Economicae^©

an illustrated encyclopedia of economics

Famous Economists

Mathematics of Economics

CAFE:	A federal law passed in 1975 at the peak of “the energy crisis” established CAFE (Corporate Average Fuel Economy). These regulations specify minimum average mileage per gallon for passenger cars and light trucks for all such vehicle manufacturers that sell in the United States. CAFE is intended to reduce energy consumption.
calendar effect:	See January effect.
call option:	A call option (or call) is a contract between a buyer and a seller that provides the buyer with the right but not any requirement to purchase a specific amount of a commodity or a specific asset at a fixed strike price no later than a specific expiration date. An American option may be exercised on any day prior to the end of the expiration date. A European option can be exercised only on the specified expiration date. See also option, American option, European option, put, hedge, short, and long.
call provision:	A call provision allows the issuer of a bond to repurchase it at will, with the bondholder being paid specific amounts that depend on when a call provision is exercised. Call provisions tend to be exercised when the values of bonds increase because of a drop in relevant interest rates. This limits the potential appreciation of the bond to the bondholder. However, call provisions are seldom if ever exercised when interest rates rise causing the values of bonds to fall. Consequently, a call provision shifts the bulk of interest rate risk to the bond holder. See also bond indenture, sinking fund and collateral.
Cambridge equation:	The Cambridge equation can be written as Md = kY, where Md is the demand for money and k is the proportion of nominal income (Y = PQ) that people desire for transactions purposes. In this specification, k = 1/V, where V is the income velocity of money. The Cambridge equation first appeared in 1917 in a paper by Arthur Cecil Pigou, but there are indications that the concept originated with Alfred Marshall. The Cambridge equation is an alternative to Irving Fisher’s [MV=PQ] formulation of the equation of exchange.
cannibalization:	Cannibalization occurs when expansion of one aspect of a firm reduces the sales or profitability of another part of the firm. For example, if Wal-Mart opens stores that are close enough to existing stores, the sales and profitability of the existing stores may decline because of cannibalization even if overall sales and profits increase.
capacity:	Capacity is an ambiguous term that sometimes suggests that a firm operate at capacity when it is producing the quantity at which average total costs are minimized. At other times, capacity seems to mean that a firm is operating at a level of output where the marginal cost curve becomes quite steep.
capacity utilization rate:	The capacity utilization rate is the proportion of a nation’s economic capital currently employed productively during some period of time.
capital:	Economic capital includes productive transformations of natural resources. Capital includes all construction, and machinery and equipment. Click on the resources link for more information on capital.
capital abundant:	A nation is capital abundant if it has more capital per worker (a higher K/L ratio) than other nations. See also labor abundant and Heckscher-Ohlin model.
capital account:	The capital account in the balance of payments accounting system is conventionally a record of the flows of financial and economic capital between a country and its trading partners. In the 1990s, this broad definition was renamed the financial account, and the term capital account was narrowed to consider only unilateral transfers of financial capital (ownership documents) between countries.
capital consumption allowance:	The capital consumption allowance is the amount of depreciation calculated by accountants to conform to tax laws and accounting conventions, a procedure that may yield tremendous discrepancies between the “book value” and the true market values of capital assets.
capital deepening:	Economic growth in which a country’s capital stock increases proportionally faster than its labor force; real per capita output normally rises.
capital formation:	Capital formation is the process by which a firm or nation accumulates new economic capital. Saving on the part of some economic agents is necessary for investment, which is usually an activity of different agents. The conveyance of the savings of some entities (e.g., households or firms) to investors in economic is called financial intermediation. See also saving, investment and economic investment.
capital gain:	A capital gain is a positive difference between the price at which an asset is sold and the lower price paid when the seller originally purchased the asset.
capital goods:	Capital goods are any produced resources (e.g., tools, equipment, or machines) other than buildings that ultimately benefit people indirectly by facilitating the production of consumer goods. See also roundabout production.
capital intensive:	A production process is described as capital intensive if efficiency (cost minimization) requires a higher capital-to-labor ratio than do most other production processes. A good for which efficiency in the production process requires relatively more capital than labor (a higher K/L ratio) than some other good is described as a capital intensive good. A good efficiently produced with relatively less capital and more labor (a lower K/L ratio) is described as a labor intensive good. The relative factor (resource) intensities of alternative goods and the relative factor abundances of nations are the foundations of the Heckscher-Ohlin model of international trade.
capital intensive labor:	Capital intensive labor is labor for which certain forms of capital are highly complementary in production. For example, a computer programmer is unlikely to be noticeably productive without a computer, oodles of software, electricity, and access to the internet.
capital market:	A capital market is a market in which long term (>1 year) financial capital (stocks and bonds) is traded. International capital markets are increasingly efficient, so that economic and financial capital flow across national borders rapidly (over $600 trillion annually) when investors perceive differences in expected rates of return.
capital structure:	1. The term capital structure is sometimes used as a synonym for a nation’s infrastructure. 2. The capital structure of a corporation is the mix of debt (e.g., bonds) and equity (e.g., stock) used to finance the firm. See also debt-equity ratio.
capital widening:	Capital widening occurs when an economy grows and the labor force and the capital stock increase by the same proportion.
capitalism:	An economic system based on private property rights and emphasizing private, as opposed to governmental or collective, decision making. See also laissez faire and contrast with socialism.
capitalization:	Capitalization is the process whereby income streams are transformed into wealth, resulting in the elimination of economic profits. See also present value.
capital-to-labor ratio:	The capital-to-labor ratio (K/L) is the amount of capital used per worker in a firm, or on average across an entire nation, and tends to be positively related to productivity and per capita income.
capitation:	Capitation is a pricing policy for medical care wherein a health maintenance organization agrees to care for its clients for a single fee per member.
cardinal measurement:	A variable is cardinally measurable if a given interval between units of the variable has a consistent meaning, i.e., if the measure of the variable corresponds to fixed-interval points along a line. For example, height, output, and income are cardinally measurable. Open the cardinal vs. ordinal file for more discussion, or see also ordinal measurement.
caring externality:	A caring externality is the positive enjoyment one person derives from the knowledge that other people are benefiting from an activity, such as the provision of health care. Another example of a caring externality occurs when people are not guilt-ridden by being confronted with impoverished people because other people have donated to charities that have ameliorated poverty somewhat.
cartel:	A cartel is an organization of firms that jointly make decisions about prices and production for the entire group, and usually attempts to charge monopoly prices and limit production to monopoly rates of output. The Organization of Petroleum Exporting Countries (OPEC) is an example.
Cartesian coordinate:	Cartesian coordinates are an ordered set of numbers (x,y) that identifies how variables may be related graphically along a horizontal x-axis and a vertical y-axis. Open the figure for the Cartesian coordinate system for more discussion.
cash:	Noun: Cash is a synonym for currency. Verb: To cash is to convert an asset into cash. In a strategic game [e.g., poker], to cash is to convert an advantageous position into cash, by, for example, raising a bet and forcing the withdrawal of an opponent who has, at least temporarily, a disadvantaged position.
cash cow:	A cash cow is a product or a division of an organization or, from the perspective of a potential acquirer, an entire organization that is not expected to grow appreciably, but which is expected to generate a reasonably stable net cash flow into the predictable future.
cash crop:	A cash crop is a crop grown by a farmer and intended for sale instead of being consumed on the farm. Contrast with subsistence crop, which is grown to provide sustenance for a farmer’s family.
cash flow:	The total monetary revenue derived from an asset during a specific time interval. See also net cash flow.
castle-in-the-air theory:	Market fundamentalists who describe castle-in-the-air theory are usually skeptics who believe that gullible investors often create “castles in the air” because irrational optimism leads them to rush into investments without adequately considering down-side risk. These fundamentalists identify intrinsic value as the only reliable guide for asset pricing. See also: efficient markets, fundamental analysis, technical analysis, Keynesian beauty contest.
catallaxy:	Catallaxy is the term Friedrich Hayek applied to his theory that orderly rules governing market transactions emerge spontaneously and naturally when people meet to pursue their own interests by buying and selling goods and resources within the framework of laws established by the government.
catch-up effect:	The catch-up effect is the core of a theory contending that poorer and more backwards economies tend to grow more quickly than prosperous developed economies.
categorical assistance:	Categorical assistance entails governmental transfer payments or provision of assistance in kind to members of specific groups of people, such as single parents, veterans (education subsidies or VA hospitals), the elderly, or the disabled.
causation:	The relationship whereby one variable (the independent variable) is not only highly correlated with another variable (the dependent variable), but actually causes changes in the independent variable. In 2003, C.W.J. Granger [1934- ] was awarded a Nobel Prize, in part because of his development of time-series statistical methods for ascertaining causation.
caveat emptor:	Caveat emptor is Latin phrase used to characterize an ancient legal doctrine which suggests that buyers are the best judges of whether or not they receive full value from the goods they purchase, and that buyers should bear the consequences of their own decisions; a Latin phrase meaning “let the buyer beware.” Contrast with caveat venditor, and see also consumer protection.
caveat venditor:	Caveat venditor is a legal doctrine reflected in prohibitions against fraud and in sellers’ legal liability for damages if unknown dangers lurk in a product; a Latin phrase meaning “let the seller beware.” Contrast with caveat emptor.
CDO:	See collateralized debt obligation.
ceiling:	A price ceiling is the maximum price that can be charged by a seller when wage- or price controls are enacted by a legislative body. See also price controls and floor.
Celler-Kefauver Antimerger Act:	The Celler-Kefauver Antimerger Act (1950) made it illegal for major firms to acquire the stock or assets of their competitors.
central bank:	An institution whose function it is to make a nation’s financial system operate smoothly by issuing currency and regulating the supply of money and credit; and which serves as the government’s banker. The central bank of the United States is the Federal Reserve System, or FED.
central planning:	When central planning (or centralized decisionmaking) is the dominant allocative mechanism in a country, major economic decisions are made by government bureaucrats employed at some central authority, as in the Soviet Union from 1927 until it dissolved in 1989. Even the most capitalistic of nations may temporarily rely heavily on central planning during major wars, as happened in the United States, for example, during World War II. For a comparison between central planning policies and laissez-faire ones, click on the link.
centralization:	An organizational structure in which decision making entails “top – down micromanagement” is a centralized bureaucracy. Although often ascribed to government agencies, many huge corporations also suffer from excessive centralization.
ceremonial fund:	A ceremonial fund is the value of resources devoted to such ceremonies or rituals as promotions, graduations, weddings, inaugurations, coronations, funerals, celebrations of victory, self aggrandizement, or other rites of passage. See also conspicuous consumption, Thorstein Veblen and institutional economics.
certainty:	Certainty, an aspect of complete information, entails precise knowledge of current and all future values of an economic variable or set of economic variables (e.g., market conditions). See the link for risk and uncertainty for more discussion. Contrast with uncertainty, risk, and Knightian uncertainty.
certainty effect:	The certainty effect focuses on how people prefer an option with a given gain perceived as certain over an alternative gain which may have at least as great or an even greater expected value if the alternative gain is perceived to be less certain. The elimination of perceived risk is viewed as more desirable than a mere reduction of risk. For example, many people will choose an option guaranteeing a $3,000 gain over an option that yields $4,000 80% of the time, but nothing 20% of the time. However, behavioral economists also note that people have limited understanding of how differences in probabilities affect the expected values of alternatives. See also behavioral economics and prospect theory.
certificates of deposit	Certificates of deposit (CDs) are very long-term, high-value savings accounts issued by financial institutions.
ceteris paribus:	Economists use the Latin phrase ceteris parebus to mean, “All else held constant.” Following methodology formalized by Alfred Marshall, economists invoke ceteris paribus extensively in their analyses, especially in partial equilibrium models. Contrast with general equilibrium and mutatis mutandus.
chain of distribution:	A chain of distribution begins with raw material suppliers, and continues to manufacturers who transform raw materials into products. These goods are then frequently distributed to wholesalers or other intermediaries, who in turn convey these goods to retailers, which are then sold to the ultimate users. See also supply chain and disintermediation.
chain –weighted CPI:	Unlike the standard CPI, which measures only price changes from year to year, a chain weighted CPI includes changes in quantities purchased, thus reflecting changes in spending patterns. See also Consumer Price Index.
Chamberlin, Edwin Hastings	Edwin Hastings Chamberlin [1899-1967] developed the theory of monopolistic competition, which addressed firm behavior in markets in which differentiated products that are close substitutes are sold, but in which no significant barriers to entry exist, with the result that in the long run, monopolistically competitive firms can expect to generate no economic profit. In the past thirty years, this theory has become a foundation for the new theory of international trade.
change in demand:	Graphically, a change in demand is a shift of the entire demand curve in response to a change in one of the determinants of demand. A change in price does not change demand—the demand curve does not shift.
change in quantity demanded:	A change in quantity demanded results from a change in the price of the good, and is reflected in a movement from one point on a given demand curve to another point on that curve.
change in quantity supplied:	A change in quantity supplied is shown by a movement along an existing supply curve and occurs with a change in the price of the good or service.
change in supply:	Graphically, a change in supply is a shift of the entire supply curve in response to any change in a determinant of supply other than the good’s own price.
channel stuffing:	Channel stuffing is an illegal strategy that involves overfilling orders from intermediaries further along in the supply chain, and billing those intermediaries so that inflated accounts receivable initially overstate the channel stuffer’s profitability in a period. This can result in a temporary increase in the price of a stock, enabling corporate managers to survive irate shareholders, or to sell stock options that are part of executive compensation packages. The excess shipments are usually returned, reducing reported accounting profits in a subsequent period, and deflating the value of the company’s stock.
chaos theory:	Most scientific theory (including much of conventional economics) posits convergent and stable paths towards a fixed long run equilibrium. Chaos theory is the notion that either a small change in initial conditions or minute random disturbances across time can drastically change the long-term path or behavior of a system. See also hysterisis, path dependence, and historicism. Contrast with determinism.
charity:	[1] Charity is private giving from those who deem themselves fortunate to those whom the givers deem as markedly less fortunate. [2] A charity is an organization that channels goods or funds from private givers to the recipients of charity. Charitable giving entails a free rider problem because generous private givers may reduce the need for charity perceived by other potential donors. Consequently, many voters support governmental redistributions of income and wealth. See also welfare payments.
chartists:	Individuals who use technical analysis in attempts to predict the future paths of the prices of financial instruments are called chartists. Chartists reject efficient markets theory and believe that past changes in price can be used to predict future changes. See also efficient markets, technical analysis, Keynesian beauty contest, and castle-in-the-air theory.
chase equilibrium:	Chase equilibrium is the idea that a static equilibrium is never achieved, and that instead, equilibrium may be a moving target towards which market economies gravitate. This term was coined by David Colander, a neoKeynesian.
check-off provisions:	A check-off provision in a labor union contract requires deductions of union dues from workers’ paychecks, and the dues are then paid directly to the union. A majority of workers in a union must formally vote for a check-off provision or the practice is illegal, under the Taft-Hartley Act of 1947.
cherry picking:	“Cherry picking,” also known as favorable selection, is an antonym for adverse selection. Examples of favorable selection would include an HMO attempting to cover only relatively healthy patient populations, or an auto insurance company’s attempts to choose clients with characteristics [good driving records, age, occupation, education, gender, or place of residence] associated with lower probabilities of costly auto accidents.
Chicago Climate Exchange:	The Chicago Climate Exchange (CCX) is a market based on legally binding “cap-and-trade” pollution-control credits that allow the owner to emit specified amounts of one of the six major greenhouse gasses.
Chicago School:	The Chicago School broadly advocates a libertarian approach to social issues and a laissez-faire approach to economic issues. This school of thought was centered at the University of Chicago roughly from the 1920s when it was led by Frank Knight and Jacob Viner through the 1970s, when Milton Friedman and George Stigler were its most notable advocates. During Friedman’s tenure, it was a bastion of monetarism, which offered an alternative to Keynesian theory in addressing A