Economicae^©

an illustrated encyclopedia of economics

Famous Economists

Mathematics of Economics

a posteriori:	The method of a posteriori entails reaching a conclusion through logical reasoning supported by fact or theory. Inductive reasoning is an example.
a priori:	The method of a priori entails reaching a logical conclusion by assuming or, somewhat intuitively, “knowing” something to be true independent of experience. Contrast with a posteriori.
abatement:	Abatement is a reduction in the rates at which gaseous, liquid, or solid wastes are emitted into the environment. Open the abatement file for more discussion, and see also externalities, negative externalities, Coase theorem, effluent charges, and tradable pollution rights.
ability to pay principle of taxation:	The ability to pay principle is the normative idea that taxes should be based on the financial ability to support government—i.e., that the rich should pay more taxes than the poor. Open the file on the ability to pay for a graph and more discussion. See also progressive tax, and benefit principle of taxation.
absolute advantage:	A country, individual, or firm has an absolute advantage in producing a good if production of the good absorbs fewer resources (or less time, in the case of an individual) than are required in other countries or by other individuals or firms. An early theory credited to Adam Smith based international trade on absolute advantage, but a subsequent theory developed by David Ricardo more completely and correctly focused on relative advantages. Open the file on comparative and absolute advantage for a table and more discussion. See also comparative advantage.
absolute poverty:	People are absolutely impoverished if the minimum amounts of food, clothing and shelter necessary for survival absorb all of their income, and they live a razor’s edge existence. Open the link absolute and relative poverty for more discussion, or see also relative poverty.
absolute price:	The monetary or “nominal” price of anything is also sometimes called its absolute price. The file relative and nominal prices offers more discussion. See also relative price.
absorption problem:	The absorption problem is summarized by the equation: [G–T] = [S–I] + [M–X]. Thus, any federal government budget deficit (G-T) must be offset by an excess of private saving over private investment (S–I) or by an excess of imports over exports (M–X). This equation is a simplification and rearrangement of an accounting identity for Aggregate Expenditures: Y = C + I + G + (X–M) = C + S + T. If the economy is at its productive capacity, then unless a federal deficit is funded by foreigners (M–X), private investment may be “crowded out” because G–T will equal S–I. Open the absorption equation link for more discussion, and the link fiscal policy and the great depression for a discussion of an exception to the crowding-out hypothesis. See also aggregate expenditures, crowding-out, and twin deficit. And contrast with crowding-in.
absorptive capacity:	Absorptive capacity refers to limits to the ability of a society (or a firm) to implement new technologies. For example, societies with low literacy rates tend to be relatively slower to adopt cutting edge technologies than are societies in which most workers are educated. Or a firm’s culture [the informal mechanisms for working that have been developed by the firm’s existing personnel] may foster resistance to the automation of certain operations – “if it ain’t broke, don’t fix it.” In some cases, external consultants may be hired to guide productivity growth, or a firm may rely on a research and development division or a “skunk works” [a group of especially creative superior workers] to develop prototypes for new products, or to implement the proposed technology. The learning curve link illustrates the relationships between production costs, the learning curve, and absorptive capacity—the speed with which a society or organization can adapt to new technology. See also insider-outsider problem and learning curve.
abstraction:	Abstraction [or generalization] is the process of grouping similar phenomena or events into categories, and ignoring differences among them judged unimportant for the purposes of specific analysis. The judgment that these differences are trivial can be quite wrong. Stereotyping, for example, is one type of abstraction. Abstraction is a preliminary step in categorizing concepts or elements of a theory intended to explain the behaviors of a broad set of phenomena. Occam’s razor relies heavily on abstraction to simplify theories or models. See also reductionism.
abundance:	Goods or resources are described as abundant (absolutely) when perceived as neither especially scarce (high quantity) nor especially valuable (relatively low price – and they may even be “free”). For example, in the middle of the Sahara desert, sand is quantitatively abundant and virtually free (at its current location and in its current state). However, much of the theory of international trade focuses on the relative abundance (endowments) of resources. For example, a nation with relatively large amounts of capital per worker (high K/L à low L/K) is described as abundantly endowed with capital or capital abundant, and nations with relatively little capital per worker (low K/L à high L/K) are described as abundantly endowed with labor, or labor abundant. Open the link to Heckscher-Ohlin theory for elaboration.
accelerationist view:	The accelerationist view is a variant of natural rate theory that assumes inflationary expectations to be adaptive, so that attempts by policymakers to reduce unemployment below its natural rate requires ever more rapid rates of monetary growth, with the result the inflation accelerates. This perspective also supports a conclusion that persistent attempts by monetary policymakers to reduce interest rates below their natural rate will also cause accelerating inflation, a theory originated by Knut Wicksell.
accelerator:	The accelerator is a causal relationship between increases in aggregate demand and national output(ΔQ), and the resulting increase in net investment (ΔI). Net investment is a function of the change in output rather than the level of national output. ΔAD à ΔQ à ΔI à AD à ΔQ à ΔI, and the momentum for sustained economic growth builds. Interactions between the accelerator and the Keynesian spending multiplier were first explored by Roy Harrod [1900-1978], an early disciple of Keynesian theory. Open the accelerator file for a figure and more discussion, and see also multiplier-accelerator effect and multiplier effect.
accommodation:	Accommodation occurs when an existing firm with market power attempts to merge, acquire, or co-opt a potential competitor that appears likely to enter the market.
accounting costs vs. economic costs:	The real (economic) costs of production usually exceed the accounting (bookkeeping) costs of production because economic costs include both explicit accounting costs and implicit costs – the value of the personal resources the owners of a firm make available (e.g., their labor and capital). Open the file accounting vs. economic costs for a discussion of economic costs and profits. See also explicit costs and implicit costs.
accounting profit:	Accounting or bookkeeping profit is the total revenue of a firm minus its explicit (out-of-pocket) total costs. See the file accounting vs. economic costs for a discussion of economic costs and profits. See also explicit costs and implicit costs.
Ackley’s Law:	Gardner Ackley, the Chairman of the President’s Council of Economic Advisors during 1961-1965, observed that every U.S. president takes credit for every favorable event that occurs during his own administration, and attributes every unfavorable turn of events to the lagged effects of the mistaken policies of his predecessor. This observation has become known as Ackley’s law.
acquired assets:	See infrastructure.
acquisition:	Verb: Acquisition is the absorption of one organization by another, and usually entails one corporation purchasing all assets of another corporation. Noun: Acquisition refers to the assets acquired. Also see merger, takeover.
acquisitive society:	The term acquisitive society was coined by John Kenneth Galbraith to describe a society in which class, status, and power are determined by possession of certain goods or resources that contribute to personal health or wellbeing only indirectly, through positioning in a socioeconomic hierarchy.
activism:	Activism is a term applied to the Keynesian notion that government should adjust Aggregate Demand regularly by changing monetary and fiscal policies to offset shocks to Aggregate Demand or Aggregate Supply. “Fine-tuning” is an extreme version of this approach. See the link to John Maynard Keynes for some information about the thinker who launched “the Keynesian revolution.”
actual money multiplier:	The actual money multiplier (ma) equals the monetary supply (MS) divided by the monetary base (MB): ma = MS / MB. Open banks and money multipliers for more on this concept, and see also potential money multiplier.
actuary:	An actuary uses historical records to predict the likelihood of specific events. Such events include rates of morbidity or mortality over a specific interval for people with certain demographic characteristics, or birth rates for families with given characteristics, or damages to homes in certain areas from tornadoes or hurricanes, or automobile collisions for teenage drivers. Such statistical estimates are then used for such purposes as determining when to build schools or hospitals, or by insurance companies to calculate the premiums that will be charged to cover damages from accidents.
ad hominem fallacy:	The ad hominem fallacy is committed when opponents of a position attack personal characteristics of its advocates. Ad hominem argument is incompatible with logical or scientific approaches to solving problems. For example, the efficacy of activist fiscal policy is not logically undermined by slurs aimed at, say, the political ideology or personal behavior of John Maynard Keynes, who developed models that seem to support active fiscal policies. The scientific efficacy of fiscal policy or lack thereof is properly addressed using logical and empirical analysis. See also fallacy, fallacy of appeals to authority, and post hoc ergo propter hoc fallacy.
ad valorem tax:	An ad valorem tax is a percentage tax levied on the value ($ PQ) of a sale or purchase. Retail sales taxes are examples of ad valorem taxes.
adaptive expectations:	Expectations about the future value of some variable are “adaptive” when extrapolated from (formed as) a weighted average of recent values of that variable. The theory that expectations are adaptive frequently focuses on forecasts of inflation (price level changes) or prices for such assets as stocks or bonds. Adaptive expectations may entail adjustments for both past trends and previous forecasting errors. Contrast with rational expectations and static expectations.
adaptive markets hypothesis:	The adaptive markets hypothesis is a theory that expectations about market conditions are based in somewhat imperfect perceptions of how recent events might affect the future, and with less than perfect rationality. This theory permits possible inefficiencies to exist in financial markets and is an alternative to the neoclassically-based theories of rational expectations and efficient markets, which conclude that asset prices reflect optimal forecasts of market conditions, based on perfectly rational models and instantaneous and full capitalization of all the information available that might be relevant for the price of an asset. See also salience, adaptive expectations, bounded rationality, and behavioral economics. Contrast with efficient markets theories and rational expectations.
adjustable peg:	An adjustable peg system of exchange rates occurs when exchange rates for currencies are “pegged” – exchange rates between the currencies are held constant for long periods, but can be changed when countries recognize that pegged exchange rates are in “fundamental disequilibrium.”
adjustable rate mortgage:	An adjustable rate mortgage (ARM) is a mortgage loan upon which the interest rate charged adjusts as interest rates change across time See also interest rate risk and Fisher effect.
adjusted gross income (AGI):	Adjusted gross income (AGI) is a computation required in completing an Internal Revenue Service (IRS) Form 1040, and equals all income subject to taxation under the individual income tax after subtracting “above-the-line” deductions, such as certain contributions for individual retirement accounts and alimony payments. Personal exemptions and the standard or itemized deductions are subtracted from AGI to determine taxable income.
adjustment mechanisms:	Adjustment mechanisms are modes by which markets with shortages or surpluses move towards equilibrium. The most common mechanisms are adjustments to prices or to the amounts produced, and then bought or sold, but quality may also be adjusted in some cases. See also Walrasian (price) and Marshallian (quantity) adjustment.
administered-price inflation:	Administered-price inflation is the mirror image of cost-push inflation and asserts that firms with market power may grant union wage hikes, for example, to rationalize raising output prices. Firms may fear that without such “cost-push” justifications, price hikes may foment adverse publicity, antitrust actions, new government regulations, or other threats to their market power.
administration lag:	The administration lag is the period that passes before discretionary policy changes can be implemented. Monetary policy can be implemented quickly through the FED’s Federal Open Market Committee. Fiscal policies tend to entail long administration lags because discretionary changes in taxes or government expenditures require changing the law. See also recognition lag and impact lag.
administrative costs of regulation:	The administrative costs of regulation include the salaries of government workers, inspectors, office supplies, etc. See also compliance costs of regulation. Open the file for direct costs of regulation for more discussion.
administrative costs of taxation:	The burden of taxes unavoidably exceed net government revenues because of such administrative costs of taxation as printing of forms and the operating expenses of the Internal Revenue Service. See also distortion costs of taxation and compliance costs of taxation.
advanced industrialized countries:	Advanced industrialized countries tend to possess abundant economic capital, an educated populace that on average enjoys a relatively high standard of living, and to be technologically advanced, with well-developed markets for goods and resources. Most advanced industrialized countries are in the Western or Northern hemispheres and include the United States, Britain and Japan.
adverse selection:	Adverse selection occurs when a party to a contract is deceived prior to reaching an agreement about the quantities or qualities it could expect from a transaction. See also asymmetric information, lemons market, principal-agent problem, and moral hazard.
advertising:	Advertising is the costly attempt by a firm or economic agent to convey information or images that will induce a desired response, such as purchases, from the targeted customer, whether that be a consumer in a household or purchasing agent in a firm. Advertising is an important tool for firms attempting to differentiate their products.See also informative advertising and persuasive advertising.
affirmative action:	Affirmative action refers to sets of policies that provide favorable legal treatment (legal discrimination) based on gender, race, or ethnicity in an attempt to compensate for disadvantages to individuals based on past discrimination.
affluenza:	The word “affluenza” is a term critics of “rampant materialism” derived by combining the words affluence and influenza. Overconsumption and constant striving to secure ever larger piles of material goods is alleged to be both personally unfulfilling and socially destructive, with symptoms that include stress, waste, and excessive debt.
AFL-CIO:	The AFL-CIO is a federation of 64 labor unions, and was formed in 1955 when the American Federation of Labor, which had previously comprised only craft unions, merged with the Congress of Industrial Organizations, which had focused primarily on industrial unions.
ageism:	Ageism is occupational, economic, or personal discrimination based on the age of an individual.
Agency for International Development:	The Agency for International Development [AID] is an American-based organization that administers billions of dollars in aid each year to underdeveloped or developing foreign countries. Related organizations: World Bank.
agency costs:	Agency costs are incurred when an agent’s behavior is contrary to the principal’s expectations because their interests differ. For example, a firm’s CEO may gain by making decisions contrary to the interests of shareholders. This was a common occurrence prior to the discovery in the early 200s of widespread accounting fraud in the books of such giant corporations as Enron, Global Crossing, and HealthSouth.
agency shop agreements:	An agency shop agreement requires non-union workers at a firm to pay the equivalent of union dues to the union that represents similar workers at the firm. This is intended to require all workers covered by a union contract to share in the costs of collective bargaining, and prevents non-union members from free riding. See also union shop and closed shop, and right-to-work laws.
agent:	Economists use the term “agent” in two ways: [1] An “economic agent” may refer to any entity (individual, household, firm, or governmental organization) that makes economic decisions, or that performs economic activities, such as producing or buying or selling. [2] Economists use the legal term “agent” to refer to an entity (e.g., an employee) with a legal obligation to perform on behalf of a principal (e.g., an employer). See also principal-agent problem.
aggregate:	An aggregate is the total (often, economy-wide) value of any variable (e.g., gross domestic product or the rate of unemployment). Economic aggregates are referenced primarily in macroeconomics.
aggregate demand curve:	The aggregate demand curve depicts a negative relationship between the general price level (P) and the quantity demanded (Q) of total national output. Open the aggregate demand curve file for more information.
aggregate expenditures:	Aggregate expenditures are the sum of consumption [C], gross private domestic private investment [I], government purchases [G], and net exports [X-M = exports minus imports]. Thus, AE = C + I + G + [X-M]. In equilibrium, Aggregate Expenditures (Y) equals Aggregate Production (C + S + T), so that Y = C + I + G + (X-M) = C + S + T.
aggregate expenditures curve:	The aggregate expenditures curve is a positive relationship between Aggregate Expenditures and income. This function, sometimes known as a Keynesian cross diagram, is positively sloped because additional income induces additional spending. Open the aggregate expenditures curve file for more information.
aggregate supply curve:	The aggregate supply curve depicts a positive relationship between real national output (Q) and the absolute price level (P). Open the aggregate supply curve file for more information.
aggregation:	Aggregation is the process of summing variables to yield an aggregate variable. For example, the idea that apples and oranges can’t be compared is partially refuted when the total dollar sales figures for apples and oranges are summed and become a part of an aggregate farm income variable. Demand, supply, and expenditures on gross domestic product are often aggregated. Aggregation also covers individual markets forming a larger national market.
Aid to Families with Dependent Children:	The Aid to Families with Dependent Children (AFDC) program was implemented in the 1960s and intended to alleviate poverty. The original AFDC payment structure often provided recipients with strong disincentives not to work. Much of AFDC was abandoned when welfare was “reformed” in the 1990s. See also welfare and workfare.
alienation:	Alienation refers to the emotional distance between individuals, or between an individual or group of individuals and an event. Karl Marx attributed alienation to a tendency for capitalistic development to cause workers to lose control over their work and their lives because capitalism treats workers as replaceable resources [means], and not as ends in themselves. Employment in a capitalistic system is alienating, in this view, because workers do not sell their output to users. Instead, workers sell their output to capitalists for wages. The division of labor is often perceived as contributing substantially to alienation in an industrialized society.
Allais paradox:	Research by Nobel Prize winner Maurice Allais revealed that many people are, as predicted by standard economic theory, risk averse when confronted with choices that differ in risk but involving potential gains, but they paradoxically are often risk loving (loss averse) when confronted with similar choices but involving potential losses that similarly differ in risk. This finding is known as the Allais paradox. See also reflection effect, risk averse, risk neutral, loss averse, risk loving, and prospect theory.
allocative benefits of unemployment:	Frictional unemployment yields allocative benefits through better matches of workers and jobs. Finding a new job tends to be easier if not working full-time. Idle labor pools allow firms to screen more potential employees than if unemployment were zero. Lower transaction costs enhance economic efficiency. Unemployment prompts some workers to return to school or acquire skills through apprenticeships, thus investing in human capital. See also unemployment, transaction costs, and human capital.
allocative efficiency:	Allocative efficiency requires the pattern of national output to mirror what people want and are willing and able to buy. Although this concept is hinted at in the writings of the Greek philosopher Hesiod, it was made explicit and mathematical by the Italian economist and sociologist Vilfredo Pareto. See also Pareto efficiency, productive efficiency, and distributive efficiency. Click on the link for more information on the components of economic efficiency.
allocative inefficiency:	Allocative inefficiency is any failure of an economy to produce the mix of goods consumers want relatively most, given the alternatives available and the existing distribution of income and wealth. Allocative efficiency in financial markets requires savings to flow into the most desirable combination of feasible investments – those which will permit production of the combination of goods and services consumers value most. This normally means the most profitable set of investments if the economy is reasonably competitive. See also productive (technical) efficiency, misallocation, and distributive efficiency.
allocative mechanisms:	Alternative mechanisms are the ways people can use to determine how inputs will be allocated among competing ends and how incomes and production will be distributed. Examples of mechanisms include allocation or distribution in accord with tradition, or brute force, or merit, or need, or random selection, or queuing (first-come-first served). Government and the market system are among the most commonly used allocative mechanisms. Click on the link on market failures vs. political failures for a closer look on some of the allocative failures of the market system as compared to those of the governmental one. Also, click on the link on allocative mechanisms for a closer look at each of the systems listed above.
alternative cost:	See opportunity cost.
altruism:	Altruism is charitable giving without expectation of personal gain of one’s own time or wealth to improve the wellbeing of other people perceived as in need of assistance. Related to philanthropy.
American depository receipt:	An American depository receipt (ADR) is a receipt for a share of a foreign stock that enables trading on US stock exchanges. The original documents do not need to change hands because the transfer of the receipt for a share completes a transaction.
American institutionalism:	American institutionalism is a school of thought that rejects the assumptions that people possess unbounded rationality and foresight, and that individuals single-mindedly maximize their “jollies.”