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STAVROPOL STATE MEDICAL ACADEMY
Home History, Politology, Economics Department
L.A. Limanskaya, S.V. Znamenskaya, L.V. Malkina
ECONOMICS.
PRACTICAL WORK.
Textbook for students of General Medicine
and Dentistry in the English-speaking Medium
Stavropol 2007
Федеральное Агентство по здравоохранению и социальному развитию
Ставропольская государственная медицинская академия
Кафедра Отечественной истории, политологии, экономики
The Federal Agency in Health Protection and Social Development
The Stavropol State Medical Academy
Home History, Economy, Management and Marketing Department
Л.А. Лиманская, С.В. Знаменская, Л.В. Малкина
L.A. Limanskaya, S.V. Znamenskaya, L.V. Malkina
ПРАКТИКУМ ПО ЭКОНОМИКЕ
Учебное пособие для студентов лечебного и
стоматологического факультетов англоязычного отделения
ECONOMICS. PRACTICAL WORK.
Textbook for students of General Medicine
and Dentistry in the English-speaking Medium
Ставрополь 2007
Stavropol 2007
УДК 330+61
ББК 65:53/57
Л 58
Практикум по экономике. Учебное пособие для студентов лечебного и
стоматологического факультетов англоязычного отделения (на английском языке)
Ставрополь: Изд-во СтГМА. – 2007. – с.
Economics. Practical work. Textbook for students of General Medicine and Dentistry in the
English-speaking Medium. – Stavropol: StGMA. – 2007. – p.
ISBN 5-89822-086-0
Учебное пособие включает в себя практические материалы по основным темам
курса «Экономика» для студентов неэкономического вуза. В структуру занятий входят
вопросы для дискуссии по темам лекций, вопросы и упражнения по текстам пособия
Economics for Medical Students. Textbook for students of General Medicine and Dentistry in
the English-speaking Medium. – Stavropol: StGMA.– 2006., материалы экономического
тренинга с использованием дополнительных текстов, а также работа со словарем (English
Economy Dictionary with Definitions. (For students of General Medicine and Dentistry in the
English-speaking Medium). – Stavropol: StGMA. – 2006.) и глоссарием.
АВТОРЫ:
Лиманская Любовь Алексеевна,
кандидат экономических наук, доцент, зав. кафедрой Отечественной истории,
политологии, экономики Ставропольской государственной медицинской академии.
Знаменская Стояна Васильевна,
кандидат педагогических наук, доцент кафедры иностранных языков с курсом латинского
языка Ставропольской государственной медицинской академии.
Малкина Лидия Викторовна,
Ст. преподаватель кафедры Отечественной истории, политологии, экономики
Ставропольской государственной медицинской академии.
РЕЦЕНЗЕНТЫ:
Туманян Юрий Рафаэлович,
доктор экономических наук, профессор, декан экономического факультета НОУ
ВПО «Институт Дружбы народов Кавказа»
Шибкова Оксана Сергеевна,
кандидат психологических наук, доцент, зав. кафедрой иностранных языков
естественнонаучных и экономических специальностей Ставропольского государственного
университета.
УДК 330+61
ББК 65:53/57
Л 58
Рекомендовано к изданию Цикловой методической комиссией Ставропольской
государственной медицинской академии по англоязычному обучению иностранных
студентов.
ISBN 5-89822-086-0
© Ставропольская государственная медицинская академия, 2007
Lesson № 1.
Introduction to economics.
Simply stated, economics is the study of how societies choose to allocate
scarce resources among competing uses. Many of the decisions we make are
economic decisions, and many of our interactions with others are influenced by
economic institutions. To understand society, you must have a basic knowledge of
economics.
As you begin your study of economics, keep in mind that economics will
teach you a new way of looking at the world. In some cases, you will find that the
topics we discuss are completely unfamiliar to you. But most of the time you will
be looking at things that you already know about from a different perspective.
Probably the most important reason for studying economics is to learn a
particular way of thinking. A good way to introduce economics is to review three
of its most fundamental concepts - opportunity cost, marginalism, and efficient
markets. If your study of economics is successful, you will find yourself using
these concepts every day in making decisions, both on economic matters and on
matters that have nothing to do with economics.
Opportunity cost. What happens in an economy is the outcome of
thousands of individual decisions. Households must decide how to divide up their
incomes over all the goods and services available, in the marketplace. Individuals
must decide whether to work or not to work, whether to go to school, and how
much to save. Businesses must decide what to produce, how much to produce, how
much to charge, and where to locate. It is not surprising that economic analysis
focuses °n the process of decision making.
Nearly all decisions involve trade-offs. There are advantages and
disadvantages, costs and benefits, associated with every action and every choice. A
key concept that recurs again and again in analyzing the decision-making process
is the notion of opportunity cost. The full «cost» of making a specific choice
includes what we give up by not making the alternative choice. That which we
forgo, or give up, when we make a choice or a decision is called the opportunity
cost of that decision.
The concept applies to individuals, businesses, and entire societies. The
opportunity cost of going to a movie is the value of the other things you could have
done with the same money and time. If you decide to take time off in lieu of
working, the opportunity cost of your leisure is the pay that you would have earned
had you worked. Part of the cost of a college education is the income you could
have earned by working full time instead of going to school. If a firm purchases a
new piece of modem equipment for $3000, it does so because it expects that
equipment to generate more profit. There is an opportunity cost, however, since
that $3000 could have been deposited in an interest-earning account. To a society,
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the opportunity cost of using resources for military hardware is the value of the
private/civilian goods that could have been produced with the same resources.
The reason that opportunity costs arise is that resources are scarce. Scarce
simply means limited. Consider one of our most important resources - time. There
are only 24 hours in a day, and we must live our lives under this constraint. Many
things in life are scarce, and much of economics is concerned with behaviour in the
face of scarcity. People are forced to make choices in the face of scarcity. If your
neighbour mows his lawn today, he won't have time to take his children to the zoo,
and this is an opportunity cost of mowing the lawn.
Read the text and answer the questions.
Text 1. THE SCOPE OF ECONOMICS.
Most students taking economics for the first time are surprised by the bread
of what they study. Some think that economics will teach them about the stock
market or what to do with their money. Others think that economics deals
exclusively with problems like inflation and unemployment. In fact, it deals with
all these subjects, but they are pieces of a much larger puzzle.
Economics has deep roots in, and close ties to, social philosophy. An issue
of great importance to philosophers, for example, is distributional justice. Why are
some people rich and others poor, and whatever the answer, is this fair? A number
of nineteenth century social philosophers wrestled with these questions, and out of
their musings economics as a separate discipline was born. The easiest way to get a
feel for the breadth and depth of what you will be studying is to explore briefly the
way economics is organized. First of all, there are two major divisions of
economics: microeconomics and macroeconomics.
Microeconomics deals with the functioning of individual industries and the
behaviour of individual economic decision-making units: single business firms and
households. Microeconomics explores the decisions that individual businesses and
consumers make. The choices of firms about what to produce and how much to
charge and the choices of households about what to buy and how much of it to buy
help to explain why the economy produces the things it does. Another big question
that microeconomics addresses is who gets the things that are produced. Wealthy
households get more output than do poor households, and the forces that determine
this distribution of output are the province of microeconomics. Why do we have
poverty? Who is poor? Why do some jobs pay more than others? Why do teachers
or plumbers or baseball pitchers get paid what they do? Think again about all the
things you consume in a day, and then think back to that view out over a big city.
Somebody decided to build those factories. Somebody decided to construct the
roads, build the housing, produce the cars, knit the shirts, and smoke the bacon.
Why? What is going on in all those buildings? It is easy to see that understanding
individual micro decisions is very important to any understanding of your society.
Macroeconomics, in its turn, deals with the functioning of national economic
complex and the behaviour of the main classes and social groups.
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Questions:
1. Do you like economics as a branch of science? If so, why?
2. How many years have you already studied economics? Have you got a
feel for the breadth and depth of what you have studied?
3. Does economics have deep roots in, and close ties to, social philosophy?
Why?
4. What problems does economics deal with?
5. Why, do you think, are some people poor and others rich? How can you
explain this social phenomenon?
6. Which two main divisions of economics do you know?
7. What do microeconomics and macroeconomics deal with?
8. Which issue of economics is of great importance to philosophers and
why?
9. Are there really a lot of people in our country, who lead a miserable
existence?
Give a short summery of the text.
Text 2. WHY STUDY ECONOMICS?
Some of you may already be excited by the prospect of studying economics,
but others among you will answer the question posed in the heading with 'It was
part of my course of study, so I had no choice.' To both the reluctant conscripts and
the willing volunteers we offer hope and encouragement.
Economics studies topics that are highly relevant both to decision-making in
most jobs that you are likely to do in life and to understanding many of the most
pressing issues facing today's world—free markets versus government
intervention, resource exhaustion, pollution and environmental degradation, global
warming, the revolution in digital communications media, government taxes and
spending, employment and unemployment, inflation, the EU, the euro, changing
living standards in advanced nations, growth and stagnation among many of the
world's poorest nations. Thus, economics is both a preparation for taking day-today decisions in a firm or other organization, and training in the analysis of many
of the 'big issues' of our time.
One of the most important events in the first three quarters of the twentieth
century was the rise of communism. One of the most important events in the last
quarter of that century was communism's fall. By the first decade of the twentyfirst century, the century-long battle between free markets and government
planning as alternatives for organizing economic activity had been settled in almost
all countries with a degree of decisiveness that is rare for great social issues.
Understanding why market-oriented, capitalist economies perform so much better
than fully planned or highly government-controlled economies is a core issue in
economics. Economic theories are expressly designed to help us understand the
successes (and, where they occur, the failures) of free-market economies.
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The triumph of market-oriented economies suggests that income- and
wealth-creating activities are usually best accomplished through the efforts of
private citizens operating in largely unregulated markets. But this is not the end of
the story, for at least three fundamental reasons.
First, although market economies certainly work better than fully planned
economies, they do not work perfectly. One of today's great social issues is how
best to allocate the responsibilities of government, leaving it to do what it can do
best and leaving free markets to do what they can do best. We ask: 'What are the
important roles that governments can play in improving the functioning of a
basically market-oriented economy?'
Second, market economies produce severe short-term cycles as well as longterm growth. Long-term growth has raised the living standards of the ordinary
working person from the horrors and degradations in the early and mid-nineteenth
century and described by Charles Dickens to those of the property-owning workers
of today, whose living standards are higher than those of 99.9 per cent of all the
people of all classes who ever lived on Earth. Yet capitalist growth is uneven
growth because economic activity cycles around its rising trend. In recessions,
unemployment is high and living standards typically stand still or even fall.
Although each cycle tends to leave living standards higher than all previous cycles,
the ups and downs of uneven market-driven growth can be upsetting to those
affected by it.
Third, capitalist growth is unequal growth. Although it is desirable to create
national income and wealth, we also care about how these are distributed among
all citizens. Poverty for a minority in the midst of plenty for the majority has
always been a problem in wealthy countries—just as poverty for the majority has
always been a problem for poor countries. We ask: 'What can governments do to
alleviate the poverty and suffering of those who do not share in the income and
employment that well-functioning market economies create for the majority?'
The world is complex, and fully understanding its economic aspects
requires much more economic theory than can be packed into one elementary
textbook. But mastery of the subject to the level of this one book will contribute
greatly to your understanding of many important issues and many of the policies
directed at dealing with them. It will also provide you with a toolbox that will
prove useful in the world of work, whatever occupation you eventually enter.
***
A modern economy makes available millions of goods and services for
people to choose from. It provides jobs for most people who want to work. It
allows us to travel and communicate easily with anybody anywhere in the world.
Yet no one has sat down and planned how all this will work. It has evolved as a
response to economic forces interacting with individuals and institutions. One of
our main tasks in this book is to understand how such an economy works, how
well it works, and what can be done when it does not work well.
If you want a pint of milk, you go to the shop and buy it. The shop owner is
just one part of a complex supply chain that makes this milk available when you
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want it. When the shop owner needs more milk, she orders it from the distributor,
who in turn gets it from the bottling plant, which in its turn gets it from the dairy
farmer. The dairy farmer buys cattle feed and electric milking machines, and gets
power to run all his equipment by putting a plug into a wall socket where the
electricity is supplied as he needs it. The milking machines are made from parts
manufactured in several different countries throughout the world, while these parts
in their turn are made from materials mined and refined in a dozen or more
different countries.
As it is with the milk you drink, so it is with everything else that you buy.
When you go to the appropriate shop, what you want is normally in stock. Those
who make these products find that all the required components and materials are
available when needed — even though these things typically come from many
different parts of the world and are made by people who have no direct dealings
with each other. The economy is so good at delivering what we want when we
want it that we only tend to notice when it goes wrong.
Read the text and answer the questions.
Text 3. HOW TO STUDY ECONOMICS?
The study of economics should begin with a sense of wonder. Pause for?
moment and consider a typical day in your life. For breakfast you might have bread
made in a local bakery with flour produced in Minnesota from wheat grown in
Kansas and bacon from pigs raised in Ohio, packaged in plastic made in New
Jersey. You spill coffee from Colombia on your shirt made in Texas from textile
shipped from South Carolina. After class you drive with a friend in a Japanese car
on an interstate highway system that took 20 years and billions of dollars worth of
resources to build. You stop for gasoline refined in Louisiana from Saudi Arabian
crude oil brought to the United States on a supertanker that took three years to
build at a shipyard in Maine. At night you call your brother in Mexico City. The
call travels over newly laid fiber-optic cable to a powerful antenna that sends it to;
transponder on one of over 1.000 communications satellites orbiting the earth.
You use or consume tens of thousands of things, both tangible and
intangible every day: buildings, the music of a rock band, the compact disc it is
recorded on, telephone services, staples, paper, toothpaste, tweezers, soap, a digital
watch, fire protection, antacid tablets, beer, banks, electricity, eggs, insurance,
football fields, computers, buses, rugs, subways, health services, sidewalks, and so
forth. One hundred twenty million people in the United States - almost half the
total population -work at hundreds of thousands of different kinds of jobs
producing nearly six trillion dollars worth of goods and services every year. Some
cannot fine work, some choose not to work for pay. Some are rich, others are poor.
The United States imports $60 billion worth of petroleum and petroleum
products each year and exports $37 billion worth of food. High-rise office
buildings go up in central cities. Condominiums and homes are built in the
suburbs. In other places homes are abandoned and boarded up. Some countries are
7
wealthy. Others are impoverished. Some are growing. Some are stagnating. Some
businesses are doing well. Others are going bankrupt.
Economics is the study of how individuals and societies choose to use the
scarce resources that nature and previous generations have provided. The key word
in this definition is «choose». Economics is a behavioural science. In large
measure it is the study of how people make choices. The choices that people make,
when added up, translate into societal choices.
Questions:
1. Are modern economies interacted now? How can you prove it?
2. What are the main features of modern world economies?
3. Is there a common international market today?
4. Does this market have influence on economic situation in Russia?
5. Why do students begin the study of economics with a sense of wonder?
6. Why, in your opinion, are some countries wealthy and others are
impoverished?
7. Do you know how many people live in poverty in todays world? Is it
possible to put an end to impoverishing people or not? What do you think of it?
8. Foreign scientists assure that economics is the study of how individuates
and societies choose to use the resources provided them by nature and previous
generations. Do you agree with such a point of view?
9. Are there specific economic laws that determine development of societies
or people make their choices ignoring them?
10. Do you agree with the affirmation that economics is a behavioural
science? How did the great economists of the past define economics?
Exercises:
1. Complete the sentences by using the words from the texts:
A) … deals with the functioning of national economic complex and the behaviour
of the main classes and social groups.
B) … explores the decisions that individual businesses and consumers make.
C) By the first decade of the twenty-first century, the century-long battle between
… and … as alternatives for organizing economic activity had been settled in
almost all countries with a degree of decisiveness that is rare for great social issues.
D) Economics is the study of how individuals and societies choose to use the …
resources that nature and previous generations have provided.
2. List some of the choices you make on a daily basis in terms of how you
spend your time and how you spend your money.
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3. Make a list of all the different goods and services you typically buy in a
normal week. In how many different markets does this suggest that a typical
individual trades on a regular basis?
4. In what ways does money facilitate specialization and the division of labour?
New vocabulary:
economy; economics; microeconomics; macroeconomics; household; national
economy; inflation; unemployment.
Homework:
1. Economics for Medical Students. Textbook for students of General
Medicine and Dentistry in the English-speaking Medium. – Stavropol:
StGMA. – 2006. (text 1, p.3; text 2, p.p. 4-11).
2. English Economy Dictionary with Definitions. (For students of General
Medicine and Dentistry in the English-speaking Medium). – Stavropol:
StGMA. – 2006. (p.15 – econometric model, p.16 - economics, p.22 household, p.24 – inflation, p.42 - statistics).
Lesson 2.
The Subject and Methods of Economics.
Read the texts of «Economics for Medical Students» and answer the
questions:
Text 1 at p.3
Questions:
1)
2)
3)
4)
5)
6)
7)
Is Economics a social science?
What natural sciences do you know?
What does Economics attempts to find?
Why Economics tries to find laws or principles?
What does microeconomics mean?
Say about macroeconomics.
What does Economics study?
Text 2, p.p.4-11
Questions:
1) What definitions of Economics did A. Marshall call?
2) What definitions of Economics did L. Robbins call?
3) What does Economics mean of the modern history?
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4)
5)
6)
7)
8)
9)
What sciences are related to Economics?
What does positive statement mean?
Give us some examples of positive statements.
What does normative statement mean?
Give us some examples of normative statements.
What are the methods of Economics?
Read the text and answer the questions:
Text 1. METHODS OF ECONOMICS
Economics asks and attempts to answer two kinds of questions, positive and
normative. Positive economics attempts to understand behaviour and the operation
of economic systems without making judgements about whether the outcomes are
good or bad. It strives to describe what exists and how it works. What determines
the wage rate for unskilled workers? What would happen if we abolished the
corporate income tax? Who would benefit? Who would lose? The answers to such
questions are the subject of positive economics.
Normative economics, on the other hand, looks at the outcomes of economic
behaviour and asks if they are good or bad and whether the outcomes can be made
better. Normative economics involves judgements and prescriptions for preferred
courses of action. Should the government be involved in regulating the price of
gasoline? Should the income tax be changed to reduce or increase the burden on
upper income families? Should AT&T have been broken up into a set of smaller
companies? Should we protect the automobile industry from foreign competition?
Should the savings and loan industry be regulated? Normative economics is often
called policy economics.
Questions:
1. What kind of questions does economics ask and attempt to answer?
2. What problems does positive and normative economics attempt to
understand?
3. Does positive economics make judgements about behaviour and operation
of economic systems and their outcomes?
4. Does normative economics involve judgements and prescriptions for
preferred courses action of economics systems?
5. Should the income tax be raised or reduced in our country? What do
you think of it?
6. Do you find that modern system of taxation in Russia is fair?
7. Why do people grumble at taxation today? Are modern taxes high now
or don’t people like paying taxes at all?
8. Who collects taxes in Russia? How often do you fill in a tax declaration?
9. Do our modern industries need to be protected from foreign competition?
10. What are the outcomes of the national economy development within last
10
years?
Read about methods of economics else and give a short summery of the texts.
Text 2. ECONOMIC ADVICE: POSITIV AND NORMATIVE
STATEMENTS
Economists give advice on a wide variety of topics. If you read a newspaper,
watch television news, or listen to commentaries on the radio you will often notice
some economist's opinions being reported, perhaps on the prospects for
unemployment, inflation, or interest rates, on some new tax, or on the case for
privatization or regulation of an industry.
Advice comes in two broad types: normative and positive. Normative
statements depend on value judgements. They involve issues of personal opinion,
which cannot be settled by recourse to facts. In contrast, positive statements do not
involve value judgements. They are statements about what is, was, or will be: that
is, statements that are about matters of fact.
It is difficult to have a rational discussion of issues if positive and normative
issues are confused. Much of the success of modern science depends on the ability
of scientists to separate their views on what does, or might, happen in the world,
from their views on what they would like to happen. For example, until the
eighteenth century almost everyone believed that the Earth was only a few
thousand years old. Evidence then began to accumulate that the Earth was
thousands of millions of years old. This evidence was hard for most people to
accept since it ran counter to a literal reading of many religious texts. Many did not
want to believe the evidence. Nevertheless, scientists, many of whom were
religious, continued their research because they refused to allow their feelings
about what they wanted to believe to affect their search, as scientists, for the truth.
Eventually all scientists came to accept that the Earth is about 4,000 million years
old.
Distinguishing what is true from what we would like to be, or what we feel
ought to be, depends to a great extent on being able to distinguish between positive
and normative statements.
Text 3. MODELS.
Economists often proceed by constructing what they call economic models.
This term has several different but related meanings.
Sometimes the term 'model' is used as a synonym for a theory, as when
economists speak of the model of the determination of national income. Sometimes
it may refer to a particular subset of theories, such as the Keynesian model or the
neoclassical model of income determination.
More often, a model means a specific quantitative formulation of a theory. In
this case, specific numbers are attached to the mathematical relationships defined
by the theory, the numbers often being derived from observations of the economy.
11
The specific form of the model can then be used to make precise predictions about,
say, the behaviour of prices in the potato market, or the course of national income
and total employment. Forecasting models used by the Bank of England and the
International Monetary Fund (IMF) are of this type.
The term 'model' is often used to refer to an application of a general theory
in a specific context. So if we take our theory of consumer demand and apply it to
the egg market in southern England, we might speak of a model of the southern
English egg market.
Finally, a model may be an illustrative abstraction, not meant to be elaborate
enough to be tested. The circular flow in the scheme is a model of this sort:
Illustrating how income
flows between consumers and
producers helps us to
understand how the decisions
of these two groups influence
each other through labour
markets and goods markets.
However, the actual flows in
any real economy are vastly
more complex than the simple
flows shown in the figure.
Figure 2.1. The circular flow of income and expenditure
The model helps us to understand what is going on without being detailed
enough to yield specific testable predictions about real-world behaviour. In some
ways, a model of this sort is like a political caricature. Its value is in the insights it
provides that help us to understand key features of a complex world.
Exercises:
1. Complete the sentences by using the words from the texts:
A) Sometimes the term 'model' is used as a synonym for …, as when economists
speak of the model of the determination of national income.
B) Sometimes a model means a … of a theory.
C) a model may be …, not meant to be elaborate enough to be tested.
2. Why does the distinction between positive and normative statements
matter for economics? Which of the following statements are positive?
A. Higher interest rates cause people to save more.
B. People should save more.
C. People are more worried about inflation than unemployment.
D. Governments should do more to reduce carbon emissions in order to save the
planet from global warming.
E. High taxes on cigarettes discourage smoking.
F. Smoking should be discouraged.
3. Which of the following statements are normative?
12
A. High income tax rates discourage effort.
B. Road-use charges would increase traffic.
C. Governments should tax the rich to help the poor.
D. The tax system should be used to reduce traffic.
E. Technical change is a bad thing because it puts some people out of work.
F. The burning of fossil fuels is causing global warming.
4. Discuss the view why do economists use models in order to help explain
how the economy works?
New vocabulary:
positive statement, normative statement, scientific method, economic model.
Homework:
1. Economics for Medical Students. (text 3, p.12; text 4, p.p.12-15; text 5,
p.p.15-17)
2. English Economy Dictionary with Definitions. ( p.25 – Keynesian, p.economics, p.25 – keynesian revolution, p.26 – Laissez-Faire, p.28 –
marginal school, p.29 – marxism,p.30 – mercantilists, p.31 – monetarism,
p.31 – monetarists, p.37 – protectionist measures, p.42 – statistics).
Lesson 3.
The Development of Economics.
Questions for discussion. (Lecture 1)
1) What does Economic study? What do we must examine underlining
problem in Economics? Is some people independence from Economy?
2) Is a high standard of living connect with the development of Economy?
3) In the economically developed countries we are rich, not as individuals,
but only as members of a complex economic organization. Is this right
or wrong?
4) What can you say about our wants?
5) Have people limited or unlimited wants?
6) Have all the countries problems of Choice?
7) Why all people have the problems of Choice?
8) Say about three fundamental choices or basic problems.
9) Is this a main problem: Which goods shall be produced and in what
quantities of each economic sistem?
10) If at first we say ‘Which goods and what quantities’, at second we say
‘How should the various goods and services be produced’. What can you
say about this problem
11) What is the third basic problem of Economy?
13
12) Are these basic problems common to all societies or to a poor
country? Can we say that there is very great varieties of Economic
systems now in the modern history?
13) What does Economy mean?
14) What does Economics mean?
15) What does Economic try to find by building models.
16) What does the definition “macroeconomics” mean?
17) What is the name of Economics’ part which analysing the Economic
Growth, employment, inflation?
18) What can you say about the end showing of macroeconomic?
19) What does the word “microeconomics” mean?
Read the texts of «Economics for Medical Students» and answer the
questions:
Text 1, p.17
Questions and exercises:
1. Answer these questions:
a) What is meant by the economy?
b) What is an economy?
c) What happens in an economy?
d) How does an economy work?
2. Complete the sentences by using the words from the text:
The economy is a social..., which answers these three questions.
The economy means a system for the ... of the money, goods and other
resources of...
Repeat the definition of the term "the economy" given at the end of the text.
Text 2, p.p. 18-19
Questions:
1. General understanding:
a) What does the word macroeconomics mean?
b) What are the concerns of the macroeconomist?
c) What is the difference between the questions asked by macroeconomists
and microeconomics?
d) What is, according to the text, the important task of macroeconomist?
e) What does macroeconomic analysis attempt to explain?
f) What are the concepts of macroeconomics?
g) What are the most important theories of macroeconomics?
h) What is it said about the correlation between the inflation and
unemployment?
2. Questions for discussion:
a) Was there such a difference between macroeconomics and
microeconomics in the Soviet economics? In 18th century? In 19th century?
b) What is more important for economy in general – microeconomics or
14
macroeconomics?
c) Is there a difference in analyzing macroeconomic and microeconomic
problems?
Text 3, p.p. 20-22.
Questions:
a)
b)
c)
d)
e)
f)
g)
What is, according to the text, microeconomics?
What is meant by "economics in the small"?
Where is microeconomic theory used?
What is "optimization"?
What is the concept of the theory of consumer?
What areas of applied economics are of the most importance?
What distinction in methodology between macro- and microeconomics is the
most distinctive?
h) Does the author's concept of theories of consumer and producer comply with
your own?
Read the text “The famous Economists”.
Adam Smith
Adam Smith was a great scientist who made extraordinary contributions in
economics. He was born in 1723 in Kirkcaldy, a small fishing town near
Edinburgh, Scotland. His father was a customs officer. He died before his son was
born.
At the age of 28 Adam Smith became a Professor of Logics at the University of
Glasgow. It was his first academic appointment. Some time later he became a tutor
to a wealthy Scottish duke. Then he received a grant of £300 a year. It was a very
big sum, 10 times the average income at that time.
With the financial security of his grant, Smith devoted 10 years to writing
his work which founded economic science. Its full title was An Inquiry into the
Nature and Causes of the Wealth of Nations. It was published with great success in
1776.
Adam Smith made economics a science. This Scottish economist is often
regarded as the founder of political economy too.
Adam Smith (1723-1790) developed the intuition that as long as firms are
constrained by robust competition, their self-interested profit seeking inadvertently
causes them to act in ways that are socially optimal — as though they are guided
by an invisible hand to do the right thing.
But Smith was not naive. He believed that businessmen prefer to collude rather
than compete whenever possible, and that governments have a very important
economic role to play in fostering the robust competition needed for the invisible
hand to work its magic. He also believed that governments must provide many
15
essential public goods, like national defense, that aren't readily produced by the
private sector.
The Development of Economics: Adam Smith.
Economics, like every other intellectual discipline, has its roots in early Greece
and Rome; but economics was first considered as a branch of domestic science
(home economics) dealing with such matters as the management of slaves and the
allocation of manure among alternative agricultural uses. In the revival of learning
that followed the Middle Ages, economics emerged as a branch of moral
philosophy concerned with such issues as the ethics of loan interest and the
«justness» of market-determined wages and prices.
By the beginning of the eighteenth century, the subject had lost most of its
theological overtones and had taken shape as an academic discipline, largely as a
branch of political theory dealing with problems of government intervention in
economic affairs.
Then in 1776 the Scottish moral philosopher Adam Smith published the first
edition of his monumental Inquiry into the Nature and Causes of the Wealth of
Nations, and economics soon became an independent science.
The Vision of Adam Smith
Smith lived in an age when the right of rulers to impose arbitrary and
oppressive restrictions on the political and economic liberties of their subjects was
coming under strong attack throughout the civilized world. As other men of that
time were arguing that democracy could and should replace autocracy in the sphere
of politics, so Adam Smith argued that laissez-faire could and should replace
government direction and regulation in economics. The «should» was so mixed
with the «could» portion of Smith's analysis that much of his book seemed almost
as much a political tract as a work of science. What gave the book lasting
significance was the Smith's strong arguments that the economic activities of
individuals would be more effectively coordinated through the indirect and
impersonal action of natural forces of self-interest and competition than through
the direct and frequently ill-conceived actions of government authorities. Smith
opened minds to the existence of a «grand design» in economic affairs similar to
that which Newton had earlier shown to exist in the realm of physical phenomena.
The impact of Smith's ideas upon his contemporaries was widespread and
immediate. As one modern scientist observed: «Before Adam Smith there had been
much economic discussion; with him we reach the stage of discussing economics».
That Smith's vision of the economy should ever have been considered original
might seem strange to modern minds, but that would be because we now see
economic phenomena in the light of his conception. As two leading scholars
recently remarked, «The immediate «common sense» answer to the question,
«What will an economy motivated by greed and controlled by a large number of
different agents look like?» is probably: There will be chaos». That is certainly the
answer that would have been given by most of Smith's contemporaries—before
they read his book. The greatness of Smith's accomplishment lies precisely in the
fact that he, unlike his predecessors, was able to think away extraneous
16
complications and so perceive an order in economic affairs that common sense did
not reveal.
It is one thing, of course, to say that Smith's conception of economic
phenomena is original, another to suggest that it corresponds to contemporary
experience. According to Smith, society in its economic aspect is a vast concourse
of people held together by the desire of each to exchange goods and services with
others. Each person is concerned directly only to further his own self-interest, but
in pursuing that aim each «is led by an invisible hand» to promote the interests of
others. Forbidden by law and social custom to acquire the property of other people
by force, fraud, or stealth, each person attempts to maximize his own gains from
trade by specializing in the production of goods and services for which he has a
comparative advantage, trading part of his produce for the produce of others on the
best terms he can obtain. As a consequence, the «natural forces» of market
competition—the result of each person attempting to «buy cheap and sell dear»—
come into play to establish equality between demand and supply for each
commodity at rates of exchange (prices).
The economic system (so Smith and later writers argued) is an essentially selfregulating mechanism that, like the human body, tends naturally toward a state of
equilibrium (homeostasis) if left to itself.
There are two types of commercial banks. A national bank is chartered by the
federal government. About one third of all commercial banks are national. A state
bank, which is smaller than a national bank, is chartered by an individual state.
Alfred Marshall
Alfred Marshall (1842-1924) invented the supply-and-demand method for
analyzing markets. Applying mathematics to economic theory, he clearly differentiated between shifts of demand and supply curves and movements along
demand and supply curves. In doing so, he cleared up 2,000 years of faulty
reasoning. He also made the revolutionary prediction that the market price would
be where the demand and supply curves cross.
Marshall then went one step farther and realized that by comparing points along
demand and supply curves with the market price, you could quantify the benefits
that consumers and producers derive from market transactions. These benefits are,
respectively, consumer surplus and producer surplus, and their sum is the total
economic surplus.
This method of quantifying the benefits of production and consumption is still
used today and forms the basis of welfare economics, which studies the costs and
benefits of economic activities. This method also just happens to illustrate in a very
simple graph the intuition behind Adam Smith's invisible hand. The free market
equilibrium, where demand and supply cross, is exactly the same as what a
benevolent social planner would choose to do if she were trying to maximize social
welfare by maximizing total economic surplus. In other words, a free market does
indeed act "as if moved by an invisible hand" to promote the common good.
17
David Ricardo
David Ricardo (1772-1823) discovered comparative advantage and argued
correctly that international trade is a win-win situation for the countries involved.
Comparative advantage destroyed the intellectual respectability of mercantilism,
the mistaken theory behind colonialism that viewed trade as being one-sided and
consequently argued that trade should be set up to benefit the mother country at the
expense of its colony.
In addition, Ricardo correctly analyzed the economic phenomenon of diminishing returns, which explains why costs tend to increase as you increase production
levels. He was also a strong early proponent of the quantity theory of money, the
idea that increasing the money supply will increase prices.
John Maynard Keynes
John Maynard Keynes, first Baron Keynes (1883—1946) is an English
economist, whose The General Theory of Employment, Interest and Money (1936)
proposed the prevention of financial crises and unemployment by adjusting
demand through government control of credit and currency. He is responsible for
that part of economics now known as macroeconomics.
John Maynard Keynes saw the cause of a depression as reduced aggregate
demand, and in the absence of any automatic stimulus to demand he argued that
governments must intervene to increase aggregate demand and end depression. He
suggested that governments stimulate consumption by putting money into
consumers' pockets through tax cuts or directly increase governments' own
expenditure to add to aggregate demand.
John Maynard Keynes (1883-1946) invented modern macroeconomics and the
idea of using government-provided economic stimuli to overcome recessions.
Much of the rest of 20th-century macroeconomics was a series of responses to his
seminal ideas.
His most famous ideas were developed in response to the long agony of the
Great Depression of the 1930s. He first asserted that the Great Depression was the
result of a collapse in the expenditures being made on goods and services. He then
asserted that monetary policy had been ineffective in combating the decline in
expenditures. And he finally concluded, given his dismay about monetary policy,
that fiscal policy was the only remaining source of salvation. In particular, Keynes
believed that the best way to increase expenditures in such dire circumstances was
for the government to spend heavily to pay for programs that would buy up lots of
goods and services in order to get the economy moving again.
Keynes's policy prescriptions were adopted during the Great Depression in
many countries, including the United States. And while many of his specific ideas
about the cause of the Great Depression and the best policies for dealing with
18
recessions are no longer embraced, his underlying idea that governments are
responsible for taming the business cycle remains very much with us today.
Karl Marx
Karl Marx (1818-1883) was the foremost economist among 19th-century
socialists. None of his major economic theories is now believed to be true, but
because proponents of his Marxist ideas came to power in dozens of countries
during the 20th century, he is surely one of the most influential economists who
ever lived. (Marx gets the most space here not because he's the most important
economist on this list, but because I have to take the time to explain his ideas
before discrediting them. The ideas of the other economists on this list are already
explained in detail in other places in this book.)
Marx's most important intellectual contribution is his idea that capitalism is a
historically unique form of social and productive organization. In Capital, he
analyzed capitalism as a brand-new form of social and economic organization
based on capital accumulation and factory production. He called the owners of the
factories "capitalists" and argued that they would be forced to exploit the workers
who labored in their factories.
In particular, he believed that the only capitalists who would survive and whose
businesses would grow were those who paid workers the minimum salaries
necessary for the workers to survive. Thus, even as productivity and output rose
rapidly, workers would endure permanent, grinding poverty out of which they
could never rise except by means of a violent overthrow of the capitalists — an
overthrow in which the workers would gain control over the factories.
Marx argued that this violent overthrow would be facilitated by what he saw as
an inevitable tendency toward concentration and monopoly. When there was only
one monopoly firm in each industry, it would be much easier for the workers to
revolt and take over the system.
With a century and a quarter of hindsight, we know that Marx was wrong in his
economic thinking. In particular, workers' wages do rise over time — in fact, they
rise on average as fast as technological innovation increases productivity levels.
That's because capitalists compete over the limited supply of workers, and wages
get bid up as quickly as productivity improvements allow one capitalist to bid
higher wages to steal workers away from other capitalists.
In addition, competition does not lead to each industry being dominated by a
single monopoly firm. Rather, competition remains robust in most industries and
consequently delivers all the benefits of Adam Smith's invisible hand.
Milton Friedman
Milton Friedman (b. 1912) convinced economists that the quantity theory of
money is, in fact, true: Sustained inflations are the result of sustained increases in
19
the money supply (printing too much money). This insight put limits on using
monetary policy to stimulate the economy.
Friedman also argued that the Great Depression was chiefly a monetary disaster
and that its severity was the result of a gruesomely tight money supply that kept
real interest rates much too high. This diagnosis of the cause of the Great
Depression is now the standard explanation, meaning that the intellectual
ammunition for Keynes's solution to recessions — large increases in government
spending — has lost much of the sway that it once had. It has also led economists
to conclude that monetary policy is more important than fiscal policy for regulating
the economy and preventing recessions.
Paul Samuelson
Paul Samuelson (b. 1915) has made many contributions to economics. Perhaps
the most important was crystallizing the idea that all economic behavior can be
thought of as consumers and firms maximizing either utility or profits subject to a
set of constraints. This idea of constrained maximization has become the dominant
paradigm that governs how economists conceive of economic behavior.
Samuelson also developed a judicious blending of Keynesian and classical
ideas about the proper use of government intervention in the economy. Keynes
argued for large government interventions to mitigate recessions. Classical
economists like Smith and Ricardo argued for minimal government interventions,
fearing that government interventions tend to make things worse.
Samuelson's neoclassical synthesis states that during recessions the government
should be willing to make large interventions in the economy to get it moving
again, but when the economy is operating at full potential, the proper role of
government is to provide public goods and take care of externalities. Many
economists embrace this view of the government's place in the economy.
Robert Solow
Robert Solow (b. 1924) has made huge contributions to the understanding of
economic growth and rising living standards. In addition to developing innovative
models of how economies grow over time, he also showed that the dominant longrun force propelling economic growth is technological innovation.
Before Solow, the economic profession believed that increases in output were
the result of increases in inputs. In particular, increases in output were solely the
result of either using more workers or more capital (such as bigger factories). What
Solow demonstrated was that at most 50 percent of the long-run growth of living
standards can be explained by increases in labor and capital. The rest has to be the
result of technological innovation.
This insight created a huge paradigm shift among economists that has resulted
in the systematic study of technological innovation and the ways in which it can be
20
improved by government policies like patents and copyrights. It also opens up the
refreshing possibility that technological innovation will allow us to enjoy higher
living standards without having to constantly increase our use of the earth's
resources.
Exercises:
1. Complete the sentences by using the words from the texts:
A) So … argued, «natural forces» of market competition—the result of each
person attempting to «buy cheap and sell dear»—come into play to establish
equality between demand and supply for each commodity at rates of exchange
(prices).
B) … discovered comparative advantage and argued correctly that international
trade is a win-win situation for the countries involved.
C) … invented the supply-and-demand method for analyzing markets.
D) … invented modern macroeconomics and the idea of using governmentprovided economic stimuli to overcome recessions.
E) … argued that the Great Depression was chiefly a monetary disaster and that
its severity was the result of a gruesomely tight money supply that kept real
interest rates much too high.
F) … argued that all economic behavior can be thought of as consumers and
firms maximizing either utility or profits subject to a set of constraints.
G) … analyzed capitalism as a brand-new form of social and economic
organization based on capital accumulation and factory production, called the
owners of the factories "capitalists" and argued that they would be forced to exploit
the workers who labored in their factories.
H) … has made huge contributions to the understanding of economic growth
and rising living standards.
2. Discuss the view that economic analysis cannot generate predictions as
human behaviour is unpredictable.
New vocabulary:
keynesian economics, laissez-faire, monetarism, monetary policy
Homework:
1. Economics for Medical Students. (text 4, p.p. 23-25; text 5, p.p.25-26)
2. English Economy Dictionary with Definitions. ( p.8 – capital; p. 8 –
capital equipment; p. 16 – economic rent; p. 16 –economic growth; p. 16 –
efficiency; p. 26 – land; p. 39 – resource; p. 43 – technology).
21
Lesson № 4.
Economy: Industries, Resources, Factors of Production.
Questions for discussion (Lecture 1).
1)
2)
3)
4)
5)
6)
7)
8)
9)
What do you know about the definition of Economic systems?
What is it possible to classify Economic systems?
What does Labour mean?
Why is Economic activity take place?
What countries is leading of the size of population?
How many millions are the population of India?
What is role of the age composition of the population?
What does the working population mean?
What is the minimum age at which a person may engageen full-time
employment legally controlled?
10)
What is the women’s (man’s) working age in India? (or Pakistan,
Greece etc.)
11)
What does Natural Resources mean?
12)
What are the characteristics of the Natural Resources?
13)
What do you know about the renewable Resources?
14)
What do you know about non-renewable Resources?
15)
What is the problem of non-renewable Resources connect with the
prices of Resources?
16)
Say about the Land as a factor of production.
17)
What does leasing Land mean?
18)
What can you say about Capital?
19)
What did you write from your English Economy dictionary about the
Capital? Capital Equipment?
20)
Is money a Capital?
21)
What Types of Capital is usually divided?
22)
What does fixed Capital mean?
23)
Is this type of Capital Change its form in the course of production?
Read the text of “Economics for Medical Students” and answer the questions:
Text 4, p.p. 23-25.
Questions:
a) What kinds of the factors of production and resources do you know?
b) Give the characteristics of each factor of production.
c) What does the classification of capital vary?
d) What does human capital mean?
22
Give a short summery of the text 5, p.p. 25-26.
Read the texts and answer the questions:
Text 1. THE FACTORS OF PRODUCTION
The private enterprise system, as do all economic systems, requires
resources for its business to produce goods and services. The resources used to
provide goods and services are the factors of production: land, labour, capital, and
entrepreneurship. These four factors are blended together by a business to produce
goods and services as shown in Figure. Let's examine each.
Land is the natural resources that can be used to produce goods and services.
Natural recources are all resources growing on and under the earth's surface, such
as trees, minerals, oil, and gas.
Labour is the total human resources required to turn raw materials into
goods and services. It would include all employees of the business from top
management through the entire organisation structure.
Land
Labour
Capital
Entrepreneurship
Production Processes
Finished Goods and Services
Figure 4.1. Factors of production.
Capital is the total of tools, equipment, machinery, and buildings used to
produce goods and services. In this case capital does not refer simply to money.
Money by itself is not productive: but when it purchases drills, typewriters,
forklifts, and the building to place them in it becomes productive.
Entrepreneurship is the group of skills and risk taking needed to combine the
other three factors of production to produce goods and services. Entrepreneurship
is the catalyst - like heat to a fire. It is supplied by an entrepreneur, an individual or
individuals who are willing to take risks in return for profits.
Text 2. ECONOMIC POLICY. EFFICIENCY
Economic theory helps us understand how the world works, but the
formulation of economic policy requires a second step. We must have objectives.
23
What do we want to change? Why? What is good and what is bad about the way
the system is operating? Can we make it better? Such questions force us to be
specific about the grounds for judging one outcome superior to another. What does
it mean to be better? Four criteria are frequently applied in making these
judgements: 1. Efficiency; 2. Equity; 3. Growth; 4. Market equilibrium.
EFFICIENCY. In physics «efficiency» refers to the ratio of useful energy
delivered by a system to the energy supplied to it. An efficient automobile engine,
for example, is one that uses up a small amount of fuel per mile for a given level of
power. In economics efficiency means allocative efficiency. An efficient economy
is one that produces what people want and does so at the least possible cost. If the
system allocates resources to the production of things that nobody wants, it is
inefficient. When steel beams lie in the rain and rust because somebody fouled up a
shipping schedule, this is inefficient. If a firm could produce its product using 25%
less labor and energy without sacrificing quality, it is also inefficient.
To use the term more technically, an efficient change in the allocation of
resources is one that at least potentially makes some people better off without
making others worse off. The clearest example of an efficient change is a voluntary
exchange. If you and I each want something that the other has and we agree to
exchange, we are both better off, and no one loses. If a company reorganizes its
production or adopts a new technology that enables it to produce more of its
product with fewer resources, without sacrificing quality, this is an efficient
change; at least potentially, the resources saved could be used to produce more of
something.
Inefficiencies can arise in numerous ways. Sometimes they are caused by
government regulations or tax laws that distort otherwise sound economic
decisions. When only one firm exists in a market and competition is prohibited or
nonexistent, the incentive for efficient allocation and innovation may be lost. If
firms that cause environmental damage are in no way held accountable for their
actions, the incentive to minimize those damages is lost, and the result is
inefficient.
We shall deal with the concept of efficiency in much more detail later. For
now, though, it is important to understand two things about it. First, it assumes that
the ultimate purpose of an economic system is to produce what people want. When
we say a change makes people better off, it is the people themselves who define
what «better off» means. For example, by engaging in a voluntary exchange, you
and I reveal that we are both better off afterwards than before. A voluntary
exchange is efficient because it improves the well-being of the participants as they
themselves define it. Second, since most changes that can be made in an economy
will leave some people better off and others worse off, we must have a way of
comparing the gains and losses that may result from any given change. Most often
we simply compare their sizes in dollar terms. A change is at least I potentially
efficient if the value of the resulting gains exceeds the value of the J resulting
losses.
24
Questions:
1. What does economics help us understand?
2. What kind of questions should any government answer when formulating
its economic policy?
3. Which four criteria for judging economic outcomes do you know?
4. What does the category of efficiency mean in economics?
5. If the system allocates resources for the production of things that nobody
wants, is it efficient?
6. In what circumstances do inefficiences arise in economics? Who is to
blame for them?
7. Is it good for economics if there is no competition in the market?
8. The ultimate goal of an economic system is to produce what people
want. Do you agree with this positition?
9. Why is voluntary exchange of goods efficient?
10. What should we all do to increase the effeciency of national economic?
Text 3. ECONOMIC POLICY. EQUITY
While efficiency has a fairly precise definition that can be applied with some
degree of rigour, equity («fairness») lies in the eye of the beholder. Few people
agree on what is fair and what is unfair. To many fairness implies a more equal
distribution of income and wealth. Fairness may imply alleviating poverty but the
extent to which poverty should be reduced is the subject of enormous
disagreement. For thousands of years philosophers have wrestled with the
principles of justice that should guide social decisions. They will probably wrestle
with such questions for thousands of years to come.
Despite the impossibility of defining equity or fairness universally, public
policy makers judge the fairness of economic outcomes all the time. Rent control
laws were passed because some legislators thought that landlords treated low
income tenants unfairly. Certainly most social welfare programs are created in the
name of equity.
Questions:
1. What is equity in your own opinion? How can you define this social
category?
2. Do all people agree on what is fair and what is unfair?
3. Does fairness imply any poverty? To what extent?
4. What principles have philosophers wrestled with for thousands of years?
Have they come to a common denominator?
5. How do you think, what guides social decisions in today's world?
6. Do students like to judge the fairness of economic outcomes? To what
conclusions are they coming?
25
7. Are modern social welfare programs created in the name of equity or not?
8. Are students treated fairly or unfairly by the government?
Text 4. ECONOMIC POLICY. GROWTH
As the result of technological change, the building of machinery, and the
acquisition of knowledge, societies learn to produce new things and to produce old
things better. In the early days of the US economy it took nearly half the
population to produce the required food supply. Today less than 2% of the
country's population is engaged in agriculture.
When we devise new and better ways of producing the things we use now
and develop new products and services, the total amount of production in the
economy increases. Economic growth is an increase in the total output of an
economy. If output grows faster than the population, output per capita rises, and
standards of living increase. Presumably, when an economy grows there is more of
what people want. Rural and agrarian societies become modern industrial societies
as a result of economic growth and rising per capita output.
Some policies discourage economic growth and others encourage it. Tax
laws, for example, can be designed to encourage the development and application
of new production techniques. Research and development in some societies are
subsidized by the government. Building roads, highways, bridges, and transport
systems in developing countries may speed up the process of economic growth. If
businesses and wealthy people invest their wealth outside their country rather, than
in its own industries, growth in their home country may be slowed.
Efficiency and growth of economic outcomes witness to stability of
economic situation in this or that country. But stability itself is explicitly witnessed
to by market situation taking into account that most national economics are market
economies. Thus, market appears as the exterior and total criterion for judging
economic.
Questions:
1. Does acquisition of knowledge encourage to produce new things and to
produce old things better?
2. Under what conditions does the total amount of production in the economy
increase?
3. When does per capita output rise?
4. What is the exterior and total criterion of economic outcomes of any
country?
5. Does your government encourage or discourage economic growth?
6. Who subsidizes research and development works in Russia?
7. May economic growth be slowed if businesses and wealthy people invest
their wealth outside their country?
8. What policies are required for Russia to increase its economic output?
26
9. Do you agree with that the president is invested with full authority?
10. If you were the prime-minister of Russia what kind of measures would
you take to speed up the economic growth of the country?
Exercises:
1. Complete the sentences in the text:
All factors of production can be divided into following main categories:
• All those gifts of nature, such as land, forests, minerals, etc., commonly called
natural resources and called by economists …, for short.
• All human resources, mental and physical, both inherited and acquired, which
economists call …
• All those man-made aids to further production, such as tools, machinery, and
factories, that are used in the process of making other goods and services rather
than being consumed for their own sake. Economists call these and financial
resources …
• Those who take risks by introducing new products and new ways of making old
products, developing new businesses and forms of employment. They are called
entrepreneurs or innovators, and the factors of production they provide is …
2. Discuss the view what does equity mean? What do you guess is fair?
3. List products that you use regularly that were not available when (a) your
parents, and (b) your grandparents were born. What does the process of product
innovation tell us about the nature of economic growth?
4. Discuss the view must economic growth inevitably come to an end when
various non-renewable energy (and commodity) sources are depleted? What are
the main determinants of economic growth?
New vocabulary:
factor of production, land, labour, capital, entrepreneurship, economic policy,
efficiency, growth
Homework:
1. Economics for Medical Students. (text 2, p.p. 28-29; text 3, p.p.29-30; text 4,
p.p. 30-31; text 5, p.p. 32-33).
2. English Economy Dictionary with Definitions. (p. 6 – barter; p. 8 – centrallydirected (command); p. 14 – democratic (liberal) socialism; p. 22 – household;
p.22 – human capital; p. 28 – market economy; p. 30 – mixed economy; p.31 –
monopolistic, p.32 – monopoly, p.32 – Natural monopoly, p.33 – oligopoly, p.34
– perfect competition, p.37 – pure competition, p.37 – pure monopoly, p. 41 –
specialization; p. 44 - traditional economy).
27
Lesson 5.
Characteristics of Market Economy.
Questions for discussion (Lecture 2).
1) What are the basic types of Economic Organization in the modern
Economy?
2) What do you know about Traditional Economies?
3) How the traditional Economies solve the main problems? (What? How? For
Whom?)
4) What was the role of primitive agricultural and postural communities?
5) Is there a traditional Economy in 21 centaury?
6) What does the definition of “command Economy” mean?
7) Which methods is Economy use for deciding the Economy problem?
8) What is the main unit in this Economy?
9) Give another name of this Economy?
10)
Is it possible to be without some elements of command in the modern
Economy?
11)
What does indicative planning mean?
12)
Say, what do you know about socialist societies?
13)
What do you know about the bureaucratic Organization?
14)
Is the government play little or big role in market Economy?
15)
What is another names of market Economy?
16)
Say about six essential features of a market or capitalist system.
17)
What is the role of private property?
18)
What can you say about a freedom of choice and enterprise.
19)
Do you know the motive for economic activity?
20)
What does competition mean?
21)
Describe the principal of market pricing.
22)
What can you say about the government role in Market Economy?
23)
Describe the market’s schema.
Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
text 1, p.p. 27-28; text 2, p.p. 28-29; text 3, p.p. 29-30; text 4, p.p. 30-31.
Questions and exercises:
a)
b)
c)
d)
e)
1. Mark the right statements:
The item starts with describing the market economy.
The market economy allocates products and resources through the market
without any government control.
Then the picture relating to the mixed economy is given.
The command economy is not mentioned at all.
A mixed economy is a compromise between the two extremes.
28
f) In a mixed economy one-half of the production is carried through the market
with a certain government control. For the other half the government itself is
responsible through the public sector.
2. Fill in the gaps with the words from the text:
Thus, the government ... the allocation of the goods and services produced.
Even in the USA, a ... of free enterprise, controls or ... national income conditions.
As to Britain, today it has a ... economy.
In the public sector of Britain are the nationalized industries like...
In the private sector of Britain are the ... of the industries.
In the private sector of Britain are both large and small enterprises, from giants like
... to small...
3. Answer these questions:
a) How does the market economy work, judging by the figure?
b) What are the features of a mixed economy?
3) How are the USA and Britain characterized in terms of the economy?
d) What countries, if any, have a command economy now?
Read the texts and answer the questions:
Text 1.THE MAIN TYPES OF ECONOMIC SYSTEMS
An economic system is the method society uses to allocate its resources
(land, labour, capital, and entrepreneurship) to satisfy its needs. What distinguishes
one economic system from another is the control of the factors of production and
the interaction of business, government, and consumers. In the modern world there
are three main types of economic systems: capitalism (or pure capitalism), mixed
capitalism and communism (socialism).
Capitalism (or pure capitalism, or a market economy), as it was originally
described by Adam Smith in his eighteenth-century book «Wealth of Nations», is
an economic system where the factors of production are in private hands and ,
economic decisions are made freely according to the market forces of supply and I
demand. In this system the economic questions of
 What is to be produced?
 How much will be produced?
 Who will produce it?
 How much will it cost?
 Who will get it?
are determined by the consumers in the marketplace.
In pure capitalism consumers demand more of a product as its price
decreases. This follows the common sense notion that people are willing to
purchase something if it costs less. On the other hand: producers are more willing
to supply a product that can be sold for a higher price. Being motivated by profit,
they expect to earn more profit when they supply more.
In pure capitalism the two factors of supply and demand will balance each
other out in such a way that some middle ground called an equilibrium price will
29
be achieved. Producers will make as many units of a product as consumers are
willing to purchase at the price producers must charge to make a reasonable profit.
In pure capitalism industry and individuals use resources as they choose.
The government takes a laissez-faire, or hands-off, approach and does not interfere
in the economic system. Producers and consumers pursue their own self-interests.
Producers make as much as they can sell and consumers buy as much as they can
afford.
In this system each person behaves in the best interests of society, as if
guided by an invisible hand. The marketplace is regulated by the interaction of the
buyers and producers. If a company produces a defective product or charges too
much for the product it is rejected by consumers. As a result, the producer has to
improve the quality of the product or reduce the price to make any sales. The
marketplace, in essence the invisible hand, regulates economic conduct.
Government does not have to do any regulating.
Questions:
1. What is an economic system?
2. What distinguishes an economic system from another one?
3. What types of economic systems do you know?
4. In whose hands are the factors of production in capitalism?
5. Who makes economic decisions under capitalism? Does the marketplace
have influence on them?
6. By what are producers motivated when they supply products to the
market?
7. Whose interests do producers and consumers pursue in the market?
8. If a company produces a defective product or charges too much for the
product, will it be sold or rejected by consumers? What do think of if?
9. Some economists affirm that the government does not interfere in the
economic system. Are they right or wrong? Is it possible under capitalism?
10. Are you for or against the government's regulating of economic conduct
in Russia?
Text 2. MIXED ECONOMY
Over time the United States has evolved to a system of mixed capitalism -an
economic system based on a market economy with limited government
involvement. The government has abandoned the principle of the invisible hand in
favor of a more visible involvement in economic life.
In mixed capitalism the government has two economic tools: the power to
tax and the power to spend. By taxing individuals and businesses it acquires funds
to provide essential public programs: defense, education, transportation, and social
services. In turn the money spent for these services creates more demand for the
goods and services produced by businesses.
30
In addition, the government has become involved in the economic system
through:
 Government-owned entities such as the Tennessee Valley Authority, which
provides power to rural communities;
 Government agencies that regulate the activities of some businesses, as
when the Food and Drug Administration prevents a pharmaceutical company from
selling a new medicine until tests are made;
 Government involvement in employer-employee relations, for example,
setting a minimum wage and initiating programs to create jobs for the unemployed.
Questions:
1. Which is the difference between pure and mixed capitalism?
2. What is mixed capitalism as an economic system based on?
3. In favour of what principle has the government of Russia abandoned the
principle of the invisible hand?
4. Which economic tools does the government have in mixed capitalism?
5. How are the necessary funds acquired by the government to provide
essential public programs?
6. Do the money spent for social services create more or less demand for
the goods produced businesses?
7. May the Russian government interfere in the activities of private companies
now or not?
8. Are you a partisan of free market or government regulating of economic
conduct in our country or not? Why?
9. Which problems does government involvement in employer-employee
relations help to settle?
10. Who sets a minimum wage and initiates programs to liquidate
unemployment in Russia?
Text 3. COMMAND ECONOMY
Another economic system is communism. This is an economic system under
which the government controls the factors of production. Land, labour and capital
are under the control of the government and entrepreneurship is supplied by the
government. As a result, all the economic decisions about production, distribution,
consumption, and property ownership are made by the government. It decides what
will be produced, who will produce it, how many units will be made, how much it
will cost and who will receive it. Supply and demand and competition have no
influence in this system. Central government planners make all the economic
decisions about production and resource allocation.
Historical practice has shown that communism would not change capitalism
automatically and directly. Its partisans assure of communism's coming through
socialism which is considered as the first stage of communist society, or as an
economic subsystem in which much ownership is private, but the government
31
controls the operation and direction of basic industries. This control and direction
are based on the belief that there are certain products and services that everyone
should have. In essence this means that these need to be controlled so that all
people will have them - not just those people who have enough money.
The industries normally are under control of the government include mining,
steel production, transportation, communication, health care, and automanufacturing. In Sweden, for example, the government owns the transportation
network, communications, the banks, and the mining, steel, and chemical
industries.
Questions:
1. What is communism? How can you define this system in comparison
with capitalism?
2. Who controls the factors of production under communism?
3. What does science refer to the factors of production?
4. Who makes economic decisions about production, distribution and
consumption in communism?
5. What are the main features of socialism, the first stage of communism?
6. Is there private ownership under socialism?
7. Who decides what will be produced and who will produce it in
communism?
8. What can you say about the socialist experience in the Soviet Union
within 1917-1991?
9. Which are, in your opinion, the main causes of the crisis in the Soviet
Union and other countries?
10. Who controls the operation and direction of basic industries in modern
Russia?
11. What kind of society is Russia building now? What do you think of it?
Text 4. MODERN ECONOMIC SYSTEMS
When you examine the economic systems in the world today you will
discover, that no examples of pure capitalism, or pure communism exist. Most
economies are grouped in the center of a continuum that stretches from the
complete private ownership and market economy of pure capitalism to the total
public ownership of communism.
Even in the Soviet Union some private enterprise existed. Private vendors,
for example, could be seen in railroad stations and on country roads selling homegrown flowers and vegetables. Other economies that are called communist have
even more traces of private ownership. Yugoslavia has developed an interesting
variation of public ownership, with production decisions being made at the factory,
rather than by the central government, and being regulated by supply and demand.
32
Questions:
1. Are there any examples of pure capitalism or pure communism in the
world today?
2. Where are most of economic systems grouped now?
3. What kinds of ownership do you now? Which difference is between them?
4. Which ownership dominates under capitalism? And in socialism?
5. If you make a choice, what economic system would you prefer: a
capitalist system or a socialist one with the total public ownership? And why?
6. Did any private enterprise exist in the Soviet Union?
7. Do the now existing socialist countries have traces of private ownership?
8. What do you know about the socialist experience of Yugoslavia?
9. Where are production decisions made in this country?
10. China has achieved much progress in socialist building. How can you
explain this phenomenon?
Give a short summery of the texts.
Text 5. TRADITIONAL SYSTEMS
A traditional economic system is one in which behavior is based primarily
on tradition, custom, and habit. Young men follow their fathers' occupations—
typically, farming, hunting, fishing, and tool-making. Women do what their
mothers did—typically, cooking, mending, and fieldwork. There are few changes
in the pattern of production from year to year, other than those imposed by the
vagaries of nature. The techniques of production also follow traditional patterns,
except when the effects of an occasional new invention are felt. The concept of
private property is often not well denned, and property is frequently held in
common, such as common grazing land. Finally, production is allocated between
the members of society according to long-established traditions. In short, the
answers to the economic questions of what to produce, how to produce, and how to
distribute are determined by what has happened in the past. Such a system works
best in an unchanging environment. Under static conditions, a system that does not
continually require people to make choices can prove effective in meeting
economic and social needs.
Traditional systems were common in earlier times. The feudal system under
which most people lived in medieval Europe was a largely traditional society.
Today only a few small, isolated, self-sufficient communities still retain mainly
traditional systems; examples can be found in some of the most isolated parts of
the Canadian Arctic, the Himalayas, the Amazon jungle, and isolated parts of
Papua New Guinea.
Text 6. GOVERNMENT IN THE MODERN MIXED ECONOMY
Modern market economies in advanced industrial countries are based
primarily on market transactions between people who voluntarily decide whether
33
or not to transact. Private individuals have the right to buy and sell what they wish,
to accept or refuse work that is offered to them, and to move where they want
when they want. But governments create the legal framework that governs
transactions.
Key institutions are private property and freedom of contract, both of which
must be maintained by active government policies. The government creates laws of
ownership and contract, and then provides the courts to enforce these laws.
Governments are also responsible for provision of a stable-valued money which is
the measuring rod for all prices.
In modern mixed economies governments go well beyond these important
basic functions. They intervene in market transactions to correct what are called
'market failures'. These are identifiable situations in which free markets do not
work well. For example, natural resources such as fishing grounds and common
pastureland tend to be overexploited to the point of destruction under free-market
conditions. Some products, called public goods, are not provided at all by markets
because, once produced, no one can be prevented from using them. So their use
cannot be restricted to those who are willing to pay for them. Defence and law and
order are public goods. In other cases private agents impose costs called externalities on others by their economic activities, such as when factories pollute the air and
rivers—the public is harmed but has no part in the producers' decisions about what
to make and how to make it. These are some of the reasons why free markets
sometimes fail to function in desirable ways. They explain why citizens want
governments to intervene and alter the outcome that would result if everything
were left to the market.
There are also some products, like health and education, that could be
provided through the market, but which governments have decided should be
provided by the state and (in some cases) free of charge. These are not pure public
goods, but many countries' governments have decided that some level of minimum
provision must be available to all, so this cannot be left to the market. These are
sometimes referred to as merit goods.
Also, there are important equity (or fairness) issues that arise from letting
free markets determine people's incomes. Some people lose their jobs because
firms are reorganizing in the face of new technologies. Others may keep their jobs,
but the market values their services so poorly that they face economic hardship.
The old and the chronically ill may suffer if their past circumstances did not enable
them to save enough to support themselves. For many reasons of this sort, we
accept government intervention to redistribute income by taking something from
the 'haves' and giving it to the 'have-nots'. Almost everyone accepts that there
should be some redistribution of incomes. Care must be taken, however, not to kill
the goose that lays the golden egg. Taking too much from the 'haves' risks
eliminating their incentive to work hard and produce income, some of which would
be redistributed to the 'have-nots'.
Governments also play a part in influencing the overall level of prices and in
attempting to stabilize the economy against extreme fluctuations in income and
employment. A stable price level and full employment are the two major goals of
34
what is called the government's macroeconomic policy. These are dealt with in the
second half of this book.
These are some of the reasons why all modern economies are mixed
economies. Throughout most of the twentieth century, in advanced industrial
societies the mix was altering towards more and more government participation in
decisions about the allocation of resources and the distribution of income. In the
last two decades of the century, however, there was a worldwide movement to
lower the degree of government participation.
Read the text and discuss about it.
Text 7. MARKET AND FIRMS
The term market structure refers to the type of market in which firms
operate. Markets can be distinguished by the number of firms in the market and the
type of product that they sell.
The competitiveness of the market depends on the power of individual firms
to influence market prices. The less power an individual firm has to influence the
market in which it sells its product, the more competitive that market is.
The extreme form of competitive structure occurs when each firm has zero
market power. In such a case many firms sell an identical product and each must
accept the price set by the forces of market demand and market supply. The firms
can sell as much as they choose at the prevailing market price and have no power
to influence that price.
This extreme is called a perfectly competitive market structure. (Usually
the term 'structure' is dropped and economists speak of a perfectly competitive
market.) In it, there is no need for individual firms to compete actively with one
another, since one firm's ability to sell its product does not depend on the
behaviour of any other firm. For example, Essex and Somerset wheat farmers
operate in a perfectly competitive market over which they have no power. The
price of wheat is set in world markets, and there are thousands of suppliers to that
market in many different countries.
The perfectly competitive market structure—usually referred to simply as
perfect competition—applies directly to a number of real-world markets. It also
provides an important benchmark for comparison with other market structures.
Our analysis of perfect competition is built on a number of key assumptions
relating to the firm and to the industry.
• Assumption 1. All the firms in the industry sell an identical or
homogeneous product.
• Assumption 2. Buyers of the product are well informed about the
characteristics of the product being sold and the prices charged by each firm.
• Assumption 3. The output of each firm, when it is producing at its
minimum long-run average total cost, is a small fraction of the industry's total
output.
• Assumption 4. Each firm is a price-taker. This means that each firm can
alter its output without significantly affecting the market price of its product. Each
35
firm must passively accept the existing market price, but it can sell as much as it
wants at that price.
• Assumption 5. There is freedom of entry and exit, which means that any
new firm is free to enter the industry and start producing if it so wishes, and any
existing firm is free to cease production and leave the industry.
The difference between the wheat farmers that we considered earlier and
Shell is in their degree of market power. Each firm that is producing wheat is an
insignificant part of the whole market and so has no power to influence the price of
wheat. The oil company, on the other hand, does have power to influence the price
of petrol, because its own sales represent a significant part of the total sales of
petrol, even though all the firms in the industry are selling a product that is close to
homogeneous.
A perfectly competitive market is one in which individual firms have zero
market power.
Monopoly is at the opposite extreme from perfect competition. A monopoly
occurs when one firm, called a monopolist or a monopoly firm, produces an
industry's entire output. In contrast to perfectly competitive firms, which are pricetakers, a monopolist sets the market price.
Most real firms operate under intermediate market structures rather than the
two extremes of perfect competition and monopoly. On the one hand, they are not
monopolies because their industries contain several firms, which often compete
actively against each other. Firms manufacturing cars, refrigerators, TV sets,
breakfast cereals, and many other consumer goods are in industries containing
several close rivals, usually both foreign and domestic. Even in small towns,
residents find more than one chemist, garage, hairdresser, and supermarket
competing for their patronage. On the other hand, these firms do not operate in
perfectly competitive markets because the number of competing firms is often
small and, even when the number is large, the firms are not price-takers.
We may see firm behaviour in two intermediate market structures. One,
which is called monopolistic competition, is close to perfect competition with one
important difference: firms do not sell a homogeneous product. The second, called
oligopoly, deals with industries that typically contain a few large firms that
compete actively with each other.
One easily tractable model of imperfect competition is monopolistic
competition. Tractability of this model is achieved by limiting the form of
interdependence between producers. We deal with this case first before discussing
more general types of strategic interactions between firms in oligopolistic market
structures.
Monopolistic competition refers to a market in which there are many firms
but each sells a differentiated product and so faces a downward sloping demand
curve for its own product.
The theory is based on four key assumptions.
1. Each firm produces one specific variety, or brand, of the industry's
differentiated product. Each firm thus faces a demand curve that, although
36
negatively sloped, is highly elastic, because many close substitutes are sold by
other firms.
2. The industry contains so many firms that each one ignores the possible
reactions of its many competitors when it makes its own price and output
decisions. Each firm makes decisions based on its own demand and cost
conditions, and does not take any account of potential reactions by other firms.
3. There is freedom of entry and exit in the industry. If existing firms are
earning profits, new firms have an incentive to enter. When they do, the demand
for the industry's product must be shared among more brands.
4. There is symmetry. When a new firm enters the industry selling a new
version of the differentiated product, it draws customers equally from all existing
firms. For example, a new entrant that captured 5 per cent of the existing market
would do so by capturing 5 per cent of the sales of each existing firm.
Oligopoly is imperfect competition among the few; it applies to an industry
that contains only a few competing firms. Each firm has enough market power to
prevent it from being a price-taker, but at the same time each firm is subject to
enough inter-firm rivalry to prevent it from considering the market demand curve
as its own. In most modern economies this is the dominant market structure for the
production of consumer and capital goods as well as many basic industrial
materials such as steel and aluminium. Services, however, are often produced in
industries containing a larger number of firms—although product differentiation
prevents them from being perfectly competitive. Also, the absence of symmetry
prevents them from being monopolistically competitive. Since some firms'
products are closer substitutes for each other than other firms' products, firms do
tend to take account of the behaviour of their closest competititors.
In contrast to a monopoly, which has no competitors, and to a
monopolistically competitive firm, which has many competitors, an oligopolistic
firm faces a few competitors. Because there are only a few firms in an oligopolistic
industry, each firm realizes that its competitors may respond to any move it makes.
The prudent firm will take such possible responses into account. In other words,
oligopolists are aware that all the decisions made by the various firms in the
industry affect the other firms.
This is the key difference between oligopolists on the one hand and perfect
competitors, monopolistic competitors, and monopolies on the other. The
behaviour of oligopolists is strategic, which means that they must take explicit
account of the impact of their decisions on competing firms and of the reactions
they expect from competing firms. In contrast, firms in perfect and monopolistic
competition engage in non-strategic behaviour, which means they make decisions
based on their own costs and their own demand curves without considering any
possible reactions from their large number of competitors. The behaviour of a
monopolist is also non-strategic: it has no competitors with whom to interact.
In oligopolistic industries prices are typically administered. Products are
usually differentiated. Firms engage in rivalrous behaviour, although the intensity
of the rivalry varies greatly across industries and over time. Some aspects of this
rivalrous behaviour can be analysed using the tools of economics, but it is also the
37
subject of strategy courses in business schools and the central topic running
through thousands of business management books (a sample of which can be seen
in any airport bookstore). Successful captains of industry, whose memoirs often
sell millions of copies, are not those who are just good at deciding where marginal
cost is equal to marginal revenue: rather, they are those who lead a large team of
managers and workers in a complex competition to develop winning products and
gain market share against teams of others trying to do the same.
Questions:
1. What can you tell about perfect competition? Give a short summery of
assumptions relating to the firm and to the industry.
2. What does monopoly mean?
3. What can you say about firm behaviour in monopolistic competition?
4. Tell about firm behaviour in oligopoly.
Exercises:
1. Complete the sentences by using the words from the texts:
A) A … economic system is one in which behaviour is based primarily on
tradition, custom, and habit, and production is allocated between the members of
society according to long-established traditions.
B) This is a … economic system under which the government controls the factors
of production.
C) In a … economy millions of consumers decide what products to buy and in
what quantities, f large number of firms produce those products and buy the inputs
that are needed to make them and individual decisions collectively determine the
economy's allocation of resources between competing uses and the distribution of
its output among individual citizens.
D) The term … economy refers to an economy in which both free markets and
governments have significant effects on the allocation of resources and the
distribution of income.
2. Outline the differences between traditional, command, and market
economies and explain why the former two have been superseded.
3. Discuss the view why do governments have a role in a market economy?
New vocabulary:
economic system, traditional systems, market economy, mixed economy,
command economy
1.
Homework:
Economics for Medical Students. (text 6, p.p. 33-34; text 7, p.p.34-35).
38
2.
English Economy Dictionary with Definitions. (p. 7 – bond; p. 9 – check;
p. 11 – credit card; p. 12 – currency; p. 12 – currency depreciation; p. 14 – deposit
liabilities; p. 24 – inflation; p. 32 – near money).
Lesson 6.
Money and its Functions.
Questions for discussion (Lecture 2):
1)
2)
3)
4)
5)
What commodities have served as money in different parts of the world?
What do you know about shell money?
What is another name of this money?
What was the quality of the commodity as money?
Why precious metals were superseded many different commodities as
money?
6) What can you say about paper money?
7) What do banknotes mean?
8) What metal are made smaller denominations?
9) What metal are made bigger denominations?
10)
What are you mark the money?
11)
Say, please, about barter.
12)
When was barter adequately for aims of exchanges?
13)
Say, please, about the inefficient and frustrating of barter.
14)
What can you say about the role of specialization in economic
development?
15)
When does barter efficiency in market economy?
16)
What can you tell about 4 steps to money?
17)
What functions does money have in market economy?
18)
Describe, please, the function of a medium of exchange.
19)
What do you know about the function of a measure of value?
20)
Say us about a store of value.
21)
Why are people accumulate money and no snow or tables etc.?
22)
Please, give your understanding the function of money as a making
deferred payments.
23)
What forms of money do you know?
24)
Please, tell us about the bank deposits.
25)
How much money have government in circulation?
26)
What is the law of money circulation?
27)
What is the name of this formulary?
28)
What is the main reason of inflation?
Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
39
text 6, p.p. 33-34.
Questions:
a) What are the requirements of a commodity to serve as money?
b) Why did precious metals start to serve as money?
c) What precious metal was used first to serve as money?
d) How did coins come into existence?
e) How did paper banknotes come into existence?
text 7, p.p. 34-35.
Questions:
a) What are the main functions of money?
b) How important is the function of money as a medium of exchange?
c) Why do people accept money as a medium of exchange?
d) What is barter economy?
e) Why are barter economies wasteful?
Read the texts and answer the questions:
Text 1. MARKETS AND MONEY
People who are specialized in doing only one thing, whether they are factory
workers or computer programmers, must satisfy most of their needs by consuming
goods and services produced by other people. In early societies exchange of
products took place by simple mutual agreement between neighbours. In the course
of time, however, trading became centred on particular gathering places called
markets. For example, the French markets, or trade fairs, of Champagne were well
known throughout Europe as early as the eleventh century. Even now, many towns
have regular market days. For economists, however, the term 'market' has a much
broader meaning. We use the term market economy to refer to a society in which
people specialize in productive activities and meet most of their material wants
through voluntarily agreed exchanges. Most employed people, for example, work
for a single employer (at any one time) and buy goods and services in a wide range
in outlets (such as shops and restaurants, or by phone, internet, etc.).
Specialization must be accompanied by trade. People who produce only one
thing must trade most of it to obtain all of the other things they require.
Early trading was by means of barter, the trading of goods directly for other
goods. But barter is costly in terms of time spent searching out satisfactory
exchanges. If a farmer has wheat but wants a hammer, he must find someone who
has a hammer and wants wheat. A successful barter transaction thus requires what
is called a double coincidence of wants.
Money eliminates the restrictive system of barter by separating the
transactions involved in the exchange of products. If a farmer has wheat and wants
40
a hammer, she does not have to find someone who has a hammer and wants wheat:
she merely has to find someone who wants wheat, and takes money in exchange.
Then she finds a person who wishes to trade a hammer and gives up the money for
the hammer.
The existence of 'money' greatly expands the possibilities of specialization
and trade.
Questions:
1. What does barter mean?
2. When do economists use term market economy?
3. What is role of money in market economy?
3. How does money eliminate the restrictive system of barter?
Text 2. WHAT IS MONEY?
Money is denned as any generally accepted medium of exchange. A medium
of exchange is anything that will be widely accepted in a society in exchange for
goods and services. Although being a medium of exchange is usually regarded as
money's defining function, money can also serve other roles:
Money acts as a medium of exchange and can also serve as a store of value
and a unit of account.
A medium of exchange.
if there were no money, goods would have to be exchanged by barter (one
good being swapped directly for another). The major difficulty with barter is that
each transaction requires a double coincidence of wants: I can only buy from
someone who wants what I can offer in exchange. Anyone who specialized in
producing one commodity would have to spend a great deal of time searching for
suitable trading partners. Thus, a thirsty economics lecturer would have to find a
brewer who wanted to learn economics before he could swap a lesson in
economics for a pint of beer.
The use of money as a medium of exchange alleviates this problem. People
can sell their output for money and subsequently use the money to buy what they
want from others. So a monetary economy typically involves exchanges of goods
and services for money and exchanges of money for goods and services—but not
exchanges of goods and services for other goods and services.
The double coincidence of wants, which is required for barter, is
unnecessary when a medium of exchange is used.
By facilitating transactions, money makes possible the benefits of
specialization and the division of labour, which in turn contribute to the efficiency
of the economic system. It is not without justification that money has been called
one of the great inventions contributing to human freedom and well-being.
To serve as an efficient medium of exchange, money must have a number of
characteristics. It must be readily acceptable and therefore of known value. It must
41
have a high value relative to its weight. (Otherwise it would be a nuisance to carry
around.) It must be divisible, because money that comes only in large
denominations is useless for transactions having only a small value. Finally, it
must be difficult, if not impossible, to counterfeit.
A store of value.
Money is a convenient way to store purchasing power; goods may be sold
today, and the money taken in exchange for them may be stored until it is needed.
To be a satisfactory store of value, however, money must have a relatively stable
value. A rise in the price level leads to a decrease in the purchasing power of
money, because more money is required to buy a typical basket of goods. When
the price level is stable, the purchasing power of a given sum of money is also
stable; but when the price level is highly variable this is not so, and the usefulness
of money as a store of value is undermined.
Although in a non-inflationary environment money can serve as a
satisfactory store of accumulated purchasing power for a single individual, even in
those circumstances it cannot do so for society as a whole. A single individual can
accumulate money and, when the time comes to spend it, can command the current
output of some other individual. However, if all individuals in a society were to
save their money and then retire simultaneously to live on their savings, there
would be no current production to purchase and consume. Society's ability to
satisfy wants depends on goods and services being available. If some of this wantsatisfying capacity is to be stored up for society as a whole, some goods that are
produced today must be saved for future periods. In other words, money may be
accumulated as savings to help individuals buy future goods, but it is the future
real capital stock and labour resources that will determine future real output.
Money and real wealth should not be confused.
Money is a store of value for individuals but not for society as a whole.
A unit of account
Money also may be used purely for accounting purposes, without having a
physical existence of its own. For instance, a government store in an imaginary
centrally planned society might say that everyone had so many 'pounds' to spend or
save each month. Goods could then be assigned prices and each consumer's
purchases recorded, the consumer being allowed to buy until his or her allocated
supply of pounds was exhausted. These pounds need have no existence other than
as entries in the store's books, yet they would serve as a perfectly satisfactory unit
of account.
Whether they could also serve as a medium of exchange between individuals
would depend on whether the shop would agree to transfer credits from one
customer to another at the first customer's request. Banks will transfer pounds
credited to current account deposits in this way, and so a bank deposit can serve as
both a unit of account and a medium of exchange. Notice that the use of 'pounds' in
this context suggests a further sense in which money is a unit of account. People
think about values in terms of the monetary unit with which they are familiar.
A related function of money is that it can be used as a standard of deferred
payments. Payments that are to be made in the future, on account of debts and so
42
on, are reckoned in money. Money's ability to serve as a unit of account over time
in this manner can be diminished if there is significant inflation.
Questions:
1. When the double coincidence of wants, which is required for barter, is
unnecessary?
2. Does money makes possible the benefits of specialization and the division of
labour, which in turn contribute to the efficiency of the economic system?
3. When the purchasing power of a given sum of money is stable?
4. When the usefulness of money as a store of value is undermined?
5. Is money a store of value for individuals or for society as a whole?
6. May money used purely for accounting purposes?
7. How does money’s ability to serve as a unit of account over time alter if there is
significant inflation?
Give a short summery of the texts.
Text 3. METALLIC MONEY
All sorts of commodities have been used as money at one time or another,
but gold and silver proved to have great advantages. They were precious because
their supplies were relatively limited, and they were in constant demand by the
wealthy for ornament and decoration. Thus, these metals tended to have a high and
stable price. Further, they were easily recognized, they were divisible into
extremely small units, and they did not easily wear out.
Before the invention of coins, it was necessary to carry the metals in bulk.
When a purchase was made, the requisite quantity of the metal was carefully
weighed on a scale. The invention of coinage eliminated the need to weigh the
metal at each transaction, but it created an important role for an authority, usually a
monarch, who made the coins by mixing gold or silver with base metals to create
convenient size and durability, and affixed his or her seal, guaranteeing the amount
of precious metal that the coin contained. This was clearly a great convenience, as
long as traders knew that they could accept the coin at its 'face value'. The face
value was nothing more than a statement that a certain weight of gold or silver was
contained therein.
However, often coins could not be taken at their face value. A form of
counterfeiting—clipping a thin slice off the edge of the coin and keeping the
valuable metal— became common. This, of course, served to undermine the
acceptability of coins, even if they were stamped. To get around this problem, the
idea arose of minting the coins with a rough edge; then the absence of the rough
edge would immediately indicate that the coin had been clipped. This practice,
called milling, survives on some coins (such as the current UK 5p, lOp, Ј1, and Ј2
43
coins) as an interesting anachronism to remind us that there were days when the
market value of the metal in the coin was equal to the face value of the coin.
Not to be outdone by the cunning of their subjects, some rulers were quick to
seize the chance of getting something for nothing. The power to mint coins placed
rulers in a position to work a really profitable fraud. They often used some suitable
occasion—a marriage, an anniversary, an alliance—to re-mint the coinage.
Subjects would be ordered to bring their coins into the mint to be melted down and
coined afresh with a new stamp. Between the melting down and the recoining,
however, the rulers had only to toss some further inexpensive base metal in with
the molten coins. This debasing of the coinage allowed the ruler to earn a
handsome profit by minting more new coins than the number of old ones collected,
and putting the extras in the royal vault.
The result of debasement was inflation. The subjects had the same number
of coins as before, and hence could demand the same quantity of goods. When
rulers paid their bills, however, the recipients of the extra coins could be expected
to spend them. This caused a net increase in demand, which in turn bid up prices.
Debasing the coinage was a common cause of increases in prices.
It was the experience of such inflations that led early economists to stress the
link between the quantity of money and the price level.
To this day, the revenue generated from the power to create currency is
known as seigniorage. Today the possibility of debasement does not enter. The
term applies to the revenue that accrues from the powers to print banknotes (which
have very low production costs relative to their face value) and to require private
banks to place non-interest-bearing deposits at the central bank.
The benefits of seigniorage could arise simply because the monetary
authorities print money and spend it, so its value would be equal to the increase in
note issue each period. In practice, the relevant monetary authority is the central
bank, which is a government-owned institution that is the sole money-issuing
authority and acts as banker to the commercial banking system. The UK central
bank is the Bank of England; for the United States it is the Federal Reserve Board,
and for the euro area it is the European Central Bank (ECB). When the central
bank provides bank notes to the private sector, it typically buys interest-bearing
bonds with each new issue of notes. The seigniorage from the notes in circulation
is thus equal to the interest per period on those bonds. So, for example, if the note
issue was £100 and the central bank had bought £100 worth of bonds in issuing
those notes, and the yield on the bonds was 5 per cent, then seigniorage would be
£5 per year. Some seigniorage also arises from the policy of many central banks of
forcing commercial banks to place non-interest-bearing deposits with them, which
the central bank can also use to purchase interest-bearing securities.
Text 4. PAPER MONEY
The next important step in the history of money was the evolution of paper
currency, one source of which was goldsmiths. Since goldsmiths had secure safes,
44
the public began to deposit their gold with them for safekeeping. Goldsmiths
would give their depositors receipts promising to hand over the gold on demand.
When any depositor wished to make a large purchase, she could go to her
goldsmith, reclaim some of her gold, and hand it over to the seller of the goods. If
the seller had no immediate need for the gold, he would carry it back to the
goldsmith for safekeeping on his behalf.
If people knew the goldsmith to be reliable, there was no need to go through
the cumbersome and risky business of physically transferring the gold. The buyer
needed only to transfer the goldsmith's receipt to the seller, who would accept it as
long as he was confident that the goldsmith would pay over the gold whenever it
was needed. If the seller wished to buy a good from a third party who also knew
the goldsmith to be reliable, passing the goldsmith's receipt from the buyer to the
seller here too could effect the transaction. The deposit receipt was 'as good as
gold'. The convenience of using pieces of paper instead of gold is obvious.
When it came into being in this way, paper money represented a promise to
pay so much gold on demand. In this case the promise was made first by
goldsmiths and later by banks. Such paper money, which became banknotes, was
backed by precious metal and was convertible on demand into this metal.
Text 5. FRACTIONALLY BACKED PAPER MONEY
Early on, many goldsmiths and banks discovered that it was not necessary to
keep a full ounce of gold in the vaults for every claim to an ounce circulating as
paper money. At any one time, some of the bank's customers would be
withdrawing gold but others would be depositing it, and most would be trading in
the bank's paper notes without indicating any need or desire to convert them into
gold.
As a result, the bank was able to issue more money (initially notes, but later
deposits) redeemable in gold than the amount of gold that it held in its vaults. This
was good business, because the money could be invested profitably in interestearning loans (often called advances) to individuals and firms. The demand for
loans arose, as it does today, because some customers wanted credit to help them
over hard times or to buy equipment for their businesses. To this day, banks have
many more claims outstanding against them than they actually have in reserves
available to pay those claims. We say that the currency issued in such a situation is
fractionally backed by the reserves.
The major problem with a fractionally backed, convertible currency was
maintaining its convertibility into the precious metal by which it was backed. The
imprudent bank that issued too much paper money would find itself unable to
redeem its currency in gold when the demand for gold was even slightly higher
than usual. It would then have to suspend payments, and all holders of its notes
would suddenly find that their notes were worthless. However, the prudent bank
that kept a reasonable relationship between its note issue and its gold reserve
would find that it could meet a normal range of demand for gold without any
trouble.
45
If the public lost confidence and demanded redemption of its currency en
masse, however, the banks would be unable to honour their pledges. The history of
nineteenth-and early-twentieth-century banking around the world is full of
examples of banks that were ruined by 'panics', or sudden runs on their gold
reserves. When this happened, the banks' depositors and the holders of their notes
would find themselves with worthless pieces of paper.
Text 6. MODERN MONEY
The total amount of money in the economy is called the money supply or the
money stock. The creation of high-powered money is only part of the story of how
the money supply is created, because most measures of the money supply include a
wider range of assets than just the monetary base. In particular, money is usually
defined to include bank deposits.
Today's bank customers frequently deposit coins and paper money with the
banks for safekeeping, just as in former times they deposited gold. Such a deposit
is recorded as a credit to the customer's account. A customer who wishes to pay a
debt may come to the bank, claim the money in currency, and then pay the money
to someone else, who may himself redeposit the money in a bank.
As with gold transfers, this is a tedious procedure. It is more convenient to
have the bank transfer claims to money on deposit. As soon as cheques, which are
written instructions to the bank to make a transfer, became widely accepted in
payment for commodities and debts, bank deposits became a form of money called
'deposit money'. Deposit money is denned as money held by the public in the form
of deposits in commercial banks that can be withdrawn on demand. Cheques,
unlike banknotes, do not circulate freely from hand to hand; thus cheques
themselves are not currency. However, a balance in a current account deposit is
money; the cheque simply transfers that money from one person to another.
Because cheques are easily drawn and deposited, and because they are relatively
safe from theft, they have been widely used. New technology has recently replaced
many cheque transactions by computer transfer. Plastic cards such as Visa,
Mastercard, and Switch enable holders of bank accounts to transfer money to
another person's account in new ways. The principle is the same, however: the
balance in the bank account is the money that is to be transferred between
customers, not the cheque or the plastic card.
When commercial banks lost the right to issue notes of their own, the form
of bank money changed, but the substance did not. Today banks have money in
their vaults (or on deposit with the central bank) just as they always did. Once it
was gold; today it is the legal tender of the times—fiat money. It is true today, just
as in the past, that most of the banks' customers are content to pay their bills by
passing among themselves the banks' promises to pay money on demand. Only a
small proportion of the value of the transactions made by the banks' customers
involves the use of cash.
46
Bank deposits are money. Today, just as in the past, banks can create money
by issuing more promises to pay (deposits) than they have cash reserves available
to pay out.
The main reason that we are interested in the money stock is that if it grows
too fast it will cause inflation. For this purpose, it is the broad measure of the
money stock that includes bank deposits that is most relevant, as bank deposits can
be used in payment for goods and it is often said that 'too much money chasing too
few goods' is the source of inflation.
Exercises:
1. Complete the sentences by using the words from the texts:
A) We use the term … to refer to a society in which people specialize in
productive activities and meet most of their material wants through voluntarily
agreed exchanges.
B) A successful barter transaction thus requires what is called a …
C) Money … the restrictive system of barter by separating the transactions
involved in the exchange of products.
D) A … is anything that will be widely accepted in a society in exchange for goods
and services.
E) Money acts as a medium of exchange and can also serve as a … and a … .
F) To be a satisfactory store of value money must have a relatively … value.
G) Gold and silver proved to have great advantages and were precious because
their supplies were relatively limited, and they were in … demand by the wealthy
for ornament and decoration.
H) The convenience of using pieces of … instead of gold is obvious.
I) Over time central banks have assumed a … in the provision of money to the
economy.
J) The total amount of money in the economy is called the … .
2. What difference would it make to the economy if there were no money?
What types of commodity might serve as money instead?
New vocabulary:
barter, gold standart, medium of exchange, measure of value, money as a making
deferred payments, store of value.
Homework:
1.
Economics for Medical Students. (text 1, p.p. 36-37; text 2, p.p.37-39; text
3, p.p. 39-40, text 4, p.p. 4—42; text 5, p.p. 42-44; text 6, p.p. 44-45).
2.
English Economy Dictionary with Definitions. (p. 10 – consumer
sovereighty; p. 13 – demand; p. 13 – demand schedule; p. 16 – elastic
(demand); p. 42 – supply; p. 42 – supply and demand).
47
Lesson 7.
Theory of Demand and Supply.
Questions for discussion (Lecture 3):
1)
2)
3)
4)
5)
Is price the same thing as value?
Why are some things valuable?
What does the word “market” mean?
What kinds of market do you know?
What can you say about the pricing in market economy? What forces of
market determine the market prices?
6) Say, please, the names of the Economists, which founded the theory of
Demand and Supply.
7) Is demand the same thing as desire, or need, or want?
8) What can you say about the definition of Demand.
9) What is the graphical representation the curve of Demand?
10)
Is demand key concept in macroeconomics or microeconomics.
11)
Say, please, about the law of Demand.
12)
Which factors influence to the demand?
13)
What do you know about the exceptions to the law of Demand (or
curiosa of theorists)?
14)
Tell about the Giffen effect.
15)
And what another effects of Economy do you know?
16)
What does the definition Supply mean?
17)
What does the basic law of Supply say?
18)
Give the graphical representation of curve of Supply.
19)
What factors does influence to Supply?
20)
Tell us, please, about the elasticity of Demand and Supply.
21)
Explain, please, the direct coefficients elasticity of Demand and
Supply.
22)
Market is a dialog. What can you say about the market equilibrium?
Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
text 1, p. 36.
Exercises:
1. Sum up what the text said about:
a) A. A. Cournot;
b) J. Dupuit;
c) D. Lardner;
d) An example of the application of the principles at present.
2. Agree or disagree:
a) It is very easy to calculate such rates knowing the law of demand and
48
supply.
b) This principle of calculation is also applied to hotel charges for
accommodation.
c) This principle is applied in very many cases.
Text 2, p.p. 37-38.
Exercises:
1. Write out the definition of the terms:
demand;
demand curve;
supply;
supply curve;
2. Imagine you at a seminar. Describe the two figures given in the text.
3. Find the terms in the text:
...? – a line which shows the cost of production at different levels of output.
The curve might relate to average cost and marginal cost, or total cost.
...? – the inputs of resources used in production.
...? – the price at which the quantity demanded of a good is exactly equal to
the quantity supplied.
Text 3, p.p. 39-40.
Questions:
a) What is demand?
b) What is supply?
c) How are prices and the supplied and demanded quantities regulated by the
market?
d) Which factors influence demand?
e) How do they work?
f) How can governments regulate demand and supply?
Text 4, p.p. 40-41.
Exercises:
1. Which is not true about the law of demand:
a) Consumption is the key concept of microeconomics.
b) Classical economists contributed a lot to the development of the theory of
demand.
2. Questions for discussion:
a) Do you agree that "conspicuous consumption" plays the great role in the
economy?
b) Do you think it is logical that "consumer responds to lower prices by
buying more"? Think of an example when consumer believes that prices
would go even lower and does not react immediately in the expected way.
49
Text 5, p.p. 42-43.
Questions and exercises:
a) What is the difference of the concept of supply in macro- and
microeconomics?
b) What are opportunity costs?
c) What are implicit costs?
d) What, according to the text, a sole proprietor or the owners should do?
e) What does the elasticity of supply show?
f) What is the difference between the short-time and long-time supply?
g) Why do changes in the supply affect the position of the supply curve?
Which of the following is not true?
a) Supply is a concept of macroeconomics.
b) Economists differ from bookkeepers and tax-gatherers because they include
also opportunity costs.
c) The shape of the supply curve provides specialist with the information on
elasticity of supply and the reflection of the shareholder.
d) The supply curve is a line on a diagram where the vertical axis measures
price and the horizontal axis is quantity.
e) Bountiful crops are a cause of increase in supply.
f) Improvements in technology and changes in input prices and productivities
are the main causes of the changes in elastic demand.
Text 6, p.p. 44-45.
Questions:
a) Which demand is called elastic?
b) In what units is elasticity of supply shown?
c) Why is the price elasticity of demand coefficient negative and the
corresponding coefficient for supply positive?
d) What supply is called inelastic?
e) What is the difference between the inelastic and the perfectly inelastic
supply?
f) Why is agricultural supply usually inelastic?
g) What is the tendency of agricultural supply development?
Text 7, p.p. 45-46.
Exercises:
1. Read the sentences paying attention to the verb "to provide":
Labour market provides for an exchange of work for wages.
These workers have large families to provide for.
They provide their children with food and clothes.
They provide food and clothes for them.
50
The company must provide for their visitors.
The contract provided cooperation for a few years.
A clause in the agreement provides that the tenant shall bear the cost of all
repairs.
2. Complete the sentences in your own way:
As a consequence ...
It cannot be regarded as ...
As a result ...
They require it as ...
As the figure shows ...
It must be seen as ...
As the graph shows ...
Such professions as ...
As the practice shows...
As the labour market shows ...
As to me I ...
Such jobs as ...
Give a short summery of the texts.
Text 1. THE NATURE OF DEMAND
The amount of a product that consumers wish to purchase is called the
quantity demanded. Notice two important things about this concept. First,
quantity demanded is a desired quantity. It is how much consumers wish to purchase, not necessarily how much they actually succeed in purchasing. We use
phrases such as quantity actually purchased or quantity actually bought and
sold to distinguish actual purchases from the quantity demanded. Second, note that
quantity demanded is a flow. We are concerned not with a single isolated purchase,
but with a continuous flow of purchases. We must, therefore, express demand as so
much per period of time—for example 1 million oranges per day, or 7 million
oranges per week, or 365 million oranges per year.
The concept of demand as a flow appears to raise difficulties when we deal
with the purchases of durable consumer goods (often called 'consumer durables'). It
makes obvious sense to talk about a person consuming oranges at the rate of 30 per
month, but what can we say of a consumer who buys a new television set every
five years? This apparent difficulty disappears if we measure the demand for the
services provided by the consumer durable. Thus, at the rate of a new set every five
years, the television purchaser is using the service (viewing TV programmes) at the
rate of 1/60 of a set per month.
Five main variables are assumed to influence the quantity of each product
that is demanded by each individual consumer:
1. The price of the product
2. The prices of other products
3. The consumer's income and wealth
4. The consumer's tastes
5. Various individual-specific or environmental factors
List is conveniently summarized in what is called a demand function:
Qdn=f(pn, p1…pn-1, I, H)
51
The term Qdn stands for the quantity that the consumer demands of some
product, which we call 'product n'. The term pn, stands for the price of this product,
while p1, … , pn-1 is a shorthand notation for the prices of all other products. The
term I is the consumer's income. The term H stands for a host of factors that will
vary from individual to individual, such as age, number of children, place of
residence (e.g. big city, small town, country), and other assets. (Car owners, for
example will demand petrol while non-car owners will demand train tickets.)
There are also some environmental factors that will affect demand patterns, such as
the state of the weather and the time of year. Although these factors matter in real
markets, they are not central to our current analysis. Finally, the precise way in
which the variables listed above affect demand is determined by the tastes of the
consumer.
The demand function is just a shorthand way of saying that quantity
demanded, which is on the left-hand side, is assumed to depend on the variables
that are listed on the right-hand side. The form of the function determines the
nature of that dependence. (Recall that the 'form of the function' refers to the
precise quantitative relation between the variables on the right-hand side of the
equation and the variable on the left.)
We will not be able to understand the separate influences of each of the
above variables if we ask what happens when all of them change at once. To avoid
this difficulty, we consider the influence of the variables one at a time. To do this,
we use a device that is frequently employed in economic theory. We assume that
all except one of the variables on the right-hand side of the above expression are
held constant. Then we allow this one variable, say pn to change and see how the
quantity demanded (Qdn) changes. We are then studying the effect of changes in
one influence on quantity demanded, assuming that all other influences remain
unchanged which means 'other things being equal' or 'holding others things
constant'.
Text 2. DEMAND AND PRICE
We are interested in developing a theory of how products get priced. To do
this, we hold all other influences constant and ask, 'How will the quantity of a
product demanded vary as its own price varies?'
A basic economic hypothesis is that the lower the price of a product, the
larger the quantity that will be demanded, other things being equal.
This negative relationship between the price of a product and quantity
demanded is sometimes referred to as the law of demand. Why might this law be
true? A major reason is that there is usually more than one product that will satisfy
any given desire or need. Hunger may be satisfied by meat or vegetables; a desire
for green vegetables may be satisfied by broccoli or spinach. The need to keep
warm at night may be satisfied by several woollen blankets, or one electric blanket,
or a bedsheet and an efficient central heating system. The desire for a holiday may
be satisfied by a trip to the Scottish Highlands or to the Swiss Alps; the need to get
there by an aeroplane, a bus, a car, or a train; and so on. Name any general desire
52
or need, and there will usually be several products that will contribute to its
satisfaction.
Now consider what happens if we hold income, tastes, population, and the
prices of all other products constant and vary the price of only one product.
First, suppose the price of the product rises. The product then becomes a
more expensive way of satisfying a want. Some consumers will stop buying it
altogether; others will buy smaller amounts; still others may continue to buy the
same amount; but no rational consumer will buy more of it. Because many
consumers will switch, wholly or partially, to other products to satisfy the same
want, less will be bought of the product whose price has risen. For example, as
meat becomes more expensive, consumers may switch some of their expenditure to
meat substitutes; they may also forgo meat at some meals and eat less meat at
others.
Second, let the price of a product fall. This makes the product a cheaper
method of satisfying any given want. Consumers will buy more of it and less of
other similar products whose prices have not fallen. These other products have
become expensive relative to the product in question. For example, when a bumper
tomato harvest drives prices down, shoppers buy more tomatoes and fewer other
salad ingredients, which have now become relatively more expensive than
tomatoes.
Text 3. THE DEMAND SCHEDULE AND THE DEMAND CURVE
A demand schedule is one way of showing the relationship between quantity
demanded and price. It is a numerical tabulation that shows the quantity that will
be demanded at some selected prices.
Table 7.1 shows one consumer's demand schedule for eggs. Mrs. Brown often eats
boiled eggs for breakfast, and, living on her own, she often finds omelettes a
convenient evening meal. But she does not have a lot of money, so she keeps an
eye on the price of eggs when she does her weekly supermarket shopping. The
table shows the quantity of eggs that she wishes to buy each month at six selected
prices. For example, at a price of Ј1.50 per dozen, Mrs. Brown demands 3.5 dozen
per month. For easy reference, each of the price-quantity combinations in the table
is given a letter.
Next we plot the data from Table 7.1 in Figure 7.1, with price on the vertical
and quantity on the horizontal axis. The smooth curve drawn through these points
is called the demand curve, even though it may often be drawn as a straight line. It
shows the quantity that Mrs. Brown would like to buy at every possible price, and
its negative slope indicates that the quantity demanded increases as the price falls.
53
Table 7.1. Mrs. Brown’s demand schedule for eggs
Reference letter
Price
Quantity demanded
(£ per dozen)
(dozen per month)
a
0,50
7,0
b
1,00
5,0
c
1,50
3,5
d
2,00
2,5
e
2,50
1,5
f
3,00
1,0
A single point on the demand curve indicates a single price-quantity relationship.
The whole demand curve shows the
complete relationship between quantity
demanded and price. Economists often
speak of the conditions of demand in a
particular market as 'given' or as
'known'. When they do so they are
referring not just to the particular
quantity that is being demanded at the
moment (i.e. not just to a particular
point on the demand curve) but to the
whole demand curve. The whole
demand curve remains in one place so
long as all variables other than the price
of the product itself remain unchanged.
Figure 7.1. Mrs. Brown’s demand curve
So far we have discussed how the quantity of a product demanded by one
consumer depends on the product's price, other things being equal. To explain
market behaviour, we need to know the total demand of all consumers. To obtain a
market demand schedule, we sum the quantities demanded by each consumer at a
particular price to obtain the total quantity demanded at that price. We repeat the
process for each price to obtain a schedule of total, or market, demand at all
possible prices. A graph of this schedule is called the market demand curve.
In practice, our knowledge of market demand is usually derived by
observing total quantities of sales directly. The derivation of market demand
curves by summing individual curves is a theoretical operation. We do it to
understand the relation between curves for individual consumers and market
curves.
Text 4. SHIFTS IN THE DEMAND CURVE
The demand schedule and the demand curve are constructed on the
assumption of ceteris paribus (other things held constant). But what if other things
change, as surely they must? What, for example, if consumers find themselves with
more income? If they spend their extra income, they will buy additional quantities
54
of many products even though market prices are unchanged. But if consumers
increase their purchases of any product whose price has not changed, the new
purchases cannot be represented by the original demand curve. The rise in
consumer income shifts the demand curve to the right, as shown in Figure 7.2. This
shift illustrates the operation of an important general rule.
A demand curve shifts to a new
position in response to a change in any of
the variables that were held constant
when the original curve was drawn.
Any change that increases the
quantity of a product consumers wish to
buy at each price will shift the demand
curve to the right, and any change that
decreases the quantity consumers wish to
buy at each price will shift the demand
curve to the left.
Figure 7.2. Shifts in the demand curve
We saw that demand curves have negative slopes because the lower a
product's price, the cheaper it becomes relative to other products that can satisfy
the same needs. Those other products are called substitutes. A product becomes
cheaper relative to its substitutes if its own price falls. This also happens if the
substitute's price rises. For example, eggs can become cheaper relative to pizzas
either because the price of eggs falls or because the price of pizzas rises—either
change will increase the amount of eggs that consumers are prepared to buy. For
example, Mrs. Brown may eat more omelettes and fewer pizzas whenever she
wants a quick meal. A rise in the price of a product's substitute shifts the demand
curve for the product to the right. More will be purchased at each price.
Products that tend to be used jointly with each other are called
complements. Cars and petrol are complements; so are golf clubs and golf balls,
bacon and eggs, electric cookers and electricity, or an aeroplane trip to Austria and
tickets on the ski lifts at St Anton. Since complements tend to be consumed
together, a fall in the price of either will increase the demand for both. For
example, a fall in the price of cars that causes more people to become car owners
will, ceteris paribus, increase the demand for petrol.
A fall in the price of one product that is complementary to a second product
will shift the second product's demand curve to the right. More will be purchased
at each price.
If consumers receive more income, they can be expected to purchase more
of most products even though product prices remain the same. A product whose
demand increases when income increases is called a normal good.
A rise in consumers' incomes shifts the demand curve for normal products to
the right, indicating that more will be demanded at each possible price.
For a few products, called inferior goods, a rise in consumers' income leads
them to reduce their purchases (because they can now afford to switch to a more
expensive, but superior, substitute).
55
A rise in income will shift the demand for inferior goods to the left,
indicating that less will be demanded at each price.
If total income and all other determinants of demand are held constant while
the distribution of income changes (i.e. some become richer and others become
poorer), the demands for normal goods will rise for consumers gaining income and
fall for consumers losing income. If both gainers and losers buy a good in similar
proportions, these changes will tend to cancel out. This will not, however, always
be the case.
When the distribution of income changes, demand will rise for those goods
favoured by those gaining income and fall for those goods favoured by those losing
income.
Changes in the characteristics of the individuals who make up the market
will cause demand curves to shift. For example, a reduction in the typical number
of children per family, as happened in the twentieth century, will reduce the
demands for the things used by children or in childcare. If the number of retired
people increases, there will be a rise in the demands for goods consumed during
leisure times.
Demand for some products is different at different times of year. Some of
this is due to weather; for example, demand for electricity is higher in the winter
when days are short and the weather is cold,3 and demand for cold lager and ice
cream is higher in the summer during hot weather. Other variations may be due to
traditions associated with annual festivals, such as buying presents at Christmas, or
the timing of school holidays. From the point of view of our theory of demand
these are exogenous forces—things that lie outside the theory, affecting demand,
sometimes greatly, but not themselves being explained by the theory.
If there is a change in tastes in favour of a product, more will be demanded
at each price, causing the demand curve to shift to the right. In contrast, if there is a
change in tastes away from a product, less will be demanded at each price, causing
the entire demand curve to shift to the left. Notice that, since we are generalizing
beyond our example of eggs, we have relabelled our axes 'price' and 'quantity',
dropping the qualification 'of eggs'. The term quantity should be understood to
mean quantity per period in whatever units the goods are measured. The term price
should be understood to mean the price measured in pounds per unit of quantity for
the same product.
A movement down a demand curve is called an increase (or a rise) in the
quantity demanded; a movement up the demand curve is called a decrease (or a
fall) in the quantity demanded.
Text 5. FIRMS’ MOTIVES
Economic theory gives firms several attributes.
First, each firm is assumed to make consistent decisions, as though it were
run by a single individual decision-maker. This allows the firm to be treated as the
agent on the production or supply side of product markets, just as the consumer is
treated as the individual unit of behaviour on the consumption or demand side.
56
Second, firms hire workers and invest capital and entrepreneurial talent in
order to produce goods and services that consumers wish to buy. (There are some
markets in which firms sell to other firms, or the government, and in the labour
market individuals sell their services to firms. But here we focus on consumer
goods markets for simplicity.)
Third, firms are assumed to make their decisions with a single goal in mind:
to make as much profit as possible. This goal of profit maximization is analogous
to the consumer's goal of utility maximization.
The amount of a product that firms are able and willing to offer for sale is
called the quantity supplied. Supply is a desired flow: it indicates how much
firms are willing to sell per period of time, not how much they actually sell.
Here we make a start on the analysis of supply, establishing only what is
necessary for a theory of price. In later chapters we study the behaviour of
individual firms, and then aggregate individual behaviour to obtain the behaviour
of market supply. For present purposes, however, it is sufficient to go directly to
market supply, the aggregate behaviour of all the firms in a particular market.
Three major determinants of the quantity supplied in a particular market are:
1. The price of the product
2. The prices of inputs to production
3. The state of technology
This list can be summarized in a supply function:
Qsn=f (pn, F1, … Fm),
where
Qsn is the quantity supplied of product n;
pn is the price of that product;
F1, … Fm is shorthand for the prices of all inputs into production; and the state of
technology determines the form of the function S. (Recall, once again, that the
form of the function refers to the precise quantitative relation between the variables
on the right-hand side of the equation and the one on the left.)
Text 6. SUPPLY AND PRICE
For a simple theory of price, we need to know how quantity supplied varies with a
product's own price, all other things being held constant. We are only concerned
Qsn=f (pn),
that is, between the quantity that firms wish to supply and the price of the product
itself. We will have much to say in later chapters about this relationship. For the
moment, it is sufficient to state the hypothesis that, holding other things constant,
the quantity of any product that firms will produce and offer for sale is positively
related to the product's own price, rising when the price rises and falling when the
price falls.
All we need to note is that the basic reason behind this relationship is the
way in which costs behave as output changes. Typically, the cost of increasing
57
output by another unit tends to be higher the higher is the existing rate of output.
So, for example, if the firm is already producing 100 units per week, the cost of
increasing output to 101 units per week might be Ј1, while if 200 units were
already being produced, the cost of increasing output to 201 units might be Ј2.
Clearly, the firm will not find it profitable to increase output if it cannot at least
cover the additional costs that are incurred. As the price of the product rises, the
firm can cover the rising costs of more and more additional units of output. As a
result, higher and higher prices are needed to induce firms to make successive
increases in output. The result is a positive association between market price and
the firm's output.
The supply schedule given in Table 7.2. It records the quantity that all
producers wish to produce and sell at a number of alternative prices, rather than the
quantity consumers wish to buy.
Table 7.2. A market supply schedule for eggs
Reference letter
Price
Quantity supplied
(£ per dozen)
('000 dozen per month)
u
0,50
5,0
v
1,00
46,0
w
1,50
77,5
x
2,00
100,0
y
2,50
115,0
z
3,00
122,5
The six points corresponding to the six price-quantity combinations shown
in the table are plotted in Figure 7.3. The
curve drawn through the six points is a
supply curve for eggs. It shows the quantity
produced and offered for sale at each price.
The supply curve in Figure 7.3 has a
positive slope. This is a graphical expression
of the following assumption:
The market price and the quantity supplied
are positively related to each other.
Figure 7.3. A supply curve for eggs
Text 7. SHIFTS IN THE SUPPLY CURVE
A shift in the supply curve means that, at each price, a different quantity is
supplied. An increase in the quantity supplied at each price is plotted in Figure 7.4.
58
This change appears as a rightward shift in the supply curve. A decrease in the
quantity supplied at each price causes a leftward shift.
For supply-curve shifts there is an
important general rule similar to the one stated
earlier for demand curves:
When there is a change in any of the variables
(other than the product's own price) that affect
the amount of a product that firms are willing to
produce and sell, the whole supply curve for that
product will shift.
Figure 7.4. Shifts in the supply curve
All things that a firm uses to produce its outputs—such as,
in the case of an egg producer, chicken feed, labour, and egg-sorting machines—
are called the firm's inputs. Other things being equal, the higher the price of any
input used to make a product, the less will be the profit from making that product.
Thus, the higher the price of any input used by a firm, the lower will be the amount
that the firm will produce and offer for sale at any given price of the product.
A rise in the price of any input shifts the supply curve to the left, indicating
that less will be supplied at any given price; a fall in the price of inputs shifts the
supply curve to the right.
At any time, what is produced and how it is produced depend on the
technologies in use. Over time, knowledge and production technologies change; so
do the quantities of individual products that can be supplied.
A technological change that decreases costs will increase the profits earned
at any given price of the product. Since increased profitability leads to increased
production, this change shifts the supply curve to the right, indicating an increased
willingness to produce the product and offer it for sale at each possible price.
As with demand, it is essential to distinguish between a movement along the
supply curve (caused by a change in the product's own price) and a shift of the
whole curve (caused by a change in something other than the product's own price).
We adopt the same terminology as with demand: quantity supplied refers to a
particular quantity actually supplied at a particular price of the product, and supply
refers to the whole relationship between price and quantity supplied. Thus, when
we speak of an increase or a decrease in supply, we are referring to shifts in the
supply curve such as the ones illustrated in Figure 7.2. When we speak of a change
in the quantity supplied, we mean a movement from one point on the supply curve
to another point on the same curve.
Text 8. PRICE ELASTICITY OF DEMAND
In Figure 7.5 we were able to compare the responsiveness of quantity
demanded along the two demand curves because they were drawn on the same
59
scale. You should not try to compare two curves without making sure that the
scales are the same.
Figure 7.5 The effect of the chape of demand curve
Also, you must not leap to conclusions
about the responsiveness of quantity demanded
on the basis of the apparent steepness of a single
curve. The hazards of so doing are illustrated in
Figure 7.6. Both parts of the figure plot the same
demand curve, but the choice of scale on the
'quantity' and 'price' axes serves to make one
curve look steep and the other flat.
In order to get a measure of responsiveness
that is independent of the scale we use, so that it
can be compared across products, we need to
deal in percentage changes. A given percentage
change in the amount of petrol purchased will be
the same whether we measure it in gallons or
litres. Similarly, although we cannot easily
compare the absolute changes in kilos of carrots
and barrels of oil, we can compare their two
percentage changes.
Figure 7.6 One demand curve draw on
different scales
Figure 7.7. Three constant-elasticity
demand curves
60
These considerations lead us to the concept of the price elasticity of
demand, which is defined as the percentage change in quantity demanded divided
by the percentage change in price that brought it about. This elasticity is usually
symbolized by the lower-case Greek letter eta, η:
η =
percentage change in quantity demanded
percentage change in price
The value of price elasticity of demand ranges from zero to minus infinity, in
this section, however, we concentrate on absolute values, and so ask by how much
the absolute value exceeds zero.
Elasticity is zero if quantity demanded is unchanged when price changes, namely
when quantity demanded does not respond to a price change. A demand curve of
zero elasticity is shown as curve Dl in Figure 7.7 It is said to be perfectly or
completely inelastic.
As long as there is some positive response of quantity demanded to a change
in price, the absolute value of elasticity will exceed zero. The greater the response,
the larger the elasticity. Whenever this value is less than one, however, the
percentage change in quantity is less than the percentage change in price and
demand is said to be inelastic.
When elasticity is equal to one, the two percentage changes are then equal to
each other. This case, which is called unit elasticity, is the boundary between
elastic and inelastic demands. A demand curve having unit elasticity over its whole
range is shown as D3 in Figure 7.7.
When the percentage change in quantity demanded exceeds the percentage
change in price, the elasticity of demand is greater than one and demand is said to
be elastic. When elasticity is infinitely large, there exists some small price
reduction that will raise quantity demanded from zero to infinity. Above the critical
price, consumers will buy nothing. At the critical price, they will buy all that they
can obtain (an infinite amount, if it were available). The graph of a demand curve
with infinite price elasticity is shown as D2 in Figure 7.7. Such a demand curve is
said to be perfectly or completely elastic.
Text 9. WHAT DETERMINES ELASICITY OF DEMAND?
The main determinant of elasticity is the availability of substitutes. Some
products, such as margarine, cabbage, Coca Cola, and the Peugeot 406, have quite
close substitutes— butter, other green vegetables, Pepsi, and the VW Passat. When
the price of any one of these products changes, the prices of the substitutes
remaining constant, consumers will substitute one product for another. When the
price falls, consumers buy more of the product and less of its substitutes. When the
price rises, consumers buy less of the product and more of its substitutes. More
broadly denned products, such as all foods, all clothing, tobacco, and petrol, have
few if any satisfactory substitutes. A rise in their price can be expected to cause a
smaller fall in quantity demanded than would be the case if close substitutes were
available.
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A product with close substitutes tends to have an elastic demand; one with
no close substitutes tends to have an inelastic demand.
There is no substitute for food: it is a necessity of life. Thus, for food taken
as a whole demand is inelastic over a large price range. It does not follow,
however, that any one food—say Weetabix or Heinz tomato soup—is a necessity
in the same sense. Each of these has close substitutes, such as Kellogg's Cornflakes
and Campbell's tomato soup. Individual food products can have quite elastic
demands, and they frequently do.
Durable goods provide a similar example. Durables as a whole have less
elastic demands than do individual durable goods. For example, after a rise in the
price of TV sets, some consumers may replace their personal computer or their hifi system instead of buying a new TV. Thus, although their purchases of television
sets fall, their total purchases of durables fall by much less.
Because many specific manufactured goods have close substitutes, they tend
to have price-elastic demands. A particular Marks and Spencer own-brand raincoat
could be expected to be price elastic, but all clothing taken together will be
inelastic. This is because, while it is easy to substitute a Marks and Spencer
raincoat with a John Lewis, or Self-ridge raincoat, you have to wear something in
the winter and you cannot avoid wearing clothing altogether when its price in
general rises relative to, say, the price of food.
Any one of a group of related products will tend to have an elastic demand,
even though the demand for the group as a whole may be inelastic.
Text 10. INCOME ELASTICITY
Economic growth has raised the real income of the average citizen of Europe
and North America quite dramatically over the past two centuries. At low levels of
income most money is spent on such basics as food, clothing, and shelter. As
income rises an increasing proportion of expenditure tends to fall on manufactured
goods, particularly such durables as cars, TV sets, and refrigerators. At yet higher
levels of income more and more of any additional income goes to services such as
foreign travel, entertainment, and education.
The responsiveness of demand for a product to changes in income is termed
income elasticity of demand, and is defined as
percentage change in quantity demanded
percentage change in income
For most products, increases in income lead to increases in quantity
demanded, and income elasticity is therefore positive. If the resulting percentage
change in quantity demanded is larger than the percentage increase in income, ηy
will exceed unity. The product's demand is then said to be income-elastic. If the
percentage change in quantity demanded is smaller than the percentage change in
income, ηy will be less than unity. The product's demand is then said to be incomeinelastic. In the boundary case, the percentage changes in income and quantity
ηy
=
62
demanded are equal, making ηy unity: the product is said to have a unit income
elasticity of demand.
If the product is a normal good, a rise in income causes more of it to be
demanded, other things being equal, which means a rightward shift in the product's
demand curve. If the product is an inferior good, a rise in income causes less of it
to be demanded, which means a leftward shift in the product's demand curve. So
normal goods have positive income elasticities while inferior goods have negative
income elasticities. Finally, the boundary case between normal and inferior goods
occurs when a rise in income leaves quantity demanded unchanged, so that income
elasticity is zero.
While virtually all observed price elasticities are negative, income
elasticities are observed to be both positive and negative.
The important terminology of income elasticity is summarized in Figure
7.8. These figure illustrates all possible reactions by showing a product whose
income elasticity goes from zero
to positive to negative. No
specific good is likely to show a
pattern exactly like this. Most
goods will have a positive
income elasticity at all levels of
income—people demand more as
they get richer. (It should be
obvious that no good can have a
negative income elasticity at all
levels of income.)
Figure 7.8. The relation between quantity demanded and income/
Text 11. CROSS-ALASTICITY
The responsiveness of quantity demanded of one product to changes in the
prices of other products is often of considerable interest. Producers of, say, beans
and other meat substitutes find the demands for their products rising when cattle
shortages force the price of beef up. Producers of large cars find their sales falling
when the price of petrol rises dramatically after a large oil price rise.
The responsiveness of demand for one product to changes in the price of
another product is called cross-elasticity of demand. It is defined as
percentage change in quantity demanded of product x
ηxy =
percentage change in price of product y
Cross-elasticity can vary from minus infinity to plus infinity.
Complementary goods have negative cross-elasticities, and substitute goods have
positive cross-elasticities.
Mobile phones and the calls that can be made on them, for example, are
complements. A fall in the price of calls causes an increase in the demand for both
63
handsets and calls. Thus, changes in the price of calls and in the quantity of
handsets demanded will have opposite signs—price of calls goes down and
demand for handsets goes up. In contrast, mobile calls and fixed-line calls are
substitutes: a fall in the price of mobile calls increases the quantity of mobile calls
made but reduces the quantity demanded of fixed-line calls. Changes in the price
of mobile calls and in the quantity of fixed-line calls demanded will, therefore,
have the same sign.
Text 12. SUPPLY ELASTICITY
The price elasticity of supply is defined as the percentage change in
quantity supplied divided by the percentage change in price that brought it about.
Letting the lower-case Greek letter epsilon, ε, stand for this measure, its formula is
percentage change in quantity supplied
εs =
percentage change in price
Supply elasticity is a measure of the degree of responsiveness of quantity
supplied to changes in the product's own price.
Since supply curves normally have positive slopes, supply elasticity is
normally positive.
Figure
7.9
illustrates
three
cases of supply
elasticity. The case
of zero elasticity is
one in which the
quantity
supplied
does not change as
price changes.
Figure 7.9. Three constant-elasticity supply curves
This would be the case, for example, if suppliers persisted in producing a
given quantity and dumping it on the market for whatever it would bring. Infinite
elasticity occurs at some price if nothing is supplied at lower prices but an
indefinitely large amount will be supplied at that price. Any straight-line supply
curve drawn through the origin, such as the one shown in part (iii) of the figure,
has an elasticity of unity. The reason is that, for any positively sloped straight line,
the ratio of p/q at any point on the line is equal to the ratio ∆p/∆q that defines the
slope of the line. Thus, in the formula (∆q/∆p)(p/q) the two ratios cancel each other
out. The case of unit supply elasticity illustrates that the warning given earlier for
demand applies equally to supply. Do not confuse the geometric steepness of
supply curves with elasticity. Since any straight-line supply curve that passes
through the origin has an elasticity of unity, it follows that there is no simple
correspondence between geometrical steepness and supply elasticity. The reason is
that varying steepness (when the scales on both axes are unchanged) reflects
varying absolute changes, while elasticity depends on percentage changes.
64
Text 13. WHAT DETERMINES ELASICITY OF SUPPLY?
What determines the response of producers to a change in the price of the
product that they supply? First, the size of the response depends in part on how
easily producers can shift from producing other products to producing the one
whose price has risen. If agricultural land and labour can be readily shifted from
one crop to another, the supply of any one crop will be more elastic than if labour
cannot easily be shifted.
Here also, as with demand, length of time for response is critical. It may be
difficult to change quantities supplied in response to a price increase in a matter of
weeks or months, but easy to do so over a period of years. An obvious example
concerns the planting cycle of crops. Also, new oilfields can be discovered, wells
drilled, and pipelines built over a period of years, but not in a few months.
Thus, the elasticity of supply of oil is much greater over five years than over
one year, and greater over one year than over one month.
Second, elasticity is strongly influenced by how costs respond to output
changes.
Exercises:
1. Complete the sentences by using the words from the texts:
A) The amount of a product that consumers wish to purchase is called the …
B) Five main variables are assumed to influence the quantity of each product that
is demanded by each individual consumer:
1. … 2. … 3. … 4. … 5. …
C) List is conveniently summarized in what is called a demand function: …
D) We saw that demand curves have negative slopes because the lower a product's
price, the cheaper it becomes relative to other products that can satisfy the same
needs. Those other products are called …
E) Products that tend to be used jointly with each other are called …
F) A product whose demand increases when income increases is called a …
G) For a few products, called …, a rise in consumers' income leads them to reduce
their purchases.
H) This list can be summarized in a supply function: …
I) The amount of a product that firms are able and willing to offer for sale is called
the …
J) … is defined as the percentage change in quantity demanded divided by the
percentage change in price that brought it about.
K) The responsiveness of demand for a product to changes in income is termed …
L) The responsiveness of demand for one product to changes in the price of
another product is called …
M) The … is defined as the percentage change in quantity supplied divided by the
percentage change in price that brought it about.
2. List all the 'markets' in which you regularly buy goods or services. How
are the price and quantity determined during your transaction? Do these prices
65
change on a day-to-day basis or only infrequently? If prices do not adjust, what
happens when there is an excess demand or supply?
New vocabulary:
demand, elastic (demand or supply), supply, demand (supply) curve, market
equilibrium, Giffen effect.
Homework:
1. Repeat the lectures 1-3.
2. “Economics for Medical Students”, units 1-4.
3. English Economy Dictionary with Definitions.
Lesson 8.
The program of colloquium №1.
I. Questions:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
Economic as a social science.
Macroeconomics and microeconomics.
The Subject and Method of Economics.
Three Basic Problems of Economy.
The Development of Economics. (Adam Smith, John Maynard Keynes).
Labour as a factor of Production.
Natural Resources and Land.
Capital. Fixed capital. Circulating capital.
Economic systems.
Traditional Economy.
Command Economy.
Mixed Economy.
The essential features of market Economy.
Allocation of products and resources. Market schema.
Money and its functions.
The history of money.
The Law of money circulations.
Demand. Demand curve. The Law of Demand.
Supply. Supply curve. The Law of Supply.
Price elasticity of Demand and Supply. Market equilibrium.
Exercises:
1. Outline the main determinants of quantity demanded and quantity
supplied, and explain how these interact to determine the market price.
66
2. Explain the main differences between administered prices and auction
prices, and discuss which markets are most suitable for these two different
mechanisms.
3. Outline the conditions that are required to achieve equality between
demand and supply at a market-clearing price.
4. Explain the effect on market price and quantity in the market for mobile
phone handsets of each of the following:
(a) Consumer incomes rise.
(b) Technical improvements reduce production costs.
(c) The price of fixed-line calls falls sharply.
5. What is the equilibrium market price and quantity for each of the
following pairs of demand and supply curves:
Demand: p = £100 - 2q; supply: p = £0 + 3q
6. What is the equilibrium market price and quantity for each of the
following pairs of demand and supply curves:
Demand: p = £100 - 2q; supply: q = 30
7. What is the equilibrium market price and quantity for each of the
following pairs of demand and supply curves:
Demand:p = £100; supply: p = £20 + 5q
8. Use demand and supply curves to analyse what is happening in the
situation:
The price of coffee has risen because of a frost in Brazil reducing the coffee crop.
9. Use demand and supply curves to analyse what is happening in the
situation:
A fall in air fares from the Russia has raised demand for hotel rooms on the
Spanish costas.
10. Use demand and supply curves to analyse what is happening in the
situation:
Further falls in chip prices have led to a reduction in the price of laptop
computers.
11. Use demand and supply curves to analyse what is happening in the
situation:
An exceptionally cold winter in North America leads to a higher price of oil.
67
12. Use demand and supply curves to analyse what is happening in the
situation:
A disease in British beef necessitates the slaughtering of large numbers of cattle.
13. Table 8.1 shows one consumer's demand schedule for any good.
Table 8.1. Demand schedule for good
Reference letter
Price
Quantity demanded
(£ per dozen)
(dozen per month)
a
1,50
7,0
b
2,00
5,0
c
2,50
3,5
d
3,00
2,5
e
3,50
1,5
f
4,00
1,0
Draw the demand curve.
14. Table 8.2 shows one consumer's demand schedule for any good.
Table 8.2. Demand schedule for good
Reference letter
Price
Quantity demanded
(£ per dozen)
(dozen per month)
a
2,50
8,0
b
3,00
6,0
c
3,50
4,5
d
4,00
3,5
e
4,50
2,5
f
5,00
2,0
Draw the demand curve.
15. Table 8.3 shows one firm’s supply schedule for any good.
Table 8.3. Supply schedule for good
Reference letter
Price
Quantity supplied
(£ per dozen)
('000 dozen per month)
u
1,50
5,0
v
2,00
46,0
w
2,50
77,5
x
3,00
100,0
y
3,50
115,0
z
4,00
122,5
Draw the supply curve.
16. Table 8.4 shows one firm’s supply schedule for any good.
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Table 8.3. Supply schedule for good
Reference letter
Price
(£ per dozen)
u
2,50
v
3,00
w
3,50
x
4,00
y
4,50
z
5,00
Draw the supply curve.
Quantity supplied
('000 dozen per month)
15,0
56,0
87,5
110,0
125,0
132,5
17. Calculate the elasticity of demand for the demand curve P= 100-50 and
following price and quantity levels:
P=90 and Q = 2.
18. Calculate the elasticity of demand for the demand curve P= 100-50 and
following price and quantity levels:
P=50 and Q= 10.
19. Calculate the elasticity of demand for the demand curve P= 100-50 and
following price and quantity levels:
P=5 and Q=19.
20. Calculate the elasticity of supply for the supply curve P= 10 + 30 and
following price and quantity levels:
P=25 and Q=5.
21. Calculate the elasticity of supply for the supply curve P= 10 + 30 and
following price and quantity levels:
P=40 and Q =10.
22. Calculate the elasticity of supply for the supply curve P= 10 + 30 and
following price and quantity levels:
P=70 and Q = 20.
23. Define the elasticity of demand and explain why this concept should be
of interest to anyone in business who has a choice to make about the price at which
to sell their products.
24. Why is demand likely to be more elastic in the long run than in the short
run?
25. Outline the main determinants of demand and supply elasticity.
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26. Explain the concept of income elasticity. Why does the income elasticity
of demand for food tend to be low in rich countries? Give examples of types of
goods and services the demand for which you would expect to have a high income
elasticity in rich countries. How would the last answer differ in poorer countries?
27. Explain the effect on market price and quantity in the market for mobile
phone handsets of consumer incomes rise.
28. Explain the effect on market price and quantity in the market for mobile
phone handsets of technical improvements reduce production costs.
29 Explain the effect on market price and quantity in the market for mobile
phone handsets of the price of fixed-line calls falls sharply.
30. What does equilibrium and disequilibrium prices mean. Show both.
Homework:
1. Economics for Medical Students. (text 1, p.p. 47-48; text 2, p.p.49-50).
2. English Economy Dictionary with Definitions. (p.9 - collective good or
public good, p.12 - cyclical unemployment, p.14 – depression, p.20 - frictional
unemployment, p.20- full employment, p.21- Grants-in-Aid, p.21 - p. gross
domestic product (GDP), p.21 - government sector spending, p.23 – indexing,
p.25 – investment, p.32 – monopoly, p.32 - natural monopoly, p.34 - Phillips
curve, p.39 – recession, p.40 - Sherman Antitrust Act, p.42 - structural
unemployment, p.44 - transfer payments)
Lesson 9.
Macroeconomics: the main problems and national
accounting.
Questions for discussion:
1) What does word “macroeconomics” mean?
2) What can you say about the macroeconomist's concerns?
3) What do you know about the end showing of macroeconomics?
4) What does the Gross Domestic product (GDP) mean?
5) What can be measured the Gross Domestic product?
6) What does Gross National Product mean (GNP)?
7) What does business cycle show?
70
8) Say, please, about four phases, which is characterized the business
cycle.
9) What does investment mean?
10) What kinds of investment do you know?
11) Tell about financial investment, portfolio investment, fixed investment,
inventory investment, physical investment.
12) What are the ways of Government activities?
13) What can you say about the Government position in these questions as:
inflation and unemployment?
14) Draw, please, Phillip's curve.
15) Describe, please, the instruments of the Government policy, if
government decide to reduce the level of unemployment.
16) What does monopoly mean?
17) What are the reasons of Antimonopoly Policy?
18) When did the first Antimonopoly law start?
19) What does the “public interest” mean?
20) Say, please, about the problem of consumer protection.
21) What do you know about the consumers’ organizations in India,
Pakistan and another countries?
Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
text 1, p.p. 47-48.
Questions:
a)
b)
c)
d)
e)
f)
Which country had the highest GNP that year?
Which of them ran the lowest GNP then?
What was the year, to your mind?
Is the GNP of a country always higher than the GDP?
What makes the difference?
Which of the three methods is the most often applied to measure GDP, as far
as you know?
Text 2, p.p. 49-50.
Read the texts:
Text 1. ECONOMIC POLICY. MARKET EQUILIBRIUM.
The operation of the market clearly depends on the interaction between
suppliers and demanders. At any moment, one of three conditions prevails in every
market: (1) the quantity demanded exceeds the quantity supplied at the current
price, a situation called excess demand; (2) the quantity supplied exceeds the
quantity demanded at the current price, a situation called excess supply; or (3) the
quantity supplied equals the quantity demanded at the current price, a situation
called equilibrium.
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Excess Demand
Excess demand exists when quantity demanded is greater than quantity j
supplied at the current price. Figure 9.1, which plots both a supply curve and a
demand j-curve on the same graph, illustrates such a situation. As you can see,
market I demand at $1.75 per bushel (50,000 bushels) exceeds the amount that
farmers I are currently producing (25,000 bushels).
When excess demand occurs in an unregulated market, there is a tendency
for price to rise as demanders compete against each other for the limited supply.
This tendency continues until the excess demand is eliminated. In Figure this
occurs at $2.50, where quantity, demanded, has fallen from 50,000 to 35,000
bushels per year and quantity supplied has increased from 25,000 to 35,000
bushels per year. When quantity demanded and quantity supplied are equal and
there is no further bidding, the process has achieved an equilibrium, a situation in
which there is no natural tendency for further adjustment. Graphically, the point of
equilibrium is the point at which the supply curve and the demand curve intersect.
Such a process is called establishing proportional prices, and it is in
foundation of different mechanisms of regulating them in the market.
Figure 9.1. Excess demand.
Excess Supply
Excess supply exists when the quantity supplied exceeds the quantity
demanded at the current price. As with excess demand, the mechanics of price
adjustment in the face of excess supply can differ from market to market. When
there is a surplus of a particular product, that product remains unsold. If
automobile dealers find themselves with unsold cars in the fall when the new
models are coming in, for example, you can expect to see price cuts. Sometimes
dealers offer discounts to encourage buyers; sometimes buyers themselves simply
offer less than the price initially asked. In any event, when quantities supplied
exceed quatities demanded at the current prices, stores cut prices.
Questions:
1. What does the operation of the market depend on?
2. When the quantity demanded exceeds the quantity supplied, how is
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this situation called?
3. Which situation in the market is called excess supply?
4. When may a market equilibrium be achieved?
5. Is there a tendency for price to rise when excess demand occurs in an
unregulated market?
6. For what do demanders compete against each other in the market?
7. How long does a tendency for price to rise continue in the market?
8. What goods are in great demand now?
9. Can our firms compete against foreign firms now?
10. What mechanics of price adjustment do you know?
11. Under what conditions do stores cut prices?
Give a short summery of the texts.
Text 2. WHAT IS MACROECONOMICS?
Macroeconomics is the study of how the economy behaves in broad outline
without dwelling on much of its interesting, but sometimes confusing, detail.
Macroeconomics is concerned largely with the behaviour of economic aggregates,
such as total national product, total investment, and exports for the entire economy.
It is also concerned with the average price of all goods and services, rather than the
prices of specific products. These aggregates result from activities in many
different markets and from the behaviour of different decision-makers such as
consumers, governments, and firms. In contrast, microeconomics deals with the
behaviour of individual markets, such as those for wheat, computer chips, or
strawberries, and with the detailed behaviour of individual agents, e.g. firms and
consumers.
In macroeconomics we add together the value of cornflakes, beer, cars,
strawberries, haircuts, and restaurant meals along with the value of all other goods
and services produced, and we study the aggregate national product. We also
average the prices of all goods and services consumed and discuss the general
price level for the entire economy— usually just called the price level. In practice,
the averages of several different sets of prices are used. For example, one
important index measures the average price of the goods and services bought by
the typical consumer. In Britain it is known as the retail price index (RPI), while
the equivalent in some other countries (and the measure used for the official
inflation target in the UK) is called the consumer price index (CPI).
We know full well that an economy that produces much wheat and few cars
differs from one that produces many cars but little wheat. We also know that an
economy with cheap wheat and expensive cars differs from one with cheap cars
and expensive wheat. Studying aggregates and averages often means missing such
important differences, but in return for losing valuable detail we are able to view
the big picture.
In macroeconomics we look at the broad range of opportunities and
difficulties facing the economy as a whole. When national product rises, the output
73
of most firms, and the incomes of most people, usually rise with it. When interest
rates rise, most borrowers, including firms and homeowners, have to make bigger
payments on their debts, though many savers will get a higher return on their
savings. When the price level rises, virtually everyone in the economy is forced to
make adjustments, because of the lower value of money. When the unemployment
rate rises, workers are put at an increased risk of losing their jobs and suffering
losses in their incomes. These movements in economic aggregates are strongly
associated with the economic well-being of most individuals: the health of the
sectors in which they work and the prices of the goods that they purchase. These
associations between the health of the macroeconomy and the economic fortunes
of many people are why macroeconomic aggregates (particularly inflation,
unemployment, productivity, interest rates, and the balance of payments) are often
in the news.
We also study how governments can use monetary and fiscal policy to
stimulate economic activity when they are worried about recessions, and to
dampen it down when they are worried about inflationary pressures caused by
booms.
Text 3. MAJOR MACROECONOMIC ISSUES
We need a separate subject called macroeconomics because there are forces
affecting the economy as a whole that cannot be fully or simply understood by
analysing individual markets and individual products. A problem that is affecting
all firms, or many workers, in different industries may need to be tackled at the
level of the whole economy. Certainly, if circumstances are common across many
sectors of the economy, then analysis at the level of the whole economy may help
us to understand what is happening. Let us look at some of the issues that are best
thought about in a macroeconomic context.
Economic growth
Both total and per capita output have risen for many decades in most
industrial countries. These long-term trends have produced rising average living
standards. Long-term growth is the predominant determinant of living standards
and the material constraints facing a society from decade to decade and generation
to generation. Macroeconomics has traditionally taken the trend in output as given
and looked at how to minimize deviations from that trend. Growth is therefore a
clear objective of macro-economic policy.
Business cycles
The economy tends to move in a series of ups and downs, called business
cycles, rather than in a steady pattern. During recessions many businesses go bust,
while profits fall for the survivors. In contrast, during a boom demand for most
products rise, profits rise, and most businesses find it easy to expand.
Understanding the business cycle is therefore important for successful businesses.
Expanding capacity during the onset of a recession could be a recipe for disaster,
while having too little capacity during a boom may result in a lost opportunity.
Most importantly, although business cycles are beyond the control of individual
74
firms, firms do need to understand that the economy moves in cycles.
Governments sometimes claim that their policies will bring stable growth and the
end to cycles, but business cycles have been around for a long time, and they are
likely to be with us for much longer yet.
Macroeconomics as a subject was invented to help produce policies that
could ameliorate economic fluctuations. Much of what follows is devoted to
explanations of I why the economy goes through these ups and downs, and what, if
anything, the government can do about them.
Productivity
Economic growth can be achieved either by using more inputs, such as
increased capital or numbers of workers, or by getting more output for any given
amount of inputs. The latter is known as productivity growth. Increasing
productivity is a central target of most governments, as this is the most obvious
way to make real incomes grow. Labour productivity (calculated as either output
per worker or output per hour worked) is especially important in this regard, as
growth in this is a necessary condition for sustained growth of real wages. Those
who do not work do not produce, so the real living standards of the entire
population are ultimately determined by the output per head of each of those who
are in work. Labour productivity can increase if workers have more capital to work
with, but over the long term what matters is technical progress.
Inflation
Swings in economic activity have usually accompanied swings in inflation.
Generally, attempts by governments to control high inflation have tended to bring
about recessions. However, the relationship between inflation and recession has
changed over time. An important policy problem for governments in the past has
been to stimulate economic activity without causing inflation. The rise in inflation
during boom times has often led policy-makers to raise interest rates or taxes in
order to bring inflation under control. When inflation falls after a recession, policymakers have often felt that they have the leeway to stimulate the economy again.
But they have to tread carefully to achieve a suitable balance between stimulus and
contraction, and we will learn below that timing policy interventions in order to
achieve a desired outcome is not a simple matter. More recently policy-makers
have become much more cautious in their attempts to influence the cycle in the
economy.
Unemployment
A recession in economic activity causes an increase in unemployment. A
new bout of high unemployment can never be ruled out, even for those countries
where it has been low for some time; and even in countries where aggregate
unemployment is not a major problem there are still big problems of youth
unemployment or unemployment among certain ethnic groups, which are of great
social and political concern.
The main method of reducing aggregate unemployment that economists
developed early in the twentieth century was for governments to increase their
spending and reduce taxes. Such deliberate use of government spending and taxes
to influence the economy is known as fiscal policy.
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Government budget deficits
At one time it was thought that budget deficits might be good for the
economy because government spending created jobs. Nowadays there is more
concern about the potential burden of the debt, in the form of interest, which has to
be paid by taxpayers and which, therefore, keeps taxes high.
Interest rates
In addition to fiscal policy, government (or the monetary authority where
this is independent of government) has available the tools of monetary policy.
Monetary policy involves changing interest rates in order to influence the
economy. High interest rates are a symptom of a tight monetary policy. When
interest rates are high, firms find it more costly to borrow, and this makes them
more reluctant to invest. Individuals with mortgages or bank loans are also hit by
high interest rates, since it costs them more to make their loan repayments. Hence
high interest rates tend to reduce demand in the economy—firms invest less, and
those with mortgages have less to spend. Low interest rates tend to stimulate
demand.
Another important channel of monetary policy is via the exchange rate, at
least for countries whose exchange rates are flexible. Exchange rate changes can
affect the relative prices, and thereby the competitiveness, of domestic and foreign
producers. A significant rise in the cost of buying domestic currency on the foreign
exchange market makes domestic goods expensive relative to foreign goods. This
may lead to a shift of demand away from domestic goods towards foreign goods.
Such shifts have an important influence on domestic economic activity. Targets
and instruments
The issues that we have just discussed are of two types. First, there are
issues that really matter for their own sake, things that affect living conditions and
the state of the economic environment. Living standards, unemployment, business
cycles, and inflation are outcomes that matter. Almost everyone wants growing
living standards, high employment, and low unemployment, as well as an
avoidance of recessions and inflation. These are known as the targets of policy.
'Good' values of these variables are what governments would like to achieve.
Fiscal and monetary policies (government spending, taxes, interest rates, and
the money supply) are not valued so much for their own sake: rather, they are the
instruments of policy and are valued for the effect they have on the targets.
Instruments are the variables that the government can change directly in order to
change the targets, which are the things that it would like to change.
The macroeconomic policy problem is to choose appropriate values of the
policy instruments in order to achieve the best possible combination of the
outcomes of the targets. This is a continually changing problem, because the
targets are perpetually being affected by shocks from various parts of the world
economy.
76
Text 4. VALUE ADDED AS OUTPUT
National output and national income are central topics in macroeconomics.
For the most part we measure both of these by gross domestic product, which is
usually shortened to GDP.
The reason that getting a total for the nation's output is not quite as
straightforward as it may seem at first sight is that one firm's output is often
another firm's input. A maker of clothing buys cloth from a textile manufacturer
and buttons, zips, thread, pins, hangers, etc., from a range of other producers. Most
modern manufactured products have many ready-made inputs. A car or aircraft
manufacturer, for example, has hundreds of component suppliers.
Production occurs in stages: some firms produce outputs that are used as
inputs by other firms, and these other firms in turn produce outputs that are used as
inputs by yet other firms.
If we merely added up the market values of all outputs of all firms, we
would obtain a total that was greatly in excess of the value of the economy's actual
output. The error that would arise in estimating the nation's output by adding all
sales of all firms is called double counting. 'Multiple counting' would be a better
term, since, if we added up the values of all sales, the same output would be
counted every time that it was sold from one firm to another.
The problem of double counting is resolved by distinguishing between two
types of output. Intermediate goods and services are the outputs of some firms
that are in turn used as inputs for other firms. Final goods and services are goods
that are not used as inputs by other firms in the period of time under consideration.
The term final demand refers to the purchase of final goods and services for
consumption, for investment (including inventory accumulation), for use by
governments, and for export. It does not include goods and services that are
purchased by firms and used as inputs for producing other goods and services.
If the sales of firms could be readily separated into sales for final use and
sales for further processing by other firms, measuring total output would still be
straightforward. Total output would equal the value of all final goods and services
produced by firms, excluding all intermediate goods and services. However, when
a textile manufacturer sells a piece of cloth, it does not necessarily know whether it
is being purchased by a fashion house, which will sell it on in the form of a dress,
or is being purchased by a consumer for use as, say, a sofa cover. Thus, at the point
of sale it is not always obvious if this is a final or intermediate sale. The problem
of double counting must therefore be resolved in some other manner.
To avoid double counting, statisticians use the important concept of value
added. Each firm's value added is the value of its output minus the value of the
inputs that it purchases from other firms (which were in turn the outputs of those
other firms). Thus, a steel mill's value added is the value of its output minus the
value of the ore that it buys from the mining company, the value of the electricity
and other fuel that it uses, and the values of all other inputs that it buys from other
firms. A bakery's value added is the value of the bread and cakes it produces minus
the value of the flour and other inputs that it buys from other firms.
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The total value of a firm's output is the gross value of its output. The firm's
value added is the net value of its output. It is this latter figure that is the firm's
contribution to the nation's total output. It is what its own efforts add to the value
of what it takes in as inputs.
Value added measures each firm's own contribution to total output, the
amount of market value that is produced by that firm. Its use avoids the statistical
problem of double counting.
The sum of all values added in an economy is a measure of the economy's
total output. This measure of total output is called gross value added. It is a
measure of all final output that is produced by all productive activity in the
economy.
Text 5. THE CIRCULAR FLOW OF INCOME, OUTPUT, AND SPENDING
Figure 9.2 gives a stylized version of how income and expenditure interact
with each other in what is called a circular flow diagram. To begin with, consider
an economy that is made up solely of domestic individuals and domestic firms. For
a moment we assume that the economy has no imports or exports and no
government. The individuals provide labour for the firms and they buy the firms'
output. The income that flows to individuals is represented by line in the figure
running up the left-hand side of the diagram, and their spending on the final output
of firms is represented by the line running down the right-hand side. National
output (or national income) can be measured either from the spending side in terms
of spending on final goods produced, or on the income side. These incomes of
resource owners can be
measured either as the sum
of values added in the
economy or as the sum of
individual incomes. In
practice, final spending is
not made up simply of
individuals' consumption
spending, so when we
approach the explanation
of GDP from the spending
side we need to add in
investment
spending,
government consumption,
and exports.
Figure 9.2. An economy is made up of income and
spending flows between firms and households
The circular flow diagram shows how incomes give rise to spending which
gives rise to output which gives rise to incomes.
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Withdrawals, or leakages, arise from income that is not passed on in the
circular flow through spending; while injections are spending that does not arise
out of incomes but is exogeneous.
Text 6. THE MEASURES OF NATIONAL INCOME AND
NATIONAL PRODUCT
The measures of national income and national product that are used derive
from an accounting system that has recently been standardized by international
agreement and is thus common to most major countries. It is known as the System
of National Accounts. A more detailed specification of this accounting system
applies to all EU member states under the European System of Accounts 1995.
These accounts have a logical structure, based on the simple yet important idea that
all output must be owned by someone. So whenever national output is produced, it
must generate an equivalent amount of claims to that output in the form of national
income.
Corresponding to the two sides of the circular flow in Figure 9.2 are two
ways of measuring national income: by determining the value of what is produced
and the value of the income claims generated by production. Both measures yield
the same total, which is called gross domestic product (GDP). When it is
calculated by adding up the total spending for each of the main components of
final output, the result is called GDP spending-based. When it is calculated by
adding up all the incomes generated by the act of production, it is called GDP
income-based.
All value produced in the form of output must also generate a claim to the
income generated in the process of creating that value. For example, any spending
you make when you buy a TV set must also be received by the supplier of that set.
The value of what you spend is the spending; the value of the product sold to you
is the output. Thus, the two values calculated on income and spending bases are
identical conceptually, and they differ in practice only because of errors of
measurement. Any discrepancy arising from such errors is then reconciled so that
one common total is given as the measure of GDP. Both calculations are of interest, however, because each gives a different and useful breakdown. Also, having
two independent ways of measuring the same quantity provides a useful check on
statistical procedures and on unavoidable errors in measurement.
Text 7. GDP SPENDING-BASED
GDP spending-based for a given year is calculated by adding up the
spending going to purchase the final output produced in that year. Total spending
on final output is expressed in the National Accounts as the sum of three broad
categories of spending: consumption, investment, and net exports. Consumption is
further divided into the consumption spending of government and that of private
individuals (and non-profit organizations serving households). So there are four
79
important categories of spending that we will discuss: private consumption,
government consumption, investment, and net exports.
Private consumption spending (C) includes spending by individuals on
goods and services produced and sold to their final users during the year—services
such as haircuts, medical care, and legal advice; nondurable goods such as fresh
meat, clothing, cut flowers, and fresh vegetables; and durable goods such as cars,
television sets, and microwave ovens.
When governments provide goods and services that their citizens want, such
as health care and street lighting, it is obvious that they are adding to the sum total
of valuable output in the same way as do private firms that produce cars and CDs.
Spending by the government where the consumption cannot be assigned to specific
individuals is called in the National Accounts collective government final
consumption. In macroeconomics we lump together individual government final
consumption and collective government final consumption into one term:
government consumption, sometimes just called government spending.
It is important to recognize that only government spending (G) on currently
produced goods and services is included as part of GDP. A great deal of
government spending is not a part of GDP. For example, when the Department of
Health and Social Security (DHSS) makes a payment to an old-age pensioner, the
government is not purchasing any currently produced goods or services from the
retired. The payment itself adds neither to employment nor to total output. The
same is true of payments on account of unemployment benefit, income support,
student grants, and interest on the National Debt (which transfers income from
taxpayers to holders of government bonds). All such payments are examples of
transfer payments, which is government spending not made in return for
currently produced goods and services.
Investment spending (I) is denned as spending on the production of goods
not for present consumption, but rather for future use. The goods that are created
by this spending are called investment (or capital) goods. Investment spending
can be divided into three categories: changes in inventories, fixed capital
formation, and the net acquisition of valuables.
Almost all firms hold stocks of their inputs and their own outputs. These
stocks are known as inventories. Inventories of inputs and unfinished materials
allow firms to maintain a steady stream of production in spite of short-term fluctuations in the deliveries of inputs bought from other firms. Inventories of outputs
allow firms to meet orders in spite of temporary fluctuations in the rate of output or
sales. Modem 'just-in-time' methods of production pioneered by the Japanese aim
to reduce inventories held by manufacturing plants to nearly zero by delivering
inputs just as they are needed. Most of the economy, however, does not achieve
this level of efficiency and never will. Retailing, for example, would certainly not
be improved if shops held no stocks. An accumulation of stocks and unfinished
goods in the production process counts as current investment because it represents
goods produced (even if only half-finished) but not used for current consumption.
All of gross investment is included in the calculation of GDP. This is
because all investment goods are part of the nation's total output, and their
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production creates income (and employment) whether the goods produced are a
part of net investment or are merely replacement investment.
The fourth category of aggregate spending, and one that is very important to
the economy, arises from foreign trade. How do imports and exports affect the
calculation of GDP?
A country's GDP is the total value of final goods and services produced in
that country.
It is convenient to group actual imports and actual exports together as net
exports. Net exports are defined as total exports of goods and services minus total
imports of goods and services (X- IM), which will also be denoted by NX. When
the value of exports exceeds the value of imports, the net export term is positive.
When the value of imports exceeds the value of exports, the net export term is
negative.
Total spending
The spending-based measure of gross domestic product at market prices is
the sum of the four spending categories that we have discussed above; in symbols,
GDP = C + I+ G+ (X - IM).
GDP spending-based is the sum of private consumption, government
consumption, investment, and net export spending on currently produced
goods and services. It is GDP at market prices.
Text 8. GDP INCOME – BASED
The production of a nation's output generates income. Labour must be
employed, land must be rented, and capital must be used. The calculation of GDP
from the income side involves adding up the income claims of owners of resource
inputs (land, labour, capital, etc.) so that all of that value is accounted for. National
income accountants distinguish three main categories of income: operating surplus,
mixed incomes, and compensation of employees.
Operating surpluses are net business incomes after payment has been made
to hired labour and for material inputs but before direct taxes (such as corporation
tax) have been paid. Direct taxes are those taxes levied on individuals or firms,
usually in relation to their income. Operating surpluses are in large part the profits
of firms, but also include the financial surplus of organizations other than
companies, such as universities. Some profits are paid out as dividends to owners
of firms; the rest are retained for use by firms. The former are called distributed
profits, and the latter are called undistributed profits or retained earnings. Both
distributed and undistributed profits are included in the calculation of GDP.
Mixed incomes. This category covers the many people who are earning a
living by selling their services or output but are not employed by any organization.
It includes some consultants and those who work on short contracts but are not
formally employees of an incorporated business; they are self-employed
individuals running sole-trader businesses. Also included are some partnerships
where the partners own the business. The reason why the incomes of this group are
81
referred to as mixed incomes is that it is not clear what proportion of their earnings
is equivalent to a wage or salary and what proportion is the profit or surplus of the
business. They are a mixture of the two.
Compensation of employees. This is wages and salaries (usually just
referred to as wages). It is the payment for the services of labour. Wages include
take-home pay, taxes withheld, national insurance contributions, pension fund
contributions, and any other fringe benefits. In other words, wages are measured
gross. In total, wages represent that part of the value of production that is
attributable to hired labour.
Text 9. GROSS NATIONAL PRODACT
While GDP measures the output, and hence the income, that is produced in
this country, the gross national income (GNI) measures the income that is
received by this country. To convert GDP into GNI, it is necessary to add three
terms that combine to account for the difference between the income received by
this country and the income produced in this country. The first term is employees'
compensation receipts from the rest of the world minus payments to the rest of the
world. Thus, if a London-based consultant sells her services to a French firm, the
income received will contribute to UK GNI but will be part of French GDP.
The second term is (minus) net taxes on production paid to the rest of the
world plus subsidies received from the rest of the world. The logic of this is that
we are measuring GNI (like GDP) at market prices. If some element of the market
prices paid is an indirect tax that generates revenue for a foreign government, then
that tax represents a loss of income for the domestic economy as a whole and
reduces domestic gross national income. Equally, if the product is subsidized by a
foreign government, then this raises domestic incomes by enabling us to consume a
given amount of goods at lower prices.
The third component of the difference between GDP and GNI is property
and entrepreneurial income receipts from the rest of the world minus payments to
the rest of the world. If, for example, you live in Manchester and own a holiday
home in Spain that you rent out for part of the year, the revenue earned will count
as part of GDP in Spain (as it is produced there), but the income accrues to a UK
resident so it adds to UK GNI. Similarly, many UK firms have subsidiaries located
in other countries. The value added of those subsidiaries counts as part of GDP in
the host country, but profits remitted to the parent count as part of the UK's GNI.
Conversely, a Japanese firm located in the UK contributes all its value added to
UK GDP, but profits remitted back to Japan are deducted from GDP in order to
arrive at GNI (as they are not part of UK income).
Total output produced in the economy, measured by GDP, differs from
total income received, measured by CNI, because of net income from abroad.
It is important to note that the term gross national income was introduced as
recently as 1998 to replace the term gross national product or GNP. GNI and
GNP are conceptually identical. GDP and GNI (or GNP) at market prices are the
most commonly used concepts of national output and national income. Once we
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move on to theory in the next chapter, we shall ignore the small difference between
GDP and GNI and refer to GDP at all times unless stated otherwise.
***
Other income concepts
Personal income is income that is earned by or paid to individuals, before
allowing for personal income taxes on that income. Some personal income goes on
taxes, some goes on savings, and the rest goes on consumption. Personal
disposable income is the amount of current income that individuals have available
for spending and saving; it is personal income minus personal income taxes and
national insurance contributions.
Personal disposable income is GNI minus any part of it that is not actually
paid to persons (such as retained profits of companies) minus personal income
taxes plus transfer payments received by individuals.
Text 10. REAL AND NOMINAL MEASURES
The information provided by National Accounts data is useful, but unless it
is carefully interpreted it can be misleading. Furthermore, each of the specific
measures gives different information. Each may be the best statistic for studying a
particular range of problems, but it is important to understand these differences if
you are going to use the data for analytical purposes. Here we discuss some of the
caveats to bear in mind.
It is important to distinguish between real and nominal measures of national
income and output. When we add up money values of outputs, spending, or
incomes, we end up with what are called nominal values. Suppose that we found
that a measure of nominal GDP had risen by 70 per cent between 2000 and 2010. If
we wanted to compare real GDP in 2010 with that in 2000, we would need to
determine how much of that 70 per cent nominal increase was due to increases in
the general level of prices and how much was due to increases in quantities of
goods and services produced. Although there are many possible ways of doing this,
the basic principle is always the same. It is to compute the value of output,
spending, and income in each period by using a common set of base-period
prices. When this is done, we speak of real output, spending, or income as being
measured in constant prices or, say, 2000 prices.
GDP valued at current prices (i.e. money GDP) is a nominal measure.
GDP valued at base-period prices is a real measure of the volume of national
output and national income.
Any change in nominal GDP reflects the combined effects of changes in
quantities and changes in prices. However, when real income is measured over
different periods by using a common set of base-period prices, changes in real
income reflect only changes in real output.
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If nominal and real GDP change by different amounts over some timeperiod, this must be because prices have changed over that period. Comparing
what has happened to nominal and real GDP over the same period implies the
existence of a price index measuring the change in prices over that period. We say
'implies' because no price index was used in calculating real and nominal GDP.
However, an index can be inferred by comparing these two values. Such an index
is called an implicit price index or an implicit deflator. It is defined as follows:
Implicit deflator
=
GDP at current prices
GDP at base-period prices
x 100 %.
The implicit GDP deflator is the most comprehensive index of the price
level because it covers all the goods and services that are produced by the entire
economy. Although some other indexes use fixed weights, or weights that change
only periodically, implicit deflators are variable-weight indexes. They use the
current year's 'bundle' of production to compare the current year's prices with those
prevailing in the base period. Thus, the 2000 deflator uses 2000 output weights,
and the 2005 deflator uses 2005 output weights.
Exercises:
A)
B)
C)
D)
E)
F)
G)
H)
I)
J)
1. Complete the sentences by using the words from the texts:
If the quantity demanded exceeds the quantity supplied at the current price,
a situation called …
If the quantity supplied exceeds the quantity demanded at the current price,
a situation called …
When the quantity supplied equals the quantity demanded at the current
price, a situation called …
Average the prices of all goods and services consumed and discuss the …
for the entire economy.
… goods and services are the outputs of some firms that are in turn used as
inputs for other firms.
… goods and services are goods that are not used as inputs by other firms
in the period of time under consideration.
stylized version of how income and expenditure interact with each other in
what is called a …
The measures of national income and national product that are used derive
from an accounting system that has recently been standardized by
international agreement and is thus common to most major countries. It is
known as the ...
When it is calculated by adding up the total spending for each of the main
components of final output, the result is called GDP …-based.
When it is calculated by adding up all the incomes generated by the act of
production, it is called GDP …-based.
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K) The spending-based measure of gross domestic product at market prices is
the sum of the four spending categories that we have discussed above; in
symbols, …
L) National income accountants distinguish three main categories of income:
1)… 2)… 3)…
M) A country's GDP is the total value of final goods and services … in that
country.
N) The gross national income (GNI) measures the income that is … this
country.
O) … is income that is earned by or paid to individuals, before allowing for
personal income taxes on that income.
P) … is the amount of current income that individuals have available for
spending and saving; it is personal income minus personal income taxes
and national insurance contributions.
Q) Implicit price index or an implicit deflator is defined as follows: …
2. Explain why we cannot calculate the national product simply by
adding up the production of all firms.
New vocabulary:
Indexing, monopoly, collective good or public good, transfer payments,
unemployment, Phillips Curve, gross domestic product (GDP), government sector
spending, investment, gross national product (GNP).
Homework:
1. Economics for Medical Students. (text 3, p. 50-51; text 4, p.p. 52-53; text
5, p.p. 53-54; text 6, p.p. 55-56).
2. English Economy Dictionary with Definitions. (p. 17 - exchange rate;
p.u818 - financial markets; p. 19 - fixed exchange rates; p. 19 - foreignexchange market; p. 21 - gold standard; p. 24 - inflation rate; p. 24 – interest;
p. 24 - interest rate; p. 27 - M 1-A, M 1-B, M 2, M 3; p. 31 - monetary
policy; p. 42 – stagflation.)
Lesson 10
Monetary System and Monetary Policy. Inflation.
Questions for discussion (Lecture 5):
1) What do your know about the Monetary System and Monetary Policy?
2) Describe the main functions of Central Bank in Monetary System.
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3) Remember, please, the Law of money circulation.
4) What can you say about money aggregates?
5) What does M1-A mean?
6) What does M1-B mean?
7) What does M2 mean?
8) What does M3 mean?
9) Say about gold standard.
10) What types of Banking Systems do you know?
11) What are the main functions of the financial institutions?
12) What do you know about the financial intermediary?
13) There is the banking sector in all states. Describe the banking services.
14) Describe the functions of foreign exchange market.
15) What can you say about foreign exchange rate and foreign exchange rate
regimes.
Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
text 3, p.p. 50 -51.
Questions and exercises:
a) How does the ratio between the amounts of money holdings and interesting
deposits vary?
b) What are the responsibilities of the Central Bank?
c) How can the Central Bank regulate money supply and money market?
d) What is monetary policy?
e) In what way does consumption depend on interest rates and taxes?
f) Of what is money supply made up?
II. Complete the sentences. Use: interest rate, within, without, to alter,
tight, outside (2), money supply, ratio (2), thus, in addition, in addition to,
because of, responsibility (2)
1. ... regulation of the Central Bank is considered to prevent sudden increases
in.......
2. Changes in the ...... on government securities often affect industrial share prices.
3. A gold card is a credit card that gives its holder access to various benefits
.........those offered to standard card holders.
4. Being the only manager and worker at the same time, the owner of a one-person
firm takes all the ... for performance of his business.
5. Most food can be produced ... the household......., some part of the required
food can be exchanged for other food or services ... the household ... money. ...,
these transactions remain ... statistics.
6. The Central Bank has the ... for the government's monetary policy.
7. The ... of pensioners to the labour force ...... negative demographic tendencies
is currently 0.5 percent smaller in Russia than in Germany or the United Kingdom.
The ... is expected to grow to an unfavourable one by 2007.
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8. Although the Central Bank is constantly trading in securities to change the
actual reserves of the banking system, it seldom ... reserve requirements.
Text 4, p.p. 52-53.
Questions and exercises:
a) What situation is described as an inflationary spiral? By what means can it
be kept under control?
b) Which two schools of thought are mentioned in the text? What is the
difference between them?
c) What do monetarists think to be effective in restraining inflation rates?
d) Why is aggregate demand low?
e) Do Keynesians consider incomes policies to be in good means of coping
with inflation in the end?
f) What do the costs of inflation depend on?
g) By what means can the costs of inflation be reduced?
h) Does indexation help to cope with inflation?
II. Complete the sentences. Use: temporary, tight, to account for, to mean,
inflation rate, to adjust (2), adjustment, to anticipate, indexation, to speed up,
hyperinflation, to cope with, to argue, money supply
1. The incomes policy is known to be a ... means of......the ... of wages to growing
money supply.
2. ... regulation of the Central Bank, it is argued, will prevent sudden increases
in.......
3. The situation is referred to as ... , provided the......per month is about 50 percent
for several months in succession.
4. Before 1971 banks rarely ... interest rates on deposits. This ... that a rise in
inflation reduced the real interest rate on all deposits with fixed interest rate.
5. Even when inflation is perfectly ..., and the economy is fully ... to inflation, it is
impossible to......all its costs.
6. ... cannot cope with all the costs of high inflation.
Read the texts and answer the questions:
Text 1. INTRODUCTION TO BANKING AND FINANCIAL MARKETS
A commercial bank borrows money from the public, crediting them with a
deposit. The deposit is a liability of the bank. It is the money owed to depositors.
In turn the bank lends money to firms, households, or governments wishing to
borrow.
Commercial banks are financial intermediaries with a government license to
make loans and issue deposits, including deposits against which cheques can be
written.
Major important banks in most countries are included in the clearing system
in which debts between banks are settled by adding up all the transactions in a
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given period and paying only the net amounts needed to balance inter-bank
accounts.
The balance sheet of a bank includes assets and liabilities. We begin by
discussing the asset side of the balance sheet.
Cash assets are notes and coins kept in their vaults and deposited with the
Central Bank. The balance sheet also shows money lent out or used to purchase
short-term interest-earning assets such as loans and bills. Bills are financial assets
to be repurchased by the original borrower within a year or less. Loans refer to
lending to households and firms and are to be repaid by a certain date. Loans
appear to be the major share of bank lending. Securities show bank purchases of
interest-bearing long-term financial assets. These can be government bonds or
industrial shares. Since these assets are traded daily on the Stock Exchange, these
securities seem to be easy to cash whenever the bank wishes, though their price
fluctuates from day to day.
We now examine the liability side of the balance sheet which includes
mainly, deposits. The two most important kinds of deposits are sure to be sight
deposits and time deposits. Sight deposits can be withdrawn on sight4 whenever the
depositor wishes. These are the accounts against which we write cheques, thus
withdrawing money without giving the bank any warning. Therefore, most banks
do not pay interest on sight deposits, or chequing accounts.
Before time deposits can be withdrawn, a minimum period of notification
must be given within which banks can sell off some of their high-interest securities
or call in some of their high-interest loans in order to have the money to pay out
depositors. Therefore, banks usually pay interest on time deposits. Apart from
deposits banks usually have some other liabilities as, for instance, deposits in
foreign currency, cheques in the process of clearance and others.
Exercises:
I. Use the text and complete the sentences:
1. Banks borrow money from the public in order to ...
2. The clearing system lets banks ...
3. The asset side of the bank balance sheet includes ...
4. The liability side of the balance sheet includes ...
5. The two most important kinds of deposits are known ...
6. Cheques can be written against...
7. Interest is usually paid on ...
8. To withdraw a time deposit one must give the bank a period of notification for
the bank ...
II. Complete the sentences. Use: to owe, liability, to undertake, therefore
(2), interest (2), to settle debts, chequing account, securities, net, bill, to handle
transactions
1. The purpose of money is to make it possible for firms and individuals ..........
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2. Facing an unstoppable rise in unemployment in the early 1980s, many European
economists simply accepted it as structural, and ... it could not be influenced by
policy-makers.
3. Employers obtain their ... profits only after they have paid all expenses: ...,
wages, rents, and others.
4. The household sector of American economy holds about one-third of the
nation's......money, which makes up nearly 80 percent of the total amount of
money.
5. Most... are bought for an amount less than their face value and the difference
between the two makes up the ... .
6. The clearing house system is a centralized mechanism for......between banks,
sellers of commodities and financial ....
7. A ... is something a business or an individual ... to another business or
individual.
8. A woman may work hard at home, but she receives no wages for this work. It is
not ... labour in terms of economics.
9. If there exists a stock market, transactions can......over the telephone.
Text 2. LIQUIDITY
Liquidity is determined by the speed and certainty with which an asset can
be converted into cash (notes and coins) in order to be used as a means of payment.
The quicker an asset can be converted into cash, the more liquid it is. Therefore,
money is sure to be the most liquid asset of all since it is widely accepted as a
medium of exchange, while durable and highly specific assets such as machinery
are the least liquid as such asset cannot be converted into money without finding a
buyer and determining the value of the asset to be sold.
A bank's assets can also be characterized in terms of their liquidity.
Loans to households and firms do not appear to be very liquid forms of bank
lending, for the borrower may not be able to repay the sum owed to the bank
whenever the bank demands.
Securities including government bonds and shares of firms, though traded on
the stock exchange, cannot be relied upon for a certain amount of cash as their
prices are known to fluctuate from day to day. Therefore, financial investment in
securities seems also to be illiquid.
Of all bank assets cash and short-term market loans are sure to be the most
liquid ones.
Exercises:
Use the text and complete the sentences:
1. The easier an asset is converted into cash, ...
2. Machinery can be included in illiquid assets since ...
3. Loans to households and firms turn out not to be highly liquid for ..
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4. The bank cannot expect to raise a needed amount of cash by selling securities
because ...
5. The most liquid bank assets happen ...
Read the texts and give a short summery of the texts.
Text 3. RESERVE REQUIREMENT AS A TOOL OF MONEY POLICIES
A banker would like his money holdings to be reduced to a minimum, since
they produce no income.
But there is always an important reason for the banker to hold his money
balances at a certain level. The Central Bank makes him hold a certain share of his
total balances in reserve. These reserve balances must be in the form of cash or of
deposits made by commercial banks with a certain authorized bank. Most of
reserve balances are known to be in the form of deposits. Setting the reserve
requirements, the Central Bank can regulate money circulation and money supply
in an economy.
The Central Bank can, on the one hand, increase commercial banks' reserves
by direct intervention. One way of doing this is by the so-called open market
operations: it buys government bonds from the public; thus, the money that goes to
the public in payment for these bonds will eventually be deposited with
commercial banks, most likely in interest-earning deposits. Having been deposited
with a bank, money stops being money, but it represents a net addition to reserve
balances capable of supporting loan transactions several times their own value. For
this reason, the Central Bank is said to have supplied "high powered" money to
commercial banks.
On the other hand, selling bonds to the public, the Bank can reduce the
banking system's reserves and thus make the money supply reduce.
Open market operations are not the only method of direct reserve intervention. Another way for the Central Bank to increase money in circulation is to
make loans to commercial banks who in turn lend out to the public the money to be
used for daily expenditure.
Finally, the Central Bank can change the money supply without affecting the
amount of reserves to be held by commercial banks. It can do this simply having
changed the reserve requirement. Having been decreased from 20 percent to 10
percent, the reserve balances will actually double their capacity to support
transactions. As a result, maintaining the same reserve balances, banks get a
chance of handling loan transactions twice as large as before.
Thus, the three monetary policies a Central Bank can implement are as
follows: 1. Open market operations. 2. Loans to commercial banks. 3. Changes in
reserve requirements.
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Text 4. THE SUPPLY AND THE DEMAND OF MONEY
In a modern economy the supply of money is determined by the interaction
of the banking system and the non-bank private sector.
In most major countries the authorities implement monetary policy by
setting interest rates and letting the money stock be determined by how much is
demanded at that interest rate.
The amount of wealth that everyone in the economy wishes to hold in the
form of money balances is called the demand for money. Because people can
choose how to divide their given stock of wealth between money and bonds, it
follows that if we know the demand for money, we also know the demand for
bonds. With a given level of wealth, a rise in the demand for money necessarily
implies a fall in the demand for bonds; if people wish to hold £1 billion more
money, they must wish to hold £1 billion less of bonds. It also follows that, if
households are in equilibrium with respect to their money holdings, they are in
equilibrium with respect to their bond holdings.
When we say that in first quarter of 2007 the quantity of money demanded
was £1,300 billion (the approximate value of the broad money stock, M4, at that
time), we mean that at that time the public wished to hold money balances that
totalled £1,300 billion. But why do firms and individuals wish to hold money
balances at all? There is a cost to holding any money balance. The money could
have been used to purchase bonds, which earn higher interest than does money. For
the present we assume no ongoing inflation, so there is no difference between real
and nominal interest rates. The opportunity cost of holding any money balance is
the extra interest that could have been earned if the money had been used instead to
purchase bonds.
Clearly, money will be held only when it provides services that are valued at
least as highly as the opportunity cost of holding it. Three important services that
are provided by money balances give rise to three motives for holding money: the
transactions, precautionary, and speculative motives.
The transactions motive. Most transactions require money. Money passes
from consumers to firms to pay for the goods and services produced by firms;
money passes from firms to employees to pay for the labour services supplied by
workers to firms. Money balances that are held to finance such flows are called
transactions balances.
In an imaginary world in which the receipts and disbursements of consumers
and firms were perfectly synchronized, it would be unnecessary to hold
transactions balances. If every time a consumer spent £10 she received £10 as part
payment of her wages, no transactions balances would be needed. In the real
world, however, receipts and payments are not perfectly synchronized.
Consider the balances that are held because of wage payments. Suppose, for
purposes of illustration, that firms pay wages every Friday and that employees
spend all their wages on goods and services, with the spending spread out evenly
over the week. Thus, on Friday morning firms must hold balances equal to the
weekly wage bill; on Friday afternoon the employees will hold these balances.
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Over the week, workers' balances will be drawn down as a result of their
purchasing goods and services. Over the same period, the balances held by firms
will build up as a result of selling goods and services until, on the following Friday
morning, firms will again have amassed balances equal to the wage bill that must
be met on that day.
The transactions motive arises because payments and receipts are not
synchronized.
What determines the size of the transactions balances to be held? It is clear
that in our example total transactions balances vary with the value of the wage bill.
If the wage bill doubles for any reason, the transactions balances held by firms and
households for this purpose will also double, on average. As it is with wages, so it
is with all other transactions: the size of the balances held is positively related to
the value of the transactions.
It is the average value of money balances that people choose to hold over a
particular period that is relevant for macroeconomics, but we need to know how
money demand relates to GDP rather than to total transactions. In fact, the value of
all transactions exceeds the value of the economy's final output. When the miller
buys wheat from the farmer and when the baker buys flour from the miller, both
are transactions against which money balances must be held, although only the
value added at each stage is part of GDP.
Generally there will be a stable, positive relationship between transactions
and GDP. A rise in GDP also leads to a rise in the total value of all transactions
and hence to an associated rise in the demand for transactions balances. This
allows us to relate transactions balances to GDP.
The larger the value of GDP, the larger is the value of transactions balances
that will be held.
The precautionary motive. Many reasons for spending arise unexpectedly,
such as when your car breaks down, or you have to make an unplanned journey to
visit a sick relative. As a precaution against cash crises, when receipts are
abnormally low or disbursements are abnormally high, firms and individuals carry
money balances. Precautionary balances provide a cushion against uncertainty
about the timing of cash flows. The larger such balances are, the greater is the
protection against running out of money because of temporary fluctuations in cash
flows.
The seriousness of the risk of a cash crisis depends on the penalties that are
inflicted for being caught without sufficient money balances. A firm is unlikely to
be pushed into insolvency, but it may incur considerable costs if it is forced to
borrow money at high interest rates in order to meet a temporary cash crisis.
The precautionary motive arises because individuals and firms are uncertain
about the degree to which payments and receipts will be synchronized.
The protection provided by a given quantity of precautionary balances
depends on the volume of payments and receipts. A £100 precautionary balance
provides a large cushion for a person whose volume of payments per month is
£800 and a small cushion for a firm whose monthly volume is £250,000. To
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provide the same degree of protection as the value of transactions rises, more
money is necessary.
The precautionary motive, like the transactions motive, causes the demand
for money to vary positively with the money value of GDP.
For most purposes the transactions and precautionary motives can be
merged, as they both show that desired money holdings are positively related to
GDP. Indeed, they both show money being held in relation to transactions, either
planned or potential.
The speculative motive Money can be held for its characteristics as an
asset. Firms and individuals may hold some money in order to provide a hedge
against the uncertainty inherent in fluctuating prices of other financial assets.
Money balances held for this purpose are called speculative balances. This motive
was first analysed by Keynes. Professor James Tobin, the 1981 Nobel Laureate in
economics, developed the modern analysis.
Any holder of money balances forgoes the extra interest income that could
be earned if bonds were held instead. However, market interest rates fluctuate, and
so do the market prices of existing bonds (whose present values depend on the
interest rate). Bonds are risky assets, because their prices fluctuate. Many
individuals and firms do not like risk; they are said to be risk-averse.
In choosing between holding money and holding bonds, wealth-holders must
balance the extra interest income that they could earn by holding bonds against the
risk that bonds carry. At one extreme, if individuals hold all their wealth in the
form of bonds, they earn extra interest on their entire wealth, but they also expose
their entire wealth to the risk of changes in the price of bonds. At the other
extreme, if people hold all their wealth in the form of money, they earn less interest
income, but they do not face the risk of unexpected changes in the price of bonds.
Wealth-holders usually do not take either extreme position. They hold part of their
wealth as money and part of it as bonds; that is, they diversify their holdings. The
fact that some proportion of wealth is held in money and some in bonds suggests
that, as wealth rises, desired money holdings will also rise.
The speculative motive implies that the demand for money varies positively
with wealth.
Although one individual's wealth may rise or fall rapidly, the total wealth of
a society changes only slowly. For the analysis of short-term fluctuations in GDP,
the effects of changes in wealth are fairly small, and we will ignore them for the
present. Specific individuals may undergo large wealth changes in response to
bond price changes, but with inside wealth the total effect is small. When lenders
gain, borrowers lose; and when lenders lose, borrowers gain. Over the long term,
however, variations in aggregate wealth can have a major effect on the demand for
money.
Wealth that is held in cash or deposits earns less interest than could be
earned by holding bonds; hence the reduction in risk involved in holding money
carries an opportunity cost in terms of interest earnings forgone. The speculative
motive leads individuals and firms to add to their money holdings until the
reduction in risk obtained by the last pound added is just balanced (in each wealth93
holder's view) by the cost in terms of the interest forgone on that pound. A fall in
the rate of return on bonds for the same level of risk will encourage people to hold
more of their wealth as money and less in bonds. A rise in their rate of return for a
given level of risk will cause people to hold more bonds and less money.
The speculative motive implies that the demand for money will be
negatively related to the rate of interest.
The precautionary and transactions motives may also be negatively related to
interest rates at the margin, because higher returns on bonds encourage people to
economize on their money holding. However, in practice we only observe total
money holdings, so we cannot distinguish the components held for different
motives. Hence demand for money, as a whole, is likely to be positively related to
GDP and wealth, and negatively related to the interest rate.
Text 5. REAL AND NOMINAL MONEY BALANCES
The money supply is a nominal quantity, but it is important to distinguish
demand for real money balances from nominal money demand. Real money
demand is the number of units of purchasing power that the public wishes to hold
in the form of money balances. For example, in an imaginary one-product (wheat)
economy, the number of bushels of wheat that could be purchased with the money
balances held would be the measure of their real value. In a more complex
economy it could be measured in terms of the number of 'baskets of goods',
represented by a price index such as the RPI, that could be purchased with the
money balances held. When we speak of the demand for money in real terms, we
speak of the amount demanded in constant pounds (that is, with a constant price
level): The real demand for money (or the demand for real money balances) is the
nominal quantity demanded divided by the price level.
In the twenty-four years from March 1982 to February 2006, on the M4
definition, the nominal quantity of money balances held in the country increased
nearly ten-fold, from around £140 billion to around £1,333 billion. Over the same
period, however, the price level, as measured by the RPI, approximately trebled.
This tells us that the real quantity of money rose from £140 billion to about £500
billion, measured in constant 1982 prices, roughly a three-fold increase.
So far we have held the price level constant, and so we have identified the
determinants of the demand for real money balances as real GDP, real wealth, and
the interest rate. Now suppose that, with the interest rate, real wealth, and real GDP
held constant, the price level doubles. Because the demand for real money balances
will be unchanged, the demand for nominal balances must double. If the public
previously demanded £300 billion in nominal money balances, it will now demand
£600 billion. This keeps the real demand unchanged at £600/2 = £300 billion. The
money balances of £600 billion at the new, higher price level represent exactly the
same purchasing power as £300 billion at the old price level.
Other things being equal, the nominal demand for money balances varies in
proportion to the price level; when the price level doubles, desired nominal money
balances also double.
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Text 6. INFLATION
Inflation is generally defined as a persistent rise in the general price level
with no corresponding rise in output, which leads to a corresponding fall in the
purchasing power of money.
In this section we shall look briefly at the problems that inflation causes for
business and consider whether there are any potential benefits for anicnterprise
from an inflationary period.
Inflation varies considerably in its extent and severity. Hence, the
consequences for the business community differ according to circumstances. Mild
inflation of a few per cent each year may pose few difficulties for business.
However, hyperinflation, which entails enormously high rates of inflation,
can create almost insurmountable problems for the government, business,
consumers and workers. In post-war Hungary, the cost of having was published
each day and workers were paid daily so as to avoid the value of their earnings
falling.
Businesses would have experienced great difficulty in costing and pricing
their production while the incentive for people to save would have been removed.
Economists argue at length about the causes of, and «cures» for, inflation.
They would, however, recognize that two general types of inflation exist:
• Demand-pull inflation
• Cost-push inflation
Demand-pull inflation occurs when demand for a nation's goods and
services outstrips that nation's ability to supply these goods and services. This
causes prices to rise generally as a means of limiting demand to the available
supply.
An alternative way that we can look at this type of inflation is to say that it
occurs when injections exceed withdrawals and the economy is already stretched
(i.e. little available labour or factory space) and there is little scope to increase
further its level of activity.
Cost-push Inflation. Alternatively, inflation can be of the cost-push variety.
This takes place when firms face increasing costs. This could be caused by an
increase in wages, the rising costs of imported raw materials and components or
companies pushing up prices in order to improve their profit margins.
Exercises:
1. Complete the sentences by using the words from the texts:
A) The amount of wealth that everyone in the economy wishes to hold in the
form of money balances is called the …
B) The transactions motive arises because payments and receipts are …
C) The precautionary motive arises because individuals and firms are uncertain
about the degree to which payments and receipts will be …
D) The speculative motive implies that the demand for money varies positively
with …
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E) The speculative motive implies that the demand for money will be
negatively related to ...
F) The real demand for money (or the demand for real money balances) is the
nominal quantity demanded divided by ...
G) Other things being equal, the nominal demand for money balances varies in
proportion to the price level; when the price level doubles, desired nominal
money balances ...
H) … occurs when demand for a nation's goods and services outstrips that
nation's ability to supply these goods and services.
I) … could be caused by an increase in wages, the rising costs of imported raw
materials and components or companies pushing up prices in order to
improve their profit margins.
2. Explain how a change in monetary policy works its way through the
economy to influence GDP and the price level in both the short and the long
term.
3. If inflation cannot occur without money, does this mean that changes in the
money stock always cause changes in inflation and that controlling the
money stock is the only way to control inflation?
New vocabulary:
financial markets; foreign-exchange market; inflation rate; interest; interest rate;
money aggregates; monetary policy; stagflation.
Homework:
1.
Economics for Medical Students. (text 5, p.p. 53-54; text 6, p.p.55-56).
2.
English Economy Dictionary with Definitions. (p. 12 - currency; p. 13 deficit; p. 13 - deflation; p. 14 - deposit liabilities; p. 14 - depository institutions;
p. 19 - fiscal policy; p. 19 – fiscal federalism; p. 23 - incidence of a tax; p. 23 indirect taxes; p. 32 - negative income tax; p. 36 – progressive income tax; p. 36 –
progressive tax system; p. 36 – property tax; p. 36 – proportional tax; p. 40 –
sales tax; p. 42 – stagflation; p. 43 – tariff.)
Lesson 11.
Fiscal Policy. Taxes and Public Spending.
Questions for discussion (Lecture 5):
1) What does fiscal policy mean?
2) What kinds of taxes can government use to control aggregate demand and
spending?
3) What can you say about indirect taxes?
4) Say, please, about government regulate the problems of budget deficit and
inflation with taxes and government spending.
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5) Write down Laffer’s Curve.
6) What can you say about indirect taxes?
7) How do the government spending money from budget?
8) Characterize, please, a transfer payment.
9) What is the problem of cutting government spending?
10)
Say, please, about some kinds of taxes.
11)
Explain the definitions: proportional tax, progressive tax, regressive
tax, budget deficit.
Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
text 5, p.p. 53 -54.
Questions:
a) What is the effect of reduced aggregate demand in an economy?
b) How can aggregate demand be reduced?
c) What is the effect of higher aggregate demand?
d) How can aggregate demand be increased?
e) What can decrease the effectiveness of fiscal policy?
Text 6, p.p. 55-56.
Questions:
a) How is government spending financed?
b) What do governments pay for?
c) What are the three reasons for cutting government spending?
d) Which share of national income comes from taxes?
e) What are the characteristics of the progressive tax structure?
f) What may be the result of very high tax rates?
Read the texts and give a short summery of the texts.
Text 1. GOVERNMENT SPENDING
Government consumption is part of GDP. When the government hires a civil
servant, buys a paper clip, or purchases fuel for the navy, it is directly adding to the
demand for the economy's current output of goods and services. Thus, desired
government purchases, G, are part of aggregate spending.
The other part of government spending, transfer payments, also affects
desired aggregate spending, but only indirectly. Consider, for example, state
pensions or unemployment benefit. These are payments (transfers) made by
government to individuals, who will spend at least some of the money. Since that
spending is recorded as personal consumption, we do not want to count it twice by
recording it under G as well. Government transfer payments affect aggregate
spending only through the effect that these payments have on personal disposable
income. Transfer payments increase disposable income, and increases in
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disposable income, via the consumption function, increase desired consumption
spending.
This distinction (between transfers and government consumption) is
important when it comes to issues such as determining the amount of GDP that is
accounted for by government. Measuring the size of government to include
transfers makes it look as though government's share of GDP is much bigger than
it really is. However, looking only at G makes the government's revenue needs
look smaller than they are, since transfers must be financed by taxes or borrowing,
just as spending on goods and services must be. In what follows, government
spending always excludes transfers, unless the contrary is stated.
Text 2. TAX REVENUES
Tax revenues may be thought of as negative transfer payments in their effect
on desired aggregate spending. Tax payments reduce disposable income relative to
national income; transfers raise disposable income relative to national income. For
the purpose of calculating the effect of government policy on desired consumption
spending, it is the net effect of the two that matters.
We define net taxes to be total tax revenues received by the government
minus total transfer payments made by the government, and we denote net taxes as
T. (For convenience, when we use the term 'taxes', we will mean net taxes unless
we explicitly state otherwise.) Since transfer payments are smaller than total taxes,
net taxes are positive, and personal disposable income is less than national income.
TEXT 3. THE BUDGET BALANCE
The budget balance is the difference between total government revenue and
total government spending, or equivalently net taxes minus government spending,
T- G. When revenues exceed spending, the government is running a budget
surplus. The government will then reduce the national debt, since the surplus
funds will be used to pay off old debt. When spending exceeds revenues, as it has
for much of the period since the Second World War (1969-70, 1988-9, and 19982001 were the only exceptions between 1945 and 2005), the government is running
a budget deficit. The government must then add to the national debt, since it must
borrow to cover its deficit.
When the budget surplus (and deficit) is zero, the government has a
balanced budget. Since the budget deficit is simply a negative budget surplus, we
generally use the term 'budget surplus' to cover both cases, so bear in mind that the
budget surplus can be negative.
TEXT 4. TAX AND SPENDING FUNCTION
We treat government spending as exogenous; that is, it does not vary with
GDP. The government is assumed to decide how much it wishes to spend in real
terms and to hold to these plans whatever the level of GDP. We also treat tax rates
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as exogenous. The government sets its tax rates and does not vary them as GDP
varies. This makes tax revenues endogenous. As GDP rises with given tax rates,
the tax revenue will rise. For example, when incomes rise, people pay more total
tax, even if tax rates are unchanged.
Table 11.1 The budget surplus function (£ million)
GDP
Government
Net taxed
Government
spending (G)
(T=0,1 GDP)
surplus (T-G)
500
170
50
-120
1.000
170
100
-70
1.750
170
175
5
2.000
170
200
30
3.000
170
300
130
4.000
170
400
230
Table 11.1 and Figure 11.1 illustrate these assumptions with a specific
example. They show the size of the government's surplus when its desired
purchases (G) are constant at £170
million and its net tax revenues are
equal to 10 per cent of GDP
(national income). Notice that the
government budget surplus (or
public saving) increases with GDP.
This relationship occurs because net
tax revenues rise with GDP but, by
assumption, government spending
does not. The slope of the budget
surplus function is just equal to the
income tax rate.
Figure 11.1 Budget surplus function
For given tax rates, the government budget surplus (public saving)
increases as GDP rises and falls as GDP falls.
Text 5. FISCAL POLICY
Fiscal policy involves the use of government spending and tax policies to
influence total desired spending in order to achieve any specific goal set by the
government.
Since government spending increases aggregate desired spending and
taxation decreases it, the directions of the required changes in spending and
taxation are generally easy to determine once we know the direction of the desired
change in GDP. But the timing, magnitude, and mixture of the changes pose more
difficult issues.
Any policy that attempts to stabilize GDP at or near any desired level
(usually potential GDP) is called stabilization policy.
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If the government has some target level of GDP, it can use its taxation and
spending as instruments to push the economy towards that target. First, suppose the
economy is in a serious recession. The government would like to increase GDP.
The appropriate fiscal tools are to raise spending and/or to lower tax rates. Second,
suppose the economy is 'overheated'. Without worrying too much about the details,
just assume that the current level of GDP is higher than the target level that the
government judges to be appropriate. What should the government do? The fiscal
tools at its command are to lower government spending and to raise tax rates, both
of which will have a depressing effect on GDP.
The proposition that governments can alleviate recessions by deliberately
stimulating aggregate demand created a major revolution in economic thought.
This is still known as the Keynesian revolution. According to Keynesian theory,
governments can use fiscal policy to increase aggregate spending by increasing
government spending or reducing taxes (or both).
The aggregate spending model of national income and output determination
predicts that GDP can get stuck at a level below its full potential. It also suggests
how fiscal policy might be used to return an economy to its potential level of GDP.
Text 6. GOVERNMENT OBJECTIVES
Governments have multiple objectives:
1 To protect life and property by exercising a monopoly of force and establishing
property rights
2. To improve economic efficiency by addressing the various causes of market
failure
3. To protect the environment
4. To achieve some accepted standard of equity
5. To protect individuals from others and from themselves
6. To influence the rate of economic growth
7. To stabilize the economy against income and price-level fluctuations
Markets generate reasonably efficient allocations of the nation's resources
because, most of the time, the information that they need to allow them to perform
well, even if not optimally, is derived from agents' desires to improve their private
circumstances. No one should be surprised, therefore, that markets do not
efficiently allocate resources towards achieving such broad social goals as
establishing an 'equitable' distribution of income and promoting shared community
values. Markets do not directly foster these goals, precisely because individuals do
not seek to achieve them when they are purchasing goods and services in markets.
Instead, they look to the political system to achieve desired outcomes in this
respect.
The distribution of income. An important characteristic of any market economy
is the distribution of income that it determines. People whose skills are scarce
relative to supply earn large incomes, whereas people whose skills are plentiful
relative to supply earn much less.
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Differentials in earnings serve the important function of motivating people to
adapt. The advantage of such a system is that individuals can make their own
decisions about how to alter their behaviour when market conditions change. The
disadvantage is that temporary rewards and penalties are dealt out as a result of
changes in market conditions that are beyond the control of the affected
individuals. The resulting differences in incomes will seem inequitable to many—
even though they are the incentives that make markets work.
Concerns about equity have two dimensions: horizontal and vertical.
Horizontal equity means that people in similar circumstance should be treated
similarly. Although this type of equity appeals to many people as desirable, it is
not always a goal of government policies. For example, people who are exposed to
similar natural risks are given more government assistance when they are planting
crops than when they are mining ore, cutting trees, or extracting oil. This may be
because farmers have more political power than others, or it may stem from a gut
feeling on the part of the electorate that food production is more basic than any
other economic activity. Vertical equity means treating people in different economic situations differently in order to reduce inequalities between them.
Figure 11.2 shows what is called a Lorenz curve. It shows how much of
total income is received by various proportions of the nation's income earners. It
indicates how total income is distributed among individuals or groups. The further
the curve bends away from the diagonal, the more unequal are the incomes of the
people in society. The curve shows, for example, that the bottom 20 per cent of all
individuals received only 2.6 per cent of all taxable income earned, while the bottom 80 per cent received only 51 per cent of
total taxable income. The remaining 49 per
cent went to the top 20 per cent of incomeearners. The income shown in the figure is
taxable income, measured before taxes and
benefits. After the impact of taxes and
benefits is included, the share of the bottom
20 per cent rises to 9 per cent and the share
of the top 20 per cent falls to 39 per cent.
Thus, the tax-benefit system has the effect
of substantially narrowing the large
disparities in the distribution of income
between the various income classes.
Figure 11.2 A Lorenz curve of individual pre-tax income
Redistributive policies are of two general types. Some, such as the
progressive income tax, are concerned with vertical equity. They seek to alter the
size distribution of income in quite general ways. High marginal rates of income
tax, combined with a neutral spending system that benefits all income groups more
or less equally, will narrow income inequalities.
Other policies seek to mitigate the effects of markets on particular
individuals. They seek not to narrow income gaps in general, but rather to deal
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with specific unfortunate events. Should farmers bear all the losses associated with
the destruction of livestock after an outbreak of foot and mouth or mad cow
disease? Should heads of households be forced to bear the full burden of their
misfortune if they lose their jobs through no fault of their own? Even if they lose
their jobs through their own fault, should they and their families have to bear the
whole burden, which may include starvation? Should the ill and the aged be
thrown on the mercy of their families? What if they have no families? Policies
designed to deal with such situations usually seek horizontal equity in treating
similarly all those who fall into some group.
Both private charities and a great many government policies are concerned
with modifying the distribution of income that results from such things as one's
parents' abilities, luck, and how one fares in the labour market.
It is sometimes argued that egalitarian economic policy should devote more
attention than it does to the distribution of wealth and less to the distribution of
income. Wealth confers economic power, and wealth is more unequally distributed
than is income.
There are two main ways in which inequalities in the distribution of wealth
can be reduced. The first is to levy taxes on wealth at the time that wealth is
transferred from one owner to another, either by gifts during the lifetime of the
owner or by bequest after death. The second method is an annual tax on the value
of each person's wealth.
Problems arise when government measures designed to improve equity
seriously inhibit the efficient operation of the price system.
Often the goal of a more equitable distribution conflicts with the goal of a
more efficient economy.
Text 7. GOVERNMENT POLICIES
People can use and even abuse other people for economic gain in ways that
the members of society find offensive. Child labour laws and minimum standards
of working conditions are responses to such actions. In an unhindered free market,
the adults in a household usually decide how much education to buy for their
children. Selfish parents might buy no education, while egalitarian parents might
buy the same education for all of their children, regardless of their abilities.
Members of society may want to interfere in these choices, both to protect the child
of the selfish parent and to ensure that some of the scarce educational resources are
distributed according to ability rather than a family's wealth. All households are
forced to provide a minimum of education for their children, and a number of
inducements are offered—through public universities, scholarships, loans, and
other means —for talented children to consume more education than they or their
parents might choose if they had to pay the entire cost themselves.
Members of society, acting through the government, often seek to protect
adult (and presumably responsible) individuals not from others, but from
themselves. Laws prohibiting the use of heroin, crack cocaine, and other drugs, and
laws prescribing the installation and use of car seat belts, are intended primarily to
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protect individuals from their own ignorance or short-sightedness. This kind of
interference in the free choices of individuals is called paternalism. Whether such
actions reflect the wishes of the majority in society or the interference of overbearing governments, there is no doubt that the market will not provide this kind of
protection. Buyers do not buy what they do not want, and sellers have no motive to
provide it.
Paternalism is often closely related to merit goods. Merit goods are goods
that society, operating through the government, deems to be especially important,
or that those in power feel individuals should be encouraged to consume. Housing,
education, health care, and cultural amenities such as museums and art galleries are
often cited as merit goods. Critics argue that the concept is merely a way of
imposing the tastes of an elite group on others.
Policies to promote social obligations. In a free-market system, if you can
persuade someone else to clean your house in return for £40, both parties to the
transaction are presumed to be better off. You prefer to part with £40 rather than to
clean the house yourself, and the person you hire prefers to have £40 than to avoid
cleaning your house. Normally society does not interfere with people's ability to
negotiate mutually advantageous contracts.
Most people do not feel this way, however, about activities that are regarded
as social obligations. For example, during major wars when military service is
compulsory, contracts similar to the one between you and your housekeeper could
also be negotiated. Some people, faced with the obligation to do military service,
could no doubt pay enough to persuade others to do their tour of service for them.
By exactly the same argument as we just used, we can presume that both parties
will be better off if they are allowed to negotiate such a trade. Yet such contracts
are usually prohibited as a result of widely held values that cannot be expressed in
the marketplace. In times of major wars, of the sort that were experienced twice in
the twentieth century, military service by all healthy males in the right age group is
held to be a duty that is independent of an individual's tastes, income, wealth, or
social position.
Military service is not the only example of a social obligation. Citizens are
not allowed to buy their way out of jury duty or to sell their votes, even though in
many cases they could find willing trading partners. Even if the price system
allocates goods and services with complete efficiency, members of a society do not
wish to rely solely on the market for all purposes, since they have other goals that
they wish to achieve.
Policies for economic growth. Over the long haul, economic growth is the
most powerful determinant of living standards. Whatever their policies concerning
efficiency and equity, people who live in economies with rapid rates of growth find
their living standards rising on average faster than those of people who live in
countries with low rates of growth. Over a few decades, these growth-induced
changes tend to have much greater effects on living standards than any policyinduced changes in the efficiency of resource allocation or the distribution of
income.
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For the last half of the twentieth century, most economists viewed growth
mainly as a macroeconomic phenomenon related to total savings and total
investment. Reflecting this view, most textbooks do not even mention growth in
their chapters on microeconomic policy.
More recently there has been a shift back to the perspective of earlier
economists, who saw technological change as the engine of growth, with
individual entrepreneurs and firms as the agents of innovation. This is a
microeconomic perspective that is meant to add to, not replace, the macroeconomic
stress on capital accumulation.
Governments are aware of this microeconomic perspective on growth.
Today few microeconomic policies escape being exposed to the question, 'Even if
this policy achieves its main goal, will it have unfavourable effects on growth?'
Answering yes is not a sufficient reason to abandon a specific policy. But it is a
sufficient reason to think again. Is it possible to redesign the policy so that it can
still achieve its main objective, while removing its undesirable side-effects on
growth?
Text 8. TAXATION
Taxes and spending are by far the most important items on this list.
Governments spend money to achieve many objectives, and that money must be
either borrowed or raised through taxes. We leave borrowing aside here, as it is
only a temporary measure. Interest must be paid on borrowed money, and if that
too is borrowed the total government debt will eventually explode to unmanageable proportions.
Sooner or later, all government spending must be paid for out of taxes.
Borrowing only postpones the need to tax.
As well as providing the revenues needed to finance all of the government's
activities, taxes are also used as tools in their own right for a wide range of
purposes. They can be used to alter the incentives to which private maximizing
agents react, and to alter the distribution of income.
Indirect taxes.
Taxes are divided into two broad groups, depending on whether it is people or
transactions that are taxed. An indirect tax is levied on a transaction and is paid by
an individual by virtue of being involved in that transaction. Taxes and stamp
duties on the transfer of assets from one owner to another are indirect taxes, since
they depend on the assets being transferred. Inheritance taxes, which depend on the
size of the estate being inherited and not on the circumstances of the beneficiaries,
are another indirect tax. The most important indirect taxes in today's world are
those on the sale of currently produced products. These taxes are called excise
taxes when they are levied on manufacturers, and sales taxes when they are levied
on the sale of goods from retailer to consumer. The EU countries levy a
comprehensive tax of this sort on all transactions, whether at the retail, wholesale,
or manufacturer's level, called the value added tax (VAT). Value added is the difference between the value of inputs that a firm purchases from other firms and the
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value of its output. It therefore represents the value that a firm adds by virtue of its
own activities. VAT is an indirect tax, because it depends on the value of what is
made and sold and not on the wealth or income of the maker or seller. Thus, two
self-employed fabric designers, each with a value added of £50,000 in terms of
designs produced and sold, would pay the same VAT even if one had no other
source of income while the other was independently wealthy.
Indirect taxes may be levied in two basic ways. An ad valorem tax is a
percentage of the value of the transaction on which it is levied. A specific or perunit tax is a tax expressed as so many pence per unit, independent of the
commodity's price. Taxes on cinema and theatre tickets, and on each litre of petrol
or alcohol, and on each packet of cigarettes are all specific, indirect taxes.
Direct taxes.
Taxes in the second broad group are called direct taxes. These are levied on
people and vary with the status of the taxpayer. The most important direct tax is
the income tax. The personal income tax falls sometimes on the income of
households and sometimes separately on each member of the household. It varies
with the size and source of the taxpayer's income and various other characteristics,
such as marital status and number of dependants.
Firms also pay taxes on their incomes. Companies are subject to corporation
tax, which is levied on their profits. This is a direct tax, both in the legal sense that
the company is an individual in the eyes of the law, and in the economic sense that
the company is owned by its shareholders so that a tax on the company is a tax on
them. A poll tax, which is simply a lump-sum tax levied on each person, is another
direct tax.
It is important for many purposes to distinguish average from marginal rates
of any tax. The average rate of income tax paid by a person is that person's total tax
divided by her income. The marginal rate of tax is the rate she would pay on her
next pound's worth of income.
Progressivity. The general term for the relation between the level of income and
the percentage of income paid as a tax is progressivity. A regressive tax takes a
smaller percentage of people's incomes the larger is their income. A progressive
tax takes a larger percentage of people's incomes the larger is their income. A
proportional tax is the boundary case between the two, since it takes the same
percentage of income from everyone. Taxes on food, for example, tend to be
regressive, because the proportion of income spent on food tends to fall as income
rises. Taxes on alcoholic spirits tend to be progressive, since the proportion of
income spent on spirits tends to rise with income. (Taxes on beer, on the other
hand, are regressive.)
Progressivity can be denned for any one tax or for the tax system as a whole.
Different taxes have different characteristics. Inevitably, some will be progressive
and some regressive. The impact of a tax system as a whole on high-, middle-, and
low-income groups is best judged by looking at the progressivity of the whole set
of taxes taken together. For example, income taxes are progressive in the United
Kingdom, rising to a maximum marginal rate of 40 per cent. The overall tax
system is also progressive, but much less so than one would guess from studying
105
only the income tax rates. This is because much revenue is raised by indirect taxes,
which are much less progressive than income taxes.
Exercises:
1. Complete the sentences by using the words from the texts:
A) We define … to be total tax revenues received by the government minus
total transfer payments made by the government.
B) The budget … is the difference between total government revenue and total
government spending, or equivalently net taxes minus government spending.
C) When revenues exceed spending, the government is running a budget …
D) When spending exceeds revenues the government is running a budget …
E) For given tax rates, the government budget surplus (public saving) increases
as GDP … and falls as GDP ...
F) … equity means that people in similar circumstance should be treated
similarly, but … equity means treating people in different economic situations
differently in order to reduce inequalities between them.
G) Laws prohibiting the use of heroin, crack cocaine, and other drugs, and
laws prescribing the installation and use of car seat belts, are intended primarily to
protect individuals from their own ignorance or short-sightedness. This kind of
interference in the free choices of individuals is called …
H) An … tax is levied on a transaction and is paid by an individual by virtue
of being involved in that transaction. … taxes are levied on people and vary with
the status of the taxpayer.
I) An … tax is a percentage of the value of the transaction on which it is
levied, and a … or … tax is a tax expressed as so many pence per unit, independent
of the commodity's price.
J) The general term for the relation between the level of income and the
percentage of income paid as a tax is …
K) A … tax takes a larger percentage of people's incomes the larger is their
income.
L) A … tax takes a smaller percentage of people's incomes the larger is their
income.
M) A … tax is the boundary case between the two, since it takes the same
percentage of income from everyone.
2. Can you think of government programmes that would have effects on all
three goals of equity, efficiency, and growth? Select those programmes that have
desirable effects on some and undesirable effects on others of these three goals.
(Assume that your equity criterion is to have a less unequal distribution of
income.) Discuss the trade-offs involved in these policy conflicts.
3. Discuss the relative efficiency and equity effects of two programmes
designed to assist certain needy groups. One programme provides coupons that
reduce the purchase price of groceries by 50 per cent. (The shop returns the
coupons to the governmentand gets back the discount that it gave to the coupon106
holder.) The other programme gives a money income supplement that has the same
value as the food coupons.
4. List some things that only governments can do and some things that the
government can do better than the private sector. Can you think of anything that
the Russian and Indian government did thirty years ago, or that it does now, that
the private sector could probably do better? Can you think of anything that the
private sector did thirty years ago, or is doing now, that the government could
probably do better?
5. What difficulties arise in determining and implementing an optimal
government intervention in the economy?
6. What are the arguments for and against government provision of health
and education?
7. What government policies might best encourage economic growth?
New vocabulary:
budget deficit, fiscal policy, indirect taxes, direct taxes, progressive taxes,
proportional taxes, sales taxes, tariff, Laffer’s Curve.
Homework:
1. Economics for Medical Students. Repeat unit №5.
2. English Economy Dictionary with Definitions.
Lesson 12
The program of colloquium №2.
I. Questions:
1. Macroeconomics problems. The aims of macroeconomics activity.
2. National accounting.
3. Gross Domestic Product.
4. Gross National Product.
5. Business cycle and its phases.
6. Government’s Role in the Economy.
7. Phillip’s Curve.
8. Antimonopoly Policy.
9. Unemployment (Frictional, Structural, Cyclical).
10. Monetary System and its intermediaries.
11. Types of Banking Systems.
12. The main functions and tools of the Central Bank.
13. Money aggregates.
14. The Law of money circulation.
15. The main kinds of commercial banks.
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16. The banking services.
17. Fiscal Policy.
18. Taxes. Direct and indirect Taxes.
19. Laffer’s Curve.
20. Public Spending. Transfer payment.
21. Budget deficit.
22. Inflation.
II. Exercises:
1) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 100 + 0.8Y; I= 1,000.
2) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 100 + 0.8Y; I= 2,000.
3) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 100 + 0.8Y; I= 4,000.
4) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 100 + 0.8Y; I= 10,000.
5) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 1,000 + 0.6Y; I= 1,000.
6) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 0.9Y; I= 1,000.
7) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 1Y; I= 1,000.
8) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 1,000 + 0.6Y; I= 2,000.
9) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 0.9Y; I= 2,000.
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10) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 1Y; I= 2,000.
11) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 1,000 + 0.6Y; I= 4,000.
12) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 0.9Y; I= 4,000.
13) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 1Y; I= 4,000.
14) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= 1,000 + 0.6Y; I= 10,000.
15)) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 0.9Y; I= 10,000.
16) Calculate GDP using the following information (where there is no government
and no foreign trade and C = consumption, I= investment, and Y= GDP):
C= -200 + 1Y; I= 10,000.
17) Calculate GDP using the following information (where there is C = private
consumption spending, I = investment spending, G = government spending, NX =
net export):
C= 10,000; I=15,000; G=5,000; NX=2,000
18) Calculate GDP using the following information (where there is C = private
consumption spending, I = investment spending, G = government spending, NX =
net export):
C= 8,000; I=10,000; G=1,000; NX=2,000
19) Calculate GDP using the following information (where there is C = private
consumption spending, I = investment spending, G = government spending, NX =
net export):
C= 100,000; I=150,000; G=15,000; NX=20,000
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20) Calculate GDP using the following information (where there is C = private
consumption spending, I = investment spending, G = government spending, NX =
net export):
C= 80,000; I=150,000; G=15,000; NX=20,000
21) Calculate net exports using the following information (where there is EX =
total exports of goods and services, IM = total imports of goods and services):
EX=15,000 IM=10,000
22) Calculate net exports using the following information (where there is EX =
total exports of goods and services, IM = total imports of goods and services):
EX=25,000 IM=25,000
23) Calculate net exports using the following information (where there is EX =
total exports of goods and services, IM = total imports of goods and services):
EX=15,000 IM=20,000
24) Calculate implicit deflator using the following information:
- GDP at current prices = 4,000,000
- GDP at base-period prices = 4,200,000
25) Calculate implicit deflator using the following information:
- GDP at current prices = 6,000,000
- GDP at base-period prices = 4,000,000
26) Calculate implicit deflator using the following information:
- GDP at current prices = 4,000,000
- GDP at base-period prices = 4,000,000
27) Calculate Government surplus using the following information:
- GDP = 4,000,000
- Government spending (G) = 400,000
- Net taxed (T) = 0,1 GDP
28) Calculate Government surplus using the following information:
- GDP = 6,000,000
- Government spending (G) = 400,000
- Net taxed (T) = 0,1 GDP
29) Calculate Government surplus using the following information:
- GDP = 8,000,000
- Government spending (G) = 400,000
- Net taxed (T) = 0,1 GDP
30) Calculate Government surplus using the following information:
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- GDP = 10,000,000
- Government spending (G) = 400,000
- Net taxed (T) = 0,1 GDP
31) Why is there a close relationship between personal disposable income and
consumers' expenditure?
32) What factors do you think would put limits on how far increases in spending
can lead to increases in real GDP?
33) What do you think are likely to be the main determinants of investment by
firms?
34) Explain why it is that changes in the price level lead to changes in desired
aggregate spending for each level of GDP.
35) Explain why the change in GDP in response to an increase in export demand is
smaller than that suggested by the simple multiplier. What happens to the size of
this effect as GDP gets above its potential level?
36) How do you think interest rates would affect aggregate demand?
37) Compare and contrast monetary and fiscal policies as tools for controlling
output and inflation.
38) When the monetary authorities set interest rates, what role does the money
stock play in monetary policy?
39) Explain the differences between cyclical, frictional, and structural
unemployment.
40) Outline potential policy solutions to (a) cyclical and (b) structural
unemployment.
Homework:
1. Economics for Medical Students. (text 1, p.p. 57-59; text 2, p.60; text 3,
p.p. 61-62; text 4, p.63; text 6, p.p. 66-68).
2. English Economy Dictionary with Definitions (p.6 - average costs, p.7 –
break even point, p.11 – corporation, p.17 – entrepreneur, p.19 –fixed costs,
p.21 – free enterprise, p.27 – marginal revenue, p.27 – marginal costs, p.36 –
productivity, p.36 – profits, p.37 – proprietorship, p.46 – variable costs.
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Lesson 13
Microeconomics. The Basic of Enterprise. Business and its
legal forms.
Questions for discussion:
1) What can you tell us about the factors of Productions?
2) Who will organize the factors of Productions?
3) What questions must decide entrepreneur?
4) Say us, please, about the main entrepreneurial functions.
5) Who is a sole proprietor?
6) Who is the leader of the large company?
7) What do you know about the forms of business or law type of business?
8) What kind of business is likely to be a sole proprietorship?
9) What can you say about the kinds of business in the UK?
10) Sole trader. Are there one man owners?
11) The partnership. When is this form use?
12) Limited partnership. Say, please, about this form of business.
13) Describe the limited liability company.
14) What do you know about the business in the U.S.A.?
15) What do you know about the business in the UK?
16) What is the difference between a general partnership and a limited
partnership?
Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
text 1, p.p. 57 -59.
Questions and exercises:
a) What is the most common type of company in the USA?
b) Are all limited liability companies joint-stock ones?
c) What can you say about the types of the following companies: Fine Furniture
Ltd. General Foods p. l. e.
Compare types of business in the UK and USA and their incorporation
requirements:
Sole traders
Individual businesses
Partnerships
General and limited partnerships
Limited liability companies (Public and Corporations (closed and ordinary)
private)
Branches of foreign companies
Alien corporations
Charter,
statutes,
memorandum, Charter and certificate by the company
delivered
and certificate of issued by the state in
corporation, issued by the Registrar
authorities
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Text 2, p. 60.
Questions and exercises:
a) What is the difference between a general partnership and a limited partnership?
b) Is there any difference between a silent partner and a secret partner?
c) In what professional fields are the partnerships found?
d) In what businesses is the partnership a common form?
e) What are the advantages of a partnership?
f) Discuss the disadvantages of a partnership. Would you prefer partnership or sole
proprietorship for business? Give your reasons.
Select the necessary word and put it in the sentence.
1 .Partnership very often receives... from the government.
2. Limited partnerships is a common form of ownership in
...
3. Partnerships have many... one is that they receive tax
benefits from the government.
4. ... are the partners with unlimited liability.
5. ... has the authority in management but he is not known
to public.
6. A secret partner takes part in …
7. General partners have ...
8. One advantage of a partnership is that it offers a multiple
source of...
9. A partnership can bring much ... to the partners.
1 secret partner
2 unlimited liability
3 real estate
4 general partner
5 advantage
6 profit
7 capital
8 management
9 tax benefits
Text 3, p.p. 61-62.
Questions and exercises:
a) Who can own a corporation?
b) Is a corporation necessarily larger than a sole proprietorship?
c) What are the advantages of the corporate form of ownership?
d) What can you say about the disadvantages of the corporate form of
ownership?
e) Do the corporations issue stock to stockholder?
f) What kind of corporations usually does not issue the stock?
g) What world-known corporations do you know?
h) What types of business usually take the corporate form of ownership?
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Choose the necessary word and put it in the sentence:
1. What kind of ... is better: buying stock or buying real
estate?
2. To attract greater financial ... the company issues the
stock.
3. A university can be ... corporation.
4. The partners did not put the same . . . into business.
5. The group of people from different countries are going
to ... a corporation.
6. The Red Cross is an international... organization.
7. I want to buy some ... in IBM and General Motors.
8. An educational ... usually reinvests all its money.
1 charitable
2 stock
3 resources
4 institution
5 investment
6 nonprofit
7 amount of capital
Text 6, p.p. 66-68. Give a short summery of the texts
Read the texts and answer the questions.
Text 1. WHAT IS BUSINESS?
When you think of «business» what picture do you have in your mind Xerox, American Airlines, American Telephone and Telegraph? If so, you are
on the right track. But business in America is more than the large corporations with
which we are all familiar. Businesses come in all shapes and sizes.
Businesses are either goods-producing or service-producing firms. Goodsproducing firms, such as mining, construction, and manufacturing firms,
produce tangible products or goods -commodities that have a physical presense.
Service-producing firms provide services - activities that benefit consumers or
other businesses. Transportation firms, insurance companies, beauty shops, and repair
shops are all examples of service businesses.
But, regardless of whether a business produces a good or provides a
service, the common ingredient is profit. Profit is the difference between a
business's total revenues or sales receipts and the total of its production costs,
operating expenses, and taxes. In a bread bakery example the bakery has to pay for its
raw materials (flour, butter or shortening, yeast, salt), equipment (mixers, ovens,
wrapping machines), employees, and the energy it uses. When the bakery sells the
bread to the supermarket, it charges more than the cost of making the bread. That
extra part of the selling price is profit.
Why do businesses want profit? Profit is the ultimate goal of business. It is the
measure of success for the businessperson and the reward for taking a chance. Each
person who operates a business is risking money. The baker does not know that people
will buy the bread when it is produced: but money is invested in the business on
the possibility that people will buy. The baker is taking a chance, a risk. Were there no
profits, it would not be worthwhile for the baker to risk the money.
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Questions:
1.
2.
3.
4.
5.
What is business? In what shapes do business come in?
Why do businesses want profit?
How do you understand the category of «profit»?
Do people who operate businesses risk money?
If there were no profits do people risk money in business?
Text 2. BUSINESS AND PRIVATE ENTERPRISE
In the private enterprise system businesses are owned by private individuals,
not by public institutions like the government. Private enterprise is based on
four principles or rights: the right to private property, freedom of choice, profits,
and competition.
The right to private property. In the private enterprise system individuals
have the right to buy, own, use, and sell property as they see fit. This right of
ownership includes land, buildings, equipment, and intangible property such as
inventions.
The right of freedom of choice. The private enterprise system also provides
the right of freedom of choice. This freedom of choice applies to the individual's
right to decide what type of work to do, where to work, and how and where money
is to be spent.
The right to profit. In the private enterprise system, the person who takes the
chance in starting the business by investing is guaranteed the right to all profits.
This right is what attracts people to begin businesses, and it is the ultimate goal
of business. Not all entrepreneurs are successful, but the opportunity is there to
start a business and reap the rewards.
The right to compete. Under the private enterprise system people have the
freedom to compete with others. Competition, along with profit, is the cornerstone of
the private enterprise system. Competition makes for better products and more
responsiveness to consumer needs.
The private enterprise system, as do all economic systems, requires resources
for its business to produce goods and services. The resources used to provide
goods and services are the factors of production: land, labour, capital, and
entrepreneurship.
One of the major decisions an entrepreneur must make is to determine
which legal form of business ownership to use in creating a business venture.
There are three basic forms of business ownership:
1) sole proprietorship;
2) partnership;
3) corporation.
Questions:
1. What principles or rights is private enterprise system based on?
2. Who owns the resourses necessary for production and business under the private
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3.
4.
5.
6.
enterprise system?
What does the right to property mean in capitalism?
How do you understand the right of freedom of choice under the private enterprise
system?
What is the cornerstone of the private enterprise system?
What basic forms of business ownership do you know?
Text 3. SOURCES OF FINANCING
It is essential to start with sufficient capital. A company with inadequate
financing is like a rowboat with a hole in the bottom: given enough time, it is
bound to sink. Some small-business owners dream and save for so long that they
reach the end of their patience and open the business come hell or high water.
Rather than, start a company on a shoestring, it is best either to wait until there is
enough capital to ensure success or to begin on a smaller scale than originally
planned. Both accountants and trade associations can help potential business
owners decide if they have enough capital to make a sound beginning.
Personal savings. Personal savings is the source of financing used most
often. Many observers advise small-business owners to avoid excessive borrowing.
Firms that start off under the heavy weight of creditors' claims may take years to
struggle out of debt, while their owners have to put up with the nervous questions
and suggestions of the creditors. Still, under the right circumstances, a firm can
profit impressively using the leverage of borrowed money. Thus the question of
how much debt a firm should carry in relation to the owner's investment has no
simple answer.
Manufacturer financing of equipment. Manufacturers (and sometimes
distributors) of equipment and fixtures may be willing to finance purchases made
by financially sound customers or help them to arrange financing through a
commercial bank. Even if they do not get involved directly, the supportive phone
call from a well-established manufacturer to a bank lending officer might make it
considerably easier for a customer firm to get a loan.
Commercial banks. A commercial bank may make a term loan that the small
business can pay off within several years. In addition, commercial banks give
qualified small businesses a line of credit or a revolving credit agreement.
Naturally the business owner will have to provide financial statements listing
personal and company assets and debts. Unfortunately banks are often reluctant to
lend money to companies that have only been operating for a few years unless the
loan also is secured by the Small Business Administration /SBA/.
The Small Business Administration. The steps in the SBA lending process
are:
1. Describe the kind of business to be started.
2. List the owner's experience and management capabilities.
3. Estimate the amount the owner is prepared to invest and the amount he or
116
4.
5.
6.
7.
8.
9.
she will need to borrow.
Prepare a personal financial statement listing the owner's assets and debts.
Develop pro forma statements of the business's sales, expenses
and profits for the first 2 years.
List the owner's collateral (security) for the loan, at current market value.
Ask a commercial bank for a letter stating the amount of the loan the owner
requested, the interested rate, the payment terms, and the reason for rejecting
the application.
If the bank agrees to be involved in the SBA's guarantee or participation
plans (in which the bank joins with the SBA to make the loan), the banker
will contact the SBA to negotiate the terms.
If the bank declines to be involved, contact the SBA for a direct loan.
Questions:
1.
2.
3.
4.
May a company do business without sufficient capital?
What are the main sources of financing business?
Are personal savings used in starting a business?
On what terms do commercial banks usually lend money to small-owners? Are
they reliable partners in business?
5. What kind of financial help can the Small Business Administration provide to
small-owners and on what terms?
Text 4. BUSINESS TERMINATION
There are several ways in which a company may be terminated (dissolved):
its registration may be cancelled, it may be removed from the register if it has
simply ceased to function as a company; or, it may be liquidated, or wound up.
This means that its resources will be used to pay creditors in an established order
priority. It is likely that the reason the company is being wound up is that it is
bankrupt - that is, it cannot pay all its debts. This means that creditors may only get
a proportion of what they are owed. As mentioned above, shareholders may be
liable for up to the value of shares they hold but have not, yet paid for. Sometimes
liquidation is voluntary, at the insistence of most of the shareholders, and
sometimes it is ordered by the court.
Setting up, running, and winding down a company are not the only legal
matters businessmen have to deal with. At some stage, most of them employ the
services of lawyers for advice on how to minimize their tax liabilities and to make
sure their business does not exceed noise or pollution regulations. Company
directors, partners and sole traders alike have to consider the legal implications of
making contracts to buy and supply goods and services, and the torts they may face
if a product injures a consumer.
Questions:
1. In what ways may companies be terminated?
117
2. A company may be liquidated or wound up. How are its resources
used in this case? Whom do they pass to?
3. For which value of shares are shareholders liable in case their
company has gone bankrupt?
4. May companies be liquidated at the insistence of the shareholders
or not? If they may, then in what cases?
5. What kind of legal matters do businessmen usually deal with in
their business daily activities? Do they employ the services of lawyers? In
what cases?
Read the texts and give a short summery of the texts.
Text 5. INFLATION AND BUSINESS
Inflation can adversely affect business in a number of ways:
1. Accounting and financial problems. Significant rates of inflation can
cause accounting and financial problems for businesses. They may experience
difficulty in valuing assets and stocks, for example. Such problems can waste
valuable management time and make forecasting, comparisons and financial
control more onerous.
2. Falling sales. Many businesses may experience falling sales during
inflationary periods for two broad reasons. Firstly, it may be that saving rises in a
time of inflation. We would expect people to spend more of their money when
prices are rising to avoid holding an asset (cash), which is falling in value.
However, during the mid-1970s, when industrialized nations were experiencing
high inflation rates, savings as a proportion of income rose! It is not easy to
identify the reason for this, but some economists suggest that people like to hold a
relatively high proportion of their assets in a form which can tie quickly converted
into cash when the future is uncertain.
Whatever the reason, if people save more they spend less and businesses
suffer falling sales. The economic model predicts that if savings rose the level of
activity in the economy would fall. Clearly, if this happened we would expect
businesses to experience difficulty in maintaining their levels of sales.
Businesses may be hit by a reduction in sales during a time of inflation for a
second reason. As inflation progresses, it is likely tliat workers' money wages (that
is, wages unadjusted for inflation,) will be increased broadly in line with inflation.
This may well take a worker into a higher tax bracket and result in a higher
percentage of his or her wages being taken as tax. This process, known as fiscal
drag, will cause workers to have less money available to spend on firms' goods and
services. The poverty trap has a similar impact. As money wages rise, the poor
may find that they no longer qualify for state benefits to supplement their incomes
and at the same time they begin to pay income tax on their earnings. Again, this
leaves less disposable income to spend on the output of firms. Finally, it may be
that the wages of many groups are not index-linked and so they rise less quickly
118
than the rate of inflation, causing a reduction in spending power and demand for
goods and services.
Once again, the economic model can be used to predict that increases in the
level of taxation will increase withdrawals, lowering the level of economic activity
and depressing firms' sales.
Not all businesses will suffer equally from declining demand in an
inflationary period. Those selling essential items, such as food, may be little
affected whilst others supplying less essential goods and services, such as foreign
holidays, may be hard hit.
3. High interest rates. Inflation is often accompanied by high interest rates.
High interest rates tend to discourage investment by businesses as they increase the
cost of borrowing funds. Thus, investment may fall. Businesses may also be
dissuaded from undertaking investment programmes because of a lack of
confidence in the future stability and prosperity of the economy. This fall in
investment may be worsened by foreign investment being reduced as they also lose
some confidence in the economy's future. Such a decline in the level of investment
can lead to businesses having to retain obsolete, inefficient and expensive means of
production and cause a loss of international competitiveness. Finally, a fall in
investment can lower the level of economic activity, causing lower sales, output
and so on. Thus, to some extent, businesses can influence the economic
environment in which they operate.
4. Higher costs. During a bout of inflation firms will face higher costs for
the resources they need to carry on their business. They will have to pay higher
wages to their employees to compensate them for rising prices. Supplies of raw
materials and fuel will become more expensive as will rents and rates. The
inevitable reaction to this is that the firm has to raise its own prices. This will lead
to further demands for higher wages as is called the wage-price spiral. Such costpush inflation may make the goods and services produced by that enterprise
internationally less competitive in terms of price. An economy whose relative or
comparative rate of inflation is high may find that it is unable to compete in home
or foreign markets because its products are expensive. The economic model tells us
that a situation of declining exports and increasing imports will lower the level of
activity in the economy with all the consequent side-effects.
Text 6. THE MAIN FORMS OF BUSINESS ORGANIZATION
Business is the production, distribution, and sale of goods and services for
the benefit of the buyer and the profit of the seller. In the modern world the control
of production is largely in the hands of individual business people or entrepreneurs,
who organize and direct industry for gaining profits.
The main forms of business organization are described below.
Individual Proprietorship (Sole Trader or Sole Proprietor). This is the
simplest way of starting a business. You are self-employed and fully responsible
for all the aspects of the management of your business.
119
In this form of organization the owner is in sole charge of the business and is
responsible for its success or failure. Any line of business is open to an owner.
Although this form of small business has its advantages, it has certain
drawbacks. In the first place the single owner is seldom able to invest as much capital as can be secured by a partnership or a corporation. If single owners are able to
invest large amounts of capital, they run great risk of losing it all because they are
personally liable for all the debts of their businesses. This is called unlimited
liability.
Partnership. Two or more people starting a business together can set up a
partnership. All partners are responsible for the debts of the partnership and profits
and losses are shared between them.
The agreement to form an association of this nature is called a partnership
contract and may include general policies, distribution of profits, fiscal responsibilities, and a specific length of time during which the partnership is in effect.
Public and private companies. A company is usually formed for the
purpose of conducting business that is separate from its owners, the shareholders.
The main difference is between public and private companies.
Private companies cannot sell shares to or raise money from the general
public.
Public companies can sell their shares to the general public (which they
usually do through a stock exchange). A company continues to exist despite changes in (or deaths among) its owners. A company can hold assets; it can sue, and it
can be sued. The profits are distributed to the members as dividends on their
shareholding. Losses are borne by the company. The day-to-day management of
the company is carried out by a board of directors. Private limited companies are
often local family businesses and are common in the building, retailing and
clothing industries.
A private company can be formed with a minimum of two people becoming
its shareholders. They must appoint a director and a company secretary. If the
company goes out of business, the responsibility of each shareholder is limited to
the amount that they have contributed; they have limited liability. Such a company
has Ltd (Limited) after its name.
Many large businesses in the UK are Public Limited Companies (PLC),
which means that the public can buy and sell their shares on the stock exchange.
Marks & Spencer, British Telecom and the National Westminster Bank are the
examples of public limited companies.
In the US, businesses take the same basic forms. American companies have
abbreviations Inc and Corp.
Other types of companies are:
1) Associated company, which is a company over which another company has
substantial influence; for example it owns between 20 per cent and 50 per cent of
its shares.
2) Holding company, a company that owns another company or other companies
and which is sometimes referred to as the parent company (most public companies
120
operate through a number of companies controlled by the group's holding
company);
3) Subsidiary company, a company controlled by a holding company, usually
because the holding company owns (or indirectly owns through another subsidiary)
more than 50 per cent of the subsidary company's shares.
The Corporation. As business became more competitive, new and more
complex corporate combinations appear. Single ownerships and the partnerships
have finance weaknesses and that is the reason why the corporation came into
existence.
The major simple forms of integration are the following:
• A vertical integration characterizes companies that engage in the different steps
in manufacturing or marketing a product.
• A horizontal combination brings under one control companies engaged in the
sale of the same or similar products.
• A complementary combination takes place when companies, selling allied but not
competitive products, combine.
• A conglomerate combination involves firms in widely diverse industries, such
as a motor company owning a food manufacturer or book publisher.
• Of great economic importance are multinational corporations. Such companies
maintain extensive business activities and large-scale production facilities
throughout the world, and their revenues sometimes exceed the total revenues of
some countries in which they operate.
International business is a dynamic activity which changes, adapts and
responds according to the conditions. Apart from conventional trade it takes
various forms such as franchising, buy-back transactions, turnkey projects,
transactions in patents, licences, know-how, services, various joint ventures, joint
banks, mixed commissions and many other forms.
Franchising. Franchising is a form of business in which a product or service
may be provided by people or firms who have obtained a licence from the
originators or owners of that product or service.
A franchise agreement is drawn up in which the rights of the two parties are
set down. The parties to the agreement are:
a) the franchisor — usually the person or firm who develops a new product
or service under licence
b) the franchisee — the person or firm who buys the license granting the
right to provide the product or service.
The franchisor will have tried the product out by piloting it for a reasonable
trading period before selling it to potential franchisees. The franchisee is provided
with a total package for marketing the product, including tho product's name and
logo, any patented processes, accounting procedures, marketing strategy and
training services. The franchisee has to raise capital to pay the franchise fee, find
suitable premises, equip them according to the franchisor's house-style, buy or
lease equipment, and market the product to the standard specified by the
franchisor. The franchisee is not employed by the franchising company, but has to
establish and operate his own business. The fees are to be paid to the franchisor
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throughout the term of the franchise, usually as a royalty, for example a fixed
percentage (typically 10%) of weekly takings.
Advantages. Franchising provides the opportunity of developing business
without having large capital sums. For the franchisee it:
a) enables people to go into business with limited risk and outlay,
b) insures that the product or service has been thoroughly tested and marketed
before the franchise has been approved,
c) provides a well-known brand name and image, and large-scale advertising backup,
d) requires less capital than other forms of business start-up,
e) provides continuing back-up support and advice during the period of the
franchise agreement.
Exercises:
1. Decide which of the advantages and disadvantages below you would
associate with the following forms of business. In some cases there may be more
than one correct answer.
1. a sole trader
2. a partnership
3. a private limited company
4. franchising
Advantages
1. You have total control of your business.
2. This is a good way of sharing the pressure and work of starting a business.
3. The financial risks that you are taking are restricted.
4. You can increase your capital by selling shares.
5. You can go into business with limited risk and outlay.
Disadvantages
1. There is a danger that conflicts of personality could ruin your business.
2. It may be difficult to expand.
3. You may have to sell your possessions if the company goes into debt.
2. Prepare a short checklist of the questions that you would need to ask
yourselves before starting a business.
Examples: How much money will I need?
What starting investments are necessary?
Where to place the enterprise? What are the prospects of the business? etc.
3. What position would you like to have:
A. to manage people — manager
B. to work for someone else — an employee
C. to be your own boss — self-employed, businessman
D. be responsible for everything — top manager, director
E. to work for the state — state employee
4. How do you see your future profession? Please answer the following
questions:
What kind of work are you interested in:
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1. well paid work
2. interesting work
3. work in a large and famous company
4. quiet work
5. work in an industry which has future prospects
6. prestigious work
7. a kind of work such as not to sit the whole day in the office
8. to travel a lot
5. Please, discuss advantages and disadvantages of your future profession.
1. Do you think that your future profession is prestigious?
2. Do you think it will be still prestigious and well paid by the time you graduate?
3. How difficult is it to find a good work in your field?
4. Is there a competition in your group?
5. Do you think that competition among your coeds is a good stimulus to study
well or it just makes communication between you more difficult?
6. Do the questionnaire, then compare your answers with a partner.
The questionnaire “How do you rate as an entrepreneurs?”
1. Are you a self starter?
a. I only make an effort when I want to.
b. If someone explains what to do, then I can continue from there.
с / make my own decisions. I don't need anyone to tell me what to do.
2. How do you get on with other people?
a. / get on with almost everybody.
b. I have my own friends and I don't really need anyone else.
с / don't really feel at home with other people.
3. Can you lead and motivate others?
a. Once something is moving I'll join in.
b. I'm good at giving orders when I know what to do.
c. I can persuade most people to follow me when I start something.
4. Can you take responibility?
a. I like to take charge and to obtain results.
b. I'll take charge if I have to but I prefer someone else to be responsible.
с Someone always wants to be the leader and I'm happy to let them do the job. 5.
Are you a good organizer?
a. / tend to get confused when unexpected problems arise.
b. / like to plan exactly what I'm going to do.
с / just like to let things happen.
6. How good a worker are you?
a. I'm willing to work hard for something I really want.
b. / find my home environment more stimulating than work.
c. Regular work suits me but I don't like it to interfere with my private life.
7. Can you make decisions?
a. / am quite happy to execute other people's decisions.
b. I often make very quick decisions which usually work but sometimes don't.
с Before making a decision, I need time to think it over.
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8. Do you enjoy taking risks?
a. / always evaluate the exact dangers of any situation.
b. / like the excitement of taking big risks.
c. For me safety is the most important thing.
9. Can you stay the course?
a. The biggest challenge for me is getting a project started.
b. If / decide to do-something, nothing will stop me.
c. If something doesn't go right first time, I tend to lose interest.
10. Are you motivated by money?
a. For me, job satisfaction cannot be measured in money terms.
b. Although money is important to me, I value other things just as much. с. Making
money is my main motivation.
11. How do you react to criticism?
a. / dislike any form of criticism.
b. If people criticise me I always listen and may or may not reject what they have
to say.
c. When people criticise me there is usually some truth in what they say.
12. Can people believe what you say?
a. / try to be honest, but it is sometimes difficult or too complicated to explain
things to other people.
b. I don't say things I don't mean.
c. When I think I'm right, I don't care what anyone else thinks.
13. Do you delegate?
a. / prefer to delegate what I consider to be the least important tasks.
b. When I have a job to do I like to do everything myself.
c. Delegating is an important part of any job.
14. Can you cope with stress?
a. Stress is something I can live with.
b. Stress can be a stimulating element in a
business.
c. I try to avoid situations which lead to stress.
15. How do you view your chances of success?
a. I believe that my success will depend to a large
degree on factors outside my control.
b. / know that everything depends on me and my
abilities.
c. It is difficult to foresee what will happen in the
future.
16. If the business was not making a profit after
five years, what would you do?
a. give up easily.
b. give up reluctantly. с carry on.
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44 or above
You definitely have the necessary qualities to become the director of a successful
business. You have a strong sense of leadership, you can both organise and
motivate and you know exactly where you and your team are going.
Between 44 and 22
You may need to think more carefully before setting up your own business.
Although you do have some of the essential skills for running business, you will,
probably, not be able to deal with the pressures and strains that are a part of the
job. You should perhaps consider taking some professional training or finding an
associate who can compensate for some of your weaknesses.
Below 22
Managing your own business is not for you. You are better suited to an
environment where you are not responsible for making decisions and taking risks.
To operate successfully you need to follow well defined instructions and you
prefer work that is both regulai and predictable.
New vocabulary:
average costs, break even point, corporation, entrepreneur, fixed costs, free
enterprise, marginal revenue, marginal costs, productivity, profits, proprietorship,
variable costs.
Homework:
1. Economics for Medical Students. (text 1, p.p. 68-70; text 2, p. 72; text
3, p.p. 73-74; text 4, p.p. 75-76; text 5, p.p. 76-77).
2. English Economy Dictionary with Definitions. (p. 10 - consumer
surplus; p. 10 - consumer tastes and preferences; p. 11 - copyright; p. 42
– substitute).
Lesson 14.
Marketing: functions, concept, research, plan.
Questions for discussion:
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
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
What does “marketing” mean?
How does Philip Kotler define marketing?
What do you know about retailing?
Tell about the essential functions of marketing.
What does marketing operations include?
Why is it so important for the producer to predict the trends?
What does producer must know?
What is marketing research used for?
Is it reasonable to use independent marketing research is small business?
What you may say about the channels of marketing?
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Read the texts of “Economics for Medical Students”, answer the questions
and do exercises:
text 3, p.p. 73 -74.
Questions and exercises:
a) What are individual consumers and corporate buyers aware of?
b) What combinations of institutions specializing in manufacturing,
wholesaling, and retailing usually do to maximize their profits?
c) What is an example of health care delivery used for?
d) What is the major focus of marketing channel management concentrated
on?
e) What the verb «to digest» is used for in the text?
Which of the following is false?
a) Channel structure could be very complex.
b) Many partners coordinate their efforts to make possible the delivery of
goods.
c) Channels of marketing are of the most importance and effectiveness in
health care delivery.
d) Marketing channels stimulate demand through the promotional activities
of the units.
e) Public and private goods could be available for consumption only through
distribution.
f) According to the author, legislators also use the channels of marketing to
distribute their products - laws.
g) The only way to use marketing channel is to digest them.
Questions for discussion:
a) Does channel structure for individual consumers differ from that of
organization? In what way?
b) Do you agree that laws of marketing could be applied to the sphere of
politics? Why? Give an example.
c) Do you agree that theory of marketing could be used in the field of
medicine? Does it come into contradiction with ethics or morals?
Text 4, p.75.
Questions and exercises:
a) What is retailing?
b) What are four different types of retail stores?
c) What are at least two types of retailing that do not include the use of a
store?
d) In what way does a retailer serve a customer?
e) In what way does a retailer serve a manufacturer?
f) Which percent of the price of the good sold goes to the retailer?
g) What is the trend with a single line retailer now?
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Put the necessary word in the sentence:
1 . ... is one function a retailer may perform.
1 mail-order
2. You can buy newspaper, cigarettes, cookies from a ...
2 discount
3. ... is the most expensive link in the chain between a
producer and a consumer.
4. The firm ... good quality of the product.
3 vending-machine
4 guarantees
5. She doesn’t like to go shopping, she prefers to do it by 5 retailer
...
6. The department store is having a sale and there is a 20 6 extending credit
per cent ... on all light dresses.
7. Wholesaler is an important ... between a producer and a 7 link
consumer.
Text 5, p.p. 76-77.
Questions and exercises:
a) Why is it difficult to determine the right price?
b) Why is the seller interested in the price that produces the highest volume of
sales at the lowest unit cost?
c) Why do many businesses follow unsound pricing policies?
d) In what way are agricultural prices decided?
e) How are usually industrial products priced?
f) Why does the government usually set the prices for public utility services?
g) Why is it so important to know the levels of supply and demand when
dealing with pricing?
h) Why is everything related by price?
Put the necessary word in the sentence:
1. It is very difficult ... without sound price policy.
2. Of course we are interested in producing the . . . with
the lowest unit costs.
3. I decided to buy a new car at this company because
they offered the best ... on my old model.
4. The ... of this store are very beneficial for a customer.
5. Their business will fail if they pursue unsound ...
6. The government usually... for public utility services.
7. In pure competition the forces of ... operate.
1 supply and demand
2 volume of sales
3 trade-in allowance
4 compete
5 price policies
6 credit terms
7 to set prices
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Read the text and answer the questions
Text 1. WHAT IS MARKETING?
Marketing is the performance of business activities that direct the flow of goods
and services from producer to consumer or user. Simply to produce a
product is not enough: the product must be transported, stored, priced, advertised,
and sold before the satisfaction of human needs and wants is accomplished.
Marketing activities range from the initial conception and design of the product to
its ultimate sale, and account for about half the cost of the product. Marketing is
the whole process of having the right product, at the right time, in the right place,
calling attention to it and thereby bringing a mutual benefit to customer and
vendor. Customers benefit by having what they want, when and where they want
it. Vendors benefit by making a profit. The greater the benefits customers perceive,
the more frequently they will trade with the businesses that provide them. You are
engaging in marketing when you:
 Design or develop a product or service.
 Transport and store goods.
 Provide a variety of choice.
 Buy in large volumes and sell them by item.
 Install, service, repair, instruct.
 Update and improve.
Marketing is the Four Ps:
The product, the place, the price, and the promotion. But most of all,
marketing is research: finding out who the customers are and what they need.
Successful vendors never forget that benefit lies in the customer's perception,
not in the vendor's. Marketing is asking the question, «Who will buy my product or
service?»
Although many critics claim that the cost of marketing is too high, an analysis
of the marketing functions does not bear these criticisms out. Rather than think of
the cost of marketing, one should consider the value added through marketing.
Marketing becomes too costly only when its cost exceeds the value it adds.
Questions:
1.
2.
3.
4.
5.
What is marketing?
What benefits do vendors and customers have from marketing?
What are the main tasks of marketing?
How wide do marketing activities range?
Is the cost of marketing high? What do you think of it.
Give a short summery of the text
Text 2. MARKETING
The word marketing has a broad meaning including both the market research
concerning the goods which are going to be produced and the advertisement
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already existing ones. If you want to introduce a new product and find a ready
market for it you should know the market situation in detail. When there is a
business boom people have generally more money on luxury items. When there is
a slack and unemployment tends to increase one can sell products, which are not
necessary for life, even in big quantities, but only if their price is as low as
possible. This is only one arbitrary example of the way to consider the general
market situation. Particular market situation deals more with the tastes and
fashions of the present and near future. Fashion and consumers tastes and needs are
constantly changing. So market research-should promptly find out such changes.
This was the case with the increase in price of fuel oil when wood and coal for
heaters became popular again. Those who were prepared for this change in the
market did a great business. Thus customers' wishes should be foreseen and
satisfied.
Of course market research may not disregard any existing or probable
competition. To sell a similar product in the market succesfully a manufacturer
should make sure whether the demand is sufficient. Then he should either improve
the quality or offer lower prices.
Advertisement is a very important branch of marketing which develops with
the development of mass media. It is a well-known fact that more and more money
is spent on advertisement every year. Apparently it pays off and it is not always
true that the consumer has to pay more for the goods he buys because of the
commercials being so expensive. Actually if an ad gives rise to an exceedingly
high sales rate of a product its production cost can even become lower. Besides
newspapers and magazines would be much more expensive but for advertisement
covering most of the publishing costs.
The most efficient ad is the so called directly addressed ad. This kind of
advertisement addresses some certain sector of the society, taking into account the
values the people of this particular group appreciate. It is essential to choose the
right media, the most popular source of information among this group of people.
An effective commercial should fulfill requirements. In America this ru|e is called
«AIDA» which means that a good ad creates Attention, Interest and Desire and
leads to Action.
One of the oldest means of advertisement is a fair. Fairs date back to early
middle ages and have proved to be really efficient ever since. At that time
sovereigns could give their towns a privilege of conducting an event like that.
Every year over 60 fairs and exhibitions take place in the Federal Republic of
Germany. The biggest and most well known one is organized in Hannover, where
more than 4500 home and foreign companies have the chance to display their
products.
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Read the texts and answer the questions
Text 3. MARKETING FUNCTIONS
Marketing adds value to the product by the specific functions it performs.
These are:
Marketing information. Market information flows throughout the marketing
process, from consumer to retailer, from retailer to wholesaler, from wholesaler
to manufacturer. Producers are made aware of coming trends because marketers
inform them of changes in consumer wants, supply and demand, and new market
developments.
B u y i n g . Before stocking shelves, a retailer must first determine not only
what to buy but how much, which models or styles, in what sizes and colors.
Buying is a fine art that may involve forecasting or predicting fashion trends six
months or even a year in advance.
S e l l i n g . Marketers must not only know what goods are available but must
also inform potential buyers of where those goods can be bought and how much
they cost. Selling may also involve helping consumers discover their own
unconscious needs and wants.
T r a n s p o r t i n g . In order to have value, goods must first be transported
from the place they are produced to the point where they are needed.
S t o r i n g . Because marketers often maintain extensive inventories, the
consumer desire to buy is satisfied without waiting.
C r e d i t - g r a n t i n g . Most manufacturers grant credit to wholesalers who,
in turn, grant credit to retailers, who grant credit to the consumer. This is an
important function because it enables those involved in the marketing channel to
operate with less capital.
R i s k - t a k i n g . Marketers assume risk in granting credit and in storing
inventories (e.g. spoilage, theft, obsolescence).
P r i c i n g . Pricing involves the art of determining which price is best. Is
demand elastic or inelastic? Will consumers buy proportionately more of a good at
a lower price? Will the reverse hold true?
S e r v i c i n g . Many retailers provide credit, delivery, shop-at-home services,
catalog sales, layaways, etc.
Standardizing
and
g r a d i n g . Standardizing involves the
maintenance of uniform size and quality standards throughout an industry. In
buying a lightbulb, for example, few of us have any doubts as to whether that bulb
will fit or how much light it will furnish. Grading is also an important marketing
function, particularly in the processing of agricultural products. Farm commodities,
such as eggs, milk, wheat, etc., are assigned grades attesting their quality and
uniformity.
Questions:
1. Why does marketing add value to the product?
2. What are the essential functions of marketing?
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3. What kind of information do marketers inform producers of? Why do producers
need this information?
4. What can you say about such functions of marketing as credit-granting and
pricing? How big is their role in today's trade?
5. Why are standardizing and grading important in marketing activities?
Text 4. THE MARKETING CONCEPT
This concept involves two ideas:
(1) Th e ma r k e t i n g d e p a r t me n t b e c o me s t h e ma i n ma n a g e me n t
f o r c e i n a c o mp a n y . The company recognizes that essentially every important
decision facing the company is in reality a marketing decision. Because the firm
has the technological ability to produce almost anything, most companies realize
that production is no longer a problem. The problem today is one of determining
whether or not the corporation can market the products it is capable of producing.
(2) Th e c o mp a n y b e c o me s c o mp l e t e l y c o n s u me r - o r i e n t e d . Most
of today's new products come about as a result of extensive marketing research.
With the consumer foremost in the mind of the company, long before production
begins, the firm must first answer such questions as:
▪ Is there a need or want for the product that we are capable of producing?
▪ What characteristics or (attributes should that product possess?
▪ How can we differentiate our product from similar and competing products?
▪ What styles, colors, models, sizes, etc., should be produced?
▪ What channels of distribution are best?
▪ What price policy will most maximize profits?
▪ What types of people or market segments will the product most appeal to?
Questions:
1. What ideas does the marketing concept involve?
2. Why does the marketing department become the main
management force in a company?
3. What makes the company be completely consumer oriented?
4. Which questions must the firm fist answer before it begins to
produce goods or services?
5. Does your own firm follow this concept or does it have another one?
Text 5.MARKETING RESEARCH
Marketing research is defined as the systematic gathering, recording, and
analyzing of marketing data. The five basic steps involved in conducting marketing
research are: (1) defining the problem, (2) collecting secondary data, (3) collecting
primary data, (4) compiling and collating the data, and (5) analyzing and
interpreting the results.
Defining the problem. Before attempting any type of research it is important
that the firm come up with a clear and concise statement of the problem. This may
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well be the most important step in conducting any form of research because if the
wrong problem is defined, the wrong problem will be solved.
Collecting secondary data. Secondary data is information easily obtained
through examination of company records or through library research. In general, a
firm should always try to solve its problem using secondary data rather than
collecting primary or first-hand data: secondary information is much faster and
cheaper.
Two major problems do exist, however, when using secondary data: the data
may be out of date, and there is the possibility of bias.
Collecting primary data. The three basic methods for collecting primary
data are:
O b s e r v a t i o n me t h o d . Some marketing problems can be solved simply
through observation.
E x p e r i me n t a l me t h o d . This is the basic approach used in the sciences.
For example, most firms introducing a new product first test-market the product in
a limited location before attempting national distribution.
S u r v e y me t h o d . This method simply involves questioning people. It can
be accomplished either through telephone interviews, personal interviews, or
mailed questionnaires.
Compiling and collating the data. The data is organized (collected manually
or with use of electronic data processing equipment) so that it may be studied.
Interpreting the findings. The final step in marketing research involves
using the data after it has been analyzed. Interpretation of the findings is extremely
important because it generally exerts great influence on management decisions
relating to the original problem.
Questions:
1. How can marketing research be defined? What are the basic steps involved in
conducting it?
2. The first step of marketing research is defining the problem. What does it
mean?
3. Collecting data is one of the most important steps in marketing research. How
can firms obtain the necessary information?
4. What must you do after collecting secondary and primary data?
5. Which is the final step in marketing research? What does it involve? Is it of
much importance or not?
Give a short summery of the texts.
Text 6. CREAT A MEDICAL PRACTICE MARKETING PLAN
Creating a marketing plan for a medical practice is no different from creating
a marketing plan for any other business. The purpose of a marketing plan is to
serve as a road map or blueprint for the future. Here is an analogy: if you are
planning to go on a trip, you prepare by buying maps and guidebooks. Similarly, in
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order to manage the future of your practice, you need a well-designed plan that
includes future goals and a series of practical steps designed to reach those goals.
A marketing plan is an analytic process designed to change amorphous concepts
into clearly defined steps that lead to a desired result.
A marketing plan has several basic elements: 1) Situation review 2) External
environment assessment – Internal environment assessment 3) SWOT analysis 4)
Objectives 5) Target audiences 6) Strategies 7) Tactics 8) Measurement 9)
Budgeting
Situation Review
The situation review is like a diagnosis of your practice. It comprises an
evaluation of your current situation and an overview of your current market.
You begin by researching the internal and external environment. You will
need to identify national trends, the competitive environment in your community,
potential patients' needs, and current patients' perceptions and needs. You will use
this information to identify opportunities and create the objectives of your
marketing plan.
Below are the important questions to ask and data to gather.
External Environment Assessment
Begin with the big picture. What are the national trends in insurance,
particularly managed care? Is there under- or oversaturation of physicians in your
specialty? What are the effects of changing referral pathways on your specialty or
type of practice? Which new technologies are affecting your patients' care?
Some key questions in this era of managed care are – What managed care
plans are predominant in your community? How many enrollees are in each plan?
How much growth is anticipated in managed care plans? Are you a provider on the
panels of these plans? (If you are not participating in the right plans in your area,
you are automatically eliminating a potential large patient base before you even
begin to think about other aspects of marketing.) You can acquire information on
the number of enrollees in managed care plans (both HMOs and PPOs) from
insurance companies or state medical societies.
To assess your competition, find out how many physicians are in your
community (both physicians in your specialty and potential referrers). Ask two
vital questions: What is the competition doing? What are they not doing? When
you uncover something they are not doing, you have identified an opportunity.
What are the demographics of your community? What are the current
numbers and the projected growth over the next five years? Which groups are
growing in number? Children, middle-aged women, the elderly? Your Chamber of
Commerce probably can provide these data.
What are the current medical trends in your community? For example, is there
a trend toward preventive care, increased use of ambulatory care, shorter hospital
stays, or increased home health care?
Survey potential patients to learn whether they are interested in fitness,
nutrition, sports medicine, or preventive medicine strategies. Are their main
concern hours of operation? If so, do they require Saturday and evening hours?
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Internal Environmental Assessment
How many additional patients could your practice handle currently? What is
your capacity? (Nothing would be worse than to attract so many patients that you
could not offer them quality service.)
What is your practice's market share in the community? Determine total
projected number of visits based on the population (you can obtain the appropriate
rate to use from your specialty's national organization), then determine what
percentage of those visits are yours.
Is your practice computerized so that you can generate accurate demographic
data on your patients? In what ZIP codes do most of your patients live? Should you
consider placing a satellite office in one or more of these?
Can your computers provide a breakdown of patients in managed care plans
and in Medicare and fee-for-service segments? (If you do not have a system that
allows you to collect and analyze these data, be sure your next computer system
does offer this capability.)
Regularly survey your current patients to assess their perceptions and
attitudes. The tool can be as simple as a postcard with five or six questions that are
easy for an office staff member to tally on a weekly basis. For example, ask
patients whether they were seen within 15 minutes of their arrival. Ask if their calls
are returned promptly. Leave space for subjective opinions and suggestions for
improved service. If you are a small practice, for example, you may learn that
personalized service is a strong desire – and that is something you could provide
better than a large organization or a multispecialty group practice.
Not long ago, a group of pediatricians I know joined a large HMO. When one
of their old patients called, she reached an answering service that said, "Please
leave us your name and chart number and within one hour a doctor or nurse will
call you back." In one hour a nurse did call back – a complete stranger who did not
know how to handle the specific situation. The patient waited another two hours at
home while the nurse gave the message to the doctor. Then a different nurse called
back and answered the question. This patient never did get to speak to the doctor
herself, and she still feels certain uneasiness about the lack of personal attention.
That kind of story is a clue to a marketing opportunity. If I were a pediatrician
in that city, I would position myself as someone who is available. "When you call
our practice, you’ll hear a familiar voice, ready to help you, and you'll be able to
speak directly to the doctor when you need to."
A situation analysis is an opportunity to think about your strengths and
capabilities and then base your marketing efforts upon the strengths you have to
offer.
Ask your colleagues and referral base to tell you about their perceptions about
your practice. Ask for their suggestions – and be prepared to implement them if
you do! That will demonstrate that you are concerned and that you are listening.
SWOT Analysis
Using the data acquired in your external and internal analyses, you should be
able to write a quick list of your practice’s strengths, weaknesses, opportunities,
and threats (SWOT). Using your SWOT list, you should be able to pinpoint
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marketing objectives or desired outcomes for your marketing plan. Sample SWOT
items are given below.
Strengths
• We have 40 percent managed care patients compared with the community's
average of only 25 percent.
• We are an obstetric practice delivering patients in a major tertiary hospital,
with all the benefits of high technology and capable of caring for high-risk
pregnancies.
Weaknesses
• We are a family practice with only three providers, so we are at capacity and
already have waiting lists, particularly because we act as gatekeepers in so
many managed care plans.
• Our obstetric patients are increasingly moving out to the suburbs and say
they would prefer to see a physician closer to home, even though they like
the idea of delivering at a large downtown hospital.
Opportunities
• Recruit additional physicians, nurse practitioners, or physicians’ assistants
to handle the growing patient load.
• Open satellite offices in the suburbs in which the highest percentage of our
patients live (as revealed by a ZIP code analysis).
Threats
• Younger, upscale families are moving into our community and insist
on using a pediatrician instead of a family practice physician because their
perception is that a family physician is not as well-trained to handle children.
• More and more patients are seeking both obstetricians and hospitals closer to
home.
By systematically listing all SWOT factors, you have constructed the
foundation of your marketing plan. You are basing your plans on research and
analysis, not on speculative ideas and gut feelings.
Shooting from the hip will not work in 1996 or beyond. You have to get the
data and devise a systematic, informed research plan.
Objectives
You need to think in terms of different types of objectives – marketing and
communications objectives as well as personal goals.
It is not enough to just set very general goals. Do not just say, "I want to build
up my practice." You need to set specific goals that include numerical values and
usually a deadline.
A typical marketing objective might be something like this: "We want to
increase revenues by 15 percent and new patients by 10 percent within the next 12
months." Or you might say, "By the end of next year we'd like our clientele to be
40 percent managed care, 30 percent Medicare, and 30 percent fee-for-service." A
primary care practice might set a goal of increasing pediatric patients by 10
percent, since pediatric patients are likely to stay with a practice for a long time.
In any case, you need to think carefully about your goals and objectives and
write them down in clear, specific language, because they provide the targets
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against which you measure your success. Remember, you cannot hit a target you
cannot see.
Target Audiences
First, analyze all the potential patients and customers in the community you
want to influence, including individuals and organizations.
Begin with your own employees. Are they satisfied? Do they feel good at the
end of the day? Do they feel they are valued and appreciated and have
opportunities to grow? Or are they stressed out? Do you have a high turnover rate?
Any marketing plan must start at the top, but the employees must buy into it
for it to succeed, since they will play an important role in implementing it. If the
employees do not buy into it, all your effort will be wasted.
Your current patients, both active and inactive, are another vitally important
target audience. You have to look at ways to continue to satisfy your active patients as well as ways to reactivate patients who have drifted away.
Look at a wide range of important target audiences: new patients, potential
patients, referring physicians, insurance companies and providers, and managed
care plans. In addition, think of all the target audiences that are sources of referrals:
pharmacists and pharmaceutical representatives, attorneys, social workers, clergy,
civic and community organizations. How much of an impact have you had in the
media, print and electronic?
Strategies
A strategy is a general plan or method for accomplishing a goal.
Suppose, for example, that your target audience is your employees and your
goals include ensuring that your employees experience pride and high morale, are
loyal to the practice, have low turnover, are very productive, and have
opportunities for personal growth. Your strategies might include trying to improve
employer-employee communication, instituting a reward system, arranging for
continuing education, and demonstrating recognition of exemplary performance.
If your target audience consists of current active patients and your goals
include maintaining your relationship with these patients, promoting patient
satisfaction and word-of-mouth marketing, and making these patients ambassadors
of your practice, your strategies might include improving communication, service,
and access to your practice and regularly surveying attitudes and perceptions.
(Table 39-1 shows possible goals, key messages, and strategies for six target
audiences.)
Tactics
Tactics are the specific, detailed methods used to carry out a strategy and
achieve a goal. For example, if your goal is to provide outstanding service, you
might want to perform a patient service cycle and evaluate the way the patients are
treated from the time they enter the practice until they leave. Based on this
evaluation, you would develop a specific tactical plan for improved service.
Your tactics might include weekend, evening, and early morning hours if that
is what your patients want. Develop effective scheduling so there is no waiting
time. Provide patients a “no paperwork” service. Offer optional installment billing
for elective surgery patients. Provide educational materials.
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If your goal is to provide more services, you might want to set up a patient
network where patients can talk to other patients about their experiences. You
might consider offering the services of a nutritionist.
Exercises:
1. Complete the sentences by using the words from the texts:
A) Marketing is the Four Ps: ..
B) Marketing adds value to the product by the specific functions it performs:
1) … 2) … 3) … 4) … 5) … 6) … 7) … 8) … 9) … 10) … 11) …
C) The marketing concept involves two ideas: (1)…, (2)…
D) The five basic steps involved in conducting marketing research are: (1) …,
(2) …, (3) …, (4) …, (5) …
E) A marketing plan has several basic elements: 1) … 2) … 3) … 4) … 5) …
6) … 7)… 8)… 9) ….
2. Discuss problem of create a medical practice marketing plan.
New vocabulary:
marketing, channels of marketing, retailing, pricing, advertising, marketing
research
Homework:
1. Economics for Medical Students. (text 1, p.p. 78-79; text 2, p.p. 80-81;
text 3, p.p. 83-84; text 4, p.p. 84-90).
2. Economics for Medical Students. Check up from the text №№1,2,3,4
(unit 8) the main definitions: manager, management, leadership,
planning, organizing, controlling, staffing, organization structure.
Lesson 15
The main functions of management.
Questions for discussion (Lecture 8):
1) What does definition “management” mean?
2) Describe, please, the main functions of management.
3) What does planning include?
4) What does organizing include?
5) What does directing mean?
6) What does controlling mean?
7) What does good manager must know?
8) Tell us about the functions of financial management.
9) Describe, please, the financial manager plan.
10)
Who is effective manager?
11)
Is it right: “The effective manager need to be effective leader”.
12)
What does leadership mean?
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13)
14)
15)
Are leadership and motivation closely interconnected.
What can you tell about main roles of leader?
What are the main purposes of models in management?
Read the texts of “Economics for Medical Students” and answer the
questions:
Text 1, p.p. 78-79.
Questions:
a) What are the main functions of management?
b) What does planning involve?
c) What is required in planning?
d) What is decision making?
e) What is it necessary to do before a real plan is made?
f) What does real planning imply?
g) What is the basic element in establishing an environment for performance?
h) How can managers enable people to perform their tasks effectively?
i) What must people know to make their group effort effective?
j) What does the concert of a role imply?
k) What enables people to accomplish their tasks?
l) What does organizing involve?
m) How is intentional structure understood?
n) What is the purpose of an organization structure?
o) How should the roles be designed?
p) Why is an effective organization structure not an easy managerial task?
Text 2, p.p. 80-81.
Questions and exercises:
a) What is staffing?
b) What is to be done to perform staffing effectively?
c) Why should developing apply both to candidates and to current jobholders?
d) How should leading influence people?
e) What aspect of managing is it?
f) What do the most important problems of managing arise from?
g) What does leadership imply?
h) What does leading involve?
i) What is controlling?
j) Why is it important?
k) Why is it necessary to check the activities of subordinates?
l) What does each means of controlling show?
m) How can deviations be corrected?
n) What does it mean to make events to conform to plans?
o) How are outcomes controlled?
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Complete the sentences with an appropriate word:
1. Before recruiting new candidates, the manager should ... deviations ensure
work-force requirements.
2. Staffing involves... both candidates and a current guides
jobholders.
3. Recruiting, selecting, placing, promoting, planning the subordinates measuring
career, compensating are all important in the process of ...
4. It is necessary to ... people so that they will contribute to define
organization goals.
5. Most important problems from people, their desires and follower ship motivation
....
6. Leadership implies ...because people tend to follow arise
those who can satisfy their needs.
7. Leading involves ..., leadership styles and approaches. developing
8. Controlling is the ... and correcting of activities of ....
influence
9. Controlling is necessary to that events conform to staffing
...plans.
10. The plan ... managers in the use of resources.
attitudes
11. ...should be corrected.
Text 3, p.p. 83-84.
Questions:
a) Why should the terms "managership" and "leadership" be distinguished?
Do they mean the same thing?
b) How is leadership connected with managership?
c) What does managerial work demand?
d) What is the essential part of leadership?
e) How do leaders influence the performance of their subordinates?
f) What is the definition of leadership?
II. Think and answer:
a) Do you agree that the terms "leadership" and "managership" should be
distinguished? If not, give your reasons.
b) Why is followership so important?
c) What can you say about the organizational climate in your office?
d) Does your manager (or leader) respond to your motivation?
e) What is the best way to encourage people to work with zeal and
confidence?
Text 4, p.p. 84-90.
Questions:
a) What is the difference between the book examples and practice?
a) What role does the problem of definition play for the problem
management?
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c) What role does context play for problem definition?
d) What is «truism»?
e) What is the difference between the objective in a public and private sector
decision?
b) What are the difficulties of the decision-making?
c) What is according to the author natural logic of a manager?
d) What would an ideal decision maker do?
e) What is a sequential decision making?
f) What is a «commonly acknowledged fact about negotiation»?
g) When does elementary arithmetic suffice?
h) When must decision maker rely on models?
i) What is a model in general?
j) What types of predictive models are mentioned in the text?
II. Which of the following is not true?
a) Decisions come as a part of the planning process.
b) In practice, problems are very hard to recognize.
c) Identifying context is a key part of problem definition.
d) Profit is the aim of any firm's transaction.
e) Maximizing profits and minimizing yields is the primary problem of any
manager.
f) Ultimate profit from either method cannot be pinned down ahead of time.
Questions for discussion:
a) Under what circumstances can a private firm compute the profit results?
b) What is impractical for solving complex problems?
c) What are methods of identifying the problems?
d) What is important in understanding and explaining the problem?
e) What is sensitivity analysis?
f) How do the projections of revenue and costs come?
g) When is sensitivity analysis useful?
h) Do you agree that the method of enumeration is ineffective in solving
massive problems?
i) Should a decision maker, do you think, rely on the data provided. What
sources of information could be referred to as more reliable and less reliable?
j) Could press publications be used as sources of information for making a
decision? Give an example of a) international b)federal c) local press which
is d)completely reliable e) completely unreliable.
Read the texts and answer the questions:
Text 1. WHAT IS A MANAGER?
A number of different terms are often used instead of the term «manager»,
including «director», «administrator» and «president». The term «manager» is used
more frequently in profit-making organizations, while the others are used more
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widely in government and non-profit organizations such as universities, hospitals
and social work agencies.
So, who do we call a «manager»?
In its broad meaning the term «managers» applies to the people who are
responsible for making and carrying out decisions within a certain system. A
personnel manager directly supervises people in an organization. Financial
manager is a person who is responsible for finance. Sales manager is responsible
for selling of goods.
Almost everything a manager does involves decision-making. When a
problem exists a manager has to make a decision to solve it. In decision-making
there is always some uncertainty and risk.
Management is a variety of specific activities. Management is a function of
planning, organizing, coordinating, directing and controlling. Any managerial system, at any managerial level, is characterized in terms of these general functions.
Managing is a responsible and hard job. There is a lot to be done and relatively
little time to do it. In all types of organizations managerial efficiency depends on
manager's direct personal relationships, hard work on a variety of activities and
preference for active tasks. The characteristics of management often vary according to national culture, which can determine how managers are trained, how
they lead people and how they approach their jobs.
The amount of responsibility of any individual in a company depends on the
position that he or she occupies in its hierarchy. Managers, for example, are responsible for leading the people directly under them, who are called subordinates.
To do this successfully, they must use their authority, which is the right to take
decisions and give orders. Managers often delegate authority. This means that
employees at lower levels in the company hierarchy can use their initiative, that is
make decisions without asking their manager.
Questions:
1. What is manager's role in an organization?
2. What concrete activities a production manager (financial manager, personnel
manager, marketing manager) is responsible for?
3. What is the difference between sales management and marketing management?
4. What means to delegate authority?
Text 2. MARKETING MANAGEMENT
Management is a function of planning, organizing, coordinating, directing
and controlling. Any managerial system, at any managerial level, is characterized
in terms of these general functions.
Management is a variety of specific activities. Marketing management refers
to a broad concept covering organization of production and sales of products,
which is based on consumer requirements research. All companies try to look
beyond their present situation and develop a long-term strategy to meet changing
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conditions in their industry. Marketing management, therefore, consists of
evaluating market opportunities, selecting markets, developing market strategies,
planning marketing tactics and controlling marketing results.
Strategic planning includes defining the company's long-term objectives as
well as specific objectives, such as sales volume, market share, profitability and
innovation, and deciding on financial, material and other resources necessary to
achieve those objectives.
In problems of market selection and product planning one of the key
concepts is that of the Product Life Cycle. That products pass through various
stages between life and death (introduction — growth — maturity — decline) is
hard to deny. Equally accepted is the understanding that a company should have a
mix of products with representation in each of these stages. Companies can make
far more effective marketing decisions if they take time to find out where each of
their products stands in its life cycle.
However, the concept of the product life cycle seems frequently forgotten in
marketing planning, which leads to wrong decision-making. This may well be seen
in the following story.
A supplier of some light industrial equipment felt that the decline in the sales
of his major product was due to the fact that it was not receiving the sales support
it deserved. In order to give extra sales support to this problem case, a special
advertising campaign was run. This required cutting into marketing budgets of
several promising products that were still in their «young» growth phase. In fact,
the major product has long since passed the zenith of its potential sales, and no
amount of additional sales support could have extended its growth. This became
quite clear in the end-of-year sales results which showed no improvement. The
promising products, however, went into gradual sales decline. In short,
management has failed to consider each product's position in its life cycle.
Questions:
1. What is strategic planning?
2. Why is the Product Life Cycle considered one of the key concepts in marketing?
3. What is marketing management?
Give a short summery of the texts.
Text 3. MANAGEMENT AND CONTROL OF COMPANIES
The simplest form of management is the partnership. In Anglo-American
common-law and European civil-law countries, every partner is entitled to take
part in the management of the firm's business, unless he is a limited partner;
however, a partnership agreement may provide that an ordinary partner shall riot
participate in management, in which case he is a dormant partner but is still
personally liable for the debts and obligations incurred by the other managing partners.
The management structure of companies or corporations is more complex.
The simplest is that envisaged by English, Belgian, Italian, and Scandinavian law,
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by which the shareholders of the company periodically elect a board of directors
who collectively manage the company's affairs and reach decisions by a majority
vote but also have the right to delegate any of their powers, or even the whole
management of the company's business, to one or more of their number. Under this
regime it is common for a managing director (directeur general, direttore generale)
to be appointed, often with one or more assistant managing directors, and for the
board of directors to authorize them to enter into all transactions needed for carrying on the company's business, subject only to the general supervision of the board
and to its approval of particularly important measures, such as issuing shares or
bonds or borrowing. The U.S. system is a development of this basic pattern. By the
laws of most states it is obligatory for the board of directors elected periodically by
the shareholders to appoint certain executive officers, such as the president, vice
president, treasurer, and secretary. The latter two have no management powers and
fulfill the administrative functions that in an English company are the concern of
its secretary; but the president and in his absence the vice president have by law or
by delegation from the board of directors the same full powers of day-today
management as are exercised in practice by an English managing director.
The most complex management structures are those provided for public
companies under German and French law. The management of private companies
under these systems is confided to one or more managers (gerants,
Geschaftsfuhrer) who have the same powers as managing directors. In the case of
public companies, however, German law imposes a two-tier structure, the lower
tier consisting of a supervisory committee (Aufsichtsrat) whose members are
elected periodically by the shareholders and the employees of the company in the
proportion of two-thirds shareholder representatives and one-third employee representatives (except in the case of mining and steel companies where shareholders
and employees are equally represented) and the upper tier consisting of a management board (Vorstand) comprising one or more persons appointed by the
supervisory committee but not from its own number. The affairs of the company
are managed by the management board, subject to the supervision of the
supervisory committee, to which it must report periodically and which can at any
time require information or explanations. The supervisory committee is forbidden
to undertake the management of the company itself, but the company's constitution
may require its approval for particular transactions, such as borrowing or the
establishment of branches overseas, and by law it is the supervisory committee that
fixes the remuneration of the managers and has power to dismiss them.
The French management structure for public companies offers two
alternatives. Unless the company's constitution otherwise provides, the
shareholders periodically elect a board of directors (conseil d'admi-nistration),
which «is vested with the widest powers to act on behalf of the company» but
which is also required to elect a president from its members who «undertakes on
his own responsibility the general management of the company,» so that in fact the
board of directors' functions are reduced to supervising him. The similarity to the
German pattern is obvious, and French legislation carries this further by openly
permitting public companies to establish a supervisory committee (conseil de
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surveillance) and a management board (directoire) like the German equivalents as
an alternative to the board of directors-president structure.
Dutch and Italian public companies tend to follow the German pattern of
management, although it is not expressly sanctioned by the law of those countries.
The Dutch commissarissen and the Italian sindaci, appointed by the shareholders,
have taken over the task of supervising the directors and reporting on the wisdom
and efficiency of their management to the shareholders.
Text 4. SEPARATION OF OWNERSHIP AND CONTROL
The investing public is a major source of funds for new or expanding
operations. As companies have grown, their need for funds has grown, with the
consequence that legal ownership of companies has become widely dispersed. For
example, in large American corporations, shareholders may run into the hundreds
of thousands and even more. Although large blocks of shares may be held by
wealthy individuals or institutions, the total amount of stock in these companies is
so large that even a very wealthy person is not likely to own more than a small
fraction of it.
The chief effect of this stock dispersion has been to give effective control of
the companies to their salaried managers. Although each company holds an annual
meeting open to all stockholders, who may vote on company policy, these
gatherings, in fact, tend to ratify ongoing policy. Even if sharp questions are asked,
the presiding officers almost invariably hold enough proxies to override outside
proposals. The only real recourse for dissatisfied shareholders is to sell their stock
and invest in firms whose policies are more to their liking. (If enough shareholders
do this, of course, the price of the stock will fall quite markedly, perhaps impelling
changes in management personnel or company policy.) Occasionally, there are
«proxy battles,» when attempts are made to persuade a majority of shareholders to
vote against a firm's managers (or to secure representation of a minority bloc on
the board), but such struggles seldom involve the largest companies. It is in the
managers' interest to keep the stockholders happy, for, if the company's shares are
regarded as a good buy, then it is easy to raise capital through a new stock issue.
Thus, if a company is performing well in terms of sales and earnings, its
executives will have a relatively free hand. If a company gets into trouble, its usual
course is to agree to be merged into another incorporated company or to borrow
money. In the latter case, the lending institution may insist on a new chief
executive of its own choosing. If a company undergoes bankruptcy and
receivership, the court may appoint someone to head the operation. But managerial
autonomy is the rule. The salaried executives typically have the discretion and
authority to decide what products and services they will put on the market, where
they will locate plants and offices, how they will deal with employees, and whether
and in what directions they will expand their spheres of operation.
The markets that corporations serve reflect the great variety of humanity and
human wants; accordingly, firms that serve different markets exhibit great differences in technology, structure, beliefs, and practice. Because the essence of
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competition and innovation lies in differentiation and change, corporations are in
general under degrees of competitive pressure to modify or change their existing
offerings and to introduce new products or services.
Similarly, as markets decline or become less profitable, they are under
pressure to invent or discover new wants and markets. Resistance to this pressure
for change and variety is among the benefits derived from regulated
manufacturing, from standardization of machines and tools, and from labour
specialization. Every firm has to arrive at a mode of balancing change and stability,
a conflict often expressed in distinctions drawn between capital and revenue and
long-and short-term operations and strategy. Many corporations have achieved
relatively stable product-market relationships, providing further opportunity for
growth within particular markets and expansion into new areas. Such relative
market control endows corporate executives and officers with considerable discretion over resources and, in turn, with considerable corporate powers. In theory
these men and women are hired to manage someone else's property; in practice,
however, many management officers have come increasingly to regard the
stockholders as simply one of several constituencies to which they must report at
periodic intervals through the year.
Text 5. EXECUTIVE MANAGEMENT
Managerial decision-making. The guidelines governing management decisions
cannot be reduced to a simple formula. Traditionally, economists have assumed
that the goal of a business enterprise was to maximize its profits. There are, however, problems of interpretation with this simple assertion.
First, over time the notion of «profit» is itself unclear in operational terms.
Today's profits can be increased at the expense of profits years away, by cutting
maintenance, deferring investment, and exploiting staff.
Second, there are questions over whether expenditure on offices, cars, staff
expenses, and other trappings of status reduces shareholders' wealth or whether
these are part of necessary performance incentives for executives. Some
proponents of such expenditures believe that they serve to enhance contacts, breed
confidence, improve the flow of information, and stimulate business.
Third, if management asserts primacy of profits, this may in itself provide
negative signals to employees about systems of corporate values. Where long-term
success requires goodwill, commitment, and cooperation, focus on short-term
profit may alienate or drive away those very employees upon whom long-term
success depends. Generally speaking, most companies turn over only about half of
their earnings to stockholders as dividends. They plow the rest of their profits back
into the operation. A major motivation of executives is to expand their operations
faster than those of their competitors. The important point, however, is that without
profit over the long term no firm can survive.
For growing firms in competitive markets a major indicator of executive
competence is the ability to augment company earnings by increasing sales or productivity or by achieving savings in other ways. This principle distinguishes the
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field of business from other fields. A drug company makes Pharmaceuticals and
may be interested in improving health, but it exists, first and foremost, to make
profits. If it found that it could make more money by manufacturing frozen orange
juice, it might choose to do so.
Text 6. THE MODERN EXECUTIVE
Much has been written about business executives as «organization men».
According to this view, typical company managers no longer display the individualism of earlier generations of entrepreneurs. They seek protection in committeemade decisions and tailor their personalities to please their superiors; they aim to
be good «team» members, adopting the firm's values as their own. The view is
commonly held that there are companies-and entire industries-that have
discouraged innovative ideas. The real question now is whether or not companies
will develop policies to encourage autonomy and entrepreneurship among
managers.
In Japan, where the employees of large corporations tend to remain with the
same employer throughout their working lives, the corporations recruit young men
upon their graduation from universities and train them as company cadets. Those
among the cadets who demonstrate ability and a personality compatible with the
organization are later selected as managers. Because of the seniority system, many
are well past middle age before they achieve high status. There are signs that the
system is weakening, however, as efforts are more often made to lift promising
young men out of low-echelon positions. Criticism of the traditional method has
been stimulated by the example of some of the newer corporations and of those
owned by foreign capital. The few men in the Japanese business world who have
emerged as personalities are either founders of corporations, managers of family
enterprises, or small businessmen. They share a strong inclination to make their
own decisions and to minimize the role of directors and boards.
Exercises:
1. Complete the sentences by using the words from the texts:
A) In its broad meaning the term «managers» applies to the people who are
responsible for …
B) A personnel manager directly supervises …
C) Financial manager is a person who is responsible for …
D) Sales manager is responsible for ...
E) Management is a function of …
F) Marketing management refers to a broad concept covering …, which is
based on consumer requirements research.
G) In problems of market selection and product planning one of the key
concepts is that of the …
H) That products pass through various stages between life and death (… —
… — … — …) is hard to deny.
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2. Discuss about modern business executives and different management structures
of companies.
New vocabulary:
manager, management, personnel management, financial management, sales
management, marketing management, leadership, planning, organizing, coordinating, directing, controlling, staffing, organization structure.
Homework:
1. Economics for Medical Students. (text 1, p.p. 92-94; text 4, p.p. 99-100; text 5,
p.p. 100-103).
2. English Economy Dictionary with Definitions. (p. 19 - foreign-exchange
market; p.19 - foreign sector; p.19 - fourth world; p. 44 - third world)
Lesson 16
International Economy: the main trends of development.
Questions for discussion:
1) What kind of contradictions is our common world full of?
2) Which group of contradions is the most important from the viewpoint of
mankind's destiny?
3) How can the contradictions between the states of different social systems
be solved?
4) Is there any sane alternative to peaceful coexistence in present day
conditions?
5) Will the path of war lead to sensible solutions?
6) What idea is the Russian philosophy of peace being guided in the nuclear
age?
7) Which formula defines the most explicitly the Russian military doctrine?
8) Do you really think that unemployment has reached a new high of late
and social stratification has grown?
9) What is the true cause of many conflicts in Asia, Africa and Latin
America?
10)
How, in your opinion, can be stopped such processes as the
destruction
of the human environment and the depletion of natural resources?
11)
What do you think of the European countries' policy towards Russia
nowadays?
12)
What can you tell about Global matters?
Read the texts of “Economics for Medical Students” and answer the
questions:
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Text 1, p.p. 92-94.
Questions:
a) What is the basis for classifying nations?
b) What are industrial countries?
c) What are developing nations?
d) What measures of prosperity are taken in to account in defining the gap
between the developed and developing countries?
e) What processes are taking place in the Second World countries?
f) What countries are members of the OPEC organization?
g) What are the three important conclusions of the theory of the classification?
h) Explain what the following abbreviations and notions mean:
-OPEC countries;
-«tigers»;
-«North/South»;
-«East-west»;
-The Heckschler-Ohlin theory.
i) Have all former Second World countries moved to capitalistic direction? Do
you agree that NATO's membership is an entrance ticket to the developed
countries community?
j) What is the present position of the Russian Federation in the described system
of classification?
k) Do you find Heckscher-Ohlin theory reasonable? Give examples to prove or
disapprove it.
Text 6, p.p. 103-104. Give a short summery of the text.
Read the texts and answer the questions:
Text 1. HOW INTERNATIONAL RELATIONS SHOULD BE BUILT?
The XX-th century, along with the second millennium, is coming to its end.
The XXI-st century along with the third millennium is entering into its rights.
Mankind is approching a new and very important chronological boundary. On the
threshold of the third millennium it is full of hopes. Never before the world had
such unlimited possibilities for further developing civilization. But it is also a
world that is overburdened by dangers and contradictions. This makes our time
probably the most troubling period of history. How should countries and nations
with different views, ideologies, and policies shape their relations in such a world?
Will they make the simple laws of morality and justice, which ought to govern
relations among private individuals, into the supreme laws also in relations among
nations. Russia is prepared to do this.
The differencies between social systems, countries and nations are both
numerous and fundamental. But the need to solve urgent universal problems
should compel them to cooperate, to awaken the instinct and forces of mankind's
self-preservation. What is required is constructive cooperation of states on a global
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scale so that, terrestrial civilization may survive. But the world cannot be saved of
the way of thinking and actions built up over the centuries on the acceptability and
permissibility of wars and armed conflicts are not shed once and for all, resolutely
and irrevocably.
Therefore Russia tries to base its relations with other countries on the
following principles: First. The character of present-day weapons leaves no
country any hope of safeguarding itself exclusively by military-technological
means. The task of ensuring security is seen increasingly as a political problem.
Second. Security can only be universal and mutual. Third. There is an objective
need for ail states of the world to live in peace with each other and to cooperate on
a basis of equality and mutual benefit. They must learn to live in a civilized
manner, without ignoring their existing differencies, in other words, under
conditions of civil international relations and cooperation. Confrontation between
them must occur only and exclusively in forms of peaceful competition and
peaceful rivalry.
Questions:
1. What chronological boundary are we all approching? What hopes do you
tie with this event?
2. What kind of problems does mankind face on the threshold of the third
millennium?
3. Scientistis ensure us that global matters (problems) can be solved now.
What do you think of it?
4. Is our world overburdened by dangers and contradictions? If so, which
are they?
5. Are there in our days possibilities for further developing civilisation?
6. Do you think that our time is the most troubling period of history?
7. On which principles should countries and nations with different ideologies
base their relations?
8. Is there an objective need for all states of the world to live in peace and
decide their differencies by peaceful means?
9. Do you think that peaceful coexistence is possible between different
civilisations?
10. How is the task of ensuring security seen now?
Text 2. THE MAIN DIRECTIONS OF RUSSIAN FOREIGN POLICY
Russia has never threatened anyone, nor does it threaten anyone now. We
lay no territorial claims against any country in the world, nor do we intend to
deprive anyone of his natural or any other wealth. The fundamental direction of
Russia's foreign activity is the struggle against the nuclear threat, against the arms
race, for the preservation and strengthening of universal peace. Its ultimate goal is
to provide the Russian people with the possibility of working and living in
conditions of lasting peace and freedom.
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The world historic experience convincingly says that the genuinely reliable
security of one nation cannot be ensured at the expense of the other nation.
Security can be reliable only if it is equal, if no state lays claim to exclusiveness.
This is clearly understood in today's Russia which attaches considerable
significance to its relations with the nuclear powers, primarely with the United
States, and seeks to promote cooperation with them on a basis of equality and
mutual benefit.
Russia also pays especial attention to maintaining its traditionally good
relations with neighbouring coutries, that entered the Soviet Union not long ago
and are forming now a new community - the Community of Independent States.
The strengthening of close and friendly relations with socialist China and
democratic India is in the centre of Russia's policy too. Russia is in favour of
constructive quests for ways of defusing conflict situations in the Middle and Near
East, Central America, Asia and the other regions. Crises and conflicts are fertile
soil for international terrorisminciples, Russia rejects terrorism and is prepared to
cooperate with all the countries in order to uproot it.
One of the main directions of the Russian international activity is the
European one. The future of Europe lies, in our view, in peaceful cooperation
among the states of that continent. While preserving the experience that has
already been accumulated, it is important to move further, to a more stable and
dependable security through a radical reduction of nuclear and conventional
weapons and close cooperation in deciding all other global problems. This is what
we should think about, this is where the power of human intellect and hands should
be directed. This should be done without delay, for time is pressing as never
before.
Questions:
1. Which is the fundamental direction of Russia's foreign policy?
2. Does Russia lay any territorial claims to other countries? What do you
think of it?
3. What is the ultimate goal of Russian foreign policy?
4. Are there any countries today that lay claim to exclusiveness? What are
they in you opinion?
5. Russia attaches considerable significance to its relations with the nuclear
powers, how do you think, why?
6. Which other countries are in the centre of Russia's foreign policy?
7. Who is the main trade partner of Russia today?
8. What is the main cause of international terrorism? Does it threaten Russian
people's lives?
9. What do you think of today's foreign policy of the United States? Do you
believe in sincerity of their intentions towards Russia?
10. Do you believe in Russia's integration with European countries?
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Text 3. RUSSIA AND THE WORLD ECONOMIC ORDER
Russia has entered a new stage of economic development. It has maped
unprecedented plans for restructuring the economy and the mechanism of
managing it. Important for this stage is the development of new forms of foreign
economic activity, such as direct access for enterprises and organisations to the
world market, joint ventures, broader direct links, industrial and technological
cooperation, and the like. That is why Russia wants international economic
relations to be normalized and economic development made stable and predictable.
The situation in the world economy remains complicated and contradictory. On the
one hand the international division of labour continues to develop, enhancing
economic interdependance of states. On the other hand, the aggravation of many
economic, trade and political problems hampers the development of international
economic cooperation.
Practice shows that spontaneous development of international economic
relations compounds and increases problems and contradictions. Falling oil prices,
the deteriorating debt problem, rapid changes in the correlation of leading
currencies, and sharp fluctuations at the world stock exchanges prove the world
economy and national economies defenceless before upheavals. This harms
economic interests of states, breeding uncertainty in tomorrow. Would the world
trade be overburdened with protectionism? Would an economic crisis in a major
power trigger a chain reaction with unpredictable consequences?
That is why Russia suggests establishing a broad dialogue on economic
issues of all interested parties and finding solutions to problems on the basis of
concord, which would guarantee that these solutions are objective and fair. At this
stage of world development, economic cooperation, like political or militarystrategic cooperation, should be reformed on the basis of a new thinking, which is
the ability to realistically assess this dynamic world. The Russian concept of
economic security, on inalienable part of the comprehensive system of
international security, is designed to establish on all-round international
cooperation free from confrontation. Until we restore order in this sphere of
international relations on principles acceptable to all, humanity would continue to
be threatened by catastrophic crises and upheavals, which would inevitably affect
all nations, however strong economically.
Questions:
1. What kind of economic plans did Russia map ten years ago? At what
are they directed?
2. Is the development of new forms of foreign activity important now? Why?
3. Which new forms of foreign economic activity do you know?
4. Does Russia want international economic relations to be normalized
and made stable and predictable?
5. Why does the situation in the world economy remain complicated and
contradictory?
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6. Which problems in the world economy are, in your opinion, the sharpest
and the most difficult to be solved?
7. On what basis does Russia suggest to solve sharp economic problems
of the world?
8. What is the Russian concept of economic security designed to?
9. What can you say about today's correlation of Russian and foreign leading
currencies? Is it fair?
Exercises:
1. Complete the sentences by using the words from the texts:
A) The first principle, which Russia tries to base its relations with other
countries, is …
B) The second principle , which Russia tries to base its relations with other
countries, is …
C) The third principle, which Russia tries to base its relations with other
countries, is …
D) The fundamental direction of Russia's foreign activity is …
2. Discuss about role Russia, India, Pakistan and other countries in the world
economic order.
New vocabulary:
foreign-exchange market; foreign sector; third world; fourth world; trade balance;
unfavorable balance of trade.
Homework:
1. Economics for Medical Students. (text 2, p.p. 95-96; text 3, p.p. 96-98; text 6,
p.p. 103-104).
2. English Economy Dictionary with Definitions. (p. 17-export, p.17 – export
embargo, p.17 – exchange rate, p.20- free trade, p.20 – freely-fluctuating exchange
rates, p.22 – import, p.32 – multilateral trade negotiations, p. 44 - trade balance; p.
45 - unfavorable balance of trade.)
Lesson 17.
International trade and finance.
Questions for discussion:
a) What does foreign trade mean in economic terms?
b) What are the three main advantages of trade?
c) What examples of comparative and competitive advantages of trade can
you think of?
d) What is the role of international trade nowadays?
e) Are developing or developed nations more interested in foreign trade?
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a)
b)
c)
d)
e)
f)
What is protectionism?
What is free trade?
What is a most-favored nation status?
What processes are taking place under the GATT aegis?
What is the future role of the USA?
What is the balance of trade?
Read the texts of “Economics for Medical Students” and answer the
questions:
Text 2, p. 95. Give a short summery of the text.
Text 3, p.p. 96-98.
Exercise:
Which of the following is not true:
a) Protectionism is a policy concerned with the regulation of international
trade.
b) Free trade is a process of selling commodities free.
c) Some politicians are afraid of foreign economies.
d) Aggregate surpluses and deficits balance for the world trade.
e) International trade is weak.
Text 4, p.p. 99-100. Write a short summery.
Text 5, p.p. 100-102. Write a short summery.
Give a short summery of the texts.
Text 1. INTERNATIONAL TRAD
Sales and purchases of goods and services that take place across
international boundaries are referred to as international trade. For example, the
British buy BMWs made in Germany, Germans take holidays in Italy, Italians buy
spices from Tanzania, Belgians import oil from Kuwait, Egyptians buy Japanese
cameras, the Japanese depend heavily on American soybeans as a source of food,
and the Taiwanese make many electronic goods whose parts are manufactured
throughout Southeast Asia. There is substantial evidence to show that international
trade and economic growth are positively linked.
An economy that engages in international trade is an open economy. One
that does not is a closed economy. A situation in which a country does no foreign
trade is called autarky. The advantages realized as a result of trade are called the
gains from trade. Although politicians often regard foreign trade as different from
domestic trade, economists from Adam Smith on have argued that the causes and
consequences of international trade are simply an extension of the principles
governing domestic trade.
Let us start by thinking about trade between individuals. Without trade, each
person would have to be self-sufficient; each would have to produce all the food,
clothing, shelter, medical services, entertainment, and luxuries that she consumed.
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A world of individual self-sufficiency would be a world with extremely low living
standards.
Trade between individuals allows people to specialize in those activities they
can do relatively well and to buy from others the goods and services they
themselves cannot easily produce. A good doctor who is a bad carpenter can
provide medical services not only for her own family, but also for an excellent
carpenter who lacks the training or the ability to practise medicine. Thus, trade and
specialization are intimately connected. Without trade, everyone must be selfsufficient. With trade, everyone can specialize in what she does well and satisfy
other needs by trading.
The same principles apply to regions. Without interregional trade, each
region would be forced to be self-sufficient. With trade, each region can specialize
in producing goods or services for which it has some natural or acquired
advantage. Plains regions can specialize in growing grain, mountain regions can
specialize in mining and forest products, and regions with abundant manpower can
specialize in manufacturing. Cool regions can produce dairy products, wool, and
crops that thrive in temperate climates, and hot regions can grow such tropical
crops as rice, cotton, bananas, sugar, and coffee. Places with lots of sunshine and
sandy beaches can specialize in the tourist trade. The living standards of the
inhabitants of all regions will be higher when each region specializes in products in
which it has some natural or acquired advantage and obtains other products by
trade than when all regions seek to be self-sufficient.
The same principle applies to nations. Nations, like regions or persons, can
gain from specialization. Almost all countries produce more of some goods than
their residents wish to consume. At the same time, they consume more than they
produce of some other goods.
International trade is necessary to achieve the gains that international
specialization makes possible. Trade allows each individual, region, or nation to
concentrate on producing those goods and services that it produces relatively
efficiently, while trading to obtain goods and services that it would produce less
efficiently than others.
Specialization and trade go hand in hand, because there is no motivation to
achieve the gains from specialization without being able to trade the goods
produced for the different goods desired. The term 'gains from trade' encompasses
the results of both.
There are three main sources of gains from trade. The first is those
differences between regions of the world in climate and resource endowment that
lead to advantages in producing certain goods and disadvantages in producing
others. These gains would occur even if each country's costs of production were
unchanged by the existence of trade. The second source is the reduction in each
country's costs of production resulting from the greater production that
specialization brings. The third is the international competition, which usually
promotes more rapid technological change and economic growth than would occur
if domestic firms produced solely for a protected home market.
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Text 2. GAINS FROM SPECIALIZATION WITH GIVEN COSTS
In order to focus on differences in countries' conditions of production,
suppose that each country's average costs of production are constant. We will use
an example below involving only two countries and two products, but the general
principles apply as well to the real-world case of many countries and many
products.
One region is said to have an absolute advantage over another in the
production of good X when an equal quantity of resources can produce more X in
the first region than in the second.
These gains from specialization make possible the gains from trade. If
consumers in both countries are to get the goods they desire in the required
proportions, each must export some of the commodity in which it specializes and
import commodities in which other countries are specialized.
When each country has an absolute advantage over others in a product, the
gains from trade are obvious. But what if one country can produce all commodities
more efficiently than other countries? In essence this was the question that English
economist David Ricardo (1772-1823) posed 200 years ago. His answer underlies
the theory of comparative advantage, which is still accepted by economists today
as a valid statement of the potential gains from trade.
The gains from specialization and trade depend on the pattern of
comparative rather than absolute advantage. Let us assume that there are two
economies, the United States and the European Union. Both produce the same two
goods, wheat and cloth, but the opportunity costs of producing these two products
differ between countries. For the moment we assume that this opportunity cost is
constant in each country at all combinations of outputs.
The gains from trade arise from differing opportunity costs in the two
countries.
The slope of the production possibility boundary indicates the opportunity
costs, and the existence of different opportunity costs implies comparative
advantages and disadvantages that can lead to gains from trade.
Conclusions about the gains from trade arising from international differences
in opportunity costs can now be summarized.
1. Country A has a comparative advantage over country B in producing a product
when the opportunity cost (in terms of some other product) of production in
country A is lower. This implies, however, that it has a comparative disadvantage
in the other product.
2. Opportunity costs depend on the relative costs of producing two products, not on
absolute costs.
3. When opportunity costs are the same in all countries, there is no comparative
advantage and there is no possibility of gains from specialization and trade.
4. When opportunity costs differ in any two countries, and both countries are
producing both products, it is always possible to increase production of both products by a suitable reallocation of resources within each country.
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Text 3. GAINS FROM SPECIALIZATION WITH VARIABL COSTS
If costs vary with the level of output, or as experience is acquired via
specialization, additional sources of gain are possible.
Real production costs, measured in terms of resources used, often fall as the
scale of output increases. The larger the scale of operations, the more efficiently
large-scale machinery can be used and the more efficient the division of labour that
is possible. Smaller countries such as Switzerland, Belgium, and Israel, whose
domestic markets are not large enough to exploit economies of scale, would find it
prohibitively expensive to become self-sufficient by producing a little bit of
everything at very great cost.
Trade allows smaller countries to specialize and produce a few products at
high enough levels of output to reap the available economies of scale.
One of the important lessons learned from patterns of world trade since the
Second World War results from imperfect competition and product differentiation.
Virtually all of today's manufactured consumer goods are produced in multiple
differentiated product lines. In some industries many firms produce this range; in
others only a few firms produce the entire product range. In both cases firms are
not price-takers, and they do not exhaust all available economies of scale, as a
perfectly competitive firm would do. This means that an increase in the size of the
market, even in an economy as large as the USA or the EU, may allow the
exploitation of some previously unexploited scale economies in individual product
lines.
These possibilities were first dramatically illustrated when the European
Common Market (now called the European Union, the EU) was set up in the late
1950s. Economists had expected that specialization would occur according to the
classical theory of comparative advantage, with one country specializing in, say,
cars, another in refrigerators, another in fashion clothes, another in shoes, and so
on. This is not the way it worked out. Instead, much of the vast growth of trade
was in intra-industry trade. Today one can buy French, English, Italian, and
German fashion goods, cars, shoes, appliances, and a host of other goods in the
shops of London, Paris, Berlin, and Rome. Ships loaded with Swedish furniture
bound for London pass ships loaded with English furniture bound for Stockholm;
and so on.
What free European trade did was to allow a proliferation of differentiated
products, with different countries each specializing in differentiated sub-product
lines. Consumers have shown by their expenditures that they value this enormous
increase in the range of choice between differentiated products. As Asian countries
have expanded into European and American markets with textiles, cars, and
electronic goods, European and American manufacturers have increasingly
specialized their production, and they now export textiles, cars, and electronic
equipment to Japan even while importing similar but differentiated products from
Japan.
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The discussion so far has assumed that costs vary only with the level of
output. They may also vary with the experience accumulated in producing a good
over time.
Text 4. TRADE AS A SOURCE OF TECHNOLOGICAL CHANG AND
ECONOMIC GROWTH
When countries protect their home markets with high tariffs, they reduce the
amount of international competition faced by their domestic firms. This is
particularly important when the countries are small so that there is room for only a
few, or possibly even just one, domestic firm to serve the local market. In these
circumstances, International trade can increase competitive pressures that face
domestic firms. This in turn may lead to more product and process innovation than
occurred under protection. Also, because firms throughout the world are
innovating in both product and production processes, an open trading regime
allows consumers to benefit from the many technological changes that occur in
other countries as well as locally.
Text 5. TERMS OF TRADE
A rise in the price of imported goods, with the price of exports unchanged,
indicates a fall in the terms of trade; it will now take more exports to buy the same
quantity of imports. Similarly, a rise in the price of exported goods, with the price
of imports unchanged, indicates a rise in terms of trade; it will now take fewer
exports to buy the same quantity of imports. Thus, the ratio of these prices
measures the amount of imports that can be obtained per unit of goods exported.
Because actual international trade involves many countries and many
products, a country's terms of trade are computed as an index number:
Terms of trade
=
Index of export prices
Index of import prices
X 100%
A rise in the index is referred to as a favourable change in a country's terms
of trade. A favourable change means that more can be imported per unit of goods
exported than previously. For example, if the export price index rises from 100 to
120 while the import price index rises from 100 to 110, the terms of trade index
rises from 100 to 109. At the new terms of trade, a unit of exports will buy 9 per
cent more imports than at the old terms.
A decrease in the index of the terms of trade, called an unfavourable
change, means that the country can import less in return for any given amount of
exports or, equival-ently, that it must export more to pay for any given amount of
imports.
These are the real exchange rate and competitiveness. They also are
indexes of the relative prices of domestic and foreign goods. However, both
competitiveness and the real exchange rate normally relate to the prices of
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domestic production relative to foreign production, while terms of trade apply just
to the subset of outputs that are imported and exported.
Text 6. THE CASE FOR FREE TRADE
Government policy towards international trade is known as commercial
policy. Complete freedom from interference with trade is known as a free trade
policy. Any departure from free trade designed to give some protection to domestic
industries from foreign competition is called protectionism.
Today debates over commercial policy are as heated as they were two
hundred years ago when the theory of gains from trade that we presented above
was still being worked out. Should a country permit the free flow of international
trade, or should it seek to protect its local producers from foreign competition?
Such protection may be achieved either by tariffs, which are taxes designed to raise
the price of foreign goods, or by non-tariff barriers, which are devices other than
tariffs that are designed to reduce the flow of imports. Examples of the latter
include quotas and customs procedures deliberately made more cumbersome than
is necessary.
The case for free trade is based on the analysis presented above. We saw
that for any given set of costs, whenever opportunity costs differ among countries,
specialization and trade will raise world living standards. Free trade allows all
countries to specialize in producing products in which they have a comparative
advantage.
Free trade allows the maximization of world production, thus making it
possible for each consumer in the world to consume more goods than she could
without free trade.
This does not necessarily mean that everyone will be better off with free
trade than without it. Protectionism could allow some people to obtain a larger
share of a smaller world output so that they would benefit even though the average
person would lose. If we ask whether it is possible for free trade to improve
everyone's living standards, the answer is 'yes'. But if we ask whether free trade
does in fact always do so, the answer is 'not necessarily'.
There is abundant evidence that significant differences in opportunity costs
exist and that large gains are realized from international trade because of these
differences. What needs explanation is the fact that trade is not wholly free. Why
do tariffs and non-tariff barriers to trade continue to exist two centuries after Adam
Smith and David Ricardo stated the case for free trade? Is there a valid case for
protectionism?
Text 7. THE CASE FOR PROTECTIONISM
Two kinds of argument for protection are commonly offered. The first
concerns national objectives other than total income; the second concerns the
desire to increase one country's national income, possibly at the expense of world
national income.
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Objectives other than maximizing national income
It is possible to accept the proposition that national income is higher with
free trade, and yet rationally to oppose free trade, because of a concern with policy
objectives other than that of maximizing income.
Comparative advantage might dictate that a country should specialize in
producing a narrow range of products. The government might decide, however,
that there are distinct social advantages in encouraging a more diverse economy.
Citizens would be given a wider range of occupations, and the social and
psychological advantages of diversification would more than compensate for a
reduction in living standards to, say, 5 per cent below what they could be with
complete specialization of production according to comparative advantage.
For a very small country, specializing in the production of only a few
products—though dictated by comparative advantage—may involve risks that the
country does not wish to take. One such risk is that technological advances may
render its major product obsolete. Everyone understands this risk, but there is
debate over what governments can do about it. The pro-tariff argument is that the
government can encourage a more diversified economy by protecting industries
that otherwise could not compete. Opponents argue among other things that
governments, being naturally influenced by political motives, are in the final
analysis poor judges of which industries can be protected in order to produce
diversification at a reasonable cost.
Another non-economic reason for protectionism concerns national defence.
It used to be argued, for example, that the United Kingdom needed an experienced
merchant navy in case of war, and that this industry should be fostered by
protectionist policies even though it was less efficient than the foreign competition.
The same argument is sometimes made for the aircraft industry. Agriculture has
also been protected for strategic reasons in the past—we would need to feed
ourselves if trade were disrupted by war. The United States does not allow foreign
ships to transport cargo between its domestic ports on the grounds that a strong
merchant navy, which would not exist without protection, is needed for times of
war.
Although free trade will maximize per capita GDP over the whole economy,
some specific groups may have higher incomes under protection than under free
trade. An obvious example is a firm or industry that is given monopoly power
when tariffs are used to restrict foreign competition. If a small group of firms, and
possibly their employees, find their incomes increased by, say, 25 per cent when
they get tariff protection, they may not be concerned that everyone else's incomes
fall by, say, 2 per cent. They get a much larger share of a slightly smaller total
income and end up better off. If they gain from the tariff, they will lose from free
trade.
Tariffs tend to raise the relative income of a group of people who are in short
supply domestically and to lower the relative income of a group of people who are
in plentiful supply domestically. Free trade does the opposite.
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Other things being equal, most people prefer more income to less.
Economists cannot say that it is irrational for a society to sacrifice some income in
order to achieve other goals. Economists can, however, do three things when faced
with such reasons for adopting protectionist measures. First, they can ask if the
proposed measures really do achieve the ends suggested. Second, they can
calculate the cost of the measures in terms of lowered living standards. Third, they
can see if there are alternative means of achieving the stated goals at lower cost in
terms of lost output.
Maximizing national income. Here we consider five important arguments for the
use of tariffs when the objective is to make national income as large as possible.
The oldest valid argument for protectionism as a means of raising living
standards concerns economies of scale. It is usually called the infant industry
argument.
This comes in a static and a dynamic form. The static form assumes that
world technology is given and constant. If an industry has large economies of
scale, costs will be high when the industry is small but will fall as the industry
grows. In such industries the country first in the field has a tremendous advantage.
A newly developing country may find that in the early stages of development its
industries are unable to compete with established foreign rivals. A trade restriction
may protect these industries from foreign competition while they grow. When they
are large enough, they will be able to produce as cheaply as foreign rivals and then
will be able to compete without protection.
The dynamic form emphasizes that technology is constantly changing
endogenously and that those countries who are at the frontier of technological
advance have an enormous advantage of experience and acquired ability in
inventing and innovating over those who seek to industrialize later on. To develop
these abilities, so goes the argument, a country needs to protect its domestic
industries during the early stages of development. The object is not to move along
a given falling long-run cost curve. Instead, it is to develop industries that will
have cost curves that fall, over time, as fast as similar cost curves are falling in the
advanced countries owing to invention and innovation. To prevent the new
industries from becoming stagnant under the protection that shields them from
foreign competition, protection must, it is argued, be contingent on achieving
success in foreign markets within a stated period of time. Once they have
developed the skills needed to hold their own in the intense international
competition associated with new technologies, the protection can be removed. The
advocates of this argument point out that virtually all the economically advanced
countries developed their early industries under tariff protection. This was true of
Germany and France (and to some extent also of the early English industries in the
industrial revolution, which were helped by the prohibition of imports of Indian
cotton goods), the United States, Canada, Australia, and New Zealand, as well as
the most successful of the Asian economies, e.g. Taiwan, South Korea, and
Singapore.
160
Those who support such polices argue that the assumption of fixed
technology that is implicit in the major arguments for completely free trade is
misleading in a world in which most competition is in terms of the technological
change. They also point out that the argument does not deny the importance of
trade: it just holds that, to take part in globalized trade as a fully developed
country, early protection may be needed—for reasons found both in the theory of
endogenous technological change and in the evidence of what most developed
countries actually did in the early stages of their development. In so far as there is
any validity in this argument, it provides a possible qualification to the proposition
that free trade maximizes world income. If some limited protection actually raises
the level of world innovation in new products and processes, world income may be
higher with some protection than with pure free trade. What this possibility shows
is that, just like all propositions that follow from economic theory, the proposition
that free trade maximizes world income is open to empirical testing. It is not
something that can be shown to be necessarily true in the real world by virtue of
theoretical propositions alone.
The dynamic version of the infant industry argument is supported by the
argument based on learning by doing. Skills and other things that help to create
comparative advantages are not fixed for ever: they can be learned by producing
the new products if enough time is allowed for the learning to take place. Learning
by doing therefore suggests that the pattern of comparative advantage can be
changed. If a country learns enough through producing products in which it
currently is at a comparative disadvantage, it may gain in the long run by
specializing in those products, and could develop a comparative advantage as the
learning process lowers their costs.
The successes of such newly industrializing countries (NICs) as Brazil,
Hong Kong, South Korea, Singapore, and Taiwan are based largely on acquired
skills. For example, nothing in Singapore or Taiwan in 1960—in terms of natural
resources, capital, or skills—suggested that they would become major producers of
state-of-the-art electronic products well before the end of the twentieth century.
This type of experience provides evidence that comparative advantages can
change, and that they can be developed by suitable government policies. Also,
government policies created favourable business conditions and encouraged the
development of specific industries that went on to develop comparative
advantages—although the importance of such policies in contributing to these
developments is subject to debate.
Protecting a domestic industry from foreign competition may give its
management time to learn to be efficient, and its labour force time to acquire
the needed skills.
If this is so, it may pay in the very long run to protect the industry against
foreign competition while a dynamic comparative advantage is being developed.
Some countries have succeeded in developing strong comparative advantages in
targeted industries, but others have failed. One reason such policies sometimes fail
is that protecting local industries from foreign competition may make the industries
unadaptive and complacent. Another reason is the difficulty of identifying the
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industries that will be able to succeed in the long run. All too often, the protected
infant grows up to be a weakling requiring permanent tariff protection for its
continued existence; or else the rate of learning is slower than for similar industries
in countries that do not provide protection from the chill winds of international
competition. In these instances the anticipated comparative advantage never
materializes. Where such a 'picking of winners' has succeeded, it has almost always
been the result of co-operation between government bodies and private sector
firms, rather than civil servants picking and fostering potential winners on their
own initiatives. Examples are Japan's auto industry, Taiwan's electronics industry,
Singapore's software industry, and the software and semiconductor industries of
the United States.
A recent argument for tariffs or other trade restrictions is that they enable the
creation of a strategic advantage in producing or marketing some new product that
is expected to generate profits. To the extent that all lines of production earn
normal profits, there is no reason to produce goods other than ones for which a
country has a comparative advantage. Some goods, however, are produced in
industries containing a few large firms where large-scale economies provide a
natural barrier to further entry. Firms in these industries can earn extra-high profits
over long periods of time. Where such industries are already well established, there
is little chance that a new firm will replace one of the existing giants.
The situation is, however, more fluid with new products. The first firm to
develop and market a new product successfully may earn a substantial pure profit
over all of its opportunity costs and become one of the few established firms in the
industry. If protection of the domestic market can increase the chance that one of
the protected domestic firms will become one of the established firms in the
international market, the protection may pay off.
Many of today's high-tech industries experience declining average total cost
curves because of their large fixed costs of product development. For a new
generation of civilian aircraft, silicon chips, computers, software, and
Pharmaceuticals, a very high proportion of each producer's total costs goes on
product development. These are the fixed costs of entering the market, and they
must be incurred before a single unit of output can be sold. In such industries there
may be room for only a few firms.
The production of full-sized commercial jet aeroplanes provides an example
of an industry that possesses many of these characteristics. The development costs
of a new generation of jet aircraft have risen with each new generation. If the
aircraft manufacturers are to recover these costs, each of them must have large
sales. Thus, the number of firms that the market can support has diminished
steadily, until today there is room in the world aircraft industry for only two or
three firms producing a full range of commercial jets.
The characteristics just described are sometimes used to provide arguments
for subsidizing the development of such industries and/or protecting their home
markets with a tariff. Suppose, for example, that there is room in the aircraft
industry for only three major producers of the next round of passenger jets. If a
government assists a domestic firm, this firm may become one of the three that
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succeed, and the profits that are subsequently earned may more than repay the cost
of the subsidy. Furthermore, another country's firm, which was not subsidized,
may have been just as good as the three that succeeded; without the subsidy,
however, that firm may lose out in the battle to establish itself as one of the three
surviving firms in the market.
This example is not unlike the story of the European Airbus. The European
producers received many direct subsidies (and they charge that their main
competitor, the Boeing 767, received many indirect ones). Whatever the merits of
the argument, several things are clear: the civilian jet aircraft industry remains
profitable; there is room for only two or three major producers; and one of these
would not have been the European consortium had it not been for substantial
government assistance.
Generalizing from this and similar cases, some economists advocate that
their governments should adopt strategic trade policies more broadly than they
now do. This means, for high-tech industries, government protection of the home
market and government subsidization (either openly or by more subtle back-door
methods) of the product development stage. These economists say that if their
country does not follow their advice it will lose out in industry after industry to the
more aggressive Japanese and North American competition—a competition that is
adept at combining private innovative activity with government assistance.
Opponents argue that, once all countries try to be strategic, they will all
waste vast sums trying to break into industries in which there is no room for most
of them. Advocates of strategic trade policy reply that a country cannot afford to
stand by while others play the strategic game.
Advocates also argue that there are key industries that have major 'spillovers'
into the rest of the economy. If a country wants to have a high living standard, it
must, they argue, compete with the best. If a country lets its key industries migrate
to other countries, many of its other industries will follow. The country then risks
being reduced to the status of a less developed nation. Opponents argue that
strategic trade policy is just the modern version of mercantilism, a policy of trying
to enrich oneself at the expense of one's neighbours rather than looking for
mutually beneficial gains from trade. They point to the rising world prosperity of
the entire period following the Second World War, which has been built largely on
a rising volume of relatively free international trade. There are real doubts that
such prosperity could be maintained if the volume of trade were to shrink steadily
because of growing trade barriers.
Tariffs may be used to prevent foreign industries from gaining an advantage
over domestic industries by use of predatory practices that will harm domestic
industries and hence lower national income. Two common practices are subsidies
paid by foreign governments to their exporters and price discrimination by foreign
firms, which is called dumping when it is done across international borders. These
practices are typically countered by levying tariffs known as countervailing and
anti-dumping duties.
Trade restrictions can be used to turn the terms of trade in favour of
countries that produce, and export, a large fraction of the world's supply of some
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product. They can also be used to turn the terms of trade in favour of countries that
constitute a large fraction of the world demand for some product that they import.
When the OPEC countries restricted their output of oil in the 1970s, they were able
to drive up the price of oil relative to the prices of other traded goods. This turned
the terms of trade in their favour; for every barrel of oil exported, they were able to
obtain a larger quantity of imports. When the output of oil grew greatly in the mid1980s, the relative price of oil fell dramatically, and the terms of trade turned
unfavourably for the oil-exploring companies. These are illustrations of how
changes in the quantities of exports can affect the terms of trade.
Now consider a country that provides a large fraction of the total demand for
some product that it imports. By restricting its demand for that product through
tariffs, it can force the price of that product down. This turns the terms of trade in
its favour, because it can now get more units of imports per unit of exports.
Both of these techniques lower world output. They can, however, make it possible
for a small group of countries to gain because they acquire a sufficiently larger
share of the smaller world output. However, if foreign countries retaliate by raising
their tariffs, the ensuing tariff war can easily leave every country with a lowered
income.
In today's world a country's products must stand up to international
competition if they are to survive. Over time this requires that they hold their own
in competition for successful innovations. Protection that is high enough to confer
a national monopoly reduces the incentive for firms to fight to hold their own
internationally. If any one country adopts high tariffs unilaterally, its domestic
industries may become less competitive. Secure in its home market because of the
tariff wall, the protected industries may become less and less competitive in the
international market. As the gap between domestic and foreign industries widens,
any tariff wall will provide less and less protection. Eventually the domestic
industries will succumb to the foreign competition.
Although restrictive policies have sometimes been pursued following a
rational assessment of the approximate cost, it is hard to avoid the conclusion
that more often than not such policies are pursued for political objectives, or
on fallacious economic grounds, with little appreciation of the actual costs
involved.
One major exception to this tendency is the postwar Japanese car industry.
The Japanese government protected the local market against imports and prevented
foreign firms from establishing production facilities in Japan. But fierce
competition among the local Japanese firms led to the development of the methods
of 'lean production' which, after 20 years of internal development, allowed
Japanese firms to challenge foreign automobile industries and become world
leaders in the industry.
Text 8. METHODS OF PROTECTION
Policies that directly raise prices
The first type of protectionist policy directly raises the price of the imported
product. A tariff, also often called an import duty, is the most common policy of
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this type. Other such policies include any rules or regulations that fulfil three
conditions: they are costly to comply with; they do not apply to competing,
domestically produced products; and they are more than is required to meet any
purpose other than restricting trade.
The initial effect is to raise the domestic price of the imported product above
its world price by the amount of the tariff. Imports fall, and as a result foreign
producers sell less and so must transfer resources to other lines of production. The
price received on domestically produced units rises, as does the quantity produced
domestically. On both counts domestic producers earn more. However, the cost of
producing the extra output at home exceeds the price at which it could be
purchased on the world market. Thus, the benefit to domestic producers comes at
the expense of domestic consumers. Indeed, domestic consumers lose on two
counts: first, they consume less of the product because its price rises; and second,
they pay a higher price for the amount that they do consume. This extra spending
ends up in two places: the extra that is paid on all units produced at home goes to
domestic producers (partly in the resource costs of extra production and partly in
profit), and the extra that is paid on units still imported goes to the government as
tariff revenue.
Policies that directly lower quantities
The second type of protectionist policy directly restricts the quantity of an
imported product. Any implicit or explicit restriction on trade that does not involve
a tariff is known as a non-tariff barrier. These can take various subtle forms,
including quality standards that are complicated to interpret or customs forms that
take weeks to get approved. But many non-tariff barriers are more obvious and
easy to understand. A common example is the import quota, by which the
importing country sets a maximum on the quantity of some product that may be
imported each year. Increasingly popular in the recent past, however, has been the
voluntary export restriction (VER), an agreement by an exporting country to
limit the amount of a good that it sells to the importing country.
The European Union and the United States have used VERs extensively, and
the EU also makes frequent use of import quotas. Japan has been pressured into
negotiating several VERs with the European Union and the United States in order
to limit sales of some of the Japanese goods that have had the most success in
international competition. Jot example, in 1983 the United States and Canada
negotiated VERs whereby the Japanese government agreed to restrict total sales of
Japanese cars to these two countries for three years. When the agreements ran out
in 1986, the Japanese continued to restrain their car sales by unilateral voluntary
action. In 2005 the EU negotiated a voluntary export restraint for exports of
textiles from China.
Text 9. GLOBAL COMMERCIAL POLICY
We now consider the supranational influences on commercial policy in the
world today. We start with the many international agreements that govern current
commercial policies and then look in a little more detail at the European Union.
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Before 1947 most countries were free to impose any tariffs on its imports.
However, when one country increased its tariffs, the action often triggered
retaliatory actions by its trading partners. The Great Depression of the 1930s saw a
high-water mark of world protectionism, as each country sought to raise its
employment by raising its tariffs. The end result was lowered efficiency, less
trade—but no increase in employment. Since that time, much effort has been
devoted to reducing tariff barriers, on both a multilateral and a regional basis.
The GATT and the WTO
One of the most notable achievements of the postwar era was the creation of
the General Agreement on Tariffs and Trade (GATT). The principle of the GATT
was that each member country agreed not to make unilateral tariff increases. This
prevented the outbreak of tariff wars in which countries raise tariffs to protect
particular domestic industries and to retaliate against other countries' tariff
increases. Such wars usually harm all countries as mutually beneficial trade shrinks
under the impact of escalating tariff barriers.
There were eight 'rounds' of global trade talks under the GATT, beginning in
1948 and ending in 1993. The three most recently completed rounds of GATT
agreements, the Kennedy round (completed 1967), the Tokyo round (completed
1979), and the Uruguay round (completed 1993), each reduced world tariffs
substantially, the first two by about one-third each, and the last by about 40 per
cent.
The Uruguay round created a new body, the World Trade Organisation
(WTO), which superseded the GATT in 1995. It also created a new legal structure
for multilateral trading. Under this new structure all members have equal mutual
rights and obligations. Until the WTO was formed, developing countries who were
in the GATT enjoyed all the GATT rights but were exempt from most of its
obligations to liberalize trade—obligations that applied only to the developed
countries. However, all such special treatments were phased out over seven years
starting in 1995. There is also a new dispute settlement mechanism with much
more power to enforce rulings over non-tariff barriers than existed in the past. In
its first eight years the WTO dealt with around 300 disputes; while the GATT only
heard 300 in 47 years!
In 1997 three strands of negotiation that had been left incomplete in the
Uruguay round were completed, involving agreements to lower trade barriers in
telecommunications, financial services, and information technology. These
agreements were important because they greatly increased the amount of trade
covered by WTO rules and dispute settlement procedures, they may lead to larger
trade volume gains than the entire Uruguay round, and they complete most of the
unfinished business from Uruguay, clearing the way for a new global trade round.
This was started in 2001 at the Qatar capital, Doha, and hence known as the Doha
round. This round was still continuing in 2006.
By December 2005 the WTO had 149 member countries including China,
with a further 30 or so, including Russia, at various stages of negotiation to join. 2 It
is thus growing into a truly global forum for the regulation of government
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involvement in world trade. There is further discussion of some of the issues
surrounding the WTO in the second case study below.
Indeed, while real GDP has grown ten-fold, world export volumes have
grown twenty-eight-fold. It is hard to believe that this could have occurred without
the liberalization of international trade brought about through successive rounds of
tariff negotiation.
Text 10. TYPES OF REGIONAL AGREEMENT
Regional agreements seek to liberalize trade over a much smaller set of
countries than WTO membership. Three standard forms of regional tradeliberalizing agreement are free trade areas, customs unions, and common markets.
A free trade area (FTA) is the least comprehensive of the three. It allows for
tariff-free trade among the member countries, but it leaves each member free to
impose its own trade restrictions on imports from other countries. As a result,
members must maintain customs points at their common borders to make sure that
imports into the free trade area do not all enter through the member that is levying
the lowest tariff on each item. They must also agree on rules of origin to establish
when a good is made in a member country, and hence is able to pass duty-free
across their borders, and when it is imported from outside the free trade area, and
hence is liable to pay duties when it crosses borders within the free trade area.
A customs union is a free trade area plus an agreement to establish common
barriers to trade with the rest of the world. Because they have a common tariff
against the outside world, the members need neither customs controls on goods
moving among themselves nor rules of origin.
A common market is a customs union that also has free movement of
labour and capital among its members.
An economic union takes things still further and creates an area that shares
many other aspects of economic policy and harmonized legal structures, such as in
the European Union today.
TEXT 11. TRADE CREATION AND TRADE DIVERCION
A major effect of regional trade liberalization is on resource reallocation.
Economic theory divides these effects production into two categories.
This occurs when producers in one member country find that they can
undersell producers in another member country because the latter loses its tariff
protection. For example, when the North American Free Trade Agreement
(NAFTA) came into force, some Mexican firms found that they could undersell
their US competitors in some product lines, while some US firms found that they
could undersell their Mexican competitors in others, once tariffs were eliminated.
As a result, specialization occurred and new international trade developed.
This occurs when exporters in one member country replace foreign exporters
as suppliers to another member country as a result of preferential tariff treatment.
For example, US trade diversion occurs when Mexican firms find that they can
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undersell competitors from the EU in the US market, not because they are the
cheapest source free trade area has been formed, known as Mercosur. In 1994 an
initiative was started to put in place a free trade area for the whole of the Americas.
Negotiations started in 1998 and were scheduled to be concluded by January 2005;
however, this deadline was not met. The new free trade area was planned to create
the Free Trade Area of the Americas (FTAA), but at the time of writing (June
2006) there is considerable doubt as to whether this will come about in the
foreseeable future.
Text 12. COMMON MARKETS: THE EUROPEAN UNION
By far the most successful common market, which is now referred to as a
'single market', is the European Union. Its origins go back to the period
immediately following the Second World War in 1945. After the war there was a
strong belief throughout Europe that the way to avoid future military conflict was
to create a high level of economic integration between the existing nation-states.
Later the motivation switched to creating a powerful economic bloc that could be
competitive with Japan and the USA.
In 1952, as a first step towards economic union, France, Belgium, West
Germany, Italy, Luxembourg, and Holland formed the European Coal and Steel
Community. This removed trade restrictions on coal, steel, and iron ore among
these six countries. In 1957 the same six countries signed the Treaty of Rome. This
created the European Economic Community (EEC), which later became the
European Community (EC), and after 1993 the European Union (EU). In 1973 the
United Kingdom, Denmark, and Ireland joined, and they were followed in 1981 by
Greece and in 1986 by Spain and Portugal. Austria, Sweden, and Finland entered
in 1995. The European Union welcomed ten new countries in 2004: Cyprus, the
Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and
Slovenia. Bulgaria and Romania followed in 2007.
In the first two decades of its existence, the main economic achievements of
the EEC were the elimination of internal tariff barriers and the establishment of
common external tariffs (in other words, the establishment of a customs union),
and the establishment of the Common Agricultural Policy (CAP), which
guarantees farm prices by means of intervention and an import levy. There were
other significant EEC policies, such as regional aid and protection of competition,
but they did not have great economic impact to begin with.
By the mid-1980s it was clear that the intended 'Common Market' had not
been achieved. There remained many non-tariff barriers to trade and to the
mobility of labour. These included quality standards, licensing requirements, and a
lack of recognition of qualifications. In financial services there were explicit
exchange controls and other regulatory restrictions on cross-border trade. In
response, a new push to turn the customs union into a genuine common market
began in 1985.
The Single Market Act was signed in 1986. Its intention was to remove all
remaining barriers to the creation of a fully integrated single market by the end of
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1992. The Single Market Act did not in itself create the single market. Rather, it
was a statement (or treaty) of intent which instituted a simplified administrative
procedure whereby most of the single market legislation needed only 'weighted
majority' support, rather than unanimity. The single market itself was to be created
by a large number of Directives, which are drafted by the European Commission,
the EU's civil service. These become Community law after they have been
'adopted' by the European Council (a committee of the heads of state or other
ministers of member states). They then have to be ratified in the law of each
member state. Once in force, they have precedence over the domestic laws of
member states if there is a conflict.
The elimination of non-tariff barriers has been approached on a product-byproduct basis. Only in this way could minimum quality standards be created that
would permit cross-border trade without the threat of quality checks as a
prerequisite to entry (a problem that plagues some branches of Canada-USA trade).
This has required a complicated set of negotiations on quality standards, relating to
everything from condoms to sausages and from toys to telecommunications. There
is even a quality standard for the bacterial content of aqueous toys—transparent
plastic souvenirs containing, perhaps, a model of Big Ben or the Eiffel Tower,
which, when shaken, create a snow scene.
All countries have such safety or quality standards for their products, and what has
been happening is the harmonization of these standards, which is something that
Canada and the United States have been trying to do since their Agreement was put
into force in 1989.
The Single Market Programme is an ongoing process, not a discrete jump.
Some of the intended measures have been implemented, but many are still in the
pipeline. The process will continue well into the twenty-first century.
Perhaps the most significant achievements of the Single Market Programme
to date have been in the area of trade in financial services. Although the Treaty of
Rome called for free movement of capital as well as goods, this was ignored until
the mid-1980s. Until recently, most member countries had exchange controls on
capital movements until recently which prohibited residents of each country from
investing in any other country. The Capital Liberalization Directive required all
member states to abolish exchange controls by June 1990. Some member states,
such as the UK and Germany, had already abolished controls. France and Italy,
which had not, were forced to do so by the Directive. Spain, Portugal, Ireland, and
Greece were given longer to comply. All except Greece fully abolished their
controls by the end of 1992, and Greece abolished most of its controls by 1994.
Once exchange controls were abolished, it could be argued that nothing else
had to be done to create a single market in financial services. Certainly wholesale
financial markets rapidly integrated with the global financial system, once they
were free to do so. However, agreement was still needed on how to facilitate
greater cross-border competition in retail financial markets. Each country in
isolation had already created a domestic regulatory regime designed, in part, to
protect the consumer. How was the EU to encourage competition but maintain a
sensible regime of consumer protection? Financial services are particularly prone
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to fraud, because the profit margin for a crook is 100 per cent—even a used car
salesman has to show you a car, but the seller of an investment product offers only
future promises!
The European Union adopted a pragmatic approach based upon assuming
the competence of existing regulators. Firms in each sector were to be authorized
as 'fit and proper' by their home country regulator, and they would then be
presumed to be fit and proper to trade in any member state. In effect, the home
country gave a driving licence which then permitted an authorized company to
'drive' anywhere in the Union. This mutual recognition of regulators has been
wrongly interpreted as permitting financial services firms to trade anywhere in the
European Union on the basis of their home country's rules. A moment's thought
will tell you why it has to be wrong. Imagine, for example, British drivers being
permitted to drive on the left in France just because that is the law in Britain. It is
just as disastrous to have banks in any one location trading under fifteen different
legal structures.
The single market in financial services is built on a dual set of principles:
home country authorization, and host country conduct of business rules. This
means that a firm can be authorized to trade throughout the Union by the home
regulator, but the trade itself must obey the local laws in the country concerned.
Allowing home countries to regulate entry and host countries to regulate
performance is a simple application of the principle of national treatment that was
developed in the context of the Uruguay round. It means that foreign firms get
treated just the same as local firms.
The Cecchini Report of 1989 estimated that the completion of the Single
Market Programme may increase the GDP of the European Union by up to 6 per
cent. However, a well known American economist, Richard Baldwin, has
challenged that figure, suggesting that the gains could be at least twice as large
(owing to economies of scale external to firms). And this is only the gain in one
year. Similar gains will continue to flow in future years. Thus, while politically
tortuous, the process of reducing trade barriers, even within groups of countries, is
capable of creating considerable gains in economic efficiency.
In 2000 a renewed agenda for economic progress in the European Union up
to 2010 was adopted at a European Council meeting in Lisbon, Portugal (hence
known as the Lisbon Agenda). It aims at making 'the EU the world's most dynamic
and competitive economy' by 2010. Little progress towards this goal had been
made by 2005 so it was relaunched:
It is accepted that member states have not made the necessary progress on
the Lisbon Agenda goals. There have been some advances on specific goals, for
example the liberalisation of energy, telecoms and financial services sectors. But
the headline objectives of boosting jobs by 20 million and ensuring annual growth
of 3 per cent by 2010 a year will not be met. . . . European Commission President
Jose Manuel Barroso said in February: 'Lisbon has been blown off course by a
combination of economic conditions, international uncertainty, slow progress in
the member states and a gradual loss of political focus.'Leaders are likely to
address these problems by reducing the number of goals and focusing on boosting
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jobs and growth. Instead of the current confusing myriad of progress indicators
there will be one national action programme and implementation report for each
country. (BBC website, March 2005)
Text 13. THE FUTURE OF THE MULTILATERIAL TRADING SYSTEM
At the end of the Second World War the United States took the lead in
forming the GATT and in pressing for reductions in world tariffs through
successive rounds of negotiations. Largely as a result of this US initiative, the
world's tariff barriers have been greatly reduced, while the volume of world trade
has risen steadily.
The next few years will be critical for the future of the multilateral trading
system, which has served the world so well since the end of the Second World
War. The dangers are, first, a growth of regional trading blocs that will trade more
with their own member countries and less with others, and second, the growth of
state-managed trade.
The 1920s and 1930s provide a cautionary tale. Arguments for major trade
restrictions always have a superficial appeal and sometimes have real short-term
payoffs. In the long term, however, a major worldwide escalation of tariffs would
lower efficiency and incomes and restrict trade worldwide, while doing nothing to
raise employment. Both economic theory and the evidence of history support this
proposition. Although most agree that pressure should be put on countries that
restrict trade, the above analysis suggests that these pressures are best applied
using the multilateral institution, the WTO. Unilateral imposition of restrictions in
response to the perceived restrictions in other countries can all too easily degenerate into a round of mutually escalating trade barriers.
In the first few years of the twenty-first century, the United States has been
more protectionist than at any other time during the last half of the previous
century. New heavy anti-dumping duties on steel and softwood lumber and big
new protectionist measures for the US agricultural industry are causing worrying
ripples internationally. If the United States abandons the position it established
over the last 60 years as the leader of the movement for trade liberalization, there is
no obvious successor.
The European Union, although it has achieved something close to free trade
within the Union, has been equivocal on free trade with the rest of the world. Antidumping duties, voluntary export agreements, and other non-tariff barriers have
been used with effect against successful importers—particularly the Japanese.
Although these measures may bring short-term gains, both economic theory and
historical experience suggest that they will bring losses in the long term.
Protectionism reduces incomes because low-priced goods are excluded to the
detriment of current consumers, particularly those with lower incomes. It also
reduces employment because restrictions on imports are sooner or later balanced
by restrictions on exports as other countries retaliate. It also inhibits the
technological dynamism that is the source of long-term growth, by shielding
domestic producers from the need that free international competition forces on
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them: to keep up with all foreign competitors.
Text 14. WHY DOES OPENNES MATTER?
There are three main reasons why we have to take a much closer look at the
interactions between our macro model and the rest of the world:
- First, while we have always had net exports in our model, we have not paid
attention to all the possible implications of trade imbalances.
- Second, financial markets have become more integrated around the world. The
high international mobility of financial capital implies that money markets in one
country are influenced by what happens in the rest of the world's financial markets.
- Third, the exchange rate regime matters for the conduct of monetary policy
because it affects the possibilities for arbitrage between domestic and overseas
financial markets (and therefore the link between domestic and overseas interest
rates). Arbitrage involves buying where a price is low and selling where it is high,
in order to make profit. The process of arbitrage tends to drive prices of the same
commodity or asset towards equality in different locations.
When we talk about capital flows in the context of the balance of payments,
we are not talking about imports and exports of capital goods, such as machine
tools and heavy equipment. Rather, we are talking about trade in assets and
liabilities, such as shares and bonds, or about lending by banks in one country to
customers in another.
Capital flows matter for two reasons. First net capital flows must be equal in
magnitude (but with the opposite sign) to the current account balance. Since this
relationship is true by definition, it must always hold. It is important to realize,
however, that changes affecting capital flows have implications for net exports
(possibly via exchange rate changes), just as shifts affecting net exports have
implications for the capital account.
The second reason why capital flows matter for the macro model is that they
influence the domestic interest rate. If everyone is free to borrow and lend both
domestically and internationally, they will borrow where the interest rate is lowest
and lend where it is highest. Mobile capital tends to drive the domestic interest rate
towards the level of interest rates in world markets. In effect, the domestic
economy is close to being a price-taker in world financial markets.
Text 15. THE GLOBALIZATION OF FINANCIAL MARKETS
Technological innovations in communication and financial liberalization
have led to a globalization of the financial services industry over the past few
decades. Computers, satellite communication systems, reliable telephones with
direct world-wide dialling, electronic mail, and fax machines have put people in
instantaneous contact anywhere in the world.
As a result of these new technologies, borrowers and lenders can learn about
market conditions anywhere in the world and then move their funds instantly in
search of the best loan rates. Large firms need transaction balances only while
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banks in their area are open. Once banks close for the day in each area, the firms
will not need these balances until the following day's reopening. So the funds can
be moved to another market, where they can be used until IT closes, and then
moved to yet another market. Funds are thus free to move from, say, London to
New York to Tokyo and back to London on a daily rotation. This is a degree of
global sophistication that was inconceivable before the advent of the computer,
when international communication was much slower and costlier than it now is. To
facilitate the movement in and out of various national currencies, increasing
amounts of bank deposits are denominated in foreign rather than domestic
currencies.
One of the first developments in this movement towards globalization was
the growth of the foreign currency markets in Europe in the 1960s. At first the
main currency involved was the US dollar. (The market for dollar-denominated
bank deposits and loans outside the United States was known as the Eurodollar
market—not to be confused with the foreign exchange market in which the euro
exchanges for the dollar today.) The progressive world-wide lifting of domestic
interest rate ceilings and other capital market restrictions that occurred in the
1980sled toafur-ther globalization of financial markets. Particularly important was
the abolition of exchange controls in country after country. The United Kingdom
abolished its exchange controls in 1979, Japan did so in 1980, France and Italy in
1989, Spain in 1991, Portugal and Ireland in 1992, and Greece in 1994. Once such
restrictions were abolished, the wholesale money markets integrated with the
international money markets very quickly. This is because sophisticated borrowers
and lenders dealing with large amounts of money have an incentive to shop around
for the best terms.
The increasing sophistication of information transfer has also led to a
breakdown of the high degree of specialization that had characterized financial
markets in earlier decades. When information was difficult to obtain and analyse,
an efficient division of labour called for a host of specialist institutions, each with
expertise in a narrow range of transactions. New developments in communications
technology created economies of scale that led to the integration of various
financial operations within one firm. For example, in many countries banks have
moved into the markets where securities are traded, while many security-trading
firms have begun to offer a range of banking services. As the scale of such
integrated firms increases, they find it easier to extend their operations
geographically as well as functionally. The introduction of the euro in 1999 added
further impetus to globalization as it increased the integration of EU financial
markets and created a currency that has become an important international
instrument.
The heavy government intervention in domestic capital markets and
government control over international capital flows that characterized the 1950s
and 1960s is no longer possible. International markets are just too sophisticated.
Globalization is here to stay; and, by removing domestic restrictions and exchange
controls, governments in advanced countries were only bowing to the inevitable.
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Text 16. ANTI-GLOBALIZM
In recent years there have been many demonstrations against the World
Trade Organisation (WTO), the International Monetary Fund (IMF), and the World
Bank. These have been referred to as 'anti-capitalist' or 'anti-globalization'
demonstrations. Some of the arguments made by the protesters are difficult to
disagree with (like the desirability of reducing poverty in the poorest countries),
but others are plain wrong. Virtually all economists, for example, would agree that
globalization in the form of greater international trade in goods and services is both
wealth- and welfare-increasing, and that closing down international trade would
make the world a very much poorer place for all.
There have long been debates about free trade, and there have certainly been
times when there have been doubts about whether capitalism is the best system.
The collapse of communism helped to squash the latter doubts, but the case for a
free and open trading system has come under renewed threat in recent years from a
number of apparently rational sources.
Professor Jagdish Bhagwati of Columbia University identifies four different
new critiques that question the benefits of an open trading system:
• Demands for 'fair trade' that either mask protectionism or degenerate into it, in
both cases charging that free trade lacks fairness and that fair trade restores it.
• Concerns that free trade harms the environment.
• Charges that free trade (and it chief institution, the WTO) is incompatible with
the advancement of social and moral agendas.
•
Fears that free trade hurts the real wages of workers and that rich countries
trading with poor countries create poor in rich countries: and in poor countries, that
free trade accentuates poverty. (Bhagwati 2002, page 50)
Let us look at each of these issues in turn.
Fair trade
'Fair' trade seems hard to object to—who could possibly support 'unfair'
trade? One common form of this argument is similar to what used to be called 'the
sweated labour fallacy'. This says that we should restrict imports from countries
that have lower labour or environ mental standards (in extreme cases using child
labour) as this is not fair competition with domestic suppliers. However, to restrict
such trade would hurt the poor country, whose best chance of reducing poverty and
increasing labour standards is to export to rich countries. So this is just an excuse
for protectionism and restricting the benefits that flow from comparative
advantage. This is the version of fair trade that Bhagwati criticizes above.
There are two forms of the fair trade argument that are less problematic. The
first is that industrial countries have pressured some developing countries to open
their markets to the products of the richer countries while at the same time
imposing restrictions on developing-country exports into rich-country markets.
This is a case of uneven bargaining power, and the poorer countries clearly have a
good case. The case for free trade has to apply to all and not in one direction only.
The second argument for fair trade applies to some products like bananas and
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coffee, where some charitable groups argue that industrial countries' monopsony
power has depressed the prices of commodities. They aim to counter these povertyinducing low prices by offering a 'fair trade' product at a higher price, the revenues
from which go to the poor-country producers. Rich-country consumers are free to
buy these 'fair-trade' products as they are sold along side comparable but cheaper
products in supermarkets. This form of fair trade allows people who so wish to
direct charitable giving to specific producers, and there is nothing in economics to
say that they should not do this. The only doubt is whether this will catch on in a
big enough way to solve the underlying problem. Counteracting monopsony power
in commodity markets is likely to require a stronger intervention from
governments if this is the true nature of the problem. Notice, however, that our
discussion of coffee prices on page 81 points out that the main problem in coffee
markets is over-production.
Trade and the environment
The environment is important for all of us and perhaps will be even more
important for our children and grandchildren. Economic analysis clearly shows that
free markets may not adequately protect the environment and government intervention is necessary to deliver the social optimum resource use. This applies to
many common property resources such as fisheries and rain forests. It also applies
to pollution issues like greenhouse gases and acid rain.
However, it makes no sense to address environmental problems by closing
down world trade. Environmental issues should be handled directly with suitable
policies to solve the problem in hand. World trade per se is not the cause of
environmental problems. Indeed, the higher standards of living that world trade
provides can be helpful in providing the extra output that takes living standards
sufficiently above subsistence that quality of life is also in high demand.
Social and moral agendas
Some politicians have sought to include a 'social clause' in the WTO rules.
This would permit the use of trade sanctions against countries whose labour laws
or social conventions we did not like. This is presented as a moral crusade to help
poor people, but Bhagwati points out that these demands are widely seen as
protectionism hiding behind a moral mask. And it is a mistake to bundle together
two issues that should be dealt with by separate processes and institutions: 'By
trying to kill these two birds (i.e. social agendas and free trade) with one stone (i.e.
trade treaties and institutions), you are likely to miss both (Bhagwati 2002, page
69). Rather, he argues, it is important to pursue these different goals in
international agencies suited to the specific agendas for which they were set up:
'the WTO for trade liberalization, the International Labour Organization for labour
standards, the UN Environment Program for environmental issues, UN1CEF for
children's rights, UNESCO for cultural preservation, and so on' (p. 69).
Trade is bad for wages
There are two elements to this argument depending on whether we are
talking about workers in rich countries or poor ones. In rich countries, it is
certainly true that some specific workers may be hurt if their employer loses
business to cheaper imports from abroad. However, the overwhelming weight of
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evidence is that the growth of real GDP that is supported by growth in international
trade during the past three decades or so has been associated with rising real wages
for most classes of worker in the rich countries. Some have tried to argue that trade
has hurt unskilled workers in the rich countries, but the case remains unproven, as
it is difficult to disentangle the effects of trade from changes in technology that
have been occurring at the same time. For the workers in poor countries, here is
Bhagwati again:
Speaking at least for India, I would say that autarky helped produce a
slow average growth rate of 3.5 per cent annually for over a quarter of a
century until early 1980s. During this period, it was virtually impossible to
pull people up into gainful employment, and out of poverty, in a
significantway. With the 1980s, the increasing pace of outward-oriented
reforms has been associated with growth rates closer to 6-6.5 per cent
annually; and after much controversy, there is a fair degree of consensus that
poverty has been dented. Contradicting the anti-free-trade rhetoric that flows
ceaselessly from the street theater and even from certain international
agencies, the facts show that a shift out of autarky into closer integration into
the world economy is producing better, not worse, results for poverty
reduction. (Bhagwati 2000, page 89)
Exercises:
1. Complete the sentences by using the words from the texts:
A) Sales and purchases of goods and services that take place across
international boundaries are referred to as …
B) An economy that engages in international trade is an …. One that does
not is a …
C) A situation in which a country does no foreign trade is called …
D) The advantages realized as a result of trade are called the …
E) country's terms of trade are computed as an index number: …
F) A rise in the index is referred to as a … change in a country's terms of
trade.
G) A decrease in the index of the terms of trade, called an …change, means
that the country can import less in return for any given amount of exports or,
equival-ently, that it must export more to pay for any given amount of imports.
H) Government policy towards international trade is known as …
I) Complete freedom from interference with trade is known as a … policy.
J) Any departure from free trade designed to give some protection to
domestic industries from foreign competition is called …
K) Such protection may be achieved either by tariffs, which are taxes
designed to raise the price of foreign goods, or by …, which are devices other than
tariffs that are designed to reduce the flow of imports.
L) Generalizing from this and similar cases, some economists advocate that
their governments should adopt … more broadly than they now do.
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M) Two common practices are subsidies paid by foreign governments to
their exporters and price discrimination by foreign firms, which is called … when
it is done across international borders. The first type of protectionist policy directly
raises the price of the imported product. A tariff, also often called an …, is the
most common policy of this type.
N) The second type of protectionist policy directly restricts the quantity of
an imported product. Any implicit or explicit restriction on trade that does not
involve a tariff is known as a ….
O) The principle of the … (GATT) was that each member country agreed
not to make unilateral tariff increases.
P) The Uruguay round created a new body, the … (WTO), which superseded
the GATT in 1995.
Q) A … is a free trade area plus an agreement to establish common barriers
to trade with the rest of the world. Because they have a common tariff against the
outside world, the members need neither customs controls on goods moving
among themselves nor rules of origin.
R) A … is a customs union that also has free movement of labour and capital
among its members.
S) An … takes things still further and creates an area that shares many other
aspects of economic policy and harmonized legal structures, such as in the
European Union today.
2. Discuss about Russian export and import.
New vocabulary:
open economy, closed economy, export, export embargo, exchange rate, free
trade, freely-fluctuating exchange rates, import, multilateral trade negotiations,
trade balance; unfavorable balance of trade, international trade, autarky, gains from
trade, a favourable change, an unfavourable change, commercial policy, a free
trade policy, protectionism, non-tariff barriers, strategic trade policies, dumping,
an import duty, the General Agreement on Tariffs and Trade (GATT), the World
Trade Organisation (WTO), a customs union, a common market, an economic
union
Homework:
1. Economics for Medical Students, units 1-9
2. English Economy Dictionary with Definitions.
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Lesson 18
Credit-test.
Questions:
2. Economic as a social science.
2. Macroeconomics and microeconomics.
3. The Subject and Method of Economics.
4. Three Basic Problems of Economy.
5. The Development of Economics. (Adam Smith, John Maynard Keynes).
6. Labour as a factor of Production.
7. Natural Resources and Land.
8. Capital. Fixed capital. Circulating capital.
9. Economic systems.
10. Traditional Economies.
11. Command Economy.
12. Mixed Economy.
13. The essential features of market Economy.
14. Allocation of products and resources. Market schema.
15. Money and its functions.
16. The history of money.
17. The Law of money circulations.
18. Demand. Demand curve. The Law of Demand.
19. Supply. Supply curve. The Law of Supply.
20. Price elasticity of Demand and Supply. Market balance.
21. Macroeconomics problems. The aims of macroeconomics activity.
22. National accounting.
23. Gross Domestic Product.
24. Gross National Product.
25. Business cycle and its phases.
26. Government’s Role in the Economy.
27. Phillip’s Curve.
28. Antimonopoly Policy.
29. Unemployment (Frictional, Structural, Cyclical).
30. Monetary System and its intermediaries.
31. Types of Banking Systems.
32. The main functions and tools of the Central Bank.
33. Money aggregates.
34. The Law of money circulation.
35. The main kinds of commercial banks.
36. The banking services.
37. Fiscal Policy. Taxes. Direct and indirect Taxes.
38. Laffer’s Curve.
39. Public Spending. Transfer payment.
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40. Budget deficit.
Credit-test.
1. Which of the following statements are positive and which are normative?
a) The health of poor people is worse than the health of rich people.
b) Economic growth in sub-Saharan Africa is affected by the AIDS epidemic.
c) Rich countries should provide medicine more cheaply to Africa.
d) Protectionist policies in rich countries are hurting poor countries and should be
abolished.
2. The term “labour” as factor of production means:
a) All those gifts of nature, such as land, forests, minerals, etc.
b) All human resources, mental and physical
c) All those man-made aids to further production, such as tools, machinery, and
factories, that are used in the process of making other goods and services rather
than being consumed for their own sake
d) Those who take risks by introducing new products and new ways of making old
products, developing new businesses and forms of employment.
3. The term “land” as factor of production means:
a) All those gifts of nature, such as land, forests, minerals, etc.
b) All human resources, mental and physical
c) All those man-made aids to further production, such as tools, machinery, and
factories, that are used in the process of making other goods and services rather
than being consumed for their own sake
d) Those who take risks by introducing new products and new ways of making old
products, developing new businesses and forms of employment.
4. The term “entrepreneurship” as factor of production means:
a) All those gifts of nature, such as land, forests, minerals, etc.
b) All human resources, mental and physical
c) All those man-made aids to further production, such as tools, machinery, and
factories, that are used in the process of making other goods and services rather
than being consumed for their own sake
d) Those who take risks by introducing new products and new ways of making old
products, developing new businesses and forms of employment.
5. The term “capital” as factor of production means:
a) All those gifts of nature, such as land, forests, minerals, etc.
b) All human resources, mental and physical
c) All those man-made aids to further production, such as tools, machinery, and
factories, that are used in the process of making other goods and services rather
than being consumed for their own sake
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d) Those who take risks by introducing new products and new ways of making old
products, developing new businesses and forms of employment.
6. The term “consumer” means:
a) In economics, all public agencies, government bodies, and other
organizations belonging to, or owing their existence to, the government;
sometimes (more accurately) called the central authorities.
b) An agent who consumes goods or services.
c) All people living under one roof and taking, or subject to others taking for
them, joint financial decisions.
d) The unit that employs factors of production to produce commodities that it
sells to other firms, to households, or to the government.
e) Any unit that makes goods or services.
7. The term “producer” means:
a) In economics, all public agencies, government bodies, and other
organizations belonging to, or owing their existence to, the government;
sometimes (more accurately) called the central authorities.
b) An agent who consumes goods or services.
c) All people living under one roof and taking, or subject to others taking for
them, joint financial decisions.
d) The unit that employs factors of production to produce commodities that it
sells to other firms, to households, or to the government.
e) Any unit that makes goods or services.
8. The term “government” means:
a) In economics, all public agencies, government bodies, and other
organizations belonging to, or owing their existence to, the government;
sometimes (more accurately) called the central authorities.
b) An agent who consumes goods or services.
c) All people living under one roof and taking, or subject to others taking for
them, joint financial decisions.
d) The unit that employs factors of production to produce commodities that it
sells to other firms, to households, or to the government.
e) Any unit that makes goods or services.
9. The term “private sector” means:
a) That portion of an economy in which producers must cover their costs by
selling their output to consumers.
b) That portion of an economy in which producers must cover their costs from
some source other than sales revenue.
c) That portion of an economy in which the organizations that produce goods
and services are owned and operated by private units such as households and
firms.
d) That portion of an economy in which production is owned and operated by
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the government or by bodies created by it, such as nationalized industries.
10. The term “market sector” means:
a) That portion of an economy in which producers must cover their costs by
selling their output to consumers.
b) That portion of an economy in which producers must cover their costs from
some source other than sales revenue.
c) That portion of an economy in which the organizations that produce goods
and services are owned and operated by private units such as households and
firms.
d) That portion of an economy in which production is owned and operated by
the government or by bodies created by it, such as nationalized industries.
11. The term “public sector” means:
a) That portion of an economy in which producers must cover their costs by
selling their output to consumers.
b) That portion of an economy in which producers must cover their costs from
some source other than sales revenue.
c) That portion of an economy in which the organizations that produce goods
and services are owned and operated by private units such as households and
firms.
d) That portion of an economy in which production is owned and operated by
the government or by bodies created by it, such as nationalized industries.
12. The term “factor markets” as factor of production means:
a) A market in which goods are sold at prices that violate some legally imposed
pricing restriction.
b) An agreement among a group of countries to have free trade among
themselves, a common set of barriers to trade with other countries, and free
movement of labour and capital among themselves.
c) A market in which there are no sunk costs of entry or exit, so that potential
entry may hold the profits of existing firms to low levels—zero in the case
of perfect contestability.
d) Markets where factor services are bought and sold.
e) Markets where goods and services are bought and sold.
13. The term “black market” means:
a) A market in which goods are sold at prices that violate some legally imposed
pricing restriction.
b) An agreement among a group of countries to have free trade among
themselves, a common set of barriers to trade with other countries, and free
movement of labour and capital among themselves.
c) A market in which there are no sunk costs of entry or exit, so that potential
entry may hold the profits of existing firms to low levels—zero in the case
of perfect contestability.
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d) Markets where factor services are bought and sold.
e) Markets where goods and services are bought and sold.
14. The term “goods markets” means:
a) A market in which goods are sold at prices that violate some legally imposed
pricing restriction.
b) An agreement among a group of countries to have free trade among
themselves, a common set of barriers to trade with other countries, and free
movement of labour and capital among themselves.
c) A market in which there are no sunk costs of entry or exit, so that potential
entry may hold the profits of existing firms to low levels—zero in the case
of perfect contestability.
d) Markets where factor services are bought and sold.
e) Markets where goods and services are bought and sold.
15. What is the act of making goods and services?
a) consumption.
b) consumption expenditure
c) demand
d) production
e) productive efficiency
f) supply
16. What is the act of using goods and services to satisfy wants?
a) consumption
b) consumption expenditure
c) demand .
d) production
e) productive efficiency.
f) supply
17. The term “demand” means:
a) The act of using goods and services to satisfy wants.
b) The amount that individuals spend on purchasing goods and services for
consumption.
c) The entire relationship between the quantity of a commodity that buyers
wish to purchase per period of time and the price of that commodity, other
things being equal.
d) The act of making goods and services.
e) Production of any output at the lowest attainable cost for that level of output,
so that it is impossible to reallocate resources and produce more of one
output without simultaneously producing less of some other output.
f) The whole relation between the quantity supplied of some commodity and
its own price.
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18. The term “supply” means:
a) The act of using goods and services to satisfy wants.
b) The amount that individuals spend on purchasing goods and services for
consumption.
c) The entire relationship between the quantity of a commodity that buyers
wish to purchase per period of time and the price of that commodity, other
things being equal.
d) The act of making goods and services.
e) Production of any output at the lowest attainable cost for that level of output,
so that it is impossible to reallocate resources and produce more of one
output without simultaneously producing less of some other output.
f) The whole relation between the quantity supplied of some commodity and
its own price.
19. What is productive efficiency?
a) The act of using goods and services to satisfy wants.
b) The amount that individuals spend on purchasing goods and services for
consumption.
c) The entire relationship between the quantity of a commodity that buyers
wish to purchase per period of time and the price of that commodity, other
things being equal.
d) The act of making goods and services.
e) Production of any output at the lowest attainable cost for that level of output,
so that it is impossible to reallocate resources and produce more of one
output without simultaneously producing less of some other output.
f) The whole relation between the quantity supplied of some commodity and
its own price.
20. What are names of goods, which the quantity demanded of one is
negatively related to the price of the other?
a) commodities
b) complements
c) final goods and services
d) substitutes
21. What are names of goods if the quantity demanded of one is positively
related to the price of the other?
a) commodities
b) complements
c) final goods and services
d) substitutes
22. The term “final goods and services” means:
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a) A term that usually refers to basic goods, such as wheat and iron ore, that are
produced by the primary sector of the economy. Sometimes also used by
economists to refer to all goods and services.
b) Two goods for which the quantity demanded of one is negatively related to
the price of the other.
c) The outputs of the economy after eliminating all double counting, i.e.
excluding all intermediate goods.
d) Two goods are substitutes if the quantity demanded of one is positively
related to the price of the other.
23. Opposite inferior good:
a) Ciffen good
b) normal good
c) investment good
d) public good
24. The term “Ciffen good” means:
a) A good with a positively sloped demand curve.
b) A commodity with a negative income elasticity; demand for it diminishes
when income increases.
c) A commodity whose demand increases when income increases.
d) The goods and services that result from the process of production
25. What is name of an economy in which the decisions of individuals and
firms (as distinct from the central authorities) exert the major influence over
the allocation of resources?
a) command
b) free-market economy
c) mixed economy
d) traditional economic system
26. What is name of an economy which the decisions of the central authorities
(as distinct from households and firms) exert the major influence over the
allocation of resources and the distribution of income?
a) free-market economy
b) mixed economy
c) traditional economic system
d) command economy
27. What is name of an economy in which some decisions about the allocation
of resources are made by firms and households and some are made by the
government?
a) command economy
b) free-market economy.
c) mixed economy
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d) traditional economic system
28. The market structure in which the industry contains only one firm
a) monopolistic competition
b) monopoly
c) oligopoly
d) perfect competition
29. The market structure in which all firms in an industry are price-takers
and in which there is freedom of entry into, and exit from, the industry
e) monopolistic competition
f) monopoly
g) oligopoly
h) perfect competition
30. The market structure in which there are many sellers and freedom of
entry but in which each firm sells a differentiated version of some generic
product and, as a result, faces a negatively sloped demand curve for its own
product.
a) monopolistic competition
b) monopoly
c) oligopoly
d) perfect competition
31. What is curve showing the extent of departure from equality of income
distribution? It graphs the proportion of total income earned by all people up
to each stated point in the income distribution, such as the proportion earned
by the bottom quarter, the bottom half, and the bottom three-quarters.
a) demand curve
b) Laffer curve
c) Phillips curve
d) Lorenz curve
e) supply curve
32. What is curve showing the quantity of some commodity that households
would like to buy at each possible price?
a) demand curve
b) Laffer curve
c) Phillips curve
d) Lorenz curve
e) supply curve
33. What is curve that relates the percentage rate of change of money wages
(measured at an annual rate) to the level of unemployment (measured as the
percentage of the working population unemployed)?
185
a)
b)
c)
d)
e)
demand curve
Laffer curve
Phillips curve
Lorenz curve
supply curve
34. What is curve showing the quantity of some commodity that producers
wish to make and sell per period of time and the price of that commodity,
ceteris paribus?
a) demand curve
b) Laffer curve
c) Phillips curve
d) Lorenz curve
e) supply curve
35. What is gross national product (CNP)?
a) The value of total output actually produced in the whole economy over some
period, usually a year (although quarterly data are also available).
b) A measure of what a nation earns from all its economic activity throughout
the world. It differs from gross domestic product, which measures only what
is produced in the domestic economy (some of which may generate income
for non-residents). Used to be known as gross national product.
c) A National Accounts concept equivalent to gross national income used prior
to 1998. It measures income earned by domestic residents in return for
contributions to current production, whether production is located at home
or abroad, and is equal to GDP plus net property income from abroad.
d) The after-tax income that individuals have at their disposal to spend or to
save.
e) Income earned by or paid to individuals before personal income taxes are
deducted.
36. What is disposable income?
a) The value of total output actually produced in the whole economy over some
period, usually a year (although quarterly data are also available).
b) A measure of what a nation earns from all its economic activity throughout
the world. It differs from gross domestic product, which measures only what
is produced in the domestic economy (some of which may generate income
for non-residents). Used to be known as gross national product.
c) A National Accounts concept equivalent to gross national income used prior
to 1998. It measures income earned by domestic residents in return for
contributions to current production, whether production is located at home
or abroad, and is equal to GDP plus net property income from abroad.
d) The after-tax income that individuals have at their disposal to spend or to
save.
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e) Income earned by or paid to individuals before personal income taxes are
deducted.
37. What is gross domestic product?
a) The value of total output actually produced in the whole economy over some
period, usually a year (although quarterly data are also available).
b) A measure of what a nation earns from all its economic activity throughout
the world. It differs from gross domestic product, which measures only what
is produced in the domestic economy (some of which may generate income
for non-residents). Used to be known as gross national product.
c) A National Accounts concept equivalent to gross national income used prior
to 1998. It measures income earned by domestic residents in return for
contributions to current production, whether production is located at home
or abroad, and is equal to GDP plus net property income from abroad.
d) The after-tax income that individuals have at their disposal to spend or to
save.
e) Income earned by or paid to individuals before personal income taxes are
deducted.
38. What is gross national income?
a) The value of total output actually produced in the whole economy over some
period, usually a year (although quarterly data are also available).
b) A measure of what a nation earns from all its economic activity throughout
the world. It differs from gross domestic product, which measures only what
is produced in the domestic economy (some of which may generate income
for non-residents). Used to be known as gross national product.
c) A National Accounts concept equivalent to gross national income used prior
to 1998. It measures income earned by domestic residents in return for
contributions to current production, whether production is located at home
or abroad, and is equal to GDP plus net property income from abroad.
d) The after-tax income that individuals have at their disposal to spend or to
save.
e) Income earned by or paid to individuals before personal income taxes are
deducted.
39. What is personal income?
a) The value of total output actually produced in the whole economy over some
period, usually a year (although quarterly data are also available).
b) A measure of what a nation earns from all its economic activity throughout
the world. It differs from gross domestic product, which measures only what
is produced in the domestic economy (some of which may generate income
for non-residents). Used to be known as gross national product.
c) A National Accounts concept equivalent to gross national income used prior
to 1998. It measures income earned by domestic residents in return for
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contributions to current production, whether production is located at home
or abroad, and is equal to GDP plus net property income from abroad.
d) The after-tax income that individuals have at their disposal to spend or to
save.
e) Income earned by or paid to individuals before personal income taxes are
deducted.
40. What does term “disequilibrium” mean?
a) The total desired purchases of all the nation's buyers of final output.
b) The total desired output of all the nation's producers.
c) A state of imbalance between opposing forces so that there is a tendency to
change, as when quantity demanded does not equal quantity supplied at the
prevailing price.
d) The price at which quantity demanded equals quantity supplied.
e) The amount that is bought and sold at t equilibrium price.
41. What are the total desired purchases of all the nation's buyers of final
output?
a) aggregate demand {AD)
b) aggregate supply (AS)
c) disequilibrium
d) equilibrium price
e) equilibrium quantity
42. What does “aggregate supply” mean?
a) The total desired purchases of all the nation's buyers of final output.
b) (The total desired output of all the nation's producers.
c) A state of imbalance between opposing forces so that there is a tendency to
change, as when quantity demanded does not equal quantity supplied at the
prevailing price.
d) The price at which quantity demanded equals quantity supplied.
e) The amount that is bought and sold at t equilibrium price.
43. What does “equilibrium price” mean?
a) The total desired purchases of all the nation's buyers of final output.
b) The total desired output of all the nation's producers.
c) A state of imbalance between opposing forces so that there is a tendency to
change, as when quantity demanded does not equal quantity supplied at the
prevailing price.
d) The price at which quantity demanded equals quantity supplied.
e) The amount that is bought and sold at t equilibrium price.
44. What is equilibrium quantity?
a) The total desired purchases of all the nation's buyers of final output.
b) The total desired output of all the nation's producers.
188
c) A state of imbalance between opposing forces so that there is a tendency to
change, as when quantity demanded does not equal quantity supplied at the
prevailing price.
d) The price at which quantity demanded equals quantity supplied.
e) The amount that is bought and sold at t equilibrium price.
45. The shortfall of current revenue below current expenditure, usually with
reference to the government, is…
a) balanced budget
b) balanced growth
c) budget deficit d) budget surplus
46. A situation in which current revenue is exactly equal to current
expenditure is…
a) balanced budget
b) balanced growth
c) budget deficit
d) budget surplus
47. The excess of current revenue over current expenditure, usually with
reference to the government is…
a) balanced budget
b) balanced growth.
c) budget deficit
d) budget surplus
48. This occurs when most major sectors of the economy grow together at
similar rates.
a) balanced budget
b) balanced growth
c) budget deficit
d) budget surplus
49. The “index number” means…
a) A time-period chosen for comparison purposes in order to express or
compute index numbers. Values in all other periods are expressed as
percentages of the base-period value.
b) A base period that is a year.
c) Any particular period that is being compared with a base period by an index
number.
d) An observation in a given time-period expressed as a ratio to the observation
in a base period and then multiplied by 100.
e) A statistical measure of the average percentage change in some group of
prices relative to some base period.
189
50. A base period that is a year called …
a) base period
b) base year
c) given period
d) index number
e) price index
51. A time-period chosen for comparison purposes in order to express or
compute index numbers.
a) base period
b) base year
c) given period
d) index number
e) price index
52. The “given period” means…
a) A time-period chosen for comparison purposes in order to express or
compute index numbers. Values in all other periods are expressed as
percentages of the base-period value.
b) A base period that is a year.
c) Any particular period that is being compared with a base period by an index
number.
d) An observation in a given time-period expressed as a ratio to the observation
in a base period and then multiplied by 100.
e) A statistical measure of the average percentage change in some group of
prices relative to some base period.
53. The “price index” is …
a) A time-period chosen for comparison purposes in order to express or
compute index numbers. Values in all other periods are expressed as
percentages of the base-period value.
b) A base period that is a year.
c) Any particular period that is being compared with a base period by an index
number.
d) An observation in a given time-period expressed as a ratio to the observation
in a base period and then multiplied by 100.
e) A statistical measure of the average percentage change in some group of
prices relative to some base period.
54. What is name of prolonged period of very low economic activity with very
high unemployment and high excess capacity?
a) boom
b) depression
c) economic growth
d) slump.
190
55. What “business cycles” means?
a) Fluctuations in the general level of activity in an economy that affect many
sectors at roughly the same time, though not necessarily to the same extent.
In recent times, the period from the peak of one cycle to the peak of the next
has varied in the range of five to ten years. Used to be known as trade
cycles.
b) A prolonged period of very low economic activity with very high
unemployment and high excess capacity.
c) The positive trend in the nation's total real output or GDP over the long
term.
d) Long cycles in economic activity of around fifty years' duration. Sometimes
referred to as long waves.
56. What “Kondratieff cycles” means?
a) Fluctuations in the general level of activity in an economy that affect many
sectors at roughly the same time, though not necessarily to the same extent.
In recent times, the period from the peak of one cycle to the peak of the next
has varied in the range of five to ten years. Used to be known as trade
cycles.
b) A prolonged period of very low economic activity with very high
unemployment and high excess capacity.
c) The positive trend in the nation's total real output or GDP over the long
term.
d) Long cycles in economic activity of around fifty years' duration. Sometimes
referred to as long waves.
57. The boom is…
a) Period of high output and high employment.
b) A prolonged period of very low economic activity with very high
unemployment and high excess capacity.
c) The positive trend in the nation's total real output or GDP over the long
term.
d) A period of low output and low employment.
58. The positive trend in the nation's total real output or GDP over the long
term is …
a) boom
b) depression
c) economic growth
d) slump
60. A period of low output and low employment is…
a) business cycles
b) depression
191
c) economic growth
d) slump
61. The tern “stagflation” means …
a) Unemployment that occurs when a person is willing to accept a job at the
going wage rate but cannot find such a job.
b) A positive rate of growth of the general price level.
c) The simultaneous occurrence of a recession (with its accompanying high
unemployment) and inflation.
d) Unemployment that occurs when there is a job available but the unemployed
person is not willing to accept it at the existing wage rate.
e) The total of the employed, the self-employed, and the unemployed, i.e. those
who have a job plus those who are looking for work.
62. The tern “inflation” means
a) Unemployment that occurs when a person is willing to accept a job at the
going wage rate but cannot find such a job.
b) A positive rate of growth of the general price level.
c) The simultaneous occurrence of a recession (with its accompanying high
unemployment) and inflation.
d) Unemployment that occurs when there is a job available but the unemployed
person is not willing to accept it at the existing wage rate.
e) The total of the employed, the self-employed, and the unemployed, i.e. those
who have a job plus those who are looking for work.
63. Unemployment that occurs when a person is willing to accept a job at the
going wage rate but cannot find such a job called…
a) involuntary unemployment
b) stagflation
c) voluntary unemployment
d) working population
64. Unemployment that occurs when there is a job available but the
unemployed person is not willing to accept it at the existing wage rate called…
a) involuntary unemployment
b) inflation
c) voluntary unemployment
d) working population
65. The total of the employed, the self-employed, and the unemployed, i.e.
those who have a job plus those who are looking for work called…
a) involuntary unemployment b) inflation
c) stagflation.
d) voluntary unemployment
192
e) working population
66. A tax that takes the same percentage of people's income whatever the
level of their income called…
a) ad valorem tax
b) progressive tax
c) proportional tax
d) regressive tax
e) specific tax
67. A tax that takes a smaller percentage of people's incomes the larger their
income is
a) ad valorem tax
b) progressive tax
c) proportional tax
d) regressive tax
e) specific tax
68. The specific tax means …
a) A tax levied as a percentage of the value of some transaction.
b) A tax that takes a larger percentage of people's income the larger their
income is.
c) A tax that takes the same percentage of people's income whatever the level
of their income.
d) A tax that takes a smaller percentage of people's incomes the larger their
income is. Compare progressive tax.
e) A tax expressed as so much per unit, independent of its price.
69. The ad valorem tax is…
a) A tax levied as a percentage of the value of some transaction.
b) A tax that takes a larger percentage of people's income the larger their
income is.
c) A tax that takes the same percentage of people's income whatever the level
of their income.
d) A tax that takes a smaller percentage of people's incomes the larger their
income is. Compare progressive tax.
e) A tax expressed as so much per unit, independent of its price.
70. The proportional tax is …
a) A tax levied as a percentage of the value of some transaction.
b) A tax that takes a larger percentage of people's income the larger their
income is.
c) A tax that takes the same percentage of people's income whatever the level
of their income.
193
d) A tax that takes a smaller percentage of people's incomes the larger their
income is. Compare progressive tax.
e) A tax expressed as so much per unit, independent of its price.
71. Taxes on imported goods are…
a) direct taxes
b) indirect tax
c) net taxes
d) tariffs
72. Taxes levied on persons that can vary with the status of the taxpayer, e.g.
income tax called…
a) direct taxes
b) indirect
c) net taxes
d) tariffs
73. The indirect tax means…
a) Taxes levied on persons that can vary with the status of the taxpayer, e.g.
income tax.
b) A tax levied on a transaction that is paid by an individual by virtue of her
association with that activity and does not vary with the circumstances of the
individual who pays it, e.g. VAT on a restaurant meal.
c) Total tax receipts net of transfer payments.
d) Taxes on imported goods.
74. The net taxes means…
a) Taxes levied on persons that can vary with the status of the taxpayer, e.g.
income tax.
b) A tax levied on a transaction that is paid by an individual by virtue of her
association with that activity and does not vary with the circumstances of the
individual who pays it, e.g. VAT on a restaurant meal.
c) Total tax receipts net of transfer payments.
d) Taxes on imported goods.
75. The government's policy towards international trade, investment, and
related matters called…
a) commercial policy
b) competition policy
c) fiscal policy
d) monetary policy
76. Policy of trying to control aggregate demand (and ultimately inflation) via
the setting of short-term interest rates is
a) commercial policy
194
b) competition policy
c) fiscal policy
d) monetary policy
77. The competition policy is …
a) The government's policy towards international trade, investment, and related
matters.
b) Policy designed to prohibit the acquisition and exercise of monopoly power
by business firms.
c) Attempts to influence the aggregate demand curve by altering government
expenditures and/or taxes, thereby shifting the IS curve.
d) Policy of trying to control aggregate demand (and ultimately inflation) via
the setting of short-term interest rates.
78. The fiscal policy is …
a) The government's policy towards international trade, investment, and related
matters.
b) Policy designed to prohibit the acquisition and exercise of monopoly power
by business firms.
c) Attempts to influence the aggregate demand curve by altering government
expenditures and/or taxes, thereby shifting the IS curve.
d) Policy of trying to control aggregate demand (and ultimately inflation) via
the setting of short-term interest rates.
79. A bank that acts as banker to the commercial banking system and often to
the government as well. In the modern world it is usually a governmentowned institution that is the sole money-issuing authority and has a key role
in the setting and implementation of monetary policy.
a) cartel
b) central bank
c) industrial union
d) public corporation
80. A body set up to run a nationalized industry. It is owned by the state but
is usually under the direction of a more or less independent, state-appointed
board.
a) cartel
b) central bank
c) industrial union
d) public corporation
81. The term “cartel” means …
a) A group of firms that agree to act as if they were a single seller.
b) A bank that acts as banker to the commercial banking system and often to
the government as well. In the modern world it is usually a government195
owned institution that is the sole money-issuing authority and has a key role
in the setting and implementation of monetary policy.
c) A single union representing all workers in a given industry, whatever their
trade.
d) A body set up to run a nationalized industry. It is owned by the state but is
usually under the direction of a more or less independent, state-appointed
board.
82. The industrial union is …
a) A group of firms that agree to act as if they were a single seller.
b) A bank that acts as banker to the commercial banking system and often to
the government as well. In the modern world it is usually a governmentowned institution that is the sole money-issuing authority and has a key role
in the setting and implementation of monetary policy.
c) A single union representing all workers in a given industry, whatever their
trade.
d) A body set up to run a nationalized industry. It is owned by the state but is
usually under the direction of a more or less independent, state-appointed
board.
83. The term “autarky” means …
a) Situation existing when a country does no foreign trade.
b) An economy that engages in international trade.
c) An economy that is a price-taker for both its imports and its exports. It must
buy and sell at the world price, irrespective of the quantities that it buys and
sells.
d) A group of countries that agree to have free trade among themselves and a
common set of barriers against imports from the rest of the world.
84. The customs union is …
a) Situation existing when a country does no foreign trade.
b) An economy that engages in international trade.
c) An economy that is a price-taker for both its imports and its exports. It must
buy and sell at the world price, irrespective of the quantities that it buys and
sells.
d) A group of countries that agree to have free trade among themselves and a
common set of barriers against imports from the rest of the world.
85. An economy that is a price-taker for both its imports and its exports. It
must buy and sell at the world price, irrespective of the quantities that it buys
and sells.
a) autarky
b) open economy
c) small open economy (SOE)
d) customs union
196
86. An economy that engages in international trade is…
a) autarky
b) open economy
c) small open economy (SOE)
d) customs union
87. The diversion of the source of a member country's imports from other
countries to union members as a result of the preferential removal of tariffs
following the formation of a customs union or a free trade area.
a) dumping
b) free trade
c) protectionism.
d) trade diversion
88. An absence of any form of government interference with the free flow of
international trade.
a) dumping
b) free trade
c) protectionism
d) trade diversion
89. The term “dumping” means…
a) The selling of a commodity in a foreign country at a price below its
domestic sale price, for reasons not related to costs.
b) An absence of any form of government interference with the free flow of
international trade.
c) Any departure from free trade designed to give some protection to domestic
industries from foreign competition.
d) The diversion of the source of a member country's imports from other
countries to union members as a result of the preferential removal of tariffs
following the formation of a customs union or a free trade area.
90. The term “protectionism” means …
a) The selling of a commodity in a foreign country at a price below its
domestic sale price, for reasons not related to costs.
b) An absence of any form of government interference with the free flow of
international trade.
c) Any departure from free trade designed to give some protection to domestic
industries from foreign competition.
d) The diversion of the source of a member country's imports from other
countries to union members as a result of the preferential removal of tariffs
following the formation of a customs union or a free trade area.
91. The term “globalization” means…
a) The difference between imports and exports.
197
b) An agreement between two or more countries to abolish tariffs on all, or
most, of the trade among themselves, while each remains free to set its own
tariffs against other countries.
c) The increased world-wide interdependence of most economies. Integrated
financial markets, the sourcing of the production of components throughout
the world, the growing importance of transnational firms, and the linking of
many service activities through the new information and communications
technologies are some of its many manifestations.
d) Total exports minus total imports (X - IM).
92. The term “net exports” means ..
a) The difference between imports and exports.
b) An agreement between two or more countries to abolish tariffs on all, or
most, of the trade among themselves, while each remains free to set its own
tariffs against other countries.
c) The increased world-wide interdependence of most economies. Integrated
financial markets, the sourcing of the production of components throughout
the world, the growing importance of transnational firms, and the linking of
many service activities through the new information and communications
technologies are some of its many manifestations.
d) Total exports minus total imports (X - IM).
93. The difference between imports and exports is …
a) balance of trade
b) free trade area
c) globalization
d) net exports
94. An agreement between two or more countries to abolish tariffs on all, or
most, of the trade among themselves, while each remains free to set its own
tariffs against other countries.
a) balance of trade
b) free trade area
c) globalization
d) net exports
95. A measure of the money stock which includes currency plus current
account bank deposits. This measure is no longer reported by the Central
Bank.
a) MO
b) Ml
c) M2
d) M3
e) M4
198
96. Currency in circulation plus all sterling deposits in banks and building
societies.
a) MO
b) Ml
c) M2
d) M3
e) M4
97. In one particular month 1.2 million kilos of potatoes are sold at £1.20 per
kilo. In the next month 1.5 million kilos are sold at £1.40 per kilo. Which of
the following explanations is consistent with this observation (there may be
more than one or none at all)?
a) The price of carrots has risen, and carrots are a close substitute for potatoes.
b) The price offish has risen, and fish is a complement to potatoes.
c) Bad weather has reduced the potato crop.
d) Consumer incomes have risen, and potatoes are an inferior good.
e) Newspapers have reported that potatoes have health-giving properties, and this
has generated a shift of tastes towards potatoes.
98. Which of the following statements is true (there may be more than one or
none)?
If the price of good X rises holding all other prices and income constant:
a) the substitution effect alone will make a consumer buy more of X if X is
inferior.
b) the income effect alone will make a consumer buy more of if it is a normal
good.
c) the income effect alone will make a consumer buy less of if it an inferior good.
d) the substitution effect will make a consumer buy less of X and it is irrelevant
whether X is a normal or inferior good.
e) the consumer will buy less of good X unless it is an inferior good, in which case
she will always buy more.
99. Which of the following observed facts about an industry are inconsistent
with its being perfectly competitive?
a) Different firms use different methods of production.
b) The industry's product is extensively advertised by a trade association.
c) Individual firms devote a large fraction of their sales receipts to advertising their
own product brands.
d) There are 24 firms in the industry.
e) All firms made economic profits in 2006.
f) All firms are charging the same price.
100. Your local authority undoubtedly provides a police station, a fire
brigade, and a public library.
a) What are the market imperfections, if any, that each of these seeks to correct?
199
b) Which of these are closest to being public goods?
c) Which are furthest from being public goods?
d) What would happen if governments were prevented from offering these
services?
KEYS for exercises:
Lesson 1.
1.1. A) macroeconomics
B) microeconomics
C) between free markets and government planning
D) scarce
Lesson 2.
2.1. A) theory
B) specific quantitative formulation
C) illustrative abstraction
2.2. A, C, E
2.3. C, D, E.
Lesson 3.
3.1. A) A.Smith
B) D.Ricardo
C) A.Marshall
D) J.M.Keynes
E) M.Friedman
F) P.Samuelson
G) K.Marx
H) R.Solow
Lesson 4.
4.1. land, labour, capital, entrepreneurship.
Lesson 5.
5.1. A) a traditional economic system
B) a command economic system
C) a pure market economic system
D) a mixed economic system
Lesson 6.
6.1. A) market economy
B) a double coincidence of wants
C) eliminates
D) medium of exchange
200
E) a store of value and a unit of account
F) stable
G) constant
H) paper
I) monopoly
J) the money supply or the money stock
Lesson 7.
7.1 A) quantity demanded
B) 1) The price of the product. 2) The prices of other products. 3) The
consumer's income and wealth. 4) The consumer's tastes. 5) Various individualspecific or environmental factors.
C) Qdn=f(pn, p1…pn-1, Y, S)
D) substitutes
E) complements
F) normal good
G) inferior goods
H) Qsn=f (pn, F1, … Fm)
I) quantity supplied
J) price elasticity of demand
K) income elasticity of demand
L) cross-elasticity of demand
M) price elasticity of supply
Lesson 9.
9.1. A) excess demand
B) excess supply
C) equilibrium
D) general price level
E) intermediate goods and services
F) final goods and services
G) a circular flow diagram
H) the System of National Accounts
I) GDP spending-based
J) GDP income-based
K) GDP = C + I+ G+ (X - IM)
L) 1) operating surplus, 2) mixed incomes, 3) compensation of employees
M) produced in that country
N) received by this country
O) Personal income
P) Personal disposable income
GDP at current prices
Q) Implicit deflator
=
x 100 %.
GDP at base-period prices
201
Lesson 10.
10.1. A) the demand for money
B) not synchronized
C) synchronized
D) wealth
E) the rate of interest
F) the price level
G) also double
H) Demand-pull inflation
I) Cost-push Inflation
Lesson 11.
11.1. A) net taxes
B) The budget balance
C) a budget surplus
D) a budget deficit
E) rises … falls
F) Horizontal equity … vertical equity
G) paternalism
H) An indirect tax …. direct taxes
I) An ad valorem tax … a specific or per-unit tax
J) progressivity
K) A progressive tax
L) A regressive tax
M) A proportional tax
Lesson 14.
14.1. A) The product, the place, the price, and the promotion
B) 1) marketing information, 2) buying, 3) selling, 4) transporting, 5)
storing, 6) storing, 7) credit-granting, 8) risk-taking, 9) pricing, 10) servicing, 11)
standardizing and grading
C) (1) The marketing department becomes the main management force in a
company. (2) The company becomes completely consumer-oriented.
D) (1) defining the problem, (2) collecting secondary data, (3) collecting
primary data, (4) compiling and collating the data, and (5) analyzing and
interpreting the results.
E) 1) Situation review 2) External environment assessment – Internal
environment assessment 3) SWOT analysis 4) Objectives 5) Target audiences 6)
Strategies 7)Tactics 8)Measurement 9) Budgeting
Lesson 15.
15.1 A) making and carrying out decisions within a certain system
B) people in an organization
C) for finance
D) selling of goods
202
E) planning, organizing, coordinating, directing and controlling
F) organization of production and sales of products
G) Product Life Cycle
H) introduction — growth — maturity — decline
Lesson 16.
16.1 A) The character of present-day weapons leaves no country any hope of
safeguarding itself exclusively by military-technological means. The task of
ensuring security is seen increasingly as a political problem.
B) Security can only be universal and mutual.
C) There is an objective need for ail states of the world to live in peace
with each other and to cooperate on a basis of equality and mutual benefit.
D) the struggle against the nuclear threat, against the arms race, for the
preservation and strengthening of universal peace.
Lesson 17.
17.1 A) international trade.
B) open economy, closed economy.
C) autarky.
D) gains from trade.
E)
Index of export prices
Terms of trade =
Index of import prices
X 100%
F) a favourable change
G) an unfavourable change
H) commercial policy
I) a free trade policy
J) protectionism.
K) non-tariff barriers
L) strategic trade policies
M) dumping, an import duty
N) non-tariff barrier
O) the General Agreement on Tariffs and Trade (GATT)
P) the World Trade Organisation (WTO)
Q) A customs union
R) A common market
S) An economic union
203
BIBLIOGRAPHY
1. Arrow, K. (1962). 'The Economic Implications for Learning by Doing'.
Review of Economic Studies, vol. 29, pp. 155-73.
2. Barber, N. (2004). Kindness in a Cruel World: The Evolution of Altruism.
New York: Prometheus.
3. Bean, C. (2005). 'European Employment: The Evolution of Facts and Ideas'.
Economic Policy, vol. 21, pp. 47-51.
4. Bhagwati, J. (2002). Free Trade Today. Princeton, NJ: Princeton University
Press.
5. Blanchard, O. (2006). 'European Unemployment: The Evolution of Facts
and Ideas'. Economic Policy, vol. 21, pp. 5-47.
6. Blaug, M. (1997). Economic Theory in Retrospect. Cambridge: Cambridge
University Press.
7. Chandler, A. D. Jr (1990). Scale and Scope: The Dynamics of Industrial
Capitalism. Cambridge, Mass.: Harvard University Press.
8. Department of Trade and Industry (DTI) (2005). Government Evidence to
the Low Pay Commission on the National Minimum Wage. London: DTI;
atwww.dti.gov.uk/files/filel4450.pdf
9. Dickens, R. and Draca, M. (2005). The Employment Effects of the October
2003 Increase in the National Minimum Wage. London: Low Pay
Commission.
10. Economics. Lipsey & Chrystal. Eleventh edition. – OXRORD University
Press, 2007.
11.HM Treasury (2005). Pre-Budget Report. London: HM Treasury.
12.International Monetary Fund (IMF) (various issues). World Economic
Outlook. Washington: IMF.
13.Kaounides, L. C. (1995). 'New Materials and Simultaneous Engineering in
the Car Industry: The Alcoa-Audi Alliance in Lightweight Aluminium Car
Body Structures'. Based on L. C. Kaounides, Advanced Material
Management and Government Strategies in the 1990s, Financial Times
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14.Keynes, J. M. (1936). The General Theory of Employment, Interest and
Money. London: Macmillan.
15.Kreuger, A. (2002). Speech given to the NBER on 17 July; available at
http://www.imf.org/external/np/speeches/2002/ 071702.htm
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экономических
специальностей:
учебник/
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Е.Н.Комарова.- 2-е изд., испр. – М.: АСТ: Астрель, 2005.
204
GLOSSARY
 absolute advantage - The advantage that one region is said to have over
another in the production of some commodity when an equal quantity of
resources can produce more of that commodity in the first region than in the
second. Compare comparative advantage.
 absolute price - The price of a good or a service expressed in monetary
units. Also called a money price.
 accelerator theory of investment - The theory that the level of investment
depends on the rate of change of output.
 accommodation - Said to occur when the monetary authorities increase the
money supply in response to a negative aggregate supply shock.
Accommodation has the effect of offsetting the downward impact of the
shock on real GDP at the cost of a permanently higher price level.
 actual GDP - The level of GDP actually produced over a given period.
 AD curve - See aggregate demand curve.
 ad valorem tax - A tax levied as a percentage of the value of some
transaction.
 adaptive expectations - The expectation of the future value of a variable
formed on the basis of an adjustment which is some proportion of the error
in expectations made last period. The error is the difference between what
was expected last period and what actually happened.
 administered price - A price that is set by the decisions of individual firms
rather than by impersonal market forces.
 adverse selection - The tendency for people most at risk to insure, while
people least at risk do not, so that the insurers get an unrepresentative
sample of clients within any one fee category.
 agents - All decision-makers, including consumers, workers, firms, and
government bodies.
 aggregate demand {AD) - The total desired purchases of all the nation's
buyers of final output.
 aggregate demand curve - A curve that plots all combinations of the price
level and national income that yield equilibrium in the goods and the asset
markets—i.e. that yield IS-LM equilibrium.
 aggregate demand shock - A shift in the aggregate demand curve resulting
from an autonomous change in exogenous expenditures or the money supply
(or equivalently, a policy-induced change in interest rates).
 aggregate (desired) expenditure (AE) - The total volume of purchases of
currently produced goods and services that all spending units in the
economy wish to make.
 aggregate production function - The technical relation which expresses the
maximum national output that can be produced with each possible
combination of capital, labour, and other resource inputs. See also
production function.
 aggregate spending - See aggregate expenditure.
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 aggregate supply (AS) - The total desired output of all the nation's
producers.
 aggregate supply curve - A curve relating the economy's producers' total
desired output, Y, to the price level, P.
 aggregate supply shock - A shift in the aggregate supply curve resulting
from an exogenous change in input prices or from technical change
(exogenous or endogenous). One example is the oil price shocks of the
1970s.
 allocative efficiency - Situation in which production cannot be rearranged in
order to make someone made better off without at the same time making
someone else worse off.
 allocative inefficiency - Situation in which production can be rearranged to
make someone better off while making no one else worse off.
 appreciation - When a change in the free market exchange rate raises the
value of one currency relative to others.
 arbitrage - Trading activity based on buying where a product is cheap and
selling where it has a higher price (from the French word arbitrer: to referee
or arbitrate). Arbitrage activity helps to bring prices closer in different
segments of the market.
 arc elasticity - A measure of the average responsiveness of quantity to price
over an interval of the demand curve.
 asymmetric information - A situation in which some economic agents have
more information than others and this affects the outcome of a bargain
between them.
 auction prices - Prices that are set by the continuous bidding of buyers,
often against each other.
 autarky - Situation existing when a country does no foreign trade.
 automatic fiscal stabilizers - Stabilizers that arise because the value of
some tax revenues and benefits changes with the level of economic activity.
For example, income tax revenue rises as personal incomes rise, corporation
tax revenue increases with company profits, and unemployment benefit falls
as employment increases.
 autonomous expenditures - Expenditures that are determined outside the
domestic economy or are independent of the current level of GDP.
 autonomous variable - See exogenous variable.
 average fixed costs {AFC) - Total fixed costs divided by the number of
units produced.
 average product (AP) - Total output divided by the number of units of the
variable factor used in its production.
 average propensity to consume (APC) Total consumption expenditure
divided by total national income, CIY.
 average propensity to import - Total imports divided by total national
income (or expenditure), IM/Y.
 average propensity to save (APS) - Total saving divided by total national
income, SIY. Also known as the savings ratio.
206
 average propensity to tax - Total tax revenue divided by total national
income, T/Y.
 average revenue (AR) - Total revenue divided by the number of units sold.
 average total cost (ATC) - The total cost of producing any given output
divided by the number of units produced, i.e. the cost per unit.
 average variable cost (AVC) - Total variable cost divided by the number of
units produced. Also called unit cost.
 balance of payments accounts - A summary record of a country's
transactions involving payment or receipts of foreign exchange.
 balance of trade - The difference between imports and exports.
 balanced budget - A situation in which current revenue is exactly equal to
current expenditure.
 balanced budget multiplier - The change in GDP divided by the balanced
budget change in government expenditure that brought it about.
 balanced growth - This occurs when most major sectors of the economy
grow together at similar rates.
 barriers to entry - Anything that prevents new firms from entering an
industry that is earning profits.
 barter - The trading of goods directly for other goods.
 base period - A time-period chosen for comparison purposes in order to
express or compute index numbers. Values in all other periods are expressed
as percentages of the base-period value.
 base rate The interest rate quoted by UK banks as the reference rate for
much of their loan business. For example, a company may be given a loan at
'base plus 2 per cent'. The base rate changes periodically when the monetary
authorities signal that they want money market rates in general to change.
The equivalent term used by US banks is 'prime rate'.
 base year - A base period that is a year.
 basic prices - Used in National Accounts to refer to prices received by
producers that exclude taxes on products, as in 'gross value added at basic
prices'.
 BB line - The locus of levels of the interest rate and real GDP for which the
desired current account balance of payments surplus (deficit) just equals the
desired capital account deficit (surplus).
 beta - The relationship between the price of a share and the share market in
general. A beta of 1 implies a perfect correlation between the share in
question and the market.
 bill - A tradable security, usually with an initial maturity of up to six
months, which pays no explicit interest and so trades at a discount to its
maturity value.
 black market - A market in which goods are sold at prices that violate some
legally imposed pricing restriction.
 bond - In economic theory, any evidence of a debt carrying a legal
obligation to pay interest and repay the principal at some stated future time.
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This concept covers many different debt instruments that are found in
practice.
boom - Period of high output and high employment. See also slump.
break-even price - The price at which a firm is just able to cover all of its
costs, including the opportunity cost of capital. See also shutdown price.
budget balance - See balanced budget.
budget deficit - The shortfall of current revenue below current expenditure,
usually with reference to the government.
budget line - Line showing all those combinations of commodities that are
just obtainable, given a household's income and the prices of all
commodities.
budget surplus - The excess of current revenue over current expenditure,
usually with reference to the government.
built-in stabilizer - Anything that reduces the economy's cyclical
fluctuations and is activated without a conscious government decision. See
also automatic fiscal stabilizers.
business cycles - Fluctuations in the general level of activity in an economy
that affect many sectors at roughly the same time, though not necessarily to
the same extent. In recent times, the period from the peak of one cycle to the
peak of the next has varied in the range of five to ten years. Used to be
known as trade cycles.
buyout - What happens when a group of investors buys up a controlling
interest in a firm.
capacity - The output that corresponds to the minimum short-run average
total cost.
capital - All those man-made aids to further production, such as tools,
machinery, and factories, which are used up in the process of making other
goods and services rather than being consumed for their own sake.
capital and financial account - Part of the balance of payments accounts
that records international transactions in assets and liabilities.
capital consumption allowance - An estimate of the amount by which the
capital stock is depleted through wear and tear. Also called depreciation.
capital goods - See investment goods.
capital inflow - This arises when overseas residents buy assets in the
domestic economy or domestic residents sell foreign assets.
capital-labour ratio - The ratio of the amount of capital to the amount of
labour used in production.
capital outflow - This arises when overseas residents sell assets in the
domestic economy or domestic residents buy foreign assets.
capital stock - The total quantity of physical capital in existence.
capital widening - Increasing the quantity of capital without changing the
proportions in which the factors of production are used.
cartel - A group of firms that agree to act as if they were a single seller.
cash base - See high-powered money and MO.
central authorities - See government.
208
 central bank - A bank that acts as banker to the commercial banking system
and often to the government as well. In the modern world it is usually a
government-owned institution that is the sole money-issuing authority and
has a key role in the setting and implementation of monetary policy.
 centrally planned economy - See command economy.
 ceteris paribus - 'Other things being equal': commonly used to describe a
situation in which all but one of the independent variables are held constant
in order to study the effect that a change in the remaining independent
variable has on the variables of interest
 change in demand - A shift in the whole demand curve, i.e. a change in the
amount that will be bought at each price.
 change in the quantity demanded - An increase or decrease in the specific
quantity bought at a specified price, represented by a movement along a
demand curve.
 circular flow of income - The flow of expenditures on output and factor
services passing between domestic (as opposed to foreign) firms and
domestic households.
 classical dichotomy - Concept in classical economics that monetary forces
could influence the general price level but had no effect on real activity.
Related to the concept of neutrality of money.
 classical economics - Usually refers to the body of thought on economics
that evolved in the hundred years or so before the 1930s; often associated
(probably incorrectly) with the notion that government policy cannot
influence the level of economic activity. Contrasted with Keynesian
economics, which attempted to break down the classical dichotomy.
 closed economy - An economy that does not engage in international trade
(autarky).
 closed shop - A firm in which only union members can be employed.
Closed shops may be either 'pre-entry', where the worker must be a member
of the union before being employed, or 'post-entry', where the worker must
join the union on becoming employed.
 Coase theorem - The proposition that, if those creating an externality and
those affected by it can bargain together with zero transaction costs, the
externality will be internalized independently of whether it is the creators of
or the sufferers from the externality who have the property rights.
 collective consumption goods See public goods.
 command economy - An economy in which the decisions of the central
authorities (as distinct from households and firms) exert the major influence
over the allocation of resources and the distribution of income. Also called a
centrally planned economy.
 commercial policy - The government's policy towards international trade,
investment, and related matters.
 commodities - A term that usually refers to basic goods, such as wheat and
iron ore, that are produced by the primary sector of the economy. Sometimes
also used by economists to refer to all goods and services.
209
 common market - An agreement among a group of countries to have free
trade among themselves, a common set of barriers to trade with other
countries, and free movement of labour and capital among themselves.
 common property resource - A resource that is owned by no one and may
be used by anyone.
 comparative advantage - The ability of one nation (or region or individual)
to produce a commodity at a lower opportunity cost in terms of other
products forgone than another nation (or region or individual). Compare
absolute advantage.
 comparative statics - Short for 'comparative-static equilibrium analysis':
studying the effect of a change in some variable by comparing the positions
of static equilibrium before and after the change.
 compensating variation - The amount of income that has to be taken away
from a consumer following a price fall in one good
 in order to return the consumer to the original indifference curve and thereby
leave her feeling equally well off.
 competition policy - Policy designed to prohibit the acquisition and exercise
of monopoly power by business firms.
 complements - Two goods for which the quantity demanded of one is
negatively related to the price of the other.
 concentration ratio - The fraction of total market sales (or some other
measure of market occupancy) accounted for by a specific number of the
industry's largest firms, four-firm and eight-firm concentration ratios being
the most frequently used.
 constant returns to scale - Situation existing when a firm's output increases
at the same rate as all its inputs increase.
 consumer - An agent who consumes goods or services.
 consumers' surplus - The difference between the total value that consumers
place on all units consumed of a commodity and the payment they must
make to purchase that amount of the commodity.
 consumption - The act of using goods and services to satisfy wants.
 consumption expenditure - The amount that individuals spend on
purchasing goods and services for consumption.
 consumption function - The relationship between personal planned
consumption expenditure and the variables that affect it, such as disposable
income and wealth.
 contestable market - A market in which there are no sunk costs of entry or
exit, so that potential entry may hold the profits of existing firms to low
levels—zero in the case of perfect contestability.
 co-operative solution - A situation in which existing firms co-operate to
maximize their joint profits.
 cost minimization - An implication of profit maximization that the firm will
choose the method that produces any specific output at the lowest attainable
cost.
210
 creative destruction - Schumpeter's theory that high profits and wages
earned by monopolistic or oligopolistic firms and unions are the spur for
others to invent cheaper or better substitute products and techniques which
allow their suppliers to gain some of these profits.
 credibility - The extent to which actors in the private sector of the economy
believe that the government will carry out the policy it promises in the
future. Important in policy analysis in macro models which assume rational
expectations, since expectations of future policy action influence current
behaviour.
 cross-elasticity of demand - The responsiveness of demand for one
commodity to changes in the price of another, defined as the percentage
change in quantity demanded of one commodity divided by the percentage
change in the price of another commodity.
 cross-sectional data - A number of observations on the same variable, such
as individuals' savings or the price of eggs, all taken at the same time but in
different places or for different agents.
 current account - Account recording all international transactions related to
goods and services.
 customs union - A group of countries that agree to have free trade among
themselves and a common set of barriers against imports from the rest of the
world.
 cyclical unemployment - See demand-deficient unemployment.
 debt - Anything that is owed by one agent to another. In the context of
corporate finance this applies to bonds or bank loans, but not equity.
 debt deflation - A fall in aggregate demand that is associated with falling
asset values, causing a negative wealth effect on consumption. It could also
involve a decline in investment as investors wait for asset values to stop
falling.
 debt instruments - Any written documents that record the terms of a debt,
often providing legal proof of the conditions under which interest will be
paid and the principal repaid.
 decision lag - The time it takes to assess a situation and decide what
corrective action should be taken.
 decreasing returns to scale - A situation in which output increases less than
proportionately to inputs as the scale of production increases.
 deflation - A decrease in the general price level.
 degree of risk - A measurement of the amount of risk associated with some
action such as lending money or innovating. When the nature of the risk is
known, the degree can be measured by the variance of the probability
distribution describing the possible outcomes.
 demand - The entire relationship between the quantity of a commodity that
buyers wish to purchase per period of time and the price of that commodity,
other things being equal.
 demand curve - A graphical relation showing the quantity of some
commodity that households would like to buy at each possible price.
211
 demand-deficient unemployment - Unemployment that occurs because
aggregate desired expenditure is insufficient to put-chase all of the output of
a fully employed labour force. Also called cyclical unemployment.
 demand for money - The amount of wealth that agents in the economy wish
to hold in the form of money balances.
 demand for money function - The relation between the quantity of money
demanded and its principle determinants such as income, wealth, and
interest rates.
 demand function - A functional relation between quantity demanded and all
of the variables that influence it.
 demand management - Policies that seek to shift the aggregate demand
curve by shifting either the IS curve (fiscal policy) or the LM curve
(monetary policy).
 demand schedule - A numerical tabulation showing the quantities that are
demanded at selected prices.
 demand shock - In macroeconomics, a change of an exogenous variable
that causes the AD curve to shift.
 dependent variable - The variable that is determined by the independent
variables; e.g., in the consumption function consumption is the dependent
variable.
 depreciation - (1) The loss in value of an asset over a period of time owing
to physical wear and tear and obsolescence. (2) A fall in the free-market
value of domestic currency in terms of foreign currencies. See also capital
consumption allowance.
 depression - A prolonged period of very low economic activity with very
high unemployment and high excess capacity.
 derived demand - The demand for a factor of production that results from
the demand for the products it is used to make.
 developed countries - Usually refers to the rich industrial countries of
North America, Western Europe, Japan, and Australasia.
 developing countries - See less developed countries.
 development gap - The gap between less developed countries and
developed countries.
 differentiated product - A product that is produced in several distinct
varieties, or brands, all of which are sufficiently similar to distinguish them,
as a group, from other products (e.g. cars).
 diminishing marginal rate of substitution - The hypothesis that the less of
one commodity is presently being consumed, the less willing the consumer
will be to give up a unit of that commodity to obtain an additional unit of a
second commodity; its geometrical expression is the decreasing absolute
slope of an indifference curve as one moves along it to the right.
 direct investment - See foreign direct investment.
 direct taxes - Taxes levied on persons that can vary with the status of the
taxpayer, e.g. income tax.
212
 discount rate - The difference between the current price of a bill and its
maturity value expressed as an annualized interest rate.
 discouraged worker - Someone of working age who has withdrawn
permanently from the labour force because of the poor prospects of
employment.
 diseconomies of scale - See decreasing returns to scale.
 disembodied technical change - Technical change that is the result of
changes in the organization of production that are not embodied in specific
capital goods, e.g. improved management techniques.
 disequilibrium - A state of imbalance between opposing forces so that there
is a tendency to change, as when quantity demanded does not equal quantity
supplied at the prevailing price.
 disposable income - The after-tax income that individuals have at their
disposal to spend or to save.
 distortions - Anything that creates a deviation from some optim-ality
conditions, and thereby induces some inefficiency.
 distribution of income - The division of total national income among
various groups. See also functional and size distribution of income.
 distribution theory - The theory of what determines the way in which the
nation's total income is divided among various groups. See also functional
and size distribution of income.
 dividends - Profits that are paid out to shareholders.
 division of labour - The breaking-up of a production process into a series
of repetitive tasks, each done by a different worker.
 dominant strategy - A strategy that offers the best choices for one player
independent of what the other players do.
 double counting - In national income accounting, adding up the total
outputs of all the sectors in the economy so that the value of intermediate
goods is counted both in the sector that produces them and in the sector that
purchases them.
 dumping - The selling of a commodity in a foreign country at a price below
its domestic sale price, for reasons not related to costs.
 duopoly - An industry containing exactly two firms.
 economic growth - The positive trend in the nation's total real output or
GDP over the long term.
 economic models - A term used in several related ways: sometimes as a
synonym for theory, sometimes for a specific quantification of a general
theory, sometimes for the application of a general theory to a specific
context, and sometimes for an abstraction designed to illustrate some point
but not meant as a full theory on its own.
 economic profits - The difference between the revenues received from the
sale of an output and the full opportunity cost of the inputs used to make the
output. The cost includes the opportunity cost of the owners' capital. Also
called pure profits or simply proofs.
213
 economic rent - Any excess that a factor is paid above what is needed to
keep it in its present use.
 economic union - A combination of a currency union and a customs union
which may involve other harmonized economic policies and some common
political institutions.
 economies of scale - See increasing returns to scale.
 economies of scope - Economies achieved by a multi-product firm owing to
its overall size rather than its amount of production of any one product;
typically associated with large-scale distribution, advertising, and
purchasing and lower cost of borrowing money.
 economy - Any specified collection of interrelated marketed and nonmarketed productive activities.
 effective exchange rate - An index number of the value of a nation's
currency relative to a weighted basket of other currencies. Whereas an
exchange rate measures the rate of exchange of one currency for another,
specific, currency, changes in the effective exchange rate indicate
movements in a single currency's value against other currencies in general.
 efficiency wage - A wage rate above the market-clearing level which
enables employers to attract and keep the best workers as well as to provide
their employees with an incentive to perform well so as to avoid being
sacked.
 elastic - A percentage change in quantity that is greater than the percentage
change in price (elasticity is greater than 1).
 elasticity of demand - See price elasticity of demand.
 elasticity of supply - See price elasticity of supply.
 embodied technical change - A technical change that is the result of
changes in the form of particular capital goods.
 endogenous variable - A variable that is explained within a theory. Also
called an induced variable.
 entrepreneur - One who innovates, i.e. takes risks by introducing new
products and/or and new ways of making old products.
 entrepreneurship - The skill required to be an entrepreneur.
 entry barrier - Any natural barrier to the entry of new firms into an
industry, such as a large minimum efficient scale for firms, or any firmcreated barrier, such as a patent.
 envelope - Any curve that encloses, by being tangent to, a series of other
curves. In particular, the envelope cost curve is the LRAC curve, which
encloses the SRAC curves by being tangent to each without cutting any of
them.
 equation of exchange - MV = PT, where M is the money stock, V is the
velocity of circulation, P is the average price of transactions, and T is the
number of transactions. As usually defined, it is an identity which says that
the value of money spent is equal to the value of goods and services sold.
Howe\ with additional assumptions it provides a basis for the quantity theory
of money.
214
 equilibrium - A state of balance between opposing forces so that there is no
tendency to change.
 equilibrium differentials - Differentials in the prices of factors that persist
in equilibrium without generating forces eliminate them.
 equilibrium employment (unemployment) - The level of employment
(unemployment) achieved when GDP is at its potent level. Traditionally
referred to as full employment. Equilibrium, unemployment (frictional plus
structural) is total unemployment minus demand-deficient unemployment.
 equilibrium price - The price at which quantity demanded equals quantity
supplied.
 equilibrium quantity - The amount that is bought and sold at t equilibrium
price.
 equities - Certificates indicating part ownership of a joint-stock company.
 equivalent variation - The change in income that leaves a consumer just as
well off as some specific change in the price of a good.
 excess capacity theorem - The prediction that each firm in monopolistically
competitive industry is producing below i minimum efficient scale and
hence at an average cost that higher than it could achieve by producing its
capacity output.
 excess demand - The amount by which quantity demand( exceeds quantity
supplied at some price; negative excess supply.
 excess supply - The amount by which quantity supplied exceeds quantity
demanded at some price; negative excess demand.
 exchange rate - The rate at which two national currencies exchange for each
other. Often expressed as the amount < domestic currency needed to buy one
unit of foreign currency.
 excludable - The owner of an excludable good can prevent others from
consuming it or its services.
 execution lag - The time it takes to initiate corrective policies an for their
full influence to be felt.
 exhaustible resource- See non-renewable resource.
 exhaustive expenditures- Government purchases of current! produced
goods and services. Also called government direct expenditures.
 exogenous variable - A variable that influences other variables within a
theory but is itself determined by factors outside the theory. Also called an
autonomous variable.
 expectations-augmented Phillips curve - See short-run Phillip curve.
 expected value - The most likely outcome of some procedure the is repeated
over and over again; the mean of the probability distribution expressing the
possible outcomes.
 explicit collusion - This occurs when firms explicitly agree t co-operate
rather than compete. See also tacit collusion.
 extensive form game - Game in which players make moves i: some order
over time.
215
 external economies - Economies of scale that arise from sources outside the
firm.
 externalities - Costs or benefits of a transaction that fall on people not
involved in that transaction.
 extrapolative expectations - Expectation formation based on the
assumption that a past trend will continue into the future. The simplest form
of extrapolation would be to assume that next period's value of a variable
will be the same as this period's.
 factor markets - Markets where factor services are bought and sold.
 factor price theory - The theory of the determination of the prices of factors
of production.
 factors of production - Resources used to produce goods and services;
frequently divided into the basic categories of land, labour, and capital.
Sometimes entrepreneurship is distinguished as a fourth factor; sometimes it
is included in the category of labour.
 fiat money - Inconvertible paper money that is issued by government order
(or fiat).
 final demand - Demand for the final goods and services produced in the
economy.
 final goods and services - The outputs of the economy after eliminating all
double counting, i.e. excluding all intermediate goods.
 financial capital - The funds used to finance a firm, including both equity
capital and debt. Also called money capital.
 financial innovation - Occurs when new products ate introduced into the
financial system, or when existing suppliers behave in new ways. Changes
are often a complex interaction of regulatory changes, changing technology,
and competitive pressures.
 financial intermediaries - Financial institutions that stand between those
who deposit money and those who borrow it.
 fine-tuning - The attempt to maintain national income at, or near, its fullemployment level by means of frequent changes in fiscal and/or monetary
policy. Compare gross-tuning.
 firm - The unit that employs factors of production to produce commodities
that it sells to other firms, to households, or to the government.
 fiscal consolidation - A situation in which governments that have been
running substantial budget deficits decide to aim for a sustainable budgetary
position, usually by getting their expenditure under control.
 fiscal policy - Attempts to influence the aggregate demand curve by altering
government expenditures and/or taxes, thereby shifting the IS curve.
 fixed capital formation - See fixed investment.
 fixed cost - A cost that does not change with output. Also called overhead
cost, unavoidable cost, or indirect cost.
 fixed exchange rate - An exchange rate that is held within a narrow band
around some pre-announced par value by intervention of the country's
central bank in the foreign exchange market.
216
 fixed factors - Inputs whose available amount is fixed in the short run.
 fixed investment - Investment in plant and equipment. fixed prices See
administered prices.
 flexible prices - See auction prices.
 floating exchange rate - An exchange rate that is left free to be determined
on the foreign exchange market by the forces of demand and supply.
 flow variable - See stock variable.
 foreign direct investment (FDI) - Non-resident investment in the form of a
takeover or capital investment in a domestic branch, plant, or subsidiary
corporation in which the investor has voting control. See also portfolio
investment.
 foreign exchange - Foreign currencies and claims to them in such forms as
bank deposits, cheques, and promissory notes payable in the currency.
 foreign exchange market - The market where foreign exchange is traded—
at a price that is expressed by the exchange rate.
 45° line - Used in macroeconomics to indicate points where expenditures
and output are equal, so that what firms produce is just equal to what agents
wish to buy.
 free-market economy - An economy in which the decisions of individuals
and firms (as distinct from the central authorities) exert the major influence
over the allocation of resources.
 free rider problem - The problem that arises because people have a selfinterest in not revealing the strength of their own preferences for a public
good in the hope that others will pay for it.
 free trade - An absence of any form of government interference with the
free flow of international trade.
 free trade area - An agreement between two or more countries to abolish
tariffs on all, or most, of the trade among themselves, while each remains
free to set its own tariffs against other countries.
 frictional unemployment - Unemployment that is associated with the
normal turnover of labour.
 function - Loosely, an expression of a relationship between two or more
variables. Precisely, Y is a function of the variables X,, . . ., X,, if, for every
set of values of the variables X,, . . . , X,,, there is associated a unique value
of the variable Y. Also referred to as a functional relation.
 functional distribution of income - The distribution of income among
major factors of production.
 functional relation - A mathematical relation between two or more
variables such that, for every value of the independent variables, there is one
and only one associated value of the dependent variable.
 gains from trade - Advantages realized as a result of specialization made
possible by trade.
 game theory - The study of the strategic choices between firms, applicable
when the outcome for one firm depends on the behaviour of the others.
 CDP See gross domestic product. GOP gap See output gap.
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 general price level - Average level of the prices of all goods and services
produced in the economy. Usually just called the price level.
 Ciffen good - A good with a positively sloped demand curve.
 gilt-edged securities - UK government bonds; so called because they are
considered to carry lower risk than private sector debt.
 given period - Any particular period that is being compared with a base
period by an index number.
 globalization - The increased world-wide interdependence of most
economies. Integrated financial markets, the sourcing of the production of
components throughout the world, the growing importance of transnational
firms, and the linking of many service activities through the new information
and communications technologies are some of its many manifestations.
 GNI - See gross national income.
 GNP See gross national product.
 gold standard - Currency standard whereby a country's money is
convertible into gold.
 Coodhart's law - The view that many statistical relations (particularly those
established by monetarists) cannot be used for policy purposes because they
do not depend on causal relations and are, therefore, unstable.
 goods - Tangible production, such as cars or shoes. Sometimes all goods and
services are loosely referred to as goods.
 goods markets - Markets where goods and services are bought and sold.
 government - In economics, all public agencies, government bodies, and
other organizations belonging to, or owing their existence to, the
government; sometimes (more accurately) called the central authorities.
 government direct expenditures - See exhaustive expenditures.
 government failure - Where government intervention imposes costs that
would not have been accrued if it had acted efficiently.
 Cresham's law - Axiom that bad money (i.e. money whose intrinsic value is
less than its face value) drives good money (i.e. money whose intrinsic value
exceeds its face value) out of circulation.
 gross capital formation - See gross investment.
 gross domestic product (CDP) - The value of total output actually
produced in the whole economy over some period, usually a year (although
quarterly data are also available).
 gross investment - The total value of all investment goods produced in the
economy during a stated period of time.
 gross national income (GNI) - A measure of what a nation earns from all
its economic activity throughout the world. It differs from gross domestic
product, which measures only what is produced in the domestic economy
(some of which may generate income for non-residents). Used to be known
as gross national product.
 gross national product (CNP) - A National Accounts concept equivalent
to^ross national income used prior to 1998. It measures income earned by
domestic residents in return for contributions to current production, whether
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production is located at home or abroad, and is equal to GDP plus net
property income from abroad.
gross return on capital - The market value of output minus all non-capital
costs: made up of depreciation, the pure return on capital, any risk premium,
and the residual, which is pure profit.
gross-tuning - Use of monetary and fiscal policies to attempt to correct only
large deviations from potential national income. It is contrasted with finetuning, which aims to adjust aggregate
demand frequently in order to keep national income close to its potential
level at all times.
high-powered money - The monetary magnitude that is under the direct
control of the central bank. In the UK, it is composed of cash in the hands of
the public, bank reserves of currency, and clearing balances held by the
commercial banks with the Bank of England. Measured by MO.
hog cycles - A term used to characterize cycles of over- and underproduction because of time-lags in the production process. For example,
high prices for pork today lead many farmers to start breeding pigs; when
the pigs mature there will be an increased supply of pork, which will drive
down its price; so fewer farmers will breed pigs and the price will later rise
again, starting the cycle over again.
homogeneous product - A product for which, as far as purchasers are
concerned, every unit is identical to every other unit.
horizontal equity - Treating similar groups equitably, which usually means
treating them similarly. Compare vertical equity.
household - All people living under one roof and taking, or subject to others
taking for them, joint financial decisions.
human capital - The capitalized value of productive investments in persons.
Usually refers to value derived from expenditures on education, training, and
health improvements.
hyperinflation - Episodes of very rapid inflation.
hysteresis - The lagging of effects behind their causes. In economics the
term has come to relate to persistence or irre-versibility of effects. An
example is the difficulty of returning the long-term unemployed to work
because their skills have deteriorated. It also implies path-dependency,
which means that the ultimate equilibrium is not independent of how the
economy gets there (i.e. it is not unique).
identification problem - The problem of how to estimate both demand and
supply curves from observed market data on prices and quantities actually
traded.
import quota - A maximum amount of some product that may be imported
each year.
imputed costs - The costs of using factors of production already owned by
the firm, measured by the earnings they could have received in their best
alternative employment.
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 incentives - Motivational influences that drive the behaviour of economic
agents. Consumers make choices to increase their satisfaction or utility,
while firms respond to choices that increase their profit.
 incidence - In tax theory, where the burden of a tax finally falls.
 income-consumption line - On an indifference-curve diagram, a line
showing how consumption bundles change as income changes, with prices
held constant.
 income effect - The effect on quantity demanded of a change in real income,
relative prices held constant.
 income-elastic - The percentage change in quantity demanded exceeds the
percentage change in income.
 income elasticity of demand - The responsiveness of quantity demanded to
a change in income as measured by the percentage change in quantity
divided by the percentage change in income.
 income-inelastic - The percentage change in quantity demanded is smaller
than the percentage change in income.
 increasing returns industry - One in which all firms operate under
increasing returns to scale.
 increasing returns to scale - A situation in which long-run average total
cost falls as output increases, enabling large firms able to produce at lower
unit cost than small firms.
 incremental ratio - When Y is a function of X, the incremental ratio is the
change in Y divided by the change in X that brought it about, AV/AX. The
limit of this ratio as AX approaches 0 is the derivative of V with respect to
X, dY/dX.
 independent variable - A variable that can take on any value in some
specified range; it determines the value of the dependent variable.
 index number - An observation in a given time-period expressed as a ratio
to the observation in a base period and then multiplied by 100.
 index of retail prices - See retail price index.
 indexation - When a contract for wages, pensions, or repayment of debt is
specified in real terms. Any specified money payment would be increased to
compensate for actual inflation. More generally, the term applies to any
contingent contract tied to an index number.
 indicators - Variables that policy-makers monitor for the information they
yield about the state of the economy.
 indifference curve - A curve showing all combinations of commodities that
yield equal satisfaction to the consumer.
 indifference map - A set of indifference curves in which curves further
away from the origin indicate higher levels of satisfaction than curves closer
to the origin.
 indirect tax - A tax levied on a transaction that is paid by an individual by
virtue of her association with that activity and does not vary with the
circumstances of the individual who pays it, e.g. VAT on a restaurant meal.
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 induced - Anything that is determined from within a theory. The opposite of
autonomous or exogenous; also called endogenous.
 induced expenditure - Any expenditure flow that is related to national
income (or to any other variable explained by the theory).
 induced variable- See endogenous variable.
 industrial union - A single union representing all workers in a given
industry, whatever their trade.
 industry - A group of firms that sell a well defined product or closely
related set of products.
 inefficient exclusion - Situation in which producers with excess capacity set
positive prices.
 inelastic - The percentage change in quantity is less than the percentage
change in price (elasticity is less than 1).
 infant industry argument - The argument that new domestic industries
with potential economies of scale need to be protected from competition
from established low-cost foreign producers so that they can grow large
enough to achieve costs as low as those of foreign producers.
 inferior good - A commodity with a negative income elasticity; demand for
it diminishes when income increases.
 inflation - A positive rate of growth of the general price level.
 inflationary gap - A positive output gap, i.e. where actual GDP exceeds
potential output (GDP).
 inflationary shock - Any autonomous shift in aggregate demand or
aggregate supply that causes the price level to rise.
 information lag - The time between an event happening and policy-makers
learning about it. For example, National Accounts data for a quarter do not
arrive until six weeks or so after the quarter ends and are then revised
several times subsequently.
 infrastructure - The basic facilities (especially transportation and
communications systems) on which the commerce of a community depends.
 injections - Exogenous expenditure flows into the home economy. The
main injections in the macro model are government spending, exports, and
investment.
 innovation - The introduction of something new, either a new product or a
new way of making an old product. See also entrepreneur.
 innovators - Those who innovate. Also called entrepreneurs.
 inputs - The materials and factor services used in the process of production.
 insider—outsider model - An analysis of labour markets which gives more
influence over market outcomes to those in employment (usually via trade
union representation) than to the unemployed.
 instruments - The variables that policy-makers can control directly. (In
econometrics, instruments are proxy variables used in regression equations
because of their desirable statistical properties—usually independence from
the equation error.)
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 interest - The amount paid each year on a loan, usually expressed as a
percentage (e.g. 5 per cent) or as a ratio (e.g. 0.05) of the principal of the
loan.
 intermediate goods and services - All goods and services used as inputs
into a further stage of production.
 internal economies - Economies of scale that arise from sources within the
firm.
 internal labour market - The market inside the firm in which employees
compete against each other, particularly for promotion.
 internalizing an externality - Doing something that makes an externality
enter into the firm's own calculations of its private costs and benefits.
 inventories - Goods and materials that are held during the production or
distribution process. See also stocks.
 investment - The act of producing or purchasing goods that are not for
immediate consumption.
 investment demand function - A negative relationship between the
quantity of investment per period and the interest rate, holding other things
constant. Used to be more commonly called the marginal efficiency of
investment.
 investment expenditure - Expenditure on capital goods.
 investment goods - Goods produced not for present consumption, i.e.
capital goods, inventories, and residential housing.
 invisibles - Services, especially in the context of the balance of payments
accounts, that we cannot see crossing the frontier, such as insurance, freight
haulage, and tourist expenditures.
 involuntary unemployment - Unemployment that occurs when a person is
willing to accept a job at the going wage rate but cannot find such a job.
 IS curve - The locus of combinations of the interest rate and the level of real
GDP for which desired aggregate expenditure equals actual national output.
So called because, in a closed economy with no government, it also reflects
the combinations of the interest rate and national income for which investment equals saving, / = S. In general it reflects points for which injections
equal withdrawals.
 IS/LM model - A diagrammatic representation of a model of aggregate
demand determination based upon the locus of equilibrium points in the
aggregate expenditure sector (IS) and the monetary sector (LM). It is
incomplete as a model of GDP determination because it does not include an
aggregate supply curve.
 isocost line - A line showing all combinations of inputs that have the same
total cost to the firm.
 isoquant - A curve showing all technologically efficient factor combinations
for producing a given level of output.
 isoquant map - A series of isoquants from the same production function,
each isoquant relating to a specific level of output.
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 J-curve - Pattern usually followed by the balance of trade after a
devaluation of the domestic currency. Initially the trade balance deteriorates,
and then after a lag it improves.
 joint-stock company - A firm regarded in law as having an identity of its
own. Its owners, who are its shareholders, are not personally responsible for
anything that is done in the name of the firm. Called a corporation in North
America.
 Keynesian economics - Economic theories based on AE, IS, LM,
 AD, and AS curves and assuming enough short-run price inflexibility that
AD and AS shocks cause substantial deviations of real GDP from its
potential level.
 Keynesian revolution - Adoption of the idea that government could use
monetary and fiscal policy to control aggregate demand and thereby
influence the level of GDP. For a while it was believed that Keynesian
economics had found ways in which policy-makers could smooth business
cycles and eliminate unemployment.
 Kondratieff cycles - Long cycles in economic activity of around fifty years'
duration. Sometimes referred to as long waves.
 labour - All productive human resources, mental and physical, both
inherited and acquired.
 labour force - See working population.
 labour force participation rate - The percentage of the population of
working age that is actually in the labour force (i.e. either working or
seeking work).
 labour productivity - Total output divided by the labour used in producing
it, i.e. output per unit of labour.
 Laffer curve - A curve relating total tax revenue to the tax rate.
 land - All free gifts of nature, such as land, forests, minerals, etc. Sometimes
called natural resources.
 law of demand - Axiom stating that a lower price increases the quantity
demanded and vice versa; that is, demand curves have a negative slope.
 law of diminishing returns- Law stating that, if increasing quantities of a
variable input are applied to a given quantity of a fixed input, the marginal
product, and the average product, of the variable input will eventually
decrease.
 law of price adjustment - Law stating that, if there is an excess demand
price will rise, and if there is an excess supply price will fall.
 leakages - See withdrawals.
 learning by doing - The increase in output per worker that often results as
workers learn on the job through repeatedly performing the same tasks. It
causes a downward shift in the average variable cost curve.
 legal tender - Currency that is recognized in law as the acceptable medium
for payment of debts. Bank of England notes became legal tender in England
and Wales in 1833. Euro notes became legal tender for members of the euro
zone in 2002.
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 less developed countries (LDCs) - The lower-income countries of the
world, most of which are in Asia, Africa, and South and Central America.
Also called underdeveloped countries and developing countries.
 life-cycle theory - A theory that relates a household's actual consumption to
its expected lifetime income.
 limited partnership - A form of business organization in which the firm has
two classes of owner: general partners, who take part in managing the firm
and who are personally liable for all of the firm's actions and debts; and
limited partners, who take no part in the management of the firm and who
risk only the money that they have invested.
 liquidity - The ease with which an asset can be converted into money.
Sometimes refers to money itself—liquidity preference used to be widely
used in economics as an expression meaning demand for money.
 liquidity preference - The demand to hold wealth as money rather than as
interest-earning assets. Also called the demand for money.
 liquidity trap - A situation that may arise when interest rates are so low that
further reductions either are not possible or do not stimulate spending. In
such situations the monetary authorities cannot stimulate aggregate demand
by interest rate changes alone.
 LM curve - The locus of combinations of the interest rate and real GDP for
which money demand equals money supply. So called because it represents
the points where liquidity preference equals the money supply.
 logarithmic scale - A scale on which equal proportional changes are shown
as equal distances (e.g. 1 cm may always represent doubling of a variable,
whether from 3 to 6 or 50 to 100). Also called log scale or ratio scale.
 long run - A period of time in which all inputs may be varied but the basic
technology of production is unchanged.
 long-run aggregate supply (LRAS) curve - A curve that relates the price
level to equilibrium real GDP after all input costs, including wage rates,
have been fully adjusted to eliminate any excess demand or supply.
 long-run average cost (LRAC) curve - Curve showing the least-cost
method of producing each level of output when all inputs can be varied.
Also sometimes called the long-run average total cost curve.
 long-run industry supply {LRS) curve - Curve showing the relation
between equilibrium price and the output that the firms in an industry will be
willing to supply after all desired entry or exit has occurred.
 long-run Phillips curve (LRPC)- Curve showing the relation between
unemployment and stable rates of inflation that neither accelerate nor
decelerate (and therefore for which actual and expected inflation are equal).
Usually thought to be vertical at the natural rate of unemployment or
NAIRU.
 long wave - See Kondratieff cycles.
 Lorenz curve - A curve showing the extent of departure from equality of
income distribution. It graphs the proportion of total income earned by all
people up to each stated point in the income distribution, such as the
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proportion earned by the bottom quarter, the bottom half, and the bottom
three-quarters.
Lucas aggregate supply curve - An aggregate supply curve which is
positively sloped for unexpected increases in the price level but vertical for
anticipated increases in the price level. Also known as the 'surprise'
aggregate supply curve.
Lucas critique - The proposition that empirical macro models will be
inaccurate when used to predict the effects of changes in policy. This is
because the behaviour of agents will be different under different policy
regimes.
MO - Currency held by the non-bank public plus bankers' deposits with the
central bank. Also known as the monetary base, the cash base, or highpowered money.
Ml - A measure of the money stock which includes currency plus current
account bank deposits. This measure is no longer reported by the Bank of
England.
M2 - Currency held by the public plus retail current and savings accounts in
banks and building societies. Also known as 'retail M4'.
M3 - Measure of broad money no longer used by the UK authorities. It was
equal to Ml plus all savings deposits in banks. A harmonized measure of
M3, M3H, is in use in the euro area as a monetary indicator; however, this
has a different definition, as it is equal to M4 plus foreign currency and
some other deposits.
M4 - Currency in circulation plus all sterling deposits in banks and building
societies.
macroeconomic policy - Any measure directed at influencing such
macroeconomic variables as the overall levels of employment,
unemployment, GDP, and prices.
macroeconomics - The study of the determination of economic aggregates
and averages, such as total output, total employment, the general price level,
and the rate of economic growth.
marginal cost (MC) - The increase in total cost resulting from raising the
rate of production by one unit.
marginal cost pricing - A policy of setting the price of a product equal to
its marginal cost.
marginal efficiency of capital - The rate at which the value of the stream of
output of a marginal unit of capital must be discounted to make it equal to
Ј1.
marginal efficiency of capital schedule - A schedule that relates the
marginal efficiency of each additional Ј1 worth of capital to the size of the
capital stock.
marginal efficiency of investment - The relation between desired
investment and the rate of interest, assuming all other things are equal.
marginal physical product (MPP) - See marginal product.
225
 marginal product {MP) - The change in total product resulting from using
one more (or less) unit of the variable factor. Also called marginal physical
product. Mathematically, the partial derivative of total product with respect
to the variable factor.
 marginal productivity theory - The demand half of the neoclassical theory
of income distribution, in which the demand for any variable factor is
determined by the value of that factor's marginal revenue product.
 marginal propensity not to spend - The proportion of any new increment
of income that is not passed on in spending, and instead leaks out of (i.e. is
withdrawn from) the circular flow of income. Also called the marginal
propensity to withdraw and the marginal propensity to leak.
 marginal propensity to consume (MPC) - The proportion of any new
increment of income that is spent on consumption, AC/AY.
 marginal propensity to import - The proportion of any new increment of
income that is spent on imports, AM/AY.
 marginal propensity to leak - See marginal propensity not to spend.
 marginal propensity to save (MPS) - The proportion of any new increment
of income that is saved, AS/AY.
 marginal propensity to spend - The ratio of any increment of induced
expenditure to the increment in income that brought it about.
 marginal propensity to tax - The proportion of any increment in income
that is taxed away by the government, ATI AY.
 marginal propensity to withdraw - See marginal propensity not to spend.
 marginal rate of substitution (MRS) - The rate at which one factor is
substituted for another with output held constant. Graphically, the slope of
the isoquant.
 marginal rate of transformation - The slope of the production possibility
boundary, indicating the rate of substitution of production of one good for
that of another.
 marginal revenue - The change in total revenue resulting from a unit
change in the sales per period of time. Mathematically, the derivative of total
revenue with respect to quantity sold.
 marginal revenue product (MRP) - The addition to a firm's revenue
resulting from the sale of the output produced by an additional unit of the
variable factor.
 marginal utility - The change in satisfaction resulting from consuming one
unit more or one unit less of a commodity.
 market - An area over which buyers and sellers negotiate the exchange of a
well denned commodity.
 market economy - A society in which people specialize in productive
activities and meet most of their material wants through exchanges
voluntarily agreed upon by the contracting parties.
 market failure - Any market performance that is less than the most efficient
possible (the optimal) performance.
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 market for corporate control - Where potential buyers and sellers (both
willing and unwilling) bargain about transferring the ownership of firms.
 market prices - In National Accounts, refers to the fact that expenditures
are measured in the prices actually paid by consumers and so include taxes
on products. See also basic prices.
 market sector - That portion of an economy in which producers must cover
their costs by selling their output to consumers.
 market structure - The characteristics of a market that influences the
behaviour and performance of firms that sell in the market. The four main
market structures are perfect competition, monopolistic competition,
oligopoly, and monopoly.
 maturity - The length of time until the redemption date of a security such as
a bond.
 medium of exchange - A commodity or token that is widely accepted in
payment for goods and services.
 menu costs - Costs associated with changing prices, such as the costs of
reprinting catalogues or menus. These costs make it rational for producers to
keep output prices fixed until input prices have changed significantly, or to
respond only periodically.
 mercantilism - The doctrine that the gains from trade are a function of the
balance of trade, in contrast with the classical theory, in which the gains
from trade are a function of the volume of trade.
 merchandise account - The part of the balance of payments accounts
relating to trade in goods.
 merchandise trade - Trade in physical products. Same as visible trade.
 merger - The uniting of two or more formerly independent firms.
 merit goods - Goods which the government decides have sufficient merit
that more should be produced and consumed than people would choose to do
if left to themselves.
 microeconomics - The study of the allocation of resources and the
distribution of income as they are affected by the working of the price
system and by the policies of the central authorities.
 minimum efficient scale (MES) - The smallest level of output at which
long-run average cost is at a minimum; the smallest output required to
achieve all economies of scale in production.
 mismatch - See structural unemployment.
 mixed economy - An economy in which some decisions about the allocation
of resources are made by firms and households and some are made by the
government.
 monetarism - The doctrine that monetary magnitudes exert powerful
influences in the economy and that control of these magnitudes is a potent
means of affecting the economy's macroeconomic behaviour.
 monetary base- See high-powered money and MO.
 monetary equilibrium - A situation in which there is no excess demand for
or supply of money.
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 monetary policy - Policy of trying to control aggregate demand (and
ultimately inflation) via the setting of short-term interest rates.
 monetary transmission mechanism - The mechanism that turns a monetary
shock into a real expenditure shock and thus links the monetary and the real
sides of the economy.
 money - Any generally accepted medium of exchange, i.e. anything that will
be accepted in exchange for goods and services.
 money demand function - The function that determines the demand to hold
money balances.
 money illusion - Refers to behaviour that responds to purely nominal
changes in money prices and incomes in either direction, even though real
incomes or relative prices have not changed.
 money income- Income measured in terms of some monetary unit. See also
real income.
 money multiplier - The ratio of the money stock to the monetary base
(high-powered money).
 money price - See absolute price.
 money rate of interest - The rate of interest as measured in monetary units.
 money stock - See supply of money.
 money supply - See supply of money.
 monopolist - The sole seller in a market.
 monopolistic competition - A market structure in which there are many
sellers and freedom of entry but in which each firm sells a differentiated
version of some generic product and, as a result, faces a negatively sloped
demand curve for its own product.
 monopoly - A market structure in which the industry contains only one firm.
 monopsonist - The sole purchaser in a market.
 moral hazard - Any change in behaviour resulting from the fact that a
contract has been agreed. One example is drivers who drive more recklessly
because they have accident insurance; another is employees who do not
work hard because employers cannot monitor their performance effectively.
 multinational enterprises (MNEs) - See transnational corporations.
 multiplier - The ratio of the change in GDP to the change in autonomous
expenditure that brought it about.
 multiplier-accelerator theory - An element of business-cycle dynamics
caused by the interaction of the multiplier and the accelerator, which can
make the economy follow a cyclical path in response to a one-off exogenous
shock.
 NAIRU - The amount of unemployment (all of it frictional or structural) that
exists when GDP is at its potential level and that, if maintained, will result in
a stable rate of inflation. The acronym stands for 'non-accelerating-inflation
rate of unemployment'. In the long run the NAIRU is equivalent to the
natural rate of unemployment.
228
 Nash equilibrium - In the case of firms, an equilibrium that results when
each firm in an industry is currently doing the best that it can, given the
current behaviour of all other firms.
 Nash theorem - Theory that every game with a finite number of players and
a finite number of strategies will have at least one Nash equilibrium (so long
as some random element to strategies is possible).
 national debt - The debt of the central government.
 national income - In general, the value of the nation's total output, and the
value of the income generated by the production of that output. Measured in
practice by gross national income and assumed in most of this book to be
equivalent to GDP.
 national product - A generic term for the nation's total output, which might
be measured more specifically by GDP. See gross national product.
 natural monopoly - An industry whose market demand is insufficient to
allow more than one firm to cover costs at any positive level of output.
 natural rate of unemployment - The level of unemployment in a
competitive economy that corresponds to potential GDP in long-run
equilibrium and that is associated with stable inflation. For most purposes it
is equivalent to the NA1RU, but the latter may differ when the economy is
adjusting slowly back to full equilibrium following some large shock.
 natural scale - A scale on which equal absolute amounts are represented by
equal distances. Compare logarithmic scale.
 negatively related - Refers to the relationship where an increase in one
variable is associated with a decrease in another.
 neoclassical theory- In general, a theory based on the maximizing choices
of well informed agents pursuing their own selfinterest. In distribution it is a
theory that factor incomes are determined by demand and supply, where
demand depends on the value of the factor's marginal product and supply
depends on the maximizing decisions of those who own the factors.
 net exports - Total exports minus total imports (X - IM).
 net investment - Gross investment minus replacement investment, which is
new capital that represents net additions to the capital stock.
 net present value - The difference between the present value of revenues
and the present value of costs.
 net taxes - Total tax receipts net of transfer payments.
 neutrality of money - Hypothesis that the level of real national income is
independent of the level of the money stock.
 New Classical theory - A theory that assumes that the economy behaves as
if it were perfectly competitive, with all markets always clearing; where
deviations from full employment can occur only if people make mistakes
and where, given rational expectations, these mistakes will not be
systematic.
 New Keynesian economics- Recent research agenda which has focused on
explaining why prices do not adjust to clear markets, especially the labour
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market. It differs from the traditional Keynesian approach in its concern for
equilibrium unemployment as well as demand-deficient unemployment.
newly industrialized countries (NICs) - Formerly less developed countries
that have become major industrial exporters in recent times. Sometimes
called newly industrialized economies (NIEs).
nominal interest rate - Actual interest rate in money terms. It is contrasted
with the real interest rate, which is the nominal interest rate minus the
inflation rate (or expected inflation rate).
nominal money supply - The money supply measured in monetary units.
nominal national product - Total output valued at current prices and
usually measured by 'money GDP'.
non-cooperative equilibrium - The equilibrium reached when firms
calculate their own best policy without considering competitors' reactions
and without explicit collusion.
non-excludable - A good or service is non-excludable if its owners cannot
dictate who will consume it.
non-market sector - That portion of an economy in which producers must
cover their costs from some source other than sales revenue.
non-renewable (or exhaustible) resource - Any productive resource that
exists as a fixed stock that cannot be replaced once it is used, such as natural
petroleum.
non-rivalrous - A good or a service is non-rivalrous if a given unit of it can
be consumed by everyone. Thus, one person's consumption of it does not
reduce the ability of another person to consume it—as with knowledge,
national defence, police protection, and navigational aids.
non-strategic behaviour - Behaviour that does not take account of the
reactions of others, as when a firm acts in perfect or monopolistic
competition.
non-tariff barriers - Devices other than tariffs that are designed to reduce
the flow of imports.
non-tradables - Goods and services that are produced and sold domestically
but do not enter into international trade.
normal good A commodity whose demand increases when income
increases. Compare inferior good.
normal form game Players make choices based on expected payoffs
simultaneously.
normative Things that concern what ought to be and thus depend on value
judgements. Compare positive.
oligopoly - An industry that contains only a few firms.
open economy - An economy that engages in international trade.
open-market operations - Sales or purchases of securities by the central
bank aimed at influencing monetary conditions.
open shop - A place of employment in which a union represents its
members but does not have bargaining jurisdiction for all workers, and
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where membership of the union is not a condition of getting or keeping a
job.
opportunity cost - Measurement of cost by reference to the alternatives
forgone.
optimum output - See profit-maximizing output.
option - Options come in two varieties. A call option is the right (but not the
obligation) to buy some commodity or security at a specific price called the
exercise price. A put option is the right (but not the obligation) to sell some
commodity or security at a specific price.
ordinary partnership - An enterprise composed of a group of individuals
who are all jointly liable for the debts and other obligations of that
enterprise.
output - The goods and services that result from the process of production.
output gap - The difference between potential output and actual output (V Y*); negative output gaps are called recessionary gaps; positive output gaps
are called inflationary gaps.
overshooting - Occurs when the impact effect of a shock takes a variable
beyond its ultimate equilibrium level. Most widely applied to the exchange
rate. A characteristic of a wide class of exchange rate models under rational
expectations is that when monetary policy is, say, tightened, the exchange
rate initially appreciates to a point from which it will depreciate towards its
long-run equilibrium level.
Pareto optimality - A situation in which it is impossible to reallocate
production activities to produce more of one good without producing less of
some other good, and in which it is impossible to reallocate consumption
activities to make at least one person better off without making anyone
worse off. Also called Pareto efficiency.
partnership - An enterprise with two or more joint owners, each of whom is
personally responsible for all of the partnership's debts.
paternalism - The belief that the individual is not the best judge of his or
her own self-interest; i.e. the belief that someone else knows better.
path-dependence - Non-uniqueness of equilibrium resulting from the
possibility that what happens in one period affects the stock of physical and
human capital for a long time thereafter. Sometimes referred to as hysteresis.
per capita economic growth - The growth of per capita GDP or GNI (GDP
or GNI divided by the population).
per-unit tax - See specific tax.
perfect competition - A market structure in which all firms in an industry
are price-takers and in which there is freedom of entry into, and exit from,
the industry.
permanent income - The maximum amount that a person can consume per
year into the indefinite future without reducing her wealth.
permanent income theory- A theory that relates actual consumption to
permanent income.
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 perpetuity - A bond that pays a fixed sum of money each year for ever and
has no redemption date. Sometimes called a consol.
 personal disposable income (PDI) - The gross income of the personal
sector less all direct taxes and national insurance contributions.
 personal income - Income earned by or paid to individuals before personal
income taxes are deducted.
 Phillips curve - Curve that relates the percentage rate of change of money
wages (measured at an annual rate) to the level of unemployment (measured
as the percentage of the working population unemployed).
 point elasticity - Uses the derivative at a point on the demand curve (dq/dp)
x (p/q). See also arc elasticity.
 political business cycles - Cycles in the economy resulting from the
political goals of incumbent (or potentially incumbent) politicians. The
simplest form is the deliberate pre-election boom, though modern theories
are more subtle.
 poll tax - A tax that takes the same lump sum from everyone.
 portfolio investment - Investment in bonds and other debt instruments that
do not imply ownership, or in minority holdings of shares that do not
establish legal control.
 positive - Refers to statements concerning what is, was, or will be; they
assert alleged facts about the universe in which we live. Compare normative.
 positively related Refers to the relationship whereby an increase in one
variable is associated with an increase in another.
 potential output (GDP), - Y* The level of output at which there is a
balance between inflationary and deflationary forces. It is also the level of
output at which there is no demand-deficient unemployment (the economy is
at the NAIRU) and the existing capital stock is being run at its normal rate
of utilization.
 precautionary balances - The amount of money people wish to hold
because of uncertainty about the exact timing of receipts and payments.
 present value The value now of a sum to be received in the future. Also
called discounted present value.
 price-consumption line - A line on an indifference curve diagram showing
how consumption changes as the price of one commodity changes, ceteris
paribus.
 price control - Anything that influences prices by law rather than by market
forces.
 price discrimination - Situation arising when firms sell different units of
their output at different prices for reasons not associated with differences in
costs.
 price elasticity of demand - The percentage change in quantity demanded
divided by the percentage change in price that brought it about. Often called
elasticity of demand.
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 price elasticity of supply - The percentage change in quantity supplied
divided by the percentage change in price that brought it about. Often called
elasticity of supply.
 price index - A statistical measure of the average percentage change in
some group of prices relative to some base period.
 price level - See general price level.
 price-makers - Firms that administer their prices. See administered price.
 price system - An economic system in which market-determined prices play
a key role in determining the allocation of resources and the distribution of
the national product.
 price-taker - A firm that can alter its rate of production and sales within any
feasible range without having any effect on the price of its products.
 principal - (1) The amount of a loan, or (2) the unit that employs agents to
work on its behalf.
 principal-agent problem - The problem of resource allocation that arises
because contracts that will induce agents to act in their principals' best
interests are often impossible to write or too costly to monitor.
 principle of substitution - Methods of production reflecting the relative
prices of inputs, with relatively more of the cheaper input and relatively less
of the more expensive input being used.
 prisoner's dilemma - A term in game theory for a game in which the Nash
equilibrium leaves both players less well off than if they co-operated with
each other.
 private benefits - The benefits of some activity that accrue to the parties in
that activity.
 private consumption spending - Spending for which the consumption of
the goods bought is done by private individuals (even where payment may
have been made by the government, such as on health services).
 private cost - The value of the best alternative use of the resources used in
production as valued by the producer.
 private sector - That portion of an economy in which the organizations that
produce goods and services are owned and operated by private units such as
households and firms. Compare public sector.
 pro-cyclical - Positively correlated with the business cycle.
 producer - Any unit that makes goods or services.
 producers' surplus Total revenue minus total variable cost; the market
value that the firm creates by producing goods, net of the value of the
resources currently used to create these goods.
 production - The act of making goods and services.
 production function - A mathematical relation showing the maximum
output that can be produced by each and every combination of inputs.
 production possibility boundary - A curve that shows the alternative
combinations of commodities that can just be attained if all available
productive resources are used; the boundary between attainable and
unattainable output combinations.
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 productive efficiency - Production of any output at the lowest attainable
cost for that level of output, so that it is impossible to reallocate resources
and produce more of one output without simultaneously producing less of
some other output.
 productivity - Output per unit of input employed.
 products - A general term referring to all goods and services. Sometimes
also referred to as commodities.
 profit - (1) In ordinary usage, the difference between the value of outputs
and the value of inputs. (2) In microeconomics, the difference between
revenues received from the sale of goods and the value of inputs, which
includes the opportunity cost of capital. Also called pure profit or economic
profit. (3) In macroeconomics, a component of factor incomes (and thus
income-based measures of national product) which is measured as trading
surpluses plus a component of mixed incomes.
 profit-maximizing output - The level of output that maximizes a firm's
profits. Sometimes also called the optimum output.
 progressive tax - A tax that takes a larger percentage of people's income the
larger their income is. Compare regressive tax.
 progressivity - The general term for the relation between income and the
percentage of income paid in taxes.
 proportional tax - A tax that takes the same percentage of people's income
whatever the level of their income.
 protectionism - Any departure from free trade designed to give some
protection to domestic industries from foreign competition.
 public corporation - A body set up to run a nationalized industry. It is
owned by the state but is usually under the direction of a more or less
independent, state-appointed board.
 public goods - Goods and services that, once produced, can be consumed by
everyone in the society. Also called collective consumption goods.
 public sector - That portion of an economy in which production is owned
and operated by the government or by bodies created by it, such as
nationalized industries. Compare private sector.
 purchasing power parity (PPP) exchange rate - The exchange rate
between two currencies that equates their purchasing powers and hence
adjusts for relative inflation rates.
 purchasing power parity theory - Theory that the equilibrium exchange
rate between two national currencies will be the one that equates their
purchasing powers.
 pure market economy An economy in which all decisions, without
exception, are made by individuals and firms acting through unhindered
markets.
 pure profit - Any excess of a firm's revenue over all opportunity costs
including those of capital. Also called economic profit.
 pure rate of interest - See pure return on capital.
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 pure return on capital - The amount that capital can earn in a riskless
investment. Also called the pure rate of interest.
 quantity actually bought and sold - The amount of a commodity that
consumers and firms actually succeed in purchasing and selling.
 quantity actually purchased - See quantity actually bought and sold.
 quantity demanded - The amount of a commodity that households wish to
purchase in some time-period.
 quantity supplied - The amount of a commodity that firms offer for sale in
some time-period.
 quantity theory of money - Theory predicting that the price level and the
quantity of money vary in exact proportion to each other; e.g., changing M
by X per cent changes P by X per cent.
 ratio scale - See logarithmic scale.
 rational expectations - The theory that people understand how the economy
works and learn quickly from their mistakes, so that, while random errors
may be made, systematic and persistent errors are not made.
 rational ignorance - This occurs when agents have no incentive to inform
themselves about some government action because the costs of so doing
greatly exceed the potential benefits of any action the agent could take as a
result of having the correct information.
 reaction curve - The optimal choices that will be made by one firm in the
light of each possible choice made by a rival firm. Could refer to the price
reaction or the output reaction, but usually relates to output.
 real business cycles - An approach to the explanation of business cycles
which uses dynamic equilibrium market-clearing models and relies on
productivity shocks as a trigger. In such models all cycles are an optimal
response to the real shock and there are no deviations from potential output:
rather, it is the full equilibrium that fluctuates over time.
 real capital - Physical assets, including factories, machinery, and stocks of
material and finished goods. Also called physical capital.
 real exchange rate - An index of the relative prices of domestic and foreign
goods.
 real income - The purchasing power of money income, measured by
deflating nominal income by an index of the price level.
 real money supply - The money supply measured in purchasing power
units, measured as the nominal money supply divided by a price index.
 real national product - Total output valued at base-year prices, measured
for example by GDP at 1999 prices.
 real product wage - The proportion of the sale value of each unit that is
accounted for by labour costs (including the pre-tax nominal wage rate,
benefits, and the firm's national insurance contributions).
 real rate of interest - The money rate of interest minus the inflation rate (or
expected inflation rate), which expresses the real return on a loan.
 real wage - The money wage deflated by a price index to measure the
wage's purchasing power.
235
 reallocation of resources S- ome change in the uses to which the economy's
resources are put.
 recession - A sustained drop in the level of economic activity.
 recessionary gap - A negative output gap, when actual GDP falls short of
potential GDP.
 redemption date - The time at which the principal of a loan is to be repaid.
 regressive tax - A tax that takes a smaller percentage of people's incomes
the larger their income is. Compare progressive tax.
 relative price - Any price expressed as a ratio of another price.
 renewable resources - Productive resources that can be replaced as they are
used up, as with real capital or forests; distinguished from non-renewable
resources, which are available in a fixed stock that when depleted cannot be
replaced, such as natural oil and coal.
 replacement investment - Investment that replaces capital as it wears out
but does not increase the capital stock.
 replacement ratio - Benefits received by those out of work as a proportion
of the wage of those in employment.
 repo - Short for a 'sale and repurchase agreement', whereby a firm sells a
security (such as a gilt) to a bank and agrees to buy it back at some future
time. The difference in price between sale and repurchase reflects the ruling
rate of interest. The deal is a loan (usually short-term) secured on the
security involved. Central banks typically set the rate of interest in repo
transactions for a specific term. In the UK the Bank of England sets the twoweek repo rate.
 reservation price - The price below which some action will not be taken,
such as selling a commodity or accepting a job.
 resource allocation - The allocation of the economy's scarce resources
among alternative uses.
 retail price index (RPI) - An index of the general price level based on the
consumption pattern of typical consumers.
 reverse repo - Similar to a repo, but here the bank sells the security to the
firm and agrees to buy it back at some future date.
 risk-averse - Description of people who wish to avoid risks and so will play
only those games that are sufficiently biased in their favour to overcome
their aversion to risk; they will be unwilling to play mathematically fair
games, let alone games that are biased against them.
 risk-loving - Description of people who are willing to play some games that
are biased against them, the extent of the love of risk being measured by the
degree of bias that they are willing to accept.
 risk-neutral - Description of people who are indifferent about playing a
mathematically fair game and are also willing to play games that are biased
in their favour but not games that are biased against them.
 risk premium - The return on capital necessary to compensate owners of
capital for the risk of loss of their capital.
236
 rivalrous - A good or service is rivalrous if, when one person consumes a
unit of it, no other person can also consume that unit, as with all ordinary
goods and services such as apples or haircuts.
 saving - Income received by individuals that they do not spend through
consumption expenditure.
 savings ratio - See average propensity to save.
 scatter diagram - Plots of a series of observations each made on two
variables, e.g. the price and quantity of eggs sold in 20 different cities.
 seigniorage - The revenue that accrues to the issuer of money.
 self-employed - Those people who work for themselves.
 sellers' preferences - Allocation of a commodity that is in excess demand
by the decisions of sellers.
 services - Intangible production that does not produce a physical product,
such as haircuts and medical services.
 shares See equities.
 share option - See option.
 shifting - The passing of tax incidence from the person who initially pays it
to someone else.
 short run - The period of time over which the inputs of some factors cannot
be varied.
 short-run aggregate supply (SRAS) curve - The total amount that will be
produced and offered for sale at each price level on the assumption that all
input prices are fixed.
 short-run equilibrium - Generally, equilibrium subject to fixed factors or
other things that cannot change over the time-period being considered.
 short-run Phillips curve - Any particular Phillips curve drawn for a given
expected rate of inflation.
 short-run supply curve - A curve showing the relation of quantity supplied
to price when one or more factor is fixed; under perfect competition, the
horizontal sum of marginal cost curves (above the level of average variable
costs) of all firms in an industry.
 shutdown price - The price that is equal to a firm's average variable costs,
below which it will produce no output. See also break-even price.
 simple multiplier - Usually applies to the value of the multiplier in the
aggregate expenditure system before any account is taken of the feedback
from the monetary sector and from aggregate supply.
 single proprietorship - An enterprise with one owner who is personally
responsible for everything that is done. More commonly called a sole trader.
 size distribution of income - A classification of income according to the
amount of income received by each individual irrespective of the sources of
that income.
 slump - A period of low output and low employment. See also boom.
 small open economy (SOE) - An economy that is a price-taker for both its
imports and its exports. It must buy and sell at the world price, irrespective
of the quantities that it buys and sells.
237
 social benefits - The value of an activity to the whole society, which
includes the internal effects on those who are involved in deciding on it and
the external effects on those who are not involved in the activity.
 social cost- The value of the best alternative use of resources that are
available to the whole society.
 sole trader - A non-incorporated business operated by a single owner.
Modern UK terminology for a single proprietorship.
 specialization of labour - The organization of production so that individual
workers specialize in the production of particular goods or services (and
satisfy their wants by trading) rather than producing everything they
consume (and satisfying their wants by being self-sufficient).
 specific tax - A tax expressed as so much per unit, independent of its price.
Also called a per-unit tax.
 speculation - Taking a financial position that will yield profits if prices
move in a particular direction in future but will yield losses if they move the
other way.
 speculative balances - Monetary assets held for their expected rate of return
rather than for transactions purposes.
 speculative motive - The motive that leads agents to hold money in
response to the risks inherent in fluctuating bond prices. More generally, it
refers to the asset motive, as opposed to the transactions motive, for holding
money.
 spread - The difference between the prices or interest rates on specific
assets or loans, such as the spread between deposit and loan rates offered by
banks.
 SRAS curve - See short-run aggregate supply curve.
 stabilization policy - The attempt to reduce fluctuations in GDP,
employment, and the price level by use of monetary and fiscal policies.
 stagflation - The simultaneous occurrence of a recession (with its
accompanying high unemployment) and inflation.
 stock - See equities.
 stock variable - A variable that does not have a time dimension. It is
contrasted with a flow variable, which does.
 stockholding - The process of building stocks or inventories.
 stocks - Accumulation of inputs and outputs held by firms to facilitate a
smooth flow of production in spite of variations in delivery of inputs and
sales of outputs. Now called inventories in National Accounts.
 strategic - Behaviour that takes into account the reactions of others to one's
own actions, as when an oligopolistic firm makes decisions that take account
of its competitors' reactions.
 strategic form game - See normal form game.
 structural unemployment - Unemployment that exists because of a
mismatch between the characteristics of the unemployed and the
characteristics of the available jobs in terms of region, occupation, or
industry.
238
 substitutes - Two goods are substitutes if the quantity demanded of one is
positively related to the price of the other.
 substitution effect - The change in quantity demanded of a good resulting
from a change in the commodity's relative price, eliminating the effect of the
price change on real income.
 sunk costs of entry - Those costs that must be incurred for a firm to enter a
market and cannot be recouped when the firm leaves.
 supergame - A game that is repeated an infinite number of times.
 supply - The whole relation between the quantity supplied of some
commodity and its own price.
 supply curve - The graphical representation of the relation between the
quantity of some commodity that producers wish to make and sell per period
of time and the price of that commodity, ceteris paribus.
 supply function - A mathematical relation between the quantity supplied
and all the variables that influence it.
 supply of effort - The total number of hours people in the labour force are
willing to work. Also called supply of labour.
 supply of labour - See supply of effort.
 supply of money - The total amount of money available in the entire
economy. Also called the money supply or the money stock.
 supply schedule - A numerical tabulation showing the quantity supplied at a
number of alternative prices.
 supply shocks - A shift in any aggregate supply curve caused by an
exogenous change in input prices or technology.
 supply-side policies - Policies that seek to shift either the short-run or the
long-run aggregate supply curve.
 surprise aggregate supply curve - See Lucas aggregate supply curve.
 tacit collusion - Occurs when firms arrive at the co-operative solution
(which maximizes their joint profit) even though they may not have formed
an explicit agreement to co-operate.
 takeover - When one firm buys another firm.
 targets - The variables in the economy that policy-makers wish to influence.
Typical policy targets might be inflation, unemployment, or real growth.
 tariffs - Taxes on imported goods.
 term - The amount of time between a bond's issue date and its redemption
date.
 terms of trade - The ratio of the average price of a country's exports to the
average price of its imports.
 theory of games - The study of rational decision-making in situations in
which each player must anticipate the reactions of competitors to the moves
that she makes. It can be applied to analysis of the strategic interaction of
firms in oligopolistic markets.
 third-party effects - See externalities.
 time-inconsistency - Problem that arises in rational expectations models
when policy-makers have an incentive to abandon their commitments at a
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later time. The existence of this incentive is generally understood by private
sector agents, and it may influence their current behaviour.
time-series data - Data on some variable taken at different, usually
regularly spaced, points in time, such as consumer spending in each quarter
for the last 10 years.
total cost (rc) - The total of all costs of producing a firm's output, usually
divided into fixed and variable costs.
total final expenditure T- he total expenditure required to purchase all the
goods and services that are produced domestically when these are valued at
market prices.
total fixed costs - The total of a firm's costs that do not vary in the short run.
total product (TP) - Total amount produced by a firm during some timeperiod.
total revenue (TR) - Total amount of money that a firm receives from the
sale of its output over some period of time.
total utility - The total satisfaction derived from consuming some amount of
a commodity.
total variable costs - The total of those of the firm's costs that vary in the
short run.
tradables - Goods and services that enter into international trade.
trade account - The part of the balance of payments accounts relating to
trade in goods.
trade creation - Trade between the members of a customs union or free
trade area where previously protected industries had served their own home
markets.
trade cycles - See business cycles.
trade diversion - The diversion of the source of a member country's imports
from other countries to union members as a result of the preferential removal
of tariffs following the formation of a customs union or a free trade area.
trade or craft union - A union covering workers with a common set of
skills, no matter where, or for whom, they work.
trade-weighted exchange rate -The average of the exchange rates between
a particular country's currency and those of each of its major trading
partners, with each rate being weighted by the amount of trade with the
country in question. Also called the effective exchange rate.
traditional economic system - Economic system in which behaviour is
based primarily on tradition, custom, and habit.
transaction costs - Costs involved in making a trade in addition to the price
of the product itself, such as the time involved or the cost of transport.
transactions balances - Holdings of money intended to be used for buying
goods or services at some unknown future time.
transactions demand for money T- he amount of money that people wish
to hold in order to finance their transactions.
transfer earnings - The amount that a factor must earn in its present use to
prevent it from moving (i.e. transferring) to another use.
240
 transfer payments - Payments not made in return for any contribution to
current output, such as unemployment benefits.
 transition economies - Countries that have abandoned central planning and
have been making the transition to market economies, such as the countries
of eastern Europe and the former Soviet Union.
 transmission mechanism - See monetary transmission mechanism.
 transnational corporations (TNCs) Firms that have operations in more
than one country. Also called transnational or multinational enterprises
(MNEs).
 underdeveloped countries - See less developed countries.
 unit cost - See average variable cost.
 unit elasticity - An elasticity with a numerical measure of 1, indicating that
the percentage change in quantity is equal to the percentage change in price
(so that total expenditure remains constant).
 utility - See marginal utility and total utility.
 utils - An imaginary measure of utility used in the exposition of marginal
utility theory, which assumes that utility is cardinally measurable.
 validation - When the authorities sustain an ongoing inflation by increasing
the money supply.
 value added - The value of a firm's output minus the value of the inputs that
it purchases from other firms.
 value added tax (VAT) - Tax charged as a proportion of a firm's value
added.
 value of money - See purchasing power of money.
 variable - Any well defined item, such as the price of a commodity or its
quantity, that can take on various specific values.
 variable cost - A cost that varies directly with changes in output. Also
called direct cost or avoidable cost.
 variable factors - Inputs whose amount can be varied in the short run.
 velocity of circulation - The number of times an average unit of money is
used in transactions within a specific period. Defined as the ratio of nominal
GDP to the money stock.
 vertical equity - Equitable treatment of people in different income brackets.
Compare horizontal equity.
 very long run - A period of time over which the technological possibilities
open to a firm are subject to change.
 visible account - The part of the balance of payments accounts relating to
trade in goods.
 visible trade - Trade in physical products. Same as merchandise trade.
 visibles - Goods such as cars, aluminium, coffee, and iron ore, which we can
see when they cross international borders.
 voluntary export restriction (VER) - Restriction whereby an exporting
country agrees to limit the amount it sells to a second country.
241
 voluntary unemployment - Unemployment that occurs when there is a job
available but the unemployed person is not willing to accept it at the existing
wage rate.
 winner's curse - The possibility that the agent who wins the bidding on a
contested takeover may pay more than the target firm is really worth because
the winner is the one with the highest valuation of all bidders.
 withdrawals - Spending that leaves the economy and does not create further
incomes for domestic residents. Import spending, for example, creates
incomes overseas. Also called leakages.
 working population - The total of the employed, the self-employed, and the
unemployed, i.e. those who have a job plus those who are looking for work.
 X-inefficiency - Failure to use resources efficiently within the firm so that
firms are producing above their relevant cost curves and the economy is
inside its production possibility boundary.
 yield curve - A line on a graph plotting the yield on securities against the
term to maturity.
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