Ebook Economic (6th edition): Part 2

(BQ) Part 2 book Economic has contents: The national economy, the roots of modern macroeconomics, fiscal and monetary policy, the relationship between the money and goods markets, money and interest rates, international trade, the balance of payments and exchange rates, global and regional interdependence, economic problems of developing countries.

EC6_C13.qxd 10/27/05 16:50 Page 365 Part D: Foundations of Macroeconomics 13 The National Economy 367 14 Macroeconomic Issues and Analysis: an Overview 395 Why economies sometimes grow rapidly, while at other times they suffer from recession? Why, if people want to work, they sometimes find themselves unemployed? Why economies experience inflation (rising prices), and does it matter if they do? Why exchange rates change and what will be the impact of such changes on imports and exports? These macroeconomic issues affect all countries, and economists are called on to try to find explanations and solutions In the next three chapters we will be looking at these issues and giving you a preliminary insight into the causes of these problems and what governments can to tackle them EC6_C13.qxd 10/27/05 16:50 Page 366 EC6_C13.qxd 10/27/05 16:50 Page 367 Chapter 13 The National Economy We turn now to macroeconomics This will be the subject for the second half of the book As we have already seen, microeconomics focuses on individual markets It studies the demand for and supply of oranges, videos, petrol and haircuts; of bricklayers, doctors, office accommodation and computers It examines the choices people make between goods, and what determines their relative prices and the relative quantities produced In macroeconomics we take a much loftier view We examine the economy as a whole We still examine demand and supply, but now it is the total level of spending in the economy and the total level of production In other words, we examine aggregate demand and aggregate supply We still examine output, employment and prices, but now it is national output and its rate of growth, national employment and unemployment, and the general level of prices and their rate of increase (i.e the rate of inflation) In this chapter, we identify the major macroeconomic objectives and have a preliminary look at how they are related Then we focus on national income and output We look at how they are measured and what causes them to grow over time CHAPTER MAP 13.1 The scope of macroeconomics The major macroeconomic issues Government macroeconomic policy 368 368 369 13.2 The circular flow of income The inner flow, withdrawals and injections The relationship between withdrawals and injections Circular flow and the four macroeconomic objectives Equilibrium in the circular flow 370 370 13.3 Measuring national income and output Three ways of measuring GDP Taking account of inflation Taking account of population Taking account of exchange rates Do GDP statistics give a good indication of a country’s standard of living? 373 373 374 375 375 372 372 372 376 13.4 Short-term economic growth and the business cycle Actual and potential growth Economic growth and the business cycle The business cycle in practice Causes of fluctuations in actual growth 377 377 379 380 382 13.5 Long-term economic growth Causes of long-term growth Policies to achieve long-term growth Postscript: the role of investment 384 384 387 387 Appendix: Calculating GDP The product method The income method The expenditure method National income Households’ disposable income 388 388 389 391 392 392 EC6_C13.qxd 10/27/05 16:50 Page 368 368 13 THE NATIONAL ECONOMY 13.1 THE SCOPE OF MACROECONOMICS Unemployment The major macroeconomic issues Economic growth KI p4 Governments try to achieve high rates of economic growth over the long term: in other words, growth that is sustained over the years and is not just a temporary phenomenon To this end, governments also try to achieve stable growth, avoiding both recessions and excessive short-term growth that cannot be sustained (governments are nevertheless sometimes happy to give the economy an excessive boost as an election draws near!) Key Economies suffer from inherent instability Idea As a result, economic growth and other 31 Inflation macroeconomic indicators tend to fluctuate Table 13.1 shows the average annual growth in output between 1960 and 2005 for selected countries As you can see, the differences between countries are quite substantial ‘Newly industrialised countries’, such as Malaysia and Singapore, have experienced particularly rapid rates of economic growth There are also big differences between the growth rates of individual countries in different periods Look, for example, at the figures for Japan From being an ‘economic miracle’ in the 1960s, Japan by the 1990s had become a laggard, with a growth rate well below the OECD average Table 13.1 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 KI p4 a drain on government revenues Unemployment in the 1980s and early 1990s was significantly higher than in the 1950s, 1960s and 1970s (see Table 13.1) Then, in the late 1990s and early 2000s, it fell in some countries, such as the UK and USA In others, such as Germany and France, it remained stubbornly high We take a preliminary look at the nature and causes of unemployment in Chapter 14 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 Definition Rate of economic growth The percentage increase in national output over a 12-month period Economic growth (average % per annum), unemployment (average %) and inflation (average % per annum) France Germany Italy Japan UK USA EU (15) OECDa 7.5 3.2 2.2 1.7 2.0 4.4 2.6 1.8 2.2 1.0 5.3 3.8 2.4 1.5 1.5 10.9 4.3 4.0 1.7 1.9 2.9 2.0 2.4 2.1 2.7 4.3 2.8 2.5 3.0 2.9 3.5 3.2 2.2 2.1 2.0 4.6 3.6 2.6 2.6 2.6 5.4 8.1 3.0 1.8 2.8 6.5 7.9 5.8 6.9 5.2 8.8 8.3 6.1 7.7 4.6 Unemployment 1960–9 1.5 1970–9 3.7 1980–9 9.0 1990–9 10.6 2000–5 9.2 0.9 2.3 5.9 7.7 8.9 5.1 6.4 9.5 10.4 9.0 1.3 1.7 2.5 3.7 5.0 2.2 4.5 10.0 8.1 5.1 4.1 6.1 7.2 5.8 5.3 2.5 4.0 9.3 9.2 7.9 2.5 4.3 7.3 6.9 6.7 n.a n.a n.a 9.3 10.5 n.a n.a 6.2 3.4 3.5 n.a 3.6 3.6 2.8 3.8 Inflation 1960–9 1970–9 1980–9 1990–9 2000–5 3.2 5.0 2.9 2.2 1.4 4.4 13.9 11.2 4.7 2.7 4.9 9.0 2.5 0.8 −1.3 4.1 13.0 7.4 3.9 1.8 2.8 6.8 5.5 2.4 2.2 3.7 10.3 7.4 3.3 2.1 3.1 9.2 8.9 4.4 2.3 46.1 30.6 332.2 847.0 7.1 −0.3 7.3 2.2 3.6 1.6 1.1 5.9 2.5 1.9 1.0 Growth 1960–9 1970–9 1980–9 1990–9 2000–5 a 4.2 9.4 7.3 2.0 1.8 Brazil Malaysia Singapore The Organisation for Economic Co-operation and Development: the 30 major industrialised countries (excluding Russia, but including Korea, Mexico and Turkey) EC6_C13.qxd 10/27/05 16:50 Page 369 13.1 THE SCOPE OF MACROECONOMICS Today we are used to inflation rates of around or per cent, but it was not long ago that inflation in most developed countries was in double figures In 1975, UK inflation reached 24 per cent In most developed countries, governments have a particular target for the rate of inflation In the UK the target 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 19) The balance of payments and the exchange rate The final issue has to with the country’s foreign trade and its economic relationships with other countries 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 investments 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: these include the sales of exports, inflows of investment into the country and earnings of interest and dividends from abroad The sale of exports and any other receipts 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 = $1.60 If the government does nothing to correct the balance of payments deficit, then the exchange rate must fall (We will show just why this is so in section 14.4.) 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 uncer- tainty for traders and can damage international trade and economic growth What are the underlying causes of balance of payments problems? How the balance of payments and the exchange rate relate to the other macroeconomic issues? What are the best policies for governments to adopt? We take an initial look at these questions in Chapter 15 and then examine them in more detail in Chapters 24 and 25 Government macroeconomic policy From the above four issues we can identify four macroeconomic policy objectives that governments typically pursue: • • • • High and stable economic growth Low unemployment Low inflation The avoidance of balance of payments deficits and excessive exchange rate fluctuations Unfortunately, these policy objectives may conflict For example, a policy designed to accelerate the rate of economic growth may result in a higher rate of inflation and a balance of payments deficit Governments are thus often faced with awkward policy choices Key Societies face trade-offs between economic Idea objectives For example, the goal of faster growth 32 may conflict with that of greater equality; the goal of lower unemployment may conflict with that of lower inflation (at least in the short run) This is an example of opportunity cost: the cost of achieving one objective may be achieving less of another The existence of trade-offs means that policy-makers must make choices Definitions Rate of inflation The percentage increase in prices over a 12-month period 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 a1.40 = £1) Section summary Macroeconomics, like microeconomics, looks at issues such as output, employment and prices; but it looks at them in the context of the whole economy The four main macroeconomic goals that are generally of most concern to governments are 369 economic growth, reducing unemployment, reducing inflation, and avoiding balance of payments and exchange rate problems Unfortunately, these goals are likely to conflict Governments may thus be faced with difficult policy choices EC6_C13.qxd 10/27/05 16:50 Page 370 370 13 THE NATIONAL ECONOMY 13.2 THE CIRCULAR FLOW OF INCOME One way in which the four objectives are linked is through their relationship with aggregate demand (AD) This is the total spending on goods and services made within the country (‘domestically produced goods and services’) This spending consists of four elements The first is consumer spending on domestically produced goods and services (Cd), (i.e total consumer expenditure on all products (C) minus expenditure on imports (M)) The other three elements are: investment expenditure by firms (I), government spending (G) and the expenditure by residents abroad on this country’s exports (X ) Thus:1 AD = Cd + I + G + X or, put another way: AD = C + I + G + X − M To show how the four objectives are related to aggregate demand, we can use a simple model of the economy This is the circular flow of income, and is shown in Figure 13.1 It is an extension of the model that we looked at back in Chapter (pages 15–16) In the diagram, the economy is divided into 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 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 KI 23 p 251 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 £1 billion) But that does not tell us the level of national income Income is a flow concept (as is expenditure) It is 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 We assume, for simplicity, in this first equation that all investment, government expenditure and export expenditure is on domestic products If, however, any part of these three went on imports, we would have to subtract this imported element (as we did with consumption) We would then have to write AD = Cd + Id + Gd + Xd in detail later on.) If there is £1 billion of money in the economy and each £1 on average is paid out as income five times per year, then annual national income will be £5 billion 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 ? 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 Let us examine these withdrawals and injections 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) Definitions Aggregate demand Total spending on goods and services produced in the economy It consists of four elements, consumer expenditure (C), investment (I), government expenditure (G) and the expenditure on exports (X), less any expenditure on foreign goods and services (M) Thus AD = C + X + G + X − M, or C d + I + G + X The consumption of domestically produced goods and services (Cd ) The direct flow of money payments from households to firms 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 EC6_C13.qxd 10/27/05 16:50 Page 371 13.2 THE CIRCULAR FLOW OF INCOME Figure 13.1 371 The circular flow of income 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 13.1 as leaving the circular flow at just one point.) 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 consumption is of totally home-produced goods 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 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 (I) This is the money that firms spend after obtaining it from various financial institutions – either past savings or loans, or through a new issue of shares They Definitions 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 (I) plus government expenditure (G) plus expenditure on exports (X) EC6_C13.qxd 10/27/05 16:50 Page 372 372 13 THE NATIONAL ECONOMY may invest in plant and equipment or may simply spend the money on building up stocks of inputs, semi-finished or finished goods ? Government expenditure (G) When the government spends money on goods and services produced by firms, this counts as an injection Examples of such government expenditure include spending on roads, hospitals and schools (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.) Export expenditure (X) Money flows into the circular flow from abroad when residents abroad buy our exports of goods and services.2 Total injections are thus the sum of investment, government expenditure and exports: Are the following net injections, net withdrawals or neither? If there is uncertainty, explain your assumptions (a) Firms are forced to take a cut in profits in order to give a pay rise (b) Firms spend money on research (c) The government increases personal tax allowances (d) The general public invests more money in banks and building societies (e) UK investors earn higher dividends on overseas investments (f) The government purchases US military aircraft (g) People draw on their savings to finance holidays abroad (h) People draw on their savings to finance holidays in the UK (i) The government runs a budget deficit (spends more than it receives in tax revenues) and finances it by borrowing from the public (j) The government runs a budget deficit and finances it by printing more money J=I+G+X The relationship between withdrawals and injections There are indirect links between saving and investment, taxation and government expenditure, and imports and exports, via financial institutions, the government (central and local) and foreign countries respectively If more money is saved, there will be more available for banks and other financial institutions to lend out If tax receipts are higher, the government may be more keen to increase its expenditure Finally, if imports increase, incomes of people abroad will increase, which will enable them to purchase more of our exports These links, however, not guarantee that S = I or G = T or M = X Firms may wish to invest (I ) more or less than people wish to save (S); governments can spend (G) more than they receive in taxes (T) or vice versa; and exports (X) can exceed imports (M) or vice versa A major point here is that the decisions to save and invest are made by different people, and thus they plan to save and invest different amounts Likewise the demand for imports may not equal the demand for exports As far as the government is concerned, it may choose not to make T = G It may choose not to spend all its tax revenues: to run a ‘budget surplus’ (T > G) Or it may choose to spend more than it receives in taxes – to run a budget deficit (G > T) – by borrowing or printing money to make up the difference Thus planned injections (J) may not equal planned withdrawals (W) Note that X would not include investment in the UK by foreign companies (i.e credits on the financial account of the balance of payments) Foreign ‘investment’ involves the acquisition of assets in the UK and thus represents an income to the previous owners of these assets It therefore represents an inflow from abroad to the household sector and thus has the effect of reducing M The circular flow of income and the four macroeconomic objectives If planned injections are not equal to planned withdrawals, what will be the consequences? If, for example, injections exceed withdrawals, the level of expenditure will rise: there will be a rise in aggregate demand This extra spending will increase firms’ sales and thus encourage them to produce more Total output in the economy will rise Thus firms will pay out more in wages, salaries, profits, rent and interest In other words, national income will rise The rise in aggregate demand will have the following KI 32 p 369 effects upon the four macroeconomic objectives: • There will be economic growth The greater the initial excess of injections over withdrawals, the bigger will be the rise in national income • Unemployment will fall as firms take on more workers to meet the extra demand for output • Inflation will tend to rise The greater the rise in aggregate demand relative to the capacity of firms to produce, the more will firms find it difficult to meet the extra demand, and the more likely they will be to raise prices • The exports and imports part of the balance of payments will tend to deteriorate The higher demand sucks more imports into the country, and higher domestic inflation makes exports less competitive and imports relatively cheaper compared with home-produced goods Thus imports will tend to rise and exports will tend to fall ? What effect will there be on the four objectives of an initial excess of withdrawals over injections? Equilibrium in the circular flow When injections not equal withdrawals, a state of disequilibrium will exist This will set in train a process to EC6_C13.qxd 10/27/05 16:50 Page 373 13.3 MEASURING NATIONAL INCOME AND OUTPUT bring the economy back to a state of equilibrium where injections are equal to withdrawals To illustrate this, let us consider the situation again where injections exceed withdrawals Perhaps there has been a rise in business confidence so that investment has risen Or perhaps there has been a tax cut so that withdrawals have fallen As we have seen, the excess of injections over with- 373 drawals will lead to a rise in national income But as national income rises, so households will not only spend more on domestic goods (Cd), but also save more (S), pay more taxes (T) and buy more imports (M) In other words, withdrawals will rise This will continue until they have risen to equal injections At that point, national income will stop rising, and so will withdrawals Equilibrium has been reached Section summary The circular flow of income model depicts the flows of money round the economy The inner flow shows the direct flows between firms and households Money flows from firms to households in the form of factor payments, and back again as consumer expenditure on domestically produced goods and services Not all incomes get passed on directly round the inner flow Some is withdrawn in the form of saving, some is paid in taxes, and some goes abroad as expenditure on imports Likewise not all expenditure on domestic firms is by domestic consumers Some is injected from outside the inner flow in the form of investment expenditure, 13.3 government expenditure and expenditure on the country’s exports Planned injections and withdrawals are unlikely to be the same If injections exceed withdrawals, national income will rise, unemployment will tend to fall, inflation will tend to rise, imports will tend to rise and exports fall The reverse will happen if withdrawals exceed injections If injections exceed withdrawals, the rise in national income will lead to a rise in withdrawals This will continue until W = J At this point, the circular flow will be in equilibrium MEASURING NATIONAL INCOME AND OUTPUT The circular flow of income is very useful as a model for understanding the working of an economy It shows how national income can increase or decrease as a result of changes in the various flows But just how we measure national income or output? The measure we use is called gross domestic product (GDP) This section shows how GDP is calculated It also looks at difficulties in interpreting GDP statistics Can the figures be meaningfully used to compare one country’s standard of living with another? The appendix to this chapter goes into more detail on the precise way in which the statistics for GDP are derived Figure 13.2 The circular flow of national income and expenditure The three ways of measuring GDP GDP can be calculated in three different ways, which should all result in the same figure These three methods are illustrated in the simplified circular flow of income shown in Figure 13.2 Definition Gross domestic product (GDP) The value of output produced within the country over a 12-month period The first method of measuring GDP is to add up the value of all the goods and services produced in the country, industry by industry In other words, we focus on firms and add up all their production This first method is known as the product method The production of goods and services generates incomes for households in the form of wages and salaries, profits, rent and interest The second method of measuring GDP, EC6_C13.qxd 10/27/05 16:50 Page 374 374 13 THE NATIONAL ECONOMY therefore, is to add up all these incomes This is known as the income method The third method focuses on the expenditures necessary to purchase the nation’s production In this simple model of the circular flow of income, with no injections or withdrawals, whatever is produced is sold The value of what is sold must therefore be the value of what is produced The expenditure method measures this sales value Because of the way the calculations are made, the three methods of calculating GDP must yield the same result In other words: National National National ≡ ≡ product income expenditure In the appendix to this chapter, we look at each of the three methods in turn, and examine the various factors that have to be taken into account to ensure that the figures are accurate also 10 per cent higher, then the average person will be no better off at all There has been no real increase in income (see discussion in Appendix at the end of the book on page A:6) An important distinction here is between nominal GDP TC 12 and real GDP Nominal GDP, sometimes called ‘money p 374 GDP’, measures GDP in the prices ruling at the time and thus takes no account of inflation Real GDP, however, measures GDP in the prices that ruled in some particular year – the base year Thus we could measure each year’s GDP in, say, 1990 prices This would enable us to see how much real GDP had changed from one year to another In other words, it would eliminate increases in money GDP that were merely due to an increase in prices The official statistics give both nominal and real figures Web Case 13.1 on the book’s website shows in more detail how real GDP figures are calculated Definitions Taking account of inflation If we are to make a sensible comparison of one year’s national income with another, we must take inflation into account For example, if this year national income is 10 per cent higher than last year, but at the same time prices are Nominal GDP GDP measured at current prices Real GDP GDP after allowing for inflation: i.e GDP measured in constant prices: i.e in terms of the prices ruling in some base year THINKING LIKE AN ECONOMIST THRESHOLD CONCEPT 12 THE DISTINCTION BETWEEN REAL AND NOMINAL VALUES Which would you rather have: (a) a pay rise of per cent when inflation is per cent, or (b) a pay rise of 10 per cent when inflation is per cent? Which debt would you rather have: (a) one where the interest rate is 10 per cent and inflation is per cent, or (b) one where the interest rate is per cent and the inflation rate is per cent? To answer these questions, you need to distinguish between real and nominal values Nominal values are measured in current prices and take no account of inflation Thus in the questions above, the nominal pay rises are (a) per cent and (b) 10 per cent; the nominal interest rates are (a) 10 per cent and (b) per cent In each case it might seem that you are better off with alternative (b) But if you opted for answers (b), you would be wrong Once you take inflation into account, you would be better off in each case with alternative (a) What we need to is to use real values Real values take account of inflation Thus in the first question, although the nominal pay rise in alternative (a) is per cent, the real pay rise is only per cent, since of the per cent is absorbed by higher prices You are only per cent better off in terms of what you can buy In alternative (b) the real pay rise is only per cent, since of the 10 per cent is absorbed by higher prices Thus in real terms, alternative (a) is better In the second question, although in alternative (a) you are paying 10 per cent in nominal terms, your debt is being reduced in real terms by per cent and thus you are paying a real rate of interest of only per cent In alternative (b), although the nominal rate of interest is only per cent, your debt is being eroded by inflation by only per cent The real rate of interest is thus per cent Again, in real terms, you are better off with alternative (a) The distinction between real and nominal values is a threshold concept, as understanding the distinction is fundamental to assessing statistics about the economy Often politicians will switch between real and nominal values depending on which are most favourable to them Thus a government wishing to show how strong economic growth has been will tend to use nominal growth figures On the other hand, the opposition will tend to refer to real growth figures, as these will be lower (assuming a positive inflation rate) It’s easy to make the mistake of using nominal figures when we should really be using real ones This is known as ‘money illusion’: the belief that a rise in money terms represents a real rise ? When comparing two countries’ GDP growth rates, does it matter if we use nominal figures, provided we use them for both countries? EC6_Z06.qxd 10/27/05 17:19 Page 24 I:24 INDEX money (continued) current transfers 416 definition 479, 480 establishing value 480 evaluation role 480 functions 479–80 interest rates and 478 –503, 506–7 M0 490, 491, 494, 510, 543 – 4, 547, 549, 558, 563 M1 491 M2 491 M3 490, 491, 495, 548, 549, 561 M3 (eurozone) 490, 491 M4 490, 491, 493 – 6, 510, 544, 549, 563 marginal utility 96–7 medium of exchange 479 – 80, 479 motives for holding 497 multiplier 493, 494, 548 –9, 493 narrow definitions 480 near 493 printing extra 438 –9 quantity theory 436, 440 –1, 443, 448–9, 505, 436 store of wealth 480 unstable demand for 506 –7 velocity of circulation 370, 436, 510, 511–12, 548, 566 money, demand for 406, 497, 543 – curve 498–9, 500 effects of expectations 499, 500 interest rate and 498, 499, 500 –1, 518, 550 Keynesian/monetarist analyses 514 motives for holding 497 national income and 518 speculative (asset) demand 499 –500 total demand 500–1 transactions and precautionary demand 497– unstable 507–8, 552–3 money GDP 374 money illusion 374, 414, 576, 578, 414, 576 money market 484, 513, 484 changes (full effects) 519 –22 complementary 488 deregulation 483 discount 319, 488 – 9, 545, 560 equilibrium in 501, 517 goods market and 504–27 ISLM analysis 515–22 London (role) 488 – parallel 488, 489 repos 483, 488–9, 545 – 6, 548, 549, 550–1, 483 money supply 406, 448 –9, 543 aggregate demand and 440 –1, 448 –9, 505 –8, 552 changes (effects) 501, 505 –8 control 542–3, 544 –50 credit and 490 –3 curve 496, 534 definitions 490 direct transmission mechanism 509 –11 endogenous 496, 509, 515, 496 eurozone 490, 491 exchange rate and 507, 509, 672, 681 exogenous 496, 515, 534, 496 flow-of-funds equation 495 –6 Goodhart’s law 548, 552, 561, 567, 552 interest rate and 496, 550 –3 national income and 479, 505 –8, 509 portfolio balance 509 –11, 509 rise in (causes) 493 –5, 555 rise in (effects) 505, 506 targets 444, 507, 511–12, 552, 566, 696 UK 413 –14 USA 694 Monitor 618 monitoring performance 208 Monopolies and Mergers Commission 183, 353 monopolistic competition 157, 158, 164, 182, 305, 574, 157 assumptions of 178 equilibrium of firm 178 – ice-cream sellers 179 limitations of model 179 – 80 monopoly and (comparison) 181 non-price competition 180 perfect competition and 180 –1 public interest and 180 –1 monopoly 25, 157, 158, 164, 574, 157 advantages 170 –1 barriers to entry 166 –7, 168, 174, 175, 348, 353 bilateral 237, 238 –9, 237 competition under 323 –4, 348 –9, 350, 352, 353 contestable markets and 172 –6 deadweight loss under 305 definitions 166 disadvantages 169 –70, 172 equilibrium price and output 168 –9 EU policy 350, 662 foreign-based (prevention) 648 import-substituting industrialisation 729 kinked demand under 191 legislation 313 limit pricing 168 –9 Microsoft case 170 –1 monopolistic competition and 181 natural 144, 166 –7, 173, 356 –7, 361, 362, 617, 166 policies 348 –9, 350, 352, 353 potential 172–3 power 166, 172, 214, 224, 237–8, 252, 255, 271, 306, 310, 317, 349, 352, 357, 412, 593 –610, 646, 648, 657, 662, 679, 723, 729 privatised industry as 357–8 profit maximising under 166 –72 public interest and 169 –71 supply of exports 648 taxes to correct for 310 –11 UK policy 352, 353 X inefficiency 172 monopsony 236 –7, 242–3, 236 power 238, 243, 249 –50, 251, 252, 271, 274, 306, 648 –9 Victorian times 238 Monsanto 167, 735 Mont Pelerin Society 112, 324 –5 Monti, Mario 351 moonlighting 280, 376 moral dilemma 75 moral hazard 104, 747, 104 moral judgement 77, 229 morale (wage rates) 243 mortgages 46 –7, 484 most-favoured nation status 652 motoring costs 340 –1 motorways 343 –4 multi-divisional form 206 –7, 206 multi-factor case (in long run) 134 multi-product firms 224 multi-stage production 132 multinational companies 207, 218, 220, 648, 731, 735, 736 multiple aims 219 –25 multiplier 463, 509, 532, 533, 535, 591, 463 accelerator interaction 473 – 4, 535, 537 balanced budget 442 bank (or deposit) 492, 542–3, 544, 546, 547, 492 formula 464, 466 –7, 464 income and expenditure approach 464, 465 –6 EC6_Z06.qxd 10/27/05 17:19 Page 25 INDEX multiplier (continued) marginal propensity to consume 464–5, 466 –7 money 493, 494, 548 – 9, 493 numerical illustration 465 size of 517, 533, 535 withdrawals/injections 463 –5 multiplier effect 441–2, 493, 533–4, 441 on 45° line diagram 467– regional 625, 657, 625 world 652 mutual recognition 659, 660, 661, 660 narrow definitions of money 480 narrow monetary base 490 Nash equilibrium 190, 192, 193, 194, 190 National Bus Corporation 617 national debt 487, 529, 546, 706, 711, 529 national economy calculating GDP 388 –93 circular flow of income 370–3 long-term growth 384 – measuring national income and output 373 –7 scope of macroeconomics 368 –9 short-term growth 377– 84 National Grid Company 360, 361 National Grid Transco 359 National Health Service 75 –7, 308 – internal market 618 national income 19, 531, 535 accelerator effect see accelerator aggregate demand and 370, 371, 452 circular flow 370–3 comparisons 375 – consumption and 377, 453 –5, 457 demand for money and 518 determination 462– equilibrium 462–3, 601–2 exchange rate and 375, 459, 507, 669, 675, 680 external balance 669 –70, 678, 681, 669 full employment level 468 – 9, 669, 468 gross 392, 393 inflation and 374, 523 – injections 370 –3, 458 –9, 371 internal balance 669 –70, 678, 679, 681, 669 investment and 371–2, 473 ISLM analysis see ISLM analysis living standards and 376 – measurement 373 –7 monetary changes (effects) 505 –12 money supply and 479, 505 –8, 509 nominal 498 ratios of shares in 267 real 452–3, 505 –12, 526 steady-state level 602, 604 –5, 602 underground economy 19, 376 –7 welfare measurement 377 withdrawals 370 –2, 373, 455 –60, 463 –5, 370 national insurance contributions 277, 279, 371, 393, 400, 614, 626 National Loans Fund 487 national output 405, 602 aggregate supply and 432–3, 574 –6, 579 – 80 measurement 373 –7 National Power 360, 361 National Savings certificates 487 National Vocational Qualification (NVQ) 621, 623 national wealth 479 nationalisation 621–2 privatisation and 355, 356 nationalised industries 315, 355, 356 –7, 355 natural level of output 577 natural level of unemployment 401, 444, 447, 532, 537, 577, 590, 577 natural monopoly 144, 166–7, 356 –7, 361, 362, 617, 166 contestable markets and 173 natural rate of unemployment 444, 447, 583, 610, 678, 583 natural resources 4, 260, 337, 378, 385, 411 natural unemployment see equilibrium unemployment natural wastage 238, 595, 238 nature (determinant of supply) 41 near money 493 needs 18 negative equity 46 negative externalities 301 negative income elasticity of demand 60 negative income tax 287–8, 287 negative marginal utility 93 negative sign 49 negative tax 371, 372 negotiations (outcome) 239 –40 Neighbourhood Renewal Unit 630 neo-Austrian/libertarian school 323, 324 –5, 610 neo-classical theory 229, 232, 296, 611, 731, 736 I:25 neo-Marxist economists 731 net importer (agricultural) 82 net marginal tax propensity 531 net national income 392 net present value calculation 319, 320 –1 of investment 253 net saving 371, 455, 457 net taxes 371, 455 –6 NETA system 361 network 218 network economies 167 network effects 170 –1 new classical school 447, 509, 574, 586, 447, 586 fixed exchange rates 669, 681 inflation and unemployment 586 –92 supply-side policies 610 –11 New Deal for Communities 630 New Electricity Trading Arrangements (NETA) 361 new Keynesians 448 new products 171 newly industrialised countries 368, 728 no-strike agreements 239 nominal exchange rate 670 –1, 678–9 nominal GDP 374 nominal national income 498 nominal values 374, A:6 non-accelerating-inflation rate of unemployment (NAIRU) 583, 593, 583 non-bank private sector 493, 494, 495, 493 non-collusive oligopoly 182 breakdown of collusion 188 –9 game theory 191–5 kinked demand curve 190 –1 rival behaviour 189 – 91 non-discrimination 248, 652 non-distortionary tax 276 non-economic advantages (trade) 644 non-excludability 302, 303, 331, 303 non-human factors of production 249 –50 see also capital; land non-interest bearing deposits 716 non-intervention policies 296, 323–6 Keynesian criticism 595 see also laissez-faire policy non-linear function A:9 non-market-based environmental policies 333 –6 EC6_Z06.qxd 10/27/05 17:19 Page 26 I:26 INDEX non-marketed items 376 non-monetary benefits 315, 316, 317–18 non-monetary costs 315, 316 non-monetary externalities 318 non-price competition 180, 182, 196, 180 non-profit institutions serving households (NPISH) 391 non-renewable resources 260, 329, 379 non-rivalry 302 non-tariff barriers 660 non-traded goods (in developing countries) 723, 725 non-union labour 239 normal goods 36, 59 – 60, 112–14, 36, 60, 112 normal profit 151, 152, 153, 159 – 60, 235, 151 normal rate of return 255 normative statement 28 – 9, 28 norms and regulations (EU) 660 North American Free Trade Association (NAFTA) 658 North Sea oil 411, 561, 693, 694 number unemployed 396, 397, 396 numerical flexibility 246, 247, 246 objective function 109 objectives macroeconomic 307, 372, 424 –7 microeconomic 9–11 policy (exchange rate regimes) 669–70 occupational distribution of wages and salaries 268 – odds (in gambling) 64, 66, 101–2 OECD 329, 351, 397, 402, 407– Office of Communications (Ofcome) 359 Office of Electricity Regulation (OFFER) 360 Office of Fair Trading 169, 352, 353, 354, 359, 362 Office of Gas and Electricity Markets (OFGEM) 359, 360, 361 Office of Rail Regulation (ORR) 359 Office of Water Services (OFWAT) 314, 359 Official List (Stock Exchange) 256 official loans 741, 743 oil crises 693–4, 740–1 debt problem and 740 –1 North Sea 411, 561, 693, 694 OPEC 186 –7, 411, 412, 648, 679, 692– prices 186 –7, 260, 411, 444, 560, 679, 692, 694 –5 shocks 740 –1 oligopoly 157, 158, 164, 178, 181, 193, 305, 309, 574, 157 brewing industry 183 collusion 182 –9, 313, 349 –50, 362, 657, 182 competition 182, 323 –4, 349 –50 equilibrium of industry 182–3 key features 182 labour with market power 237–8 legislation 313 non-collusive 182, 188–95, 182 power 224, 255, 412, 662 public interest and 195 –6 oligopsony 236, 242, 236 OPEC 186 –7, 411, 412, 648, 679, 692– open-market operations 544 –5, 546, 547, 549, 550, 672, 544 open economy 416, 703, 416 balance of payments in 416 –19 crowding out in 513 exchange rates 419 –23, 697–700 ISLM analysis 697–700 macroeconomic objectives 424 –7 open unemployment rates 737 operating expenses (total variable cost) 127–8 operational balances (central bank) 483 –4, 487 opportunity (for merger) 214 opportunity costs 8, 21, 100, 126, 127, 292, 626, 722, 8, 126 car use 340 choice and 8, 11, 13 constant (gains from trade) 638 –40 of growth 378 –9 of holding money 499 increasing 13 –14, 640 –1, 642, 13 international trade 638 –41, 642, 646 of leisure 282 optimal currency areas 713 optimum tariff 649 Organisation of Petroleum Exporting Countries see OPEC organisational economies 132 organisational slack 210, 220 –1, 221 organisational structure of firm 206 –7 outcomes, uncertain 66, 318 –19 output 18, 120, 141–2, 596 actual 380, 383, 385, 424 agricultural 81, 735 classical analysis 435 –6 determination 43 – economic growth and 600, 606 –7 equilibrium price and 43 –5, 168 – 9, 222, 224 expectations 578 gaps 378, 382–3 highest (given product cost) 138 –9 least-cost method 134, 138 –9 long-term trend 358, 380 under monopoly 168 –9 national see national output natural level of 577 potential 14 –15, 378, 380, 383, 385, 424, 378 price and 146 –8 price discrimination and 199, 201 profit maximisation 150 –2, 199, 201, 295 short-run 357–8, 381 steady-state 602 sustainable 382–3, 577, 382 technological progress and 604 –5 unemployment and 400 outsiders 240, 445, 240, 445 outsourcing 165 outward-looking policies 151, 725 –6, 729, 731–4 overdrafts 483, 484 overheads 132 overshooting (exchange rate) 687–8, 689, 687 ownership of capital/land 236, 261 of dwellings (GDP measurement) 389 factors of production 126 –7 key inputs 167 public 315, 355 –7 public interest and 355 wholesale/retail outlets 167 Oxfam 746 ozone depletion 331, 333 Paish, Frank 538 paradox of thrift 467 parallel money markets 488, 489 parent company 213 Pareto, Vilfredo 292 Pareto improvement 292–3, 298 –9, 322, 343, 349, 292 Pareto optimality 292–6, 297, 298 –9, 300, 305 –6, 307, 310, 292 in cost-benefit analysis 322 lack of 304 EC6_Z06.qxd 10/27/05 17:19 Page 27 INDEX Paris Club 741, 743, 744 park-and-ride schemes 344 parking charges 341, 346 –7 parking restrictions 345 parking spaces (tax) 345, 347 part-time work 243, 247, 274, 397, 614, 620 partial derivative A:12 partial differentiation A:12 partial equilibrium 22 participation rate 603 – 4, 603 passenger transport 339 – 48 patents 255, 623, 653, 737 PAYE system 277, 280 peak-load pricing 198 peaking out phase (business cycle) 380 pedestrian-only areas 345 pensions 272, 274, 284, 285, 371, 393 per-capita measures (national income) 375, 376 percentage changes 52, A:6–A:7 percentage measures (elasticity) 49 perestroika 19 perfect common market 655 perfect competition 34, 157, 169, 305, 643, 650, 34, 157 agriculture 78 assumptions 158 best (or total) 160 demand for labour 232–5 e-commerce 165 economies of scale 163 – efficiency under 292 –300 equality/inequality 235 – income distribution 228 –36 incompatibility of 163 – labour supply under 229 –32 long run under 158 – 60, 162–3, 159 loss minimising 153, 161 monopolistic competition and 180–1 perfect labour markets 228 –9 private efficiency 292, 295, 297, 298, 292 profit maximisation under 157– 66 public interest and 164 short run under 158 – 62, 158 social efficiency and 295, 298 –9 wage determination 228 –36 wages and profits under 235 perfect knowledge 158, 165, 228 perfect labour markets 228 –9 perfectly contestable market 173, 174, 173 performance 9, 208 peripheral workers 246 –7 perks 210, 239, 729, 731 personal income tax see income tax persuasion (intervention) 622 perverse incentives 21 petrol prices 334, 340, 345 Phillips, A.W 414 Phillips curve 414 –15, 470, 532, 567, 611, 669, 678, 414 aggregate demand and 414 –15, 449, 591 aggregate supply and 586, 587–90, 591, 592, 596 breakdown of 592 clockwise Phillips loops 584 –6 common ground among economists 596 effects of deflation 583 –4 expectations-augmented 581–6, 581 Keynesian approach 443 long-run 443, 449, 583, 585 –6, 591, 610 monetarist approach 444 policy implications 585 –6 short-run 447, 590, 591, 593, 594 –6 stagflation (explanations) 584 –5 physical capital 249, 254, 606, 623 supply of 254 physical product see average physical product; marginal physical product; total physical product picketing 239, 615, 239 pie chart A:4 planned economy 16, 17–20, 21, 16 planning of industry 357 national economic 622 Soviet system 18 –19, 20, 21 plant closure 239 plant economies of scale 132 point elasticity 52, 55 –6, 59, 55 police (as public service) 303 policy co-ordination (international) 704 – economics and 28 –9 harmonisation 706 –10, 706 objectives (exchange rate regimes) 669 –70, 669 political business cycle 425, 585 political problems (monetary control) 543 poll tax 278 polluter pays principle 310, 312, 332 pollution 26, 164, 378, 390, 737, 745 agricultural policy and 84, 85 car access and 344 I:27 costs 260, 293, 310, 312, 331–2 economics of the environment 328 –39 Kyoto Protocol 320 –1, 336 –7, 338 social costs 312 tax 310, 312, 313, 332, 333 –5, 338 tradable permits 336 –8 population in developing countries 737–8, 739 growth 122, 434 national income and 375 pressures (limited resources) 328–9 workforce increase 603 –4 portfolio balance 509 –11, 509 portfolio investment 417–18 positive externalities 314 –15, 386 positive income elasticity of demand 60 positive sign 49 positive statement 28 –9, 28 positive sum game 24 post-Keynesians 448 Post Office 355 potential competition 172–3 potential economic growth 377–9, 386, 387, 378 potential monopoly 172–3 potential output 14 –15, 378, 380, 383, 385, 424 poverty 236, 261, 279 –80, 378, 735, 740, 743 absolute 264, 271, 272 analysis of 264 –5 determinants 271–3 harmonisation to reduce 708 heavily indebted poor countries initiative 744 –6 inequality and 264 –74 minimum wage 274 –5 in the past 271 relative 264, 271, 272 social protection 285, 286 underdevelopment problem 721, 725 ‘Poverty Funds’ proposal 747 Poverty Reduction Strategy Paper 744 poverty trap 287, 532, 615, 287 power in collective bargaining 239 –41 market see market power mergers/acquisitions 349 monopoies/oligopolies 195 –6, 349 trade unions 239 –41 PowerGen 360, 361 Pratten, C.F 144 –5 pre-trade position 638 –9, 643 EC6_Z06.qxd 10/27/05 17:19 Page 28 I:28 INDEX pre-trade production possibilites 638–9 precautionary demand for money 497–9 precautionary motive (holding money) 497 predatory pricing 175, 201, 353, 201 prediction 27, 28 see also speculation preferential trading arrangements 654 –5, 654 common market 655, 657, 655 customs union 655 –7, 655 EU 659–65 most-favoured nations 652 in practice 657–8 trade creation 655– 6, 657 trade diversion 656–7 types of arrangements 655 see also international trade present value approach 252–3, 252 price-cap regulation 359, 362, 359 price-consumption curve 111 price-fixing agreements 352–3 price-setting behaviour 223, 359 price benchmark 187– 8, 187 price change budget lines and 105, 107–9, 231, 284 demand and 36 demand curve and 35– 6, 53– expectations of future 36, 41 income effect 111–16, 111 quantity demanded 37– substitution effect 111–16, 111 price control 73 imperfect markets 314 setting maximum 71–2 setting minimum 70 price discrimination 197, 350, 353, 197 advantages to firm 198 – in cinema 200 conditions necessary for 197– first-degree 197, 199, 197 output and 199, 201 profit-maximising prices and 199, 201 profits and 201 public interest and 201 second-degree 197 third-degree 197, 199, 201, 197 on trains 197 price elasticity of demand 48, 200, 340, 48 agriculture 79 calculus 56 consumer expenditure and 50 –2 cross-price elasticity 60 determinants 50, 59 formula 49, 54, 59, 49, 54 marginal revenue and 147–8 measurement 49 –50 time periods 50 price elasticity of supply 57–8, 57 determinants 57 formula 57, 58, 57, 58 measurement 57–8 time period 57 price index A:7 consumer 359, 360, 407, 564, A:7 exports/imports see terms of trade retail 359, 360, 407, 564, A:7 price leadership 184 –5 price levels 405 –7 price makers 148, 168 price mechanism 20, 23, 345, 20 supply and demand 33 –68 price stability 191 price takers 34, 146 –7, 148, 158, 250, 301, 648, 651, 34, 146 prices 537 arc elasticity 52– buffer stocks to stabilise 80 –1 of capital services 252 change (indifference analysis) 108, 110 –16 classical analysis 436 consumption and 454 control see price control current 260 demand and 34 –5, 340 determination 223, 252, 642 in developing countries 723 equilibrium 20, 43 –5, 168 –9, 222, 224, 407, 20 exchange rate and 675 –6 expectations 61–4, 500 factor services 249 firm’s power over (reduction) 165 fixed 70 –3, 81, 82, 349, 350, 351 flexible 432, 587 fluctuations 63, 78 –9, 82, 728 higher 353 of houses 46 –7 inflation see inflation of land 259 –61 maximum 70, 71–2, 70 minimum 70, 82, 70 under monopoly 168 –9 of non-renewable resources 260, 329 output and 43 –8, 168 –9, 596 output determinants 43 –8, 168 –9 profit-maximising 199, 201, 224 reform (agriculture) 86,735 regulation and 357–8 relative 25, 456, 25 of resources (increases) 260 road space/usage 340 RPI 359, 360, 407, 564, A:7 of securities (changes) 499 short-run equilibrium of firm 160 signals/incentives 21 speculation and 61–4 stickiness 413, 577, 592, 681 supply and 39 –40 taxation and 73, 276 –81, 393, 560 zero 13, 73, 76 prices and incomes policy 559, 560, 610, 559 pricing on buses 54 cost-based 222–4 the environment 332 limit 168 –9, 168 peak-load 198 in practice 222–5 predatory 175, 201, 353, 201 road 345 –7 primary exports balance of payments problems 727– comparative advantage 726 –7 as engine of growth 727 importance of 726 justification for 726 traditional trade theory 727 as vent for surplus 726 –7 primary labour market 246 –7, 246 primary market in capital 256 primary production 727 principal-agent problem 207–8, 242, 306, 207 prisoners’ dilemma 192, 193, 338, 706, 192 private benefits 302 private efficiency 292, 295, 297, 298, 292 Private Finance Initiative (PFI) 616 –17, 618, 630 private monetary costs 315, 316, 342 private non-monetary benefits/costs 315, 316 private property rights 312, 313, 332, 611 privatisation 241, 445, 560, 742 arguments for 355 –6 nationalisation and 355, 356 EC6_Z06.qxd 10/27/05 17:19 Page 29 INDEX privatisation (continued) potential problems 356 –7 regulation and 355– 63 supply-side policies 617, 621 privatised industries behaviour 358 competition in 356, 360 –2 externalities 357, 358 as monopoly 357– privatised utilities 314, 356 electricity industry 360 –1, 362 merger 216 regulation 359 UK 360–2 problem of the second best 308 procurement hubs 165 procurement policies 646, 655 producer sovereignty 648 producer supply 295, 296 producer surplus 295, 305 producers aims of 41 in circular flow 15–16 individual 52 share of tax on goods 75 social efficiency between 298 product alternative (profitability) 41 development 180 differentiation 167, 178 domestic 370 –1, 466 –7 identical 158 method (GDP measurement) 373, 388–9 new 171 production of ‘bads’ 377 in circular flow 15–16 in common market 655 consumption and 377 costs 41, 126 –7, 138 –9, 160, 377, 620 efficency 10 equity 11 external benefits 301 external costs 301 factors see factors of production gains from trade 639 – 40 human costs 377 increasing opportunity costs of 13–14, 13 long-run theory 131– 40 marginal rate of transformation 298–9 methods (change) 404 private efficiency and 298 quotas (agriculture) 85 scale of 131–3 short-run theory 120 –6 social efficiency and 293 –5 subsidy 651 production function 121 Cobb-Douglas 135, 136, 135 short-run 121–5 production possibility curve 12–13, 298 –9, 637, 639, 640, 643, 650, 12 economic growth and 727 macroeconomics and 14 –15 microeconomics and 13 –14 productive capacity 212 productive efficiency 10, 134, 10, 134 productivity of capital 255, 385, 715 deal 238 economic growth and 606 –7 of factors 386, 601 gap 620 importance of 607 of labour 386 of resources 385 profit aims of firms and 120 capital and 249 –58 corporation tax 277, 371, 393, 614, 623, 663 in Cournot model 190 economic 153 meaning of 151–3 mergers and 214 normal 151, 152, 153, 159 –60, 235, 151 in perfect competition 157–66, 235 pure 153 rate of 159 –60, 159 retained 212, 255 short-run equilibrium 161 size of 151 supernormal 153, 161, 162, 164, 180, 235, 306, 348, 153 profit-push inflation 411 profit maximisation 120, 208, 210, 574 –5 alternative market structures 157–8 cartels 182, 184 contestable markets theory 172–6 difficulties in 205 by firms 149 –53 under imperfect competition 177–203 income distribution and 242 labour demand and 232– I:29 long-run 151, 153, 209 –10, 212, 209 loss minimising 153 under monopoly 166 –72 natural monopoly 356 –7 under oligopoly 189 –90 output 150 –1, 152, 199, 201, 295 under perfect competition 157–66 price discrimination and 199, 201 rule 150 short-run 149 –51 stock of capital 254 use of land/capital 249 –50 profit satisficers/satisficing 206, 211, 206 profitability alternative products 41 of banks 484 –6 of goods in joint supply 41 liquidity and 484 –6 progressive taxation 279, 280, 282, 532, 279 prohibition illegal products 77 undesirable structures 313–14 promissory notes 489 property rights 611 changes in 312–13 extending 332 intellectual 623 proportional tax 279, 280, 279 proportionate change 52, 53 –4 proportionate measures (elasticity) 49 proportionate values A:5 protection 679, 681 agriculture 727 bureaucracy and 652 corruption and 652 costs of 650 –2 declining industries 649 effective rate of 730 inefficiency and 652 infant industries 646, 729 most-favoured nation status 652 people’s interests 306 –7 problems with 650 –2 reciprocity 652 retaliation and 652 as second best 651 senile industries 646 strategic trade theoy 647–8 trade restrictions 645 –54 US steel industry 652 world multiplier effects 652 prudential control 487 public goods 302–3, 307, 314, 302 EC6_Z06.qxd 10/27/05 17:19 Page 30 I:30 INDEX public interest 24 alernative maximising theories 218–19 competition policy and 348 –9, 353 contestable markets and 175 monopolistic competition and 180–1 monopoly and 169 –71 oligopoly and 195– ownership and 355 perfect competition and 164 price discrimination and 201 satisficing and 221 public limited company 205 – 6, 256, 205 public opinion, environment and 329 public ownership 315 arguments against 355 – arguments for 355 of nationalised industries 315, 355, 356, 357 of natural monopolies 356 –7 public property 313 public sector debt 495, 530 deficit 494–5, 530 –1, 543, 566 market relationships in 618 surplus 495, 530 –1 public sector borrowing requirement 529 public sector net cash requirement (PSNCR) 51, 529, 581, 529 financing 513 fiscal policy and 529 –30,538, 563 monetary policy and 543, 545, 561 money supply and 494 –5, 496, 561 reducing 612 UK policy 561, 563 public services police as 303 private provision 616 –17 public transport 343, 344, 346, 347 public works 438–9 purchase taxes 278 purchasing power parity 375 Big Mac index 684 –5 exchange rates and 375, 694, 695 gross national income and 723, 724, 725 rates 375, 684–5, 688, 694, 695 theory 683, 693, 683 purchasing power standard GDP 375, 376, 600, 375 pure fiscal policy 534 pure profit 153 qualifications 399, 621, 623, 663 inequality and 271 quality, relative 458 quantiles 265, 267, 265 quantitative controls (foreign exchange) 715 quantity arc elasticity 54 of assets owned 261 of capital 601–3 changes 49 Cournot model 189 –90 demanded 35 demanded (change) 37–8, 113, 39 effect of tax 73 of factors 600 national output 373 –7 supplied 39 supplied (change) 41, 57–8, 41 quantity theory of money 436, 443, 448 –9, 505, 436 aggregate demand and 440 –1 questionnaires 318 queues 71 quintiles 265, 268, A:4, 265 quotas 184, 423, 184 CAP 85 cartels 182–4, 187, 188, 184 IMF 691 new cars (Singapore) 346 trade restrictions 645, 652 racial discrimination 243 – radical left 448 radical right 447 railways 340, 341, 346, 347, 356, 359 random shocks 475, 535, 553 determinants of supply 41 random walk 258 rate of discount 253, 319, 484, 547, 551, 253 rate of economic growth 368 rate of exchange see exchange rates rate of inflation 6, 368 –9, 407–8, 413 –14, 423, 523 –4, 562, 6, 369 rate of interest see interest rates rate of profit 159 –60, 159 rate of return approach (to investment) 253 –4 on assets 499 internal (IRR) 253 normal 255 supernormal 255 rational behaviour consumer 95, 98 economic 292 rational choices 8, 10, 292, 324, rational consumer 92, 95, 98, 109, 116, 293, 92 rational consumer behaviour 95, 98, 95 rational decision making 9, 10, rational economic behaviour 292 rational expectations 447, 587–90, 594 –5, 587 rational producer behaviour 120 rationalisation 132, 213, 349, 132 as industrial policy 622 rationing 19, 71–2, 323, 71 credit 544, 551–2, 560 raw materials 4, 133, 385, reaction function (or curve) 189 Reagan administration 283, 325, 612, 613, 694 Reaganomics 613, 694 real-wage unemployment 401–2, 401 real balance effect 406 real business cycle theory 381, 447, 590 –2, 447, 591 real exchange rate 670 –1, 673, 678, 679, 695, 670 real GDP 374 real income 34, 110 real interest rates 730 real national income 452–3, 505 –12, 526 real values 374, A:6 recession 6, 216, 387, 454, 463, balance of payments deficits 673, 681 in business cycle 380, 381, 471–6 debt problem 740 –1, 742 Great Depression 437–9, 529 hysteresis 445, 578, 593, 445, 578 Japan 506, 536 –7 managed floating 693 –4 unemployment and 396, 402, 618 reciprocity (GATT rule) 652 rectangular hyperbola 52 red tape 612, 623, 729, 737 rediscounting bills of exchange 488 –9, 545, 548, 488 redistribution see income redistribution redundancies 239, 246, 616, 662 reference value 548, 549, 711 reflation 591, 681, 690 budgets (1972/1973) 559 fiscal policy 413, 442–3, 413 monetary policy 413, 442–3, 413 refusal to supply 353 EC6_Z06.qxd 10/27/05 17:19 Page 31 INDEX Regional Development Agencies (RDAs) 622, 627, 630, 627 regional electricity companies 360, 362 Regional Greenhouse Gas Initiative 337 regional interdependence 706 –18 regional multiplier effects 625, 657, 662, 625 regional policy 404 approaches 626 disparities 624 –5 effectiveness 627 EU 622, 628 – 9, 659, 712 government attitudes 630 imbalance (causes) 625 interventionist policies 626 UK 627, 628 –9 Regional Selective Assistance (RSA) 627 regional unemployment 404, 624 – 6, 627, 404 regression analysis 39, 42, 39 regressive taxation 279, 280, 335, 279 regulation 626 assessment (UK) 359 – 62 command-and-control 333, 336, 338, 333 in common market 655 electricity industry 360 –1, 362 in EU 660 optimum price and output 357– privatisation and 355 – 63 privatised utilities 359 transport policy 344 –5 in UK 359– 62 undesirable structures 313 –14 see also legislation regulatory bodies 314 regulatory capture 362 relative efficiency 637 relative incomes 25 relative poverty 264, 271, 272 relative price 25, 456, 25 relative quality 458 renewable resources 260 rent 249, 252 control 71 determination of 259 economic 232, 261, 232 land and 259 – 61 rental value 261 replacement cost 127 repos/repo rate 483, 488 –9, 545 – 6, 548, 549, 550 –1, 483 resale price index 359, 360, 407 resale price maintenance 352 rescheduling debt 741–3, 744 research and development 171, 305, 349, 387, 423, 743 reserve ratios, minimum 542–3, 544, 546 –7, 542 reserves 418 –19, 423, 688 resources allocation 10 –11, 17, 19, 20, 23, 164, 297, 324, 325, 445 common 303–4, 313, 330, 331 crowding out 438 depletion/damage 390 distribution of environment as 328 –9, 331, 332 factors of production flow (customs union) 657 increasing quantity 378, 384 –5 inflation and 409 non-renewable 260, 329, 379 output and 120 productivity of 385 renewable 260 use of 14 restricting trade arguments for 645 –54 comparative advantage 636 – 40, 642, 646 economic arguments for 646 –50 methods 645 –6 non-economic arguments 650 protection problems 650 –2 World Trade Organisation 652– restrictive practices 349 –51, 359, 349 retail banks 481, 482, 488, 481 retail deposits and loans 481 retail market for electricity 360 –1 retail outlets (ownership/control) 167 retail price index 359, 360, 564, A:7 see also consumer price index (CPI) retail price maintenance 352 retailers 165, 353 retaliation 647, 652 returns to scale 136 constant 131, 142, 604 revaluation 676, 691, 676 revenue curves 146 –9 revenue of the firms costs and 149 –53 curve 146 –9 total, average and marginal 144 – revenue maximisation 200 reverse repos 484 reverse shocks 592 Ricardo, David 97, 637 risk 64 I:31 attitudes towards 101–2, 208 –9, 739 aversion 102, 193 in cost-benefit analysis 318 –19 demand under conditions of 100–5 diminishing marginal utility of income 102–3 independent 104 insurance and 104 investment 254 loving 102, 193 neutrality 102 premium 151 spreading 103, 648, 103 survival and 208 –9 taking 102–3, 612, 619 tranformation 481 uncertainty and 64 –6, 100 –5, 318–19 rivalry 189 –91, 214, 221, 248, 331 road-building schemes 343–4, 357, 735 road accidents 339, 342 road pricing 345 –7 road safety 317, 318 road space building schemes 343 –4, 357, 735 demand for 340 –1 environmental impact of roads 344 existing system 340 –1 long-run supply 341 short-run supply 341 socially optimum level 343 supply of 341 traffic congestion 339 –48 road usage 341–3, 345 Roskill Commission (1968) 318 Rowntree Foundation inquiry 272 RPI minus X formula 359, 360 rules 564 discretion and 565 –70 rules of thumb 185 –8, 205 rural-urban migration 721, 738 –9 rural co-operatives 736 rural development 86 rural infrastructure projects 735 rural way of life 78 Russia 18 –19, 217, 336, 337 salaries see wages sale and repurchase agreements (repos) 483, 488 –9, 545 –6, 548, 549, 550 –1, 483 sales, tie-in 353 sales revenue maximisation 210 –12, 218 –19, 210 price elasticity of demand 48 –52 total 51 EC6_Z06.qxd 10/27/05 17:19 Page 32 I:32 INDEX satisficing 219–20, 221 savings in circular flow 371 consumption and 457 determinants 455 effect of increase 602–3, 605 golden-rule savings rate 603 interest rate and 516 investment and 372 marginal propensity to save 455, 466–7, 470, 734, 455 net 371, 455, 457 optimum rate 603 paradox of thrift 467 as withdrawals 371, 455, 457 Say, Jean-Baptiste 436 Say’s law 436, 441, 436 scarcity 4, 8, 20, 23, 297, abundance and 13 problem of 4–5, 13 rationing 19, 71–2, 323, 71 search procedure 220 search unemployment 403 seasonal unemployment 404 second-best solution 309, 317, 309 policies 310 privatised industries 357– problem of 308 protection as 651 second-degree price discrimination 197 second derivate A:12 second derivative test A:12 secondary action 241, 615, 241 secondary labour market 247 secondary market in capital 256 secondary marketing of assets 485 securities 256, 494, 499 Securities and Exchange Commission 215 security prices 499 Selective Finance for Investment 627 selective intervention 614, 622–3 self-employment 267, 280, 376 self-fulfilling speculation 62 self-interest 23, 25, 98 –9, 296, 304, 335 self-sufficiency 82, 650, 725 sellers 61–2, 64, 65 semi-strong efficiency (share market) 257 senile industry (protection) 646 sensitivity analysis 318 –19, 318 Serious Fraud Office 352 services balance 416 circular flow 15 –16 competition (EU) 661 deadweight loss from tax on 311 direct provision of 314 –15 domestically produced 370 –1, 370 free movement 655 free at point of delivery 76 –7 production prohibiting sale of illegal 77 taxes on 280, 311 set-aside scheme 85, 86, 85 sex, income inequality by 269 sexual discrimination 244 –5 shadowing the mark 562 share markets (weak efficiency) 257 shareholders 207, 212, 214, 356, 619 shares 212, 213, 255 efficient market hypothesis 257–8, 257 equities 255 –6, 255 on-line dealing 618 yield on 258 shirking 242, 243 shocks asymmetric 713 economic 294 fixed exchange rate 678 –9 oil price 740 –1 random 41, 475, 533, 535 reverse 592 supply 411, 579 short-run 57, 120 –1, 139, 120 adjustment 61 aggregate demand 424 –5 aggregate supply 574 –5 consumption function 454, 537 effect (internal shock) 678 equilibrium of firm 160 –1, 178 macroeconomic equilibrium 451–77 optimum price and output 357–8 under perfect competition 158 –62, 158 Phillips curve 447, 590, 591, 593 –6 profit maximisation 149 –51 sales revenue maximisation 210 –12, 210 socially efficient road usage 341–3 supply of capital services 251 supply curve 161–2 supply of road space 341 variability of velocity circulation 510, 511 short-run average cost curves 142 short-run costs average and marginal 128 –30 inputs and 127 marginal 128 –30, 358 measuring production costs 126 –7 total cost 127–8 short-run shut-down point 153 –4, 153 short-run theory of production 120 average and marginal product 123 –5 changes in production 120 –1 law of diminishing returns 121 production function 121–5 total product 121–3 short-term economic growth 377–84 short-term finance 255 short-term loans 484 short-term operation of monetary policy 542, 543 –4 short-term price fluctuations 78 –9 short-termism 256 –7, 359, 620, 256 shortages 20, 21, 323 sickness benefit 285 side-effect problems (taxation and subsidies) 310 side-effects see externalities side streets (no entry) 345 sight deposits 482, 490, 482 signs (negative/positive) 49 simple dominant strategy games 191–2 simple linear function A:8 –A:9 single currency 655 European see euro Single European Act (1987) 324, 618, 660, 661, 710 Single European Market 216, 618 benefits and costs 660 –2 features 663 Internal Market Scoreboard 662, 664 legislation 324 single farm payments 86 Single Regeneration Budget 630 size distribution of income 264–70, 264 skills deskilling 400, 445, 578, 593 shortages 620 transferable 620 slowdown (in business cycle) 380 see also recession slump (in business cycle) 380 see also recession small firms 267 assistance to 622–3 smart card (in cars) 347 Smith, Adam 22, 24 –5, 97 smuggling 75 Snowdon, Philip 437 EC6_Z06.qxd 10/27/05 17:19 Page 33 INDEX social-impact standards 333 social benefit 301 marginal 292–3, 301–2, 342 road usage 342 social chapter (Maastricht Treaty) 660 social charter 659 – 60 social cost 301, 620, 731, 301 marginal 293 – 4, 301–2, 304, 309–11, 330, 342 of pollution 312 road usage 342 social effects (economic growth) 379 social efficiency 292, 297, 292 approach (environment) 330, 331, 334 in exchange 298 –9 externalities and 293, 295, 300 –2, 308 general equilibrium and 294, 295 –7 in goods market 298–9 government intervention 300 –15 imperfect markets 300 –15 improvement 292–3, 298 –9, 292 intermediate analysis 297 through the market 293 –5 Pareto optimality 292– 6, 297, 298–9, 292 under perfect competition 295, 298–9 simple analysis 292–3 sustainability and 330, 331 taxes/subsidies to achieve 309 –12 urban transport policy 341–3 Social Exclusion Unit 272 social implications of choice 12 social indifference curve 299, 643 social justice 314, 357 social objectives, markets and 26 social policy (EU) 659 – 60 social protection benefits 285, 286 social rate of discount 319, 330, 319 social science, economics as 28 social security employer contributions 277 individual contributions 277, 279 taxation and (unified system) 287 see also benefits; national insurance contributions socialisation process 271 socialism 324–5 ‘soft buffers’ 717 Solow, Robert 601 Solow growth model 601–2 Soros, George 717 sound finance 434 Southern Common Market 657 Soviet Union 18 –19, 20, 21, 337 Spahn, Paul Bernd 717 special deposits 547 special treatment (domestic industries) 655 specialisation 132 as basis for trade 636 in China 732 division of labour 132, 207, 132 efficiency 10 limits to 640 –1 specific tax 73, 278, 73, 278 spectrum diagram 17 speculation 47, 62, 421, 552–3, 679 –80, 684, 62 adjustable peg system 691 currency stability and 714 –16 demand for money 497, 499 –500, 555 destabilising 63, 64, 463, 511, 685 –6, 687–8, 693, 694, 696, 63 free-floating exchange rate 684, 686– managed floating 692, 694, 695 price expectations and 61–4 self-fulfilling 62 stabilising 63, 64, 685 –7, 688, 63 see also risk; uncertainty speculators 62, 64, 65, 502, 62 spot price 65 spreading overheads 132 spreading risks 103 stabilising exchange rates 676, 706 –10 farm income 79 – 80 prices (buffer stocks) 80 –1 speculation 63, 64, 685 –7, 688, 63 Stability and Growth Pact 540 –1, 543, 711, 713 stagflation 443, 445, 559, 443, 559 demand management policies 559 – 60 explanation of 584 –5 Keynesian analysis 443, 552, 592 problem of 559 –60 response to 560 stakeholders 219–20, 219 Stalinist system 18–19 standard of living see living standards standardised unemployment rate 397, 399, 397 statistics (economic analysis) data in A:2–A:6 elementary differentiation A:9 –A:12, A:9 I:33 functional relationships A:7–A:9, A:8 index numbers A:6 –A:7, A:6 real-life A:2–A:4 true picture from A:4 –A:6 statutory cash ratios 547, 548 statutory reserves 544, 560 steady-state growth path 605 level of national income 602, 604 –5, 602 ‘steady as you go’ approach 560, 561 sterilisation 672, 674 sterling 419 –20, 423, 670, 671 assets 483 –4 crisis 694 –5 demand/supply 422 managed floating 693, 694 –5 Stimulus Bill (USA) 532 stock appreciation 389, 390, 389 Stock Exchange 256 –7, 485, 617–18, 620 stock market 255, 256, 463 role 256 – stocks and flows 251 fluctuations (business cycle) 475 in GDP measurement 388 –9 risk 65, 66 stop-go policies 442, 557, 560, 561, 562, 691, 442, 557 straight-line demand curve 56, 148 strategic alliances 214 –18, 214 strategic trade theory 647–8, 648 strict Pareto criterion 322 strike action 239, 241, 615 strong efficiency (share market) 257–8, 257 structural adjustment 741, 743 structural change 679 structural deficit/surplus 531 Structural Funds 628 –9, 630 structural inflation 412 structural policies agriculture 83 income redistribution 274 –5 unemployment 446 structural problems 445 developing countries 735 –40 structural reform 313, 743 structural unemployment 403 –4, 412, 436, 446, 577, 593, 620, 662, 403 subcontracting 218 subsidiaries 217 EC6_Z06.qxd 10/27/05 17:19 Page 34 I:34 INDEX subsidies 623 advantage of 312 in agriculture 81–2, 84, 86 in depressed areas 626 disadvantage of 312 environment 333 GDP measurement 389, 390 –1 government intervention 309 –12 income method (GDP measurement) 389, 391 income redistribution 274 privatisation and 358 protection and 646, 647 taxation and 309–12 trade restriction by 646 –7, 648, 651 transport 347, 357 subsistence production 17 substitute goods 34, 36, 41, 51, 60, 341, 36 substitutes in supply 41 substitution effect 34, 35, 532, 34 aggregate demand 406 exchange rate 674 –5, 674 expenditure switching 674 –5, 674 inferior goods 114 normal goods 112–13 of price change 111–16, 112 tax cuts 613, 626 tax rise 282–3, 282 wage rise 230 sulphur-free fuels 320 –1 sunk costs 126, 173 supernormal profit 153, 161, 162, 164, 180, 235, 306, 348, 153 supernormal rate of return 255 suppliers 41 speculation 61–4 supply 5, 15 aggregate see aggregate supply background 119 –55 of capital for purchase 252 – of capital services 250 –2 change in 21–2, 41–2, 44, 76 –7, 41 determinants 41 elastic 74 equations 42, 45, 58 in free-market economy 435 inelastic 74 joint 41, 42, 41 of labour see labour supply of money see money supply of physical capital 254 price and 39–40 price elasticity of 57– 8, 57 problems (agriculture) 78 reductions (agriculture) 82–3 of road space 341 Say’s law 436, 441 shocks 411, 525 –6, 579 substitutes in 41 time dimension 61–6 supply-side economics 433 supply-side effects, adverse 532 supply-side inflation 411–12, 413, 414, 610 supply-side policies 6, 385, 413, 532–3, 560, 596, 606, 679, 681, 743, 6, 413 capital movements 612, 618 competition and 616 –18 demand-side and 610, 611–12 deregulation and 613, 617–18 economic growth 610 exchange rate 683 fixed exchange rate 423 free trade 618 government expenditure 612–13 inflation and 411–12, 413, 414, 610, 413 interventionist 611, 619 –24, 626, 611 Keynesian approach 611 labour power and 615 macro objectives and 610 market-orientated 610, 612–19, 610 neo-Austrian/libertarian school 610 new classical approach 610 –11 in 1980s 612 regional and urban policy 624 –31 tax cuts and 613 –15 Third Way 611, 616 –17, 624 transport policies 343 –4 unemployment 586, 610, 614 in USA 613 welfare reduction and 612, 615 –16 supply curve 40–1, 43, 57–8, 224, 642–3, 40 aggregate 405 –7, 409 –11, 433, 438 –9, 447, 524 –5, 574 –5, 577–9, 586 agriculture 85 – bilateral monopoly 237, 238 –9 of capital 254 of capital services 250 –2 elasticity of 73 –5 identifying position of 45 –8 indirect taxes and 73 of labour 231 long-run industry 162–3 movements along 41–2 shifts in 41–2, 44, 45, 48, 421–2 short-run 161–2 supply schedule 40 supply shocks 411, 525 –6, 579 surpluses 20 agriculture 80 –1, 84 –6 deficits and 416, 529 general government 530 government intervention 323 public sector 495, 530 –1 vent for 726 –7, 726 survey data 42 survival 208 –9 sustainability 330, 331, 333, 330 sustainable communities 630 sustainable development 653 sustainable economic welfare, index of (ISEW) 390 –1 sustainable output 382–3, 577, 382 sweatshops 248, 660 Sweezy, Paul 190 syndicated loans 482 table A:8 tacit collusion 184, 350, 184 price leadership 184 –5 rules of thumb 185 –8 takeover bid 190 takeover constraint 212 takeovers 183, 213, 313, 488, 619, 657 barrier to entry 167 tap stock 487 target-setting exchange rate 562–3, 566, 716 –18 by firms 219 –20 inflation 413, 523, 524, 563, 564, 566 –70, 579 –60, 585, 669, 695 –6, 706 money supply 444, 507, 511–12, 552, 566, 696 tariffs 82, 167, 278, 423, 650 –1, 657, 726, 82, 278 ad valorem 645 binding 652 common external 659 effective rate of protection 730 escalation 728 –9, 736, 728 GATT 652 –4 optimum 649 taste 36, 164, 221, 727–8 consumption and 454, 458 demand for road space 341 influence of trade 648, 727 structural unemployment and 404 tax-push inflation 411 tax credits 272 EC6_Z06.qxd 10/27/05 17:19 Page 35 INDEX taxation 77, 400, 438 ad valorem 73, 278, 73, 278 advantage of 312 allowances 277, 283, 614, 277 average rate 277, 280 avoidance 276, 280, 717, 276 balance of 279 basic rate 277, 282–3, 284 –5, 277 benefit principle of 276 capital gains 277 changes 535, 537, 538 –9 collection costs 276 in common markets 655 concessions 623, 626, 737 consumption and 454 convenience requirements 276 corporation 277, 371, 393, 614, 623, 663 correcting for monopoly 310 –11 council 278, 625, 630 credits 272, 287– 8, 622 cuts 280, 283, 284 –5, 356, 511, 532, 613–15, 626 direct see direct taxation disadvantages 312 disincentives 276, 287 in EU 659, 660, 663 evasion 276, 280, 276 excess burden of 311 export 646, 649 fiscal policy and 532, 538 –9 GDP measurement 389, 390 –1 as government intervention 309 –12 green 333, 334 –5, 338, 521 higher rate 282 incentives and 282 –5, 613–15 incidence of 74 –5, 280 –1, 74 income see income tax income redistribution 274 –5, 279–82 indirect see indirect taxation inheritance 270, 271, 277 local authority 278, 625, 630 lump-sum 279, 280, 310 –11 marginal rate 277, 279, 282, 613, 614 negative 371 net 371, 455– non-distortionary 276 pollution 260, 293, 310, 312, 331–2 privatisation and 358 progressive 279, 280, 282, 532, 279 proportional 279, 280, 279 regional policy and 626 regressive 279, 280, 335, 279 road usage and 345 social security and (unified) 287 specific 73, 278, 73, 278 subsidies and 309 –12 supply-side policies 613 –15 system (requirements) 275 –6 threshold 280, 282, 285 of tobacco 75 Tobin 715–17 types (UK) 276 –9 undesired incidence 280 –1 VAT see value added tax (VAT) on wealth 277–8 as withdrawal 371, 455 –6 Taylor rule 567, 568 –9, 678, 567 team work 247 technical diseconomies 142 technical inefficiency 172 technological change 560 technological developments 329, 727 technological progress 601–6 technological unemployment 404, 560, 593, 662, 404 technology 141 agricultural 735 – -based standards 333 capital-intensive 135, 626, 640, 730, 736, 737 development/spread 386 developments (environment) 329 EU 662, 663, 665 inappropriate (developing countries) 736 –7 rapid spread (customs union) 657 see also information technology telecommuting 231 temporary unemployment 397 temporary workers 620 tendering, collusive 352, 354, 352 tendering process 616 terms of trade 641 comparative advantage and 642 in customs union 657 determination of 642–3 developing countries 728 improvement (market power) 648 –9 textile mill (Victorian England) 238 Thatcher government 47, 325, 355, 401, 543, 612, 613, 615, 618 monetarism under 444, 560 –1, 694, 695 theory (role/usefulness) 210 third-degree price discrimination 197, 199, 201, 197 Third Way policies 611, 616 –17, 624 Third World see developing countries threats/promises (game theory) 194 I:35 threshold concepts 8, T:1 threshold hypothesis 391 thrift, paradox of 467 thriftiness 254 Thurow, Lester 647 tie-in sales 353 time comparison (statistics) A:6 costs of (traffic congestion) 342 deposits 482–3, 490, 482 dimension 61–6, 100 lags 306, 475, 535, 536 –7, 554 time-series data A:2–A:3, A:2 index numbers A:6 –A:7, A:6 time periods decision-making 139 –40 for price elasticity 50, 57 for profit-maximisation 205 timing, importance of (oligopoly) 194 timing problems (fiscal policy) 535–8 tobacco duties/taxation 75 Tobin, James 715, 716 Tobin tax 715 –17 tolls (on roads) 345 total (private) surplus 295, 305, 295 total consumer expenditure 50 –1, 457, 51 total consumer surplus 95 –6, 305, 95 total costs 127–8, 149 –50, 152, 127 total currency flow 669, 672 total curves 149 –50 total demand for money 500 –1 total expenditure 95 –6 total factor productivity 606 total fixed cost 127–8 total market demand schedule 35 total physical product 121–5, 135–6, 138, 121 total producer surplus 294, 305, 294 total profit 149 –50, 152, 224 total quality management 247 total revenue 51, 144 –6, 148, 149–50, 51, 144 total social surplus 295 total utility 92, 93 –6, 97, 102–3, 104, 92 total variable cost 127–8, 294 total withdrawals function 371, 458 totalitarianism 325 totally fixed exchange rate 671 totally inelastic demand 51–2 tradable permits 336 –8, 336 trade in common market 655 creation 655 –6, 657, 660 –1, 665, 655 EC6_Z06.qxd 10/27/05 17:19 Page 36 I:36 INDEX trade (continued) deficit 416 and development 653 diversion 656–7, 662, 656 as engine of growth 644 equality and 727 as exploitation 640 in goods account 416 interdependence through 703 – international see international trade limits to 640–1 restrictions see restricting trade rounds (WTO) 652 – in services account 416 strategies 725–6 terms of see terms of trade traditional theory 727 unfair practices 647, 648 trade-offs 8, 307 trade cycle 379 see also business cycles trade unions 236, 401, 432, 560, 593 closed shops 241, 615, 241 collective bargaining 239 – 41 in developing countries 730 industrial action 239 – 41, 615 labour movement 240 –1 membership 240–1, 660 monopoly 237–8, 273, 612 promises/threats 239 secret ballots 615 traded goods 723, 725 traders, uncertainty for 688 traditional theory of the firm 120 problems with 205 –9 traditional trade theory 727 traffic congestion (urban policy) 339 road space (existing system) 340 –1 socially efficient road use 341–3 socially optimum road space 343 solutions 343–7 training 423, 736 alternative approaches 620 –1 schemes 623 Training and Enterprise Council 621 transactions 497–9 transfer payments 371, 372, 390, 393, 371 transfers of money 416 transmission mechanism direct monetary 509–11 exchange rate 508 – Keynesian 505–8, 511 Transport Act (2000) 347 transport costs 133, 251, 316, 349, 641, 657 transport policies, urban 339 –48 transport subsidies 347, 357 transposition deficit 662, 664, 665 Treasury 437–8, 439, 486 Treasury bills 484, 487, 488, 494, 495, 529, 545, 547, 550, 484 Treaty of Amsterdam 350, 352, 659, 715 Treaty on European Union see Maastricht Treaty Treaty of Rome 83, 659 trend growth rate 383 turnover (sales revenue) 212 two-factor case (long run) 134 two-year foundation degrees 621 U-form (corporate organisation) 206 uncertainty 66, 317, 688, 66 attitudes towards 101–2 cost-benefit analysis 318 –19 demand under 100 –5 ignorance and 306 lack of investment and 409 mergers to reduce 214 reduced (growth through) 213 risk and 64 –6, 100 –5, 318 –19 underconsumption 467 underdevelopment problem 721–5 underemployment 737 underground economy 19, 376 –7 see also black markets undesirable structure/behaviour 313 –14 unemployed long-term 400, 595 number (economist’s definition) 396 unemployment 6, 19, 368, 432, 650, 704, age factor 399 aggregate demand and 372, 400 –3, 445 aggregate supply and 400 –1, 403, 445, 581 Argentina 742 benefit 272, 285, 368, 371, 397, 400, 403, 532, 543, 614, 615, 616, 626 business cycle and 396, 398, 402–3 causes 400 –4 in circular flow 441–2 claimant 397, 624, 397 classical Treasury view 438 composition 399 –400 costs of 400 cyclical 396, 402–3, 402 demand-deficient 402–3, 410, 424 –5, 440, 447, 469 –70, 577–8, 593–4, 610, 681, 402 in developing countries 725, 737– 40 disequilibrium 400, 401–3, 432, 577, 615, 669, 401 disguised 737 duration 397–9, 403, 414 equilibrium see equilibrium unemployment ethnic groups 399 –400 frictional (search) 403, 414, 435, 577, 610, 403 geographical differences 399 inflation and 408, 413 –15, 437, 448, 470, 557, 586 –95 inflow/outflow 397–9 involuntary 400 Keynesian analysis 402, 440, 445, 468 –71, 592–5 labour market and 399, 400 –1, 402 macroeconomic objectives 424 –7 meaning of 396 monetarist approach 444 natural see equilibrium unemployment natural level 401, 444, 447, 532, 537, 577, 590, 577 natural rate 444, 447, 583, 610, 678, 583 new classical position 586 –92 non-accelerating-inflation rate of 583, 593, 583 official measures of 397 poverty and 273, 274 rate 396, 397, 399 –400, 396, 397 real-wage (classical) 401–2, 401 reducing (Third Way) 624 regional/regional policy 404, 624 –7, 404 seasonal 404 structural 403 –4, 412, 436, 446, 577, 593, 620, 662, 403 supply-side policies 586, 610, 614 technological 404, 560, 593, 662, 404 temporary 397 underemployment 737 urban policy 624 –31 voluntary 587, 615 Welfare to Work policy 624 see also Phillips curve unfair trade practices 645, 647 unions see trade unions UNISON 241 unit elasticity of demand 50, 52, 50 unitary form (corporate organisation) 206 EC6_Z06.qxd 10/27/05 17:19 Page 37 INDEX United Nations 747 Conference on Environment and Development (UNCED) 745 Development Program (UNDP) 724 United States airline deregulation 174–5 budget deficit 694 cartels 351 exchange rates 686 –7, 691–2, 694 –5 globalisation and 703, 704, 705 Justice Department (Microsoft case) 170–1 managing the economy 532 merger activity 216 –17 monetary policy 547 Reaganomics 613, 694 steel industry 652 trade imbalance 705 training approach 620 universal benefits 284, 287, 284 unpredictable events (determinants of supply) 41 unstable demand 507– 8, 552–3 upturn phase (business cycle) 380 urban policy approaches 626 developing countries 721, 730 effectiveness 630 interventionist policies 626 rural-urban migration 721, 738 – transport 339 – 48 in UK 627, 630 wages and 626 Urban Regeneration Agency (URA) 630 urban regeneration companies 630 urban sector (dualism) 737 urban shantytowns 721, 738 Uruguay Round 652– user charges 332 util 92, 93, 288, 92 utility demand for road space 341 interpersonal comparisons 288 marginal see marginal utility maximisation 206, 208, 210 total 92, 93 – 4, 95 – 6, 97, 102–3, 104, 92 utility curves (total/marginal) 93– vacancies 403, 432 value elasticity 49 –50 future claims/payments 480 labour theory of 97, 229 value-in-exchange 97 value-in-use 97 value added (in GDP) 388, 389, 390 value added tax (VAT) 73, 276, 277–8, 371, 393, 400, 412, 560, 561, 614, 659, 663, 278 values absolute A:5 nominal 374, A:6 proportionate A:5 real 374, A:6 variable costs 127 variable factors 120, 406, 120 variable minimum reserve ratios 546 –7, 549 velocity of circulation 370, 436, 510, 511–12, 548, 566, 436 vent for surplus 726 –7, 726 vertical equity 275, 280, 275 vertical integration 183, 212–13, 361 vertical merger 213, 217, 349, 361, 213 vertical price-fixing agreements 352 vertical restraints 353 visibles 416 vitamin cartel 351 vocational training 620 –1, 623 voluntary agreements (VAs) 334 –5 voluntary economic interaction 24 voluntary unemployment 587, 615 wage-push inflation 411 wage determination collective bargaining 239 –41 firms with market power 237, 238 –9 in imperfect markets 236 –48 labour with market power 237–9 perfect competition 228 –36 wage inflation 408 Phillips curve 414 –15 wage setters 237 wage takers 228, 230, 228 wages 210 in developing countries 640 efficiency 241–3, 447, 593, 241, 593 equal pay 235, 244 –5, 660 equality method 235, 244 –5, 660 EU 660, 665 flexibility 432, 587 of homeworkers 232 imperfect markets 236 –48 locally negotiated 626 market-clearing 243, 730, 736 minimum (legislation) 70, 240 –1, 248, 274 –5, 660, 730 occupational distribution 268 –9 under perfect competition 228 –36 rates 238 –9, 242, 268, 640 real 401–2, 577–8 I:37 stickiness 402, 403, 413, 439, 447–8, 577, 592, 596, 669, 681 unemployment and 396, 401–2, 403, 440 wages councils 274 waiting lists 76, 323 Wall Street crash (1929) 437, 652 Walras, Leon 97, 324 War Communism 18 War on Want 715, 716 warehousing costs 349 waste, elimination of 247 waste disposal 301, 328, 332 weak efficiency (share markets) 257 wealth 236, 261 distribution of 264, 270 –1 international comparisons 721, 725 money as store of 480 national 479 taxes on 277–8 Websites A:3, A:14 –A:16 weighted average A:7 welfare loss (deadweight) 281, 305 measurement 377, 390 –1 reducing (supply-side policies) 612, 615 –16 Welfare to Work policy 624 White Knight stragegy 214 whole curve 52–3 whole industry (size) 133 –4 whole market 52 whole public sector 529 –30 wholesale banks 481–2, 488, 481 wholesale deposits and loans 482 wholesale market (electricity) 360–1 wholesale outlets (ownership/control) 167 wide monetary base 490, 491, 490 Williamson, John 716 –17 Williamson, O.E 210 windfall tax 310 Windows system 170 –1 with trade position (two-goods model) 643 – withdrawals 370, 555, 370 in circular flow 370 –2, 373 imports as 371, 456 injections and 372, 436, 463 –5, 467, 479, 513, 515, 530 marginal propensity 458, 464–5, 458 multiplier 463 –5, 466 –7 national income and 370 –2, 455 –60, 463 –5 savings as 371, 455, 457 shift in 465 EC6_Z06.qxd 10/27/05 17:19 Page 38 I:38 INDEX withdrawals (continued) tax as 371, 455–6 total (function) 458 women equal pay 244–5 income inequality 269 unemployment 399 work marginal disutility 229–30, 229 see also employment; labour Work-based Learning for Adults 621 workers output per 606 supply of hours by 229 surplus 243 see also labour workforce increase (economic growth) 603– working age, output and 606 working conditions (in EU) 660 working hours 228, 229 –30, 271, 606, 613–14, 660 working population 384, 386 working to rule 239 working tax credit 288 Workplace Parking Levy 347 World Bank 708, 716 –17, 730, 743 HIPC initiative 744 –6, 747 world depression 681 world multiplier effects 652 World Trade Center 175, 460, 532, 535, 564, 569 World Trade Organisation 652– 4, 703, 727, 734 worldwide merger activity 216 –17 X inefficiency 172, 208, 733 Yeltsin, Boris 19 yield (on a share) 258 zero price 13, 73, 76 ... 4.4 2. 6 1.8 2. 2 1.0 5.3 3.8 2. 4 1.5 1.5 10.9 4.3 4.0 1.7 1.9 2. 9 2. 0 2. 4 2. 1 2. 7 4.3 2. 8 2. 5 3.0 2. 9 3.5 3 .2 2 .2 2.1 2. 0 4.6 3.6 2. 6 2. 6 2. 6 5.4 8.1 3.0 1.8 2. 8 6.5 7.9 5.8 6.9 5 .2 8.8 8.3 6.1... position 24 35 20 1 948 89 20 6 −14 − 52 – −30 −504 −36 −35 −3 32 29 2 −8 – 37 4067 −316 1470 1 92 −446 25 − 127 −8 −43 −537 −36 28 − 920 −718 20 9 3 82 52 64 02 −917 23 68 365 −1160 −109 20 6 −58 −36... 3.6 2. 8 3.8 Inflation 1960–9 1970–9 1980–9 1990–9 20 00–5 3 .2 5.0 2. 9 2. 2 1.4 4.4 13.9 11 .2 4.7 2. 7 4.9 9.0 2. 5 0.8 −1.3 4.1 13.0 7.4 3.9 1.8 2. 8 6.8 5.5 2. 4 2. 2 3.7 10.3 7.4 3.3 2. 1 3.1 9 .2 8.9