debit or credit card, would be an expenditure flow Tax receipts would be an income flow for governments; and money spent on imports would be an expenditure flow for a country There are three key accounts which are compiled for the main sectors of the economy: the household, corporate and government sectors and the economy as whole ■■ First, there is the income account which records the var- ious flows of income alongside the amounts either spent or saved Economic growth refers to the annual real growth in a country’s income flows (i.e after taking inflation into account) ■■ Secondly, there is the financial account The financial balance sheet gives a complete record of the stocks of financial assets (arising from saving) and financial liabilities (arising from borrowing) of a sector, and include things such as currency, bank deposits, loans, bonds and shares Changes in such balances over time (flows of new saving and borrowing) have been key in explaining the credit crunch and subsequent deep recession of the late 2000s/early 2010s ■■ Thirdly, there is the capital account which records the stock of non-financial (physical) wealth, arising from acquiring or disposing of physical assets, such as property and machinery Changes over time (inflows and outflows) in the capital balance sheets of the different sectors give important insights into relationships between the sectors of the economy and to possible growing tensions The national balance sheet is a measure of the wealth of a country It can be presented so as to show the contribution of each sector and/or the composition of wealth The balance of a sector’s or country’s stock of both financial and non-financial wealth is referred to as its net worth Figure 8.4 presents the national balance sheet for the UK since 1997 It shows the actual value (£) of the stock of net worth and its value relative to the value of output from domestic production over a 12-month period: i.e annual gross domestic product (see the appendix to this chapter for an analysis of the measurement of GDP) In 2014, the net worth of the UK was £8.1 trillion, equivalent to 4.4 times the Sector accounts KI 21 There are two main types of accounts used to show the p 148 financial position of individuals, businesses and other organisations, governments and nations The first type, known as a balance sheet, shows the stock of assets and liabilities An asset is something owned by or owed to you Thus money in your bank account is an asset A liability is a debt: i.e something you owe to someone else, such as outstanding balances on your credit card(s) At any given moment in time, we will be holding a certain amount of assets and liabilities The same applies to organisations, governments and countries The second type, known as an income and expenditure account or profit and loss account, shows flows of incomes Definitions Balance of payments account  A record of the country’s transactions with the rest of the world It shows the country’s payments to or deposits in other countries (debits) and its receipts or deposits from other countries (credits) It also shows the balance between these debits and credits under various headings Exchange rate  The rate at which one national currency exchanges for another The rate is expressed as the amount of one currency that is necessary to purchase one unit of another currency (e.g €1.25 £1) 8.1  Introduction to Macroeconomics  205 Figure 8.4  UK net worth 9000 500 8000 480 460 7000 440 6000 £ billions 400 4000 380 3000 360 2000 340 1000 Percentage of GDP 420 5000 320 1997 1999 2001 2003 2005 2007 2009 2011 2013 300 Source: Based on data from National Balance Sheet and Quarterly National Accounts (National Statistics) country’s annual GDP and equivalent to £125 000 per person The stock of net worth fell for two consecutive years – 2008 and 2009 – at the height of the financial crisis and the economic slowdown These various accounts are part of an interconnected story detailing the financial well-being of a country’s households, corporations and government To illustrate how, consider what would happen if, over a period of time, you were to spend more than the income you receive – a deficit on your income account To finance your excess spending you could perhaps draw on any financial wealth that you have accumulated through saving Alternatively, you might fund some of your spending through a loan from a financial institution, such as a bank Either way, your financial balance sheet will deteriorate Or you may dispose of some physical assets, such as property, causing the capital balance sheet to deteriorate But however your excess spending is financed, your net worth declines Key Idea 30  alance sheets affect peoples’ behaviour The size B and structure of governments’, institutions’ and individuals’ liabilities (and assets too) affect economic well-being and can have significant effects on behaviour and economic activity The importance of balance sheet effects in influencing behaviour and, hence, economic activity has been recognised increasingly by both economists and policy makers, especially since the financial crisis of 2007–9 Yet there remains considerable work to be done in understanding KI 31 their effects and so in devising the most appropriate policies p 205 Pause for thought Is the balance of payments account an income and expenditure account or a balance sheet? Financial stability A core aim of the government and the central bank is to ensure the stability of the financial system After all, financial markets and institutions are an integral part of economies Their well-being is crucial to the well-being of an economy Furthermore, because of the global interconnectedness of financial institutions and markets, problems can spread globally like a contagion The financial crisis of the late 2000s showed how financially distressed financial institutions can Definition Central bank  A country’s central bank is banker to the government and the banks as a whole (see Section 10.2) In most countries the central bank operates monetary policy by setting interest rates and influencing the supply of money The central bank in the UK is the Bank of England; in the eurozone it is the European Central Bank (ECB) and in the USA it is the Federal Reserve Bank (the ‘Fed’) 206 Chapter 8 Aggregate demand and the national economy cause serious economic upheaval on a global scale Therefore models of the macroeconomy need to incorporate financial markets and institutions and to capture the interaction between the financial system and the macroeconomy As we shall see in Chapter 10, a major part of the global response to the financial crisis has been to try to ensure that financial institutions are more financially resilient In particular, financial institutions should have more lossabsorbing capacity and therefore be better able to withstand ‘shocks’ and deteriorating macroeconomic conditions Government macroeconomic policy From the above issues we can identify a series of macroeconomic policy objectives that governments might typically pursue: ■■ High and stable economic growth ■■ Low unemployment ■■ Low inflation ■■ The avoidance of balance of payments deficits and ­excessive exchange rate fluctuations ■■ The avoidance of excessively financially-distressed ­sectors of the economy, including government ■■ A stable financial system Unfortunately, these policy objectives may conflict For ex- KI 29 ample, a policy designed to accelerate the rate of economic p 177 growth may result in a higher rate of inflation, a balance of payments deficit and excessive lending Governments are thus often faced with awkward policy choices, further demonstrating how societies face trade-offs between economic objectives (see Section 7.4) Recap Macroeconomics, like microeconomics, looks at issues such as output, employment and prices; but it looks at them in the context of the whole economy Among the macroeconomic goals that are generally of most concern to governments are economic growth, reducing unemployment, keeping inflation low and stable, avoiding balance of payments and exchange rate problems, avoiding excessively financially-distressed economic agents (i.e households, businesses and governments) and ensuring a stable financial system 8.2 The Circular Flow of Income Model How is spending related to income and who are the key groups of purchasers in the economy? One way in which the objectives are linked is through their relationship with aggregate demand (AD) This is the total spending on goods and services made within the country by four groups of people: consumers on goods and services (C), firms on investment (I), the government on goods, services and investment (such as education, health and new roads) (G) and people abroad on this country’s exports (X) From these four we have to subtract any imports (M) since aggregate demand refers only to spending on domestic firms Thus:2 AD = C + I + G + X - M To show how the objectives are related to aggregate de- TC p 12 mand, we can use a simple model of the economy This is the circular flow of income model and is shown in Figure 8.5 It is an extension of the model we looked at back in Chapter 1 (see Figure 1.5 on page 15) If we look at the left-hand side of the diagram we can identify two major groups: firms and households Each group has two roles Firms are producers of goods and services; they are also the employers of labour and other factors of production Households (which include all individuals) are the consumers of goods and services; they are also the An alternative way of specifying this is to focus on just the component of each that goes to domestic firms We use a subscript ‘d’ to refer to this component (i.e with the imported component subtracted) Thus AD = Cd + Id + Gd + X suppliers of labour and various other factors of production In the diagram there is an inner flow and various outer flows of incomes between these two groups Before we look at the various parts of the diagram, a word of warning Do not confuse money and income Money is a stock concept At any given time, there is a certain quantity of money in the economy (e.g £12 trillion) But that does not tell us the level of national income Income is a flow concept, measured as so much per period of time The relationship between money and income depends on how rapidly the money circulates: its ‘velocity of circulation’ (We will examine this concept in detail later on.) If there is £1 trillion of money in the economy and each £1 on average is paid out as income twice each year, then annual national income will be £2 trillion Definition Aggregate demand (AD)  Total spending on goods and services made in the economy It consists of four elements, consumer spending (C), investment (I), government spending (G) and the expenditure on exports (X), less any expenditure on foreign goods and services (M): AD = C + I + G + X - M 8.2 The Circular Flow of Income Model  207 Figure 8.5  The circular flow of income The inner flow, withdrawals and injections The inner flow Firms pay money to households in the form of wages and salaries, dividends on shares, interest and rent These payments are in return for the services of the factors of ­production – labour, capital and land – that are supplied by households Thus on the left-hand side of the diagram, money flows directly from firms to households as ‘factor payments’ Households, in turn, pay money to domestic firms when they consume domestically produced goods and services (Cd) This is shown on the right-hand side of the inner flow There is thus a circular flow of payments from firms to households to firms, and so on If households spend all their incomes on buying domestic goods and services, and if firms pay out all this income they receive as factor payments to domestic households, and if the velocity of circulation does not change, the flow will continue at the same level indefinitely The money just goes round and round at the same speed and incomes remain unchanged Pause for thought Would this argument still hold if prices rose? In the real world, of course, it is not as simple as this Not all income gets passed on round the inner flow; some is withdrawn At the same time, incomes are injected into the flow from outside To help understand this we need to recognise that there other groups of purchasers (i.e demanders) So far we have identified households and firms as two key groups in the economy If we introduce government into our model we have a third group While this increases the complexity of our model, it makes it more realistic and increases the ways in which the total spending on goods and services in the economy can be affected A fourth group in our economic model is overseas purchasers This group comprises the foreign equivalents of our three domestic groupings For instance, it includes French households and Japanese car manufacturers The final group in the model is financial institutions, such as banks and building societies, and they play a key role These institutions provide the link between those who wish to borrow and those who wish to save In other words, they are ‘intermediaries’, which allow some in the economy to save while others borrow For instance, they can provide firms with the access to the credit they need to fund investment projects, such as the purchase of new machinery Definition The consumption of domestically produced goods and services (Cd)  The direct flow of payments from households to firms for goods and services produced within the country 208 Chapter 8 Aggregate demand and the national economy Let’s now incorporate our additional purchasers and the financial system into our model We begin by focusing on the withdrawals from and injections into the inner flow Withdrawals (W) Only part of the incomes received by households will be spent on the goods and services of domestic firms The remainder will be withdrawn from the inner flow Likewise only part of the incomes generated by firms will be paid to UK households The remainder of this will also be withdrawn There are three forms of withdrawals (or ‘leakages’ as they are sometimes called) Net saving (S).  Saving is income that households choose not to spend but to put aside for the future Savings are normally deposited in financial institutions such as banks and building societies This is shown in the bottom centre of the diagram Money flows from households to ‘banks, etc’ What we are seeking to measure here, however, is the net flow from households to the banking sector We therefore have to subtract from saving any borrowing or drawing on past savings by households to arrive at the net saving flow Of course, if household borrowing exceeded saving, the net flow would be in the other direction: it would be negative Net taxes (T).  When people pay taxes (to either central or local government), this represents a withdrawal of money from the inner flow in much the same way as saving: only in this case, people have no choice! Some taxes, such as income tax and employees’ national insurance contributions, are paid out of household incomes Others, such as VAT and excise duties, are paid out of consumer expenditure Others, such as corporation tax, are paid out of firms’ incomes before being received by households as dividends on shares (For simplicity, however, taxes are shown in ­Figure 8.5 as leaving the circular flow at just one point It does not affect the argument.) When, however, people receive benefits from the government, such as unemployment benefits, child benefit and pensions, the money flows the other way Benefits are thus equivalent to a ‘negative tax’ These benefits are known as transfer payments They transfer money from one group of people (taxpayers) to others (the recipients) In the model, ‘net taxes’ (T) represent the net flow to the government from households and firms It consists of total taxes minus benefits Import expenditure (M).  Not all household consumption (C) is of totally home-produced goods (C d) Households spend some of their incomes on imported goods and services, or on goods and services using imported components Although the money that consumers spend on such goods initially flows to domestic retailers, it will eventually find its way abroad, either when the retailers or wholesalers themselves import them, or when domestic manufacturers purchase imported inputs to make their products This expenditure on imports constitutes the third withdrawal from the inner flow This money flows abroad As we shall see, households are not the only group to purchase imported goods and services or goods and services using imported components: firms and government too These expenditures also contribute towards the sum of import expenditures (M) and affect the level of aggregate demand Total withdrawals are simply the sum of net saving, net taxes and the expenditure on imports: W=S+T+M Injections (J) Only part of the demand for firms’ output arises from consumers’ expenditure The remainder comes from other sources outside the inner flow These additional components of aggregate demand are known as injections (J) There are three types of injection Investment on domestically produced goods (Id ).  This is firms’ spending on domestically produced goods and services after obtaining the money from various financial institutions – either past savings or loans, or through a new issue of shares They may invest in plant and equipment or may simply spend the money on building up stocks of inputs, semi-­finished or finished goods Not all of the investment expenditure (I) undertaken by domestic firms is on totally home-produced goods Investment expenditure on goods and services produced overseas contributes towards import expenditure (M) Government expenditure on domestically produced goods and services (Gd ).  When the government (both central and local) spends money on goods and services produced by domestic firms, this counts as an injection (Note that government expenditure in this model does not include state benefits These transfer payments, as we saw above, are the equivalent of negative taxes and have the effect of reducing the T component of withdrawals.) As well as providing goods and services by purchasing from firms, governments can actually own and run operations themselves In these cases, the wages of publicsector staff will also be a component of the government’s expenditure and are a flow of factor payments to households Definitions Withdrawals (W) (or leakages)  Incomes of households or firms that are not passed on round the inner flow Withdrawals equal net saving (S) plus net taxes (T) plus import expenditure (M): W = S + T + M Transfer payments  Moneys transferred from one person or group to another (e.g from the government to individuals) without production taking place Injections (J)  Expenditure on the production of domestic firms coming from outside the inner flow of the circular flow of income Injections equal investment (Id) plus government expenditure (Gd) plus expenditure on exports (X) Index  I:7 change in demand 37 change in supply 37 monopoly 110 output and 37–9, 110 equity 167, 176, 183 established monopoly 110 Euribor 276 euro 274, 334, 386 birth of 416 currency turmoil 411–12 future 419 origins 413–15 Euro-firms 385 Euro-zone 265, 273 austerity measures 344, 365, 417 currency turmoil 411–12 European Stability Mechanism 335 IMF support 365 monetary policy 338, 343–4, 348 optimal currency area 418 structural deficits 419 European Central Bank 265, 272, 273, 276, 415, 417 actions due to financial crisis 344 exchange rates 411–12 fiscal policy and 335 independence 343–4 monetary policy and 338, 342, 343–4 Outright Monetary Transactions 344 quantitative easing 344, 366, 412, 419 Securities Market Programme 419 structure 343 European Coal and Steel Community 383 European Court of Justice 335 European Economic Community (EEC) 382–3 see also European Union European Financial Stabilisation Mechanism 365 European Financial Stability Facility 365 European Stability Mechanism 335, 365 European System of Central Banks (ESCB) 343, 415 European Union 379, 382–6 CAP 69, 70–1, 384 common economic policies 383–4 competition policy 180–1 Emissions Trading Scheme 189, 190–1, 192–3 EMU 334, 416–19 fiscal policy 418, 419 monetary policy 418, 419 single currency 415 Fiscal Compact 335, 339, 418, 419 fiscal stimulus plan 335 future 386 inflation 293 membership 383 new member states (effect) 385–6 R&D funding 355 recession 335 single market 88–9, 354 benefits and costs 384–5 features 383 Stability and Growth Pact 335, 418, 419 structural deficits 335 trade 371 underemployment 321–2 unemployment 304, 305, 307 evaluation, money as means of 261 excess capacity under monopolistic competition 117 excess demand 236–7 exchange controls 278, 354, 412 exchange equalisation account 275 exchange market, forward 410 exchange rate index 402, 403 exchange rate mechanism (ERM) 414–15, 414 features of 414 in practice 414–15 exchange rates 204, 401–5 adjustable peg system 413, 414 automatic correction 408 balance of payments and 204, 405–7 Bank of England 274, 275, 409 China 393 currency turmoil 411–12 demand and supply of currencies 289 determination in free market 404–5 effective 402 EMU 380, 415, 416, 418 expenditure on imports 217–18 and exports 218 fixed 380, 407–8 floating 404–5, 404 free-floating 408–12 import-substituting industrialisation 390, 391 and interest rates 303 managed floating 413–14, 413 nominal 403 in practice 412–13 real 403 speculation and expectation 286, 345 unstable 409 exchange-rate transmission mechanism 288, 289, 302 Exchequer 274 excise duties 72, 159 exit, costless 112–13 exogenous money supply 284, 285 exogenous variable 303 expansionary fiscal policy 328, 332, 409 expectations future income 240 future price changes 30, 36, 212, 240 inflation and 297, 314, 316–19 and investment 212, 216–17 Keynesian analysis 318–19 rational 299, 318–19 role 201 share prices 43 speculation and 61–3, 286 expectations-augmented Phillips curve 316 accelerationist theory 316–17, 317 equilibrium rate of unemployment 316 expected value 65 expenditure export see export expenditure government see government expenditure and income approach to national income 220, 222 investment see investment expenditure national 220 total consumer 54–5, 54 expenditure method of calculating GDP 225 expert advice (bank role) 263 explicit costs 77 exploitation of foreign workers 375 export expenditure 206, 209 calculation of GDP 225 export-orientated industrialization, strategy 394 exports 302, 303 and aggregate demand 218 balance of payments and 398 gains from trade 370 manufactured 387, 391–4 and money supply 284 primary commodities 374, 387–8 world 2011 363 world - growth in 363–6 see also developing countries (trade) external benefits 168 of consumption 170, 172 of production 169–70 external costs 168 of consumption 170 exporting primary commodities 388 of production 168–9 I:8 Index external diseconomies of scale 85 external economies of scale 85, 381 externalities 167, 168–72, 168, 374 direct provision 184 environment and 187–8 health care 176 large positive 184 taxes and subsidies to correct 178 factor markets 14, 15 interdependence with goods markets 20 labour 138–46 factor payments 207 factor prices 86 factors of production (resources) circular flow of goods and incomes 14 free movement in common markets 380 immobility 176 increases in productivity 248 increases in quantity 248 least-cost combination 86 ownership/control 109 quality 86, 87 fallacy of composition 267 family-friendly policies 153 Federal Open Market Committee 346 Federal Reserve Bank 272, 273, 281, 338, 346, 347, 411–12, 419 female participation rates 140 final expenditure 328, 329 final income 147 finance availability 215 and trade 244–5 financial accelerator 240 financial account 204, 209 balance of payments 398, 400, 409 Financial Conduct Authority 275 financial crisis 2008/09 244, 283, 321–2, 335, 337, 339, 347, 364, 412, 417 Bank of England response 276 ECB actions 344 fiscal policy 332–3 impact on public finances 22 open-market operations 341 financial crowding out 331, 339 financial economies 84–5 financial instability hypothesis 240, 282–3 financial institutions circular flow of income 207 nationalisation 354 financial instruments 263 financial interdependence, globalisation and 363–6 financial intermediaries 263 financial intermediation 263 Financial Services Authority (FSA) 275 financial stability 205–6 Financial Stability Board 365 financial system 262–77 Bank of England in 272–5 banks (key role) 262–8 central bank 272–5 household consumption and 211–12 liquidity and profitability 268–72 money market (role) 275–7 secondary marketing 270–1, 270, 272–3 securitisation 266, 270–1, 270, 272–3 Financial Times Stock Exchange index 42 financialisation 244 fine tuning 339 firms circular flow of goods and incomes 14 circular flow of income 206–10 costs 76–89, 109 degree of competition 101–2 different tax rates/subsidies 179 economies of scale 84–5, 84 in EU single market 383 inefficient, protection and 376 interdependence (in oligopoly) 118 monopolistic competition 114–15 perfect competition 102–8 price discrimination 131–4, 131 as price takers 101 profit-maximising level of employment 139 revenue 89–92 first-degree price discrimination 132 first-mover advantage 131 Fiscal Compact 335, 339, 418, 419 fiscal consolidation 332–3, 337 fiscal indicators, comparison of various countries 1998-2011 22 fiscal policy 8, 9, 243, 328–38, 328 approach (in UK) 336–7 Charter for Budget Responsibility 337 Coalition government 337 Conservative government 337 deficits and surpluses 328–9 deflationary 328, 408 demand-side policy 348–50 discretionary 330–8, 330, 336 effectiveness 331–5 EMU 418, 419 expansionary 328, 332, 409 financial crisis 2008/09 332–3 fiscal mandate 333, 337, 339 functions 328 golden rule 336–7 Labour government 336–7 magnitude problems 331, 334 pure 331 structural reform 422 timing problem 334–5 use of 330 fiscal rules 336–7 fiscal stance 328 fixed assets, in national accounts 249 fixed costs 79 average 79, 80 total 79, 80 fixed exchange rates 380 advantages 407–8 disadvantages 408 floating exchange rate versus 407–13 over long term 406–7 fixed factor 76, 77 fixed term contracts 141 floating exchange rate 404–5, 404 advantages 408–9 disavantages 409–12 fixed exchange rate versus 407–13 floors to business cycles 243 fluctuations in actual growth 238 markets (risk spreading) 374 football television broadcasts - BT 113 television broadcasts - Sky’s monopoly - breaking 112–13 forecasting effect of change in tax 331 effect of changes in government expenditure 331 multiplier effect on national income 331 problems of 201 rational expectations 299, 318 foreign competition 186 foreign currency loans 406 foreign direct investment 378 into China 392–3 foreign exchange, ISI 390 foreign exchange dealing 404, 406, 407 foreign exchange market 276, 406, 410 Bank of England intervention 274, 275, 400, 406 equilibrium 289 see also exchange rates foreign markets, access to 387 foreign-based monopoly 374 forward exchange market 410 foundation trusts 353 Index  I:9 France 414, 415 unemployment 305, 307 free trade capital movement and 354 restrictions 373–7 world trading system 377–9 free trade areas 377, 380 free-market economy 15–16, 15, 17–21, 320 advantages of 46, 186 changes in demand and supply 18–21 competitive markets 21 decision-making by individuals 17 exchange rate determination 404–5 interdependence of markets 20–1 price mechanism 18–20, 18 problems with 46 free-rider problem 172 freedom of entry 101, 102–3, 106–7, 114 individual (lack) 186 of movement 380 frequency of payment, demand for money and 286 frictional (search) unemployment 278, 309–10, 309 Friedman, Milton 302, 316 full-employment level of national income 298 functional distribution of income 147, 150–4 funding 342 funds, expertise in channelling (banks) 263 future price 66 futures markets 66 gambling 65–6 game theory 127–31, 127 complex games no dominant strategy 128 repeated games 128–31 simple dominant strategy games 127–8 game tree 130 GDP deflator 232, 293, 294 gender distribution of wages/salaries 152–3 female participation labour rates 140 unemployment rates 306 General Agreement on Tariffs and Trade (GATT) 377 Doha Round 378, 379 Uruguay Round 379 general equilibrium 167–8, 168 general government debt 334 deficits/surpluses 328, 329 Germany 414, 415 exports 367 unemployment 305, 307 gilt repos 265, 274, 276, 340, 341 gilts see government bonds (gilts) Gini coefficient 149–50, 149, 158 ’glass ceiling’ 153 global interdependence 244–5 global policy responses 366 globalisation 340, 353, 378 financial interdependence 363–6 interdependence through trade 363–6 unemployment and 308 golden rule of fiscal policy 336–7 Goodhart’s law 349 goods circular flow of incomes and 14 direct provision 184 domestically produced 206, 207 free movement 380 importation of harmful 374 indirect taxes on 72 with little dynamic potential 374 taxes on 72, 159 goods in joint supply 35 goods markets 14, 15 general equilibrium 168 interdependence with factor markets 20 money market and (links) 288–9 Gorbachev, Mikhail 18 government Bank of England as banker to 274 budget deficit 201, 209, 328 budget surplus 209, 328 in common market 380 economists’ role in advising 177 exchange rate policy 275 fiscal policy see fiscal policy investment expenditure 336 monetary policy see monetary policy support, inequality and 155 government assistance, regional and urban policy 355–6 government bonds (gilts) 23, 265, 268, 276, 328, 329 open market operations 339, 342 PSNCR 284 government borrowing 274, 284, 339, 342, 406 government expenditure aggregate demand 215–16 calculating GDP 225 capital 215 circular flow of income 206, 207, 208–9 comparison of various countries 352 cuts 351, 422 funding research and development 354–5 goods and services 215 on investment 336 and national income 215–16 predicting effect of changes 331 see also fiscal policy; public sector government intervention advantages of free market 186 allocative role 21 assistance to small firms 355 change in property rights 183 controlled prices 68–71 direct provision of goods/services 184, 354 discretionary fiscal policy 330–8, 330 distributive role 21–2, 21 drawbacks 185–6 in economy 15, 16 exchange rates and balance of payments 406–7 indirect taxes 72 laws and regulations 180–2 macroeconomic role 22–3, 22 market failures 23 mixed market economy 21–3 nationalisation and privatisation 184–5 objectives 167 optimum level 186–7 provision of information 183–4, 186, 357 regulatory role 22 sovereign debt crisis 2010s 22–3 supply-side policies 351–7 support, inequality and 155 taxes and subsidies 178–80 trade restrictions 373–7 see also interventionist policies government motivation, demand-side policy 348 government policy changes 186, 243 exchange rates and 407–8, 409, 412 irresponsible 407–8, 412 supply and 35 see also fiscal policy; monetary policy Great Depression 377 Greece 365 bailout 23, 322 unemployment 322 green taxes 178, 179, 188–91, 189, 190–1 revenues as percentage of GDP (OECD) 190 I:10 Index gross domestic final expenditure 216 gross domestic product (GDP) 201, 223, 224, 232, 234–5 at market prices 224 deflator 232 measurement of 223–7 nominal 227, 228 real 227, 228 gross income 147 gross national income (GNY) 225–6, 225 gross value added (GVA) at basic prices 223, 224–5 group behaviour 243 Group of Seven (G7) 366 Group of Twenty (G20) 365, 366 groupthink 48 Halifax Bank of Scotland 64 harmful goods 374 health 386, 387 health care 160, 353 provision (market failure) 176–7 heavily indebted poor countries (HIPC) initiative 422–3 herding 48 heuristics 47 high-powered money (monetary base) 278 hire-purchase controls 340 historic costs 79 home ownership 39–41 homogenous products 101, 103 horizontal integration 125 hours worked 155, 351, 352 house prices determinants 40–1 global dimension 41 inflation 39–40 household balance sheets 212, 213–15 household consumption 239–40 age of durables 212 aggregate demand and 211–12 consumption smoothing 211 and debt repayment 214 disposable income 211 expectations of future prices 212 expected future income 211 financial system and 211–12 household wealth and 212 marginal propensity to consume 211 tastes and attitudes 212 household income, sources 150, 151 households circular flow of goods and incomes 14 circular flow of income 206–10 composition, income inequality and 150, 155 number of 40 secured debt 215 unsecured debt 213–14 households’ disposable income 226–7, 226 housing equity withdrawal 215 housing market 39–41, 63 volatility 215 housing wealth 215 human capital 251, 256–7, 386–7 estimates of 256 inequality and 256–7 measurement 256 human rights 375 human wants 5, 14 hysteresis 320–1, 320, 322 IBOR 276 Iceland 365–6 ignorance 174–5, 176–7, 184, 188 immediate run 59, 87 immobility of factors 176 imperfect competition 102, 114 labour markets 143–6 see also monopolistic competition; oligopoly imperfect information 174, 310, 318 see also asymmetric information imperfect labour markets 143–6 implicit costs 77–9, 77 import expenditure 208, 209 calculation of GDP 225 import-substituting industrialisation (ISI) 387, 389–91 adverse effects 390–1 comparative advantage 390 costs 394 domestic market 391 environment 390–1 exchange rates 390, 391 income distribution 390 interest rates 390 monopolies 390 wages 390 imports 302, 303 and aggregate demand 216–18 balance of payments and 398 determinants of expenditure on 217–18 growth in 388 morality of buying cheap 375 restrictions 373–6, 407 within EU 383 see also trade incentives 17, 20 disincentives 161–3 government intervention and 185 investment, tax cuts and 351 principal-agent problem 175 taxation and 159–60 income circular flow of goods and 14 circular flow of see circular flow of income commodity prices and 44 defining 206 demand and 30 disposable 147 exchange rate and 405 expectations of future 240 expenditure approach to national income 220, 222 final 147 gross 147 house prices and 40 household disposable 226–7, 226 income elasticity of demand and 59–60, 59 national see national income original 147 post-tax 147 proportion spent on goods 53–4 sources of household (UK) 150, 151 stock market prices and 43 thresholds (benefits) 162 see also benefits/subsidies; wages income account 204 income distribution 212 by class of recipient 147 by occupation 150–4 by sex 152–3 by source 150 demand and 30 functional 147, 150–4 import-substituting industrialisation 390 inequality 147, 150–5 manufactured exports and 393–4 primary exports and 388 size 147 measuring 148–50 UK 147–8 income effect 29, 53–4, 352 income effect of a tax rise 160 income elasticity of demand 59–60, 59 formula 59 for primary products 374, 388 income, expected future, household consumption and 211 income and expenditure account 204 income flows (balance of payments) 399 income method of calculating GDP 223–5 Index  I:11 income redistribution 159–63 benefits 161 government intervention 167 poverty trap 161, 163 taxation 159–60, 161, 163 income tax cuts 159 negative 163 increasing opportunity costs 13 increasing returns to scale 83 independence Bank of England 273, 323 central banks 273, 323, 338 of firms in a market 114 Independent Commission on Banking 262 independent risks 68 India 295 indirect tax 72 individual voluntary arrangements (IVAs) 212 indivisibilities 84 industrial action 144, 145, 352–3 industrial policy, interventionist 354–7 industrialisation 18 export-oriented (strategy) 394 inward-looking/outward-looking 391 see also import-substituting industrialisation (ISI) industry central planning and 18 equilibrium under perfect competition 103–8, 109 infrastructure 85 size of, economies of scale and 85 inefficiency 186, 376 see also efficiency inelastic demand 53, 55–8 for loans 345 inequality assessing extent of 147–54 causes 155 distribution of wealth 154–5 and economic growth 158 gender pay gap 152–3 Gini coefficient 149–50, 149, 158 growth 1980’s and 1990’s 148 human capital and 256–7 income distribution 147 Lorenz curve 148–9, 148 macroeconomic implications 158 measuring size distribution of income 148–50 trade may lead to 388 types of 147–8 in UK 150–5 infant industry 373–4, 373, 376, 390 inferior goods 30, 60 infinitely elastic demand 55, 57 inflation 6, 13, 293–7 aggregate demand and output 297–301 causes 293–7 cost-push 294, 296–7, 314, 352 demand-pull 293–4, 293, 296, 299, 313 expectations 297, 314, 316–19 and change in money supply 301–4 comparison of GDP 227, 228 control 338, 339–40 ECB target 338 EMU 415, 416, 417 exchange rate and 403, 405, 407, 408, 412 expectations 297, 314, 316–19, 350 Keynesian analysis of business cycle 239–44 Keynesian analysis of unemployment and 312, 313, 318–19 macroeconomic aims/issues 201, 202–4, 209 output gaps and 314 price levels 293 rate 6, 202–4, 202 rates (various countries) 293 supply-side policies and 351 targeting 322–4 unemployment and 312–19 unemployment at same time 313 inflation targeting 315, 338, 339–40, 348, 349, 350 unemployment and 319–24 inflationary gap 299, 312, 313 information asymmetric 96, 175, 177 and decision-making 3–4 imperfect 174, 310, 318 lack of, and profit maximisation 95–6 lack of, taxes/subsidies and 179 market 174–5 perfect 103, 107 poor, government intervention and 186 provision (by government) 183–4, 186, 357 technology 413 infrastructure 354, 387 inheritance 154 injections 208–9, 208 multiplier 221–3 withdrawals approach to national income 219–20, 221–2, 349 withdrawals and (relationship) 208, 209 inner flow 207–8 innovation 109, 111, 286, 354–5 input-output analysis 16–17, 16 insider power 309 insurance 67–8 adverse selection 67 asymmetric information 67 moral hazard 67 pooling risks 68 screening 67 intellectual property rights 352 inter-bank lending 265–7, 268, 269, 281, 284 inter-bank market 276, 341 rate 276–7 inter-bank rates 341 inter-generational problems, environment and 188 inter-temporal substitution effect 232 interdependence financial 363–6 of firms (under oligopoly) 118 global 244–5 of markets 20–1, 300 public interest and 21 through trade 363–6 interest rates 201 Bank of England 273, 274, 276, 322, 324, 341, 346, 347 Bank Rate 338 demand for money and 286–8, 289 EMU 415, 416, 418 equilibrium 338, 341, 342 examples 288 exchange rate and 405, 406, 408, 409 and exchange rates 303 import-substituting industrialisation 390 and investment 215 monetary policy 338, 339, 340, 342–8 money supply and 284–5, 287–8, 289, 302–3 problems of high 345 interest-rate transmission mechanism 288, 289, 302 internal economies of scale 381 internal market, completing (EU) 385 Internal Market Scoreboard 385 international business cycle 245, 366 international co-operation 366 International Labour Organization (ILO) 306 I:12 Index international liquidity 408, 409 International Monetary Fund 365, 366, 406 European Financial Stabilisation Mechanism 365 HIPC initiative 422–3 rescue packages 364–5 resources 365, 366 role 365, 366 structural adjustment programmes 421, 422 international substitution effect 232 international trade green taxes and 191 see also globalisation; trade international trade multiplier 363 Internet 106–7 interventionist policies supply-side 351, 354–7 Third Way 356 Welfare to Work 356 Work Programme 356 investment 13 and aggregate demand 212, 215 availability of finance 215 by banks 268 China 392–3 circular flow of income and 206, 208, 209 consumer demand 212 determinants 212, 215 in EU 385 expectations 212 financial account direct 400 portfolio 400 incentives (tax cuts) 351, 352 increased inward (EMU) 416, 417 induced 331 instability 240–1, 242 interest rates and 215, 302–3 manufactured exports 392–3 money and prices 301, 302 multiplier 221–3 national income and 242, 248 overseas, exchange rate and 405 social rate of return 354 supply-side policies 354 see also foreign direct investment investment banks 262 investment expenditure 206, 209 calculation of GDP 225 government 336 investment income 150 investors, uncertainty for 410 Ireland, bailout 23, 365 Italy 307, 414 Japan deflation 295 inflation 293 liquidity trap 347 quantitative easing 366 unemployment 304 Jobseeker’s Agreement 353 Jobseekers Allowance 353, 356 justice, social 184 Keynes, J.M Keynesian economics analysis of business cycle 239–44 analysis of unemployment and inflation 312, 313, 318–19 demand-side policy 313, 349–50 equilibrium level of national income 218–21 Keynesian diagram 219 on long run AS curve 301, 302 on money and prices 297, 298, 302, 303 rules and discretion 349–50 on short run AS curve 298 kinked demand curve 124 kinked demand theory 124 knowledge see information Kyoto Treaty 189, 192 labour demand for see demand for labour division of 84 legislation 156–7 marginal cost of 139, 143 market demand, elasticity of 142 reducing power of 352–3 labour force 305 Labour government golden rule 336–7 Third Way 356 labour market flexibility 320, 321 imperfect 143–6 perfect 138–42 trends 140 unemployment and 307–8 wage determination see wages labour mobility 139, 152, 380, 383, 385, 417–18 labour productivity 139–42, 144, 145–6, 152 international comparisons 252–3 measurement 252 total 252 labour supply 138–9 effect of tax cuts 351 elasticity of 138–9 growth 140, 309 supply-side policies 351 wage determination and 138–9, 143 labour turnover 146 Lancaster, K 33 land land use, and commodity prices 45 Latin American Integration Association (LAIA) 381 law of large numbers 68 leakages see withdrawals least-cost production method 86 legal protection 109 legal restrictions 180 legislation common markets 380 environment 189 labour 156–7 minimum wage 156–7 prohibiting undesirable structures and behaviour 180–2 regulation and 180–2 UK competition policy 181–2 Lehman Brothers 267 lender of last resort 276 liabilities 204 banks’ 263, 264–5, 264 LIBOR 265, 276, 277 liquidity 268, 271 Bank of England 274–7 banks 339 financial crisis 2008/09 276 international 408, 409 preference for 413 profitability and (banks) 268–72 liquidity coverage ratio 271 liquidity ratio 269 banks holding lower 281, 284 credit creation 278–81 simple (not operated) 280 varying 279 liquidity trap 347 Lloyds Banking Group 354 loans 262, 263, 265–7 balance between profitability and liquidity 268, 269 commercial bank (rescheduling) 421–2 inelastic demand for 345 inter-bank 265, 266, 268, 281–2 market 266 official (rescheduling) 421 see also credit Local Enterprise Partnerships 356 London money market 275–7 long run 76 aggregate supply curve 297, 300–1 decision-making 87 equilibrium of firm Index  I:13 monopolistic competition 115, 116 perfect competition 104–8, 116 market adjustment over time 61 money supply changes, aggregate demand and 303 price elasticity of supply 59 price and output 111 production 76 costs 83–9, 94 profit maximisation 93, 94 under perfect competition 104–8, 104 very long run 87 long-run average cost curves 85–7, 86 assumptions behind 86 in practice 87 short-run average cost curves and 86–7 long-run Phillips curve 317–18 long-run shut-down point 94 long-term output trend 238 longer-term loans 268 Lorenz curve 148–9, 148 loss minimisation 94, 95 lump-sum taxes (correcting for monopoly) 178–9 Maastricht Treaty EMU 334, 415, 416 Social Chapter 384 machinery efficiency of large 84 exit costs 112–13 macro-prudential regulation 271, 275, 283 macroeconomic issues 201–6 historical perspective UK indicators from 1900 macroeconomic objectives 176–7, 201–6, 209 macroeconomic policy common (in common market) 380 demand-side 348–50 irresponsible 407–8, 412 supply-side 351–7 see also fiscal policy; monetary policy macroeconomic role of government 22–3, 22 macroeconomics 6–7, circular flow of goods and incomes 14 production possibility curve 13–14 Malthus Thomas R 78 managed floating 413–14, 413 managers/management attitude to risk 97 profit maximisation 96 sales revenue maximisation 96 manufactured exports (developing countries) 387, 391–4 manufacturing employment 140 marginal benefits 10–11, 10 externalities 169–72 marginal consumer surplus 33 marginal cost curve, perfect competition and 104 marginal cost of labour 139, 143, 145 marginal costs 10–11, 10, 13, 79–80, 79 prices and (perfect competition) 105 profit maximisation 92–5 marginal physical product of labour (marginal productivity of labour) 139, 141, 152 marginal productivity theory 139–42, 139 marginal propensity to consume 211 marginal propensity to consume domestically produced goods 220 marginal propensity to save 393 marginal propensity to withdraw 221 marginal returns see diminishing returns marginal revenue 90–1, 90 profit maximisation 92–5 marginal revenue product of labour 139–41, 139, 143, 145 marginal social benefits 167, 168 externalities 169–72 marginal social costs 167, 168 externalities 168–72, 168 marginal utility 31–3, 31 demand curve and 31–3 and individual’s demand curve 32 market demand curve 32–3 measurement 31–2 principle of diminishing 31 marginals/averages (relationship) 81 mark-up pricing 96 market clearing 37 market demand for labour, elasticity of 142 market demand schedule 29 market failures 167 economists advising governments 177 environment and 187–8 externalities 167, 168–72, 168 government intervention 23, 178–87 health care provision 176–7 ignorance and uncertainty 174–5 immobility of factors/time-lags in response 176 macroeconomic goals 176–7 monopoly power 173–4 principal-agent problem 175–6 protecting people’s interests 175 public goods 172 social efficiency 167–8, 167 market loans 266 market power, abuse of EU legislation 181 UK legislation 181 market research 95 market-orientated supply-side policies 351–4 encouraging competition 353–4 reducing government expenditure 351 reducing power of labour 352–3 reducing welfare 353 tax cuts 351–2 markets 14 and adjustment over time 61–4 competitive 21 controlled prices 68–71 equilibrium 37–45 fluctuating (spreading risks) 374 information 174–5 interdependence of 20–1, 300 introduction into public sector 353 see also demand; prices; supply materials, free movement of 380 maturity gap 269, 270 maturity transformation 263 maximum price 69–70, 69 means-tested benefits 160 medical insurance (USA) 177 medium of exchange 261 merchandise balance 398 MerCoSur (Southern Common Market) 381 mergers 110, 381 EU legislation 181 UK policy 181–2 merit goods 175 Mexico 381, 421 microeconomics 6, 7–11 circular flow of goods and incomes 14 production possibility curve and 12–13 minimum efficient plant size (MEPS) 88 minimum efficient scale (MES) 88–9 minimum price 68–9, 68 agriculture and 68–9, 70–1 minimum reserve ratio 339, 341, 342 minimum wage legislation 156–7, 308 impact of 157 Minsky’s credit cycles 282–3 I:14 Index mixed economy 16 mixed market economy 16, 21–3 government intervention 21–3 sovereign debt crisis 2010s 22–3 mobility of labour 139, 152, 380, 383, 385, 417–18 modelling economic relationships 11–15 moderate position on short run AS curve 297–8 monetarists 302, 349 on long-run AS curve 297 on natural rate of unemployment 317 monetary base 278 monetary financial institutions 262 monetary policy 338–48 Bank of England 273, 274, 338, 341 deflationary 408 demand-side policy 348–50 EMU 418, 419 European Central Bank 415 inflation control 322–4, 338 monetary control 338–48 setting 338–9 structural reform 422 using 347–8 see also money supply Monetary Policy Committee 201, 274, 276, 324, 338, 341 monetary union see Economic and Monetary Union (EMU) money current transfers (balance of payments) 400 defining 206, 261 demand for see demand for money functions 261 international transfer of 409 quantity theory of 302 velocity of circulation 206 money illusion 226 money market 265, 338 discount and repo markets 275–6 equilibrium 287–8 goods market and (links) 288–9 London 275–7 parallel 276 role 275–7 money multiplier 280, 284 money national income 286 money supply 278–85 causes of rising 281–4 change in, aggregate demand and 288, 289, 301–4 change in, inflation and 301–4 control 318, 339–48 credit creation 278–81 exports and 284 interest rate and 284–5, 287–8, 289 lending patterns and 282–3 measurement/size 278 Minsky’s credit cycles 282–3 prices and 301–4 targets 412 techniques to control 340–8 monitoring 175 monopolistic competition 101, 102, 114–17 assumptions 114–15 equilibrium of firm 115–16 non-price competition 116 public interest and 116–17 monopoly 101, 102, 108–14 advantages of free market 186 barriers to entry 108–9 bilateral 144–5 concept 108 contestable markets 111–14 deadweight loss 173–4 effect on total surplus 174 equilibrium price and output 110 foreign-based 374 import-substituting industrialisation and 390 market failure 173–4 monopolistic competition and (comparison) 117 natural see natural monopoly perfect competition versus 110–11 taxes/subsidies to correct for 178–9 trade unions 144–5 monopoly power 108, 155, 173–4, 181, 296, 308, 353 in customs union 381 EU single market 385 of labour 352 multinational corporations 390 monopsony 143 power 143, 155, 374, 388 moral hazard 67, 273, 423 morale, wages and 146 mortgages 268–9, 303 as determinant of house prices 40–1 securitisation 266, 271, 273 sub-prime debt 271, 273 most favoured nations clause (WTO) 377 movement, freedom of 380 multi-stage production 84 Multilateral Debt Relief Initiative 423 multinational corporations 374, 390 multiplier 221–3, 221, 241 formula 221 international trade 363 predicting size of 331 multiplier effect 219 numerical illustration 222–3 Nash equilibrium 124, 127, 128 national balance sheet 204–5 national debt 335, 415 national expenditure 220 National Health Service 176, 353 Clinical Commissioning Groups 353 see also health care national income 30 deflationary gap 298–9, 298 equilibrium level of 218–21 expenditure on imports 217 expenditure and income approach 220, 222 finance and trade 244–5 full-employment level 298 government expenditure 215–16 gross (GNY) 225–6, 225 inflation and 227 inflationary gap 299, 312, 313 injections and withdrawals approach 219–20, 349 instability of investment 242 investment and 242, 248 measuring 223–7 money 286 predicting multiplier effect 331 steady-state 251 technological progress and 251, 254 national living wage (NLW) 157 National Loans Fund 274 national output aggregate demand and supply 232–4 changes in money supply 301–4 equilibrium level of national income 218–21 expanding aggregate demand 319, 323, 324 fluctuations in stocks 241 measuring 223–7 multiplier 221–3 potential 234, 236–7 supply-side policies 351–7 national sovereignty 385, 419 nationalisation 184–54, 354 natural events, commodity prices 45 natural level of unemployment 308 natural monopoly 108, 185 contestable markets and 111–12 increasing competition 182, 353 minimum efficient scale 88 Index  I:15 natural rate of unemployment 317 long run Phillips curve and 317 see also equilibrium (natural) unemployment nature, supply and 35–6 necessity of goods 60 needs 17 negative income tax 163 negative taxation 215 neo-classical growth model 248, 250–1, 254 neoclassical analysis 250 net errors and omissions item (in balance of payments) 400 net national income (NNY) 225 net stable funding ratio 271 net worth of country 204–5 UK 204–5 network economies 109 new classical economics 243, 297, 299, 349 on inflation and unemployment 318 on long-run AS curve 297, 300 on short run AS curve 299 on welfare benefits reduction 353 new Keynesians 297 new products 111 newly industrialised countries (NICs) 389–91 nominal GDP 227, 228 nominal value, compared with real value 227 non-accelerating-inflation rate of unemployment (NAIRU) 317, 320, 321 long-run Phillips curve and 317 see also equilibrium (natural) unemployment non-bank private sector 280, 284 non-collusive oligopoly 118, 122–4 assumptions about rivals’ behaviour 123–4 breakdown of collusion 122 game theory 127–31, 127 kinked demand curve 124 non-discrimination (WTO) 377 non-economic advantages (gains from trade) 372 non-economic arguments for trade restriction 375 non-excludability 172, 188 non-intervention 186–7 non-price competition 116, 119, 126 non-rivalry 172 non-tariff barriers 382, 384, 387 normal goods 30, 60 normal profit 93–4, 93, 142 North American Free Trade Association (NAFTA) 371, 381–2 Northern Bank 261 Northern Rock 267, 339, 354 number unemployed (economist’s definition) 305 occupations, wage distribution by 150–4 Ofcom 182 Office of Fair Trading 181 Office of Rail Regulation 182 Ofgem 182 OFWAT 182 oil prices 18, 45, 120–1, 233–4, 295, 296, 420 oligopolistic collusion 353 oligopoly 101, 102, 108, 117–26 advantages of free market 186 collusive 118–22, 118, 381 competition and collusion 118 consumer and 126 energy sector 125 factors favouring collusion 122–3 health care 177 key features 118 non-collusive see non-collusive oligopoly power (EU single market) 385 price fixing 180 tacit collusion 119, 122 timing (importance) 130–1 oligopsony 143 on-line commerce 106–7 OPEC 120–1 open-market operations 274, 339, 340, 341, 342, 344, 346 financial crisis 341 operational balances (banks) 265 opportunity cost 7, 10, 77 choice and 7–8, 12–13 increasing 13 normal profit 93–4, 93 production costs and 77 production possibility curve 12–13, 15 specialisation and trade 370–1 optimal currency area 418 opting in versus opting out 48 Organisation for Economic Co-operation and Development (OECD) 306, 348 organisational economies 84 output actual 236–7, 238 aggregate demand and 297–301, 298, 300 costs and 79–89 economic growth and 246–51 equilibrium 110–11 equilibrium price and 37–9 gap 236–7, 237 growth (actual/potential) 13–14 input-output analysis 16–17, 16 labour productivity 252–3 long-term (trends) 238 loss minimising 94 measuring national income and 223–7 monopoly 110–11, 173, 174 national see national output perfect competition 103–4, 110–11 potential 234, 236–7, 236, 351 price elasticity of supply 59 price variation and revenue 90–1 profit maximisation and 92–5, 134 socially efficent 173, 174 steady-state 251 technological progress and 251, 254 output gaps 313 inflation and 314 overdrafts 264, 268, 269 overheads 84 overseas central banks 274 overseas purchasers, circular flow of income 207 overtime 150, 155, 352 Oxfam 423 paradox of debt 283 parallel money markets 276 Paris Club 421, 422 part-time employment 140, 153, 155, 156, 321, 353 patents 109, 254, 352 paternity pay 153 patient ignorance 176–7 payments, transmission by banks 263 pensions, household income 150 per-unit subsidy 179 percentage measures 53 perfect competition 21, 101, 102–8 assumptions 102–3 benefits 105, 108 consumer/producer surplus and 173 e-commerce 106–7 equilibrium of firm 103–8 incompatibility with substantial economies of scale 105 in labour markets 138–42 marginal costs and prices 105 monopolistic competition and (comparison) 114, 116–17 monopoly versus 110–11 short-run supply curve 104 wages and profits under 142 I:16 Index perfect knowledge 103, 107 perfect labour markets 138–42 perfectly contestable markets 111 performance, structure and conduct 102 perks 390, 391 personal loans 268–9 persuasion (supply-side policy) 357 Phillips curve 313–15, 313, 316 expectations-augmented 316 horizontal 319–20, 349 leftward shift 323 long-run, equilibrium unemployment and 317–18 rightward shift 319, 320, 321, 323 physical capital 251 picketing 144 Pigouvian tax 178 planning command economy 16–17 limits of 18–19 plant economies of scale 84 pleasantness/unpleasantness of jobs 155 point elasticity 56 pollution 169, 178, 179, 183, 188–91, 193, 194 pooling risks 68 population growth 78 portfolio balance theory 303 portfolio investment 400 Portugal, bailout 23, 322 post-tax income 147 potential competition 111 potential growth 234 potential output 234, 236–7, 236 measuring - statistical estimates 237 supply-side policies 351 poverty developing countries 422, 423 minimum wages and relief of 157 see also inequality Poverty Reduction Strategy Paper 422 poverty trap 161, 163, 353 power countervailing 126, 186 differences, inequality and 155 insider 309 of labour (reducing) 352–3 monopoly 108, 155 monopsony 143, 155 trade unions 143–4 Pratten, C.F 88 precautionary effect 215 precautionary motive (demand for money) 286 predatory pricing 133 prediction see forecasting preferential trading arrangements 379 in practice 381–2 types of 380 see also trading blocs prejudice 153 price benchmarks 122 price cap regulation 182 price ceiling 69 price discrimination 131–4, 131 advantages to firm 133 consumer and 133 price elasticity of demand 52–8, 52, 142 consumer expenditure and 54–8 determinants 53–4 formula for 52 interpreting 53 marginal revenue and 91 measuring 52, 56 price elasticity of supply 58–9, 58 determinants 59 formula for 58 price fixing, oligopoly 180 price floor 68 price leadership 119, 122 price levels, inflation rates and 293 price maker 90–1, 90 price mechanism 18–20, 18 price takers 21, 90, 102 price-setting formulae 182 prices aggregate demand and supply 232–4 controlled 68–71, 186 declining - causes of 295 demand and 29–30 determination of 37–45 equilibrium see equilibrium price expectations, speculation and 61–3 expectations of future change 30, 36, 212, 240 future 66 inflation see inflation marginal costs and (perfect competition) 105 money supply and 301–4 monopoly 110 oligopoly 119, 122, 123–4 perfect competition 103, 105, 110–11 profit-maximising 134 retail price index 322 revenue curves and 90–1 rules of thumb 122 spot 66 stickiness 297, 408 pricing, uniform 131 primary exports 374 developing countries 387–8 income-elasticity of demand 388 justification for 387–8 problems (long term) 388–9 traditional trade theory 387–8 principal-agent problem 96, 175–6, 177 principle of diminishing marginal utility 31 prisoners’ dilemma 128, 129 Private Finance Initiative (PFI) 353–4 private sector, non-bank 280, 284 privatisation 182, 184–5, 353, 354 arguments for and against 185 procurement policies, common 380 producer sovereignty 374 producer surplus 94, 173–4, 173 see also supernormal profit producers, aims of 36 product attributes, preparedness to pay 33 product development 116 product differentiation 109, 115 and competition 126 product method (GDP calculation) 223 production 4, costs of 35 long-run 83–9, 94 measuring 77–9 price elasticity of supply 57 production decision 94–5 short-run 76–83, 94 external benefits 169–70 external costs 168–9 methods (technological unemployment) 311–12, 312 regulation in common markets 380 scale of see scale of production see also output production possibility curve 12–14, 12 macroeconomics and 13–14 microeconomics and 12–13 opportunity costs 12–13, 15 productive efficiency 108 productivity efficiency wage hypothesis 145–6, 145 of labour 139–42, 144, 145–6, 152 of resources (increases) 248 productivity deal 144 products, new 111 profit and loss account 204 profit maximisation 36, 92–5 cartels 119 demand for labour 139–40 difficulties with attitudes to risk 97 firm has alternative aims 96 lack of information 95–6 Index  I:17 long-run 93, 94 monopolistic competition 116 monopoly 110 oligopoly 123–4, 126, 127–31 output 92–5 perfect competition 102–8 price discrimination 134 rule 92 and sales revenue maximisation 96 short-run 94 profit maximisation oligopoly 119, 122 profit satisficing 96 profit-maximising behaviour, criticisms of traditional theory 95–7 profitability goods in joint supply 35 interventionist supply-side policy 354 liquidity and (banks) 268–9 substitutes in supply 35 profits in Cournot model 123 meaning of 93–4 perfect competition 104, 142 price discrimination 133 supernormal see supernormal profit total 93 see also profit maximisation progressive tax 159 promise, credible 128 property rights, changes 183 proportional tax 159 proportionate measures 53 protection 408 agricultural (advanced countries) 388 arguments for 373–5 attitudes to 377–9 import-substituting industrialisation 389–91 inefficiency and 376 methods 373 of people’s interests 175 problems with 375–6 retaliation 376 second-best solution 376 prudential control 275 Prudential Regulation Authority 275 public expenditure, total 328–9 public finances, impact of financial crisis 2008/09 22 public goods 172 direct provision 184 public interest interdependence of markets and 21 monopolistic competition and 116–17 monopoly versus perfect competition 110 protection of (government role) 175 regulatory bodies 180–2 public limited company 96 profit maximisation 96 public sector deregulation 353 introducing market relationships 353 privatisation 353 supply-side policies 351 see also government expenditure public services 184 public-private partnerships (PPPs) 353–4 public-sector deficit 329, 339 cyclically-adjusted 329, 333 rising money supply 284 public-sector net borrowing 329 public-sector net cash requirement (PSNCR) 329, 336, 337 money supply 284 public-sector surplus, cyclicallyadjusted 329 pump priming 331 pure fiscal policy 331 pure profit see supernormal profit qualifications 155, 355 in EU 383 quantitative easing 274, 281, 282, 303, 341, 342, 344, 346, 366, 412, 419 quantity demanded 29 change in 31 quantity increased (factors of production) 248 quantity supplied, change in 34, 36 quantity theory of money 302 queues 17, 69, 186 quotas 377, 379, 380 OPEC 120–1 set by cartel 119 trade restrictions 373 random shocks 35–6, 243, 331, 334, 345 rational choices 8–9, rational consumer, and consumer surplus 33 rational consumer behaviour 32, 33 and individual’s demand curve 32 rational expectations 318–19 rationalisation 84 rationing 69 see also credit raw materials real balance effect 232 real business cycles 243–4, 243 real GDP 227, 228 real income 29 real value, compared with nominal value 227 real-wage unemployment 308 recession 7, 238, 240, 241–3, 295, 308– 9, 321, 322, 332, 335, 337, 339, 345, 346, 363, 408, 417, 419 1980s and 1990s 309, 321 2008/09 328, 345, 346, 378 Great Depression 377 see also business cycle recessionary gap 298–9, 298 reciprocity rule (WTO) 377 rediscounting bills of exchange 275, 340 redistribution green taxes 190–1 income see income redistribution regional development agencies 356 regional policy, EU 384 regional problems 385, 417 regional unemployment 312 regressive tax 159 regulation 177, 180–2 in common markets 380 EU competition policy 180–1 privatised industries 182 restrictive practices 180–1 see also legislation regulatory bodies 180–2 regulatory role of government 22 rent controls 70 repeated games 128–31 repos see gilt repos research and development 109, 126, 170, 174, 254, 352, 354, 372 developing countries 422 funding 354–5 reserve assets 341, 342 reserves 406, 408, 409 flows to and from 400 resources allocation 16, 17 flow (in customs union) 381 making fuller use of 13 productivity of 248 scarcity 5, 6, 17, 167, 188 see also factors of production response, time-lags in 176 restrictive practices EU policy 180–1 UK policy 181 retail banks 262 retail deposits and cash in M4 278 I:18 Index retail outlets (control) 109 retail price index 322 retaliation (trade protection) 374, 376 retraining 353, 376 revenue 89–92 average see average revenue marginal see marginal revenue price not affected by output 90 price varies with output 90–1 shifts in revenue curves 92 total see total revenue reverse repos 267 risk 65–8, 65 attitudes towards 65 diminishing marginal utility of income 66 managers 97 profit maximisation 97 of fluctuating markets (spreading) 374 independent 68 risk averse 65, 68 risk neutral 65 risk premium 93 risk transformation 263 risks, pooling 68 rivalry 188 behaviour of rival 123–4 road usage 194 Royal Bank of Scotland 339, 354 RPI minus X formula 182 rules -based approach (demand-side policy) 349–50 discretion and 349 rules of thumb (pricing) 122 ”run on the bank" 261 Russia 18–19 sale and repurchase agreements (repos) 265, 267, 341 see also gilt repos sales advertising and 57 revenue and 89–92 see also output sales revenue maximisation 96 and profit maximisation 96 savings 43 accounts 264 growth and 251 net 208, 209 scale of production diseconomies of scale 85, 86, 87, 381 economies of scale see economies of scale size of whole industry 85 scarcity 5, 6, 17, 167, 188 see also shortages search unemployment 309–10 seasonal unemployment 312 Seattle, Battle of 378 second degree price discrimination 132, 133 second jobs, workers with 140 second-best solution (protection) 376 secondary marketing, financial system 270–1, 270, 272–3 secured debt, households 215 securitisation 266, 270–1, 270, 272–3 sub-prime mortgages 284, 339 self-employment 140 income from 150 self-fulfilling speculation 62 self-sufficiency 375 services direct provision 184 domestically produced (consumption) 206, 207 free movement (common market) 380 sector (employment) 140 taxes on 159 services balance 398 share prices 42–3 shipping industry, emissions 193 shirking 146 shocks 349 EMU 418–19 fixed exchange rate 408 floating exchange rate 409 random 35–6, 243, 331, 334, 345 short run 76 aggregate supply curve 297–9, 300 costs of production 76–83, 87, 94 decision-making 87 equilibrium of firm 103–4, 115 inflation/unemployment (relationship) 312–16 market adjustment over time 61 money supply changes, aggregate demand and 302–3 price elasticity of supply 59 price and output 110–11 production function 77 profit maximisation 94 under perfect competition 103–4, 103, 110–11 very short run 87 short selling 64 ban on 64 short-run shut-down point 94, 95 short-term contracts 141 short-term loans 265–7 short-term monetary control 339–40 short-termism 354 shortages 17, 69–70, 186, 233, 344 see also scarcity sight deposits 264, 278 sign (positive/negative), calculation of price elasticity of demand 53 Singapore (traffic congestion) 195 single currency advantages 416 Maastricht Treaty 415, 416 optimal currency areas 418 Single European Act (1986) 354, 384 Single Market Directives (EU) 385 single market, EU 88–9, 354 benefits and costs 384–5 features of 383 size distribution of income 147 measuring 148–50 small firms (government assistance) 355 small and medium-sized enterprises (SMEs) 355 social benefits 161, 163, 168–72, 168 see also marginal social benefits Social Chapter of Maastricht Treaty 384 social charter 384 social costs 169–70, 169 see also marginal costs social efficiency 167–8, 167 social justice 184 social policy (EU) 384 social problems 390–1 social security benefits 150, 224 Universal Credit 356 Solow growth model 250–1, 250, 254 sovereign debt crisis 2010s 22–3 sovereignty 416 Soviet Union, former 17, 18–19 Spain 414 bailout 322 unemployment 322 special purpose vehicle (SPV) 270 special treatment (domestic industries) 380 specialisation 84 as basis for trade 368–71 China 392–3 limits to 370–1 speculation 61–4, 62, 345 and commodity prices 44–5 destabilising 63, 413 exchange rates and 405, 407, 408, 409–10, 413 future return on assets 286 housing market 41 price expectations and 61–3, 286 self-fulfilling 62 short selling 64 Index  I:19 short-term monetary contol 345 stabilising 62–3, 62 speculative attack 394 speculative demand for money 286 spend/save dilemma spending, interest rates and 302–3 spot price 66 stabilisation policy 243, 328 automatic fiscal stabilisers 330, 337 stabilising speculation 62–3, 62 Stability and Growth Pact 335, 418, 419 Stalinist system 18 standard of living 254 standardised unemployment rate 306 state benefits see benefits/subsidies steady-state national income 251 steel industries, US (tariffs) 377 sterling exchange rate 402, 403 Stock Exchange 42 stock market prices 42–3 raising finance 215 stocks fluctuations in 241 holding 66–7 store of wealth, money as 261 strategic trade theory 374 structural adjustment programmes 421 structural deficit/surplus 329 structural deficits 335 structural reforms 422 structural unemployment 243, 310– 12, 311, 375, 385 sub-prime debt/mortgages 271, 273 securitisation 284, 339 subsidies benefits and see benefits/subsidies per-unit 179 taxes and see taxes and subsidies trade 373 substitute goods 30 cross-price elasticity of demand 60, 61 as determinant of demand 30 number, price and demand 30 price of and/or return on 42–3 price elasticity of demand 53 substitute for shares 42–3 substitutes in supply 35 substitution effect 29, 160 tax rise 160 sunk costs 48, 112 Sunstein, C 48 supernormal profit 94, 142, 176 oligopoly 126 perfect competition 104 suppliers health care 177 number of 36 supply 34–6 adjustment of markets over time 61–4 aggregate see aggregate supply change in quantity supplied 36 changes in 36 demand and 5–6, 14 determinants 35–6 immobility of factors 176 of labour see labour supply price and 34, 35, 37, 38 price determination 37, 38 price elasticity of see price elasticity of supply price mechanism 18–20 schedule 34 shocks 296 stock market prices and 43 supply curve 34–6, 35 currency (shifts) 404–5 effect of a tax 72 movements along and shifts in 36, 37, 38–9 price determination 37–9 price elasticity of supply 58–9 supply decision 75–99 long-run costs 83–9 problems with traditional theory 95–7 profit maximisation 92–5 revenue 89–92 short-run costs 76–83 supply-side effects, persistence of 244 supply-side policy 7, 351–7 exchange rate and 407 growth and 351 inflation and 351 interventionist 354–7 market-orientated 351–4 structural reform 422 unemployment and 351 surpluses 17, 68–9, 70–1, 186 consumer 173, 376 cyclically-adjusted 329 deficits and 328–9 producer 94, 173–4 total 174 surveys of confidence 212 sustainable development 378 sustainable investment rule 337 tacit collusion 119, 122 takeover bid 110, 124, 381 targets 348–9, 350 money supply 412 see also inflation targeting tariff escalation 389–90, 389 tariffs 373, 375–6, 387 common external 380, 381, 383 WTO 377, 378, 379 tastes 30, 212, 374 and commodity prices 45 tax credits 162 taxation 274 allowances 159 bank levy 268 common markets 380 corporation tax 351–2, 355 cuts 159, 160, 351–2 disincentives problem 161, 163 EU 383, 384 income redistribution 159–60, 161, 163 income tax 159, 161, 163 increases 160 indirect 72 lump-sum 178–9 negative 215 net, circular flow of income and 208, 209 predicting effect of changes 331 progressive 159 proportional 159 regressive 159 relief 355 VAT see value added tax (VAT) see also fiscal policy taxes and subsidies 178–80 advantages 179 disadvantages 179 GDP measurement and 223 poverty trap 161, 163 to correct externalities 178 to correct for monopoly 178–9 Taylor rule 349–50, 349 technical standards, European Union 383 techniques (of analysis) 14 technological unemployment 311–12, 312, 385 technology advances and supply 35 customs union and spread of 381 economic growth and 251, 254–5 long-run costs 86 primary exports and 388 productivity of resources 248 progress 215 transfer 385 unemployment and 320 temporary contracts 141 terms of trade 372–3, 372, 381, 388–9 Thaler, R 48 I:20 Index third-degree price discrimination 132, 133 threat, credible 128, 130 time deposits 264–5, 264, 278 time lags business cycle 241 fiscal policy 334–5, 348–9 monetary policy 348–9 in response (market failure) 176 time, market adjustment over 61–4 time period decision-making 87 market demand for labour 142 price elasticity of demand 54 price elasticity of supply 59 timing (game theory) 130–1 tit-for-tat strategy 128 total consumer expenditure 54 price elasticity of demand and 54–5 total consumer surplus 33 total cost 79, 80 total fixed costs 80 total profit 93 total revenue 54, 89 price elasticity of demand and 54 total surplus, effect of monopoly on 174 total variable costs 79 totally inelastic demand 55, 57 tradable permits 189–91, 189, 192–3 trade arguments for restricting 373–5 blocs 379–82 cross elasticity of demand 61 developing countries see developing countries (trade) as engine of growth 372, 386, 388 EU 382–6 free, capital movements and 354 gains from 367–73 green taxes 191 interdependence through 363–6 limits to specialisation and 370–1 non-economic advantages 372 openness to 387 protection see protection specialisation as basis for 368–71 structural reform 422 terms of 372–3, 372, 381, 388–9 unfair practices 374 world (growth) 370 world trading system and WTO 377–9 trade barriers 373, 387, 394 trade creation 380 EU 384, 385 NAFTA 382 trade cycle see business cycle trade diversion 380–1, 380 EU 385 trade in goods account 398 trade in services account 398 trade unions bilateral monopoly 144–5 collective bargaining 138, 144 competitive employers and 143–4 in developing countries 390 inflation and 296 membership - decline in 145 real-wage unemployment and 308 reduced power of labour 352–3 wage determination (in imperfect market) 143–4 trade-offs 177 traders, uncertainty for 410 trading blocs 379–82 direct effects of customs union 380 long-term effects of customs union 381 preferential trading arrangements (types) 380 preferential trading in practice 381–2 see also European Union traditional theory, probems with 95–7 traffic congestion 194–5 training 152, 320, 321 interventionist supply-side policy 354, 355 retraining 353, 376 transaction motive (demand for money) 285, 286 transfer payments 208, 224 see also benefits/subsidies transfers (public expenditure) 328 transmission mechanisms of economic policy 8, transmission of payments (banks) 263 Treasury 273 Treasury bills 266, 267, 274, 275–6, 284, 328, 340, 341, 342, 346 rediscounting 276 Treaty of Rome 382 turning points (business cycle) 243, 244 turnover, labour 146 twin deficits 399 uncertainty 65–8, 65 exchange rate 410, 416 market failure 174–5, 176 reducing by use of future markets 66 reduction by insurance 67–8 reduction by stock holding 66–7 for traders/investors 410 underemployment 202, 321–2, 321 underground markets 69 unemployment 7, 417, 418 age and 307 benefits 306, 353 and business cycle 304, 309, 311, 323 by decade 304–5 costs of 306 demand-deficient 294, 308–9, 308, 313, 323 developing countries 422 disequilibrium see disequilibrium unemployment duration - determinants 310–11 equilibrium see equilibrium (natural) unemployment European Union 384 frictional 309–10, 309 inequality and 155 inflation and 312–19 inflation at same time 313 international comparison 304–5, 307 Keynesian analysis of inflation and 312, 313, 318–19 labour market and 307–8 long-term 310, 322 long-term change 320–2 macroeconomic aims/issues 201, 202, 203, 209 meaning of 305 minimum wage legislation 157 mismatch 312 number unemployed 305 official measures 305–7 pool 310–11 rate 305 gender and 306 reduced power of labour 352–3 regional 312 seasonal 312 structural 310–12, 311 supply-side policies and 351, 353 technological 311–12, 312, 385 voluntary 318, 353 youth 322 see also employment unemployment benefit 306, 353 unfair trade practices 374 uniform pricing 131 unions see trade unions unit elastic demand 53, 57, 58 United Nations 423 trade and development index 386 United States (USA) currency turmoil 411–12 exports 367 Index  I:21 Federal Open Market Committee 346 Federal Reserve Bank 272, 273, 281, 338, 346, 347, 411–12, 419 health care 177 inflation 293 interest rates and ERM 414 NAFTA 381–2 quantitative easing 419 research and development 355 unemployment 304, 305, 307 universal banks 262 universal benefits 161, 163 Universal Credits 162, 356 unpredictable events, supply and 35–6 unsecured debt, household 213–14 urban life (developing countries) 390–1 Uruguay Round 379 user-charges 188 utility maximisation 47 value, money and 261 value added tax (VAT) 72, 159, 324, 332 EU 383 income redistribution 159 values, real compared with nominal 227 variable costs 79 average 79, 80 total 79 variable factor 76 velocity of circulation 207, 302 vent for surplus 388 vertical integration 125 very long run 87 very short run 87 visibles/visible trade 398 vocational qualifications 355, 383 voluntary unemployment 318, 353 wage determination (in imperfect market) 143–6 bilateral monopoly 144–5 efficiency wage hypothesis 145–6, 145 role of trade unions 143–4 wage determination (in perfect market) 138–42 demand for labour 139–40 supply of labour 138–9 wages and profits 142 wage inflation 293, 294, 313 wage setters 143 wage takers 138, 143 wages distribution by occupation 150–4 distribution by sex 152–3 efficiency see efficiency wages equilibrium wage rate 19 exploitation of foreign workers 375 freezes/cuts 321 gender pay gap 152–3 minimum wage legislation 156–7, 308 national living (NLW) 157 perfect competition and 142 real-wage unemployment 308 stickiness 297, 309, 408 urban 390 wages councils 157 Wall Street Crash 377 wealth 43 distribution 148, 154–5 inequality 155 causes 154 money as means of storing 261 welfare reducing 353 see also benefits/subsidies West African Monetary Zone (WAMZ) 381 wholesale banks 262 wholesale deposits and loans 262, 278 wholesale outlets (control) 109 windfall tax 179 withdraw, marginal propensity to 221 withdrawals 208 and injections approach to national income 219–20, 221–2, 349 and injections (relationship) 209 working hours 155, 351, 352 working tax credit (WTC) 162 working to rule 144 World Bank 422 HIPC initiative 422–3 world population, law of diminishing returns and 78 world recession 420 world trade, patterns and trends 367, 370–1 world trade (growth) 370 World Trade Organisation (WTO) 366, 377–9 Bali Conference 378, 379 Doha Development Agenda 378, 379, 388, 394 rules 377 world trading system 377–9 zero-hours contracts 141, 145, 321, 353 ... 697 92 363 171 940 43 044 159 424 122 587 175 678 79 29 8 20 6 336 24 9 540 525 304 % of GVA 0.7 4.4 9.7 6.1 11.3 2. 8 10.5 8.0 11.5 5 .2 13.5 16.4 100.0 877 883 57.6 523 351 34.3 98 848 6.5 25 22 2 1.7... income % of GDP 26 58 .2 451.4 5883.1 506.9 323 .9 % of GDP 300.9 617.6 104.9 69.9 1681 .2 144.9 92. 6 20 40.6 346.5 23 1.0 420 1.9 3 62. 1 23 1.3 Non-financial assets 1511.8 25 6.7 171.1 524 1.4 451.7 28 8.6... 55.8 24 .9 17.8 19.3 18.4 0.9 Brazil 61.7 18.6 20 .5 11.4 12. 5 21 .1 China 42. 4 40.5 14.4 26 .7 23 .3 3.4 France 56.9 18.8 24 .6 23 .5 23 .6 20 .1 Germany 58.5 19 .2 19.0 34.1 31.1 3.0 India 61.5 30 .2 11.6