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Wage Bargaining

2026-10-06T06:22:54Z

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'''Wage bargaining''' is the process by which wages and other conditions of employment are determined through negotiation between employers and workers, or their representatives. Wage bargaining is a central institution of the labour market, and its structure affects the level of wages and of employment.

== Levels ==
Wage bargaining occurs at several levels. In firm-level bargaining, the negotiations take place between the employer and the representatives of the workers of the firm. In sectoral bargaining, the negotiations take place between the employers' associations and the trade unions of an industry.

In national bargaining, the negotiations take place at the level of the economy, often with the involvement of the government. The level of the bargaining affects the outcomes, including the wage differentials and the response of wages to the conditions of the economy.

== Models of Bargaining ==
The analysis of wage bargaining uses the framework of bilateral monopoly, in which the employer and the workers negotiate over the wage. The outcome depends on the bargaining power of the parties and on the alternatives available to them.

The bargaining power of the workers depends on the level of unionisation, on the coverage of the agreements, and on the legal framework. The bargaining power of the employers depends on the availability of substitutes and on the conditions in the market.

The analysis of bargaining also considers the effect of the outcome on employment. A wage that is set above the competitive level reduces the demand for labour and can create unemployment, unless the higher wage is offset by the higher productivity of the workers.

== Institutions ==
The institutions of wage bargaining include the trade unions, the employers' associations, and the legal framework. The framework determines the rights of the parties, the coverage of the agreements, and the mechanisms for the resolution of disputes.

The coverage of the bargaining is a key determinant of its effects. In countries with high coverage, the agreements apply to a large share of the workers, including those who are not members of the unions. In countries with low coverage, the agreements apply only to the members.

The coordination of the bargaining affects the outcomes. In countries with coordinated bargaining, the wage settlements take account of the conditions of the economy, which can improve the trade-off between wages and employment.

== Effects ==
The effects of wage bargaining on the economy depend on the institutions and on the conditions. The bargaining can raise wages above the competitive level, which can reduce employment, or it can improve the conditions of the workers without reducing employment, if the higher wages reflect higher productivity.

The bargaining also affects the response of wages to shocks. In economies with centralised bargaining, the wage response may be faster, which can facilitate the adjustment. In economies with decentralised bargaining, the response may be slower.

The design of the institutions must balance the objectives of the workers and of the employers, and it must take account of the conditions of the economy. The reform of the institutions is a subject of debate in many countries.

== The Union Behavior ==
The unions are the organizations that represent the workers in the wage bargaining, and their behavior is central to the analysis.

The unions may pursue the objectives including the wages, the employment, and the other conditions. The choice of the objective affects the outcome of the bargaining, since the union may trade the wages for the employment.

The analysis of the union behavior uses the models of the union preferences, which specify the trade-off between the wages and the employment. The models inform the understanding of the bargaining outcomes.

== The Bargaining and the Employment ==
The wage that results from the bargaining may be above the competitive level, which reduces the demand for the labour and can create the unemployment.

The effect on the employment depends on the bargaining power and on the elasticity of the demand for the labour. The higher the elasticity, the larger the effect on the employment.

The analysis considers the possibility that the higher wage reflects the higher productivity, in which case the effect on the employment may be limited. The design of the policy must consider the two possibilities.

== The Reform of the Bargaining ==
The reform of the wage bargaining is a subject of the debate in the many countries, and it concerns the level, the coverage, and the coordination of the bargaining.

The reform may involve the decentralization of the bargaining to the firm level, the reduction of the coverage, and the change in the coordination. The effects of the reform depend on the context and on the other institutions.

The analysis of the reform informs the design of the policy and the understanding of the effects on the wages and the employment.

== Summary ==
Wage bargaining is the process by which the wages are determined through the negotiation, and it is a central institution of the labor market. The analysis of the levels, the models, and the institutions informs the understanding of the wage determination and of the effects on the economy.

== See also ==
* Labour Economics
* Institutional Economics
* Industrial Organization

== References ==

<ref name="r1">Research on wage bargaining and on its effects.</ref>
<ref name="r2">Studies of the institutions of the labour market.</ref>
<ref name="r3">Analyses of the coordination of bargaining and of its outcomes.</ref>

<references />

[[Category:Labour economics]]
[[Category:Institutional economics]]
[[Category:Industrial organization]]

Total Revenue

2026-10-06T06:22:53Z

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'''Total revenue''' is the total amount of money that a firm receives from the sale of its output. Total revenue is calculated as the price of the good multiplied by the quantity sold.

== Definition ==
Total revenue is the product of the price and the quantity. For a firm that sells several products, the total revenue is the sum of the revenue from each product.

The total revenue is a component of the profit of the firm, which is the total revenue minus the total cost. The analysis of the total revenue is central to the analysis of the behaviour of the firm.

== Average and Marginal Revenue ==
The average revenue is the total revenue divided by the quantity sold, which is equal to the price for a firm that charges a single price. The marginal revenue is the change in total revenue from selling one additional unit.

For a competitive firm, which takes the price as given, the marginal revenue equals the price. For a firm with market power, the marginal revenue is less than the price, since the firm must lower the price to sell more.

The relationship between the average revenue and the marginal revenue is central to the analysis of the firm. The marginal revenue is less than the average revenue for a firm with a downward-sloping demand curve, and the difference depends on the elasticity of demand.

== Revenue and Elasticity ==
The relationship between the total revenue and the elasticity of demand is a central result of microeconomics. When the demand is elastic, a reduction in the price raises the total revenue, since the increase in the quantity sold more than offsets the reduction in the price.

When the demand is inelastic, a reduction in the price reduces the total revenue, since the increase in the quantity is proportionally smaller than the reduction in the price.

The total revenue is maximised when the elasticity of demand equals one, at the midpoint of a linear demand curve. The result is central to the analysis of the pricing decisions of the firm.

== Applications ==
The concept of total revenue is used in the analysis of the firm and of the market. It is used in the analysis of the effects of taxes, since a tax reduces the revenue of the firm. It is used in the analysis of the effects of competition, since the revenue of the firm depends on its market power.

The concept is also used in the analysis of the economy, where the total revenue of the firms is a component of the national accounts. The measurement of the revenue informs the analysis of the distribution of income and of the structure of the economy.

== The Revenue and the Market Structure ==
The total revenue and its relationship to the output and to the price differ across the market structures.

In the competitive market, the firm faces the horizontal demand curve, and the marginal revenue equals the price. The total revenue rises linearly with the output.

In the monopoly and the other markets with the market power, the firm faces the downward-sloping demand curve, and the marginal revenue is less than the price. The total revenue rises and then falls, and it is maximised where the elasticity equals one.

== The Revenue and the Taxes ==
The taxes affect the total revenue of the firm, since they raise the cost and reduce the output and the price received.

The incidence of the tax, which is the division of the burden between the consumers and the producers, depends on the elasticities. The less elastic side of the market bears the larger share of the burden.

The analysis of the incidence informs the design of the tax and the assessment of its effects. The design must consider the effect on the revenue of the firm and on the welfare.

== The Revenue and the Elasticity ==
The relationship between the total revenue and the elasticity is a central result, and it informs the pricing decisions of the firm.

The firm that seeks to maximise the revenue sets the price where the elasticity equals one. The firm that seeks to maximise the profit sets the price where the marginal revenue equals the marginal cost, which is where the elasticity is greater than one.

The analysis of the relationship informs the understanding of the pricing and of the behavior of the firm in the different market structures.

== The Revenue and the Profit ==
The total revenue is a component of the profit, and the analysis of the two is closely related.

The firm that maximises the profit sets the output where the marginal revenue equals the marginal cost, which is generally at the lower output than the revenue-maximising level. The difference reflects the cost of the additional output.

The analysis of the relationship informs the understanding of the behavior of the firm and of the effects of the market structure on the output and the price.

== Summary ==
Total revenue is the product of the price and the quantity, and it is a central concept in the analysis of the firm. The analysis of the average and the marginal revenue, of the relationship with the elasticity, of the market structure, and of the relationship with the profit informs the understanding of the firm and of the market.

== See also ==
* Microeconomics
* Cost Function
* Market Structure

== References ==

<ref name="r1">Microeconomics texts on the firm and on revenue.</ref>
<ref name="r2">Research on the relationship between revenue and elasticity.</ref>
<ref name="r3">Analyses of the effects of taxes on the revenue of firms.</ref>

<references />

[[Category:Microeconomics]]
[[Category:Cost accounting]]
[[Category:Market structure]]

Tax Base

2026-10-06T06:22:53Z

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The '''tax base''' is the amount on which a tax is levied, such as income, consumption, or the value of property. The definition of the tax base determines the scope of the tax and the distribution of the burden.

== Definition ==
The tax base is the measure to which the tax rate is applied. For an income tax, the base is the taxable income, which is the income after allowances and deductions. For a consumption tax, the base is the value of the goods and services consumed.

The definition of the base determines which activities and which entities are subject to the tax. The base may be defined broadly, to include most forms of income or consumption, or narrowly, to include only certain categories.

== Broadening and Narrowing ==
The broadening of the tax base means extending the range of activities subject to the tax, while the narrowing means restricting it. The broadening is often accompanied by a reduction in the tax rate, as in the reforms that reduce rates and eliminate allowances.

The broadening of the base can improve the efficiency of the tax, by reducing the distortions that arise from the differences in the treatment of different activities. The broadening can also increase the revenue, which allows the rates to be reduced.

The narrowing of the base, through the introduction of allowances and exemptions, is often justified by the objectives of the policy, including the promotion of particular activities and the relief of particular groups. The allowances, however, create distortions and complicate the tax system.

== International Aspects ==
The definition of the tax base is central to the international taxation of income. The allocation of the base among the jurisdictions, through the principles of source and residence, determines the division of the tax revenue.

The base erosion and profit shifting by multinational firms has prompted the reform of the international framework, to ensure that the profits are taxed where the activities that generate them take place. The reform involves the definition of the base and the allocation of the rights to tax.

== Policy ==
The choice of the tax base involves trade-offs among the objectives of revenue, efficiency, and equity. The design of the base affects the distribution of the burden and the incentives of the taxpayers.

The analysis of the tax base informs the design of tax reform. The reform must consider the effects of the base on the behaviour of the taxpayers and on the distribution of the burden, and it must balance the objectives of the policy.

== The Tax Base and the Efficiency ==
The design of the tax base affects the efficiency of the tax, since the base determines the activities that are taxed and the distortions that arise.

The broad base with the low rate is generally more efficient than the narrow base with the high rate, since the broad base reduces the distortions from the differences in the treatment. The broadening of the base also allows the reduction of the rates, which reduces the distortions for the given revenue.

The analysis of the efficiency informs the design of the tax reform. The reform that broadens the base and reduces the rates can improve the efficiency and the simplicity of the tax.

== The Tax Base and the Equity ==
The design of the tax base also affects the equity of the tax, since the base determines the distribution of the burden.

The broadening of the base can improve the equity, if the allowances that are eliminated benefit the higher-income taxpayers. The narrowing of the base, through the allowances, can reduce the equity, since the allowances often benefit the specific groups.

The analysis of the equity informs the design of the tax. The design must balance the efficiency and the equity, and the choice depends on the objectives of the policy.

== The International Tax Base ==
The international tax base concerns the allocation of the taxing rights among the jurisdictions, and it is central to the taxation of the multinational firms.

The principles of the source and the residence determine the allocation, and the transfer pricing rules determine the prices of the transactions among the affiliates. The erosion of the base and the profit shifting have prompted the reform of the framework.

The reform includes the measures to ensure that the profits are taxed where the activities that generate them take place. The design of the framework informs the understanding of the international taxation.

== The Base and the Administration ==
The definition of the tax base affects the administration of the tax, since the base determines the information that the taxpayers must report and the authorities must verify.

The broad base with the few allowances is generally simpler to administer, since the taxpayers have less scope to reduce the base and the authorities have less to verify. The narrow base with the many allowances is more complex, since the taxpayers must document the entitlements and the authorities must verify them.

The administration also concerns the withholding of the tax at the source and the filing of the returns, which affect the compliance. The design of the base and of the administration must be coordinated to ensure the effective collection of the tax.

== Summary ==
The tax base is the amount on which the tax is levied, and its definition determines the scope of the tax and the distribution of the burden. The analysis of the base, of the efficiency and the equity, of the international dimension, and of the administration informs the design of the tax.

== See also ==
* Taxation
* Public Finance
* Fiscal Policy

== References ==

<ref name="r1">Research on the design of the tax base.</ref>
<ref name="r2">Studies of the effects of broadening the base.</ref>
<ref name="r3">Analyses of the international taxation of income.</ref>

<references />

[[Category:Taxation]]
[[Category:Public finance]]
[[Category:Fiscal policy]]

Stock Option

2026-10-06T06:22:52Z

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A '''stock option''' is a contract that gives the holder the right, but not the obligation, to buy or to sell a share at a specified price within a specified period. Stock options are used for hedging, for speculation, and for the compensation of employees.

== Types ==
A call option gives the holder the right to buy the share at the strike price. A put option gives the holder the right to sell the share at the strike price.

The options may be American, exercisable at any time before the expiry, or European, exercisable only at the expiry. The value of the option depends on the price of the share, on the strike price, on the time to expiry, on the volatility of the share, and on the interest rate.

== Valuation ==
The valuation of options is based on the no-arbitrage principle, since the payoff of an option can be replicated by a combination of the underlying asset and of a risk-free bond. The Black-Scholes model provides a formula for the value of a European option, based on the assumptions of the model.

The model assumes that the price of the share follows a geometric Brownian motion, that the volatility is constant, and that there are no transaction costs or dividends. The assumptions are restrictive, and the extensions of the model address some of them.

The valuation of options is central to the analysis of financial markets, and it is used in the pricing of a wide range of derivatives.

== Employee Compensation ==
Stock options are used as a form of compensation for employees, particularly for executives and for employees of start-up firms. The options give the employees the right to buy shares at a specified price, which provides an incentive to raise the value of the firm.

The use of stock options for compensation has been criticised on several grounds. The options can encourage the managers to take excessive risks, since the payoff is asymmetric, and they can encourage the manipulation of the timing of the awards.

The accounting treatment of stock options has been a subject of debate. The recognition of the cost of the options in the financial statements affects the reported earnings and the assessment of the compensation.

== Uses ==
Stock options are used for hedging, to protect against adverse movements in the price of a share. They are used for speculation, to bet on the direction of the price. They are also used in the design of structured products, which combine options with other instruments.

The uses of options are central to the functioning of financial markets, and they are the subject of the analysis of derivatives and of risk management.

== The Options and the Corporate Governance ==
The stock options are used in the compensation of the executives, and they affect the incentives and the behavior of the managers.

The options give the managers the incentive to raise the value of the firm, since the payoff depends on the price of the shares. The use of the options can align the interests of the managers and of the shareholders.

The options can also create the incentive to take the excessive risk, since the payoff is asymmetric. The managers benefit from the increase in the price but are protected from the decline, which can encourage the risky strategies.

== The Accounting and the Disclosure ==
The accounting for the stock options has been the subject of the debate. The recognition of the cost of the options in the financial statements affects the reported earnings and the assessment of the compensation.

The standard setters have required the recognition of the cost, based on the fair value of the options. The requirement has improved the transparency and the comparability of the financial statements.

The disclosure of the options also includes the information about the terms and the conditions of the awards and the holdings of the executives. The disclosure informs the analysis of the compensation and of the incentives.

== The Market for the Options ==
The market for the options is part of the derivatives market, and it includes the exchange-traded and the over-the-counter instruments.

The exchange-traded options are standardised and cleared through the central counterparty, which reduces the credit risk. The over-the-counter options are negotiated privately and are subject to the credit risk of the counterparties.

The analysis of the market informs the understanding of the pricing and of the risk of the options. The market also provides the information about the expectations of the investors.

== Summary ==
Stock options are the contracts that give the right to buy or to sell the shares, and they are used in the hedging, the speculation, and the compensation. The analysis of the valuation, of the use in the compensation, and of the market informs the understanding of the options.

== See also ==
* Financial Economics
* Labour Economics
* Industrial Organization

== References ==

<ref name="r1">Finance texts on options and on derivatives.</ref>
<ref name="r2">Research on the valuation of options and on the Black-Scholes model.</ref>
<ref name="r3">Analyses of the use of stock options in compensation.</ref>

<references />

[[Category:Financial economics]]
[[Category:Labour economics]]
[[Category:Industrial organization]]

Stagflationary Bias

2026-10-06T06:22:51Z

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'''Stagflationary bias''' refers to a tendency in the economy or in the policy framework towards the combination of stagnation and inflation. The term is used to describe the conditions that make the economy prone to the simultaneous occurrence of high unemployment and high inflation.

== Concept ==
Stagflation is the combination of stagnation, or high unemployment, and inflation. The term was coined in the 1970s, when the advanced economies experienced both high unemployment and high inflation, a combination that the prevailing framework had not anticipated.

The stagflationary bias refers to the tendency of the economy to generate this combination, and to the factors in the policy framework that contribute to it. The concept is used in the analysis of the failures of policy and of the design of institutions.

== Sources ==
The sources of stagflationary bias include the structure of the labour market and the behaviour of wages. If wages are indexed to prices, an increase in prices raises wages, which raises costs and prices further, creating a spiral that sustains inflation.

The sources also include the presence of supply shocks, which raise costs and prices while reducing output. The oil price shocks of the 1970s are the classic example, and they contributed to the stagflation of that period.

The sources also include the policy framework. A framework that accommodates inflation, by expanding demand in response to supply shocks, can sustain the inflation while doing little to reduce the unemployment.

== Policy ==
The response to stagflation requires a framework that addresses both the inflation and the unemployment. The response includes the anchoring of inflation expectations, through a credible monetary policy framework, and the improvement of the functioning of the labour market.

The response also includes the use of supply-side policies, which raise the productive capacity of the economy and reduce the pressure on costs. The policies include the reform of the labour market, the reduction of the regulatory burden, and the support for innovation.

The design of the policy must balance the objectives, since the instruments that reduce inflation may increase unemployment in the short run, and vice versa. The credibility of the framework is central, since it affects the expectations and thereby the trade-off.

== The Modern Framework ==
The modern framework for monetary policy, based on inflation targeting, is designed in part to avoid the stagflationary bias. The framework commits the central bank to the objective of price stability, and the commitment anchors the expectations of the public.

The framework has been associated with a reduction in the level and the volatility of inflation, and with the improvement in the trade-off between inflation and unemployment. The framework has been tested by the shocks of recent years, and the experience informs the analysis of its design.

== The Experience of the 1970s ==
The stagflation of the 1970s was a turning point in the macroeconomic policy, since it challenged the framework that had dominated the post-war period.

The combination of the high unemployment and the high inflation was not anticipated by the prevailing framework, which had assumed a stable relationship between the two. The experience led to the reassessment of the framework and to the development of the new approaches.

The causes of the stagflation included the supply shocks, the accommodative policy, and the institutional factors including the wage indexation. The analysis of the causes informs the design of the policy to avoid the recurrence.

== The Wage Indexation ==
The wage indexation links the wages to the prices, and it can contribute to the stagflationary bias, since an increase in the prices raises the wages, which raises the costs and the prices further.

The indexation is more common in the economies with the high inflation and the strong unions. The indexation can sustain the inflation, since the increase in the prices is automatically passed into the wages.

The reduction of the indexation is one element of the policy to reduce the stagflationary bias. The reform of the wage setting and the change in the expectations can reduce the spiral.

== The Role of the Expectations ==
The expectations are central to the analysis of the stagflation, since the behavior of the workers and the firms depends on the expected inflation.

When the expectations are not anchored, the increase in the prices leads to the expectation of the further inflation, which leads to the higher wages and prices. The spiral can become self-sustaining.

The anchoring of the expectations is therefore central to the policy. The credible commitment to the price stability and the transparent communication can anchor the expectations and reduce the stagflationary bias.

== Summary ==
Stagflationary bias refers to the tendency towards the combination of the stagnation and the inflation. The analysis of the experience of the 1970s, of the wage indexation, and of the role of the expectations informs the understanding of the policy to avoid the stagflation.

== See also ==
* Macroeconomics
* Inflation
* Keynesian Economics

== References ==

<ref name="r1">Research on stagflation and on the experience of the 1970s.</ref>
<ref name="r2">Studies of inflation targeting and of the anchoring of expectations.</ref>
<ref name="r3">Analyses of the policy response to supply shocks.</ref>

<references />

[[Category:Macroeconomics]]
[[Category:Inflation]]
[[Category:Keynesian economics]]

Social Capital

2026-10-06T06:22:50Z

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'''Social capital''' is the networks, norms, and trust that facilitate cooperation among individuals and groups. Social capital is a resource that enables collective action, and it is associated with a range of economic and social outcomes.

== Concept ==
Social capital comprises the relationships among individuals and the norms that govern their behaviour. The networks provide information and access to resources, while the norms provide the basis for trust and for cooperation.

The concept has been developed by sociologists and by economists, and it has been applied to the analysis of a range of issues, including the functioning of communities, the performance of institutions, and the process of development.

== Forms ==
Social capital takes several forms. Bonding social capital refers to the ties within a group, which provide support and solidarity. Bridging social capital refers to the ties between groups, which provide access to a wider range of resources.

Linking social capital refers to the ties between individuals and institutions, which provide access to power and to resources. The different forms have different effects, and the balance among them affects the outcomes.

== Economic Effects ==
Social capital is associated with a range of economic effects. The trust that it generates reduces the costs of transactions, since the parties do not need to rely on formal contracts and on enforcement. The networks provide information that improves the functioning of markets.

Social capital is also associated with the provision of public goods and with the quality of institutions. Communities with high levels of social capital are better able to organise collective action and to hold institutions accountable.

The relationship between social capital and economic performance has been documented empirically, though the evidence is subject to issues of measurement and of causality.

== Measurement and Policy ==
The measurement of social capital is difficult, since the concept is broad and the data are limited. The measures include the membership of associations, the level of trust, and the extent of social networks.

The policy implications concern the support for the institutions and the networks that generate social capital. The policies include the support for community organisations, for education, and for the institutions that foster trust.

The design of policy must take account of the fact that social capital can also have negative effects, since the networks can be used to exclude others and to promote interests that are contrary to the public interest.

== The Social Capital and the Institutions ==
The social capital is related to the quality of the institutions, since the trust and the norms support the cooperation and the compliance.

The communities with the high social capital are better able to organise the collective action and to hold the institutions accountable. The social capital also supports the functioning of the markets, since the trust reduces the transaction costs.

The relationship between the social capital and the institutions is bidirectional, since the institutions also shape the social capital. The design of the institutions must consider their effect on the social capital.

== The Measurement ==
The measurement of the social capital is difficult, since the concept is broad and the data are limited. The measures include the membership of the associations, the level of the trust, and the extent of the networks.

The surveys measure the trust by asking the respondents about their confidence in the others. The measures are subjective and are subject to the biases, but they provide the comparable data across the countries.

The measurement also includes the measures of the networks, including the membership of the associations and the participation in the community. The measures inform the analysis of the social capital and of its effects.

== The Policy Implications ==
The policy implications of the social capital concern the support for the institutions and the networks that generate it.

The policies include the support for the community organisations, for the education, and for the institutions that foster the trust. The design of the policies must take account of the fact that the social capital can also have the negative effects, since the networks can be used to exclude the others.

The policy must also consider the effect of the other policies on the social capital. The design of the public policies affects the networks and the norms, and the effects should be considered in the design.

== Summary ==
Social capital is the networks, the norms, and the trust that facilitate the cooperation, and it is associated with the range of the economic and social outcomes. The analysis of the concept, of the measurement, and of the policy implications informs the understanding of the role of the social capital.

== See also ==
* Institutional Economics
* Development Economics
* Economic Development

== References ==

<ref name="r1">Research on social capital and on its economic effects.</ref>
<ref name="r2">Studies of the measurement of social capital.</ref>
<ref name="r3">Analyses of the policy implications.</ref>

<references />

[[Category:Institutional economics]]
[[Category:Development economics]]
[[Category:Economic development]]

Risk Sharing

2026-10-06T06:22:49Z

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'''Risk sharing''' is the distribution of risk among parties, so that the risk is borne by those who are best able to bear it. Risk sharing is a central function of financial markets and of insurance, and it is a key element of the analysis of financial arrangements.

== Mechanisms ==
Risk sharing operates through several mechanisms. Insurance transfers the risk from the insured to the insurer, in exchange for a premium. The insurer can bear the risk more efficiently, since it holds a portfolio of risks that are not perfectly correlated.

Financial markets share risk through the trading of securities. The issuance of shares transfers the risk of the firm's returns to the shareholders, who diversify their holdings. The issuance of debt allocates the risk between the creditors and the shareholders.

Contracts also share risk, through the specification of the payments that are contingent on the outcomes. The design of the contract determines the allocation of the risk between the parties.

== Risk Sharing and Growth ==
Risk sharing is relevant to the analysis of growth, since it affects the willingness of individuals and firms to undertake risky activities. The ability to share risk encourages investment in innovation and in activities with uncertain returns.

The development of financial markets and of insurance contributes to risk sharing, and it is associated with higher rates of growth. The relationship is one of the channels through which financial development affects the economy.

== International Risk Sharing ==
Risk sharing occurs across countries through several channels. The holding of foreign assets allows investors to diversify their portfolios and to share the risk of the domestic economy.

The integration of financial markets increases the scope for international risk sharing, and it can reduce the volatility of consumption relative to income. The evidence suggests that the scope for risk sharing has increased, though it remains limited.

The consumption correlation puzzle refers to the finding that consumption is more correlated across countries than the theory of risk sharing would predict. The puzzle suggests that the barriers to risk sharing are larger than the theory assumes.

== Limits ==
Risk sharing has limits. The problems of asymmetric information, including adverse selection and moral hazard, impede the sharing of risk, since the parties may not be able to observe the relevant characteristics and the actions.

The presence of these problems means that some risks cannot be shared, and that the ones that are shared may be subject to restrictions, including the use of collateral, the imposition of deductibles, and the monitoring of the behaviour of the parties.

The design of the arrangements must address these problems, and it must balance the benefits of risk sharing against the costs of the restrictions that are required.

== The Insurance Markets ==
The insurance markets are the central mechanism for the risk sharing, and they are subject to the problems of the asymmetric information.

The adverse selection arises when the individuals differ in their risk and the insurer cannot observe the risk. The individuals with the higher risk are more likely to buy the insurance, which raises the cost and can lead to the market failure.

The moral hazard arises when the insured can take the actions that affect the risk. The insured with the full coverage has less incentive to avoid the loss, which raises the cost of the insurance.

The design of the insurance contracts addresses these problems through the deductibles, the co-payments, and the other mechanisms. The design must balance the benefit of the risk sharing against the cost of the distortions.

== The Financial Intermediation ==
The financial intermediaries share the risk through the diversification and the pooling. The banks diversify across the borrowers, and the insurers pool the risks of the many policyholders.

The diversification reduces the risk of the individual institution, and the pooling allows the sharing of the risk among the participants. The intermediaries also transform the risk, by holding the illiquid assets and the liquid liabilities.

The risk sharing by the intermediaries can create the systemic risk, since the intermediaries are interconnected and the failure of one can affect the others. The analysis of the risk sharing must consider the systemic dimension.

== The International Risk Sharing ==
The international risk sharing occurs through the holding of the foreign assets and the borrowing across the countries. The integration of the financial markets increases the scope for the risk sharing.

The consumption correlation puzzle refers to the finding that the consumption is more correlated across the countries than the theory of the risk sharing would predict. The puzzle suggests that the barriers to the risk sharing are larger than the theory assumes.

The analysis of the international risk sharing informs the understanding of the effects of the financial integration and of the design of the international financial system.

== Summary ==
Risk sharing is the distribution of the risk among the parties, and it is the central function of the financial markets and of the insurance. The analysis of the mechanisms, of the problems of the asymmetric information, and of the international dimension informs the understanding of the risk sharing.

== See also ==
* Financial Economics
* Behavioural Economics
* Banking

== References ==

<ref name="r1">Research on risk sharing and on its mechanisms.</ref>
<ref name="r2">Studies of international risk sharing.</ref>
<ref name="r3">Analyses of the effects of asymmetric information on risk sharing.</ref>

<references />

[[Category:Financial economics]]
[[Category:Behavioural economics]]
[[Category:Banking]]

Rent Control

2026-10-06T06:22:49Z

Youku: New encyclopedia entry (batch upload)

'''Rent control''' is a government policy that limits the rent that landlords may charge for residential property. Rent control is a form of price ceiling, and its effects are analysed using the standard framework of supply and demand.

== Forms ==
Rent control takes several forms. The strictest form is a freeze on rents, which prohibits any increase. A more common form is a limit on the rate at which rents may increase, often linked to the rate of inflation.

The controls may apply to all rental housing or only to certain categories, and they may apply to existing tenancies or to new ones. The design of the controls determines their effects.

== Effects ==
The effects of rent control are analysed using the framework of a price ceiling set below the equilibrium. The ceiling reduces the quantity of housing supplied and increases the quantity demanded, creating a shortage.

The shortage manifests in several ways. The number of rental units may decline, as landlords convert the property to other uses or allow it to deteriorate. The quality of the housing may decline, since the landlords have less incentive to maintain it.

The shortage also leads to non-price rationing, in which the housing is allocated by means other than price. The allocation may be by queuing, by personal connections, or by other criteria, which can be inefficient and inequitable.

== Arguments For and Against ==
The arguments for rent control emphasise the protection of tenants from rapid increases in rents, which can cause hardship and displacement. The controls are also argued to preserve the diversity of the community and to protect the most vulnerable.

The arguments against rent control emphasise the reduction in the supply of housing and the deterioration in its quality. The controls are argued to reduce the incentive to build and to maintain rental housing, and to create a mismatch between the demand and the supply.

The evidence on the effects of rent control is mixed, and it depends on the design of the controls and on the context. The strictest forms are associated with larger reductions in supply and quality, while the more moderate forms have smaller effects.

== Alternatives ==
Alternatives to rent control include the provision of subsidies to tenants, which raise their ability to pay without reducing the supply, and the provision of public housing.

The design of the policy must balance the objective of protecting tenants against the objective of maintaining the supply of rental housing. The choice of the instrument depends on the objectives and on the constraints.

== The Second-Generation Controls ==
The second-generation rent controls, also known as the moderate controls, limit the rate at which the rents may increase rather than freezing them. The controls are linked to the rate of the inflation or to the other index.

The moderate controls are argued to have the smaller effects on the supply and the quality of the housing, since the landlords can adjust the rents over time. The controls are more common than the strict freeze, and they are the subject of the analysis.

The design of the controls affects their effects. The coverage, the indexing, and the treatment of the new tenancies all affect the impact on the market.

== The Housing Market ==
The analysis of the rent control must consider the housing market as a whole, including the owner-occupied sector and the new construction.

The controls reduce the return to the rental housing, which reduces the incentive to build and to maintain it. The reduction in the supply may raise the rents in the uncontrolled sector and may increase the price of the owner-occupied housing.

The analysis must also consider the mobility of the tenants, since the controls may discourage the tenants from moving, which can lead to the misallocation of the housing.

== The Alternatives ==
The alternatives to the rent control include the housing subsidies and the public housing.

The subsidies to the tenants raise their ability to pay without reducing the supply, and they can be targeted to the most vulnerable. The public housing provides the housing directly, and it can be targeted to the groups with the greatest needs.

The design of the alternatives must consider the cost and the incentives. The subsidies and the public housing involve the public expenditure, and their design affects the behavior of the recipients and of the providers.

== The Political Economy ==
Rent control is a subject of the political economy, since it involves the interests of the tenants and of the landlords, which differ.

The tenants, who are numerous and who benefit from the lower rents, tend to support the controls, while the landlords, who are fewer and who bear the costs, tend to oppose them. The asymmetry in the numbers helps to explain the political durability of the controls.

The controls are also supported by the concern about the affordability of the housing in the cities with the high rents. The design of the policy must consider the political and the economic dimensions.

== Summary ==
Rent control is a form of the price ceiling, and its effects are analysed using the framework of the supply and the demand. The design of the controls, the effects on the housing market, the alternatives, and the political economy inform the analysis of the policy.

== See also ==
* Market Failure
* Public Economics
* Institutional Economics

== References ==

<ref name="r1">Research on rent control and on its effects.</ref>
<ref name="r2">Studies of the evidence on the supply and the quality of housing.</ref>
<ref name="r3">Analyses of the alternatives to rent control.</ref>

<references />

[[Category:Market failure]]
[[Category:Public economics]]
[[Category:Institutional economics]]

Relative Poverty

2026-10-06T06:22:48Z

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'''Relative poverty''' is a measure of poverty that defines the poor in relation to the living standards of the rest of the society, rather than in absolute terms. A person is relatively poor if their income falls below a threshold that is set relative to the median or the average income of the society.

== Concept ==
Relative poverty is defined by comparison with the distribution of income in the society. The threshold is typically set at a proportion of the median income, often 50 or 60 percent.

The concept reflects the view that poverty is a matter of social exclusion as well as of material deprivation, and that the needs of individuals depend on the standards of the society in which they live.

== Measurement ==
The measurement of relative poverty uses the distribution of income and a threshold that is set relative to the central tendency of the distribution. The measure is often expressed as the proportion of the population with income below the threshold.

The measures vary across countries, reflecting the differences in the thresholds and in the definitions of income. The comparison across countries must account for these differences.

The measurement of relative poverty is sensitive to the definition of income and to the treatment of taxes and transfers. The measure of income may be gross or net, and the coverage may include or exclude certain components.

== Absolute and Relative Poverty ==
Absolute poverty defines the poor in relation to a fixed standard of living, typically the income required to meet basic needs. The standard is fixed in real terms, so that the measure changes only when the standard is updated.

The distinction matters for the analysis of poverty. Absolute poverty can be reduced by growth, since the income of the poor rises. Relative poverty may not fall with growth, since the threshold rises with the average income.

The two measures provide different perspectives, and both are used in the analysis of poverty and in the design of policy.

== Policy ==
The policy response to relative poverty concerns the distribution of income and the provision of public services. The instruments include the tax and transfer system, which redistributes income, and the provision of services, including education and health care.

The design of the policy must address the causes of poverty, including the lack of access to education and to employment, and the barriers that prevent individuals from improving their circumstances. The policy must also address the intergenerational transmission of poverty.

== The Measurement of the Poverty ==
The measurement of the poverty requires the choice of the indicator of the welfare, typically the income or the consumption, and the threshold that defines the poor.

The choice of the indicator affects the results, since the income and the consumption differ and the data on the consumption may be more reliable in the developing countries. The choice of the threshold affects the number of the poor, and the thresholds vary across the countries and the institutions.

The measurement must also account for the size and the composition of the households, since the needs depend on the number of the members. The equivalence scales adjust the income for the size of the household.

== The Poverty and the Inequality ==
The poverty and the inequality are related but distinct. The poverty concerns the level of the income of the poorest, while the inequality concerns the distribution of the income across the whole population.

A reduction in the inequality may reduce the poverty, but the two do not necessarily move together. The growth may reduce the absolute poverty while the relative poverty remains unchanged or rises.

The analysis must consider the two dimensions, and the design of the policy must address both. The measures include the transfers to the poor, which reduce the absolute poverty, and the progressive taxation, which reduces the inequality.

== The Policies to Reduce the Poverty ==
The policies to reduce the poverty include the transfers, the provision of the services, and the labor market policies.

The transfers include the cash transfers, which raise the income of the poor, and the in-kind transfers, which provide the goods and the services. The design of the transfers affects their effectiveness and their effect on the incentives.

The provision of the services, including the education and the health care, addresses the causes of the poverty and the intergenerational transmission. The labor market policies, including the training and the placement, improve the access to the employment.

== Summary ==
Relative poverty defines the poor in relation to the living standards of the society, and it is measured using the thresholds set relative to the central tendency of the distribution. The analysis of the poverty and of the inequality informs the design of the policies to reduce the poverty.

== See also ==
* Income Inequality
* Welfare Economics
* Economic Development

== References ==

<ref name="r1">Research on the measurement of poverty.</ref>
<ref name="r2">Studies of the comparison between absolute and relative poverty.</ref>
<ref name="r3">Analyses of the policies to reduce poverty.</ref>

<references />

[[Category:Income inequality]]
[[Category:Welfare economics]]
[[Category:Economic development]]

Regulatory Arbitrage

2026-10-06T06:22:47Z

Youku: New encyclopedia entry (batch upload)

'''Regulatory arbitrage''' is the practice of exploiting differences in the regulatory treatment of economically equivalent activities, in order to reduce the burden of regulation or to increase the profit. Regulatory arbitrage is a central issue in the design of financial regulation.

== Concept ==
Regulatory arbitrage arises when the same economic activity is treated differently by the regulations, so that firms have an incentive to conduct the activity in the form that is treated more favourably.

The differences may arise from the definition of the activities, from the rules that apply to different types of institution, or from the differences in the regulations across jurisdictions.

== Forms ==
Financial regulatory arbitrage takes several forms. Firms may conduct activities in the legal form that attracts the least regulation, for example by using a subsidiary or a special purpose entity that is subject to lighter rules.

Firms may also move activities to jurisdictions with lighter regulation, a process known as regulatory competition. The movement can undermine the effectiveness of the regulation in the home jurisdiction.

Firms may also exploit the differences in the treatment of economically equivalent instruments. The shift of activity to the instrument that is treated more favourably can undermine the intent of the regulation.

== Consequences ==
Regulatory arbitrage has consequences for the effectiveness of regulation and for financial stability. The arbitrage can shift activity to the parts of the system that are less regulated, which may increase the risk to the system.

The arbitrage can also create a race to the bottom, in which jurisdictions compete to attract activity by lowering their standards. The result may be a general weakening of the regulation.

The arbitrage complicates the measurement of risk, since the activities are conducted through entities and instruments that may not be captured by the regulatory data. The measurement of the risk of the system must therefore account for the arbitrage.

== Responses ==
The responses to regulatory arbitrage include the harmonisation of the rules across jurisdictions and across the types of institution, and the extension of the regulation to the activities that were previously unregulated.

The harmonisation is pursued through international cooperation, including the standards set by the international bodies. The standards provide a common framework, though the implementation varies across jurisdictions.

The design of the regulation must be robust to the arbitrage, which requires attention to the economic substance of the activities rather than to their legal form. The framework must be reviewed as the activities evolve, and it must address the new forms of arbitrage that emerge.

== The Shadow Banking System ==
The shadow banking system comprises the entities and the activities that provide the credit intermediation outside the regular banking system. The system includes the money market funds, the special purpose entities, and the other intermediaries.

The shadow banking system is a source of the regulatory arbitrage, since the activities can be conducted outside the regulatory perimeter. The system can therefore accumulate the risk without the oversight of the regulators.

The response includes the extension of the regulation to the activities and the strengthening of the monitoring of the system. The measurement of the size and of the risk of the system is a central task of the supervisors.

== The Basel Standards ==
The Basel standards are the international framework for the regulation of the banks, developed by the Basel Committee on Banking Supervision. The standards specify the capital and the liquidity requirements and the other prudential rules.

The standards are intended to provide the common framework across the jurisdictions and to reduce the scope for the regulatory arbitrage. The implementation varies across the jurisdictions, which creates the potential for the arbitrage.

The standards are based on the risk weights, which determine the capital that the banks must hold for each asset. The banks have the incentives to hold the assets with the lower risk weights, which can create the arbitrage if the weights do not reflect the risk accurately.

== The International Cooperation ==
The international cooperation is central to the response to the regulatory arbitrage. The cooperation includes the setting of the standards, the assessment of the compliance of the jurisdictions, and the sharing of the information among the supervisors.

The cooperation is pursued through the international bodies, including the Basel Committee and the Financial Stability Board. The bodies set the standards and monitor the implementation, and they provide the forum for the coordination of the policy.

The cooperation is subject to the limits, since the jurisdictions have the different interests and the different legal frameworks. The design of the framework must take account of these differences and must provide the incentives for the compliance.

== Summary ==
Regulatory arbitrage is the exploitation of the differences in the regulation, and it is a central issue in the design of the financial regulation. The responses, including the harmonisation of the rules and the international cooperation, inform the understanding of the governance of the financial system.

== See also ==
* Financial Economics
* Institutional Economics
* Banking

== References ==

<ref name="r1">Research on regulatory arbitrage and on its consequences.</ref>
<ref name="r2">Studies of international cooperation in financial regulation.</ref>
<ref name="r3">Analyses of the design of regulation that is robust to arbitrage.</ref>

<references />

[[Category:Financial economics]]
[[Category:Institutional economics]]
[[Category:Banking]]

Real Balance

2026-10-06T06:22:46Z

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'''Real balance''' is the value of money holdings expressed in terms of the goods and services that they can purchase. The real balance effect is the effect of a change in real balances on consumption and on aggregate demand.

== Concept ==
Real balances are the nominal money holdings of households and firms divided by the price level. They represent the purchasing power of the money that is held.

The real balance effect operates when a change in the price level alters the real value of money holdings, which affects the spending decisions of households. A fall in the price level raises the real value of money holdings, which raises consumption, and vice versa.

== The Real Balance Effect ==
The real balance effect, also known as the wealth effect, was emphasised by economists including Arthur Pigou, who argued that it provides a mechanism for the economy to return to full employment.

The argument is that a fall in the price level raises the real value of money holdings, which raises consumption, which raises demand, which raises output. The effect provides a channel through which the price level can affect output, even when the interest rate is at its lower bound.

The strength of the effect depends on the size of the money holdings and on the responsiveness of consumption to wealth. The empirical evidence suggests that the effect is small, which limits its practical importance.

== Criticisms ==
The real balance effect has been criticised on several grounds. The effect is small, and it may be offset by other effects of a fall in the price level, including the increase in the real burden of debt.

The debt deflation effect, identified by Irving Fisher, holds that a fall in the price level raises the real burden of debt, which reduces the net wealth of households and firms, which reduces spending. The effect works in the opposite direction to the real balance effect, and it may dominate.

The criticisms mean that the real balance effect is not a reliable mechanism for the restoration of full employment, and that the economy may remain below full employment for a prolonged period.

== Uses ==
The concept of real balances is used in the analysis of the demand for money, where the demand is expressed as a function of real income and of the interest rate. It is used in the analysis of the effects of monetary and fiscal policy.

The concept is also used in the analysis of inflation, where the erosion of real balances by inflation is a cost of inflation. The inflation tax is the reduction in the real value of money holdings that results from inflation, and it is a transfer from the holders of money to the issuer.

== The Demand for Money ==
The demand for the money balances is the analysis of the amount of the money that the households and the firms choose to hold. The demand depends on the income and on the interest rate, and it is often expressed as the demand for the real balances.

The demand for the real balances rises with the income, since the transactions require the money, and falls with the interest rate, since the money bears less return than the other assets. The relationship is central to the analysis of the monetary policy.

The stability of the demand for the money is a central issue. The evidence on the stability is mixed, and the instability complicates the use of the monetary aggregates as the targets of the policy.

== The Seigniorage and the Inflation Tax ==
The inflation reduces the real value of the money holdings, and the reduction is a form of the taxation of the holders. The revenue from the creation of the money is the seigniorage, and the erosion of the value is the inflation tax.

The inflation tax is a transfer from the holders of the money to the issuer, and it is a source of the revenue for the government. The tax is often regressive, since the poor hold a larger share of their wealth in the form of the money.

The analysis of the seigniorage informs the design of the monetary policy and the assessment of the fiscal position. The reliance on the seigniorage can lead to the high inflation and to the hyperinflation.

== The Wealth Effect ==
The real balance effect is a form of the wealth effect, in which the change in the real value of the money holdings affects the consumption. The effect is one of the channels through which the price level affects the demand.

The strength of the effect depends on the size of the money holdings and on the responsiveness of the consumption to the wealth. The effect is generally small, which limits its practical importance.

The effect also interacts with the debt deflation, which works in the opposite direction. The net effect depends on the balance between the two, and the analysis of the effect must consider both.

== Summary ==
Real balance is the value of the money holdings in terms of the goods that they can purchase, and it is central to the analysis of the demand for the money and of the effects of the inflation. The real balance effect and the inflation tax are the applications of the concept.

== See also ==
* Monetary Economics
* Macroeconomics
* Inflation

== References ==

<ref name="r1">Research on the real balance effect and on the demand for money.</ref>
<ref name="r2">Studies of the debt deflation effect.</ref>
<ref name="r3">Analyses of the costs of inflation.</ref>

<references />

[[Category:Monetary economics]]
[[Category:Macroeconomics]]
[[Category:Inflation]]

Rate of Return

2026-10-06T06:22:45Z

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The '''rate of return''' is the gain or loss on an investment over a period, expressed as a proportion of the amount invested. The rate of return is a central concept in finance and in the analysis of investment.

== Definition ==
The rate of return is calculated as the change in the value of the investment plus any income received, divided by the initial value. For a share, the return comprises the change in the price and the dividend. For a bond, it comprises the change in the price and the coupon.

The return may be measured over different periods, including a day, a month, or a year. The returns over different periods can be combined to compute the return over a longer period, using the geometric mean.

The return may be nominal, measured in current prices, or real, adjusted for inflation. The real return is the relevant measure for the assessment of the purchasing power of the investment.

== Expected and Required Return ==
The expected return is the average of the possible returns, weighted by their probabilities. It is the measure that investors use in assessing the attractiveness of an investment, though it is not directly observable.

The required return is the minimum return that investors demand to hold the asset. It reflects the risk-free rate and a premium for the risk of the asset. The difference between the expected return and the required return determines whether the investment is attractive.

The relationship between the expected return and the risk of an asset is central to asset pricing. The models of asset pricing, including the capital asset pricing model, specify how the expected return depends on the risk of the asset.

== Measurement ==
The measurement of the rate of return requires data on the prices and the income of the asset. The data are available for many assets, though the measurement of the return on some assets, including real estate and private equity, is more difficult.

The measurement must account for the costs of the transaction, including the commissions and the taxes, which reduce the net return. The measurement must also account for the timing of the cash flows, which affects the return.

The returns are used in the analysis of the performance of investments and of the efficiency of markets. The comparison of the returns of different assets informs the analysis of the risk premium and of the behaviour of investors.

== Applications ==
The rate of return is used in the evaluation of investment projects, where the internal rate of return is compared with the cost of capital. It is used in the analysis of the performance of portfolios and of the skill of managers.

The rate of return is also used in the analysis of the economy, where the return on capital is a determinant of investment and of growth. The measurement of the return on capital informs the analysis of the distribution of income and of the effects of policy.

== The Components of the Return ==
The return on an investment comprises the income that it generates and the change in its value. For a share, the income is the dividend, and the change in the value is the capital gain or loss.

The total return is the sum of the two components, expressed as a proportion of the initial investment. The decomposition of the return into the income and the capital components informs the analysis of the sources of the return and of the behaviour of the prices.

The return may be measured over different horizons, and the components may differ. Over the long run, the income component is a larger share of the total return, while over the short run the capital component may dominate.

== The Risk Premium ==
The risk premium is the excess return that the investors require to hold a risky asset instead of a risk-free asset. The premium compensates the investors for the risk that they bear.

The premium is a central concept in the asset pricing, and it is estimated from the difference between the return on the risky assets and the return on the risk-free assets. The estimates vary and are subject to the uncertainty.

The premium is also a central concept in the analysis of the cost of capital, since the cost of the equity of a firm reflects the risk premium that the investors require. The design of the investment decisions and of the capital structure depends on the premium.

== The Historical Returns ==
The historical returns on the major asset classes have been documented over long periods. The returns on the equity have exceeded the returns on the bonds and on the bills, and the difference is the equity premium.

The equity premium puzzle refers to the finding that the historical premium is larger than the standard models predict, given the risk aversion of the investors. The puzzle has been explained by the risk of the rare disasters, by the behaviour of the investors, and by the other factors.

The analysis of the historical returns informs the understanding of the behaviour of the markets and the design of the portfolios. The returns also inform the assumptions about the future returns, though the past performance is not a guarantee of the future.

== Summary ==
The rate of return is the gain on an investment over a period, comprising the income and the capital components. The analysis of the components, of the risk premium, and of the historical returns informs the understanding of the investment and of the asset pricing.

== See also ==
* Financial Economics
* Cost Accounting
* Financial Asset

== References ==

<ref name="r1">Finance texts on returns and on asset pricing.</ref>
<ref name="r2">Research on the measurement of returns.</ref>
<ref name="r3">Analyses of the return on capital and of investment.</ref>

<references />

[[Category:Financial economics]]
[[Category:Cost accounting]]
[[Category:Banking]]

Quantitative Tightening

2026-10-06T06:22:45Z

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'''Quantitative tightening''' is the reduction of the balance sheet of a central bank, through the sale of assets or the cessation of reinvestment, undertaken to withdraw the liquidity that was injected during a period of quantitative easing. Quantitative tightening is the reverse of quantitative easing.

== Concept ==
Quantitative easing expands the balance sheet of the central bank, through the purchase of assets, which injects liquidity into the financial system and lowers long-term interest rates. Quantitative tightening reduces the balance sheet, through the sale of assets or the run-off of maturing assets, which withdraws liquidity and raises long-term rates.

The two operations are the mirror image of each other, though the effects are not perfectly symmetric. The effects of tightening may differ from those of easing, since the conditions in the market and the behaviour of the participants may differ.

== Mechanisms ==
Quantitative tightening operates through several channels. The reduction of the balance sheet withdraws reserves from the banking system, which may raise short-term rates if the reserves are scarce.

The sales of assets raise the supply of securities in the market, which may raise the yields and tighten the financial conditions. The reduction of the balance sheet also signals the intention of the central bank to normalise policy, which affects the expectations of the market.

The effect on the economy depends on the response of the financial conditions and on the state of the economy. A tightening that is undertaken when the economy is strong may have a limited effect, while a tightening that is undertaken when the economy is weak may have a larger effect.

== Challenges ==
The use of quantitative tightening poses challenges. The effects of the reduction of the balance sheet are uncertain, since the experience is limited and the channels are not fully understood.

The reduction of the balance sheet may interact with the other instruments of policy, and the coordination between them is important. The central bank must manage the reduction without disrupting the market and without unnecessarily tightening the conditions.

The reduction also raises questions about the appropriate size of the balance sheet in the long run. The size determines the reserves in the banking system and the operating framework of the central bank.

== The Normalisation of Policy ==
The normalisation of policy involves the gradual reduction of the balance sheet and the return of the policy rate to more normal levels. The process is managed carefully, to avoid disrupting the market and the economy.

The design of the normalisation affects the expectations of the market and the behaviour of the participants. The communication of the plans is therefore important, and it must be clear and consistent.

The experience with the normalisation is a subject of research, and it informs the understanding of the effects of the balance sheet policy and of the appropriate framework for the conduct of monetary policy.

== The Balance Sheet of the Central Bank ==
The balance sheet of the central bank comprises the assets that it holds, including the government securities and the loans to the financial institutions, and the liabilities, including the currency in circulation and the reserves of the banks.

The quantitative easing expands the balance sheet, and the quantitative tightening reduces it. The size and the composition of the balance sheet affect the conditions in the financial markets and the transmission of the monetary policy.

The design of the balance sheet is a central element of the operating framework of the central bank. The framework determines the instruments that the central bank uses and the way in which it influences the interest rates.

== The Effects on the Financial Markets ==
The quantitative tightening affects the financial markets through several channels. The reduction of the balance sheet withdraws the reserves and raises the supply of the securities, which tends to raise the yields and to tighten the financial conditions.

The effects depend on the response of the market and on the state of the economy. The market may anticipate the tightening, in which case the effect is already reflected in the prices. The tightening may also have the effects on the exchange rate and on the capital flows.

The analysis of the effects informs the design of the normalisation and the communication of the plans. The central bank must manage the reduction carefully to avoid the disruption of the market.

== The Exit Strategy ==
The exit strategy from the unconventional policy involves the normalisation of the policy rate and the reduction of the balance sheet. The sequencing and the pace of the normalisation are central to the design.

The central bank may choose to raise the policy rate first and to reduce the balance sheet later, or to pursue the two in parallel. The choice depends on the conditions and on the framework of the policy.

The normalisation must be communicated clearly, and it must be adjusted as the conditions change. The credibility of the central bank is central to the success of the normalisation.

== Summary ==
Quantitative tightening is the reduction of the balance sheet of the central bank, and it is the reverse of the quantitative easing. The analysis of the mechanisms, of the effects, and of the exit strategy informs the understanding of the balance sheet policy.

== See also ==
* Central Banking
* Monetary Economics
* Financial Asset

== References ==

<ref name="r1">Research on quantitative easing and on the normalisation of policy.</ref>
<ref name="r2">Studies of the effects of the balance sheet policy.</ref>
<ref name="r3">Analyses of the operating framework of central banks.</ref>

<references />

[[Category:Central banking]]
[[Category:Monetary economics]]
[[Category:Financial economics]]

Profit Maximization

2026-10-06T06:22:44Z

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'''Profit maximization''' is the objective of a firm to maximise the difference between its total revenue and its total cost. Profit maximization is the standard assumption about the behaviour of firms in microeconomics, and it provides the basis for the analysis of supply and of market equilibrium.

== The Condition ==
The condition for profit maximization is that the firm produces the quantity at which marginal revenue equals marginal cost. At this quantity, the additional revenue from producing one more unit equals the additional cost, so that the firm cannot increase its profit by changing its output.

For a competitive firm, which takes the market price as given, the condition becomes price equals marginal cost. The firm supplies output up to the point at which the marginal cost equals the price.

For a firm with market power, the marginal revenue is less than the price, since the firm must lower the price to sell more. The condition becomes marginal revenue equals marginal cost, and the resulting price exceeds the marginal cost.

== Short Run and Long Run ==
In the short run, the firm decides whether to produce and how much, given the fixed inputs. The firm will produce if the price covers the average variable cost, and it will produce the quantity at which marginal revenue equals marginal cost.

In the long run, the firm can adjust all inputs and can enter or exit the industry. In a competitive industry, the long-run equilibrium is characterised by zero economic profit, since entry continues until the profit is eliminated.

The distinction between short-run and long-run profit maximization explains the difference between the short-run and the long-run supply curves, and the dynamics of entry and exit in an industry.

== Criticisms ==
The assumption of profit maximization has been criticised on several grounds. Firms may pursue other objectives, including the maximisation of sales, of market share, or of the utility of the managers.

The separation of ownership and control means that the managers, who make the decisions, may have objectives that differ from those of the owners. The analysis of the firm must therefore consider the incentives of the managers and the mechanisms of corporate governance.

The assumption may also be a reasonable approximation, since firms that do not maximise profit tend to be eliminated by competition over time. The analysis of the firm must therefore balance the realism of the assumptions against their analytical convenience.

== Applications ==
The condition for profit maximization is used in the analysis of pricing, of output, and of market structure. It is used in the analysis of the effects of taxes and of regulation, and in the analysis of the behaviour of firms in different market structures.

The condition is also used in the analysis of the effects of competition, since the difference between price and marginal cost is a measure of the market power of the firm. The analysis of the markup and of its determinants is central to the analysis of market structure.

== Alternative Objectives ==
The assumption of the profit maximization has been supplemented by the analysis of the alternative objectives of the firm. The alternatives include the maximisation of the sales, of the growth, and of the utility of the managers.

The analysis of the behaviour of the firm under the separation of the ownership and the control has been developed by the economists including William Baumol and Oliver Williamson. The analysis holds that the managers pursue their own objectives, which may include the size of the firm and the perquisites.

The analysis of the objectives informs the understanding of the behaviour of the firm and of the design of the corporate governance. The mechanisms of the governance, including the board of the directors and the structure of the compensation, affect the alignment of the interests.

== The Dynamics of the Competition ==
The analysis of the profit maximization is central to the analysis of the competition and of the market structure. In the competitive markets, the firms that do not maximise the profit are eliminated by the competition over time.

The dynamics of the competition mean that the profit maximization may be the long-run outcome, even when the firms pursue the other objectives in the short run. The analysis of the dynamics informs the understanding of the equilibrium of the market.

The analysis also considers the role of the entry and of the exit. The entry of the new firms drives the profit to zero, and the exit of the firms that cannot cover the cost restores the profit for the remaining firms.

== The Measurement of the Profit ==
The measurement of the profit is complicated by the differences between the accounting profit and the economic profit. The accounting profit is the revenue minus the explicit costs, while the economic profit also deducts the opportunity cost of the resources.

The distinction matters for the analysis of the behaviour of the firm, since the firm may report a profit while earning less than the opportunity cost of the capital. The distinction also matters for the analysis of the market, since the economic profit determines the entry and the exit.

The measurement of the profit is also affected by the treatment of the depreciation, of the inventory, and of the other items. The accounting standards determine the measurement, and the differences across the jurisdictions complicate the comparison.

== Summary ==
Profit maximization is the standard assumption about the behaviour of the firm, and it provides the basis for the analysis of the supply and of the market equilibrium. The analysis of the alternative objectives, of the dynamics of the competition, and of the measurement of the profit informs the understanding of the firm.

== See also ==
* Microeconomics
* Cost Function
* Market Structure

== References ==

<ref name="r1">Microeconomics texts on the firm and on profit maximization.</ref>
<ref name="r2">Research on the objectives of the firm.</ref>
<ref name="r3">Analyses of the effects of market structure on pricing.</ref>

<references />

[[Category:Microeconomics]]
[[Category:Production economics]]
[[Category:Market structure]]

Productivity Shock

2026-10-06T06:22:43Z

Youku: New encyclopedia entry (batch upload)

A '''productivity shock''' is an unexpected change in the productivity of the economy, which affects the relationship between inputs and output. Productivity shocks are a central source of fluctuations in the economy and a key driver of the business cycle.

== Concept ==
A productivity shock changes the amount of output that can be produced from a given quantity of inputs. A positive shock raises productivity, so that more output can be produced, while a negative shock reduces it.

The shocks may be technological, arising from innovation or from the diffusion of new methods. They may be structural, arising from changes in the organisation of production or in the availability of inputs. They may be temporary, such as the disruption caused by a natural disaster, or permanent, such as the adoption of a new technology.

== Sources ==
Productivity shocks arise from several sources. Technological innovation is a major source, as the development of new products and methods raises the productivity of the economy.

The shocks also arise from changes in the prices of inputs, particularly of energy, which affect the productivity of the economy. The oil price shocks of the 1970s are the classic example, and they contributed to the stagflation of that period.

The shocks also arise from changes in the regulatory and institutional environment, which affect the efficiency of production, and from the diffusion of technology across firms and countries.

== Effects ==
The effects of a productivity shock depend on the nature of the shock and on the response of policy. A positive shock raises output and, if the demand does not adjust, may create inflationary pressure. A negative shock reduces output and may raise inflation, a combination known as stagflation.

The effects also depend on the response of the labour market. A positive shock raises the marginal product of labour and, in a competitive market, the real wage. A negative shock reduces the marginal product and the real wage.

In the real business cycle framework, productivity shocks are the main source of fluctuations, and the fluctuations are the efficient response of the economy to the shocks. In other frameworks, the shocks interact with nominal rigidities and with the financial system, and the fluctuations may be amplified.

== Policy ==
The policy response to productivity shocks depends on the nature of the shock and on its effects. A negative shock that raises inflation and reduces output poses a dilemma for monetary policy, since the two objectives conflict.

The response also depends on whether the shock is temporary or permanent. A temporary shock may warrant a limited response, while a permanent shock may require adjustment of the productive capacity of the economy.

The policy must also consider the distributional effects of the shock, since the change in productivity affects the returns to the factors of production and thereby the distribution of income.

== Real Business Cycle Theory ==
The real business cycle theory holds that the fluctuations in the economy are the efficient response to the productivity shocks, and that the shocks are the main source of the business cycle.

The theory assumes that the markets clear and that the prices are flexible, so that the fluctuations reflect the changes in the productive capacity and in the preferences. The theory implies that the policy should not attempt to smooth the fluctuations, since the fluctuations are the efficient response.

The theory has been influential in the development of the modern macroeconomics, and it has stimulated the analysis of the sources of the fluctuations. The theory has been criticised for its assumptions and for the difficulty of identifying the shocks.

== The Identification of the Shocks ==
The identification of the productivity shocks is a central task of the empirical analysis. The shocks are not observed, and they must be inferred from the data on the output and on the inputs.

The methods include the estimation of the production function and the analysis of the residual, which is the part of the output that is not explained by the inputs. The residual is interpreted as the measure of the productivity, and its changes as the shocks.

The identification is subject to the problems of the measurement and of the specification. The measurement of the inputs is difficult, and the residual may capture the effects of the factors other than the productivity.

== The Policy Response ==
The policy response to the productivity shocks depends on the nature of the shock and on the framework of the analysis. In the real business cycle framework, the policy should not respond, since the fluctuations are the efficient response.

In the frameworks with the nominal rigidities, the policy can improve the outcome by offsetting the effects of the shocks. The central bank can respond to the shocks through the changes in the interest rates, and the government through the fiscal policy.

The design of the response must take account of the uncertainty about the shocks and about the effects of the policy. The response must also consider the possibility that the shock is temporary or permanent, since the appropriate response differs.

== Summary ==
Productivity shocks are the changes in the relationship between the inputs and the output, and they are a central source of the fluctuations in the economy. The analysis of the shocks, of the real business cycle theory, and of the policy response informs the understanding of the business cycle.

== See also ==
* Macroeconomics
* Business Cycle
* Production Economics

== References ==

<ref name="r1">Research on productivity shocks and on the business cycle.</ref>
<ref name="r2">Studies of the effects of the oil price shocks.</ref>
<ref name="r3">Analyses of the policy response to supply shocks.</ref>

<references />

[[Category:Macroeconomics]]
[[Category:Business cycle]]
[[Category:Production economics]]

Private Property Rights

2026-10-06T06:22:42Z

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'''Private property rights''' are the rights of individuals and firms to own, use, and dispose of assets, and to exclude others from using them. Private property rights are a central institution of a market economy, and their definition and enforcement affect economic performance.

== Concept ==
Property rights comprise several elements, including the right to use the asset, the right to exclude others, and the right to transfer the asset to others. The rights may be held by individuals, by firms, or by other entities.

The definition of property rights determines who has the authority to use the asset and to benefit from it. The enforcement determines whether the rights are respected. Both the definition and the enforcement affect the incentives of the owners.

== Role in the Economy ==
Property rights affect the incentives to invest and to use resources efficiently. A secure owner has an incentive to invest in the asset, since the owner can capture the returns. An insecure owner has less incentive, since the returns may be taken by others.

Property rights also facilitate exchange. A well-defined right can be transferred, which allows the asset to move to the use in which it is most valued. The transfer requires that the rights be well defined and that the transaction costs be low.

Property rights are central to the analysis of the firm and of the financial system. The rights to the assets of a firm determine the claims of the creditors and the shareholders, and the ability to pledge assets as collateral depends on the definition and the enforcement of the rights.

== Institutions ==
The definition and the enforcement of property rights require institutions, including the legal system, the courts, and the police. The quality of these institutions affects the security of the rights and the willingness of individuals and firms to invest.

The institutions also include the mechanisms for the registration of the ownership of assets, including land registries and registers of shares and of other securities. The registration provides information about the ownership and facilitates the transfer of the assets.

The development of these institutions is a central element of the development process. The absence of secure property rights and of effective institutions is a major constraint on investment and growth in developing countries.

== Debate ==
The analysis of property rights is connected to the debate about the role of the state and of the market. Some argue that the definition and the enforcement of property rights is the fundamental function of the state, while others argue that the state itself may threaten the rights.

The debate also concerns the balance between private and public ownership. The choice depends on the characteristics of the assets and on the objectives of the policy. The design of the arrangements must take account of the incentives and of the institutions.

== The Economics of Property Rights ==
The analysis of the property rights is central to the new institutional economics, which holds that the institutions, including the property rights, determine the performance of the economy.

The framework analyses the effect of the property rights on the incentives to invest and to use the resources efficiently. The secure rights encourage the investment, while the insecure rights discourage it.

The framework also analyses the effect of the property rights on the transaction costs. The well-defined rights reduce the cost of the exchange, since the parties can transfer the rights without the need for the complex agreements.

== The Tragedy of the Commons ==
The tragedy of the commons describes the depletion of the resources that are held in common, since the individuals have the incentive to use the resources without bearing the full cost.

The analysis holds that the common ownership leads to the overuse of the resources, and that the private ownership or the regulation can address the problem. The analysis has been applied to the fisheries, to the grazing land, and to the other resources.

The analysis has been refined by the work of Elinor Ostrom, who showed that the communities can develop the institutions to manage the common resources sustainably. The findings inform the design of the policy for the management of the resources.

== The Reform of the Property Rights ==
The reform of the property rights is a central element of the transition of the economies and of the development process. The reform involves the definition of the rights, the establishment of the institutions for their enforcement, and the transfer of the rights to the private sector.

The experience of the transition economies shows the difficulty of the reform. The reform requires the institutions, including the legal system and the financial system, and the absence of the institutions can lead to the concentration of the ownership and to the weak performance.

The design of the reform must take account of the context and must build the institutions that are required for the effective operation of the property rights.

== Summary ==
Private property rights are a central institution of the market economy, and their definition and enforcement affect the incentives to invest and to use the resources efficiently. The analysis of the rights, of the tragedy of the commons, and of the reform informs the understanding of the role of the institutions.

== See also ==
* Institutional Economics
* Political Economy
* Economic Development

== References ==

<ref name="r1">Research on property rights and on their economic effects.</ref>
<ref name="r2">Studies of the institutions that define and enforce the rights.</ref>
<ref name="r3">Analyses of the role of property rights in development.</ref>

<references />

[[Category:Institutional economics]]
[[Category:Political economy]]
[[Category:Development economics]]

Price Stabilization

2026-10-06T06:22:41Z

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'''Price stabilization''' is the use of policy to reduce fluctuations in the prices of goods, of assets, or of the general price level. Price stabilization is a central objective of economic policy, and it is pursued through a range of instruments.

== Objectives ==
The objective of price stabilization is to reduce the uncertainty and the costs associated with price fluctuations. Fluctuations in prices create uncertainty for firms and households, complicate planning, and can distort the allocation of resources.

The stabilization of the general price level is the objective of monetary policy, which seeks to keep inflation low and stable. The stabilization of particular prices is the objective of sectoral policies, which seek to reduce fluctuations in the prices of commodities and of other goods.

== Instruments ==
The instruments of price stabilization include monetary policy, which affects the general price level through its effect on demand. The central bank adjusts the policy rate and other instruments to keep inflation close to its target.

The instruments include fiscal policy, which affects prices through its effect on demand and through the taxes and subsidies that it imposes. The instruments include buffer stocks, in which the authority buys and sells the commodity to stabilise its price.

The instruments include price controls, which set the prices of particular goods. The controls are used to protect consumers and to reduce inflation, though they can create shortages and distortions.

== Commodity Price Stabilization ==
The stabilization of commodity prices is a particular concern for developing countries, which depend on the export of commodities. The prices of commodities are volatile, and the fluctuations affect the incomes of producers and the revenues of governments.

The instruments for stabilizing commodity prices include buffer stocks, export taxes, and stabilization funds. The funds accumulate revenue during periods of high prices and disburse it during periods of low prices, smoothing the effect on the budget and on the economy.

The experience with commodity price stabilization has been mixed. The buffer stocks have often been expensive to maintain and have been subject to the risk that the price will move against the authority. The stabilization funds have been more successful, though their effectiveness depends on the design and on the discipline of the management.

== Debate ==
The debate about price stabilization concerns the appropriate balance between the benefits of stability and the costs of intervention. Some argue that the authorities should focus on the stability of the general price level and allow particular prices to adjust, while others argue that the stabilization of particular prices is important for the welfare of producers and consumers.

The debate also concerns the effectiveness of the instruments. The experience with price controls suggests that they are difficult to sustain and that they can create distortions, while the experience with monetary policy suggests that it is effective in stabilizing the general price level.

== Monetary Policy and Price Stability ==
The stabilization of the general price level is the objective of monetary policy in most countries. The central bank targets the rate of inflation and adjusts the instruments of the policy to keep the rate close to the target.

The framework of inflation targeting has been adopted by many central banks, and it involves the publication of the target and the communication of the policy decisions. The framework anchors the expectations of the public and improves the credibility of the policy.

The central bank uses the policy rate, and in the periods of the stress it uses the unconventional instruments, including the asset purchases and the forward guidance. The effectiveness of the framework depends on the credibility of the central bank and on the transparency of its decisions.

== Buffer Stocks ==
The stabilization of the commodity prices is pursued through the buffer stocks, in which the authority buys the commodity when the price is low and sells it when the price is high. The objective is to keep the price within a range and to reduce the fluctuations.

The experience with the buffer stocks has been mixed. The stocks have been expensive to maintain, and the authority has been exposed to the risk that the price will move against it. The international commodity agreements that used the buffer stocks were largely abandoned.

The alternative approach is the use of the stabilization funds, which accumulate the revenue during the periods of the high prices and disburse it during the periods of the low prices. The funds smooth the effect on the budget and on the economy, and they have been more successful than the buffer stocks.

== The Costs of the Inflation ==
The analysis of the price stabilization is informed by the assessment of the costs of the inflation. The costs include the erosion of the real value of the money holdings, the distortion of the relative prices, and the redistribution of the wealth between the debtors and the creditors.

The costs are larger when the inflation is high and volatile, since the uncertainty complicates the planning and the contracts. The costs are smaller when the inflation is low and stable, which is the objective of the policy.

The assessment of the costs informs the choice of the target and the design of the framework. The benefit of the stabilization is the reduction of the costs, and the design must balance the benefit against the costs of the policy itself.

== Summary ==
Price stabilization is the use of the policy to reduce the fluctuations in the prices, and it is pursued through the monetary policy and through the sectoral policies. The analysis of the instruments and of the costs of the inflation informs the design of the policy.

== See also ==
* Monetary Economics
* Inflation
* Central Banking

== References ==

<ref name="r1">Research on price stabilization and on the instruments of policy.</ref>
<ref name="r2">Studies of commodity price stabilization.</ref>
<ref name="r3">Analyses of the debate about the appropriate role of the authorities.</ref>

<references />

[[Category:Monetary economics]]
[[Category:Inflation]]
[[Category:Central banking]]

Price Bubble

2026-10-06T06:22:41Z

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A '''price bubble''' is a situation in which the price of an asset rises far above its fundamental value, driven by expectations of further price increases rather than by the fundamentals. Bubbles are a recurrent feature of financial markets and are a source of concern for policymakers.

== Characteristics ==
A bubble is characterised by a rapid increase in the price of an asset, accompanied by high trading volume and by the entry of new investors. The increase is not justified by the fundamentals, which may change little during the episode.

The bubble is sustained by expectations of further price increases, since investors buy the asset in the belief that they can sell it at a higher price. The expectations are self-fulfilling for a time, as the purchases themselves raise the price.

The bubble eventually bursts, when the expectations change and the price falls. The fall is often rapid and is accompanied by a decline in trading and by losses for the investors who bought at the peak.

== Causes ==
Several factors contribute to the formation of bubbles. The availability of credit is a common factor, since the ability to borrow allows investors to buy the asset with leverage, amplifying the increase in the price.

The behaviour of investors also contributes. Herd behaviour, in which investors follow the actions of others, and the tendency to extrapolate recent price increases into the future, are both associated with bubbles.

Institutional factors, including the regulation of the market and the incentives of the participants, can also contribute. The design of the compensation of managers and the structure of the financial system affect the willingness of the participants to take risks.

== Examples ==
The history of finance includes many examples of bubbles, including the tulip mania of the seventeenth century, the South Sea bubble, and the railway mania. More recent examples include the dot-com bubble of the late 1990s and the housing bubble that preceded the financial crisis.

The examples share common features, including the rapid increase in prices, the entry of new investors, and the eventual collapse. The episodes differ in the assets involved and in the institutional context.

== Policy ==
The policy response to bubbles is debated. Some argue that the authorities should act to prevent bubbles, through the use of interest rates and of macroprudential instruments, since the collapse of a bubble can have severe consequences for the economy. Others argue that bubbles are difficult to identify in advance and that the authorities should instead focus on the resilience of the financial system.

The debate reflects the difficulty of identifying bubbles and of assessing their effects. The design of policy must take account of the uncertainty and of the risk that intervention may itself create distortions.

== Bubbles and Financial Stability ==
The collapse of a price bubble can have severe consequences for the economy, particularly when the bubble is financed by credit. The decline in the asset prices reduces the wealth of the households and the value of the collateral of the firms, which reduces the spending and the lending.

The interaction between the asset prices and the credit is a central feature of the analysis of financial crises. The increase in the asset prices raises the value of the collateral, which allows the borrowers to obtain more credit, which raises the asset prices further. The process reverses when the prices fall.

The analysis of the interaction informs the design of the macroprudential policy, which seeks to contain the build-up of the risk during the expansion of the credit.

== Detecting Bubbles ==
The detection of bubbles in real time is difficult, since the fundamental value of the asset is not observed. The analysts use a range of indicators, including the ratio of the price to the earnings, the ratio of the price to the rent, and the growth of the credit.

The indicators are imperfect, and the episodes of rapid price increases that are not followed by a collapse complicate the analysis. The difficulty of the detection is a central argument against the use of the policy to prevent the bubbles.

The development of the methods for the detection of the bubbles is an active area of research. The methods include the statistical tests for the explosive behaviour of the prices and the analysis of the expectations of the investors.

== The Policy Response ==
The policy response to the bubbles is debated. The advocates of the intervention argue that the authorities should act to prevent the bubbles, since the collapse can have severe consequences. The opponents argue that the bubbles are difficult to identify and that the intervention may create distortions.

The response includes the use of the monetary policy, which affects the asset prices through the interest rates, and the use of the macroprudential policy, which seeks to contain the build-up of the risk. The design of the response must take account of the uncertainty and of the costs of the intervention.

== Summary ==
Price bubbles are a recurrent feature of the financial markets and a source of concern for the policymakers. The analysis of the causes, of the consequences, and of the policy response informs the understanding of the financial stability.

== See also ==
* Financial Economics
* Market Failure Theory
* Behavioural Economics

== References ==

<ref name="r1">Research on asset price bubbles and on their causes.</ref>
<ref name="r2">Studies of the history of bubbles.</ref>
<ref name="r3">Analyses of the policy response to bubbles.</ref>

<references />

[[Category:Financial economics]]
[[Category:Market failure]]
[[Category:Behavioural economics]]

Portfolio Diversification

2026-10-06T06:22:40Z

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'''Portfolio diversification''' is the strategy of spreading investment across a range of assets to reduce risk without proportionally reducing expected return. Diversification is a central principle of investment management.

== The Principle ==
The principle of diversification is based on the observation that the risk of a portfolio depends not only on the risk of the individual assets but also on the relationship among them. When assets are not perfectly correlated, the risk of the portfolio is less than the weighted average of the risks of the assets.

The benefit of diversification increases as the correlation among the assets decreases. When assets are perfectly positively correlated, there is no benefit. When they are negatively correlated, the benefit is greatest, and the risk of the portfolio can be less than the risk of the least risky asset.

The principle implies that investors should hold a portfolio of assets rather than a single asset, and that the composition of the portfolio should reflect the correlations among the assets.

== Systematic and Unsystematic Risk ==
The analysis of diversification distinguishes between systematic risk, which is the risk that affects all assets and cannot be eliminated by diversification, and unsystematic risk, which is specific to individual assets and can be eliminated.

The capital asset pricing model holds that investors are compensated only for systematic risk, since unsystematic risk can be diversified away. The expected return of an asset therefore depends on its beta, which measures its sensitivity to the systematic risk.

The implication is that the relevant measure of risk for the pricing of an asset is its contribution to the risk of a well-diversified portfolio, not its total risk. The analysis of diversification is therefore central to the theory of asset pricing.

== Portfolio Construction ==
The construction of a diversified portfolio involves the selection of the assets, the determination of the weights, and the management of the risk. The analysis is based on the expected returns of the assets, on their variances, and on their correlations.

The efficient frontier is the set of portfolios that offer the highest expected return for each level of risk. The investor chooses the portfolio on the frontier that matches their preferences for risk and return.

The construction of the portfolio also involves consideration of the constraints, including the liquidity of the assets, the transaction costs, and the investment policy. The practical implementation of diversification must take account of these constraints.

== Limitations ==
Diversification has limitations. It cannot eliminate systematic risk, which affects all assets, and it may not protect against the losses that occur during periods of stress, when the correlations among assets increase.

Diversification also requires information about the expected returns and the correlations of the assets, which are difficult to estimate. The estimates are subject to uncertainty, and the optimal portfolio may be sensitive to the errors in the estimates.

== The Efficient Frontier ==
The efficient frontier is the set of portfolios that offer the highest expected return for each level of risk. The frontier is derived from the expected returns, the variances, and the covariances of the available assets.

The investor chooses the portfolio on the frontier that matches their preferences for risk and return. The choice depends on the risk aversion of the investor, and it determines the composition of the portfolio.

The frontier demonstrates the benefit of diversification, since the frontier for a portfolio of assets lies above the frontier for a single asset. The analysis of the frontier is central to the theory of portfolio choice.

== The Capital Asset Pricing Model ==
The capital asset pricing model extends the analysis of the frontier to the market as a whole. The model holds that the market portfolio, which comprises all the risky assets, is on the efficient frontier, and that the expected return of an asset depends on its beta.

The beta measures the sensitivity of the asset's return to the return of the market. An asset with a beta greater than one is more volatile than the market, and it requires a higher expected return. An asset with a beta less than one is less volatile, and it requires a lower expected return.

The model has been influential in finance and in practice, and it is used in the estimation of the cost of equity. The model has been criticised for its empirical performance and for the difficulty of measuring the market portfolio.

== The Limits of Diversification ==
The limits of diversification are central to the analysis of risk. Diversification cannot eliminate the systematic risk, which affects all the assets, and it may not protect against the losses during periods of stress.

The correlation among the assets tends to increase during periods of stress, which reduces the benefit of diversification precisely when it is most needed. The phenomenon is a source of concern for the investors and for the regulators.

The analysis of the limits of diversification informs the design of the portfolios and the assessment of the risk. The investors must consider the behaviour of the correlations during the stress and the exposure to the systematic risk.

== Summary ==
Portfolio diversification reduces the risk by spreading the investment across the assets. The analysis of the efficient frontier, of the capital asset pricing model, and of the limits of diversification informs the understanding of the portfolio choice and of the pricing of the assets.

== See also ==
* Financial Economics
* Statistics
* Banking

== References ==

<ref name="r1">Research on portfolio theory and on diversification.</ref>
<ref name="r2">Studies of the capital asset pricing model.</ref>
<ref name="r3">Analyses of the practical construction of portfolios.</ref>

<references />

[[Category:Financial economics]]
[[Category:Statistics]]
[[Category:Banking]]

Pollution Permit

2026-10-06T06:22:39Z

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A '''pollution permit''' is a right, granted by an authority, to emit a specified quantity of a pollutant. Pollution permits are the basis of cap-and-trade systems, in which the total quantity of emissions is limited and the permits are traded among the emitters.

== Design ==
A cap-and-trade system sets a cap on the total quantity of emissions that may be released. The authority issues permits that correspond to the cap, and the permits are allocated to the emitters, either through a free allocation or through an auction.

The emitters must surrender permits that cover their emissions, and they may trade permits with one another. The trade allows the emitters with low abatement costs to reduce their emissions and sell their surplus permits, while the emitters with high abatement costs buy permits and continue to emit.

The cap ensures that the total quantity of emissions does not exceed the limit, while the trade ensures that the reductions are achieved at the lowest cost. The system is therefore efficient, in the sense that it achieves the environmental objective at the least cost.

== Comparison with Taxes ==
A pollution tax sets a price on emissions, and the emitters decide how much to emit given the price. A cap-and-trade system sets the quantity of emissions, and the market determines the price.

The two instruments differ in the certainty that they provide. A tax provides certainty about the price, while a cap-and-trade system provides certainty about the quantity. The choice between them depends on which form of certainty is more important.

The two instruments also differ in their distributional effects and in their revenue. A tax generates revenue for the government, while a cap-and-trade system generates revenue only if the permits are auctioned. The design of the allocation affects the distribution of the costs.

== Implementation ==
The implementation of a cap-and-trade system involves several decisions, including the coverage of the system, the level of the cap, and the method of allocation. The design of these elements affects the effectiveness and the cost of the system.

The coverage determines the sources that are subject to the cap. A broader coverage increases the opportunities for low-cost abatement and reduces the cost of meeting the cap. A narrower coverage may leave some sources unregulated and may create distortions.

The level of the cap determines the environmental objective. The cap must be set at a level that achieves the objective without imposing excessive costs. The cap can be tightened over time to achieve the long-term objective.

== Experience ==
Cap-and-trade systems have been implemented for several pollutants, including sulphur dioxide, which causes acid rain, and carbon dioxide, which causes climate change. The systems have achieved reductions in emissions, and the experience has informed the design of future systems.

The experience has also highlighted challenges, including the volatility of permit prices and the risk of leakage, in which emissions are shifted to jurisdictions without a cap. The design of the systems must address these challenges.

== The European Emissions Trading System ==
The European Union emissions trading system is the largest cap-and-trade system in the world, covering the emissions of carbon dioxide and of other greenhouse gases from a range of sectors. The system was launched in 2005, and it has been revised several times.

The system sets a cap on the total emissions and allocates permits to the covered installations. The permits are traded, and the price of the permits reflects the cost of the emissions and the balance between the supply and the demand.

The experience of the system has been mixed. The price of the permits has been volatile, and it fell sharply during the financial crisis, when the demand for the permits declined. The reforms have addressed the volatility and have tightened the cap.

== The Social Cost of Carbon ==
The social cost of carbon is the estimate of the economic damage caused by the emission of an additional tonne of carbon dioxide. The estimate is used in the design of the policy and in the assessment of the benefits of the abatement.

The estimation of the social cost requires the integration of the effects of the emissions over time, including the effects on the climate, on the economy, and on the welfare of the population. The estimates are subject to substantial uncertainty and depend on the assumptions about the discount rate and about the damages.

The social cost provides a benchmark for the price of the permits and for the level of a carbon tax. The choice of the discount rate has a large effect on the estimate, and the debate about the rate is central to the analysis of the climate policy.

== The Design of the Permit System ==
The design of the permit system involves decisions about the coverage, the cap, and the allocation. The coverage determines the sources that are subject to the cap, and the cap determines the environmental objective.

The allocation determines the distribution of the costs. A free allocation to the emitters provides a windfall to the incumbent firms, while an auction captures the revenue for the government. The choice of the allocation affects the political acceptability of the system.

The design must also address the risk of leakage, in which the emissions are shifted to jurisdictions without a cap. The measures to address the leakage include the border adjustments and the free allocation to the sectors that are exposed to trade.

== Summary ==
Pollution permits are the basis of cap-and-trade systems, which achieve the environmental objective at the lowest cost. The design of the systems, the estimate of the social cost of carbon, and the responses to the risk of leakage are central to the analysis of the climate policy.

== See also ==
* Environmental Economics
* Sustainability
* Public Economics

== References ==

<ref name="r1">Research on cap-and-trade systems and on the design of permits.</ref>
<ref name="r2">Studies of the experience with emissions trading.</ref>
<ref name="r3">Analyses of the comparison between taxes and permits.</ref>

<references />

[[Category:Environmental economics]]
[[Category:Sustainability]]
[[Category:Public economics]]

Permanent Income Hypothesis

2026-10-06T06:22:38Z

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The '''permanent income hypothesis''' is a theory of consumption developed by Milton Friedman, which holds that individuals base their consumption on their permanent income, the average income that they expect to receive over their lifetime, rather than on their current income.

== The Theory ==
The theory distinguishes between permanent income, which is the average income that the individual expects to receive over the long run, and transitory income, which is the deviation of current income from the permanent level. The theory holds that consumption is determined by permanent income.

The implication is that consumption does not respond to transitory changes in income, since the individual smooths consumption over time. A temporary increase in income is saved rather than consumed, and a temporary decrease is financed by dissaving.

The theory treats the individual as forward-looking, allocating consumption over the lifetime to maximise utility subject to the lifetime budget constraint. The optimal allocation equates the marginal utility of consumption across periods, subject to the rate of interest and to the discount rate.

== Evidence ==
The evidence provides qualified support for the theory. The finding that consumption responds less to transitory income than to permanent income is supported by studies of the response of consumption to windfalls and to temporary tax changes.

The theory has been challenged by the finding that consumption is more sensitive to current income than the theory predicts, a result known as excess sensitivity. The finding has been explained by liquidity constraints, which prevent individuals from borrowing against future income, and by the behaviour of consumers who do not optimise.

The theory has also been extended to include precautionary saving, in which individuals save to protect against uncertainty about future income. The extension improves the fit of the theory and explains the accumulation of wealth by households with uncertain income.

== Implications ==
The theory has implications for the analysis of the effects of fiscal policy. A temporary tax cut, which raises transitory income, should have little effect on consumption, while a permanent tax cut should have a larger effect.

The theory also has implications for the analysis of the effects of social security and of other transfer programmes. The design of the programmes affects the permanent income of households and thereby their consumption.

The theory represents the modern approach to consumption, in which the behaviour of households is analysed in a forward-looking framework with attention to the constraints and to the uncertainty that they face.

== The Life Cycle Hypothesis ==
The life cycle hypothesis, developed by Franco Modigliani, is closely related to the permanent income hypothesis. The hypothesis holds that individuals plan their consumption and savings over their lifetime, smoothing consumption by saving during the working years and dissaving during retirement.

The hypothesis implies that consumption depends on the lifetime resources of the individual rather than on current income. The pattern of saving over the life cycle reflects the desire to smooth consumption.

The hypothesis has been tested extensively, and the evidence provides qualified support. The pattern of saving over the life cycle is consistent with the hypothesis, though the behaviour of the elderly is less consistent with the predictions of the simple model.

== Liquidity Constraints ==
The presence of liquidity constraints is a major qualification to the permanent income hypothesis. Individuals who cannot borrow against their future income are unable to smooth consumption, and their consumption responds to current income.

The constraints are particularly relevant for young households, which have low current income and high expected future income but limited collateral. The constraints explain the finding of excess sensitivity of consumption to current income.

The presence of the constraints has implications for the effects of policy. A temporary tax cut may be saved by households that are not constrained but consumed by those that are, and the aggregate effect depends on the share of the constrained households.

== Precautionary Saving ==
The presence of uncertainty about future income leads to precautionary saving, in which individuals save to protect against the risk of a decline in income. The saving raises the wealth of the households and affects the response of consumption to income.

The precautionary saving is stronger when the uncertainty is higher and when the individuals are more risk averse. The presence of the saving helps to explain the accumulation of wealth by households with uncertain income.

The extension of the model to include precautionary saving improves the fit with the data and provides a richer account of consumption behaviour.

== Summary ==
The permanent income hypothesis holds that consumption is determined by the lifetime resources of the individual rather than by current income. The theory has been extended to account for liquidity constraints, for precautionary saving, and for the behaviour over the life cycle, and the extensions improve its fit with the data.

== See also ==
* Consumer Behaviour
* Macroeconomics
* Keynesian Economics

== References ==

<ref name="r1">Research on the permanent income hypothesis and on consumption.</ref>
<ref name="r2">Studies of the evidence on consumption behaviour.</ref>
<ref name="r3">Analyses of the implications for fiscal policy.</ref>

<references />

[[Category:Consumer behaviour]]
[[Category:Macroeconomics]]
[[Category:Keynesian economics]]

Output Gap

2026-10-06T06:22:37Z

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The '''output gap''' is the difference between the actual output of an economy and its potential output, expressed as a percentage of potential output. The output gap is a key indicator of the state of the economy and of the pressures on inflation.

== Definition ==
Potential output is the level of output that the economy can produce when its resources are fully employed, without generating inflationary pressure. The output gap is positive when actual output exceeds potential, and negative when it falls short.

Potential output is not directly observable, and it must be estimated. The estimates are based on statistical methods, which extract the trend from the data, or on production functions, which estimate the productive capacity of the economy from its inputs.

== Measurement ==
The statistical methods include the Hodrick-Prescott filter, which separates the trend from the cyclical component of output, and other smoothing techniques. The methods are simple but subject to the criticism that the trend can be affected by the cycle, and that the estimates are revised as new data become available.

The production function approach estimates potential output from the capital stock, the labour force, and the trend of productivity. The approach provides a structural estimate, but it requires data on the inputs and on their utilisation.

The estimates are subject to substantial uncertainty, and they are revised over time. The revisions can be large, which complicates the use of the estimates for policy.

== Significance ==
The output gap is used to assess the inflationary pressures in the economy. A positive gap indicates that demand exceeds the capacity of the economy, which tends to raise inflation, while a negative gap indicates slack, which tends to reduce inflation.

The gap is used in the design of fiscal and monetary policy. The assessment of the gap informs the judgment about the appropriate stance of policy, and it is used in the estimation of the structural budget balance, which adjusts the budget for the effects of the cycle.

The gap is also used in the analysis of the effects of policy and of the sustainability of the public finances. The estimate of the gap affects the assessment of the cyclically adjusted fiscal position and of the fiscal effort.

== Limitations ==
The output gap is subject to substantial uncertainty, and the estimates are sensitive to the methods and to the assumptions. The uncertainty complicates the use of the gap for policy, since the appropriate stance may depend on the estimate.

The gap can also be misleading when the economy is subject to structural change, since the potential output may shift. The estimates of potential output may be too low or too high, and the gap may be misestimated.

The use of the gap for policy must therefore be cautious, and it must take account of the uncertainty and of the possibility that the economy has changed. The estimates are best used as one input among several in the assessment of the state of the economy.

== Estimating Potential Output ==
The estimation of potential output is one of the most difficult tasks in macroeconomics, since potential output is not observed. The estimates are based on statistical methods or on production functions.

The statistical methods, including the Hodrick-Prescott filter, separate the trend from the cycle. The methods are simple but subject to the criticism that the trend can be affected by the cycle, and that the estimates are revised as new data become available.

The production function approach estimates potential output from the capital stock, the labour force, and the trend of productivity. The approach provides a structural estimate, but it requires data on the inputs and on the utilisation of the capacity.

== The Uncertainty of the Estimates ==
The estimates of the output gap are subject to substantial uncertainty, and they are revised over time. The revisions can be large, particularly at the turning points of the cycle, which are the moments when the estimates are most needed.

The uncertainty arises from the difficulty of distinguishing the trend from the cycle, from the measurement of the inputs, and from the assumptions of the methods. The uncertainty complicates the use of the estimates for policy, since the appropriate stance may depend on the estimate.

The communication of the uncertainty is important, and the authorities should present the estimates as ranges rather than as precise figures. The use of the estimates for policy should be cautious, and the estimates should be updated as information accumulates.

== The Role in Policy ==
The output gap is used in the design of fiscal and monetary policy, and in the estimation of the structural budget balance. The structural balance is the budget balance adjusted for the effects of the cycle, and it is used to assess the fiscal stance.

The use of the gap in policy is subject to the criticism that the estimates are too uncertain to guide the policy. The response has been to develop frameworks that are robust to the uncertainty, and to use a range of indicators rather than a single estimate.

The gap is also used in the analysis of the effects of the financial crisis, where the persistent shortfall of output relative to the pre-crisis trend has been interpreted as evidence of hysteresis.

== Summary ==
The output gap is the difference between actual and potential output, and it is central to the analysis of inflation and to the design of policy. Its estimation is subject to substantial uncertainty, and its use for policy must take account of that uncertainty.

== See also ==
* Economic Indicators
* Okun’s Coefficient
* Business Cycle

== References ==

<ref name="r1">Research on the measurement of potential output and of the output gap.</ref>
<ref name="r2">Studies of the uncertainty in the estimates.</ref>
<ref name="r3">Analyses of the use of the gap in policy.</ref>

<references />

[[Category:Economic indicators]]
[[Category:Macroeconomics]]
[[Category:Business cycle]]

Okun’s Coefficient

2026-10-06T06:22:37Z

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'''Okun's coefficient''' is the relationship between changes in the unemployment rate and changes in output, named after the economist Arthur Okun. The coefficient measures the percentage change in output associated with a one-percentage-point change in the unemployment rate.

== The Relationship ==
Okun's law states that a one-percentage-point increase in the unemployment rate is associated with a fall in output of about two to three percent, relative to potential output. The relationship is not a precise law but an empirical regularity, and the coefficient varies across countries and over time.

The relationship reflects the response of employment to output and the response of productivity to changes in output. When output falls, firms reduce employment, but they may also reduce hours and productivity, so that the change in unemployment is smaller than the change in output would suggest.

== The Coefficient ==
The coefficient depends on the structure of the economy and on the institutions of the labour market. It is larger in economies where employment responds strongly to output, and smaller where the response is weaker.

The coefficient also depends on the time horizon. In the short run, the relationship between output and unemployment is weaker, since firms may hoard labour during temporary downturns. In the longer run, the relationship is stronger, as firms adjust their employment.

The estimates of the coefficient vary, with typical values between two and three for the United States and different values for other countries. The variation reflects the differences in the structure and in the institutions of the economies.

== Uses ==
Okun's law is used to forecast the change in unemployment associated with a given change in output. It is used to assess the output gap from the observed unemployment rate, and to assess the unemployment rate consistent with potential output.

The relationship is also used in the analysis of policy, since it informs the assessment of the effects of a change in demand on employment. The assessment must take account of the uncertainty in the coefficient and of the variation across countries and over time.

== Limitations ==
Okun's law is an empirical regularity, not a structural relationship, and it is subject to change. The relationship can break down during periods of structural change, when the response of employment to output changes.

The measurement of the variables is also subject to error. The measurement of output is subject to revision, and the measurement of unemployment depends on the definition of the labour force.

The use of the relationship for policy must therefore be cautious, and it must take account of the uncertainty and of the possibility that the relationship has changed.

== The Original Statement ==
Okun's law was formulated by Arthur Okun in the early 1960s, in the context of the analysis of the relationship between output and unemployment in the United States. Okun observed that the relationship was stable enough to be used for forecasting and for policy.

The original statement held that a one-percentage-point reduction in the unemployment rate was associated with a three-percent increase in output, relative to potential. The precise coefficient has been revised and refined in subsequent work.

The law has been interpreted as a rule of thumb rather than a structural relationship. Its usefulness derives from the empirical regularity, and its interpretation requires attention to the conditions under which it was estimated.

== The Sources of the Relationship ==
The relationship between output and unemployment reflects several mechanisms. The most direct is the change in employment, since a fall in output leads firms to reduce the number of workers.

The relationship also reflects the change in hours and in the participation of the labour force. Firms may reduce hours before reducing the number of workers, and some workers may leave the labour force when jobs are scarce.

The relationship also reflects the change in productivity. During downturns, firms may hoard labour, and the measured productivity may fall, which affects the relationship between output and unemployment.

== The Coefficients Across Countries ==
The coefficients of Okun's law vary across countries, reflecting the differences in the structure of the economies and in the institutions of the labour market.

The coefficients tend to be larger in countries with more flexible labour markets, where employment responds strongly to output, and smaller in countries with more rigid markets. The coefficients also depend on the composition of employment and on the importance of the sectors that are more sensitive to the cycle.

The variation means that the relationship must be estimated for each country, and that the estimates must be updated as the structure of the economy changes. The use of the relationship for policy must take account of the uncertainty and of the variation.

== Summary ==
Okun's law is the empirical relationship between changes in output and changes in unemployment. The coefficient varies across countries and over time, and its use for forecasting and for policy requires attention to its limitations and to the uncertainty in the estimates.

== See also ==
* Economic Indicators
* Output Gap
* Labour Economics

== References ==

<ref name="r1">Research on Okun's law and on the relationship between output and unemployment.</ref>
<ref name="r2">Studies of the variation of the coefficient across countries.</ref>
<ref name="r3">Analyses of the uses and the limitations of the relationship.</ref>

<references />

[[Category:Economic indicators]]
[[Category:Macroeconomics]]
[[Category:Labour economics]]

Offshore Finance

2026-10-06T06:22:36Z

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'''Offshore finance''' refers to financial activities that take place in jurisdictions that are outside the country of residence of the parties, typically in centres that offer favourable regulation, taxation, or secrecy. Offshore finance is a central feature of the international financial system.

== Characteristics ==
Offshore financial centres are jurisdictions that provide financial services to non-residents, often with a favourable regulatory and tax regime. The centres may be small economies that specialise in financial services, or larger economies that offer particular advantages.

The characteristics of the centres include low or zero taxation, light regulation, and strict confidentiality. The combination of these features attracts funds and activities from around the world.

== Activities ==
The activities conducted in offshore centres include banking, fund management, insurance, and the registration of companies. The centres also host special purpose entities, which are used for securitisation, for holding assets, and for other purposes.

The activities are often conducted for legitimate reasons, including the desire to reduce tax, to diversify risk, and to access specialised services. The centres also attract activities that are intended to evade regulation or to conceal the origin of funds.

== Tax and Regulation ==
Offshore finance is central to the analysis of international tax competition. The centres allow firms and individuals to reduce their tax liabilities, by shifting profits and by holding assets in low-tax jurisdictions.

The responses to tax competition include the negotiation of agreements for the exchange of information, the introduction of rules to counter base erosion and profit shifting, and the imposition of measures against jurisdictions that do not cooperate. The design of these responses is a subject of international negotiation.

The regulation of offshore finance is a concern for financial stability, since the activities may escape the supervision of the authorities in the countries where the ultimate risks reside. The response includes the extension of regulation to the activities and the strengthening of international cooperation.

== Debate ==
Offshore finance is a subject of debate. Some argue that the centres provide legitimate services and that they contribute to the efficiency of the international financial system. Others argue that they facilitate tax evasion and the concealment of illicit funds, and that they undermine the ability of countries to raise revenue and to enforce their laws.

The debate reflects broader questions about the governance of the international financial system and about the balance between national sovereignty and international cooperation. The design of the framework must address the concerns while preserving the legitimate functions of the centres.

== Tax Havens and Profit Shifting ==
Offshore financial centres are often described as tax havens, since they offer low or zero taxation to the firms and individuals that use them. The use of the centres allows the profits of multinational firms to be shifted to low-tax jurisdictions, reducing their global tax liability.

The profit shifting is achieved through several mechanisms, including the transfer pricing of transactions among the affiliates of the firm, the allocation of debt and of intangible assets, and the location of the headquarters. The mechanisms exploit the differences in the tax treatment across jurisdictions.

The reform of the international tax framework addresses the profit shifting through several measures, including the requirement for the reporting of the activities of the firms, the rules against base erosion, and the introduction of a minimum tax on the profits of multinational firms.

== Secrecy and Information Exchange ==
The confidentiality that the centres provide has been used to conceal the origin of funds and to evade taxation. The concealment is a concern for the enforcement of the tax laws and for the fight against financial crime.

The response includes the negotiation of agreements for the exchange of information, which allow the authorities to obtain information about the accounts held by their residents in the centres. The agreements have been extended to a large number of jurisdictions, and the exchange of information on request and automatically has become the standard.

The effectiveness of the exchange depends on the quality of the information and on the capacity of the authorities to use it. The reform of the framework continues, and it addresses the remaining gaps and the emerging forms of concealment.

== Financial Stability ==
The activities conducted in offshore centres may escape the supervision of the authorities in the countries where the risks reside. The activities can therefore accumulate risk outside the oversight of the regulators.

The response includes the extension of the regulation to the activities and the strengthening of the international cooperation among the supervisors. The standards set by the international bodies provide a common framework, and the assessment of the compliance of the jurisdictions is part of the framework.

The assessment of the risks also requires the collection of data on the activities of the centres and on their linkages with the rest of the financial system. The data inform the analysis of the potential for contagion and the design of the policy.

== Summary ==
Offshore finance raises issues of tax competition, of secrecy, and of financial stability. The responses to these issues, including the reform of the international tax framework and the strengthening of cooperation, are central to the governance of the international financial system.

== See also ==
* Financial Economics
* Taxation
* International Economics

== References ==

<ref name="r1">Research on offshore financial centres and on international tax competition.</ref>
<ref name="r2">Studies of the regulation of offshore finance.</ref>
<ref name="r3">Analyses of the debate about the role of the centres.</ref>

<references />

[[Category:Financial economics]]
[[Category:International economics]]
[[Category:Taxation]]

Non-Renewable Resource

2026-10-06T06:22:35Z

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A '''non-renewable resource''' is a natural resource that is available in a fixed quantity and that cannot be replenished on a human timescale. Non-renewable resources include fossil fuels, minerals, and metals, and their depletion raises issues of sustainability and of intergenerational equity.

== Characteristics ==
Non-renewable resources are available in a finite quantity, and their extraction reduces the stock available for future use. The resource is therefore a form of natural capital that is depleted by use.

The resources differ in their abundance, in the cost of extraction, and in the environmental effects of their use. The reserves of a resource are the quantities that can be economically extracted at current prices and with current technology, and the reserves change with prices and with technology.

== Optimal Depletion ==
The theory of optimal depletion analyses the rate at which a non-renewable resource should be extracted. The analysis is based on the principle that the resource should be extracted so that the present value of the marginal benefit is equal across time periods.

The Hotelling rule states that the price of the resource, net of the cost of extraction, should rise at a rate equal to the interest rate. The rule implies that the resource is extracted more slowly when the interest rate is low, and that the price rises over time as the resource becomes scarcer.

The rule is a benchmark, and its assumptions are restrictive. It assumes that the resource is owned by a single agent, that the market is competitive, and that the costs of extraction are known. When these assumptions are relaxed, the extraction path may differ.

== Economic Issues ==
The depletion of non-renewable resources raises issues of sustainability. The use of the resource reduces the stock available for future generations, and the compensation for the depletion requires investment in other forms of capital.

The revenue from the extraction of a resource is a form of rent, which accrues to the owner. The taxation of the rent and the management of the revenue are central issues in resource-rich economies. The design of the fiscal regime affects the incentive to extract and the distribution of the benefits.

The extraction of resources also generates environmental externalities, including pollution and the degradation of the environment. The internalisation of these externalities is a central issue in the design of policy.

== Policy ==
The policy issues concern the rate of extraction, the taxation of the resource, and the management of the revenue. The design of the fiscal regime must balance the objective of capturing the rent against the need to attract investment.

The management of the revenue raises questions of the use of the funds. The establishment of a sovereign wealth fund is one approach, in which the revenue is saved and invested for future generations. The approach is used in several resource-rich countries, and it is intended to convert the resource wealth into other forms of capital.

== Resource Curse ==
The resource curse refers to the tendency of resource-rich countries to experience slower growth, weaker institutions, and more conflict than countries with fewer resources. The phenomenon has been documented across a range of countries and periods.

The explanations of the curse include the volatility of commodity prices, which complicates the management of the economy, and the appreciation of the exchange rate, which reduces the competitiveness of other sectors. The explanations also include the effect of resource revenue on the quality of institutions, since the revenue can weaken the accountability of the government.

The management of the revenue is central to the avoidance of the curse. The establishment of a sovereign wealth fund and the adoption of a fiscal rule can help to smooth the effect of the revenue and to preserve the wealth for future generations.

== The Hotelling Rule ==
The Hotelling rule is the central result of the theory of exhaustible resources. The rule states that the price of the resource, net of the cost of extraction, should rise at a rate equal to the interest rate.

The rule implies that the resource is extracted more slowly when the interest rate is low, and that the price rises over time as the resource becomes scarcer. The rule also implies that the resource rent is the return to the owner of the resource, and that it should be taxed or saved for the future.

The rule has been extended to account for the exploration of new resources, for the improvement of the extraction technology, and for the presence of uncertainty. The extensions have refined the analysis and have improved the understanding of the extraction path.

== Transition to Renewable Resources ==
The transition from non-renewable to renewable resources is a central challenge for the economy. The transition requires the development of renewable sources of energy and of the technologies that use them.

The transition raises issues of the pace and of the cost. A rapid transition may disrupt the economies that depend on the extraction of fossil fuels, while a slow transition may fail to address the environmental objectives.

The design of the policy must balance the objectives and must manage the distributional consequences. The instruments include the pricing of carbon, the support for research and development, and the assistance to the affected regions and workers.

== Summary ==
Non-renewable resources are available in a fixed quantity, and their depletion raises issues of sustainability and of intergenerational equity. The Hotelling rule, the resource curse, and the transition to renewable resources are central to the analysis of the economics of exhaustible resources.

== See also ==
* Environmental Economics
* Sustainability
* Production Economics

== References ==

<ref name="r1">Research on the economics of exhaustible resources.</ref>
<ref name="r2">Studies of the Hotelling rule and of optimal depletion.</ref>
<ref name="r3">Analyses of resource taxation and of sovereign wealth funds.</ref>

<references />

[[Category:Environmental economics]]
[[Category:Sustainability]]
[[Category:Production economics]]

Network Effect

2026-10-06T06:22:34Z

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A '''network effect''' is the effect that the number of users of a product or service has on the value of that product or service to each user. Network effects are a central feature of platform markets and of industries with network characteristics.

== Types ==
A direct network effect arises when the value of a product to each user increases with the number of users. A telephone network is the classic example, since the value of the network to each subscriber increases with the number of other subscribers.

An indirect network effect arises when the value of a product increases with the number of users of a complementary product or service. A platform that connects two groups, such as buyers and sellers, exhibits indirect network effects, since the value to each group increases with the number of users on the other side.

Negative network effects can also arise, when the value of a product declines with the number of users. Congestion is an example, since an increase in the number of users can reduce the quality of the service.

== Implications for Market Structure ==
Network effects have implications for market structure. They tend to create a winner-takes-most outcome, since the firm with the largest network offers the greatest value and attracts more users, reinforcing its position.

The tendency towards concentration can create a situation in which a single firm or a small number of firms dominate the market, even in the absence of the traditional barriers to entry. The resulting market power raises concerns about pricing and about the behaviour of the firms.

The concentration is not necessarily permanent, since the market can tip from one firm to another if the entrant offers a sufficiently better product. The possibility of tipping raises questions about the sustainability of the positions of the dominant firms.

== Standards and Compatibility ==
Network effects are closely related to the adoption of standards. When users benefit from compatibility, they tend to adopt the same standard, and the standard that is adopted may be determined by the history of the market rather than by its merits.

The adoption of standards can generate lock-in, in which users are committed to a technology that may not be the best available. The transition to a new standard may require coordination, and it may take time.

The analysis of standards is relevant to the design of policy, including the regulation of interoperability and the treatment of intellectual property in standards. The design of the framework affects the incentives to innovate and the diffusion of technology.

== Policy ==
The policy issues raised by network effects concern the market power of platforms, the treatment of data, and the conditions of competition. The framework must address the risk that the dominant firms use their position to exclude competitors and to extract rents.

The instruments include the enforcement of competition law and the regulation of platforms. The design of the framework must balance the benefits of the networks against the risks of market power and must be robust to the rapid evolution of the technology.

== Platform Markets ==
Platform markets are markets in which a firm provides an infrastructure that connects two or more groups of users. The platform intermediates the interactions between the groups, and its value depends on the participation of both sides.

The platforms exhibit strong network effects, since the value to each group increases with the participation of the other. The networks give the platforms a powerful advantage, since a platform with a larger network can attract more users on both sides.

The platforms may charge prices that differ across the groups, including prices below cost or even negative on one side, in order to attract participation and to generate the network effect. The pricing structure of the platforms is a distinctive feature of these markets.

== The Chicken-and-Egg Problem ==
The platforms face the chicken-and-egg problem, since the value to each group depends on the participation of the other, and the platform must attract both sides to function.

The platforms address the problem through several strategies, including the subsidy of one side, the seeding of the network with content, and the formation of partnerships. The strategies are intended to create the initial participation that makes the platform viable.

The analysis of the problem informs the understanding of the dynamics of platform markets and of the strategies of the firms. The problem explains why some platforms succeed while others fail, and it informs the analysis of competition in these markets.

== Regulation ==
The regulation of platforms addresses the market power that arises from the network effects. The issues include the pricing of the services, the treatment of competitors, and the use of data.

The instruments include the enforcement of competition law and the regulation of the platforms. The design of the framework must balance the benefits of the networks against the risks of market power, and it must be robust to the rapid evolution of the technology.

The regulation of interoperability is one approach, which requires the platforms to allow the users to interact across the platforms. The approach can reduce the advantage of the incumbents, though it raises issues of the incentives to invest.

== Summary ==
Network effects are a central feature of platform markets, and they have implications for market structure, for pricing, and for regulation. The analysis of the effects informs the understanding of the digital economy.

== See also ==
* Platform Economy
* Industrial Organization
* Digital Economy

== References ==

<ref name="r1">Research on network effects and on platform markets.</ref>
<ref name="r2">Studies of standards and of compatibility.</ref>
<ref name="r3">Analyses of the regulation of platforms.</ref>

<references />

[[Category:Platform economy]]
[[Category:Industrial organization]]
[[Category:Digital economy]]

Net Domestic Product

2026-10-06T06:22:34Z

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'''Net domestic product''' is the value of the goods and services produced in a country during a period, after deducting the consumption of fixed capital. It differs from gross domestic product, which does not deduct the consumption of capital.

== Definition ==
Net domestic product is calculated by subtracting the consumption of fixed capital from gross domestic product. The consumption of fixed capital is the depreciation of the capital stock, which represents the capital that is used up in production during the period.

The deduction recognises that a portion of the output of the economy is required to replace the capital that has been consumed, and that this portion is not available for consumption or for net investment. The net measure therefore provides a better indication of the sustainable level of output.

== Gross versus Net ==
The distinction between gross and net measures is important for the analysis of the economy. The gross measure overstates the sustainable level of income, since it does not account for the capital that must be replaced. The net measure provides a better indication of the income that can be consumed without reducing the capital stock.

The difference between the two depends on the size of the capital stock and on its rate of depreciation. In economies with large capital stocks and high rates of depreciation, the difference is substantial. In economies with small capital stocks, the difference is smaller.

The use of the gross measure is more common in practice, because it is easier to measure and because the estimates of depreciation are subject to uncertainty. The net measure is used when the analysis requires an assessment of the sustainable level of output.

== Measurement ==
The measurement of net domestic product requires estimates of the consumption of fixed capital, which in turn require estimates of the capital stock and of its rate of depreciation. The estimates are based on the perpetual inventory method, in which the capital stock is estimated by accumulating past investment and applying depreciation rates to each vintage.

The estimates are subject to uncertainty, since they depend on assumptions about the useful lives of the assets and about the patterns of depreciation. The measurement of the capital stock is particularly difficult, since the assets are heterogeneous and their prices change over time.

The measurement also requires attention to the treatment of inventories and of natural resources, which are not included in the measure of fixed capital. The depletion of natural resources is recorded separately, and its treatment in the national accounts is a subject of debate.

== Uses ==
Net domestic product is used in the analysis of the sustainability of growth, of the productivity of the economy, and of the adequacy of investment.

The net measure is used to assess whether the economy is consuming its capital stock, which occurs when investment is less than the consumption of capital. It is used to measure the contribution of capital to production, since the measurement of productivity requires consistent treatment of capital in the measures of output and of input.

== Net Measures and Sustainability ==
The net measures of output and income are central to the analysis of sustainability. The net measure deducts the capital that is consumed, and it therefore reflects the income that can be consumed without reducing the capital stock.

The analysis of sustainability distinguishes between the consumption of produced capital and the depletion of natural capital. The depletion of natural resources is not deducted in the standard net measures, which means that the measures overstate the sustainable income of resource-dependent economies.

The adjustment of the measures for the depletion of natural resources and for the degradation of the environment is the objective of the environmental accounting framework. The framework extends the national accounts to record the stocks and the flows of natural resources.

== Productivity Measurement ==
The net measures are used in the measurement of productivity, since the measurement of output and of capital must be consistent in their treatment of capital consumption.

The measurement of productivity relates output to the inputs that produce it, including labour and capital. The capital input is measured as the flow of services from the capital stock, and the measurement must account for the depreciation of the stock.

The failure to deduct capital consumption would overstate the output relative to the input and would bias the measure of productivity. The consistent treatment of capital is therefore essential for the measurement.

== International Comparison ==
The comparison of net measures across countries requires consistent methods for the estimation of capital consumption. The estimates depend on the assumptions about asset lives and depreciation patterns, which vary across countries.

The international standards provide a framework for the estimates, and the statistical agencies follow the standards. The implementation varies, however, and the comparison of the measures requires attention to the differences in the methods.

The comparison of net measures is further complicated by the differences in the composition of the capital stocks and in the prices of the assets. The adjustment for these differences is required for a meaningful comparison.

== Summary ==
Net domestic product is the value of output after deducting the consumption of fixed capital, and it provides a better indication of sustainable income than the gross measure. Its measurement and its use in the analysis of sustainability and of productivity require attention to the estimation of capital consumption.

== See also ==
* National Accounts
* Capital Consumption
* Gross Capital Formation

== References ==

<ref name="r1">National accounts manuals and statistical publications.</ref>
<ref name="r2">Research on the measurement of capital and of depreciation.</ref>
<ref name="r3">Analyses of the sustainability of growth.</ref>

<references />

[[Category:National accounts]]
[[Category:Macroeconomics]]
[[Category:Economic indicators]]

Natural Monopoly Theory

2026-10-06T06:22:33Z

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'''Natural monopoly theory''' analyses the circumstances in which a single firm can supply a market at lower cost than multiple firms, making competition inefficient. The theory provides a rationale for the regulation of industries such as utilities and for the design of the regulatory framework.

== Concept ==
A natural monopoly arises when the cost structure of an industry is such that a single firm can produce the total output at lower average cost than two or more firms. The condition is that the average cost declines over the relevant range of output, which requires large fixed costs relative to the size of the market.

The classic examples are utilities, including the distribution of electricity and water, and the provision of telecommunications and rail services. These industries have high fixed costs, in the form of networks, and relatively low marginal costs.

== Subadditivity ==
The formal condition for a natural monopoly is that the cost function is subadditive, meaning that it is cheaper to produce the total output in a single firm than to divide it among several. Subadditivity is a stronger condition than the presence of economies of scale, since it can hold even when the average cost is rising.

The analysis of subadditivity is used to determine whether an industry is a natural monopoly and to design the appropriate regulatory framework. The measurement requires estimates of the cost function of the industry.

== Regulation ==
The regulation of natural monopolies addresses the problem that a single firm has the power to set prices above cost. The instruments include price caps, which limit the prices that the firm may charge, and rate-of-return regulation, which limits the return that the firm may earn.

The design of regulation must balance the objectives of efficiency and of cost recovery. A price equal to marginal cost would be efficient but would not allow the firm to recover its fixed costs, so that the firm would make losses. The efficient pricing of a natural monopoly therefore requires the use of two-part tariffs or of other mechanisms that allow cost recovery.

== Challenges ==
The regulation of natural monopolies faces several challenges. The regulator has less information than the firm about its costs and its technology, and the firm has an incentive to overstate its costs. The design of regulation must address this asymmetry of information.

Technological change can also alter the nature of the industry. Improvements in technology may reduce the fixed costs and make competition feasible, as has occurred in telecommunications. The regulatory framework must adapt to these changes.

The regulation must also address the quality of service, since a firm that is subject to a price cap may reduce costs by lowering quality. The framework must include provisions to ensure that the quality is maintained.

== Contestable Markets ==
The theory of contestable markets, developed by William Baumol and others, holds that the behaviour of firms in a market depends on the ease of entry and exit, not only on the number of firms. A market is contestable if entry and exit are costless, so that a potential entrant can enter, take the profits, and exit if the incumbent responds.

In a perfectly contestable market, even a single firm will price at the competitive level, since any attempt to raise the price would attract entry. The threat of entry disciplines the incumbent, and the outcome is efficient.

The theory has implications for the analysis of natural monopoly. It suggests that the regulation of a natural monopoly may not be necessary if the market is contestable, since the threat of entry would discipline the firm. In practice, however, markets are rarely perfectly contestable, since entry and exit involve costs.

== Franchise Bidding ==
Franchise bidding is a mechanism for the provision of a natural monopoly in which the right to serve the market is auctioned. Firms compete for the franchise, and the winner is the firm that offers the best terms, typically the lowest price or the highest payment.

The mechanism can introduce competition for the market, even when competition in the market is not feasible. The design of the auction determines the outcome, and the terms of the franchise contract determine the behaviour of the winner.

The mechanism has been used for the provision of services including broadcasting, transport, and utilities. Its success depends on the design of the contract, on the enforcement of the terms, and on the ability of the authority to specify the service and to monitor the performance.

== The Regulation of Quality ==
The regulation of natural monopolies must address the quality of service, since a firm that is subject to a price cap may reduce costs by lowering quality. The framework must include provisions to ensure that the quality is maintained.

The measures include the specification of the standards of service, the monitoring of performance, and the imposition of penalties for failure to meet the standards. The design of the measures must balance the objective of quality against the cost of providing it.

The regulation of quality is particularly important for services that are essential to the users, including the supply of water and of electricity. The framework must ensure that the services are provided reliably and at a reasonable cost.

== Summary ==
Natural monopoly theory analyses the circumstances in which a single firm can supply a market at lower cost, and it provides a rationale for regulation. The theory of contestable markets, the use of franchise bidding, and the regulation of quality are central to the design of the framework for the provision of the services.

== See also ==
* Market Failure
* Industrial Organization
* Competition Policy

== References ==

<ref name="r1">Research on natural monopoly and on subadditivity.</ref>
<ref name="r2">Studies of the regulation of utilities.</ref>
<ref name="r3">Analyses of the design of regulatory frameworks.</ref>

<references />

[[Category:Market structure]]
[[Category:Market failure]]
[[Category:Industrial organization]]

National Accounts

2026-10-06T06:22:32Z

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'''National accounts''' are the systematic framework for measuring the economic activity of a country, including production, income, and expenditure. The accounts provide the basis for the measurement of gross domestic product and other aggregates, and they are compiled according to international standards.

== The System ==
The system of national accounts provides a comprehensive framework for the measurement of economic activity. It records the production of goods and services, the generation and distribution of income, and the use of income for consumption and investment.

The system is based on a set of concepts, definitions, and classifications that are agreed internationally. The standards are maintained by international organisations, and they are periodically updated to reflect changes in the economy and in the statistical methods.

== Main Aggregates ==
The main aggregates of the national accounts include gross domestic product, which measures the value of the goods and services produced in the economy, and gross national income, which measures the income received by the residents of the country.

Other aggregates include consumption, investment, government expenditure, and the trade balance. These aggregates are related by the national accounting identity, which holds that output equals the sum of the components of demand.

The aggregates are measured in both gross and net terms, where the net measures deduct the consumption of fixed capital. The distinction is important, since the gross measures overstate the sustainable level of income.

== The Accounts ==
The system includes several accounts that record different aspects of the economy. The production account records the generation of value added by the industries of the economy. The income account records the distribution of income among the factors and the sectors.

The capital account records the accumulation of assets and the financing of investment, and the financial account records the changes in financial assets and liabilities. The accounts are linked, so that the flows recorded in one account are consistent with those in another.

The accounts are compiled for the economy as a whole and for the institutional sectors, including households, firms, and the government. The sectoral accounts provide information about the behaviour of each sector and about the relationships among them.

== Uses ==
The national accounts are used for a wide range of purposes. They provide the basis for the analysis of the economy, for the design of policy, and for international comparisons.

The accounts are used to measure growth, to assess the state of the economy, and to inform monetary and fiscal policy. They are used to compare the performance of countries and to monitor progress towards development goals.

The accounts are also used in the analysis of specific issues, including the distribution of income, the sustainability of the public finances, and the contribution of different industries to the economy. The framework provides the data that are required for this analysis.

== The History of the Accounts ==
The system of national accounts has its origins in the work of economists in the seventeenth century, who sought to measure the wealth and the income of nations. The modern system was developed in the twentieth century, in response to the need for data to inform policy.

The work of Simon Kuznets and of others in the 1930s and 1940s established the framework for the measurement of national income. The framework was extended and standardised after the Second World War, with the development of international standards.

The standards have been revised periodically to reflect changes in the economy and in the methods of measurement. The revisions have extended the coverage of the accounts, to include services and intangible assets, and have improved the treatment of issues including the measurement of financial services and of the environment.

== The Treatment of the Environment ==
The treatment of the environment in the national accounts has been a subject of growing attention. The standard accounts record the extraction of natural resources as income, without deducting the depletion of the resources, which overstates the sustainable income of the economy.

The system of environmental-economic accounting extends the framework to include the stocks and the flows of natural resources and the services that they provide. The framework is used to measure the depletion of resources and the degradation of the environment, and to adjust the national accounts accordingly.

The measurement is difficult, since the value of environmental assets and of the services that they provide is often not observed in markets. The development of the methods is an active area of research.

== The Accounts and Policy ==
The national accounts are used for the design and the evaluation of policy. The data inform the assessment of the state of the economy and the choice of the instruments of policy.

The accounts are also used in the analysis of specific issues, including the distribution of income, the sustainability of the public finances, and the contribution of different industries. The framework provides the data that are required for this analysis, though it must be supplemented by other sources for some purposes.

The use of the accounts in policy requires attention to their limitations. The accounts are a simplification of the economy, and they do not capture all the aspects that are relevant to welfare. The interpretation of the data must take account of these limitations.

== Summary ==
The national accounts provide the systematic framework for the measurement of economic activity, and they are central to the analysis of the economy and to the design of policy. Their history, their treatment of the environment, and their use in policy inform the understanding of their role and of their limitations.

== See also ==
* Gross Capital Formation
* Net Domestic Product
* Statistics

== References ==

<ref name="r1">National accounts manuals and statistical publications.</ref>
<ref name="r2">Research on the measurement of economic activity.</ref>
<ref name="r3">Analyses of the use of the national accounts in policy.</ref>

<references />

[[Category:National accounts]]
[[Category:Macroeconomics]]
[[Category:Statistics]]

Moral Suasion

2026-10-06T06:22:31Z

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'''Moral suasion''' is the use of persuasion and of informal pressure by a central bank or other authority to influence the behaviour of financial institutions, in place of or in addition to formal rules. Moral suasion is a form of communication-based policy that relies on the authority and the reputation of the institution.

== Concept ==
Moral suasion operates through the influence of the authority on the decisions of the institutions that it supervises or regulates. The authority may issue statements, hold meetings with the institutions, or use its influence to encourage particular behaviour.

The effectiveness of moral suasion depends on the authority of the institution, on the willingness of the institutions to cooperate, and on the credibility of the authority's signals. It is more effective when the objectives are shared and when the institutions value their relationship with the authority.

== Applications ==
Moral suasion has been used in several contexts. Central banks have used it to influence the growth of credit, encouraging banks to moderate lending during periods of rapid credit expansion and to maintain lending during periods of stress.

Supervisory authorities have used it to encourage institutions to strengthen their risk management and to comply with prudential standards. The authority may communicate its concerns and its expectations, and it may follow up with measures if the institutions do not respond.

Moral suasion has also been used in the context of monetary policy, where the central bank seeks to influence the expectations of the public and of the markets. The communication of the policy stance is a form of moral suasion, and its effectiveness depends on the credibility of the central bank.

== Advantages and Limitations ==
The advantages of moral suasion are its flexibility and its low cost. It does not require the introduction of new rules or the commitment of resources, and it can be adapted to the circumstances.

The limitations are also significant. Moral suasion relies on the willingness of the institutions to cooperate, and it may be ineffective when the interests of the institutions differ from those of the authority. It is also difficult to verify compliance, since the behaviour is not required by a rule.

The use of moral suasion raises questions about accountability and about transparency. Since the pressure is informal, it is not subject to the same scrutiny as formal rules, and it may be used in ways that are not transparent. The design of the framework must address these concerns.

== The Broader Context ==
Moral suasion is one of a range of instruments available to authorities, alongside rules, prices, and other measures. The choice of instrument depends on the objective, on the circumstances, and on the institutional framework.

The effectiveness of moral suasion is enhanced when it is part of a coherent framework that includes other instruments. The combination of communication, of rules, and of other measures is likely to be more effective than any instrument alone.

== Moral Suasion in Central Banking ==
Central banks have long used moral suasion as an instrument of policy. In the past, when the instruments available were less developed, the central bank relied on its influence over the banks to guide the growth of credit and to manage the conditions in the money market.

The use of moral suasion declined as the instruments of monetary policy became more developed, and as the emphasis shifted towards the use of the policy rate and of market operations. The instrument has, however, retained a role, particularly in the supervision of banks and in the management of financial stability.

The central bank may use moral suasion to encourage banks to strengthen their risk management, to moderate the growth of credit during periods of rapid expansion, and to maintain lending during periods of stress. The effectiveness depends on the authority of the central bank and on the willingness of the banks to cooperate.

== Moral Suasion and Communication ==
The communication of the central bank is a form of moral suasion, since it influences the expectations of the public and of the markets. The publication of the decisions of the policy committee, of the minutes of its meetings, and of its projections are all elements of the communication strategy.

The effectiveness of communication depends on the credibility of the central bank and on the clarity of its message. A credible central bank can influence expectations through its statements, which affects the behaviour of households and firms and thereby the economy.

The design of the communication strategy is a subject of research and of practice. The strategy must provide information that is useful to the public without creating confusion or unnecessary volatility in the markets.

== Moral Suasion and Financial Stability ==
Moral suasion is used in the management of financial stability, where the authorities seek to influence the behaviour of financial institutions. The authorities may communicate their concerns about the build-up of risk and encourage institutions to take measures to strengthen their resilience.

The use of moral suasion in this context is complementary to the use of formal instruments, including the macroprudential measures that constrain the behaviour of institutions. The combination of communication and of formal measures is likely to be more effective than either alone.

The design of the framework must address the accountability of the authorities, since the use of informal pressure is less transparent than the use of formal rules. The framework must ensure that the use of moral suasion is subject to appropriate scrutiny.

== Summary ==
Moral suasion is the use of persuasion and of informal pressure to influence the behaviour of institutions, and it is used in central banking, in supervision, and in the management of financial stability. Its effectiveness depends on the authority and the credibility of the institution that uses it.

== See also ==
* Central Banking
* Monetary Economics
* Regulatory Arbitrage

== References ==

<ref name="r1">Research on moral suasion and on the instruments of policy.</ref>
<ref name="r2">Studies of the use of moral suasion in central banking and in supervision.</ref>
<ref name="r3">Analyses of the effectiveness of communication policy.</ref>

<references />

[[Category:Central banking]]
[[Category:Monetary economics]]
[[Category:Institutional economics]]

Monopoly Power

2026-10-06T06:22:30Z

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'''Monopoly power''' is the ability of a firm to raise its price above the competitive level without losing all of its sales. Monopoly power is a matter of degree, ranging from the power of a single seller in a market with no substitutes to the limited power of a firm in a market with many close substitutes.

== Sources ==
Monopoly power arises from several sources. Barriers to entry, including legal restrictions, control of essential inputs, and economies of scale, protect firms from competition and allow them to sustain prices above the competitive level.

Product differentiation gives firms a degree of market power, since consumers regard the products of different firms as imperfect substitutes. The more differentiated the products, the greater the power of the firms to raise prices.

The ownership of patents and of other intellectual property gives firms a temporary monopoly, which provides an incentive to innovate. The trade-off between the incentive to innovate and the cost of the resulting market power is a central issue in the design of intellectual property policy.

== Measurement ==
Monopoly power is measured by several indicators. The Lerner index measures the markup of price over marginal cost, which is the direct measure of market power. The index ranges from zero, for a competitive firm, to one, for a firm with complete power.

The concentration of the market is used as an indicator of the potential for market power, since a market with few firms is more likely to sustain prices above the competitive level. The measures of concentration include the concentration ratio and the Herfindahl-Hirschman index.

The measurement of market power is complicated by the difficulty of defining the market and by the fact that the observed price may reflect other factors, including the quality of the product and the costs of the firm.

== Effects ==
The exercise of monopoly power reduces output below the efficient level and raises the price above marginal cost, creating a deadweight loss. It also transfers income from consumers to the firm, which raises distributional concerns.

Monopoly power can also affect the incentives to innovate and to invest. The prospect of monopoly profits provides an incentive to develop new products and to improve existing ones, while the absence of competition may reduce the pressure to be efficient.

The effects of monopoly power on welfare are therefore complex. The static loss from the exercise of market power must be weighed against the dynamic gains from the innovation and the investment that it may induce.

== Policy ==
Competition policy addresses monopoly power through the prohibition of anticompetitive practices, the control of mergers, and the regulation of firms with substantial market power.

The design of competition policy must balance the benefits of competition against the efficiencies that may arise from the concentration of production. The assessment of mergers, for example, considers both the reduction in competition and the cost savings that the merger may achieve.

== Monopoly Power and Innovation ==
The relationship between monopoly power and innovation is a central issue in the analysis of the economy. The prospect of monopoly profits provides an incentive to innovate, since a firm that develops a new product can capture the returns.

The protection of intellectual property, through patents and other instruments, provides a temporary monopoly to innovators. The design of the protection must balance the incentive to innovate against the cost of the market power that it creates.

The empirical evidence on the relationship between market structure and innovation is mixed. Some studies find that innovation is highest in markets with a moderate degree of concentration, where firms have the resources to innovate but also face competition. The relationship depends on the industry and on the type of innovation.

== Monopsony Power ==
Monopsony power is the counterpart of monopoly power on the buying side of the market. A firm with monopsony power can pay a price below the competitive level for the inputs that it purchases, including labour.

The analysis of monopsony power is relevant to the labour market, where a dominant employer can pay wages below the competitive level. The presence of monopsony power affects the analysis of the effects of the minimum wage, since a minimum wage can raise wages and employment when the employer has monopsony power.

The measurement of monopsony power is difficult, since it requires information about the alternative opportunities of the suppliers. The evidence suggests that monopsony power is more prevalent than was once thought, particularly in labour markets that are geographically isolated or that require specialised skills.

== Competition Policy ==
Competition policy addresses monopoly power through the prohibition of anticompetitive practices, the control of mergers, and the regulation of firms with substantial market power. The design of the policy must balance the benefits of competition against the efficiencies that may arise from the concentration of production.

The assessment of mergers considers the effect on competition and the cost savings that the merger may achieve. The framework used for the assessment has evolved, with greater emphasis on the effects on consumers and on the use of quantitative methods.

The enforcement of competition policy is a central task of the authorities, and its effectiveness depends on the resources available and on the legal framework. The cooperation among authorities across countries is important, since many markets are international.

== Summary ==
Monopoly power is the ability of a firm to raise its price above the competitive level, and it arises from barriers to entry, from product differentiation, and from the ownership of intellectual property. Its analysis informs the design of competition policy and the understanding of the effects of market structure on the economy.

== See also ==
* Market Structure
* Industrial Organization
* Competition Policy

== References ==

<ref name="r1">Research on monopoly power and on its measurement.</ref>
<ref name="r2">Studies of the effects of market power on welfare.</ref>
<ref name="r3">Analyses of competition policy and of its design.</ref>

<references />

[[Category:Market structure]]
[[Category:Industrial organization]]
[[Category:Microeconomics]]

Money Market

2026-10-06T06:22:30Z

Youku: New encyclopedia entry (batch upload)

The '''money market''' is the market for short-term financial instruments, typically with maturities of one year or less. The money market is the market in which banks, firms, and governments manage their short-term liquidity and in which the central bank conducts monetary policy.

== Instruments ==
The instruments of the money market include treasury bills, commercial paper, certificates of deposit, and repurchase agreements. These instruments are characterised by short maturities, high liquidity, and low credit risk.

Treasury bills are short-term securities issued by governments, and they are the lowest-risk instruments in the market. Commercial paper is short-term debt issued by firms, and it is used to finance working capital. Certificates of deposit are short-term deposits issued by banks, and they are traded in the market. Repurchase agreements are short-term collateralised loans, in which one party sells a security and agrees to buy it back at a higher price.

== Participants ==
The participants in the money market include banks, which are the central institutions, and other financial institutions, including money market funds, insurance companies, and pension funds. Non-financial firms also participate, to manage their cash balances.

The central bank participates in the money market when it conducts open market operations, buying and selling securities to influence the liquidity of the banking system and the level of short-term interest rates. The operations are the primary means by which the central bank implements monetary policy.

== Functions ==
The money market performs several functions. It provides a mechanism for the management of short-term liquidity, allowing institutions to invest surplus funds and to obtain funds when needed.

The market also provides a mechanism for the pricing of short-term credit, and the interest rates established in the market are the reference rates for many other transactions. The rates are used to price loans, to index contracts, and to value derivatives.

The market is also the channel through which monetary policy is transmitted, since the central bank operates in the market to influence the short-term rates that are the starting point of the transmission mechanism.

== Stability ==
The stability of the money market is essential to the functioning of the financial system. The market is the source of short-term funding for banks and other institutions, and a disruption can rapidly affect the availability of credit.

The crisis of 2007 and 2008 saw a severe disruption of the money market, as institutions lost confidence in one another and the market for some instruments, including asset-backed commercial paper, ceased to function. The disruption prompted extensive intervention by central banks, including the provision of liquidity and the guarantee of some instruments.

The experience led to reforms, including the regulation of money market funds and the strengthening of the infrastructure of the market. The reforms are intended to reduce the risk of runs and to improve the resilience of the market.

== Repurchase Agreements ==
Repurchase agreements, or repos, are short-term collateralised loans, in which one party sells a security and agrees to buy it back at a slightly higher price. The difference between the sale and the repurchase price is the interest on the loan.

Repos are a central instrument of the money market, used by banks and other institutions to manage their liquidity. They are also used by central banks in their open market operations, where they provide liquidity to the banking system against collateral.

The market for repos was at the centre of the financial crisis, when concerns about the quality of the collateral led to a disruption of the market. The disruption prompted reforms, including the introduction of central clearing for some repos and the strengthening of the infrastructure of the market.

== Commercial Paper ==
Commercial paper is short-term debt issued by firms to finance their working capital. It is typically issued at a discount and has a maturity of up to 270 days.

The market for commercial paper is an important source of short-term funding for large firms, and it is an alternative to bank borrowing. The market is used by financial and non-financial firms, and it is a key element of the short-term funding markets.

The market was disrupted during the financial crisis, when the failure of a large fund led to a loss of confidence in the asset-backed commercial paper market. The disruption prompted the intervention of the central bank, which provided support to the market.

== Money Market Funds ==
Money market funds are investment funds that invest in short-term instruments and seek to maintain a stable net asset value. The funds are used by investors as an alternative to bank deposits.

The funds are subject to the risk of runs, since investors may withdraw their funds if they perceive a risk to the value of the assets. The risk was realised during the financial crisis, when a large fund experienced losses and the value of its shares fell below the fixed level.

The experience prompted reforms, including requirements for the funds to hold liquid assets and to disclose the value of their assets, and the introduction of mechanisms to manage the risk of runs.

== Summary ==
The money market is the market for short-term instruments and is central to the management of liquidity and to the conduct of monetary policy. The instruments of the market, including repos and commercial paper, and the institutions that participate in it, are central to the functioning of the financial system.

== See also ==
* Monetary Economics
* Banking
* Liquidity Risk

== References ==

<ref name="r1">Research on the money market and on its instruments.</ref>
<ref name="r2">Studies of the disruption of the market during the crisis.</ref>
<ref name="r3">Analyses of the reform of the money market and of its infrastructure.</ref>

<references />

[[Category:Monetary economics]]
[[Category:Banking]]
[[Category:Financial economics]]

Monetary Transmission Mechanism

2026-10-06T06:22:29Z

Youku: New encyclopedia entry (batch upload)

The '''monetary transmission mechanism''' is the process by which changes in the stance of monetary policy affect the economy, including output and prices. The mechanism operates through several channels, which differ in their speed and in their importance.

== Interest Rate Channel ==
The interest rate channel operates through the effect of the policy rate on the rates faced by households and firms. A change in the policy rate is transmitted to the lending and deposit rates, which affect the cost of borrowing and the return to saving.

A reduction in the policy rate lowers the cost of borrowing, which encourages investment and consumption. It also lowers the return to saving, which reduces the incentive to save. The effect on demand depends on the responsiveness of investment and consumption to interest rates.

== Credit Channel ==
The credit channel operates through the effect of monetary policy on the supply of credit by banks and other financial institutions. A tightening of policy reduces the reserves of banks, which may reduce their willingness to lend, particularly to borrowers who depend on bank credit.

The credit channel has two components. The bank lending channel operates through the supply of loans by banks, while the balance sheet channel operates through the effect of policy on the financial position of borrowers. A tightening of policy worsens the financial position of borrowers, which raises the cost of external finance and reduces their access to credit.

== Asset Price Channel ==
The asset price channel operates through the effect of monetary policy on the prices of assets, including equities and real estate. A reduction in the policy rate raises the prices of assets, which raises the wealth of households and lowers the cost of capital for firms.

The effect on wealth raises consumption, through the wealth effect, and the effect on the cost of capital raises investment. The asset price channel is therefore an important element of the transmission mechanism.

== Exchange Rate Channel ==
The exchange rate channel operates through the effect of monetary policy on the exchange rate. A reduction in the policy rate lowers the return on domestic assets, which reduces the demand for the domestic currency and causes it to depreciate.

The depreciation raises the price of imports and lowers the price of exports, which raises net exports and thereby demand. The effect on inflation depends on the degree of pass-through of the exchange rate to import prices.

== Expectations Channel ==
The expectations channel operates through the effect of monetary policy on the expectations of households and firms. A credible commitment to a policy stance affects expectations about future inflation and interest rates, which in turn affect current behaviour.

The expectations channel is particularly important when the policy rate is at its lower bound, since the central bank can influence expectations through forward guidance and through asset purchases. The effectiveness of the channel depends on the credibility of the central bank and on the anchoring of expectations.

== The Role of the Financial System ==
The financial system plays a central role in the transmission of monetary policy. The structure of the system, including the importance of banks relative to markets, affects the channels through which policy operates.

In a system where banks are the main source of finance for firms and households, the credit channel is important, and the effect of policy on the supply of bank credit matters. In a system where markets are more important, the asset price channel and the interest rate channel may dominate.

The condition of the financial system also matters. A weakened banking system may be unable to transmit the policy stimulus, since the banks may be reluctant to lend even when the policy rate is low. The impairment of the transmission mechanism was a feature of the period after the financial crisis.

== Unconventional Monetary Policy ==
Unconventional monetary policy refers to the measures taken by central banks when the policy rate is at its lower bound. The measures include quantitative easing, in which the central bank purchases assets to inject liquidity and to lower long-term interest rates, and forward guidance, in which the central bank communicates its intentions about the future path of policy.

The measures operate through the transmission mechanism, though the channels differ from those of conventional policy. Quantitative easing works through the asset price channel and the portfolio balance channel, by changing the composition of the assets held by the private sector. Forward guidance works through the expectations channel, by influencing expectations about future rates.

The effectiveness of the measures is a subject of research. The evidence suggests that they have lowered long-term interest rates and supported demand, though the effects are uncertain and may depend on the circumstances.

== The Transmission Mechanism in Emerging Markets ==
The transmission mechanism in emerging markets differs from that in advanced economies. The channels are affected by the structure of the financial system, by the degree of openness of the economy, and by the credibility of the monetary authority.

In emerging markets, the exchange rate channel may be more important, since the economies are more open and the exchange rate is more sensitive to interest rate changes. The credit channel may also be more important, since the banking system is often the dominant source of finance.

The transmission mechanism is also affected by the presence of foreign currency debt, which can amplify the effects of exchange rate movements, and by the credibility of the monetary policy framework, which affects the response of expectations.

== Summary ==
The monetary transmission mechanism is the process by which policy affects the economy, and it operates through several channels whose importance varies across economies and over time. The structure of the financial system, the use of unconventional measures, and the characteristics of emerging markets all shape the mechanism.

== See also ==
* Monetary Economics
* Central Banking
* Interest Rate Spread

== References ==

<ref name="r1">Research on the monetary transmission mechanism.</ref>
<ref name="r2">Studies of the credit channel and of the asset price channel.</ref>
<ref name="r3">Analyses of the role of expectations in monetary policy.</ref>

<references />

[[Category:Monetary economics]]
[[Category:Central banking]]
[[Category:Macroeconomics]]

Mean Reversion

2026-10-06T06:22:28Z

Youku: New encyclopedia entry (batch upload)

'''Mean reversion''' is the tendency of a variable to return towards its long-run average after a deviation. The concept is used in the analysis of financial markets, of economic time series, and of interest rates.

== Concept ==
A variable that exhibits mean reversion tends to move back towards its mean after a shock. If the variable is above its mean, it tends to fall; if below, it tends to rise. The speed of reversion determines how quickly the variable returns to its mean.

Mean reversion is distinguished from a random walk, in which the variable moves randomly and does not tend to return to any level. The distinction matters for forecasting, since a mean-reverting variable can be forecast from its current level, while a random walk cannot.

== Applications in Finance ==
Mean reversion is used in the analysis of asset prices, of exchange rates, and of interest rates. The prices of some assets, including commodities and currencies, are sometimes modelled as mean-reverting, on the grounds that deviations from fundamental values are corrected over time.

Interest rates are often modelled as mean-reverting, since they tend to return to a long-run level determined by the fundamentals of the economy. The models are used to price interest rate derivatives and to assess the risk of interest rate positions.

The evidence on mean reversion in asset prices is mixed. Some studies find evidence of reversion over long horizons, while others find that prices follow a random walk. The evidence depends on the sample period, on the assets studied, and on the methods used.

== Statistical Testing ==
The testing of mean reversion is based on the analysis of time series. The standard test is the unit root test, which examines whether the series has a unit root, in which case it follows a random walk, or is stationary, in which case it tends to revert to its mean.

The tests have low power, particularly over short samples, and they may fail to reject the null hypothesis of a unit root even when the series is mean-reverting. The results are therefore sensitive to the sample and to the specification.

The analysis of mean reversion also involves the estimation of the speed of reversion, which is the parameter that determines how quickly the variable returns to its mean. The estimates are used in forecasting and in the pricing of derivatives.

== Implications ==
Mean reversion has implications for investment strategy. If prices are mean-reverting, then a strategy of buying when prices are low and selling when they are high may be profitable. The strategy is used in some hedge fund strategies and in the management of portfolios.

Mean reversion also has implications for the analysis of risk. If a variable is mean-reverting, then its variance is bounded, and the risk of extreme outcomes is limited. If it follows a random walk, the variance grows without bound, and the risk is greater.

== Mean Reversion in Interest Rates ==
The modelling of interest rates often assumes mean reversion, on the grounds that rates tend to return to a long-run level. The models are used to price interest rate derivatives and to manage the risk of interest rate positions.

The Vasicek model and the Cox-Ingersoll-Ross model are the classic mean-reverting models of the short rate. Both assume that the rate is pulled towards a long-run mean, with the strength of the pull determined by the speed of reversion. The models differ in their treatment of volatility and in the possibility of negative rates.

The estimation of the models requires data on the short rate and the application of statistical methods. The estimates are used to assess the persistence of rate movements and to forecast future rates.

== Mean Reversion in Exchange Rates ==
The analysis of exchange rates sometimes assumes mean reversion, on the grounds that deviations from fundamental values are corrected over time. The evidence on mean reversion in exchange rates is, however, mixed.

The purchasing power parity condition implies that real exchange rates should revert to a long-run level, as differences in inflation are offset by changes in nominal rates. The evidence suggests that reversion occurs, but that it is slow and that the speed of reversion is difficult to estimate.

The evidence on nominal exchange rates is less supportive of mean reversion, since nominal rates can drift for long periods. The analysis therefore distinguishes between the short-run behaviour of rates, which may resemble a random walk, and the long-run behaviour, which may exhibit reversion.

== Implications for Portfolio Management ==
The evidence on mean reversion has implications for portfolio management. If asset prices are mean-reverting, then a strategy of buying after price declines and selling after price increases may be profitable, and the risk of holding a position over a long horizon may be lower than the random walk model implies.

The strategy is used in some investment approaches, including value investing and tactical asset allocation. The evidence on the profitability of these strategies is mixed, and the results are sensitive to the sample and to the methods.

The analysis of mean reversion is also relevant to the design of risk management. The horizon over which the risk is measured matters, since mean reversion reduces the risk over long horizons relative to the random walk benchmark.

== Summary ==
Mean reversion is the tendency of a variable to return towards its long-run average, and it is used in the analysis of interest rates, of exchange rates, and of asset prices. The evidence on its presence and on its strength is mixed, and its implications for investment and for risk management depend on the context.

== See also ==
* Statistics
* Financial Economics
* Econometrics

== References ==

<ref name="r1">Research on mean reversion in financial and economic time series.</ref>
<ref name="r2">Studies of unit root tests and of the speed of reversion.</ref>
<ref name="r3">Analyses of investment strategies based on mean reversion.</ref>

<references />

[[Category:Statistics]]
[[Category:Financial economics]]
[[Category:Econometrics]]

Market Failure Theory

2026-10-06T06:22:27Z

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'''Market failure theory''' analyses the circumstances in which markets fail to allocate resources efficiently, providing a rationale for government intervention. The theory identifies several sources of market failure, including externalities, public goods, market power, and imperfect information.

== Externalities ==
An externality arises when the production or consumption of a good affects the welfare of third parties without being reflected in the price. Negative externalities, such as pollution, impose costs on others, while positive externalities, such as education, confer benefits.

The presence of externalities means that the market outcome is not efficient, since the private cost or benefit differs from the social cost or benefit. The efficient outcome requires that the marginal social cost equals the marginal social benefit, which may require taxes, subsidies, or regulation.

== Public Goods ==
A public good is a good that is non-rival and non-excludable. Non-rivalry means that the consumption of the good by one person does not reduce the amount available to others, and non-excludability means that it is not possible to prevent others from consuming it.

The characteristics of public goods mean that markets undersupply them, since individuals have an incentive to free ride on the contributions of others. The efficient provision of public goods requires collective action, typically through the government.

== Market Power ==
Market power is the ability of a firm to influence the price of its product. A firm with market power sets price above marginal cost, which reduces output below the efficient level and creates a deadweight loss.

The presence of market power provides a rationale for competition policy and for the regulation of natural monopolies. The design of policy must balance the benefits of the efficiency that market power may reflect against the costs of the distortion that it creates.

== Imperfect Information ==
Imperfect information arises when one party to a transaction knows more than the other. Asymmetric information can lead to adverse selection, in which the quality of the goods traded declines, and to moral hazard, in which one party takes actions that harm the other.

The presence of imperfect information provides a rationale for disclosure requirements, for the regulation of financial markets, and for the design of contracts and of institutions that mitigate the problems.

== Policy ==
The theory of market failure provides a rationale for government intervention, but it does not imply that intervention is always beneficial. Governments may fail to correct market failures, for reasons including imperfect information, the influence of interest groups, and the administrative costs of intervention.

The analysis of policy must therefore compare the market outcome with the outcome of intervention, taking account of the failures of government as well as those of the market. The design of policy must address the specific failure and must be robust to the limitations of the public sector.

== Externalities and Policy ==
The analysis of externalities provides the basis for several policies. A tax on a good that generates a negative externality, such as pollution, raises its price and reduces the quantity produced, aligning the private cost with the social cost. A subsidy on a good that generates a positive externality, such as education, raises its quantity.

The optimal tax or subsidy is equal to the marginal external cost or benefit at the efficient level of output. The determination of the optimal level requires estimates of the external cost or benefit, which are often difficult to obtain.

The policy can also take the form of regulation, which sets standards for the activities that generate the externality. The choice between taxes and regulation depends on the information available and on the nature of the externality. Taxes are more efficient when the costs of abatement differ across firms, since they allow firms to reduce emissions where it is cheapest.

== Public Goods and Collective Action ==
The provision of public goods requires collective action, since individuals have an incentive to free ride. The analysis of collective action, developed by Mancur Olson, examines the conditions under which groups can organise to provide public goods.

The analysis holds that small groups are more likely to organise than large ones, since the costs and the benefits are more concentrated. The provision of public goods at the national level therefore requires institutions, including the government, that can compel contributions through taxation.

The analysis also applies to the international level, where the provision of global public goods, including the prevention of climate change, requires cooperation among countries. The absence of a global authority makes the provision more difficult, and it requires institutions and agreements that can overcome the incentive to free ride.

== Government Failure ==
The theory of government failure analyses the circumstances in which government intervention fails to improve on the market outcome. The failures arise from imperfect information, from the influence of interest groups, and from the administrative costs of intervention.

The analysis holds that the comparison of the market outcome with the outcome of intervention must consider the failures of both. A policy that is intended to correct a market failure may create a worse outcome if the government fails.

The analysis informs the design of policy, which should address the specific failure and should be robust to the limitations of the public sector. The design should also include mechanisms for monitoring and for correction, so that policies that fail can be revised.

== Summary ==
The theory of market failure identifies the circumstances in which markets fail to allocate resources efficiently and provides a rationale for government intervention. Its application requires attention to the failures of government and to the design of policies that are robust to the limitations of both the market and the public sector.

== See also ==
* Economic Efficiency
* Public Economics
* Monopoly Power

== References ==

<ref name="r1">Texts on welfare economics and on market failure.</ref>
<ref name="r2">Research on externalities, public goods, and information.</ref>
<ref name="r3">Analyses of government failure and of the design of policy.</ref>

<references />

[[Category:Market failure]]
[[Category:Welfare economics]]
[[Category:Public economics]]

Market Basket

2026-10-06T06:22:27Z

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A '''market basket''' is a fixed set of goods and services whose prices are tracked to measure changes in the cost of living or in the price level. The market basket is the basis for the construction of price indices, including the consumer price index.

== Construction ==
The market basket is constructed from data on the expenditure of households, which are collected through household budget surveys. The surveys provide information on the goods and services that households buy and on the shares of expenditure allocated to each.

The basket includes the goods and services that are consumed by the reference population, and the weights reflect the share of total expenditure allocated to each item. The basket is updated periodically, to reflect changes in consumption patterns.

The composition of the basket reflects the consumption patterns of the reference population, which may be the whole population or a particular group. The choice of the reference population affects the relevance of the index for different purposes.

== Price Index Construction ==
The price index is calculated by tracking the prices of the items in the basket and combining them into an index. The simplest approach is to compute the cost of the basket at current prices and divide it by the cost at base-period prices, giving a Laspeyres index.

The Laspeyres index uses the quantities of the base period as weights, and it therefore overstates the increase in the cost of living, since it does not account for the substitution of consumers away from goods whose prices have risen. The Paasche index uses current quantities as weights and understates the increase. The Fisher index, which is the geometric mean of the two, is often used as a compromise.

== Substitution and Quality ==
The treatment of substitution is a central issue in the construction of price indices. Consumers respond to changes in relative prices by substituting away from goods that have become relatively expensive, and an index that ignores this substitution overstates the increase in the cost of living.

The treatment of quality is another issue. When the quality of a good improves, the price increase may reflect the improvement rather than a change in the value of money. Hedonic methods are used to adjust for quality and to construct constant-quality price indices.

The introduction of new goods also raises issues, since the basket must be updated to include them. The treatment of new goods affects the measured rate of inflation, and the methods used to incorporate them vary across countries.

== Uses ==
The market basket and the price index constructed from it are used to measure inflation and to index payments, including wages, pensions, and social benefits. The index is used in monetary policy, where the central bank targets the rate of inflation measured by the index.

The choice of the index matters for the assessment of the cost of living and for the design of policy. Different indices, including the consumer price index and the personal consumption expenditure deflator, may give different measures of inflation, and the choice affects the interpretation of the data.

== The Consumer Price Index ==
The consumer price index is the most widely used measure of inflation, constructed from the market basket of goods and services consumed by households. The index is published monthly and is used to index payments and to inform monetary policy.

The construction of the index involves the selection of the basket, the collection of prices, and the combination of the prices into an index. The basket is updated periodically to reflect changes in consumption patterns, and the prices are collected from a sample of outlets.

The index is subject to several sources of bias. The substitution bias arises from the use of fixed weights, which do not account for the substitution of consumers away from goods whose prices have risen. The quality bias arises from the difficulty of adjusting for changes in quality. The new goods bias arises from the delay in incorporating new goods into the basket.

== Alternative Measures ==
Several alternative measures of inflation are used, each with different coverage and different properties. The personal consumption expenditure deflator measures the prices of the goods and services consumed by households, and it is used by some central banks as the target measure.

The producer price index measures the prices received by producers, and it is used as an indicator of the pressures on consumer prices. The GDP deflator measures the prices of all the goods and services produced in the economy.

The measures differ in their coverage, in their treatment of the components of expenditure, and in their methods of construction. The differences matter for the assessment of inflation and for the design of policy.

== The Use of the Index ==
The consumer price index is used to index payments, including wages, pensions, and social benefits. The use of the index protects the recipients from inflation, but it can also create a feedback, in which the indexation of wages raises costs and prices, contributing to inflation.

The index is also used in the measurement of real interest rates and of real wages. The distinction between nominal and real values requires a price index, and the choice of the index affects the measurement.

The index is used in the conduct of monetary policy, where the central bank targets the rate of inflation measured by the index. The choice of the target measure and the treatment of volatile components, including energy and food, affect the design of policy.

== Summary ==
The market basket is the basis for the construction of price indices, and its composition and its treatment of substitution and of quality affect the measurement of inflation. The index is used for a wide range of purposes, and its limitations inform the interpretation of the data.

== See also ==
* Consumer Behaviour
* Inflation
* Hedonic Pricing

== References ==

<ref name="r1">Research on the construction of price indices.</ref>
<ref name="r2">Studies of the treatment of substitution and of quality.</ref>
<ref name="r3">Analyses of the use of price indices in policy.</ref>

<references />

[[Category:Consumer behaviour]]
[[Category:Statistics]]
[[Category:Inflation]]

Marginal Factor Productivity

2026-10-06T06:22:26Z

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'''Marginal factor productivity''' is the additional output that results from employing one more unit of a factor of production, with the other factors held constant. It is a central concept in the analysis of the demand for factors and of the distribution of income.

== Definition and Diminishing Returns ==
The marginal product of a factor is the change in output from employing one additional unit of the factor. The marginal value product is the marginal product multiplied by the price of the output, and it represents the additional revenue from employing the factor.

The marginal product of a factor typically diminishes as more of the factor is employed, holding the other factors constant. This is the law of diminishing returns, which is reflected in the shape of the production function and in the downward slope of the demand curve for the factor.

The rate of diminishing returns depends on the technology and on the quantities of the other factors. A larger quantity of the other factors raises the marginal product of the factor in question, a relationship known as complementarity.

== Factor Demand ==
The demand for a factor is derived from the value of its marginal product. A firm employs a factor up to the point at which the marginal value product equals the price of the factor. At that point, the additional revenue from employing one more unit equals the additional cost.

The condition implies that the demand for a factor is a decreasing function of its price, since a higher price requires a higher marginal product, which is achieved with a smaller quantity of the factor. The demand for labour, for example, is a decreasing function of the wage.

The demand for a factor also depends on the prices of the other factors and on the price of the output. A rise in the price of the output raises the marginal value product and increases the demand for the factor, while a rise in the price of a substitute factor increases the demand for the factor in question.

== Distribution ==
The marginal productivity theory holds that, in competitive markets, each factor is paid the value of its marginal product. The theory provides a framework for the analysis of the distribution of income among the factors of production.

The theory implies that the share of income that accrues to each factor depends on its marginal product and on the quantity employed. Changes in technology or in the supply of factors affect the marginal products and thereby the distribution of income.

The theory has been criticised for its assumptions and for its empirical performance. The assumptions of perfect competition and of full information are restrictive, and the observed distribution of income may reflect other factors, including the bargaining power of the parties and the institutions of the labour market.

== Applications ==
The concept of marginal factor productivity is used in the analysis of the demand for labour, of the effects of immigration, and of the effects of technology on employment. It is used in the analysis of the effects of taxes on the demand for factors and on the distribution of the burden.

The concept is also used in the estimation of production functions, where the marginal products of the factors are derived from the estimated function. The estimates are used to assess the returns to scale and the effects of policy.

== Marginal Productivity and the Demand for Labour ==
The marginal productivity of labour is the additional output from employing one more worker. The value of the marginal product is the marginal product multiplied by the price of the output, and it determines the demand for labour.

A profit-maximising firm employs labour up to the point at which the value of the marginal product equals the wage. The condition implies that the demand for labour is a decreasing function of the wage, and that it shifts with the price of the output and with the productivity of labour.

The demand for labour is central to the analysis of employment and of wages. The analysis of the effects of a minimum wage, of a payroll tax, and of technological change all rely on the concept of the marginal product of labour.

== The Effects of Immigration ==
The marginal productivity framework is used to analyse the effects of immigration. An increase in the supply of labour reduces the marginal product of labour, which tends to lower wages and to raise the return to capital.

The effect on wages depends on the substitutability between immigrant and native workers and on the structure of the labour market. If immigrants and natives are substitutes, the wages of native workers may fall; if they are complements, the wages may rise.

The analysis also considers the effect of immigration on the return to capital and on the total output of the economy. The gains from immigration are distributed among the factors, and the distributional effects depend on the structure of production.

== Technological Change and the Demand for Skills ==
Technological change affects the demand for different types of labour through its effect on marginal productivity. Technological change that complements skilled labour raises the demand for skilled workers and their wages, while change that substitutes for unskilled labour reduces the demand for unskilled workers.

The concept of skill-biased technological change has been used to explain the increase in the return to education and the rise in wage inequality in many countries. The evidence supports the view that technology has raised the demand for skilled labour relative to unskilled labour.

The analysis is complicated by the fact that technology can also create new tasks for labour, including tasks that require skills that were not previously valued. The net effect on the demand for labour depends on the balance between the displacement and the creation of tasks.

== Summary ==
Marginal factor productivity is the additional output from employing one more unit of a factor, and it determines the demand for the factor and the distribution of income. Its analysis informs the understanding of the effects of immigration, of technology, and of policy on the labour market.

== See also ==
* Production Economics
* Labour Economics
* Factor Price

== References ==

<ref name="r1">Texts on distribution and on factor demand.</ref>
<ref name="r2">Research on the marginal productivity of factors.</ref>
<ref name="r3">Analyses of the effects of technology and of immigration on factor demand.</ref>

<references />

[[Category:Production economics]]
[[Category:Labour economics]]
[[Category:Microeconomics]]

Long Run Production Function

2026-10-06T06:22:25Z

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The '''long run production function''' is the relationship between the maximum output that a firm can produce and the quantities of all inputs, when all inputs are variable. The long run production function is distinguished from the short run production function, in which at least one input is fixed.

== Concept ==
The long run production function describes the technological possibilities available to the firm when it can choose the quantities of all inputs. It is the fundamental constraint on production, and it determines the cost function and the supply behaviour of the firm.

The function exhibits the property of constant, increasing, or decreasing returns to scale according to how output responds to a proportional increase in all inputs. If output rises more than proportionally, the function exhibits increasing returns to scale; if less, decreasing returns.

== Returns to Scale ==
Returns to scale are a property of the technology, determined by the physical relationship between inputs and output. They are distinguished from returns to a factor, which concern the response of output to an increase in one input with others held constant.

Increasing returns to scale arise from the specialisation of labour and of capital, from the use of more efficient technologies at larger scale, and from the spreading of fixed costs. Decreasing returns to scale arise from the difficulties of managing a large organisation and from the limits of the available inputs.

The returns to scale determine the shape of the long run average cost curve. Increasing returns imply a downward-sloping curve, decreasing returns an upward-sloping curve, and constant returns a horizontal curve.

== Isoquants and the Choice of Technique ==
The long run production function can be represented by isoquants, which show the combinations of inputs that produce a given level of output. The slope of the isoquant is the marginal rate of technical substitution, which measures the rate at which one input can be substituted for another.

The firm chooses the combination of inputs that minimises cost for a given level of output. The choice depends on the relative prices of the inputs and on the shape of the isoquants. The cost-minimising combination is where the marginal rate of technical substitution equals the ratio of input prices.

The analysis of the choice of technique is central to the analysis of the effects of changes in input prices. A change in the relative price of labour and capital induces firms to substitute the cheaper input for the more expensive one, a process known as factor substitution.

== Applications ==
The long run production function is used in the analysis of growth, where the accumulation of capital and the growth of the labour force shift the function and raise output. It is used in the analysis of technical progress, which changes the relationship between inputs and output.

The function is also used in empirical work, where it is estimated from data on firms and used to assess the returns to scale, the efficiency of firms, and the effects of policy. The estimation requires attention to the functional form and to the potential for endogeneity.

== Technical Progress ==
Technical progress changes the long run production function, allowing more output to be produced from the same inputs. The progress can be embodied in new capital goods, or it can be disembodied, in the form of improved knowledge and methods.

The analysis of technical progress distinguishes between neutral progress, which raises the productivity of all inputs proportionally, and biased progress, which raises the productivity of some inputs more than others. The bias of technical progress affects the demand for the inputs and the distribution of income.

Technical progress is a central determinant of long-run growth, since it raises the productivity of the economy and allows output to grow even when the inputs are fixed. The sources of technical progress, including research and development and the diffusion of knowledge, are analysed in the theory of growth.

== The Cobb-Douglas Function ==
The Cobb-Douglas production function is the most widely used functional form in the analysis of production. It expresses output as a function of the inputs raised to constant exponents, and it exhibits constant returns to scale when the exponents sum to one.

The function has convenient properties. The exponents represent the shares of the inputs in output, and the elasticities of substitution between the inputs are equal to one. The function is therefore easy to estimate and to interpret.

The function has been extended to include human capital and other inputs, and it is used in the analysis of growth and of the sources of growth. The estimates of the exponents are used to decompose the growth of output into the contributions of the inputs and of the residual, which is often interpreted as the contribution of technical progress.

== Empirical Estimation ==
The estimation of production functions is a central task of empirical economics. The estimation requires data on the inputs and the outputs of firms or of industries, and it must address the problems of simultaneity and of measurement.

The simultaneity problem arises because the inputs are chosen by the firm, and the choice may be correlated with unobserved factors that affect output. The estimation must therefore use instruments or other methods to identify the parameters.

The measurement problem arises because the inputs and the outputs must be measured in consistent units. The measurement of capital is particularly difficult, since the capital stock is the result of past investment and its value depends on the prices of the assets.

== Summary ==
The long run production function describes the technological possibilities available to the firm when all inputs are variable, and it is central to the analysis of returns to scale, of technical progress, and of growth. Its estimation requires attention to the functional form and to the problems of simultaneity and of measurement.

== See also ==
* Fixed Input
* Production Economics
* Cost Function

== References ==

<ref name="r1">Microeconomics texts on production and on returns to scale.</ref>
<ref name="r2">Research on the estimation of production functions.</ref>
<ref name="r3">Analyses of technical progress and of factor substitution.</ref>

<references />

[[Category:Production economics]]
[[Category:Microeconomics]]
[[Category:Cost accounting]]

Liquidity Risk

2026-10-06T06:22:24Z

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'''Liquidity risk''' is the risk that an institution will be unable to meet its obligations when they fall due, or that it will be able to do so only at excessive cost. Liquidity risk is distinct from solvency risk, which concerns the adequacy of the assets relative to the liabilities.

== Funding Liquidity Risk ==
Funding liquidity risk is the risk that an institution cannot obtain the funds required to meet its obligations. It arises when the institution relies on short-term funding that may not be rolled over, or when the sources of funding are disrupted.

The risk is inherent in the business of banking, since banks hold illiquid assets and liquid liabilities. A loss of confidence can prompt depositors and other creditors to withdraw their funds, forcing the bank to sell assets at a loss or to seek emergency funding.

The management of funding liquidity risk involves the diversification of the sources of funding, the holding of liquid assets, and the maintenance of contingent funding arrangements. The design of these arrangements affects the resilience of the institution to stress.

== Market Liquidity Risk ==
Market liquidity risk is the risk that an asset cannot be sold quickly at a fair price. It arises when the market for the asset is thin, when there are few buyers, or when the conditions in the market are disrupted.

The risk is measured by the difference between the price at which an asset can be sold and its fundamental value, and by the time required to sell it. The measures are imperfect, and the risk can change rapidly, particularly during periods of stress.

Market liquidity risk is related to funding liquidity risk. When markets become illiquid, institutions may find it difficult to sell assets to raise funds, and the two risks interact in a way that can amplify stress.

== Regulation ==
The regulation of liquidity risk has been strengthened since the financial crisis. The framework includes quantitative requirements, including the liquidity coverage ratio, which requires institutions to hold sufficient liquid assets to meet their obligations over a short period, and the net stable funding ratio, which addresses the stability of funding over a longer period.

The framework also includes qualitative requirements, including the requirement for institutions to have a liquidity risk management framework and a contingency funding plan. The framework is complemented by supervisory review, which assesses the liquidity risk of individual institutions.

The regulation of liquidity risk has implications for the business of banking. The requirements raise the cost of maturity transformation, which may reduce the supply of credit and the profitability of banks. The design of the regulation must balance the benefits of stability against the costs to intermediation.

== Systemic Dimension ==
Liquidity risk has a systemic dimension, since the failure of one institution to meet its obligations can affect others. The interconnection of the financial system means that a liquidity shock can spread, and the markets themselves can become illiquid as institutions seek to sell assets simultaneously.

The systemic dimension provides a rationale for the central bank to act as lender of last resort and for the regulation of liquidity at the systemic level. The design of the framework must take account of the interactions among institutions and of the potential for contagion.

== The Interaction of Funding and Market Liquidity ==
The interaction between funding liquidity risk and market liquidity risk is central to the analysis of financial stability. When institutions face funding pressures, they may be forced to sell assets, which depresses their prices and further impairs the liquidity of the market.

This interaction can create a spiral, in which the decline in asset prices raises the losses of the institutions, which prompts further sales, which drives prices down further. The spiral can turn a liquidity problem into a solvency problem and can spread across the financial system.

The analysis of the spiral is central to the understanding of financial crises. It explains why liquidity can evaporate quickly and why the intervention of the central bank may be required to restore the functioning of the market.

== Liquidity Regulation ==
The regulation of liquidity risk has been strengthened since the financial crisis. The framework includes the liquidity coverage ratio, which requires institutions to hold sufficient high-quality liquid assets to cover their net outflows over a thirty-day stress period, and the net stable funding ratio, which requires institutions to fund their long-term assets with stable sources of funding.

The requirements have raised the cost of maturity transformation, which is the core business of banking. The assessment of the effects must consider both the benefits of the increased resilience and the costs to the provision of credit.

The framework also includes requirements for the measurement and the management of liquidity risk, including the conduct of stress tests and the maintenance of contingency funding plans. The framework is complemented by supervisory review.

== Liquidity and the Central Bank ==
The central bank plays a central role in the management of liquidity risk. It provides liquidity to the banking system through its operations and acts as the lender of last resort during periods of stress.

The design of the framework for the provision of liquidity affects the behaviour of institutions. A framework that provides liquidity freely may encourage excessive risk-taking, while a framework that is too restrictive may leave institutions exposed to runs. The design must balance these considerations.

The central bank also influences liquidity through its collateral framework, which determines the assets that it is willing to accept in its operations. The design of the framework affects the liquidity of the assets themselves and the behaviour of institutions.

== Summary ==
Liquidity risk arises from the mismatch between illiquid assets and liquid liabilities, and it has both a funding and a market dimension. The regulation of liquidity and the role of the central bank are central to the management of the risk.

== See also ==
* Banking
* Bank Liquidity Crisis
* Lender of Last Resort

== References ==

<ref name="r1">Research on liquidity risk and on its management.</ref>
<ref name="r2">Studies of the regulation of liquidity and of the prudential framework.</ref>
<ref name="r3">Analyses of the systemic dimension of liquidity risk.</ref>

<references />

[[Category:Banking]]
[[Category:Financial economics]]
[[Category:Central banking]]

Lender of Last Resort

2026-10-06T06:22:23Z

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A '''lender of last resort''' is an institution, typically a central bank, that provides liquidity to financial institutions during periods of stress, when they cannot obtain funds from other sources. The function is a central element of the safety net for the financial system.

== Concept ==
The lender of last resort provides liquidity to solvent but illiquid institutions, allowing them to meet their obligations and preventing the spread of a liquidity crisis. The distinction between solvency and liquidity is central, since an institution that is insolvent should be resolved rather than supported.

The function is based on the observation that banks are vulnerable to runs, since they hold illiquid assets and liquid liabilities. A run can force a solvent bank into insolvency, and the failure of one bank can spread to others, through the interconnection of the financial system.

== Principles ==
The classical principles of the lender of last resort were articulated by Walter Bagehot in the nineteenth century. The principles hold that the central bank should lend freely, at a penalty rate, against good collateral, to institutions that are solvent but illiquid.

The principle of lending freely is intended to reassure the market that liquidity will be available and thereby to prevent runs. The penalty rate is intended to discourage unnecessary borrowing and to ensure that the facility is used only by institutions that need it. The requirement for good collateral protects the central bank from losses.

== Modern Practice ==
Modern practice has evolved beyond the classical principles. Central banks now lend against a wider range of collateral, and they have extended the provision of liquidity to a broader range of institutions. The distinction between liquidity and solvency has become more difficult to draw, and the measures taken during crises have blurred it further.

The global financial crisis saw an extensive use of the lender of last resort function, with central banks providing liquidity on an unprecedented scale. The measures included the expansion of the collateral accepted, the lengthening of the terms of the loans, and the provision of liquidity to institutions beyond the banking sector.

The extension of the function raises issues of moral hazard, since institutions that expect to be supported may take excessive risks. The design of the facility must balance the need to provide liquidity against the need to limit the incentive for excessive risk-taking.

== Debate ==
The role of the lender of last resort is a subject of debate. Some argue that the function is essential to the stability of the financial system and that its exercise should be broad and flexible. Others argue that it creates moral hazard and that it should be limited and subject to strict conditions.

The debate is connected to the analysis of the regulation of the financial system. The provision of liquidity is one element of the safety net, which also includes deposit insurance and the resolution framework. The design of the safety net as a whole determines the incentives of financial institutions.

== The Classic Doctrine ==
The classic doctrine of the lender of last resort was developed in the nineteenth century, in the context of recurrent banking panics. The doctrine held that the central bank should lend freely to solvent institutions, at a penalty rate, against good collateral.

The rationale was to prevent panics from spreading, by assuring depositors and creditors that their claims would be met. The penalty rate was intended to discourage unnecessary borrowing and to ensure that the facility was used only when necessary.

The doctrine has been refined and debated over the years. The distinction between solvency and liquidity, which is central to the doctrine, is difficult to apply in practice, since the value of the assets of a bank depends on the market conditions, which may themselves be affected by the panic.

== The Crisis Experience ==
The financial crisis saw an extensive use of the lender of last resort function. Central banks provided liquidity on an unprecedented scale, through a range of facilities and against a wide range of collateral.

The measures included the provision of liquidity to individual institutions, the introduction of facilities to support specific markets, and the expansion of the collateral accepted. The measures were directed at preventing the failure of institutions and at restoring the functioning of markets.

The experience raised questions about the scope of the function and about the conditions under which it should be exercised. The extension of the function to a broader range of institutions and to a wider range of collateral blurred the distinction between the lender of last resort and the provision of general liquidity.

== The Moral Hazard Problem ==
The provision of liquidity creates a moral hazard problem, since institutions that expect to be supported may take excessive risks. The problem is particularly acute when the support is provided to institutions whose failure would threaten the financial system.

The design of the framework must address the problem, through the conditions attached to the support, through the supervision of the institutions, and through the resolution framework that allows failing institutions to be wound up without disrupting the system.

The problem also has a systemic dimension, since the expectation of support can encourage risk-taking across the financial system. The design of the safety net as a whole, including the deposit insurance and the resolution framework, determines the incentives of the institutions.

== Summary ==
The lender of last resort is a central function of the central bank, and its exercise has evolved in response to the crisis experience. The design of the function must balance the need to provide liquidity against the need to limit moral hazard.

== See also ==
* Central Banking
* Bank Liquidity Crisis
* Monetary Economics

== References ==

<ref name="r1">Research on the lender of last resort and on financial stability.</ref>
<ref name="r2">Studies of the central bank response to financial crises.</ref>
<ref name="r3">Analyses of moral hazard and of the design of the safety net.</ref>

<references />

[[Category:Central banking]]
[[Category:Banking]]
[[Category:Monetary economics]]

Labor Force Participation Rate

2026-10-06T06:22:22Z

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The '''labor force participation rate''' is the proportion of the working-age population that is either employed or actively seeking employment. It is a key indicator of the supply of labour and of the state of the labour market.

== Definition ==
The labor force participation rate is calculated as the labour force divided by the working-age population, expressed as a percentage. The labour force comprises the employed and the unemployed, and the working-age population is typically defined as persons above a certain age, often fifteen or sixteen, and below a retirement age.

The rate excludes persons who are neither employed nor seeking work, including students, retirees, and those who have withdrawn from the labour market. The exclusion means that the rate measures the active supply of labour rather than the potential supply.

== Determinants ==
The participation rate is influenced by demographic, economic, and institutional factors. The age structure of the population affects the rate, since participation varies with age and is highest among prime-age adults.

The participation of women has risen substantially over the past decades in many countries, reflecting changes in social norms, in education, and in the availability of childcare. The participation of older workers has also changed, reflecting the design of pension systems and the state of the labour market.

Economic conditions affect participation. During downturns, some workers withdraw from the labour market, discouraged by the difficulty of finding work, while others enter it, to supplement household income. The response depends on the group and on the state of the economy.

== Measurement ==
The measurement of the participation rate requires data on the labour force and on the population, which are collected through household surveys. The surveys define employment and unemployment according to international standards, which facilitates comparison across countries.

The measurement is subject to issues of definition and of coverage. The treatment of discouraged workers, who are not actively seeking work but would accept a job, affects the measured rate. The treatment of part-time workers, who would prefer full-time work, also affects the interpretation of the rate.

The participation rate is used together with the unemployment rate to assess the state of the labour market. A fall in the unemployment rate that is accompanied by a fall in the participation rate may reflect the withdrawal of workers rather than an improvement in conditions.

== Significance ==
The participation rate affects the productive capacity of the economy, since it determines the supply of labour. A higher participation rate raises potential output, other things equal, and it can support growth.

The rate also affects the analysis of unemployment and of the labour market. Changes in participation affect the measured unemployment rate, and the interpretation of the rate requires attention to the underlying movements in participation.

The rate is relevant to the analysis of policy, including the design of pension systems, of childcare, and of labour market institutions. Policies that raise participation can raise output and can improve the sustainability of the public finances.

== Participation and Unemployment ==
The relationship between participation and unemployment is central to the interpretation of labour market indicators. Changes in participation affect the measured unemployment rate, and the two indicators must be interpreted together.

During a downturn, the unemployment rate rises as workers lose their jobs. Some of the unemployed become discouraged and withdraw from the labour force, which reduces the measured unemployment rate, since they are no longer counted as unemployed. The fall in participation can therefore mask the deterioration in the labour market.

The opposite can occur during a recovery. As the labour market improves, discouraged workers re-enter the labour force, which raises the participation rate and can keep the unemployment rate elevated, even as employment grows. The re-entry of these workers is a sign of improving conditions, though it may be misread as a deterioration.

== The Participation of Women ==
The rise in the participation of women has been one of the most significant changes in the labour market over the past half century. The participation rate of women has risen substantially in most developed countries, narrowing the gap with men.

The increase reflects changes in social norms, in education, and in the availability of childcare and of other support. The design of family policy, including parental leave and childcare provision, affects the participation of women and the reconciliation of work and family.

The participation of women remains lower than that of men in most countries, and the gap varies across countries. The differences reflect the institutional and cultural context, and they are relevant to the analysis of the supply of labour and of the gender gap in earnings.

== The Participation of Older Workers ==
The participation of older workers has changed in recent decades. In many countries, the participation of men aged over fifty-five declined during the second half of the twentieth century, as the availability of pensions allowed earlier retirement. More recently, the trend has reversed, and the participation of older workers has risen.

The change reflects the reform of pension systems, which has raised the retirement age and reduced the generosity of benefits, and the improvement in the health of older people. The participation of older workers is relevant to the sustainability of the public finances, since it affects the ratio of contributors to beneficiaries.

== Summary ==
The labour force participation rate is a central indicator of the supply of labour, and its interpretation requires attention to its relationship with unemployment and to the demographic and institutional factors that drive it.

== See also ==
* Labour Economics
* Frictional Unemployment
* Statistics

== References ==

<ref name="r1">Research on labour force participation and on its determinants.</ref>
<ref name="r2">Studies of the participation of women and of older workers.</ref>
<ref name="r3">Analyses of the measurement of the labour force.</ref>

<references />

[[Category:Labour economics]]
[[Category:Economic indicators]]
[[Category:Statistics]]

Investment Bank

2026-10-06T06:22:21Z

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An '''investment bank''' is a financial institution that provides services related to the raising of capital and to the provision of financial advice, including underwriting securities, advising on mergers and acquisitions, and trading financial instruments.

== Activities ==
The activities of an investment bank are commonly divided into advisory and underwriting activities, which constitute investment banking in the narrow sense, and trading and market-making activities, which constitute the securities business.

Advisory services include advice on mergers and acquisitions, on restructuring, and on the raising of capital. Underwriting involves the purchase of securities from an issuer and their resale to investors, with the bank bearing the risk that the securities cannot be sold at the expected price.

Trading involves the purchase and sale of securities and of derivatives, both on behalf of clients and on the bank's own account. Market making involves quoting prices at which the bank is willing to buy and sell, providing liquidity to the market.

== Organisation ==
Investment banks are organised into divisions that correspond to their activities, including investment banking, sales and trading, and research. The divisions serve different clients, including corporations, governments, and institutional investors.

The organisational structure of investment banks has changed over time. The separation between commercial and investment banking, which was a feature of the regulatory framework in some countries, has been relaxed, leading to the emergence of large universal banks that combine both activities.

The compensation of employees in investment banks is heavily tied to performance, through bonuses and equity awards. The structure of compensation affects the behaviour of employees and has been a subject of debate in the context of risk-taking and of the financial crisis.

== Role in the Economy ==
Investment banks channel funds from savers to firms and governments, and they provide the expertise required for complex financial transactions. They play a central role in the primary market, where new securities are issued, and in the secondary market, where they are traded.

Investment banks also provide advice that shapes the structure of corporate transactions, including mergers and acquisitions. Their advice affects the allocation of corporate control and the value of the firms involved.

The role of investment banks has been criticised in the context of conflicts of interest, of excessive risk-taking, and of the conduct of the financial crisis. The reform of the sector has focused on the structure of the industry, on the regulation of capital and liquidity, and on the alignment of incentives.

== Regulation ==
The regulation of investment banks focuses on the capital and liquidity that they must hold, on the conduct of their business, and on the transparency of their operations. The framework has been strengthened since the financial crisis, with higher capital requirements and with restrictions on proprietary trading.

The regulation also addresses the risks that investment banks pose to the wider financial system, through their interconnectedness and through their role in the markets. The designation of some institutions as systemically important reflects the recognition of these risks.

The reform of the sector remains a subject of debate, with questions about the appropriate balance between regulation and market discipline and about the structure of the industry.

== The Financial Crisis and Its Aftermath ==
Investment banks were at the centre of the financial crisis, and the failure of one of the largest institutions in 2008 marked a turning point in the crisis. The failure reflected the exposure of the institution to mortgage-related securities and the fragility of its funding structure.

The crisis revealed weaknesses in the business model of investment banks, including the reliance on short-term wholesale funding and the high degree of leverage. The crisis also revealed weaknesses in the regulatory framework, which had not kept pace with the evolution of the industry.

The aftermath of the crisis saw the reform of the sector, including the strengthening of capital and liquidity requirements, the introduction of restrictions on proprietary trading, and the reform of compensation. The structure of the industry has also changed, with the consolidation of some institutions and the emergence of new entrants.

== Proprietary Trading and the Volcker Rule ==
Proprietary trading is the trading of securities and of other instruments by a bank on its own account, as distinct from trading on behalf of clients. The activity was a source of profit for investment banks, and it was also a source of risk.

The Volcker rule, introduced in the United States after the crisis, restricts banks from engaging in proprietary trading and from owning or sponsoring hedge funds and private equity funds. The rule is intended to reduce the risk that banks take and to protect the deposit insurance fund.

The implementation of the rule has been complex, and it has involved the definition of what constitutes proprietary trading and the establishment of compliance programmes. The rule has been a subject of debate, with some arguing that it reduces risk and others arguing that it reduces liquidity and imposes unnecessary costs.

== The Future of Investment Banking ==
The future of investment banking is shaped by several forces, including the regulatory framework, the evolution of technology, and the changing demands of clients. The regulatory framework constrains the activities that the banks can undertake and raises the cost of capital.

Technology is changing the nature of the business, through the growth of electronic trading and of automated advice. The changes affect the structure of the industry and the skills that are required.

The demands of clients are also changing, with the growth of emerging markets and the increasing importance of institutional investors. The banks that can adapt to these changes and that can manage the regulatory and the technological challenges will be well positioned.

== Summary ==
Investment banks provide advisory, underwriting, and trading services, and their role in the economy and their regulation have been reshaped by the financial crisis. The reform of the sector and the evolution of the industry are central to the analysis of finance.

== See also ==
* Banking
* Financial Asset
* Capital Market

== References ==

<ref name="r1">Research on investment banking and on its role in the economy.</ref>
<ref name="r2">Studies of the regulation of investment banks.</ref>
<ref name="r3">Analyses of the financial crisis and of the reform of the sector.</ref>

<references />

[[Category:Banking]]
[[Category:Financial economics]]
[[Category:Industrial organization]]

Intermediate Good

2026-10-06T06:22:20Z

Youku: New encyclopedia entry (batch upload)

An '''intermediate good''' is a good that is used as an input in the production of another good, rather than being consumed directly. Intermediate goods are distinguished from final goods, which are consumed, and from capital goods, which are used in production but not used up in a single cycle.

== Concept ==
Intermediate goods are the inputs that are transformed in the production process into other goods. They include raw materials, components, and semi-finished products. Their value is embodied in the value of the final goods that are produced.

The distinction between intermediate and final goods is not intrinsic to the good, since the same good may be intermediate in one use and final in another. The distinction depends on the use to which the good is put.

== Measurement ==
The measurement of intermediate goods is complicated by the problem of double counting. If the value of all goods produced were summed, intermediate goods would be counted multiple times, once at each stage of production. The measurement of output must therefore avoid double counting.

The value added approach avoids double counting by measuring the value added at each stage of production, which is the difference between the value of output and the value of the intermediate inputs. The sum of value added across all stages equals the value of the final output.

The input-output framework, developed by Leontief, provides a systematic account of the flows of intermediate goods among industries. The framework is used to analyse the interdependence of industries and to measure the value added content of trade.

== Trade ==
Intermediate goods account for a large share of international trade, reflecting the fragmentation of production across borders. The goods cross borders multiple times as they are processed at successive stages, which complicates the measurement of trade.

The measurement of trade in value added addresses this problem by attributing the value to the countries that contribute it. The measurement requires input-output data that track the flows across industries and countries.

The importance of intermediate goods in trade has implications for trade policy. Tariffs on intermediate goods raise the cost of production and reduce the competitiveness of downstream industries. The formation of regional trade agreements reflects in part the desire to reduce these costs.

== Significance ==
The distinction between intermediate and final goods matters for the analysis of the economy. It affects the measurement of output, of productivity, and of trade. It affects the analysis of the effects of policy, since a policy that affects the price of an intermediate good affects the cost of the final goods that embody it.

The distinction also matters for the analysis of the structure of production. The length and the complexity of the production chain affect the vulnerability of the economy to disruptions and the scope for specialisation.

== Input-Output Analysis ==
The input-output framework, developed by Wassily Leontief, provides a systematic account of the flows of goods and services among the industries of an economy. The framework records the intermediate inputs used by each industry and the outputs that it produces, and it captures the interdependence of the industries.

The framework is used to analyse the effects of changes in demand on the economy. A change in the demand for the output of one industry affects the demand for the intermediate goods that it uses, and thus the output of the industries that supply them. The multipliers that capture these effects are derived from the input-output table.

The framework has been extended to the international level, with the construction of global input-output tables that record the flows among countries. These tables are used to measure the value added content of trade and to analyse the global value chains.

== Value Added and Gross Trade ==
The distinction between gross trade and value added trade is central to the analysis of the global economy. Gross trade records the full value of the goods that cross borders, including the imported inputs that they embody. Value added trade attributes the value to the countries that contribute it.

The difference between the two is large for countries that are deeply integrated into global value chains. A country that assembles imported components and exports the finished goods has a large gross export figure but a smaller value added figure, since much of the value originates abroad.

The measurement of value added trade has implications for the analysis of trade balances and of the effects of trade on employment. The bilateral balance between two countries may differ substantially depending on the measure used.

== The Structure of Production ==
The length and the complexity of production chains affect the structure of the economy and its vulnerability to shocks. A longer chain involves more stages of production and more transactions, and it is more exposed to disruptions at any stage.

The structure of production also affects the scope for specialisation and for the division of labour. The fragmentation of production allows firms and countries to specialise in particular stages, raising the efficiency of production.

The analysis of the structure of production informs the design of industrial policy and of trade policy, and it is relevant to the assessment of the resilience of the economy.

== Summary ==
Intermediate goods are the inputs that are transformed in production, and their measurement requires the avoidance of double counting. The input-output framework and the analysis of value added trade provide the tools for the analysis of the structure of production and of the global economy.

== See also ==
* Production Economics
* National Accounts
* Global Value Chain

== References ==

<ref name="r1">Research on intermediate goods and on value added.</ref>
<ref name="r2">Studies of input-output analysis and of the measurement of trade.</ref>
<ref name="r3">Analyses of global production and of the structure of supply chains.</ref>

<references />

[[Category:Production economics]]
[[Category:National accounts]]
[[Category:Supply chain management]]

Interest Rate Spread

2026-10-06T06:22:20Z

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The '''interest rate spread''' is the difference between two interest rates, most commonly the difference between the rate at which a bank lends and the rate at which it borrows. The spread compensates the intermediary for the costs and the risks of intermediation and is a key indicator of the cost of credit.

== Banking Spread ==
The banking spread is the difference between the lending rate and the deposit rate. It compensates the bank for the cost of its operations, for the risk of default on its loans, and for the cost of holding capital and reserves.

The spread is influenced by the structure of the banking sector, by the regulation of the sector, and by the macroeconomic environment. A more competitive sector tends to have a narrower spread, while a concentrated sector tends to have a wider one. High inflation and volatile interest rates tend to widen the spread, since they increase uncertainty and the cost of intermediation.

The spread is used as an indicator of the efficiency of the banking sector and of the cost of credit. A wide spread can discourage investment and consumption by raising the cost of borrowing, and it can reduce the return to saving by lowering the deposit rate.

== Term Spread ==
The term spread is the difference between the interest rate on a long-term bond and the rate on a short-term instrument. It is a key indicator of the stance of monetary policy and of the expectations of the market.

The term spread reflects the expectations of future short-term rates and the term premium, which is the compensation that investors require for holding a longer-term instrument. A positive spread, in which long-term rates exceed short-term rates, is the normal condition. An inverted spread, in which short-term rates exceed long-term rates, has historically been a predictor of recessions.

The term spread is used to infer the expectations of the market about the future path of interest rates and about the economy. An inversion of the yield curve is interpreted as a signal that the market expects rates to fall, which typically occurs during a slowdown.

== Credit Spread ==
The credit spread is the difference between the yield on a bond with credit risk and the yield on a risk-free bond of comparable maturity. It compensates investors for the risk of default and for the liquidity of the instrument.

The credit spread is a key indicator of financial conditions. A widening of spreads signals increased concern about credit risk and a tightening of financial conditions, while a narrowing signals the opposite. The spread is used to assess the risk of individual borrowers and the state of the financial system.

The credit spread is also used in the pricing of loans and of other instruments. It reflects the creditworthiness of the borrower, the seniority of the claim, and the conditions in the market.

== Significance ==
Interest rate spreads are central to the analysis of monetary policy, of financial stability, and of the cost of credit. They affect the transmission of monetary policy, since the effect of a change in the policy rate on the rates faced by households and firms depends on the spreads.

The spreads are also used in the assessment of financial conditions and in the design of policy. A widening of spreads can signal the build-up of stress in the financial system, and it can prompt a policy response.

== Determinants of the Banking Spread ==
The banking spread is determined by several factors. The cost of operations, including the expense of running the branch network and of processing transactions, is a component. The cost of credit risk, which reflects the expected losses on loans, is another.

The structure of the banking sector affects the spread. A concentrated sector, in which a few banks dominate, tends to have a wider spread, since the banks have more market power. A competitive sector tends to have a narrower spread.

The regulatory framework also affects the spread. Reserve requirements, capital requirements, and other prudential rules increase the cost of intermediation and widen the spread. The taxation of financial services has a similar effect.

== Spreads and Financial Stability ==
The spread is an indicator of the health of the banking sector and of financial conditions. A widening of the spread can signal an increase in perceived risk or a tightening of financial conditions, and it can be a precursor of a slowdown in credit and in activity.

The spread also affects the transmission of monetary policy. A change in the policy rate is transmitted to the lending and deposit rates through the spread, and the speed and the completeness of the transmission depend on the structure of the banking sector.

The analysis of the spread is therefore central to the assessment of financial stability and to the design of policy. A widening of the spread may prompt a policy response, including the provision of liquidity to the banking sector.

== Cross-Country Variation ==
The banking spread varies substantially across countries. The variation reflects differences in the structure of the banking sector, in the regulatory framework, and in the macroeconomic environment.

The spread tends to be wider in developing countries, where the banking sector is less developed, the credit risk is higher, and the macroeconomic environment is more volatile. The spread tends to be narrower in developed countries, where the sector is more competitive and the environment is more stable.

The variation matters for the analysis of the cost of credit and of the effects of policy. A wide spread raises the cost of borrowing and reduces the return to saving, and it can discourage investment and growth.

== Summary ==
Interest rate spreads are central to the analysis of banking, of monetary policy, and of financial stability. The banking spread, the term spread, and the credit spread each provide information about different aspects of the economy, and their analysis informs the design of policy.

== See also ==
* Banking
* Monetary Economics
* Liquidity Risk

== References ==

<ref name="r1">Research on interest rate spreads and on bank behaviour.</ref>
<ref name="r2">Studies of the term structure and of the yield curve.</ref>
<ref name="r3">Analyses of credit spreads and of financial conditions.</ref>

<references />

[[Category:Banking]]
[[Category:Monetary economics]]
[[Category:Financial economics]]

Infrastructure

2026-10-06T06:22:19Z

Youku: New encyclopedia entry (batch upload)

'''Infrastructure''' is the set of physical and organisational structures that support the functioning of an economy, including transport, energy, water, telecommunications, and public buildings. Infrastructure provides the services on which production and consumption depend, and it is a major component of public investment.

== Types ==
Infrastructure may be classified as economic or social. Economic infrastructure supports production, including transport networks, power generation and distribution, water supply, and telecommunications. Social infrastructure supports human development, including schools, hospitals, and housing.

Infrastructure may also be classified by the network characteristics. Network infrastructure, including roads, railways, and electricity grids, exhibits the characteristics of natural monopoly, with high fixed costs and economies of scale. Non-network infrastructure, including schools and hospitals, does not have these characteristics to the same degree.

== Economic Role ==
Infrastructure contributes to production by providing services that raise the productivity of other inputs. A reliable power supply, an efficient transport network, and modern telecommunications reduce the cost of production and expand the market that firms can serve.

Infrastructure is also a component of aggregate demand, and public investment in infrastructure is used as a tool of stabilisation policy. The effect of infrastructure investment on demand depends on the speed of implementation and on the response of the economy.

Infrastructure has long-lived effects on the productive capacity of the economy. The capital stock of infrastructure depreciates slowly, and its benefits accrue over many years. The assessment of infrastructure investment must therefore take a long horizon.

== Financing and Provision ==
The financing and provision of infrastructure involve a combination of public and private actors. Public provision is common for network infrastructure, where the characteristics of natural monopoly and the presence of externalities justify public involvement.

Private provision, through concessions and public-private partnerships, has been used to bring private capital and expertise to infrastructure. These arrangements allocate the risks and the returns between the public and the private sectors, and their design affects the efficiency and the cost of provision.

The financing of infrastructure may be through taxation, through user charges, or through borrowing. The choice affects the distribution of the costs and the efficiency of the provision. User charges can align the cost with the benefit and can provide a signal for investment, while taxation spreads the cost more widely.

== Policy ==
Policy questions concern the level and the composition of infrastructure investment, the choice between public and private provision, and the pricing of infrastructure services. The assessment of the appropriate level requires estimates of the returns to infrastructure and of the costs of financing.

The composition of investment matters, since different types of infrastructure have different returns and serve different objectives. The assessment of priorities requires analysis of the benefits and costs of each project, and it is informed by cost-benefit analysis.

The governance of infrastructure investment is also important, since it affects the efficiency of the provision and the quality of the assets. The use of transparent processes, of independent appraisal, and of appropriate maintenance regimes contributes to the effectiveness of investment.

== Infrastructure and Productivity ==
The relationship between infrastructure and productivity is a central question in the analysis of public investment. Infrastructure provides services that raise the productivity of labour and of capital, and the level of the infrastructure stock affects the productivity of the economy.

The empirical evidence on the relationship is mixed. Some studies find that infrastructure investment raises productivity substantially, while others find smaller effects. The differences reflect the measurement of infrastructure, the specification of the models, and the difficulty of identifying the effect.

The effects depend on the type of infrastructure and on the context. Investment in transport and in telecommunications tends to have larger effects in developing countries, where the infrastructure gap is larger, while in developed countries the effects of additional investment may be smaller.

== Public-Private Partnerships ==
Public-private partnerships are arrangements in which the public and private sectors share the financing, the construction, and the operation of infrastructure. The arrangements allocate the risks and the returns between the two sectors.

The rationale for the partnerships is to bring private capital and expertise to infrastructure and to improve the efficiency of the provision. The private partner has an incentive to manage the project efficiently, and the public sector can transfer some of the risks.

The experience with the partnerships has been mixed. Some projects have delivered benefits, while others have been criticised for their cost and for the allocation of risks. The assessment of the partnerships must consider the whole-life cost of the project and the value of the risks that are transferred.

== Maintenance and Depreciation ==
The maintenance of infrastructure is as important as its construction, and the neglect of maintenance reduces the services that the assets provide. The maintenance of roads, of water systems, and of other assets requires continuing expenditure, which is often deferred in favour of new investment.

The depreciation of infrastructure reduces its value and its services over time. The measurement of depreciation is required for the national accounts and for the assessment of the sustainability of the public finances.

The management of the infrastructure stock involves decisions about maintenance, about renewal, and about the replacement of assets. The design of the institutional framework affects the quality of these decisions and the efficiency of the provision.

== Summary ==
Infrastructure provides the services on which the economy depends, and its effects on productivity, its financing, and its maintenance are central to the analysis of public investment and of growth.

== See also ==
* Development Economics
* Public Economics
* Gross Capital Formation

== References ==

<ref name="r1">Research on infrastructure and on its economic effects.</ref>
<ref name="r2">Studies of the financing and the provision of infrastructure.</ref>
<ref name="r3">Analyses of the returns to public investment.</ref>

<references />

[[Category:Development economics]]
[[Category:Public economics]]
[[Category:Economic growth]]

Induced Investment

2026-10-06T06:22:18Z

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'''Induced investment''' is investment that is undertaken in response to changes in the level of output or of demand, as distinct from autonomous investment, which is undertaken independently of current conditions. The distinction is central to the analysis of the accelerator and of investment behaviour.

== Concept ==
Induced investment is investment that firms undertake to expand capacity in response to an increase in demand for their products. When demand rises, firms that are operating near capacity will invest to expand, so that investment is induced by the change in output.

Autonomous investment is investment that is undertaken regardless of current output, for example investment driven by innovation or by expectations of long-term growth. The distinction is analytical, since in practice investment is influenced by both current conditions and longer-term factors.

== The Accelerator ==
The accelerator model formalises the relationship between induced investment and output. The model holds that the desired capital stock is proportional to output, so that investment equals the change in the desired capital stock, which is proportional to the change in output.

The model implies that investment depends on the rate of change of output rather than its level. This explains why investment is more volatile than output, since a slowdown in growth, even if output continues to rise, reduces investment.

The simple accelerator has been refined to account for the cost of capital, for lags in the adjustment of the capital stock, and for the role of expectations. The refinements improve the empirical performance of the model, though the accelerator remains a central element of the analysis of investment.

== Investment and the Business Cycle ==
The accelerator mechanism contributes to the volatility of investment over the business cycle. During an expansion, rising output induces investment, which raises demand further, amplifying the expansion. During a contraction, falling output reduces investment, which reduces demand further, amplifying the contraction.

The mechanism is an example of the interaction between the multiplier and the accelerator. The multiplier determines the effect of investment on output, and the accelerator determines the effect of output on investment. Together they can generate cycles, as the interaction amplifies and propagates shocks.

The interaction is central to the analysis of business cycles and to the design of stabilisation policy. It explains why investment is a major source of fluctuations and why policies that stabilise demand can also stabilise investment.

== Determinants ==
The level of induced investment depends on the cost of capital, on the availability of finance, and on the expectations of firms. A rise in interest rates raises the cost of capital and reduces investment. A tightening of credit conditions reduces the availability of finance.

Expectations are central. Firms invest when they expect demand to grow, and they may delay investment when uncertainty is high. The effect of uncertainty on investment is a subject of research, and it is relevant to the analysis of the effects of policy.

The determinants of investment also include the tax treatment of investment, which affects the after-tax cost of capital, and the state of the capital stock, since firms with excess capacity have less need to invest.

== Investment and Uncertainty ==
The decision to invest is made under uncertainty about future demand, costs, and technology. The theory of investment under uncertainty, developed by Avinash Dixit and Robert Pindyck, emphasises the option value of waiting, since a firm that invests irreversibly gives up the option to delay.

The option value of waiting implies that firms require a higher expected return before investing, and that investment responds less to changes in the cost of capital than the simple models predict. The effect is larger when uncertainty is high and when the investment is irreversible.

The implications for policy are significant. A policy that reduces uncertainty, for example by providing a stable framework, can raise investment without changing the cost of capital. A policy that is uncertain or reversible may have less effect than expected.

== The Role of the Cost of Capital ==
The cost of capital is a central determinant of investment. It reflects the interest rate, the tax treatment of investment, and the required return on equity. A lower cost of capital raises the present value of the returns to investment and increases the incentive to invest.

The empirical evidence on the responsiveness of investment to the cost of capital is mixed. The estimates vary, and they are sensitive to the specification of the model and to the treatment of expectations.

The cost of capital is also affected by the availability of finance. Firms that are credit constrained may be unable to invest even when the expected return is high, since they cannot raise the funds. The effect of financial frictions on investment is a subject of research.

== Investment and Corporate Governance ==
The governance of the firm affects the investment decision. Managers may invest in projects that serve their own interests rather than those of the shareholders, for example by expanding the firm beyond its optimal size.

The mechanisms of corporate governance, including the board of directors, the market for corporate control, and the structure of compensation, affect the alignment of the interests of managers and of shareholders. The design of these mechanisms affects the efficiency of investment.

The governance also affects the ability of the firm to commit to long-term investment. Firms that are subject to short-term pressure may underinvest in projects with long payback periods, even when the returns are high.

== Summary ==
Induced investment responds to changes in output and to the cost of capital, and its analysis involves the accelerator, the role of uncertainty, and the governance of the firm. The determinants of investment are central to the analysis of the business cycle and of growth.

== See also ==
* Macroeconomics
* Gross Capital Formation
* Keynesian Economics

== References ==

<ref name="r1">Research on the accelerator and on investment behaviour.</ref>
<ref name="r2">Studies of the interaction between the multiplier and the accelerator.</ref>
<ref name="r3">Analyses of the determinants of investment.</ref>

<references />

[[Category:Macroeconomics]]
[[Category:Keynesian economics]]
[[Category:Economic growth]]

Income Elasticity of Demand

2026-10-06T06:22:17Z

Youku: New encyclopedia entry (batch upload)

'''Income elasticity of demand''' measures the responsiveness of the quantity demanded of a good to a change in income, holding other factors constant. It is defined as the percentage change in quantity demanded divided by the percentage change in income.

== Definition and Classification ==
The income elasticity of demand may be positive or negative. A positive elasticity means that the quantity demanded rises with income, as is the case for most goods.

Goods with a positive income elasticity are classified by the size of the elasticity. Goods with an elasticity between zero and one are necessities, since the quantity demanded rises less than proportionally with income. Goods with an elasticity greater than one are luxuries, since the quantity demanded rises more than proportionally.

Goods with a negative income elasticity are inferior goods, since the quantity demanded falls as income rises. Consumers switch away from these goods as their income increases, in favour of higher-quality substitutes.

== Engel's Law ==
Engel's law states that the share of income spent on food declines as income rises. The law implies that the income elasticity of demand for food is less than one, so that food is a necessity. The law is one of the most robust empirical regularities in economics.

The law has implications for the structure of the economy. As income rises, the share of expenditure on food declines, and the share on other goods and services rises. The composition of output and of employment shifts accordingly.

The law also has implications for development. As countries grow, the demand for agricultural products grows more slowly than income, so that the agricultural sector declines relative to the rest of the economy. The process of structural transformation is driven in part by these differences in income elasticities.

== Measurement ==
The measurement of income elasticity requires data on the quantities demanded and on incomes, and it must control for other determinants of demand, including prices. The estimation is complicated by the endogeneity of income and by the need to distinguish the effect of income from that of other factors.

The estimates vary across goods, across countries, and across income levels. The elasticity of demand for a good may differ between rich and poor households, which matters for the analysis of distributional effects.

The measurement is also affected by the level of aggregation. The elasticity for a broadly defined category may differ from the elasticity for a particular good within the category, since substitution occurs within as well as between categories.

== Applications ==
The income elasticity of demand is used in the analysis of the effects of growth on the composition of demand and of output. It is used in the analysis of the effects of redistribution, since a transfer of income from rich to poor changes the composition of demand according to the income elasticities of the goods consumed.

The elasticity is used in the analysis of tax policy, since the incidence of a tax depends in part on the income elasticity of demand. It is used in the analysis of trade, since the income elasticities of demand for imports and exports affect the trade balance as income grows.

The elasticity is also used in forecasting, since projections of demand require estimates of how demand responds to changes in income.

== Necessities and Luxuries ==
The classification of goods as necessities or luxuries has important implications for the analysis of the economy. Necessities have income elasticities between zero and one, so that their share of expenditure declines as income rises. Luxuries have elasticities greater than one, so that their share rises.

The classification is not fixed, since the income elasticity of a good may change as income rises. A good that is a luxury at low incomes may become a necessity at higher incomes, as it is adopted by the general population.

The classification affects the analysis of the effects of growth. As income rises, the composition of demand shifts towards luxuries and away from necessities, and the structure of production adjusts accordingly. The process of structural transformation is driven in part by these differences in income elasticities.

== The Role of Income Distribution ==
The income elasticity of demand is relevant to the analysis of income distribution. A redistribution of income from rich to poor changes the composition of demand, since the two groups consume different baskets of goods.

The effect of redistribution depends on the difference in the income elasticities of the goods consumed by the two groups. If the goods consumed by the poor are more income-elastic, redistribution raises the demand for them and reduces the demand for the goods consumed by the rich.

The analysis of redistribution must therefore consider the composition of demand as well as its level. The redistribution can affect the structure of production and of employment, and it can have effects on the prices of the goods consumed by different groups.

== Estimation and Data ==
The estimation of income elasticity requires data on household expenditure and on income, and it must control for the determinants of demand. The estimation is complicated by the endogeneity of income and by the need to distinguish the effect of income from that of other factors.

The data are typically drawn from household surveys, which provide information on the expenditure and the income of a sample of households. The surveys differ in their coverage and in their definitions, and the estimates must be adjusted for these differences.

The estimates vary across countries and over time, and they are subject to uncertainty. The use of the estimates in policy analysis requires attention to their precision and to the assumptions on which they rest.

== Summary ==
The income elasticity of demand measures the responsiveness of demand to income and underpins the classification of goods as necessities or luxuries. Its analysis informs the understanding of structural transformation, of the effects of redistribution, and of the taxes and of the trade policies.

== See also ==
* Elasticity
* Consumer Behaviour
* Market Basket

== References ==

<ref name="r1">Research on the measurement of income elasticity.</ref>
<ref name="r2">Studies of Engel's law and of the composition of demand.</ref>
<ref name="r3">Analyses of structural transformation and of the effects of growth.</ref>

<references />

[[Category:Elasticity]]
[[Category:Consumer behaviour]]
[[Category:Microeconomics]]

Import Quota

2026-10-06T06:22:17Z

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An '''import quota''' is a limit on the quantity of a good that may be imported during a period. Quotas are a form of non-tariff barrier to trade, and they restrict imports by quantity rather than by price.

== Mechanism ==
A quota sets a maximum quantity that may be imported. If the quota is binding, the quantity imported equals the quota, and the domestic price rises above the world price to the level at which the quantity demanded equals the quantity supplied domestically plus the quota.

The difference between the domestic price and the world price is the quota rent, which accrues to whoever holds the right to import. The allocation of the rights determines who captures the rent, and the method of allocation affects the efficiency and the distributional effects of the quota.

== Comparison with Tariffs ==
A tariff and a quota can have similar effects on the quantity imported and on the domestic price. The two instruments differ in their effects on the distribution of the rents and in their response to changes in market conditions.

Under a tariff, the government captures the revenue, and the quantity imported adjusts to changes in demand and supply. Under a quota, the rent goes to the holders of the quota rights, which may be foreign exporters or domestic importers, and the quantity imported is fixed regardless of changes in demand.

The quota provides more certainty about the quantity imported, which may be the objective if the concern is the volume of trade. The tariff provides more certainty about the price, and it generates revenue for the government.

== Administration ==
Quotas are administered through several mechanisms. The rights may be allocated to domestic importers, to foreign exporters, or through an auction. The choice affects the distribution of the rent and the efficiency of the allocation.

The allocation of the rights to foreign exporters, through voluntary export restraints, transfers the rent abroad. This has been used in trade negotiations, where the exporting country agrees to limit its exports in exchange for avoiding more restrictive measures.

The allocation of the rights through an auction captures the rent for the government and allocates the rights to those who value them most. The auction is therefore more efficient than the allocation of the rights to particular firms.

== Effects and Policy ==
The effects of a quota on welfare are similar to those of a tariff. The quota raises the domestic price, reduces imports, and creates a deadweight loss. It transfers income from domestic consumers to the holders of the quota rights and, where the rent is captured by foreign exporters, reduces national welfare further.

Quotas have been used to protect domestic industries, particularly agriculture and textiles. Their use has declined as a result of trade liberalisation, which has converted quotas into tariffs and has reduced the scope for their use.

The use of quotas raises questions about the objectives that they serve. Where the objective is to protect domestic producers, a tariff may be more transparent and more efficient. Where the objective is to limit the volume of trade, a quota may be more effective, though at a cost in terms of welfare.

== Quotas and Rent Seeking ==
The administration of quotas creates rents, and the pursuit of these rents can divert resources from productive uses. Firms may lobby for the allocation of quota rights, and the lobbying consumes resources without creating value.

The rent-seeking behaviour is a cost of the quota that is additional to the deadweight loss. The cost depends on the method of allocation and on the value of the rents. Where the rights are allocated administratively, the scope for rent seeking is greater.

The auctioning of quota rights can reduce rent seeking, since the rights are allocated to those who value them most and the rent accrues to the government. The auction is therefore more efficient than administrative allocation, though it requires a market for the rights.

== Tariffication ==
The reform of trade policy has involved the conversion of quotas into tariffs, a process known as tariffication. The objective is to make the protection more transparent and to reduce the distortions that quotas create.

Tariffication involves the estimation of the tariff equivalent of the quota, which is the tariff that would produce the same level of imports and the same domestic price. The estimation is difficult, since it requires information about the demand and supply conditions in the market.

The conversion of quotas into tariffs has been accompanied by the reduction of the tariffs over time, as part of trade liberalisation. The process has reduced the distortions created by quotas, though the resulting tariffs are still a source of protection.

== Quantitative Restrictions and Safeguards ==
Quotas are used as safeguards, which are temporary restrictions imposed in response to a surge in imports that causes or threatens to cause serious injury to domestic industry. The safeguards are permitted under international trade rules, subject to conditions.

The use of safeguards is subject to disciplines, including the requirement that the measures be temporary and that they be applied on a non-discriminatory basis. The measures must be notified and are subject to review.

The use of quantitative restrictions has declined as a result of trade liberalisation, but they remain in use for particular products, including agricultural goods and textiles. The rules that govern their use are part of the framework of international trade.

== Summary ==
Import quotas restrict trade by quantity, and their effects depend on the method of allocation of the quota rights. The administration of quotas, the process of tariffication, and the use of quantitative restrictions as safeguards are all central to the analysis of trade policy.

== See also ==
* Trade Policy
* International Trade
* Export Tax

== References ==

<ref name="r1">Research on non-tariff barriers and on the effects of quotas.</ref>
<ref name="r2">Studies of the administration of quotas and of voluntary export restraints.</ref>
<ref name="r3">Analyses of trade liberalisation and of the conversion of quotas to tariffs.</ref>

<references />

[[Category:Trade policy]]
[[Category:International trade]]
[[Category:Market structure]]

Human Capital Theory

2026-10-06T06:22:16Z

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'''Human capital theory''' analyses the skills, knowledge, and experience of individuals as a form of capital that yields a return, in the form of higher earnings and productivity. The theory treats education and training as investments that individuals and societies make to increase their productive capacity.

== Concept ==
Human capital comprises the skills and knowledge that people acquire through education, training, and experience. Like physical capital, it is an asset that yields a flow of benefits over time, and it can be accumulated through investment.

The theory holds that individuals invest in human capital by foregoing current earnings and incurring the costs of education and training, in expectation of higher future earnings. The decision to invest depends on the costs, on the expected returns, and on the individual's rate of time preference.

== Returns to Education ==
The returns to education are measured by comparing the earnings of individuals with different levels of education. The estimates suggest that education raises earnings substantially, and that the return to an additional year of schooling is positive.

The measurement of the returns faces challenges. The correlation between education and earnings may reflect the effect of unobserved characteristics, such as ability and motivation, rather than the effect of education itself. The estimates must therefore address the problem of selection.

The returns to education vary across countries, across levels of education, and across fields of study. The variation reflects differences in the demand for skills, in the supply of educated workers, and in the quality of education.

== Human Capital and Growth ==
Human capital is a central element of the analysis of economic growth. In growth models, human capital is an input into production, alongside physical capital and labour, and its accumulation contributes to the growth of output.

The accumulation of human capital can also generate externalities, since an educated workforce benefits not only the individuals but also the firms and the society in which they work. The presence of externalities implies that private investment in education may be below the socially optimal level, providing a rationale for public support.

The relationship between human capital and growth has been documented empirically, though the estimates vary. The evidence suggests that human capital is an important determinant of growth, and that the quality of education matters as much as the quantity.

== Policy ==
The theory informs the design of education and training policy. It supports public investment in education, particularly at the levels where the returns are high and where access is limited by credit constraints.

The theory also informs the design of policies for lifelong learning, since the skills acquired in initial education may become obsolete as technology changes. Investment in training and in retraining is therefore required to maintain the productive capacity of the workforce.

The theory has implications for the analysis of inequality. Differences in access to education contribute to differences in earnings, and policies that reduce these differences can reduce inequality and raise growth simultaneously.

== Education and Earnings ==
The relationship between education and earnings is one of the most studied relationships in economics. The evidence shows that individuals with more education earn substantially more, and that the return to education is positive and, in many countries, has remained high despite the growth in the supply of educated workers.

The interpretation of the relationship has been debated. Human capital theory holds that education raises productivity and therefore earnings. The signalling theory holds that education conveys information about the ability of individuals, so that the relationship reflects the selection of more able people into education rather than the effect of education itself.

The evidence suggests that both mechanisms are at work, and that the effect of education on earnings is partly a return to the skills acquired and partly a return to the signal conveyed. The relative importance of the two is a subject of research.

== Training and Skills ==
Investment in human capital occurs not only through formal education but also through training and experience. Firms provide training, either general, which is useful in many firms, or specific, which is useful only in the firm that provides it.

The analysis of training emphasises the incentives of firms and of workers. Firms are more willing to pay for specific training, since they can capture the return, while general training is more likely to be paid for by workers, since they can use it elsewhere. The design of institutions affects the provision of training and the accumulation of skills.

Experience also contributes to human capital, through learning by doing and through the acquisition of firm-specific knowledge. The return to experience is reflected in the age-earnings profile, which rises with age and then flattens.

== Human Capital and Technology ==
The relationship between human capital and technology is central to the analysis of growth. New technology requires skilled workers to develop and to operate it, and the accumulation of human capital facilitates the adoption of technology.

The complementarity between human capital and technology implies that the return to education rises with technological change, since skilled workers are better able to work with new technology. This is one explanation for the increase in the return to education observed in many countries.

The relationship also implies that the effects of technology on the labour market depend on the distribution of skills. Technology may raise the demand for skilled workers and reduce the demand for unskilled workers, contributing to the increase in inequality.

== Summary ==
Human capital theory analyses education and training as investments that yield returns in the form of higher earnings and productivity. Its implications for the analysis of growth, of inequality, and of policy are central to the understanding of the modern economy.

== See also ==
* Labour Economics
* Economic Growth
* Development Economics

== References ==

<ref name="r1">Research on human capital and on the returns to education.</ref>
<ref name="r2">Studies of the relationship between human capital and growth.</ref>
<ref name="r3">Analyses of education policy and of lifelong learning.</ref>

<references />

[[Category:Labour economics]]
[[Category:Economic growth]]
[[Category:Development economics]]

Heterogeneous Goods

2026-10-06T06:22:15Z

Youku: New encyclopedia entry (batch upload)

'''Heterogeneous goods''' are goods that differ from one another in their characteristics, so that they are not perfect substitutes. Heterogeneous goods are distinguished from homogeneous goods, which are identical and therefore perfect substitutes.

== Concept ==
The concept of heterogeneity is central to the analysis of product differentiation and of market structure. When goods are heterogeneous, consumers have preferences over the characteristics of the goods, and firms can differentiate their products to appeal to different segments of the market.

Heterogeneity can arise from differences in physical characteristics, in quality, in location, and in the services that accompany the good. The differences give firms a degree of market power, since consumers do not regard the goods of different firms as perfect substitutes.

== Product Differentiation ==
Product differentiation is the strategy of making a product distinct from those of competitors. The differentiation may be horizontal, in which the goods differ in their characteristics but are of similar quality, or vertical, in which the goods differ in quality.

Horizontal differentiation is analysed using models in which consumers have different ideal points along a spectrum of characteristics. The location model, in which firms choose positions on a line, is the classic example. Vertical differentiation is analysed using models in which all consumers prefer higher quality but differ in their willingness to pay.

The differentiation affects the intensity of competition. When goods are more differentiated, competition is less intense, since consumers are less willing to switch. The degree of differentiation therefore affects the markup that firms can charge.

== Trade in Heterogeneous Goods ==
International trade in heterogeneous goods is analysed using models of monopolistic competition, in which firms produce differentiated products and compete in a market with many firms. The models predict that trade will occur between countries with similar endowments, since consumers value variety.

The models have implications for the gains from trade. Trade in heterogeneous goods raises welfare by increasing the variety available to consumers and by allowing firms to exploit economies of scale. The gains are additional to those from comparative advantage.

The models also have implications for the effects of trade on firms. Trade exposes firms to more competition, which forces the least productive firms to exit and allows the most productive to expand. The reallocation of resources raises average productivity.

== Measurement and Data ==
The measurement of heterogeneity is difficult, since it requires information about the characteristics of goods and about the preferences of consumers. The data are often limited, and the analysis relies on proxies for differentiation.

Trade data are typically recorded at a level of aggregation that groups heterogeneous goods together. The analysis of trade in differentiated products therefore requires disaggregated data, which are available for some countries and some products.

The measurement of quality is particularly difficult, since quality is not directly observable. The hedonic method is used to estimate the value of the characteristics of goods and to construct quality-adjusted measures.

== Monopolistic Competition ==
The theory of monopolistic competition, developed by Edward Chamberlin and Joan Robinson, analyses markets in which many firms produce differentiated products. Each firm faces a downward-sloping demand curve, since consumers regard its product as distinct from those of its rivals.

In the long run, free entry drives profits to zero, since new firms enter until the demand curve of each firm is tangent to its average cost curve. The equilibrium is characterised by excess capacity, since each firm produces less than the output that would minimise its average cost.

The theory explains the coexistence of many firms with market power and with zero profits. It has been used to analyse markets including retailing, restaurants, and professional services, and it provides the basis for the analysis of trade in differentiated goods.

== Trade Models ==
The new trade theory, developed by Paul Krugman and others, applies the framework of monopolistic competition to international trade. The models show that trade can occur between countries with similar endowments, driven by the desire of consumers for variety and by the economies of scale that firms can exploit in larger markets.

The models predict that trade raises welfare by increasing the variety available to consumers and by allowing firms to produce at lower cost. The gains are additional to those from comparative advantage, and they explain the large volume of trade between similar countries.

The models also predict that trade raises the average productivity of the industry, by forcing the least productive firms to exit and by allowing the most productive to expand. The reallocation of resources raises productivity, a result that has been documented empirically.

== Measurement and Empirics ==
The empirical analysis of trade in heterogeneous goods requires disaggregated data, since the goods must be distinguished by their characteristics. The data are available for some countries and some products, and they have been used to document the patterns predicted by the models.

The research has found that trade in differentiated goods is large and growing, and that it occurs predominantly between countries at similar levels of development. The research has also found that the variety of goods traded has increased, and that the gains from variety are substantial.

The measurement of quality remains difficult, and the research relies on proxies, including the unit values of trade, which reflect both quality and cost. The interpretation of these measures requires care, since the unit value reflects the composition of the goods as well as their quality.

== Summary ==
Heterogeneous goods are the subject of the theory of monopolistic competition and of the new trade theory, which explain the coexistence of market power and of zero profits and the gains from trade in differentiated products. The analysis of these goods requires disaggregated data and careful measurement of quality.

== See also ==
* Microeconomics
* Market Structure
* International Trade

== References ==

<ref name="r1">Research on product differentiation and on monopolistic competition.</ref>
<ref name="r2">Studies of trade in differentiated goods.</ref>
<ref name="r3">Analyses of the measurement of quality and of heterogeneity.</ref>

<references />

[[Category:Microeconomics]]
[[Category:Market structure]]
[[Category:International trade]]