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General Classification of Economics

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   Economics                       1
   Economics education            30
   History of economic thought    31
   Economic methodology           69
   Heterodox economics            76
   Mathematical economics         82
   Microeconomics                103
   Macroeconomics                110
   Monetary economics            118
   International economics       131
   Financial economics           142
   Public economics              145
   Health economics              152
   Education economics           159
   Welfare                       162
   Labour economics              170
   Demographic economics         180
   Law and economics             185
   Industrial organization       191
   Business administration       201
   Business economics            202
   Marketing                     204
   Accountancy                   213
   Economic history              221
   Economic development          226
   Technological change          231
   Economic growth               234
   Economic system               249
   Agricultural economics        255
   Natural resource economics    260
   Environmental economics       267
   Ecological economics          273
   Urban economics               284
   Rural economics               286
   Regional science                           288
   Family economics                           293
   Consumer choice                            300

   Article Sources and Contributors           307
   Image Sources, Licenses and Contributors   313

Article Licenses
   License                                    316
Economics                                                                                                                          1

            For a topical guide to this subject, see Outline of economics.
    Economics is the social science that analyzes the production, distribution, and consumption of goods and services.
    The term economics comes from the Ancient Greek οἰκονομία (oikonomia, "management of a household,
    administration") from οἶκος (oikos, "house") + νόμος (nomos, "custom" or "law"), hence "rules of the
    house(hold)".[1] Political economy was the earlier name for the subject, but economists in the late 19th century
    suggested "economics" as a shorter term for "economic science" that also avoided a narrow political-interest
    connotation and as similar in form to "mathematics", "ethics", and so forth.[2]
    A focus of the subject is how economic agents behave or interact and how economies work. Consistent with this, a
    primary textbook distinction is between microeconomics and macroeconomics. Microeconomics examines the
    behavior of basic elements in the economy, including individual agents (such as households and firms or as buyers
    and sellers) and markets, and their interactions. Macroeconomics analyzes the entire economy and issues affecting it,
    including unemployment, inflation, economic growth, and monetary and fiscal policy.
    Other broad distinctions include those between positive economics (describing "what is") and normative economics
    (advocating "what ought to be"); between economic theory and applied economics; between rational and behavioral
    economics; and between mainstream economics (more "orthodox" and dealing with the
    "rationality-individualism-equilibrium nexus") and heterodox economics (more "radical" and dealing with the
    "institutions-history-social structure nexus").[3][4]
    Economic analysis may be applied throughout society, as in business, finance, health care, and government, but also
    to such diverse subjects as crime,[5] education,[6] the family, law, politics, religion,[7] social institutions, war,[8] and
    science.[9] At the turn of the 21st century, the expanding domain of economics in the social sciences has been
    described as economic imperialism.[10] An increasing number of economists have called for increased emphasis on
    environmental sustainability; this area of research is known as Ecological economics.[11]

    There are a variety of modern definitions of economics. Some of the differences may reflect evolving views of the
    subject or different views among economists.[12] The philosopher Adam Smith (1776) defined what was then called
    political economy as "an inquiry into the nature and causes of the wealth of nations", in particular as:
            a branch of the science of a statesman or legislator [with the twofold objectives of providing] a plentiful
            revenue or subsistence for the people ... [and] to supply the state or commonwealth with a revenue for the
            publick services.[13]
    J.-B. Say (1803), distinguishing the subject from its public-policy uses, defines it as the science of production,
    distribution, and consumption of wealth.[14] On the satirical side, Thomas Carlyle (1849) coined "the dismal science"
    as an epithet for classical economics, in this context, commonly linked to the pessimistic analysis of Malthus
    (1798).[15] John Stuart Mill (1844) defines the subject in a social context as:
            The science which traces the laws of such of the phenomena of society as arise from the combined operations
            of mankind for the production of wealth, in so far as those phenomena are not modified by the pursuit of any
            other object.[16]
    Alfred Marshall provides a still widely cited definition in his textbook Principles of Economics (1890) that extends
    analysis beyond wealth and from the societal to the microeconomic level:
            Economics is a study of man in the ordinary business of life. It enquires how he gets his income and how he
            uses it. Thus, it is on the one side, the study of wealth and on the other and more important side, a part of the
            study of man.[17]
Economics                                                                                                                      2

    Lionel Robbins (1932) developed implications of what has been termed "[p]erhaps the most commonly accepted
    current definition of the subject":[18]
            Economics is a science which studies human behaviour as a relationship between ends and scarce means
            which have alternative uses.[19]
    Robbins describes the definition as not classificatory in "pick[ing] out certain kinds of behaviour" but rather
    analytical in "focus[ing] attention on a particular aspect of behaviour, the form imposed by the influence of
    Some subsequent comments criticized the definition as overly broad in failing to limit its subject matter to analysis
    of markets. From the 1960s, however, such comments abated as the economic theory of maximizing behavior and
    rational-choice modeling expanded the domain of the subject to areas previously treated in other fields.[21] There are
    other criticisms as well, such as in scarcity not accounting for the macroeconomics of high unemployment.[22]
    Gary Becker, a contributor to the expansion of economics into new areas, describes the approach he favors as
    "combin[ing the] assumptions of maximizing behavior, stable preferences, and market equilibrium, used relentlessly
    and unflinchingly."[23] One commentary characterizes the remark as making economics an approach rather than a
    subject matter but with great specificity as to the "choice process and the type of social interaction that [such]
    analysis involves." The same source reviews a range of definitions included in principles of economics textbooks and
    concludes that the lack of agreement need not affect the subject-matter that the texts treat. Among economists more
    generally, it argues that a particular definition presented may reflect the direction toward which the author believes
    economics is evolving, or should evolve.[24]


    Economic development
    Economic development refers to not only increase in the output and growth of an economy but includes the various
    changes in the institutional arrangements through which output is generated. Economic Development refers to the
    achievement of a new equilibrium over the previously attained equilibrium. It is a micro economic concept with
    direct relation to Economic Growth as Growth can be achieved with or without development but Economic
    Development always results in growth.

    Microeconomics is the study of economics analysing individual
    players of a market and the structure of such markets. It deals with, as
    its irreducible base unit, private, public and domestic players.
    Microeconomics studies how these players interact with each other
    through individual markets (assuming that there is a scarcity of
    tradable units and government regulation. A market might deal with a
    product (such as apples, aluminium and mobile phones), or with
    services of a factor of production, (brick laying, book printing, food
    packaging). Microeconomics theory considers the aggregates (the sum
                                                                                 Economists study trade, production and
    of) of quantity demanded by buyers and quantity supplied by sellers,     consumption decisions, such as those that occur
    studying each possible price per unit (i.e. supply and demand). It                in a traditional marketplace.
    studies the complex interaction between market players both through
    buying and selling. Theory holds that markets may reach equilibrium between "quantity demanded" and "quantity
    supplied" (supply and demand) over time.
Economics                                                                                                                          3

    Microeconomics also examines various market structures. Perfect
    competition describes a market structure such that no participants are
    large enough to have the market power to set the price of a
    homogeneous product. Another way of putting this is to say a perfectly
    competitive market exists when every participant is a "price taker", and
    no participant influences the price of the product it buys or sells.
    Imperfect competition refers to market structures where the conditions       In Virtual Markets, buyer and seller are not
    of perfect competition do not exist. Forms of imperfect competition       present and trade via intermediates and electronic
    include: monopoly (in which there is only one seller of a good),               information. Pictured: São Paulo Stock
    duopoly (in which there are only two sellers of a good), oligopoly (in
    which there are few sellers of a good), monopolistic competition (in
    which there are many sellers producing highly differentiated goods), monopsony (in which there is only one buyer of
    a good), and oligopsony (in which there are few buyers of a good). Unlike perfect competition, imperfect
    competition invariably means market power is unequally distributed. Firms under imperfect competition have the
    potential to be "price makers", which means that, by holding a disproportionately high share of market power, they
    can influence the prices of their products.

    Microeconomics studies individual markets by simplifying the economic system by assuming that activity in the
    market being analysed does not affect other markets. This method of analysis is known as partial-equilibrium
    analysis (supply and demand). This method aggregates (the sum of all activity) in only one market.
    General-equilibrium theory studies various markets and their behaviour. It aggregates (the sum of all activity) across
    all markets. This method studies both changes in markets and their interactions leading towards equilibrium.[25]

    Production, cost, and efficiency
    In microeconomics, production is the conversion of inputs into outputs. It is an economic process that uses inputs to
    create a commodity for exchange or direct use. Production is a flow and thus a rate of output per period of time.
    Distinctions include such production alternatives as for consumption (food, haircuts, etc.) vs. investment goods (new
    tractors, buildings, roads, etc.), public goods (national defense, small-pox vaccinations, etc.) or private goods (new
    computers, bananas, etc.), and "guns" vs. "butter".
    Opportunity cost refers to the economic cost of production: the value of the next best opportunity foregone. Choices
    must be made between desirable yet mutually exclusive actions. It has been described as expressing "the basic
    relationship between scarcity and choice.".[26] The opportunity cost of an activity is an element in ensuring that
    scarce resources are used efficiently, such that the cost is weighed against the value of that activity in deciding on
    more or less of it. Opportunity costs are not restricted to monetary or financial costs but could be measured by the
    real cost of output forgone, leisure, or anything else that provides the alternative benefit (utility).[27]
    Inputs used in the production process include such primary factors of production as labour services, capital (durable
    produced goods used in production, such as an existing factory), and land (including natural resources). Other inputs
    may include intermediate goods used in production of final goods, such as the steel in a new car.
    Economic efficiency describes how well a system generates desired output with a given set of inputs and available
    technology. Efficiency is improved if more output is generated without changing inputs, or in other words, the
    amount of "waste" is reduced. A widely accepted general standard is Pareto efficiency, which is reached when no
    further change can make someone better off without making someone else worse off.
Economics                                                                                                                       4

                                                   The production-possibility frontier (PPF) is an expository figure for
                                                   representing scarcity, cost, and efficiency. In the simplest case an
                                                   economy can produce just two goods (say "guns" and "butter"). The
                                                   PPF is a table or graph (as at the right) showing the different quantity
                                                   combinations of the two goods producible with a given technology and
                                                   total factor inputs, which limit feasible total output. Each point on the
                                                   curve shows potential total output for the economy, which is the
                                                   maximum feasible output of one good, given a feasible output quantity
                                                   of the other good.

                                                     Scarcity is represented in the figure by people being willing but unable
                                                     in the aggregate to consume beyond the PPF (such as at X) and by the
      An example PPF with illustrative points marked negative slope of the curve.[28] If production of one good increases
                                                     along the curve, production of the other good decreases, an inverse
    relationship. This is because increasing output of one good requires transferring inputs to it from production of the
    other good, decreasing the latter. The slope of the curve at a point on it gives the trade-off between the two goods. It
    measures what an additional unit of one good costs in units forgone of the other good, an example of a real
    opportunity cost. Thus, if one more Gun costs 100 units of butter, the opportunity cost of one Gun is 100 Butter.
    Along the PPF, scarcity implies that choosing more of one good in the aggregate entails doing with less of the other
    good. Still, in a market economy, movement along the curve may indicate that the choice of the increased output is
    anticipated to be worth the cost to the agents.

    By construction, each point on the curve shows productive efficiency in maximizing output for given total inputs. A
    point inside the curve (as at A), is feasible but represents production inefficiency (wasteful use of inputs), in that
    output of one or both goods could increase by moving in a northeast direction to a point on the curve. Examples
    cited of such inefficiency include high unemployment during a business-cycle recession or economic organization of
    a country that discourages full use of resources. Being on the curve might still not fully satisfy allocative efficiency
    (also called Pareto efficiency) if it does not produce a mix of goods that consumers prefer over other points.
    Much applied economics in public policy is concerned with determining how the efficiency of an economy can be
    improved. Recognizing the reality of scarcity and then figuring out how to organize society for the most efficient use
    of resources has been described as the "essence of economics", where the subject "makes its unique contribution."[29]

    Specialization is considered key to economic efficiency based on theoretical and empirical considerations. Different
    individuals or nations may have different real opportunity costs of production, say from differences in stocks of
    human capital per worker or capital/labour ratios. According to theory, this may give a comparative advantage in
    production of goods that make more intensive use of the relatively more abundant, thus relatively cheaper, input.
    Even if one region has an absolute advantage as to the ratio of its outputs to inputs in every type of output, it may
    still specialize in the output in which it has a comparative advantage and thereby gain from trading with a region that
    lacks any absolute advantage but has a comparative advantage in producing something else.
    It has been observed that a high volume of trade occurs among regions even with access to a similar technology and
    mix of factor inputs, including high-income countries. This has led to investigation of economies of scale and
    agglomeration to explain specialization in similar but differentiated product lines, to the overall benefit of respective
    trading parties or regions.[30]
    The general theory of specialization applies to trade among individuals, farms, manufacturers, service providers, and
    economies. Among each of these production systems, there may be a corresponding division of labour with different
    work groups specializing, or correspondingly different types of capital equipment and differentiated land uses.[31]
Economics                                                                                                                               5

    An example that combines features above is a country that specializes in the production of high-tech knowledge
    products, as developed countries do, and trades with developing nations for goods produced in factories where
    labour is relatively cheap and plentiful, resulting in different in opportunity costs of production. More total output
    and utility thereby results from specializing in production and trading than if each country produced its own
    high-tech and low-tech products.
    Theory and observation set out the conditions such that market prices of outputs and productive inputs select an
    allocation of factor inputs by comparative advantage, so that (relatively) low-cost inputs go to producing low-cost
    outputs. In the process, aggregate output may increase as a by-product or by design.[32] Such specialization of
    production creates opportunities for gains from trade whereby resource owners benefit from trade in the sale of one
    type of output for other, more highly valued goods. A measure of gains from trade is the increased income levels that
    trade may facilitate.[33]

    Supply and demand
    Prices and quantities have been described as the most directly
    observable attributes of goods produced and exchanged in a market
    economy.[34] The theory of supply and demand is an organizing
    principle for explaining how prices coordinate the amounts produced
    and consumed. In microeconomics, it applies to price and output
    determination for a market with perfect competition, which includes
    the condition of no buyers or sellers large enough to have price-setting

    For a given market of a commodity, demand is the relation of the
    quantity that all buyers would be prepared to purchase at each unit
    price of the good. Demand is often represented by a table or a graph
    showing price and quantity demanded (as in the figure). Demand                 The supply and demand model describes how
                                                                                     prices vary as a result of a balance between
    theory describes individual consumers as rationally choosing the most
                                                                                     product availability and demand. The graph
    preferred quantity of each good, given income, prices, tastes, etc. A        depicts an increase (that is, right-shift) in demand
    term for this is "constrained utility maximization" (with income and         from D1 to D2 along with the consequent increase
    wealth as the constraints on demand). Here, utility refers to the               in price and quantity required to reach a new
                                                                                      equilibrium point on the supply curve (S).
    hypothesized relation of each individual consumer for ranking different
    commodity bundles as more or less preferred.

    The law of demand states that, in general, price and quantity demanded in a given market are inversely related. That
    is, the higher the price of a product, the less of it people would be prepared to buy of it (other things unchanged). As
    the price of a commodity falls, consumers move toward it from relatively more expensive goods (the substitution
    effect). In addition, purchasing power from the price decline increases ability to buy (the income effect). Other
    factors can change demand; for example an increase in income will shift the demand curve for a normal good
    outward relative to the origin, as in the figure. All determinants are predominantly taken as constant factors of
    demand and supply.

    Supply is the relation between the price of a good and the quantity available for sale at that price. It may be
    represented as a table or graph relating price and quantity supplied. Producers, for example business firms, are
    hypothesized to be profit-maximizers, meaning that they attempt to produce and supply the amount of goods that will
    bring them the highest profit. Supply is typically represented as a directly proportional relation between price and
    quantity supplied (other things unchanged). That is, the higher the price at which the good can be sold, the more of it
    producers will supply, as in the figure. The higher price makes it profitable to increase production. Just as on the
    demand side, the position of the supply can shift, say from a change in the price of a productive input or a technical
Economics                                                                                                                     6

    improvement. The "Law of Supply" states that, in general, a rise in price leads to an expansion in supply and a fall in
    price leads to a contraction in supply. Here as well, the determinants of supply, such as price of substitutes, cost of
    production, technology applied and various factors inputs of production are all taken to be constant for a specific
    time period of evaluation of supply.
    Market equilibrium occurs where quantity supplied equals quantity demanded, the intersection of the supply and
    demand curves in the figure above. At a price below equilibrium, there is a shortage of quantity supplied compared
    to quantity demanded. This is posited to bid the price up. At a price above equilibrium, there is a surplus of quantity
    supplied compared to quantity demanded. This pushes the price down. The model of supply and demand predicts
    that for given supply and demand curves, price and quantity will stabilize at the price that makes quantity supplied
    equal to quantity demanded. Similarly, demand-and-supply theory predicts a new price-quantity combination from a
    shift in demand (as to the figure), or in supply.
    For a given quantity of a consumer good, the point on the demand curve indicates the value, or marginal utility, to
    consumers for that unit. It measures what the consumer would be prepared to pay for that unit.[35] The corresponding
    point on the supply curve measures marginal cost, the increase in total cost to the supplier for the corresponding unit
    of the good. The price in equilibrium is determined by supply and demand. In a perfectly competitive market, supply
    and demand equate marginal cost and marginal utility at equilibrium.[36]
    On the supply side of the market, some factors of production are described as (relatively) variable in the short run,
    which affects the cost of changing output levels. Their usage rates can be changed easily, such as electrical power,
    raw-material inputs, and over-time and temp work. Other inputs are relatively fixed, such as plant and equipment and
    key personnel. In the long run, all inputs may be adjusted by management. These distinctions translate to differences
    in the elasticity (responsiveness) of the supply curve in the short and long runs and corresponding differences in the
    price-quantity change from a shift on the supply or demand side of the market.
    Marginalist theory, such as above, describes the consumers as attempting to reach most-preferred positions, subject
    to income and wealth constraints while producers attempt to maximize profits subject to their own constraints,
    including demand for goods produced, technology, and the price of inputs. For the consumer, that point comes where
    marginal utility of a good, net of price, reaches zero, leaving no net gain from further consumption increases.
    Analogously, the producer compares marginal revenue (identical to price for the perfect competitor) against the
    marginal cost of a good, with marginal profit the difference. At the point where marginal profit reaches zero, further
    increases in production of the good stop. For movement to market equilibrium and for changes in equilibrium, price
    and quantity also change "at the margin": more-or-less of something, rather than necessarily all-or-nothing.
    Other applications of demand and supply include the distribution of income among the factors of production,
    including labour and capital, through factor markets. In a competitive labour market for example the quantity of
    labour employed and the price of labour (the wage rate) depends on the demand for labour (from employers for
    production) and supply of labour (from potential workers). Labour economics examines the interaction of workers
    and employers through such markets to explain patterns and changes of wages and other labour income, labour
    mobility, and (un)employment, productivity through human capital, and related public-policy issues.[37]
    Demand-and-supply analysis is used to explain the behavior of perfectly competitive markets, but as a standard of
    comparison it can be extended to any type of market. It can also be generalized to explain variables across the
    economy, for example, total output (estimated as real GDP) and the general price level, as studied in
    macroeconomics.[38] Tracing the qualitative and quantitative effects of variables that change supply and demand,
    whether in the short or long run, is a standard exercise in applied economics. Economic theory may also specify
    conditions such that supply and demand through the market is an efficient mechanism for allocating resources.[39]
Economics                                                                                                                              7

    Increasing business profits do not necessarily lead to increased
    economic growth, especially when they do not result in greater
    aggregate demand. When businesses and banks lack incentives to
    spend accumulated capital, for instance because of repatriation taxes
    from profits in overseas tax havens, or interest on excess reserves paid
    to banks, increased profits can lead to decreasing growth.[40][41]

                                                                                      Red: corporate profits after tax and inventory
    People frequently do not trade directly on markets. Instead, on the         valuation adjustment. Blue: nonresidential fixed
    supply side, they may work in and produce through firms. The most               investment (roughly speaking, business
                                                                                  investment), both as fractions of U.S. GDP,
    obvious kinds of firms are corporations, partnerships and trusts.
    According to Ronald Coase people begin to organise their production
    in firms when the costs of doing business becomes lower than doing it
    on the market.[42] Firms combine labour and capital, and can achieve far greater economies of scale (when the
    average cost per unit declines as more units are produced) than individual market trading.

    In perfectly competitive markets studied in the theory of supply and demand, there are many producers, none of
    which significantly influence price. Industrial organization generalizes from that special case to study the strategic
    behavior of firms that do have significant control of price. It considers the structure of such markets and their
    interactions. Common market structures studied besides perfect competition include monopolistic competition,
    various forms of oligopoly, and monopoly.[43]
    Managerial economics applies microeconomic analysis to specific decisions in business firms or other management
    units. It draws heavily from quantitative methods such as operations research and programming and from statistical
    methods such as regression analysis in the absence of certainty and perfect knowledge. A unifying theme is the
    attempt to optimize business decisions, including unit-cost minimization and profit maximization, given the firm's
    objectives and constraints imposed by technology and market conditions.[44]

    Uncertainty and game theory
    Uncertainty in economics is an unknown prospect of gain or loss, whether quantifiable as risk or not. Without it,
    household behavior would be unaffected by uncertain employment and income prospects, financial and capital
    markets would reduce to exchange of a single instrument in each market period, and there would be no
    communications industry.[45] Given its different forms, there are various ways of representing uncertainty and
    modelling economic agents' responses to it.[46]
    Game theory is a branch of applied mathematics that considers strategic interactions between agents, one kind of
    uncertainty. It provides a mathematical foundation of industrial organization, discussed above, to model different
    types of firm behavior, for example in an oligopolistic industry (few sellers), but equally applicable to wage
    negotiations, bargaining, contract design, and any situation where individual agents are few enough to have
    perceptible effects on each other. As a method heavily used in behavioral economics, it postulates that agents choose
    strategies to maximize their payoffs, given the strategies of other agents with at least partially conflicting
    interests.[47][48] In this, it generalizes maximization approaches developed to analyze market actors such as in the
    supply and demand model and allows for incomplete information of actors. The field dates from the 1944 classic
    Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern. It has significant
    applications seemingly outside of economics in such diverse subjects as formulation of nuclear strategies, ethics,
    political science, and evolutionary biology.[49]
    Risk aversion may stimulate activity that in well-functioning markets smooths out risk and communicates
    information about risk, as in markets for insurance, commodity futures contracts, and financial instruments.
Economics                                                                                                                            8

    Financial economics or simply finance describes the allocation of financial resources. It also analyzes the pricing of
    financial instruments, the financial structure of companies, the efficiency and fragility of financial markets,[50]
    financial crises, and related government policy or regulation.[51]
    Some market organizations may give rise to inefficiencies associated with uncertainty. Based on George Akerlof's
    "Market for Lemons" article, the paradigm example is of a dodgy second-hand car market. Customers without
    knowledge of whether a car is a "lemon" depress its price below what a quality second-hand car would be.[52]
    Information asymmetry arises here, if the seller has more relevant information than the buyer but no incentive to
    disclose it. Related problems in insurance are adverse selection, such that those at most risk are most likely to insure
    (say reckless drivers), and moral hazard, such that insurance results in riskier behavior (say more reckless driving).
    Both problems may raise insurance costs and reduce efficiency in driving otherwise willing transactors from the
    market ("incomplete markets"). Moreover, attempting to reduce one problem, say adverse selection by mandating
    insurance, may add to another, say moral hazard. Information economics, which studies such problems, has
    relevance in subjects such as insurance, contract law, mechanism design, monetary economics, and health care.[53]
    Applied subjects include market and legal remedies to spread or reduce risk, such as warranties,
    government-mandated partial insurance, restructuring or bankruptcy law, inspection, and regulation for quality and
    information disclosure.[54][47]

    Market failure
    The term "market failure" encompasses several problems which may
    undermine standard economic assumptions. Although economists
    categorise market failures differently, the following categories emerge
    in the main texts.[55]
    Information asymmetries and incomplete markets may result in
    economic inefficiency but also a possibility of improving efficiency
    through market, legal, and regulatory remedies, as discussed above.
    Natural monopoly, or the overlapping concepts of "practical" and
    "technical" monopoly, is an extreme case of failure of competition as a        Pollution can be a simple example of market
    restraint on producers. The problem is described as one where the more        failure. If costs of production are not borne by
                                                                                  producers but are by the environment, accident
    of a product is made, the lower the unit costs are. This means it only
                                                                                    victims or others, then prices are distorted.
    makes economic sense to have one producer.
    Public goods are goods which are undersupplied in a typical market. The defining features are that people can
    consume public goods without having to pay for them and that more than one person can consume the good at the
    same time.
    Externalities occur where there are significant social costs or benefits from production or consumption that are not
    reflected in market prices. For example, air pollution may generate a negative externality, and education may
    generate a positive externality (less crime, etc.). Governments often tax and otherwise restrict the sale of goods that
    have negative externalities and subsidize or otherwise promote the purchase of goods that have positive externalities
    in an effort to correct the price distortions caused by these externalities.[56] Elementary demand-and-supply theory
    predicts equilibrium but not the speed of adjustment for changes of equilibrium due to a shift in demand or
    In many areas, some form of price stickiness is postulated to account for quantities, rather than prices, adjusting in
    the short run to changes on the demand side or the supply side. This includes standard analysis of the business cycle
    in macroeconomics. Analysis often revolves around causes of such price stickiness and their implications for
    reaching a hypothesized long-run equilibrium. Examples of such price stickiness in particular markets include wage
    rates in labour markets and posted prices in markets deviating from perfect competition.
Economics                                                                                                                   9

    Macroeconomic instability, addressed below, is a prime source of market failure, whereby a general loss of business
    confidence or external shock can grind production and distribution to a halt, undermining ordinary markets that are
    otherwise sound.
    Some specialised fields of economics deal in market failure more than
    others. The economics of the public sector is one example, since where
    markets fail, some kind of regulatory or government programme is the
    remedy. Much environmental economics concerns externalities or
    "public bads".
    Policy options include regulations that reflect cost-benefit analysis or
    market solutions that change incentives, such as emission fees or
    redefinition of property rights.[58]
                                                                                   Environmental scientist sampling water
    Public sector
    Public finance is the field of economics that deals with budgeting the revenues and expenditures of a public sector
    entity, usually government. The subject addresses such matters as tax incidence (who really pays a particular tax),
    cost-benefit analysis of government programs, effects on economic efficiency and income distribution of different
    kinds of spending and taxes, and fiscal politics. The latter, an aspect of public choice theory, models public-sector
    behavior analogously to microeconomics, involving interactions of self-interested voters, politicians, and

    Much of economics is positive, seeking to describe and predict economic phenomena. Normative economics seeks to
    identify what economies ought to be like.
    Welfare economics is a normative branch of economics that uses microeconomic techniques to simultaneously
    determine the allocative efficiency within an economy and the income distribution associated with it. It attempts to
    measure social welfare by examining the economic activities of the individuals that comprise society.[60]

    Macroeconomics examines the economy as a whole to explain broad
    aggregates and their interactions "top down", that is, using a simplified
    form of general-equilibrium theory.[61] Such aggregates include
    national income and output, the unemployment rate, and price inflation
    and subaggregates like total consumption and investment spending and
    their components. It also studies effects of monetary policy and fiscal

    Since at least the 1960s, macroeconomics has been characterized by
    further integration as to micro-based modeling of sectors, including
    rationality of players, efficient use of market information, and
    imperfect competition.[62] This has addressed a long-standing concern
    about inconsistent developments of the same subject.[63]
    Macroeconomic analysis also considers factors affecting the long-term
    level and growth of national income. Such factors include capital
    accumulation, technological change and labour force growth.[64]
                                                                                      Circulation in Macroeconomics
Economics                                                                                                                   10

    Growth economics studies factors that explain economic growth – the
    increase in output per capita of a country over a long period of time.
    The same factors are used to explain differences in the level of output
    per capita between countries, in particular why some countries grow
    faster than others, and whether countries converge at the same rates of
                                                                                  World map showing GDP real growth rates
    Much-studied factors include the rate of investment, population
    growth, and technological change. These are represented in theoretical and empirical forms (as in the neoclassical
    and endogenous growth models) and in growth accounting.[65]

    Business cycle
    The economics of a depression were the spur for the creation of "macroeconomics" as a separate discipline field of
    study. During the Great Depression of the 1930s, John Maynard Keynes authored a book entitled The General
    Theory of Employment, Interest and Money outlining the key theories of Keynesian economics. Keynes contended
    that aggregate demand for goods might be insufficient during economic downturns, leading to unnecessarily high
    unemployment and losses of potential output.
    He therefore advocated active policy responses by the public sector, including monetary policy actions by the central
    bank and fiscal policy actions by the government to stabilize output over the business cycle.[66] Thus, a central
    conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and
    employment towards full employment levels. John Hicks' IS/LM model has been the most influential interpretation
    of The General Theory.
    Over the years, understanding of the business cycle has branched into various research programs, mostly related to or
    distinct from Keynesianism. The neoclassical synthesis refers to the reconciliation of Keynesian economics with
    neoclassical economics, stating that Keynesianism is correct in the short run but qualified by neoclassical-like
    considerations in the intermediate and long run.[67]
    New classical macroeconomics, as distinct from the Keynesian view of the business cycle, posits market clearing
    with imperfect information. It includes Friedman's permanent income hypothesis on consumption and "rational
    expectations" theory,[68] lead by Robert Lucas, and real business cycle theory.[69]
    In contrast, the new Keynesian approach retains the rational expectations assumption, however it assumes a variety
    of market failures. In particular, New Keynesians assume prices and wages are "sticky", which means they do not
    adjust instantaneously to changes in economic conditions.[70]
    Thus, the new classicals assume that prices and wages adjust automatically to attain full employment, whereas the
    new Keynesians see full employment as being automatically achieved only in the long run, and hence government
    and central-bank policies are needed because the "long run" may be very long.
Economics                                                                                                                          11

    The amount of unemployment in an economy is measured by the
    unemployment rate, the percentage of workers without jobs in the
    labour force. The labour force only includes workers actively looking
    for jobs. People who are retired, pursuing education, or discouraged
    from seeking work by a lack of job prospects are excluded from the
    labor force. Unemployment can be generally broken down into several
    types that are related to different causes. Classical unemployment
    occurs when wages are too high for employers to be willing to hire           Percent of US population employed, 1995-2012
    more workers. Wages may be too high because of minimum wage laws
    or union activity. Consistent with classical unemployment, frictional unemployment occurs when appropriate job
    vacancies exist for a worker, but the length of time needed to search for and find the job leads to a period of
    unemployment.[71] Structural unemployment covers a variety of possible causes of unemployment including a
    mismatch between workers' skills and the skills required for open jobs.[72] Large amounts of structural
    unemployment can occur when an economy is transitioning industries and workers find their previous set of skills
    are no longer in demand. Structural unemployment is similar to frictional unemployment since both reflect the
    problem of matching workers with job vacancies, but structural unemployment covers the time needed to acquire
    new skills not just the short term search process.[73] While some types of unemployment may occur regardless of the
    condition of the economy, cyclical unemployment occurs when growth stagnates. Okun's law represents the
    empirical relationship between unemployment and economic growth.[74] The original version of Okun's law states
    that a 3% increase in output would lead to a 1% decrease in unemployment.[75]

    Inflation and monetary policy
    Money is a means of final payment for goods in most price system economies and the unit of account in which prices
    are typically stated. A very apt statement by Professor Walker, a well-known economist is that, " Money is what
    money does." Money has a general acceptability, a relative consistency in value, divisibility, durability, portability,
    elastic in supply and survives with mass public confidence. It includes currency held by the nonbank public and
    checkable deposits. It has been described as a social convention, like language, useful to one largely because it is
    useful to others.
                                                        As a medium of exchange, money facilitates trade. It is essentially a
                                                        measure of value and more importantly, a store of value being a basis
                                                        for credit creation. Its economic function can be contrasted with barter
                                                        (non-monetary exchange). Given a diverse array of produced goods
                                                        and specialized producers, barter may entail a hard-to-locate double
                                                        coincidence of wants as to what is exchanged, say apples and a book.
                                                        Money can reduce the transaction cost of exchange because of its ready
      The Federal Reserve sets monetary policy as the
                                                        acceptability. Then it is less costly for the seller to accept money in
            central bank of the United States.
                                                        exchange, rather than what the buyer produces.[76]

    At the level of an economy, theory and evidence are consistent with a positive relationship running from the total
    money supply to the nominal value of total output and to the general price level. For this reason, management of the
    money supply is a key aspect of monetary policy.[77]
Economics                                                                                                                    12

    Fiscal policy
    Governments implement fiscal policy by adjusting spending and taxation policies to alter aggregate demand. When
    aggregate demand falls below the potential output of the economy, there is an output gap where some productive
    capacity is left unemployed. Governments increase spending and cut taxes to boost aggregate demand. Resources
    that have been idled can be used by the government. For example, unemployed home builders can be hired to expand
    highways. Tax cuts allow consumers to increase their spending, which boosts aggregate demand. Both tax cuts and
    spending have multiplier effects where the initial increase in demand from the policy percolates through the
    economy and generates additional economic activity.
    The effects of fiscal policy can be limited by crowding out. When there is no output gap, the economy is producing
    at full capacity and there are no excess productive resources. If the government increases spending in this situation,
    the government use resources that otherwise would have been used by the private sector, so there is no increase in
    overall output. Some economists think that crowding out is always an issue while others do not think it is a major
    issue when output is depressed. Skeptics of fiscal policy also make the argument of Ricardian equivalence. They
    argue that an increase in debt will have to be paid for with future tax increases, which will cause people to reduce
    their consumption and save money to pay for the future tax increase. Under Ricardian equivalence, any boost in
    demand from fiscal policy will be offset by the increased savings rate intended to pay for future higher taxes.

    International economics
    International trade studies determinants of goods-and-services flows across international boundaries. It also concerns
    the size and distribution of gains from trade. Policy applications include estimating the effects of changing tariff
    rates and trade quotas. International finance is a macroeconomic field which examines the flow of capital across
    international borders, and the effects of these movements on exchange rates. Increased trade in goods, services and
    capital between countries is a major effect of contemporary globalization.[78]
    The distinct field of development economics examines economic
    aspects of the development process in relatively low-income countries
    focusing on structural change, poverty, and economic growth.
    Approaches in development economics frequently incorporate social
    and political factors.[79]
    Economic systems is the branch of economics that studies the methods          World map showing GDP (PPP) per capita
    and institutions by which societies determine the ownership, direction,
    and allocation of economic resources. An economic system of a society is the unit of analysis.
    Among contemporary systems at different ends of the organizational spectrum are socialist systems and capitalist
    systems, in which most production occurs in respectively state-run and private enterprises. In between are mixed
    economies. A common element is the interaction of economic and political influences, broadly described as political
    economy. Comparative economic systems studies the relative performance and behavior of different economies or
Economics                                                                                                                       13

    Contemporary economics uses mathematics. Economists draw on the tools of calculus, linear algebra, statistics,
    game theory, and computer science.[81] Professional economists are expected to be familiar with these tools, while a
    minority specialize in econometrics and mathematical methods.

    Mainstream economic theory relies upon a priori quantitative economic models, which employ a variety of concepts.
    Theory typically proceeds with an assumption of ceteris paribus, which means holding constant explanatory
    variables other than the one under consideration. When creating theories, the objective is to find ones which are at
    least as simple in information requirements, more precise in predictions, and more fruitful in generating additional
    research than prior theories.[82]
    In microeconomics, principal concepts include supply and demand, marginalism, rational choice theory, opportunity
    cost, budget constraints, utility, and the theory of the firm.[83][84] Early macroeconomic models focused on modeling
    the relationships between aggregate variables, but as the relationships appeared to change over time
    macroeconomists, including new Keynesians, reformulated their models in microfoundations.[70]
    The aforementioned microeconomic concepts play a major part in macroeconomic models – for instance, in
    monetary theory, the quantity theory of money predicts that increases in the money supply increase inflation, and
    inflation is assumed to be influenced by rational expectations. In development economics, slower growth in
    developed nations has been sometimes predicted because of the declining marginal returns of investment and capital,
    and this has been observed in the Four Asian Tigers. Sometimes an economic hypothesis is only qualitative, not
    Expositions of economic reasoning often use two-dimensional graphs to illustrate theoretical relationships. At a
    higher level of generality, Paul Samuelson's treatise Foundations of Economic Analysis (1947) used mathematical
    methods to represent the theory, particularly as to maximizing behavioral relations of agents reaching equilibrium.
    The book focused on examining the class of statements called operationally meaningful theorems in economics,
    which are theorems that can conceivably be refuted by empirical data.[86]

    Empirical investigation
    Economic theories are frequently tested empirically, largely through the use of econometrics using economic
    data.[87] The controlled experiments common to the physical sciences are difficult and uncommon in economics,[88]
    and instead broad data is observationally studied; this type of testing is typically regarded as less rigorous than
    controlled experimentation, and the conclusions typically more tentative. However, the field of experimental
    economics is growing, and increasing use is being made of natural experiments.
    Statistical methods such as regression analysis are common. Practitioners use such methods to estimate the size,
    economic significance, and statistical significance ("signal strength") of the hypothesized relation(s) and to adjust for
    noise from other variables. By such means, a hypothesis may gain acceptance, although in a probabilistic, rather than
    certain, sense. Acceptance is dependent upon the falsifiable hypothesis surviving tests. Use of commonly accepted
    methods need not produce a final conclusion or even a consensus on a particular question, given different tests, data
    sets, and prior beliefs.
    Criticism based on professional standards and non-replicability of results serve as further checks against bias, errors,
    and over-generalization,[84][89] although much economic research has been accused of being non-replicable, and
    prestigious journals have been accused of not facilitating replication through the provision of the code and data.[90]
    Like theories, uses of test statistics are themselves open to critical analysis,[91] although critical commentary on
    papers in economics in prestigious journals such as the American Economic Review has declined precipitously in the
    past 40 years. This has been attributed to journals' incentives to maximize citations in order to rank higher on the
Economics                                                                                                                     14

    Social Science Citation Index (SSCI).[92]
    In applied economics, input-output models employing linear programming methods are quite common. Large
    amounts of data are run through computer programs to analyze the impact of certain policies; IMPLAN is one
    well-known example.
    Experimental economics has promoted the use of scientifically controlled experiments. This has reduced long-noted
    distinction of economics from natural sciences allowed direct tests of what were previously taken as axioms.[93] In
    some cases these have found that the axioms are not entirely correct; for example, the ultimatum game has revealed
    that people reject unequal offers.
    In behavioral economics, psychologist Daniel Kahneman won the Nobel Prize in economics in 2002 for his and
    Amos Tversky's empirical discovery of several cognitive biases and heuristics. Similar empirical testing occurs in
    neuroeconomics. Another example is the assumption of narrowly selfish preferences versus a model that tests for
    selfish, altruistic, and cooperative preferences.[94] These techniques have led some to argue that economics is a
    "genuine science."[10]

    The professionalization of economics, reflected in the growth of graduate programs on the subject, has been
    described as "the main change in economics since around 1900".[95] Most major universities and many colleges have
    a major, school, or department in which academic degrees are awarded in the subject, whether in the liberal arts,
    business, or for professional study; see Master of Economics.
    The Nobel Memorial Prize in Economic Sciences (commonly known as the Nobel Prize in Economics) is a prize
    awarded to economists each year for outstanding intellectual contributions in the field. In the private sector,
    professional economists are employed as consultants and in industry, including banking and finance. Economists
    also work for various government departments and agencies, for example, the national Treasury, Central Bank or
    Bureau of Statistics.

    Related subjects
    Economics is one social science among several and has fields bordering on other areas, including economic
    geography, economic history, public choice, energy economics, cultural economics, family economics and
    institutional economics.
    Law and economics, or economic analysis of law, is an approach to legal theory that applies methods of economics
    to law. It includes the use of economic concepts to explain the effects of legal rules, to assess which legal rules are
    economically efficient, and to predict what the legal rules will be.[96] A seminal article by Ronald Coase published in
    1961 suggested that well-defined property rights could overcome the problems of externalities.[97]
    Political economy is the interdisciplinary study that combines economics, law, and political science in explaining
    how political institutions, the political environment, and the economic system (capitalist, socialist, mixed) influence
    each other. It studies questions such as how monopoly, rent-seeking behavior, and externalities should impact
    government policy.[98] Historians have employed political economy to explore the ways in the past that persons and
    groups with common economic interests have used politics to effect changes beneficial to their interests.[99]
    Energy economics is a broad scientific subject area which includes topics related to energy supply and energy
    demand. Georgescu-Roegen reintroduced the concept of entropy in relation to economics and energy from
    thermodynamics, as distinguished from what he viewed as the mechanistic foundation of neoclassical economics
    drawn from Newtonian physics. His work contributed significantly to thermoeconomics and to ecological
    economics. He also did foundational work which later developed into evolutionary economics.[100]
    The sociological subfield of economic sociology arose, primarily through the work of Émile Durkheim, Max Weber
    and Georg Simmel, as an approach to analysing the effects of economic phenomena in relation to the overarching
Economics                                                                                                                       15

    social paradigm (i.e. modernity).[101] Classic works include Max Weber's The Protestant Ethic and the Spirit of
    Capitalism (1905) and Georg Simmel's The Philosophy of Money (1900). More recently, the works of Mark
    Granovetter, Peter Hedstrom and Richard Swedberg have been influential in this field.

    Economic writings date from earlier Mesopotamian, Greek, Roman, Indian subcontinent, Chinese, Persian, and Arab
    civilizations. Notable writers from antiquity through to the 14th century include Aristotle, Xenophon, Chanakya
    (also known as Kautilya), Qin Shi Huang, Thomas Aquinas, and Ibn Khaldun. The works of Aristotle had a profound
    influence on Aquinas, who in turn influenced the late scholastics of the 14th to 17th centuries.[102] Joseph
    Schumpeter described the latter as "coming nearer than any other group to being the 'founders' of scientific
    economics" as to monetary, interest, and value theory within a natural-law perspective.[103]
                                                     Two groups, later called "mercantilists" and "physiocrats", more
                                                     directly influenced the subsequent development of the subject. Both
                                                     groups were associated with the rise of economic nationalism and
                                                     modern capitalism in Europe. Mercantilism was an economic doctrine
                                                     that flourished from the 16th to 18th century in a prolific pamphlet
                                                     literature, whether of merchants or statesmen. It held that a nation's
                                                     wealth depended on its accumulation of gold and silver. Nations
                                                     without access to mines could obtain gold and silver from trade only
                                                     by selling goods abroad and restricting imports other than of gold and
        1638 painting of a French seaport during the
                  heyday of mercantilism             silver. The doctrine called for importing cheap raw materials to be used
                                                     in manufacturing goods, which could be exported, and for state
    regulation to impose protective tariffs on foreign manufactured goods and prohibit manufacturing in the

    Physiocrats, a group of 18th century French thinkers and writers, developed the idea of the economy as a circular
    flow of income and output. Physiocrats believed that only agricultural production generated a clear surplus over cost,
    so that agriculture was the basis of all wealth. Thus, they opposed the mercantilist policy of promoting
    manufacturing and trade at the expense of agriculture, including import tariffs. Physiocrats advocated replacing
    administratively costly tax collections with a single tax on income of land owners. In reaction against copious
    mercantilist trade regulations, the physiocrats advocated a policy of laissez-faire, which called for minimal
    government intervention in the economy.[105]
    Modern economic analysis is customarily said to have begun with Adam Smith (1723–1790).[106] Smith was harshly
    critical of the mercantilists but described the physiocratic system "with all its imperfections" as "perhaps the purest
    approximation to the truth that has yet been published" on the subject.[107]
Economics                                                                                                                          16

    Classical political economy
                                          Publication of Adam Smith's The Wealth of Nations in 1776, has been described
                                          as "the effective birth of economics as a separate discipline."[108] The book
                                          identified land, labor, and capital as the three factors of production and the major
                                          contributors to a nation's wealth, as distinct from the Physiocratic idea that only
                                          agriculture was productive.
                                       Smith discusses potential benefits of specialization by division of labour,
                                       including increased labour productivity and gains from trade, whether between
                                       town and country or across countries.[109] His "theorem" that "the division of
                                       labor is limited by the extent of the market" has been described as the "core of a
                                       theory of the functions of firm and industry" and a "fundamental principle of
                                       economic organization."[110] To Smith has also been ascribed "the most
                                       important substantive proposition in all of economics" and foundation of
       Adam Smith wrote The Wealth of  resource-allocation theory – that, under competition, resource owners (of labour,
                  Nations              land, and capital) seek their most profitable uses, resulting in an equal rate of
                                       return for all uses in equilibrium (adjusted for apparent differences arising from
    such factors as training and unemployment).[111]

    In an argument that includes "one of the most famous passages in all economics,"[112] Smith represents every
    individual as trying to employ any capital they might command for their own advantage, not that of the society,[113]
    and for the sake of profit, which is necessary at some level for employing capital in domestic industry, and positively
    related to the value of produce.[114] In this:
            He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it.
            By preferring the support of domestic to that of foreign industry, he intends only his own security; and by
            directing that industry in such a manner as its produce may be of the greatest value, he intends only his own
            gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of
            his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he
            frequently promotes that of the society more effectually than when he really intends to promote it.[115]
    Economists have linked Smith's invisible-hand concept to his concern for the common man and woman through
    economic growth and development,[116] enabling higher levels of consumption, which Smith describes as "the sole
    end and purpose of all production."[117][118] He embeds the "invisible hand" in a framework that includes limiting
    restrictions on competition and foreign trade by government and industry in the same chapter[119] and elsewhere
    regulation of banking and the interest rate,[120] provision of a "natural system of liberty" — national defence, an
    egalitarian justice and legal system, and certain institutions and public works with general benefits to the whole
    society that might otherwise be unprofitable to produce, such as education[121] and roads, canals, and the
    like.[122][123] An influential introductory textbook includes parallel discussion and this assessment: "Above all, it is
    Adam Smith's vision of a self-regulating invisible hand that is his enduring contribution to modern economics."[124]
    The Rev. Thomas Robert Malthus (1798) used the idea of diminishing returns to explain low living standards.
    Human population, he argued, tended to increase geometrically, outstripping the production of food, which increased
    arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns
    to labour. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the
    population from rising above the subsistence level.[125]
    Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed
    unemployment upon the economy's tendency to limit its spending by saving too much, a theme that lay forgotten
    until John Maynard Keynes revived it in the 1930s.
Economics                                                                                                                      17

    While Adam Smith emphasized the production of income, David Ricardo (1817) focused on the distribution of
    income among landowners, workers, and capitalists. Ricardo saw an inherent conflict between landowners on the
    one hand and labour and capital on the other. He posited that the growth of population and capital, pressing against a
    fixed supply of land, pushes up rents and holds down wages and profits. Ricardo was the first to state and prove the
    principle of comparative advantage, according to which each country should specialize in producing and exporting
    goods in that it has a lower relative cost of production, rather relying only on its own production.[126] It has been
    termed a "fundamental analytical explanation" for gains from trade.[127]
    Coming at the end of the Classical tradition, John Stuart Mill (1848) parted company with the earlier classical
    economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a
    distinct difference between the market's two roles: allocation of resources and distribution of income. The market
    might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to
    Value theory was important in classical theory. Smith wrote that the "real price of every thing ... is the toil and
    trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with rent and profit, other costs besides
    wages also enter the price of a commodity.[129] Other classical economists presented variations on Smith, termed the
    'labour theory of value'. Classical economics focused on the tendency of markets to move to long-run equilibrium.

    Marxist (later, Marxian) economics descends from classical economics. It
    derives from the work of Karl Marx. The first volume of Marx's major work, Das
    Kapital, was published in German in 1867. In it, Marx focused on the labour
    theory of value and the theory of surplus value which, he believed, explained the
    exploitation of labour by capital.[130] The labour theory of value held that the
    value of an exchanged commodity was determined by the labour that went into
    its production and the theory of surplus value demonstrated how the workers
    only got paid a proportion of the value their work had created.

    Neoclassical economics
    A body of theory later termed "neoclassical economics" or "marginalism" formed
    from about 1870 to 1910. The term "economics" was popularized by such
                                                                                             The Marxist school of economic
    neoclassical economists as Alfred Marshall as a concise synonym for 'economic            thought comes from the work of
    science' and a substitute for the earlier "political economy".[2] This corresponded       German economist Karl Marx.
    to the influence on the subject of mathematical methods used in the natural

    Neoclassical economics systematized supply and demand as joint determinants of price and quantity in market
    equilibrium, affecting both the allocation of output and the distribution of income. It dispensed with the labour
    theory of value inherited from classical economics in favor of a marginal utility theory of value on the demand side
    and a more general theory of costs on the supply side.[132] In the 20th century, neoclassical theorists moved away
    from an earlier notion suggesting that total utility for a society could be measured in favor of ordinal utility, which
    hypothesizes merely behavior-based relations across persons.[36][133]
    In microeconomics, neoclassical economics represents incentives and costs as playing a pervasive role in shaping
    decision making. An immediate example of this is the consumer theory of individual demand, which isolates how
    prices (as costs) and income affect quantity demanded.[36] In macroeconomics it is reflected in an early and lasting
    neoclassical synthesis with Keynesian macroeconomics.[67][134]
Economics                                                                                                                    18

    Neoclassical economics is occasionally referred as orthodox economics whether by its critics or sympathizers.
    Modern mainstream economics builds on neoclassical economics but with many refinements that either supplement
    or generalize earlier analysis, such as econometrics, game theory, analysis of market failure and imperfect
    competition, and the neoclassical model of economic growth for analyzing long-run variables affecting national

    Keynesian economics
    Keynesian economics derives from John Maynard Keynes, in particular his book
    The General Theory of Employment, Interest and Money (1936), which ushered
    in contemporary macroeconomics as a distinct field.[135] The book focused on
    determinants of national income in the short run when prices are relatively
    inflexible. Keynes attempted to explain in broad theoretical detail why high
    labour-market unemployment might not be self-correcting due to low "effective
    demand" and why even price flexibility and monetary policy might be
    unavailing. Such terms as "revolutionary" have been applied to the book in its
    impact on economic analysis.[136]

    Keynesian economics has two successors. Post-Keynesian economics also
    concentrates on macroeconomic rigidities and adjustment processes. Research on      John Maynard Keynes (right), was a
    micro foundations for their models is represented as based on real-life practices        key theorist in economics.
    rather than simple optimizing models. It is generally associated with the
    University of Cambridge and the work of Joan Robinson.[137]
    New-Keynesian economics is also associated with developments in the Keynesian fashion. Within this group
    researchers tend to share with other economists the emphasis on models employing micro foundations and
    optimizing behavior but with a narrower focus on standard Keynesian themes such as price and wage rigidity. These
    are usually made to be endogenous features of the models, rather than simply assumed as in older Keynesian-style

    Chicago school of economics
    The Chicago School of economics is best known for its free market advocacy and monetarist ideas. According to
    Milton Friedman and monetarists, market economies are inherently stable if the money supply does not greatly
    expand or contract. Ben Bernanke, current Chairman of the Federal Reserve, is among the economists today
    generally accepting Friedman's analysis of the causes of the Great Depression.[138]
    Milton Friedman effectively took many of the basic principles set forth by Adam Smith and the classical economists
    and modernized them. One example of this is his article in the September 1970 issue of The New York Times
    Magazine, where he claims that the social responsibility of business should be "to use its resources and engage in
    activities designed to increase its profits...(through) open and free competition without deception or fraud."[139]

    Other schools and approaches
    Other well-known schools or trends of thought referring to a particular style of economics practiced at and
    disseminated from well-defined groups of academicians that have become known worldwide, include the Austrian
    School, the Freiburg School, the School of Lausanne, post-Keynesian economics and the Stockholm school.
    Contemporary mainstream economics is sometimes separated into the Saltwater approach of those universities along
    the Eastern and Western coasts of the US, and the Freshwater, or Chicago-school approach.
    Within macroeconomics there is, in general order of their appearance in the literature; classical economics,
    Keynesian economics, the neoclassical synthesis, post-Keynesian economics, monetarism, new classical economics,
Economics                                                                                                                        19

    and supply-side economics. Alternative developments include ecological economics, constitutional economics,
    institutional economics, evolutionary economics, dependency theory, structuralist economics, world systems theory,
    econophysics, feminist economics and biophysical economics.[140]


    General criticisms
    "The dismal science" is a derogatory alternative name for economics devised by the Victorian historian Thomas
    Carlyle in the 19th century. It is often stated that Carlyle gave economics the nickname "the dismal science" as a
    response to the late 18th century writings of The Reverend Thomas Robert Malthus, who grimly predicted that
    starvation would result, as projected population growth exceeded the rate of increase in the food supply. However,
    the actual phrase was coined by Carlyle in the context of a debate with John Stuart Mill on slavery, in which Carlyle
    argued for slavery, while Mill opposed it.[15]
    Some economists, like John Stuart Mill or Léon Walras, have maintained that the production of wealth should not be
    tied to its distribution. The former is in the field of "applied economics" while the latter belongs to "social
    economics" and is largely a matter of power and politics.[141]
    In The Wealth of Nations, Adam Smith addressed many issues that are currently also the subject of debate and
    dispute. Smith repeatedly attacks groups of politically aligned individuals who attempt to use their collective
    influence to manipulate a government into doing their bidding. In Smith's day, these were referred to as factions, but
    are now more commonly called special interests, a term which can comprise international bankers, corporate
    conglomerations, outright oligopolies, monopolies, trade unions and other groups.[142]
    Economics per se, as a social science, is independent of the political acts of any government or other
    decision-making organization, however, many policymakers or individuals holding highly ranked positions that can
    influence other people's lives are known for arbitrarily using a plethora of economic concepts and rhetoric as
    vehicles to legitimize agendas and value systems, and do not limit their remarks to matters relevant to their
    responsibilities.[143] The close relation of economic theory and practice with politics[144] is a focus of contention that
    may shade or distort the most unpretentious original tenets of economics, and is often confused with specific social
    agendas and value systems.[145] Notwithstanding, economics legitimately has a role in informing government policy.
    It is, indeed, in some ways an outgrowth of the older field of political economy. Some academic economic journals
    are currently focusing increased efforts on gauging the consensus of economists regarding certain policy issues in
    hopes of effecting a more informed political environment. Currently, there exists a low approval rate from
    professional economists regarding many public policies. Policy issues featured in a recent survey of AEA
    economists include trade restrictions, social insurance for those put out of work by international competition,
    genetically modified foods, curbside recycling, health insurance (several questions), medical malpractice, barriers to
    entering the medical profession, organ donations, unhealthy foods, mortgage deductions, taxing internet sales,
    Wal-Mart, casinos, ethanol subsidies, and inflation targeting.[146]
    In Steady State Economics 1977, Herman Daly argues that there exist logical inconsistencies between the emphasis
    placed on economic growth and the limited availability of natural resources.[147]
    Issues like central bank independence, central bank policies and rhetoric in central bank governors discourse or the
    premises of macroeconomic policies[148] (monetary and fiscal policy) of the state, are focus of contention and
    Deirdre McCloskey has argued that many empirical economic studies are poorly reported, and while her critique has
    been well-received, she and Stephen Ziliak argue that practice has not improved.[150] This latter contention is
Economics                                                                                                                       20

    During the 2007–2012 global financial crisis, an increasing number of teachers argued that the specialized
    economics textbooks, some written by experts who did not see the crisis coming, were almost useless because their
    elaborated content was divorced from reality.[143]
    A 2002 International Monetary Fund study looked at "consensus forecasts" (the forecasts of large groups of
    economists) that were made in advance of 60 different national recessions in the '90s: in 97% of the cases the
    economists did not predict the contraction a year in advance. On those rare occasions when economists did
    successfully predict recessions, they significantly underestimated their severity.[152]

    Criticisms of assumptions
    Economics has been subject to criticism that it relies on unrealistic, unverifiable, or highly simplified assumptions, in
    some cases because these assumptions simplify the proofs of desired conclusions. Examples of such assumptions
    include perfect information, profit maximization and rational choices.[153] [154] The field of information economics
    includes both mathematical-economical research and also behavioral economics, akin to studies in behavioral
    Nevertheless, prominent mainstream economists such as Keynes[156] and Joskow have observed that much of
    economics is conceptual rather than quantitative, and difficult to model and formalize quantitatively. In a discussion
    on oligopoly research, Paul Joskow pointed out in 1975 that in practice, serious students of actual economies tended
    to use "informal models" based upon qualitative factors specific to particular industries. Joskow had a strong feeling
    that the important work in oligopoly was done through informal observations while formal models were "trotted out
    ex post". He argued that formal models were largely not important in the empirical work, either, and that the
    fundamental factor behind the theory of the firm, behavior, was neglected.[157]
    In recent years, feminist critiques of neoclassical economic models gained prominence, leading to the formation of
    feminist economics.[158] Contrary to common conceptions of economics as a positive and objective science, feminist
    economists call attention to the social construction of economics[159] and highlight the ways in which its models and
    methods reflect masculine preferences. Primary criticisms focus on failures to account for: the selfish nature of
    actors (homo economicus); exogenous tastes; the impossibility of utility comparisons; the exclusion of unpaid work;
    and the exclusion of class and gender considerations. Feminist economics developed to address these concerns, and
    the field now includes critical examinations of many areas of economics including paid and unpaid work, economic
    epistemology and history, globalization, household economics and the care economy. Feminists such as Marilyn
    Waring also argue that the discipline of economics ignores women's unpaid work and the value of nature.[160]
    Philip Mirowski observes that
            The imperatives of the orthodox research programme [of economic science] leave little room for maneuver
            and less room for originality. ... These mandates ... Appropriate as many mathematical techniques and
            metaphorical expressions from contemporary respectable science, primarily physics as possible. ... Preserve to
            the maximum extent possible the attendant nineteenth-century overtones of “natural order” ... Deny strenuously
            that neoclassical theory slavishly imitates physics. ... Above all, prevent all rival research programmes from
            encroaching ... by ridiculing all external attempts to appropriate twentieth century physics models. ... All
            theorizing is [in this way] held hostage to nineteenth-century concepts of energy.[161]
    In a series of peer-reviewed journal and conference papers and books published over a period of several decades,
    John McMurtry[162] has provided extensive criticism of what he terms the "unexamined assumptions and
    implications [of economics], and their consequent cost to people’s lives."[163] For example, he writes
            This is why we might conclude that economics ceased to be a science or an investigation once it presupposed
            an engineering physics model as its methodological given. It became instead the defining software of a
            machinal system with no place for life in its money-sequence operations. Like the received dogma of another
            epoch, its formulations decoupled from reality in a scholastic formalism, its priesthood would not
            acknowledge the right of any but trained believers to speak on issues designated by the subject, and its iron
Economics                                                                                                                        21

            laws subsumed all that lived as material ready to be made productive by transformation into the system’s
            service. ... Yet it would be a very great mistake to simply reject economics as a resource of analysis. It
            provides an articulated lexicon of exact referents, operations and principles of the global market mechanism
            which it presupposes as the natural order. And its resources are invaluable in coming to understand the system
            of rule which the global market now implements across the world in its restructuring operations. One has to
            expose and understand the principles the doctrine assumes in order to examine and unmask their implications
            for life-organization. One has to follow the assumptions its theoreticians take as given to see the trail of
            consequences for reality which obedience to this unseen metaphysic unleashes on the world. One has to
            connect across the logical lattice of the covert value system the defining axioms and co-ordinates it bears to
            see what it means for the planetary life-web as an integrated whole. One has, in short, to do what the
            economist avoids as the explosion of his own identity – open up its value structure to examination. This is
            what the study which follows [in this book] does ...[163]
    Nassim Nicholas Taleb and Michael Perelman are two additional scholars who criticized conventional or mainstream
    economics. Taleb opposes most economic theorizing, which in his view suffers acutely from the problem of overuse
    of Plato's Theory of Forms, and calls for cancellation of the Nobel Memorial Prize in Economics, saying that the
    damage from economic theories can be devastating.[164][165] Michael Perelman provides extensive criticism of
    economics and its assumptions in all his books (and especially his books published from 2000 to date), papers and
    interviews. For example, he says:
            The disconnect between what purports to be objective analysis [by classical political economists] and the
            underlying power relationships fascinates me. Like Moliere's bourgeois gentlemen, who was unaware that he
            was speaking prose, economists have developed a culture in which they communicate without any recognition
            of how much they have internalized the distorted perspective of a capitalist system. What is more surprising is
            how thoroughly the economists were able to propagate their flawed worldview throughout much of society.
            The economic worldview loses sight of essential elements of the world economists analyze. Once their
            simplistic world of economics spins out of control, economists' instinct is to explain away their deficiencies
            rather than finally coming to grips with the real world. In that sense, I feel that a critical study of economists
            and their economics becomes useful as a means of self-defense against the tyranny of markets. ... In their
            published books, the political economists at the time ignored the injustices associated with the enforcement of
            the feudal game laws, as well as the enormous economic damage done by the hunters. Instead, they described
            the economy as the result of voluntary transactions between willing buyers and sellers. Away from the public
            eye, these same economists applauded the displacement of rural masses, which was providing new bodies for
            the emerging proletariat. In this sense, capitalism was invented as I described in [the book] The Invention of
            Capitalism. Capitalism was invented in another sense. The early economists described the emergence of
            capitalism as a voluntary system that benefited everybody. This falsification of history, which was central to
            their analysis, was a very creative invention ... In [the book] The Invisible Handcuffs, I tried to show how
            economists tried to frame capitalism as a system of voluntary transactions, as I mentioned [above]. One can
            understand how the economists could have gotten away with this evasion of reality in a world when literacy
            was limited and communications [was] expensive. In a modern world, to be able to get away with such
            nonsense is an audacious act of genius. Economic theory also abstracts from virtually anything having to do
            with time.[166]
    Despite these concerns,          mainstream    graduate    programs     have   become     increasingly    technical   and
Economics                                                                                                                                              22

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Economics                                                                                                                                                  24

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           • Ross, Stephen A. "finance." Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_F000071& edition=current&
        q=Finance& topicid=& result_number=2)
           • Burnside, Craig, Martin Eichenbaum, and Sergio Rebelo. "currency crises models." Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_S000204& edition=current& q=crisis& topicid=& result_number=7)
           • Kaminsky, Graciela Laura. "currency crises." Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_C000468&
        edition=current& q=crisis& topicid=& result_number=10)
           • Calomiris, Charles W. "banking crises." Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_B000051&
        edition=current& q=crisis& topicid=& result_number=18)
    [52] Akerlof, George A. (1970). "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism", Quarterly Journal of Economics,
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    [54] From (2008), The New Palgrave Dictionary of Economics, 2nd Edition:
           • Wilson, Charles. "adverse selection", Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_A000040&
        edition=current& q=adverse selection& topicid=& result_number=1)
           • Kotowitz, Y. "moral hazard." TOC. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_M000259& edition=current&
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           • Myerson, Roger B. "revelation principle." Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_R000137&
        edition=current& q=moral& topicid=& result_number=1)
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       examination (http:/ / ideas. repec. org/ p/ wpa/ wuwpma/ 0103006. html), IDEAS at the Department of Economics, College of Liberal Arts and
       Sciences, University of Connecticut
          • Gabriel Mangano (Centre Walras-Pareto, University of Lausanne BFSH 1, 1015 Lausanne, Switzerland, and London School of
       Economics), Measuring Central Bank Independence: A Tale of Subjectivity and of Its Consequences, Oxford Economic Papers. 1998; 50:
          • Friedrich Heinemann, Does it Pay to Watch Central Bankers' Lips? The Information Content of ECB Wording (http:/ / ideas. repec. org/ p/
       zbw/ zewdip/ 4553. html), IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut
          • Stephen G. Cecchetti, Central Bank Policy Rules: Conceptual Issues and Practical Considerations (http:/ / ideas. repec. org/ p/ nbr/ nberwo/
       6306. html), IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut
    [150] Ziliak, S.T.; McCloskey, D.N. (2004). "Size Matters: The Standard Error of Regressions in the American Economic Review" (http:/ / web.
       archive. org/ web/ 20080625054144/ http:/ / www. econjournalwatch. org/ pdf/ ZiliakMcCloskeyAugust2004. pdf) (PDF). Econ Journal
       Watch 1 (2): 331–358. Archived from the original (http:/ / www. econjournalwatch. org/ pdf/ ZiliakMcCloskeyAugust2004. pdf) on
       2008-06-25. . Retrieved 2008-06-10.
    [151] Sound and Fury: McCloskey and Significance Testing in Economics (http:/ / ideas. repec. org/ p/ wpa/ wuwpem/ 0511018. html). .
       Retrieved 2008-06-10.
    [152] "How Accurate Are Private Sector Forecasts? Cross-Country Evidence from Consensus Forecasts of Output Growth", by Prakash
       Loungani, International Monetary Fund (IMF), December 2002
    [153] Rappaport, Steven (1996). "Abstraction and Unrealistic Assumptions in Economics", Journal of Economic Methodology, 3(2), pp.
       215–236. Abstract, (http:/ / www. informaworld. com/ smpp/ content~content=a739439848~db=all) (1998). Models and Reality in
       Economics. Edward Elgar, p. 6, ch. 6–8.
    [154] Friedman, Milton (1953), "The Methodology of Positive Economics", Essays in Positive Economics, University of Chicago Press, pp.
       14–15, 22, 31.
          • Boland, Lawrence A. (2008). "assumptions controversy", The New Palgrave Dictionary of Economics, 2nd Edition Online abstract. (http:/
       / www. dictionaryofeconomics. com/ article?id=pde2008_A000231& q=assumption& topicid=& result_number=1) Accessed May 30, 2008.
    [155] Hodgson, G.M (2007). "Evolutionary and Institutional Economics as the New Mainstream" (http:/ / www. jstage. jst. go. jp/ article/ eier/ 4/
       1/ 7/ _pdf). Evolutionary and Institutional Economics Review 4 (1): 7–25. . Retrieved 2010-10-02.
    [156] Keynes, J. M. (September 1924). "Alfred Marshall 1842–1924". The Economic Journal 34 (135): 311–372. doi:10.2307/2222645.
       JSTOR 2222645.
    [157] Joskow, Paul (May 1975). "Firm Decision-making Policy and Oligopoly Theory". The American Economic Review 65 (2, Papers and
       Proceedings of the Eighty–seventh Annual Meeting of the American Economic Association): 270–279, Particularly 271. JSTOR 1818864.
Economics                                                                                                                                             29

    [158] England, Paula (1993). "The Separative Self: Androcentric Bias in Neoclassical Assumptions", Beyond Economic Man: Feminist Theory
       and Economics, University of Chicago Press, pp. 37-53.
    [159] Ferber, M.A. and Julie A. Nelson, "Beyond Economic Man: Ten Years Later," in Marianne A. Ferber and Julie A. Nelson, eds., Feminist
       Economics Today: Beyond Economic Man. Chicago: University of Chicago Press, 2003.
    [160] Marilyn Waring (1988.) If Women Counted. San Francisco: Harper & Row. ISBN 0-06-250933-0
    [161] Philip Mirowski, More Heat Than Light: Economics as Social Physics (http:/ / www. amazon. com/ More-Heat-than-Light-Perspectives/
       product-reviews/ 0521426898/ ref=dp_top_cm_cr_acr_txt?ie=UTF8& showViewpoints=1). New York: Cambridge University Press, 1989,
       pp. 377–8.
    [162] Please see partial list of publications, including peer-reviewed papers and books, on John McMurtry's wikipedia page, as well as links to
       the text of several of his peer-reviewed papers and peer-reviewed secondary references analyzing and discussing his work.
    [163] John McMurtry, The Cancer Stage of Capitalism. London, Pluto Books, 1999. The book is a scholarly examination and criticism of
       economics. The book is available for free download from several sites online, for example here (http:/ / www. jaunimieciai. lt/ wp-content/
       uploads/ 2011/ 02/ the-cancer-stage-of-capitalism. pdf). (In April 2012, the author stated he is working on an updated edition.)
    [164] Cox, Adam. "Blame Nobel for crisis, says author of 'Black Swan'" (http:/ / www. reuters. com/ article/ idUSTRE68R2SK20100928),
       Reuters (2010-09-28).
    [165] Taleb, Nassim Nicholas (October 23, 2007). "The pseudo-science hurting markets" (http:/ / www. fooledbyrandomness. com/ FT-Nobel.
    [166] Self-Defense for Workers, Against Market Tyranny: An Interview with Michael Perelman (http:/ / mrzine. monthlyreview. org/ 2012/
       fanelli050512. html) by Carlo Fanelli, Monthly Review Magazine, May 5, 2012
    [167] Johansson D. (2004). "Economics without Entrepreneurship or Institutions: A Vocabulary Analysis of Graduate Textbooks" (http:/ / web.
       archive. org/ web/ 20080625054127/ http:/ / www. econjournalwatch. org/ pdf/ JohanssonPractice1December2004. pdf) (PDF). Econ Journal
       Watch 1 (3): 515–538. Archived from the original (http:/ / www. econjournalwatch. org/ pdf/ JohanssonPractice1December2004. pdf) on
       2008-06-25. . Retrieved 2008-06-07.
    [168] Sutter D, Pjesky R. (2007). "Where Would Adam Smith Publish Today? The Near Absence of Math-free Research in Top Journals" (http:/
       / www. econjournalwatch. org/ main/ intermedia. php?filename=EJWCompleteIssueMay2007. pdf#page=64). Scholarly Comments on
       Academic Economics 4 (2): 230–240. . Retrieved 2008-06-07.

    Further reading
    • McCann, Charles Robert, Jr., 2003. The Elgar Dictionary of Economic Quotations, Edward Elgar. Preview (http:/
    • Pokrovskii, Vladimir N. (2011) Econodynamics. The Theory of Social Production (
      physics/complexity/book/978-94-007-2095-4), Springer, Berlin.

    External links
    General information
    •   Economics ( at the Open Directory Project
    •   Economic journals on the web (
    •   Economics ( at Encyclopædia Britannica
    •   Intute: Economics ( Internet directory of UK universities
    •   Research Papers in Economics (RePEc) (
    •   Resources For Economists ( American Economic Association-sponsored guide to 2,000+
        Internet resources from "Data" to "Neat Stuff", updated quarterly.
    Institutions and organizations
    • Economics Departments, Institutes and Research Centers in the World (
    • Organization For Co-operation and Economic Development (OECD) Statistics (
    • United Nations Statistics Division (
    • World Bank Data (
    Study resources
Economics                                                                                                                30

    •   A guide to several online economics textbooks (
    •   Economics at (
    •   Economics textbooks on Wikibooks
    •   Introduction to Economics ( Short Creative
        commons-licensed introduction to basic economics
    •   MERLOT Learning Materials: Economics (
        US-based database of learning materials
    •   MIT OpenCourseWare: Economics ( Archive of study
        materials from MIT courses
    •   Online Learning and Teaching Materials ( UK
        Economics Network's database of text, slides, glossaries and other resources
    •   Schools of Thought ( Compare various economic schools of
        thought on particular issues
    •   The Library of Economics and Liberty (Econlib) ( Economics Books, Articles, Blog
        (EconLog), Podcasts (EconTalk)

    Economics education
    Economics education or economic education is a field within economics that focuses on two main themes: 1) the
    current state of, and efforts to improve, the economics curriculum, materials and pedagogical techniques used to
    teach economics at all educational levels; and 2) research into the effectiveness of alternative instructional
    techniques in economics, the level of economic literacy of various groups, and factors that influence the level of
    economic literacy.[1][2] Economics education is distinct from economics of education, which focuses on the
    economics of the institution of education.
    Numerous organizations devote resources toward economics education. In the United States, organizations whose
    primary purpose is the advancement of economics education include the National Council on Economic Education
    and its worldwide network of councils and centers, the Foundation for Teaching Economics and Junior
    Achievement. The U.S. National Center for Research in Economic Education is a resource for research and
    assessment in economics education. Among broader U.S. organizations that devote significant resources toward
    economics education is the Federal Reserve System. In the United Kingdom there is The Economics Network, a
    government-funded national project to support economics education in Higher education contexts, and the non-profit
    Economics & Business Education Association (EBEA) for secondary education.
    Journals devoted to the topic of economics education include the Journal of Economic Education,[3] International
    Review of Economics Education,[4] Australasian Journal of Economics Education,[5] and Computers in Higher
    Education Economics Review.
Economics education                                                                                                                          31

    [1] W.E. Becker (2001). "Economic Education," International Encyclopedia of the Social & Behavioral Sciences, pp. 4078-4084. Abstract.
        (http:/ / www. sciencedirect. com/ science?_ob=ArticleURL& _udi=B7MRM-4MT09VJ-YJ& _rdoc=6& _hierId=151000134&
        _refWorkId=21& _explode=151000131,151000134& _fmt=high& _orig=na& _docanchor=& _idxType=SC& view=c& _ct=28&
        _acct=C000050221& _version=1& _urlVersion=0& _userid=10& md5=6de8f72db39a44e991e94f47f06ae747)
    [2] Computers in Higher Education Economics Review (http:/ / www. economicsnetwork. ac. uk/ cheer)
    [3] Journal of Economic Education (http:/ / www. indiana. edu/ ~econed/ )
    [4] International Review of Economics Education (http:/ / www. economicsnetwork. ac. uk/ iree)
    [5] Australasian Journal of Economics Education (http:/ / www. uq. edu. au/ economics/ ajee/ )

    External links
    • The Economics Network (
    • Economics & Business Education Association (
    • American Economic Association (Resources for Economists) list of economic tutorials and exercises (http://rfe.

    History of economic thought
    The history of economic thought deals with different thinkers and theories in the subject that became political
    economy and economics from the ancient world to the present day. It encompasses many disparate schools of
    economic thought. Greek writers such as the philosopher Aristotle examined ideas about the art of wealth acquisition
    and questioned whether property is best left in private or public hands. In medieval times, scholars such as Thomas
    Aquinas argued that it was a moral obligation of businesses to sell goods at a just price.
    Scottish philosopher Adam Smith is often cited as the father of modern economics for his treatise The Wealth of
    Nations (1776).[1][2] His ideas built upon a considerable body of work from predecessors in the eighteenth century
    particularly the Physiocrats. His book appeared on the eve of the Industrial Revolution with associated major
    changes in the economy.[3]
    Smith's successors included such classical economists as the Rev. Thomas Malthus, Jean-Baptiste Say, David
    Ricardo, and John Stuart Mill. They examined ways the landed, capitalist and labouring classes produced and
    distributed national output and modeled the effects of population and international trade. In London, Karl Marx
    castigated the capitalist system, which he described as exploitative and alienating. From about 1870, neoclassical
    economics attempted to erect a positive, mathematical and scientifically grounded field above normative politics.
    After the wars of the early twentieth century, John Maynard Keynes led a reaction against what has been described
    as governmental abstention from economic affairs, advocating interventionist fiscal policy to stimulate economic
    demand and growth. With a world divided between the capitalist first world, the communist second world, and the
    poor of the third world, the post-war consensus broke down. Others like Milton Friedman and Friedrich von Hayek
    warned of The Road to Serfdom and socialism, focusing their theories on what could be achieved through better
    monetary policy and deregulation.
    As Keynesian policies seemed to falter in the 1970s there emerged the so-called New Classical school, with
    prominent theorists such as Robert Lucas and Edward Prescott. New Keynesian economists responded to new
    classical critiques eventually leading to a synthesis in macroeconomics. development economists like Amartya Sen
    and information economists like Joseph Stiglitz also introduced new ideas to economic thought.
History of economic thought                                                                                                         32

    Early economic thought
    The earliest discussions of economics date back to ancient times (e.g. Chanakya's Arthashastra or Xenophon's
    Oeconomicus). Back then, and until the industrial revolution, economics was not a separate discipline but part of
    philosophy. In Ancient Athens, a slave based society but also one developing an embryonic model of democracy,[4]
    Plato's book The Republic contained references to specialization of labour and production. But it was his pupil
    Aristotle that made some of the most familiar arguments, still in economic discourse today.

    Aristotle's Politics (c.a. 350 BC) was mainly concerned to analyse
    different forms of a state (monarchy, aristocracy, constitutional
    government, tyranny, oligarchy, democracy) as a critique of Plato's
    advocacy of a ruling class of "philosopher-kings". In particular for
    economists, Plato had drawn a blueprint of society on the basis of
    common ownership of resources. Aristotle viewed this model as an
    oligarchical anathema. In Politics, Book II, Part V, he argued that,

          Property should be in a certain sense common, but, as a general
          rule, private; for, when everyone has a distinct interest, men will
          not complain of one another, and they will make more progress,
          because every one will be attending to his own business... And
          further, there is the greatest pleasure in doing a kindness or
          service to friends or guests or companions, which can only be
          rendered when a man has private property. These advantages are
          lost by excessive unification of the state.[5]                              Plato and his pupil, Aristotle, have had an
                                                                                       enduring effect on Western philosophy.
    Though Aristotle certainly advocated there be many things held in
    common, he argued that not everything could be, simply because of the
    "wickedness of human nature".[5] "It is clearly better that property should be private", wrote Aristotle, "but the use of
    it common; and the special business of the legislator is to create in men this benevolent disposition." In Politics Book
    I, Aristotle discusses the general nature of households and market exchanges. For him there is a certain "art of
    acquisition" or "wealth-getting". Money itself has the sole purpose of being a medium of exchange, which means on
    its own "it is worthless... not useful as a means to any of the necessities of life".[6]

    Nevertheless, points out Aristotle, because the "instrument" of money is the same many people are obsessed with the
    simple accumulation of money. "Wealth-getting" for one's household is "necessary and honourable", while exchange
    on the retail trade for simple accumulation is "justly censured, for it is dishonourable".[7] Of the people he stated they
    as a whole thought acquisition of wealth (chrematistike) as being either the same as, or a principle of oikonomia
    (household management – oikonomos),[8][9] with oikos as house and nomos in fact translated as custom or law.[9]
    Aristotle himself was highly disapproving of usury and cast scorn on making money through means of a
History of economic thought                                                                                                      33

    Middle Ages
    Thomas Aquinas (1225–1274) was an Italian theologian and writer on
    economic issues. He taught in both Cologne and Paris, and was part of
    a group of Catholic scholars known as the Schoolmen, who moved
    their enquiries beyond theology to philosophical and scientific debates.
    In the treatise Summa Theologica Aquinas dealt with the concept of a
    just price, which he considered necessary for the reproduction of the
    social order. Bearing many similarities with the modern concept of
    long run equilibrium a just price was supposed to be one just sufficient
    to cover the costs of production, including the maintenance of a worker
    and his family. He argued it was immoral for sellers to raise their
    prices simply because buyers were in pressing need for a product.

    Aquinas discusses a number of topics in the format of questions and
    replies, substantial tracts dealing with Aristotle's theory. Questions 77
    and 78 concern economic issues, mainly relate to what a just price is,
    and to the fairness of a seller dispensing faulty goods. Aquinas argued
    against any form of cheating and recommended compensation always           St Thomas Aquinas taught that raising prices in
                                                                                response to high demand was a type of theft.
    be paid in lieu of good service. Whilst human laws might not impose
    sanctions for unfair dealing, divine law did, in his opinion. One of
    Aquinas' main critics[11] was Duns Scotus (1265–1308) in his work Sententiae (1295).

    Originally from Duns Scotland, he taught in Oxford, Cologne and Paris. Scotus thought it possible to be more
    precise than Aquinas in calculating a just price, emphasising the costs of labour and expenses – though he
    recognised that the latter might be inflated by exaggeration, because buyer and seller usually have different ideas of
    what a just price comprises. If people did not benefit from a transaction, in Scotus' view, they would not trade.
    Scotus defended merchants as performing a necessary and useful social role, transporting goods and making them
    available to the public.[11]

    Mercantilists and nationalism
    From the localism of the Middle Ages, the waning
    feudal lords, new national economic frameworks began
    to be strengthened. From 1492 and explorations like
    Christopher Columbus' voyages, new opportunities for
    trade with the New World and Asia were opening. New
    powerful monarchies wanted a powerful state to boost
    their status. Mercantilism was a political movement and
    an economic theory that advocated the use of the state's
    military power to ensure local markets and supply
    sources were protected.

    Mercantile theorists thought international trade could
    not benefit all countries at the same time. Because           A 1638 painting of a French seaport during the heyday of
    money and gold were the only source of riches, there                               mercantilism.

    was a limited quantity of resources to be shared
    between countries. Therefore, tariffs could be used to encourage exports (meaning more money comes into the
History of economic thought                                                                                                         34

    country) and discourage imports (sending wealth abroad). In other words a positive balance of trade ought to be
    maintained, with a surplus of exports. The term mercantilism was not in fact coined until the late 1763 by Victor de
    Riqueti, marquis de Mirabeau and popularised by Adam Smith, who vigorously opposed its ideas.

    Thomas Mun
    English businessman Thomas Mun (1571–1641) represents early mercantile policy in his book England's Treasure
    by Foraign Trade . Although it was not published until 1664 it was widely circulated as a manuscript before then. He
    was a member of the East India Company and also wrote about his experiences there in A Discourse of Trade from
    England unto the East Indies (1621).
    According to Mun, trade was the only way to increase England's treasure (i.e., national wealth) and in pursuit of this
    end he suggested several courses of action. Important were frugal consumption to increase the amount of goods
    available for export, increased utilisation of land and other domestic natural resources to reduce import requirements,
    lowering of export duties on goods produced domestically from foreign materials, and the export of goods with
    inelastic demand because more money could be made from higher prices.

    Philipp von Hörnigk
    Philipp von Hörnigk (1640–1712, sometimes spelt Hornick or
    Horneck) was born in Frankfurt am Main and became an Austrian
    civil servant writing in a time when his country was constantly
    threatened by Ottoman invasion. In Österreich Über Alles, Wann
    es Nur Will (1684, Austria Over All, If She Only Will) he laid out
    one of the clearest statements of mercantile policy. He listed nine
    principal rules of national economy.

          To inspect the country's soil with the greatest care, and not
          to leave the agricultural possibilities of a single corner or
          clod of earth unconsidered... All commodities found in a
          country, which cannot be used in their natural state, should
          be worked up within the country... Attention should be
          given to the population, that it may be as large as the
          country can support... gold and silver once in the country are
          under no circumstances to be taken out for any purpose...
          The inhabitants should make every effort to get along with
          their domestic products... [Foreign commodities] should be
          obtained not for gold or silver, but in exchange for other
          domestic wares... and should be imported in unfinished
          form, and worked up within the country... Opportunities
          should be sought night and day for selling the country's
                                                                               The title page to Philipp von Hörnigk statement of
          superfluous goods to these foreigners in manufactured                             mercantilist philosophy.
          form... No importation should be allowed under any
          circumstances of which there is a sufficient supply of suitable quality at home.

    Nationalism, self-sufficiency and national power were the basic policies proposed.[12]
History of economic thought                                                                                                      35

    Jean-Baptiste Colbert
    Jean-Baptiste Colbert (1619–1683) was Minister of Finance under King Louis XIV of France. He set up national
    guilds to regulate major industries. Silk, linen, tapestry, furniture manufacture and wine were examples of the crafts
    in which France specialised, all of which came to require membership of a guild to operate in. These remained until
    the French revolution. According to Colbert, "It is simply, and solely, the abundance of money within a state [which]
    makes the difference in its grandeur and power."

    British enlightenment
    Britain had gone through some of its most troubling times through the 17th century, enduring not only political and
    religious division in the English Civil War, King Charles I's execution and the Cromwellian dictatorship, but also the
    plagues and fires. The monarchy was restored under Charles II, who had catholic sympathies, but his successor King
    James II was swiftly ousted. Invited in his place were Protestant William of Orange and Mary, who assented to the
    Bill of Rights 1689 ensuring that the Parliament was dominant in what became known as the Glorious revolution.
    The upheaval had seen a number of huge scientific advances, including Robert Boyle's discovery of the gas pressure
    constant (1660) and Sir Isaac Newton's publication of Philosophiae Naturalis Principia Mathematica (1687), which
    described the three laws of motion and his law of universal gravitation. All these factors spurred the advancement of
    economic thought. For instance, Richard Cantillon (1680–1734) consciously imitated Newton's forces of inertia and
    gravity in the natural world with human reason and market competition in the economic world.[13] In his Essay on
    the Nature of Commerce in General, he argued rational self-interest in a system of freely adjusting markets would
    lead to order and mutually compatible prices. Unlike the mercantilist thinkers however, wealth was found not in
    trade but in human labour. The first person to tie these ideas into a political framework was John Locke.

    John Locke
    John Locke (1632–1704) was born near Bristol and educated in
    London and Oxford. He is considered one of the most significant
    philosophers of his era mainly for his critique of Thomas Hobbes'
    defense of absolutism in Leviathan (1651) and the development of
    social contract theory. Locke believed that people contracted into
    society which was bound to protect their rights of property.[14] He
    defined property broadly to include people's lives and liberties, as well
    as their wealth. When people combined their labour with their
    surroundings, then that created property rights. In his words from his
    Second Treatise on Civil Government (1689),

          God hath given the world to men in common... Yet every man
          has a property in his own person. The labour of his body and the
          work of his hands we may say are properly his. Whatsoever,
          then, he removes out of the state that nature hath provided and
          left it in, he hath mixed his labour with, and joined to it             John Locke combined philosophy, politics and
          something that is his own, and thereby makes it his property.[15]          economics into one coherent framework.

    Locke was arguing that not only should the government cease
    interference with people's property (or their "lives, liberties and estates") but also that it should positively work to
    ensure their protection. His views on price and money were laid out in a letter to a Member of Parliament in 1691
    entitled Some Considerations on the Consequences of the Lowering of Interest and the Raising of the Value of
    Money (1691). Here Locke argued that the "price of any commodity rises or falls, by the proportion of the number of
    buyers and sellers", a rule which "holds universally in all things that are to be bought and sold."[16]
History of economic thought                                                                                                36

    Dudley North
    Dudley North (1641–1691) was a wealthy merchant and landowner.
    He worked as an official for the Treasury and was opposed to most
    mercantile policy. In his Discourses upon trade (1691), which he
    published anonymously, he argued that the assumption of needing a
    favourable trade balance was wrong. Trade, he argued, benefits both
    sides, it promotes specialisation, the division of labour and produces an
    increase in wealth for everyone. Regulation of trade interfered with
    these benefits by reducing the flow of wealth.

    David Hume
    David Hume (1711–1776) agreed with North's philosophy and
    denounced mercantile assumptions. His contributions were set down in
    Political Discourses (1752), later consolidated in his Essays, Moral,
                                                                                 Dudley North argued that the results of
    Political, Literary (1777). Added to the fact that it was undesirable to     mercantile policy would be undesirable.
    strive for a favourable balance of trade it is, said Hume, in any case

    Hume held that any surplus of exports that might be achieved would be paid for by imports of gold and silver. This
    would increase the money supply, causing prices to rise. That in turn would cause a decline in exports until the
    balance with imports is restored.
History of economic thought                                                                                                      37

    Francis Hutcheson
    Francis Hutcheson (1694–1746) was teacher to Adam Smith during 1737-1740,[17] and is considered to be at the end
    of a long tradition of thought on economics as "household or family (οἶκος) management",[18][19][20] stemming from
    Xenophon's work Oeconomicus.[21][22]

    The circular flow
    Similarly disenchanted with regulation on trademarks inspired by
    mercantilism, a Frenchman name Vincent de Gournay (1712–1759) is
    reputed to have asked why it was so hard to laissez faire, laissez passer
    (free enterprise, free trade). He was one of the early physiocrats, a
    word from Greek meaning "government of nature", who held that
    agriculture was the source of wealth. As historian David B. Danbom
    wrote, the Physiocrats "damned cities for their artificiality and praised
    more natural styles of living. They celebrated farmers."[23] Over the
    end of the seventeenth and beginning of the eighteenth century big
    advances in natural science and anatomy were being made, including
    the discovery of blood circulation through the human body. This
    concept was mirrored in the physiocrats' economic theory, with the
    notion of a circular flow of income throughout the economy.

    François Quesnay (1694–1774) was the court physician to King Louis
    XV of France. He believed that trade and industry were not sources of
    wealth, and instead in his book, Tableau économique (1758, Economic
    Table) argued that agricultural surpluses, by flowing through the
                                                                                 Pierre Samuel du Pont de Nemours, a prominent
    economy in the form of rent, wages and purchases were the real
                                                                                   Physiocrat, emigrated to the US and his son
    economic movers. Firstly, said Quesnay, regulation impedes the flow            founded DuPont, the world's second biggest
    of income throughout all social classes and therefore economic                             chemicals company.
    development. Secondly, taxes on the productive classes, such as
    farmers, should be reduced in favour of rises for unproductive classes, such as landowners, since their luxurious way
    of life distorts the income flow. David Ricardo later showed that taxes on land are non-transferable to tenants in his
    Law of Rent.

    Jacques Turgot (1727–1781) was born in Paris and from an old Norman family. His best known work, Réflexions sur
    la formation et la distribution des richesses (1766, Reflections on the Formation and Distribution of Wealth)
    developed Quesnay's theory that land is the only source of wealth. Turgot viewed society in terms of three classes:
    the productive agricultural class, the salaried artisan class (classe stipendice) and the landowning class (classe
    disponible). He argued that only the net product of land should be taxed and advocated the complete freedom of
    commerce and industry.
    In August 1774, Turgot was appointed to be Minister of Finance and in the space of two years introduced many
    anti-mercantile and anti-feudal measures supported by the King. A statement of his guiding principles, given to the
    King were "no bankruptcy, no tax increases, no borrowing." Turgot's ultimate wish was to have a single tax on land
    and abolish all other indirect taxes, but measures he introduced before that were met with overwhelming opposition
    from landed interests. Two edicts in particular, one suppressing corvées (charges from farmers to aristocrats) and
    another renouncing privileges given to guilds inflamed influential opinion. He was forced from office in 1776.
History of economic thought                                                                                                   38

    Adam Smith and The Wealth of Nations
    Adam Smith (1723–1790) is popularly seen as the father of modern
    political economy. His publication of the An Inquiry Into the Nature
    and Causes of the Wealth of Nations in 1776 happened to coincide not
    only with the American Revolution, shortly before the Europe wide
    upheavals of the French Revolution, but also the dawn of a new
    industrial revolution that allowed more wealth to be created on a larger
    scale than ever before. Smith was a Scottish moral philosopher, whose
    first book was The Theory of Moral Sentiments (1759). He argued in it
    that people's ethical systems develop through personal relations with
    other individuals, that right and wrong are sensed through others'
    reactions to one's behaviour. This gained Smith more popularity than
    his next work, The Wealth of Nations, which the general public initially
    ignored.[24] Yet Smith's political economic magnum opus was
    successful in circles that mattered.                                         Adam Smith, the father of modern political

    William Pitt, the Tory Prime Minister in the late 1780s based his tax proposals on Smith's ideas and advocated free
    trade as a devout disciple of The Wealth of Nations.[25] Smith was appointed a commissioner of customs and within
    twenty years Smith had a following of new generation writers who were intent on building the science of political
    Smith expressed an affinity himself to the opinions of Edmund Burke,
    known widely as a political philosopher, a Member of Parliament.
          Burke is the only man I ever knew who thinks on economic
          subjects exactly as I do without any previous communication
          having passed between us.[26]
    Burke was an established political economist himself, with his book
    Thoughts and Details on Scarcity. He was widely critical of liberal
    politics, and condemned the French Revolution which began in 1789.
    In Reflections on the Revolution in France (1790) he wrote that the
    "age of chivalry is dead, that of sophisters, economists and calculators
    has succeeded, and the glory of Europe is extinguished forever."
    Smith's contemporary influences included François Quesnay and
    Jacques Turgot whom he met on a stay in Paris, and David Hume, his
    Scottish compatriot. The times produced a common need among
    thinkers to explain social upheavals of the Industrial revolution taking                  Edmund Burke.

    place, and in the seeming chaos without the feudal and monarchical
    structures of Europe, show there was order still.
History of economic thought                                                                                                                         39

    The invisible hand

    "It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own
    self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their

    Adam Smith's famous statement on self-interest

    Smith argued for a "system of natural liberty"[28] where individual effort was the producer of social good. Smith
    believed even the selfish within society were kept under restraint and worked for the good of all when acting in a
    competitive market. Prices are often unrepresentative of the true value of goods and services. Following John Locke,
    Smith thought true value of things derived from the amount of labour invested in them.
            Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries,
            conveniencies, and amusements of human life. But after the division of labour has once thoroughly taken
            place, it is but a very small part of these with which a man's own labour can supply him. The far greater part of
            them he must derive from the labour of other people, and he must be rich or poor according to the quantity of
            that labour which he can command, or which he can afford to purchase. The value of any commodity,
            therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it
            for other commodities, is equal to the quantity of labour which it enables him to purchase or command.
            Labour, therefore, is the real measure of the exchangeable value of all commodities. The real price of every
            thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring
    When the butchers, the brewers and the bakers acted under the restraint of an open market economy, their pursuit of
    self-interest, thought Smith, paradoxically drives the process to correct real life prices to their just values. His classic
    statement on competition goes as follows.
            When the quantity of any commodity which is brought to market falls short of the effectual demand, all those
            who are willing to pay... cannot be supplied with the quantity which they want... Some of them will be willing
            to give more. A competition will begin among them, and the market price will rise... When the quantity
            brought to market exceeds the effectual demand, it cannot be all sold to those who are willing to pay the whole
            value of the rent, wages and profit, which must be paid to bring it thither... The market price will sink...[30]
    Smith believed that a market produced what he dubbed the "progress of opulence". This involved a chain of
    concepts, that the division of labour is the driver of economic efficiency, yet it is limited to the widening process of
    markets. Both labour division and market widening requires more intensive accumulation of capital by the
    entrepreneurs and leaders of business and industry. The whole system is underpinned by maintaining the security of
    property rights.
History of economic thought                                                                                                  40

    Smith's vision of a free market economy, based on secure property,
    capital accumulation, widening markets and a division of labour
    contrasted with the mercantilist tendency to attempt to "regulate all evil
    human actions."[28] Smith believed there were precisely three
    legitimate functions of government. The third function was...
          ...erecting and maintaining certain public works and certain
          public institutions, which it can never be for the interest of any
          individual or small number of individuals, to erect and
          maintain... Every system which endeavours... to draw towards a
          particular species of industry a greater share of the capital of the
          society than what would naturally go to it... retards, instead of
          accelerating, the progress of the society toward real wealth and
    In addition to the necessity of public leadership in certain sectors Smith
    argued, secondly, that cartels were undesirable because of their
    potential to limit production and quality of goods and services.[31]
                                                                                  Adam Smith's title page of The Wealth of
    Thirdly, Smith criticised government support of any kind of monopoly                         Nations.
    which always charges the highest price "which can be squeezed out of
    the buyers".[32] The existence of monopoly and the potential for cartels, which would later form the core of
    competition law policy, could distort the benefits of free markets to the advantage of businesses at the expense of
    consumer sovereignty.

    Classical political economy
    The classical economists were referred to as a group for the first time by Karl Marx.[33] One unifying part of their
    theories was the labour theory of value, contrasting to value deriving from a general equilibrium of supply and
    demand. These economists had seen the first economic and social transformation brought by the Industrial
    Revolution: rural depopulation, precariousness, poverty, apparition of a working class.
    They wondered about the population growth, because the demographic transition had begun in Great Britain at that
    time. They also asked many fundamental questions, about the source of value, the causes of economic growth and
    the role of money in the economy. They supported a free-market economy, arguing it was a natural system based
    upon freedom and property. However, these economists were divided and did not make up a unified current of
    A notable current within classical economics was underconsumption theory, as advanced by the Birmingham School
    and Malthus in the early 19th century. These argued for government action to mitigate unemployment and economic
    downturns, and was an intellectual predecessor of what later became Keynesian economics in the 1930s. Another
    notable school was Manchester capitalism, which advocated free trade, against the previous policy of mercantilism.
History of economic thought                                                                                                        41

    Jeremy Bentham
    Jeremy Bentham (1748–1832) was perhaps the most radical
    thinker of his time, and developed the concept of utilitarianism.
    Bentham was an atheist, a prison reformer, animal rights activist,
    believer in universal suffrage, free speech, free trade and health
    insurance at a time when few dared to argue for any. He was
    schooled rigorously from an early age, finishing university and
    being called to the bar at 18. His first book, A Fragment on
    Government (1776) published anonymously was a trenchant
    critique of William Blackstone's Commentaries of the laws of
    England. This gained wide success until it was found that the
    young Bentham, and not a revered Professor had penned it. In The
    Principles of Morals and Legislation (1791) Bentham set out his
    theory of utility.[34]

    The aim of legal policy must be to decrease misery and suffering
    so far as possible while producing the greatest happiness for the
    greatest number.[35] Bentham even designed a comprehensive
    methodology for the calculation of aggregate happiness in society      Jeremy Bentham believed in "the greatest good for the
    that a particular law produced, a felicific calculus.[36] Society,                     greatest number".
    argued Bentham, is nothing more than the total of individuals,[37]
    so that if one aims to produce net social good then one need only to ensure that more pleasure is experienced across
    the board than pain, regardless of numbers.

    For example, a law is proposed to make every bus in the city wheel chair accessible, but slower moving as a result
    than its predecessors because of the new design. Millions of bus users will therefore experience a small amount of
    displeasure (or "pain") in increased traffic and journey times, but a minority of people using wheel chairs will
    experience a huge amount of pleasure at being able to catch public transport, which outweighs the aggregate
    displeasure of other users.
    Interpersonal comparisons of utility were allowed by Bentham, the idea that one person's vast pleasure can count
    more than many others' pain. Much criticism later showed how this could be twisted, for instance, would the felicific
    calculus allow a vastly happy dictator to outweigh the dredging misery of his exploited populus? Despite Bentham's
    methodology there were severe obstacles in measuring people's happiness.
History of economic thought                                                                                                            42

    Jean-Baptiste Say
    Jean-Baptiste Say (1767–1832) was a Frenchman, born in Lyon who helped to
    popularise Adam Smith's work in France.[38] His book, A Treatise on Political
    Economy (1803) contained a brief passage, which later became orthodoxy in
    political economics until the Great Depression and known as Say's Law of
    markets. Say argued that there could never be a general deficiency of demand or
    a general glut of commodities in the whole economy. People produce things, said
    Say, to fulfill their own wants, rather than those of others. Production is therefore
    not a question of supply, but an indication of producers demanding goods.

    Say agreed that a part of the income is saved by the households, but in the long
    term, savings are invested. Investment and consumption are the two elements of
    demand, so that production is demand, so it is impossible for production to
    outrun demand, or for there to be a "general glut" of supply. Say also argued that          Say's law, that supply always equals
    money was neutral, because its sole role is to facilitate exchanges: therefore,             demand, was unchallenged until the
    people demand money only to buy commodities. Say said that "money is a veil".                           20th century.

    To sum up these two ideas, Say said "products are exchanged for products". At most, there will be different
    economic sectors whose demands are not fulfilled. But over time supplies will shift, businesses will retool for
    different production and the market will correct itself. An example of a "general glut" could be unemployment, in
    other words, too great a supply of workers, and too few jobs. Say's Law advocates would suggest that this
    necessarily means there is an excess demand for other products that will correct itself. This remained a foundation of
    economic theory until the 1930s. Say's Law was first put forward by James Mill (1773–1836) in English, and was
    advocated by David Ricardo, Henry Thornton[39] and John Stuart Mill. However two political economists, Thomas
    Malthus and Sismondi, were unconvinced.

    Thomas Malthus
    Thomas Malthus (1766–1834) was a Tory minister in the United
    Kingdom Parliament who, contrasting to Bentham, believed in
    strict government abstention from social ills.[40] Malthus devoted
    the last chapter of his book Principles of Political Economy (1820)
    to rebutting Say's law, and argued that the economy could stagnate
    with a lack of "effectual demand".[41]

    In other words, wages if less than the total costs of production
    cannot purchase the total output of industry and that this would
    cause prices to fall. Price falls decrease incentives to invest, and
    the spiral could continue indefinitely. Malthus is more notorious
    however for his earlier work, An Essay on the Principle of
    Population. This argued that intervention was impossible because
    of two factors. "Food is necessary to the existence of man", wrote
    Malthus. "The passion between the sexes is necessary and will
    remain nearly in its present state", he added, meaning that the
    "power of the population is infinitely greater than the power in the
    Earth to produce subsistence for man."[42]                                Malthus cautioned law makers on the effects of poverty
                                                                                               reduction policies.
History of economic thought                                                                                                     43

    Nevertheless growth in population is checked by "misery and vice". Any increase in wages for the masses would
    cause only a temporary growth in population, which given the constraints in the supply of the Earth's produce would
    lead to misery, vice and a corresponding readjustment to the original population.[43] However more labour could
    mean more economic growth, either one of which was able to be produced by an accumulation of capital.

    David Ricardo
    David Ricardo (1772–1823) was born in London. By the age of
    26, he had become a wealthy stock market trader and bought
    himself a constituency seat in Ireland to gain a platform in the
    British parliament's House of Commons.[44] Ricardo's best known
    work is his Principles of Political Economy and Taxation, which
    contains his critique of barriers to international trade and a
    description of the manner the income is distributed in the
    population. Ricardo made a distinction between the workers, who
    received a wage fixed to a level at which they can survive, the
    landowners, who earn a rent, and capitalists, who own capital and
    receive a profit, a residual part of the income.[45]

    If population grows, it becomes necessary to cultivate additional
    land, whose fertility is lower than that of already cultivated fields,
    because of the law of decreasing productivity. Therefore, the cost
    of the production of the wheat increases, as well as the price of the
    wheat: The rents increase also, the wages, indexed to inflation
                                                                               Ricardo is renowned for his law of comparative
    (because they must allow workers to survive) too. Profits decrease,                         advantage.
    until the capitalists can no longer invest. The economy, Ricardo
    concluded, is bound to tend towards a steady state.

    To postpone the steady state, Ricardo advocates to promote international trade to import wheat at a low price to fight
    landowners. The Corn Laws of the UK had been passed in 1815, setting a fluctuating system of tariffs to stabilise the
    price of wheat in the domestic market. Ricardo argued that raising tariffs, despite being intended to benefit the
    incomes of farmers, would merely produce a rise in the prices of rents that went into the pockets of landowners.[46]
    Furthermore, extra labour would be employed leading to an increase in the cost of wages across the board, and
    therefore reducing exports and profits coming from overseas business. Economics for Ricardo was all about the
    relationship between the three "factors of production": land, labour and capital. Ricardo demonstrated
    mathematically that the gains from trade could outweigh the perceived advantages of protectionist policy. The idea
    of comparative advantage suggests that even if one country is inferior at producing all of its goods than another, it
    may still benefit from opening its borders since the inflow of goods produced more cheaply than at home, produces a
    gain for domestic consumers.[47] According then to Ricardo, this concept would lead to a shift in prices, so that
    eventually England would be producing goods in which its comparative advantages were the highest.
History of economic thought                                                                                                     44

    John Stuart Mill
    John Stuart Mill (1806–1873) was the dominant figure of political
    economic thought of his time, as well as being a Member of Parliament
    for the seat of Westminster, and a leading political philosopher. Mill
    was a child prodigy, reading Ancient Greek from the age of 3, and
    being vigorously schooled by his father James Mill.[48] Jeremy
    Bentham was a close mentor and family friend, and Mill was heavily
    influenced by David Ricardo. Mill's textbook, first published in 1848
    and titled Principles of Political Economy was essentially a summary
    of the economic wisdom of the mid nineteenth century.[49]

    Principles of Political Economy was used as the standard texts by most
    universities well into the beginning of the twentieth century. On the
    question of economic growth Mill tried to find a middle ground
    between Adam Smith's view of ever expanding opportunities for trade
                                                                                John Stuart Mill, weaned on the philosophy of
    and technological innovation and Thomas Malthus' view of the
                                                                                 Jeremy Bentham, wrote the most authoritative
    inherent limits of population. In his fourth book Mill set out a number               economics text of his time.
    of possible future outcomes, rather than predicting one in particular.
    The first followed the Malthusian line that population grew quicker than supplies, leading to falling wages and rising

    The second, per Smith, said if capital accumulated faster than population grew then real wages would rise. Third,
    echoing David Ricardo, should capital accumulate and population increase at the same rate, yet technology stay
    stable, there would be no change in real wages because supply and demand for labour would be the same. However
    growing populations would require more land use, increasing food production costs and therefore decreasing profits.
    The fourth alternative was that technology advanced faster than population and capital stock increased.[51]
    The result would be a prospering economy. Mill felt the third scenario most likely, and he assumed technology
    advanced would have to end at some point.[52] But on the prospect of continuing economic growth, Mill was more
          I confess I am not charmed with the ideal of life held out by those who think that the normal state of human
          beings is that of struggling to get on; that the trampling, crushing, elbowing, and treading on each other's heels,
          which form the existing type of social life, are the most desirable lot of human kind, or anything but the
          disagreeable symptoms of one of the phases of industrial progress.[53]
    Mill is also credited with being the first person to speak of supply and demand as a relationship rather than mere
    quantities of goods on markets,[54] the concept of opportunity cost and the rejection of the wage fund doctrine.[55]
History of economic thought                                                                                                        45

    Capitalism and Marx
                                                         Just as the term "mercantilism" had been coined and popularised by its
                                                         critics, like Adam Smith, so was the term "capitalism" or Kapitalismus
                                                         used by its dissidents, primarily Karl Marx. Karl Marx (1818–1883)
                                                         was, and in many ways still remains the pre-eminent socialist
                                                         economist. His combination of political theory represented in the
                                                         Communist Manifesto and the dialectic theory of history inspired by
                                                         Friedrich Hegel provided a revolutionary critique of capitalism as he
                                                         saw it in the nineteenth century. The socialist movement that he joined
                                                         had emerged in response to the conditions of people in the new
                                                         industrial era and the classical economics which accompanied it. He
                                                         wrote his magnum opus Das Kapital at the British Museum's library.

        Karl Marx provided a fundamental critique of
       classical economics, based on the labour theory
                          of value.

    Robert Owen (1771–1858) was one industrialist who determined to
    improve the conditions of his workers. He bought textile mills in New
    Lanark, Scotland where he forbade children under ten to work, set the
    workday from 6 a.m. to 7 p.m. and provided evening schools for
    children when they finished. Such meagre measures were still
    substantial improvements and his business remained solvent through
    higher productivity, though his pay rates were lower than the national
    average.[56] He published his vision in The New View of Society (1816)
    during the passage of the Factory Acts, but his attempt from 1824 to
    begin a new utopian community in New Harmony, Indiana ended in
    failure. One of Marx's own influences was the French
    anarchist/socialist Pierre-Joseph Proudhon. While deeply critical of
    capitalism and in favour of workers' associations to replace it, he also
    objected to those contemporary socialists who idolized centralised
    state-run association. In System of Economic Contradictions (1846)                With Marx, Friedrich Engels coauthored the
                                                                                   Communist Manifesto, and the second volume of
    Proudhon made a wide-ranging critique of capitalism, analysing the
                                                                                                     Das Kapital.
    contradictory effects of machinery, competition, property, monopoly
    and other aspects of the economy.[57][58] Instead of capitalism, he
    argued for a mutualist system "based upon equality, – in other words, the organisation of labour, which involves the
    negation of political economy and the end of property." In his book What is Property? (1840) he argue that property
    is theft, a different view than the classical Mill, who had written that "partial taxation is a mild form of robbery".[59]

    However, towards the end of his life, Proudhon modified some of his earlier views. In the posthumously published
    Theory of Property, he argued that "property is the only power that can act as a counterweight to the State."[60]
History of economic thought                                                                                                             46

    Friedrich Engels, a published radical author, released a book titled The Condition of the Working Class in England in
    1844[61] describing people's positions as "the most unconcealed pinnacle of social misery in our day." After Marx
    died, it was Engels that completed the second volume of Das Kapital from Marx's notes.

    Das Kapital
                                                           Karl Marx begins Das Kapital with the concept of commodities.
                                                           Before capitalist societies, says Marx, the mode of production was
                                                           based on slavery (e.g. in ancient Rome) before moving to feudal
                                                           serfdom (e.g. in mediaeval Europe). As society has advanced,
                                                           economic bondage has become looser, but the current nexus of labour
                                                           exchange has produced an equally erratic and unstable situation
                                                           allowing the conditions for revolution. People buy and sell their labour
                                                           in the same way as people buy and sell goods and services. People
                                                           themselves are disposable commodities. As he wrote in the Communist

                                                                 The history of all hitherto existing society is the history of class
                                                                 struggles. Freeman and slave, patrician and plebeian, lord and
                                                                 serf, guildmaster and journeyman, in a word, oppressor and
                                                                 oppressed, stood in constant opposition to one another... The
                                                                 modern bourgeois society that has sprouted from the ruins of
                                                                 feudal society has not done away with class antagonisms. It has
       The title page of the first edition of Capital in         but established new classes, new conditions of oppression, new
                                                                 forms of struggle in place of the old ones.
                                                           And furthermore from the first page of Das Kapital,
           The wealth of those societies in which the capitalist mode of production prevails, presents itself as an immense
           accumulation of commodities,[62] its unit being a single commodity. Our investigation must therefore begin
           with the analysis of a commodity.
    Marx's use of the word "commodity" is tied into an extensive metaphysical discussion of the nature of material
    wealth, how the objects of wealth are perceived and how they can be used. The concept of a commodity contrasts to
    objects of the natural world. When people mix their labour with an object it becomes a "commodity". In the natural
    world there are trees, diamonds, iron ore and people. In the economic world they become chairs, rings, factories and
    workers. However, says Marx, commodities have a dual nature, a dual value. He distinguishes the use value of a
    thing from its exchange value, which can be entirely different.[63] The use value of a thing derives from the amount
    of labour used to produce it, says Marx, following the classical economists in the labour theory of value. However,
    Marx did not believe labour only was the source of use value in things. He believed value can derive too from
    natural goods and refined his definition of use value to "socially necessary labour time" (the time people need to
    produce things when they are not lazy or inefficient).[64] Furthermore, people subjectively inflate the value of things,
    for instance because there's a commodity fetish for glimmering diamonds,[65] and oppressive power relations
    involved in commodity production. These two factors mean exchange values differ greatly. An oppressive power
    relation, says Marx applying the use/exchange distinction to labour itself, in work-wage bargains derives from the
    fact that employers pay their workers less in "exchange value" than the workers produce in "use value". The
    difference makes up the capitalist's profit, or in Marx's terminology, "surplus value".[66] Therefore, says Marx,
    capitalism is a system of exploitation.
History of economic thought                                                                                                           47

    Marx's work turned the labour theory of value, as the classicists used it,
    on its head. His dark irony goes deeper by asking what is the socially
    necessary labour time for the production of labour (i.e. working
    people) itself. Marx answers that this is the bare minimum for people
    to subsist and to reproduce with skills necessary in the economy.[67]
    People are therefore alienated from both the fruits of production and
    the means to realise their potential, psychologically, by their oppressed
    position in the labour market. But the tale told alongside exploitation
    and alienation is one of capital accumulation and economic growth.
    Employers are constantly under pressure from market competition to
    drive their workers harder, and at the limits invest in labour displacing
    technology (e.g. an assembly line packer for a robot). This raises
    profits and expands growth, but for the sole benefit of those who have
    private property in these means of production. The working classes
    meanwhile face progressive immiseration, having had the product of
                                                                                 Marx explained the booms and busts, like the
    their labour exploited from them, having been alienated from the tools     Panic of 1873, as part of an inherent instability in
    of production. And having been fired from their jobs for machines,                       capitalist economies.
    they end unemployed. Marx believed that a reserve army of the
    unemployed would grow and grow, fuelling a downward pressure on wages as desperate people accept work for less.
    But this would produce a deficit of demand as the people's power to purchase products lagged. There would be a glut
    in unsold products, production would be cut back, profits decline until capital accumulation halts in an economic
    depression. When the glut clears, the economy again starts to boom before the next cyclical bust begins. With every
    boom and bust, with every capitalist crisis, thought Marx, tension and conflict between the increasingly polarised
    classes of capitalists and workers heightens. Moreover smaller firms are being gobbled by larger ones in every
    business cycle, as power is concentrated in the hands of the few and away from the many. Ultimately, led by the
    Communist party, Marx envisaged a revolution and the creation of a classless society. How this may work, Marx
    never suggested. His primary contribution was not in a blue print for how society would be, but a criticism of what
    he saw it was.

    After Marx
    The first volume of Das Kapital was the only one Marx alone published. The second and third volumes were done
    with the help of Friedrich Engels, and Karl Kautsky, who had become a friend of Engels, saw through the
    publication of volume four.
    Marx had begun a tradition of economists who concentrated equally on political affairs. Also in Germany, Rosa
    Luxemburg was a member of the SPD, who later turned towards the Communist Party because of their stance against
    the First World War. Beatrice Webb in England was a socialist, who helped found both the London School of
    Economics (LSE) and the Fabian Society.

    Neoclassical thought
    In the 1860s, a revolution took place in economics. The new ideas were that of the Marginalist school. Writing
    simultaneously and independently, a Frenchman (Léon Walras), an Austrian (Carl Menger) and an Englishman
    (Stanley Jevons) were developing the theory, which had some antecedents. Instead of the price of a good or service
    reflecting the labor that has produced it, it reflects the marginal usefulness (utility) of the last purchase. This meant
    that in equilibrium, people's preferences determined prices, including, indirectly the price of labor.
History of economic thought                                                                                                    48

    This current of thought was not united, and there were three main schools working independently. The Lausanne
    school, whose two main representants were Walras and Vilfredo Pareto, developed the theories of general
    equilibrium and optimality. The main written work of this school was Walras' Elements of Pure Economics. The
    Cambridge school appeared with Jevons' Theory of Political Economy in 1871. This English school has developed
    the theories of the partial equilibrium and has insisted on markets' failures. The main representatives were Alfred
    Marshall, Stanley Jevons and Arthur Pigou. The Vienna school was made up of Austrian economists Menger, Eugen
    von Böhm-Bawerk and Friedrich von Wieser. They developed the theory of capital and has tried to explain the
    presence of economic crises. It appeared in 1871 with Menger's Principles of Economics.

    Marginal utility
    Carl Menger (1840–1921), an Austrian economist stated the basic
    principle      of     marginal       utility    in    Grundsätze       der
    Volkswirtschaftslehre        (1871, Principles of Economics). Consumers
    act rationally by seeking to maximise satisfaction of all their
    preferences. People allocate their spending so that the last unit of a
    commodity bought creates no more than a last unit bought of
    something else. Stanley Jevons (1835–1882) was his English
    counterpart, and worked as tutor and later professor at Owens College,
    Manchester and University College, London. He emphasised in the
    Theory of Political Economy (1871) that at the margin, the satisfaction
    of goods and services decreases. An example of the theory of
    diminishing returns is that for every orange one eats, the less pleasure
    one gets from the last orange (until one stops eating). Then Léon
    Walras (1834–1910), again working independently, generalised
    marginal theory across the economy in Elements of Pure Economics
    (1874). Small changes in people's preferences, for instance shifting           William Stanley Jevons helped popularise
                                                                                           marginal utility theory.
    from beef to mushrooms, would lead to a mushroom price rise, and
    beef price fall. This stimulates producers to shift production, increasing
    mushrooming investment, which would increase market supply and a new price equilibrium between the products –
    e.g. lowering the price of mushrooms to a level between the two first levels. For many products across the economy
    the same would go, if one assumes markets are competitive, people choose on self-interest and no cost in shifting

    Early attempts to explain away the periodical crises of which Marx had spoken were not initially as successful. After
    finding a statistical correlation of sunspots and business fluctuations and following the common belief at the time
    that sunspots had a direct effect on weather and hence agricultural output, Stanley Jevons wrote,
          when we know that there is a cause, the variation of the solar activity, which is just of the nature to affect the
          produce of agriculture, and which does vary in the same period, it becomes almost certain that the two series
          of phenomena – credit cycles and solar variations – are connected as effect and cause.[69]
History of economic thought                                                                                                        49

    Mathematical analysis
    Vilfredo Pareto (1848–1923) was an Italian economist, best known for
    developing the concept of an economy that would permit maximizing the utility
    level of each individual, given the feasible utility level of others from production
    and exchange. Such a result came to be called "Pareto efficient". Pareto devised
    mathematical representations for such a resource allocation, notable in
    abstracting from institutional arrangements and monetary measures of wealth or
    income distribution.[70]

    Alfred Marshall is also credited with an attempt to put economics on a more
    mathematical footing. He was the first Professor of Economics at the University
    of Cambridge and his work, Principles of Economics[71] coincided with the
    transition of the subject from "political economy" to his favoured term,
    "economics". He viewed maths as a way to simplify economic reasoning, though
                                                                                              Alfred Marshall wrote the main
    had reservations, revealed in a letter to his student Arthur Cecil Pigou.
                                                                                             alternative textbook to John Stuart
          (1) Use mathematics as shorthand language, rather than as an engine of                Mill of the day, Principles of
                                                                                                      Economics (1882)
          inquiry. (2) Keep to them till you have done. (3) Translate into English. (4)
          Then illustrate by examples that are important in real life. (5) Burn the
          mathematics. (6) If you can't succeed in 4, burn 3. This I do often.[72]
    Coming after the marginal revolution, Marshall concentrated on reconciling the classical labour theory of value,
    which had concentrated on the supply side of the market, with the new marginalist theory that concentrated on the
    consumer demand side. Marshalls graphical representation is the famous supply and demand graph, the "Marshallian
    cross". He insisted it is the intersection of both supply and demand that produce an equilibrium of price in a
    competitive market. Over the long run, argued Marshall, the costs of production and the price of goods and services
    tend towards the lowest point consistent with continued production. Arthur Cecil Pigou in Wealth and Welfare
    (1920), insisted on the existence of market failures. Markets are inefficient in case of economic externalities, and the
    State must interfere. However, Pigou retained free-market beliefs, and in 1933, in the face of the economic crisis, he
    explained in The Theory of Unemployment that the excessive intervention of the state in the labor market was the real
    cause of massive unemployment, because the governments had established a minimal wage, which prevented the
    wages from adjusting automatically. This was to be the focus of attack from Keynes.
History of economic thought                                                                                                  50

    Austrian school

                                      Early Austrian economists
                                      While the end of the nineteenth century and the beginning of the twentieth were
                                      dominated increasingly by mathematical analysis, the followers of Carl Menger,
                                      in the tradition of Eugen von Böhm-Bawerk, followed a different route,
                                      advocating the use of deductive logic instead. This group became known as the
                                      Austrian School, reflecting the Austrian origin of many of the early adherents.
                                      Thorstein Veblen in 1900, in his Preconceptions of Economic Science, contrasted
                                      neoclassical marginalists in the tradition of Alfred Marshall from the philosophies
                                      of the Austrian school.[73][74]

                                        Joseph Alois Schumpeter (1883–1950) was an Austrian economist and political
                                        scientist most known for his works on business cycles and innovation. He insisted
                                        on the role of the entrepreneurs in an economy. In Business Cycles: A theoretical,
          Carl Menger, founder of the
         Austrian school of economic    historical and statistical analysis of the Capitalist process(1939), Schumpeter
                   thought.             made a synthesis of the theories about business cycles. He suggested that those
                                        cycles could explain the economic situations. According to Schumpeter,
    capitalism necessarily goes through long-term cycles, because it is entirely based upon scientific inventions and
    innovations. A phase of expansion is made possible by innovations, because they bring productivity gains and
    encourage entrepreneurs to invest. However, when investors have no more opportunities to invest, the economy goes
    into recession, several firms collapse, closures and bankruptcy occur. This phase lasts until new innovations bring a
    creative destruction process, i.e. they destroy old products, reduce the employment, but they allow the economy to
    start a new phase of growth, based upon new products and new factors of production.[75]

    Ludwig von Mises

    Ludwig von Mises (1881–1973) was a central figure in the Austrian school. In his treatise on economics, Human
    Action, Mises introduced praxeology, "The science of human action", as a more general conceptual foundation of the
    social sciences . Praxeology views economics as a series of voluntary trades that increase the satisfaction of the
    involved parties. Mises also argued that socialism suffers from an unsolvable economic calculation problem, which
    according to him, could only be solved through free market price mechanisms.
History of economic thought                                                                                                   51

    Friedrich von Hayek
    Mises' outspoken criticisms of socialism had a large influence on the economic thinking of Friedrich von Hayek
    (1899–1992), who, while initially sympathetic to socialism, became one of the leading academic critics of
    collectivism in the 20th century.[76] In echoes of Smith's "system of natural liberty", Hayek argued that the market is
    a "spontaneous order" and actively disparaged the concept of "social justice".[77] Hayek believed that all forms of
    collectivism (even those theoretically based on voluntary cooperation) could only be maintained by a central
    authority. In his book, The Road to Serfdom (1944) and in subsequent works, Hayek claimed that socialism required
    central economic planning and that such planning in turn would lead towards totalitarianism. Hayek attributed the
    birth of civilization to private property in his book The Fatal Conceit (1988). According to him, price signals are the
    only means of enabling each economic decision maker to communicate tacit knowledge or dispersed knowledge to
    each other, to solve the economic calculation problem. Along with his contemporary Gunnar Myrdal, Hayek was
    awarded the Nobel Prize in 1974.

    Murray Rothbard
    Building on the Austrian School's concept of spontaneous order, support for a free market in money production, and
    condemnation of central planning, Murray Rothbard (1926–1995) advocated abolition of coercive government
    control of society and the economy.[78] He considered the monopoly force of government the greatest danger to
    liberty and the long-term well-being of the populace, labeling the state as "the organization of robbery systematized
    and writ large" and the locus of the most immoral, grasping and unscrupulous individuals in any

    Depression and reconstruction
    Alfred Marshall was still working on his last revisions of his Principles of Economics at the outbreak of the First
    World War (1914–1918). The new twentieth century's climate of optimism was soon violently dismembered in the
    trenches of the Western front, as the civilised world tore itself apart. For four years the production of Britain,
    Germany and France was geared entirely towards the war economy's industry of death. In 1917 Russia crumbled into
    revolution led by Vladimir Lenin's Bolshevik party. They carried Marxist theory as their saviour, and promised a
    broken country "peace, bread and land" by collectivising the means of production. Also in 1917, the United States of
    America entered the war on the side of France and Britain, President Woodrow Wilson carrying the slogan of
    "making the world safe for democracy". He devised a peace plan of Fourteen Points. In 1918 Germany launched a
    spring offensive which failed, and as the allies counter-attacked and more millions were slaughtered, Germany slid
    into revolution, its interim government suing for peace on the basis of Wilson's Fourteen Points. Europe lay in ruins,
    financially, physically, psychologically, and its future with the arrangements of the Versailles conference in 1919.
    John Maynard Keynes was the representative of Her Majesty's Treasury at the conference and the most vocal critic
    of its outcome.
History of economic thought                                                                                                        52

    John Maynard Keynes
                                                                      John Maynard Keynes (1883–1946) was born in
                                                                      Cambridge, educated at Eton and supervised by both A.
                                                                      C. Pigou and Alfred Marshall at Cambridge University.
                                                                      He began his career as a lecturer, before working in the
                                                                      British government during the Great War, and rose to
                                                                      be the British government's financial representative at
                                                                      the Versailles conference. His observations were laid
                                                                      out in his book The Economic Consequences of the
                                                                      Peace[83] (1919) where he documented his outrage at
                                                                      the collapse of the Americans' adherence to the
                                                                      Fourteen Points[84] and the mood of vindictiveness that
                                                                      prevailed towards Germany.[85] Keynes quit from the
                                                                      conference and using extensive economic data provided
                                                                      by the conference records, Keynes argued that if the
                                                                      victors forced war reparations to be paid by the
                                                                      defeated Axis, then a world financial crisis would
                                                                      ensue, leading to a second world war.[86] Keynes
                                                                      finished his treatise by advocating, first, a reduction in
                                                                      reparation payments by Germany to a realistically
                                                                      manageable level, increased intra-governmental
      John Maynard Keynes (right) with his American counterpart Harry
                 White at the Bretton Woods conference.               management of continental coal production and a free
                                                                      trade union through the League of Nations;[87] second,
    an arrangement to set off debt repayments between the Allied countries;[88] third, complete reform of international
    currency exchange and an international loan fund;[89] and fourth, a reconciliation of trade relations with Russia and
    Eastern Europe.[90]

    The book was an enormous success, and though it was criticised for false predictions by a number of people,[91]
    without the changes he advocated, Keynes' dark forecasts matched the world's experience through the Great
    Depression which ensued in 1929, and the descent into a new outbreak of war in 1939. World War I had been the
    "war to end all wars", and the absolute failure of the peace settlement generated an even greater determination to not
    repeat the same mistakes. With the defeat of fascism, the Bretton Woods conference was held to establish a new
    economic order. Keynes was again to play a leading role.

    The General Theory
    During the Great Depression, Keynes had published his most important work, The General Theory of Employment,
    Interest, and Money (1936). The depression had been sparked by the Wall Street Crash of 1929, leading to massive
    rises in unemployment in the United States, leading to debts being recalled from European borrowers, and an
    economic domino effect across the world. Orthodox economics called for a tightening of spending, until business
    confidence and profit levels could be restored. Keynes by contrast, had argued in A Tract on Monetary Reform
    (1923) that a variety of factors determined economic activity, and that it was not enough to wait for the long run
    market equilibrium to restore itself. As Keynes famously remarked,
          ...this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set
          themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is
          long past the ocean is flat again.[92]
History of economic thought                                                                                                  53

    On top of the supply of money, Keynes identified the propensity to consume, inducement to invest, the marginal
    efficiency of capital, liquidity preference and the multiplier effect as variables which determine the level of the
    economy's output, employment and level of prices. Much of this esoteric terminology was invented by Keynes
    especially for his General Theory, though some simple ideas lay behind. Keynes argued that if savings were being
    kept away from investment through financial markets, total spending falls. Falling spending leads to reduced
    incomes and unemployment, which reduces savings again. This continues until the desire to save becomes equal to
    the desire to invest, which means a new "equilibrium" is reached and the spending decline halts. This new
    "equilibrium" is a depression, where people are investing less, have less to save and less to spend.
    Keynes argued that employment depends on total spending, which is composed of consumer spending and business
    investment in the private sector. Consumers only spend "passively", or according to their income fluctuations.
    Businesses, on the other hand, are induced to invest by the expected rate of return on new investments (the benefit)
    and the rate of interest paid (the cost). So, said Keynes, if business expectations remained the same, and government
    reduces interest rates (the costs of borrowing), investment would increase, and would have a multiplied effect on
    total spending. Interest rates, in turn, depend on the quantity of money and the desire to hold money in bank accounts
    (as opposed to investing). If not enough money is available to match how much people want to hold, interest rates
    rise until enough people are put off. So if the quantity of money were increased, while the desire to hold money
    remained stable, interest rates would fall, leading to increased investment, output and employment. For both these
    reasons, Keynes therefore advocated low interest rates and easy credit, to combat unemployment.
    But Keynes believed in the 1930s, conditions necessitated public sector action. Deficit spending, said Keynes, would
    kick-start economic activity. This he had advocated in an open letter to U.S. President Franklin D. Roosevelt in the
    New York Times (1933). The New Deal programme in the U.S. had been well underway by the publication of the
    General Theory. It provided conceptual reinforcement for policies already pursued. Keynes also believed in a more
    egalitarian distribution of income, and taxation on unearned income arguing that high rates of savings (to which
    richer folk are prone) are not desirable in a developed economy. Keynes therefore advocated both monetary
    management and an active fiscal policy.
History of economic thought                                                                                                    54

    Keynesian economics
    During the Second World War, Keynes acted as advisor to HM
    Treasury again, negotiating major loans from the US. He helped
    formulate the plans for the International Monetary Fund, the
    World Bank and an International Trade Organisation[93] at the
    Bretton Woods conference, a package designed to stabilise world
    economy fluctuations that had occurred in the 1920s and create a
    level trading field across the globe. Keynes passed away little
    more than a year later, but his ideas had already shaped a new
    global economic order, and all Western governments followed the
    Keynesian prescription of deficit spending to avert crises and
    maintain full employment.

    One of Keynes' pupils at Cambridge was Joan Robinson, who
    contributed to the notion that competition is seldom perfect in a
    market, an indictment of the theory of markets setting prices. In
    The Production Function and the Theory of Capital (1953)
    Robinson tackled what she saw to be some of the circularity in
    orthodox economics. Neoclassicists assert that a competitive
    market forces producers to minimise the costs of production.
    Robinson said that costs of production are merely the prices of                           Piero Sraffa.

    inputs, like capital. Capital goods get their value from the final

    And if the price of the final products determines the price of capital, then it is, argued Robinson, utterly circular to
    say that the price of capital determines the price of the final products. Goods cannot be priced until the costs of
    inputs are determined. This would not matter if everything in the economy happened instantaneously, but in the real
    world, price setting takes time – goods are priced before they are sold. Since capital cannot be adequately valued in
    independently measurable units, how can one show that capital earns a return equal to the contribution to

    Piero Sraffa came to England from fascist Italy in the 1920s, and worked with Keynes in Cambridge. In 1960 he
    published a small book called Production of Commodities by Means of Commodities, which explained how
    technological relationships are the basis for production of goods and services. Prices result from wage-profit
    tradeoffs, collective bargaining, labour and management conflict and the intervention of government planning. Like
    Robinson, Sraffa was showing how the major force for price setting in the economy was not necessarily market

    The "American Way"
    After World War II, the United States had become the pre-eminent global economic power. Europe and the Soviet
    Union lay in ruins and the British Empire was at its end. Until then, American economists had played a minor role.
    The institutional economists had been largely critical of the "American Way" of life, especially regarding
    conspicuous consumption of the Roaring Twenties before the Wall Street Crash of 1929. After the war, however, a
    more orthodox body of thought took root, reacting against the lucid debating style of Keynes, and re-mathematizing
    the profession. The orthodox centre was also challenged by a more radical group of scholars based at the University
    of Chicago. They advocated "liberty" and "freedom", looking back to 19th century-style non-interventionist
History of economic thought                                                                                                    55

    Thorsten Veblen (1857–1929), who came from rural mid-western
    America and worked at the University of Chicago, is one of the best
    known early critics of the "American Way". In The Theory of the
    Leisure Class (1899) he scorned materialistic culture and wealthy
    people who conspicuously consumed their riches as a way of
    demonstrating success and in The Theory of Business Enterprise
    (1904) Veblen distinguished production for people to use things and
    production for pure profit, arguing that the former is often hindered
    because businesses pursue the latter. Output and technological advance
    are restricted by business practices and the creation of monopolies.
    Businesses protect their existing capital investments and employ
    excessive credit, leading to depressions and increasing military
    expenditure and war through business control of political power. These
    two books, focusing on criticism first of consumerism, and second of
    profiteering, did not advocate change. However, in 1911, Veblen
                                                                                Thorsten Veblen came from a Norwegian
    joined the faculty of the University of Missouri, where he had support
                                                                              immigrant family in rural mid-western America.
    from Herbert Davenport, the head of the economics department.
    Veblen remained at Columbia, Missouri through 1918. In that year, he
    moved to New York to begin work as an editor of a magazine called The Dial, and then in 1919, along with Charles
    A. Beard, James Harvey Robinson and John Dewey, helped found the New School for Social Research (known
    today as The New School). He was also part of the Technical Alliance,[94] created in 1919 by Howard Scott. From
    1919 through 1926 Veblen continued to write and to be involved in various activities at The New School. During
    this period he wrote The Engineers and the Price System (1921).[95]

    John R. Commons (1862–1945) also came from mid-Western America. Underlying his ideas, consolidated in
    Institutional Economics (1934) was the concept that the economy is a web of relationships between people with
    diverging interests. There are monopolies, large corporations, labour disputes and fluctuating business cycles. They
    do however have an interest in resolving these disputes. Government, thought Commons, ought to be the mediator
    between the conflicting groups. Commons himself devoted much of his time to advisory and mediation work on
    government boards and industrial commissions.
History of economic thought                                                                                                      56

                                                     The Great Depression was a time of significant upheaval in the States.
                                                     One of the most original contributions to understanding what had gone
                                                     wrong came from a Harvard University lawyer, named Adolf Berle
                                                     (1895–1971), who like John Maynard Keynes had resigned from his
                                                     diplomatic job at the Paris Peace Conference, 1919 and was deeply
                                                     disillusioned by the Versailles Treaty. In his book with Gardiner C.
                                                     Means, The Modern Corporation and Private Property (1932), he
                                                     detailed the evolution in the contemporary economy of big business,
                                                     and argued that those who controlled big firms should be better held to
                                                     account. Directors of companies are held to account to the shareholders
                                                     of companies, or not, by the rules found in company law statutes. This
                                                     might include rights to elect and fire the management, require for
                                                     regular general meetings, accounting standards, and so on. In 1930s
                                                     America, the typical company laws (e.g. in Delaware) did not clearly
      Adolf Augustus Berle, Jr. with Gardiner Means  mandate such rights. Berle argued that the unaccountable directors of
       was a foundational figure of modern corporate
                                                     companies were therefore apt to funnel the fruits of enterprise profits
                                                     into their own pockets, as well as manage in their own interests. The
                                                     ability to do this was supported by the fact that the majority of
    shareholders in big public companies were single individuals, with scant means of communication, in short, divided
    and conquered. Berle served in President Franklin Delano Roosevelt's administration through the depression, and
    was a key member of the so-called "Brain trust" developing many of the New Deal policies. In 1967, Berle and
    Means issued a revised edition of their work, in which the preface added a new dimension. It was not only the
    separation of controllers of companies from the owners as shareholders at stake. They posed the question of what the
    corporate structure was really meant to achieve.

          Stockholders toil not, neither do they spin, to earn [dividends and share price increases]. They are beneficiaries
          by position only. Justification for their inheritance... can be founded only upon social grounds... that
          justification turns on the distribution as well as the existence of wealth. Its force exists only in direct ratio to
          the number of individuals who hold such wealth. Justification for the stockholder's existence thus depends on
          increasing distribution within the American population. Ideally the stockholder's position will be impregnable
          only when every American family has its fragment of that position and of the wealth by which the opportunity
          to develop individuality becomes fully actualized.[96]
History of economic thought                                                                                                       57

    John Kenneth Galbraith
    After the war, John Kenneth Galbraith (1908–2006) became one of the
    standard bearers for pro-active government and liberal-democrat
    politics. In The Affluent Society (1958), Galbraith argued voters
    reaching a certain material wealth begin to vote against the common
    good. He argued that the "conventional wisdom" of the conservative
    consensus was not enough to solve the problems of social
    inequality.[98] In an age of big business, he argued, it is unrealistic to
    think of markets of the classical kind. They set prices and use
    advertising to create artificial demand for their own products,
    distorting people's real preferences. Consumer preferences actually
    come to reflect those of corporations – a "dependence effect" – and the
    economy as a whole is geared to irrational goals.[99] In The New
    Industrial State Galbraith argued that economic decisions are planned
    by a private-bureaucracy, a technostructure of experts who manipulate        John K. Galbraith began his career as a high
    marketing and public relations channels. This hierarchy is self-serving,     flying "new dealer", in the administration of
    profits are no longer the prime motivator, and even managers are not in      Franklin Delano Roosevelt during the Great
                                                                               Depression. An interview from the early 1990s is
    control. Because they are the new planners, corporations detest risk,                               [97]
                                                                                                  here       .
    require steady economic and stable markets. They recruit governments
    to serve their interests with fiscal and monetary policy, for instance
    adhering to monetarist policies which enrich money-lenders in the City through increases in interest rates. While the
    goals of an affluent society and complicit government serve the irrational technostructure, public space is
    simultaneously impoverished. Galbraith paints the picture of stepping from penthouse villas onto unpaved streets,
    from landscaped gardens to unkempt public parks. In Economics and the Public Purpose (1973) Galbraith advocates
    a "new socialism" as the solution, nationalising military production and public services such as health care,
    introducing disciplined salary and price controls to reduce inequality.

    Paul Samuelson
                                                        In contrast to Galbraith's linguistic style, the post-war economics
                                                        profession began to synthesise much of Keynes' work with
                                                        mathematical representations. Introductory university economics
                                                        courses began to present economic theory as a unified whole in what is
                                                        referred to as the neoclassical synthesis. "Positive economics" became
                                                        the term created to describe certain trends and "laws" of economics
                                                        that could be objectively observed and described in a value-free way,
                                                        separate from "normative economic" evaluations and judgments. The
                                                        best selling textbook writer of this generation was Paul Samuelson
                                                        (1915–2009). His Ph.D. dissertation was an attempt to show that
                                                        mathematical methods could represent a core of testable economic
                                                        theory. It was published as Foundations of Economic Analysis in 1947.
                                                        Samuelson started with two assumptions. First, people and firms will
                                                        act to maximise their self-interested goals. Second, markets tend
                                                        towards an equilibrium of prices, where demand matches supply. He
      Paul Samuelson wrote the best selling economics
                                                        extended the mathematics to describe equilibrating behaviour of
History of economic thought                                                                                                        58

    economic systems, including that of the then new macroeconomic theory of John Maynard Keynes. Whilst Richard
    Cantillon had imitated Isaac Newton's mechanical physics of inertia and gravity in competition and the market,[13]
    the physiocrats had copied the body's blood system into circular flow of income models, William Jevons had found
    growth cycles to match the periodicity of sunspots, Samuelson adapted thermodynamics formulae to economic
    theory. Reasserting economics as a hard science was being done in the United Kingdom also, and one celebrated
    "discovery", of A. W. Phillips, was of a correlative relationship between inflation and unemployment. The workable
    policy conclusion was that securing full employment could be traded-off against higher inflation. Samuelson
    incorporated the idea of the Phillips curve into his work. His introductory textbook Economics was influential and
    widely adopted. It became the most successful economics text ever. Paul Samuelson was awarded the new Nobel
    Prize in Economics in 1970 for his merging of mathematics and political economy.

    Kenneth Arrow
    Kenneth Arrow (born 1921) is Paul Samuelson's brother-in-law. His
    first major work, forming his doctoral dissertation at Columbia
    University was Social Choice and Individual Values (1951), which
    brought economics into contact with political theory. This gave rise to
    social choice theory with the introduction of his "Possibility Theorem".
    In his words,

          If we exclude the possibility of interpersonal comparisons of
          utility, then the only methods of passing from individual tastes to
          social preferences which will be satisfactory and which will be
          defined for a wide range of sets of individual orderings are either
          imposed or dictatorial.[101]
    This sparked widespread discussion over how to interpret the different
    conditions of the theorem and what implications it had for democracy
    and voting. Most controversial of his four (1963) or five (1950/1951)       Kenneth Arrow, interview (1/09) on the financial
    conditions is the independence of irrelevant alternatives.                                                   [100]
                                                                                       crisis of 2007–2010. here       .

    In the 1950s, Arrow and Gérard Debreu developed the Arrow–Debreu
    model of general equilibria. In 1971 Arrow with Frank Hahn co-authored General Competitive Analysis (1971),
    which reasserted a theory of general equilibrium of prices through the economy. In 1969 the Swedish Central Bank
    began awarding a prize in economics, as an analogy to the Nobel prizes awarded in Chemistry, Physics, Medicine as
    well as Literature and Peace (though Alfred Nobel never endorsed this in his will). With John Hicks, Arrow won the
    Bank of Sweden prize in 1972, the youngest recipient ever. The year before, US President Richard Nixon's had
    declared that "We are all Keynesians now".[102] The irony was that this was the beginning of a new revolution in
    economic thought.
History of economic thought                                                                                                     59

    Monetarism and the Chicago school
    The interventionist monetary and fiscal policies that the orthodox post-war economics recommended came under
    attack in particular by a group of theorists working at the University of Chicago, which came to be known as the
    Chicago School. This more conservative strand of thought reasserted a "libertarian" view of market activity, that
    people are best left to themselves, free to choose how to conduct their own affairs.

    Ronald Coase
    Ronald Coase (born 1910) is the most prominent economic analyst of law and the 1991 Nobel Prize winner. His first
    major article, The Nature of the Firm (1937), argued that the reason for the existence of firms (companies,
    partnerships, etc.) is the existence of transaction costs. Rational individuals trade through bilateral contracts on open
    markets until the costs of transactions mean that using corporations to produce things is more cost-effective. His
    second major article, The Problem of Social Cost (1960), argued that if we lived in a world without transaction costs,
    people would bargain with one another to create the same allocation of resources, regardless of the way a court
    might rule in property disputes. Coase used the example of an old legal case about nuisance named Sturges v
    Bridgman, where a noisy sweetmaker and a quiet doctor were neighbours and went to court to see who should have
    to move.[103] Coase said that regardless of whether the judge ruled that the sweetmaker had to stop using his
    machinery, or that the doctor had to put up with it, they could strike a mutually beneficial bargain about who moves
    house that reaches the same outcome of resource distribution. Only the existence of transaction costs may prevent
    this.[104] So the law ought to pre-empt what would happen, and be guided by the most efficient solution. The idea is
    that law and regulation are not as important or effective at helping people as lawyers and government planners
    believe.[105] Coase and others like him wanted a change of approach, to put the burden of proof for positive effects
    on a government that was intervening in the market, by analysing the costs of action.[106]

    Milton Friedman
    Milton Friedman (1912–2006) stands as one of the most influential
    economists of the late twentieth century. He won the Nobel Prize in
    Economics in 1976, among other things, for A Monetary History of the
    United States (1963). Friedman argued that the Great Depression had
    been caused by the Federal Reserve's policies through the 1920s, and
    worsened in the 1930s. Friedman argues that laissez-faire government
    policy is more desirable than government intervention in the economy.
    Governments should aim for a neutral monetary policy oriented toward
    long-run economic growth, by gradual expansion of the money supply.
    He advocates the quantity theory of money, that general prices are
    determined by money. Therefore active monetary (e.g. easy credit) or
    fiscal (e.g. tax and spend) policy can have unintended negative effects.
    In Capitalism and Freedom (1967) Friedman wrote:

          There is likely to be a lag between the need for action and
                                                                                               Milton Friedman.
          government recognition of the need; a further lag between
          recognition of the need for action and the taking of action; and a
          still further lag between the action and its effects.[107]
    Friedman was also known for his work on the consumption function, the permanent income hypothesis (1957),
    which Friedman himself referred to as his best scientific work.[108] This work contended that rational consumers
    would spend a proportional amount of what they perceived to be their permanent income. Windfall gains would
    mostly be saved. Tax reductions likewise, as rational consumers would predict that taxes would have to rise later to
History of economic thought                                                                                                           60

    balance public finances. Other important contributions include his critique of the Phillips curve and the concept of
    the natural rate of unemployment (1968). This critique associated his name with the insight that a government that
    brings about higher inflation cannot permanently reduce unemployment by doing so. Unemployment may be
    temporarily lower, if the inflation is a surprise, but in the long run unemployment will be determined by the frictions
    and imperfections in the labour market.

    Global times

    Amartya Sen
    Amartya Sen (born 1933) is a leading development and welfare economist and has expressed considerable
    skepticism on the validity of neo-classical assumptions. He was highly critical of rational expectations theory, and
    devoted his work to development and human rights. He won the Nobel Prize in Economics in 1998.

                                                            Joseph E. Stiglitz
                                                            Joseph Stiglitz (born 1943) Received the Nobel Prize in 2001 for his
                                                            work in information economics. He has served as chairman of
                                                            President Clinton's Council of Economic Advisors and as chief
                                                            economist for the World Bank. Stiglitz has taught at many universities,
                                                            including Columbia, Stanford, Oxford, Manchester, Yale, and MIT. In
                                                            recent years he has become an outspoken critic of global economic
                                                            institutions. He is a popular and academic author. In Making
                                                            Globalization Work (2007), he offers an account of his perspectives on
                                                            issues of international economics.

                                                                  The fundamental problem with the neoclassical model and the
                                                                  corresponding model under market socialism is that they fail to
                                                                  take into account a variety of problems that arise from the
                                                                  absence of perfect information and the costs of acquiring
                                                                  information, as well as the absence or imperfections in certain
        Joseph Stiglitz has both been successful as an
       economist and a popular author. He talks about             key risk and capital markets. The absence or imperfection can, in
      his book Making Globalization Work here           .         turn, to a large extent be explained by problems of
History of economic thought                                                                                                       61

    Paul Krugman
    Paul Krugman (born 1953) is a contemporary economist. His textbook
    International Economics (2007) appears on many undergraduate
    reading lists. Well known as a representative of progressivism, he
    writes a biweekly column on economics, American economic policy,
    and American politics more generally in the New York Times. He was
    awarded the Nobel Prize in Economics in 2008 for his work on New
    Trade Theory and economic geography.

    Contemporary economic thought

    Macroeconomics since the Bretton Woods era                                   Paul Krugman at the German National Library in
                                                                                              Frankfurt am Main
    From the 1970s onwards Friedman's monetarist critique of Keynesian
    macroeconomics formed the starting point for a number of trends in
    macroeconomic theory opposed to the idea that government intervention can or should stabilise the economy.[111]
    Robert Lucas criticized Keynesian thought for its inconsistency with microeconomic theory. Lucas's critique set the
    stage for a neoclassical school of macroeconomics, New Classical economics based on the foundation of classical
    economics. Lucas also popularized the idea of rational expectations,[112] which was used as the basis for several new
    classical theories including the Policy Ineffectiveness Proposition.[113]

    The standard model for new classical economics is the real business cycle theory, which sought to explain observed
    fluctuations in output and employment in terms of real variables such as changes in technology and tastes. Assuming
    competitive markets, real business cycle theory implied that cyclical fluctuations are optimal responses to variability
    in technology and tastes, and that macroeconomic stabilisation policies must reduce welfare.[114]
    Keynesian economics made a comeback among mainstream economists with the advent of New Keynesian
    macroeconomics. The central theme of new Keynesianism was the provision of a microeconomic foundation for
    Keynesian macroeconomics, obtained by identifying minimal deviations from the standard microeconomic
    assumptions which yield Keynesian macroeconomic conclusions, such as the possibility of significant welfare
    benefits from macroeconomic stabilization.[115] George Akerlof's 'menu costs' arguments, showing that, under
    imperfect competition, small deviations from rationality generate significant (in welfare terms) price stickiness, are
    good example of this kind of work.[116]
    Economists have combined the methodology of real business cycle theory with theoretical elements, like sticky
    prices, from new Keynesian theory to produce the new neoclassical synthesis. Dynamic stochastic general
    equilibrium (DSGE) models, large systems of microeconomic equations combined into models of the general
    economy, are central to this new synthesis. The synthesis dominates present day economics.
History of economic thought                                                                                                                        62

    [1] Mattick, Paul (2001-07-08). "Who Is the Real Adam Smith?" (http:/ / www. nytimes. com/ books/ 01/ 07/ 08/ reviews/ 010708. 08mattict.
        html). The New York Times. . Retrieved 2008-05-14.
    [2] Hoaas, David J.; Madigan, Lauren J. (1999). "A citation analysis of economists in principles of economics textbooks". The Social Science
        Journal 36 (3): 525–532. doi:10.1016/S0362-3319(99)00022-1
    [3] Mark Blaug.Economic theory in retrospect. Cambridge University Press. 1997. ISBN 978-0-521-57701-4 p. 34
    [4] David Held, Models of Democracy (Polity, 2006) 3rd Ed., p.11 ff.
    [5] Aristotle (350BC) Politics Book II, Part V (http:/ / classics. mit. edu/ Aristotle/ politics. html)
    [6] Aristotle (350BC) Politics Book I, Part IX (http:/ / classics. mit. edu/ Aristotle/ politics. html)
    [7] Aristotle (350BC) Politics Book I, Part X (http:/ / classics. mit. edu/ Aristotle/ politics. html)
    [8] Book I, Part III]
    [9] M. M. Austin, Pierre Vidal-Naquet. Economic and Social History of Ancient Greece (http:/ / books. google. co. uk/
        books?id=ekqCOGr1_NAC& pg=PA162& lpg=PA162& dq=household+ management+ -+ Ancient+ Greek& source=bl& ots=z-PwoYOk53&
        sig=F--uWoo7imbz7pCrJtHWgUexIRo& hl=en& sa=X& ei=BM6FT5i8OYqY1AXg89ixBw& ved=0CEMQ6AEwBA#v=onepage&
        q=household management - Ancient Greek& f=false). University of California Press, 5 Feb 1981. . Retrieved 2012-04-11.
    [10] Aristotle (350BC) Politics Book I, Part XI (http:/ / classics. mit. edu/ Aristotle/ politics. html)
    [11] Mochrie (2005) p.5
    [12] Fusfeld (1994) p.15
    [13] Fusfeld (1994) p.21
    [14] Locke (1689) Chapter 9, section 124
    [15] Locke (1689) Chapter 5, sections 26–27.
    [16] Locke (1691) Considerations Part I, Thirdly
    [17] Murray N. Rothbard An Austrian Perspective on the History of Economic Thought, vol. 1, Economic Thought Before Adam Smith (1995)
        (http:/ / mises. org/ daily/ 4942) Ludwig von Mises Institute Retrievedf 2012-05-16
    [18] Sarah B. Pomeroy, Xénophon – Xenophon, Oeconomicus: a social and historical commentary (http:/ / books. google. co. uk/ books/ about/
        Xenophon_Oeconomicus. html?id=iLJzAAAAIAAJ& redir_esc=y) Clarendon Press, 1994 Retrieved 2012-05-16
    [19] Strong's Concordances (http:/ / concordances. org/ greek/ 3624. htm)Biblos & The NAS New Testament Greek Lexicon (Strong's Number:
        3624) (http:/ / www. biblestudytools. com/ lexicons/ greek/ nas/ oikos. html) Bible Study Tools – Retrieved 2012-05-16
    [20] Douglas Harper Etymology online (http:/ / www. etymonline. com/ index. php?allowed_in_frame=0& search=economics&
        searchmode=none) Retrieved 2012-05-16
    [21] M. I. Finley (was Professor of Ancient History and Master of Darwin College at Cambridge University) The Ancient Economy (http:/ /
        books. google. co. uk/ books?id=oMmyO465s9oC& printsec=frontcover& dq=history+ of+ ancient+ economics& hl=en& sa=X&
        ei=0_WzT7TcCami0QWrl4W6CQ& redir_esc=y#v=onepage& q=history of ancient economics& f=false) University of California Press, 1
        Jan 1989 , Retrieved 2012-05-16
    [22] Edwin Cannan (editor) Adam Smith – Lectures On Justice, Police, Revenue And Arms (http:/ / books. google. co. uk/
        books?id=ZaICGm2Pu5AC& pg=PR25& dq=Francis+ Hutheson+ teacher+ of+ Adam+ Smith& hl=en& sa=X&
        ei=0fuzT-LmCMqu0QWKgNGnCQ& redir_esc=y#v=onepage& q=Francis Hutheson teacher of Adam Smith& f=false) Kessinger Publishing,
        30 Apr 2004 Retrieved 2012-05-16
    [23] Danbom (1997) Rural Development Perspectives, vol. 12, no. 1 p.15 (http:/ / www. ers. usda. gov/ publications/ rdp/ rdp1096/ rdp1096d.
        pdf) Why Americans Value Rural Life by David B. Danbom
    [24] Fusfeld (1994) p.24
    [25] Hague (2004) p.187, 292
    [26] Stephen (1898) p. 8.
    [27] Smith (1776) Book I, Chapter 2 (http:/ / www. econlib. org/ library/ Smith/ smWN1. html#B. I, Ch. 2, Of the Principle which gives
        Occasion to the Division of Labour), para 2
    [28] Smith (1776) p.533
    [29] Smith (1776) Book I, Chapter 5 (http:/ / www. econlib. org/ library/ Smith/ smWN2. html#B. I, Ch. 5, Of the Real and Nominal Price of
        Commodities), para 1
    [30] Smith (1776) Book I, Chapter 7 (http:/ / www. econlib. org/ library/ Smith/ smWN2. html#B. I, Ch. 7, Of the Natural and Market Price of
        Commodities), para 9
    [31] Smith (1776) Book I, Chapter 10 (http:/ / www. econlib. org/ library/ Smith/ smWN4. html#B. I, Ch. 10, Of Wages and Profit in the
        Different Employments of Labour and Stock), para 82
    [32] Smith (1776) Book I, Chapter 7 (http:/ / www. econlib. org/ library/ Smith/ smWN2. html#B. I, Ch. 7, Of the Natural and Market Price of
        Commodities), para 26
    [33] Keynes (1936) Chapter 1, footnote
    [34] Bentham (1791) Chapter I (http:/ / www. econlib. org/ library/ Bentham/ bnthPML1. html#Chapter I, Of the Principle of Utility), para I
    [35] Bentham (1791) Chapter II (http:/ / www. econlib. org/ library/ Bentham/ bnthPML2. html#Chapter II, Of Principles Adverse to That of
        Utility), para I
History of economic thought                                                                                                                                      63

    [36] Bentham (1791) Chapter IV
    [37] Bentham (1791) Chapter I, para IV
    [38] Fusfeld (1994) p.47
    [39] Thornton (1802) The Paper Credit of Great Britain
    [40] Historical figures – Thomas Malthus (1766–1834) (http:/ / www. bbc. co. uk/ history/ historic_figures/ malthus_thomas. shtml), BBC
    [41] "Thomas Robert Malthus, 1766–1834" (http:/ / homepage. newschool. edu/ het/ / profiles/ malthus. htm). The History of Economic Thought
        Website. . "Malthus denied the validity of Say's Law and argued that there could be a "general glut" of goods. Malthus believed that economic
        crises were characterized by a general excess supply caused by insufficient consumption."
    [42] "Rationale and Core Principles" (http:/ / desip. igc. org/ malthus/ principles. html), The International Society of Malthus
    [43] Who is Thomas Malthus? (http:/ / www. allaboutscience. org/ malthus-faq. htm), ALL About Science
    [44] David Ricardo (http:/ / eh. net/ encyclopedia/ article/ stead. ricardo), Economic History Services
    [45] David Ricardo's Contributions to Economics (http:/ / www. victorianweb. org/ economics/ ric. html), The Victorian Web
    [46] "David Ricardo" (http:/ / www. econlib. org/ library/ Enc/ bios/ Ricardo. html), Library of Economics and Liberties
    [47] David Ricardo, 1772–1823 (http:/ / homepage. newschool. edu/ het/ / profiles/ ricardo. htm), The History of Economic Thought Website
    [48] John Stuart Mill: Overview (http:/ / www. iep. utm. edu/ m/ milljs. htm), The Internet Encyclopedia of Pholosophy.
    [49] Pressman (2006) p.44
    [50] John Stuart Mill, 1806–1873 (http:/ / homepage. newschool. edu/ het/ / profiles/ mill. htm), The History of Economic Thought: "Happily,
        there is nothing in the laws of Value which remains for the present or any future writer to clear up; the theory of the subject is complete: the
        only difficulty to be overcome is that of so stating it as to solve by anticipation the chief perplexities which occur in applying it." (Mill's quote)
    [51] Stanford Encyclopedy of Philosophy – John Stuart Mill (http:/ / plato. stanford. edu/ entries/ mill/ ) section Political Economy
    [52] Pressman (2006) p.45
    [53] Mill (1871) Book 4, Chapter 6
    [54] Stigler (1965) pp. 1–15
    [55] Pressman (2006) p.46
    [56] In 1819 this was 9 shillings, 11 pence; Fusfeld (1994) p.57
    [57] Proudhon (1846) Volume 1 (http:/ / anarchism. pageabode. com/ pjproudhon/ system-of-economic-contradictions-1)
    [58] Proudhon (1846) Volume 2 (http:/ / anarchism. pageabode. com/ pjproudhon/ system-of-economic-contradictions-2)
    [59] Mill (1848) Book V, Chapter II; Interestingly Mill amended his wording from the 3rd edition in 1852, see (http:/ / 64. 233. 183. 104/
        search?q=cache:aXLDmW7H4uUJ:www. efm. bris. ac. uk/ het/ mill/ ellis. pdf+ "a+ mild+ form+ of+ robbery"& hl=en& ct=clnk& cd=1&
        gl=uk); see generally, Variations in the Editions of J.S. Mill's Principles of Political Economy, M.A. Ellis, Economic Journal, vol. 16, June
        1906, pp. 291–302.
    [60] Copleston, Frederick. Social Philosophy in France, A History of Philosophy, Volume IX, Image/Doubleday, 1994, p. 67
    [61] Engels (1845) Die Lage der arbeitenden Klassen von England in 1844 (http:/ / www. marxists. org/ archive/ marx/ works/ 1845/
        condition-working-class/ index. htm)
    [62] Marx (1859) Zur Kritik der Politischen Oekonomie, Berlin, p. 3.
    [63] In Marx's words, "the exchange of commodities is evidently an act characterised by a total abstraction from use value."
    [64] Marx (1867) Volume I, Part I, Chapter 1, para 14. In Marx's words, "The labour time socially necessary is that required to produce an article
        under the normal conditions of production, and with the average degree of skill and intensity prevalent at the time."
    [65] Marx (1867) Volume I, Part I, Chapter 1, Section 4, para 123
    [66] Marx (1867) Volume I, Part III, Chapter 9, Section 1
    [67] Marx (1867) Volume I, Part II, Chapter VI, para 10. In Marx's words, "Therefore the labour-time requisite for the production of
        labour-power reduces itself to that necessary for the production of those means of subsistence; in other words, the value of labour-power is the
        value of the means of subsistence necessary for the maintenance of the labourer."
    [68] Menger, Carl (1871) Grundsätze der Volkswirtschaftslehre, full text in html (http:/ / www. mises. org/ etexts/ menger/ principles. asp)
    [69] Jevons (1878) p.334
    [70] • Alan Kirman (2008). "Pareto, Vilfredo (1848–1923)", Efficiency or ‘Pareto optimality', The New Palgrave Dictionary of Economics.
        Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_P000026& edition=current& q=pareto& topicid=&
           • Pareto (1897). Cours d'économie politique, v. 2.
           • Pareto ([1906] 1971). Manual of Political Economy, ch. 6, Mathematical Appendix, sect. 145-52. Translation of French edition from 1927.
    [71] Principles of Economics (http:/ / www. econlib. org/ library/ Marshall/ marP. html), by Alfred Marshall, at the Library of Economics and
    [72] Buchholz (1989) p.151
    [73] Veblen, Thorstein Bunde; "The Preconceptions of Economic Science" Pt III, Quarterly Journal of Economics v14 (1900).
    [74] Colander, David; The Death of Neoclassical Economics.
    [75] Alessandro Roncaglia. The wealth of ideas: a history of economic thought. Cambridge University Press. 2005. ISBN 978-0-521-84337-9. p.
    [76] "Biography of F. A. Hayek (1899–1992)" (http:/ / mises. org/ about/ 3234). . Retrieved 2009-06-26.
    [77] Law, legislation and liberty (1970)
History of economic thought                                                                                                                        64

    [78] Free Market Money System (http:/ / www. mises. org/ store/ Free-Market-Monetary-System-A-P553. aspx?AFID=14) by F.A. Hayek
    [79] The Ethics of Liberty (http:/ / mises. org/ rothbard/ ethics/ twentytwo. asp), Murray Rothbard
    [80] Hans-Hermann Hoppe. "The Ethics of Liberty" (http:/ / mises. org/ rothbard/ ethics/ hoppeintro. asp). Ludwig von Mises Institute. .
    [81] Repudiating the National Debt (http:/ / mises. org/ article. aspx?Id=1423), Murray Rothbard
    [82] To Save Our Economy From Destruction (http:/ / www. lewrockwell. com/ rothbard/ rothbard200. html), Murray Rothbard
    [83] Keynes (1919) The Economic Consequences of the Peace (http:/ / www. econlib. org/ library/ YPDBooks/ Keynes/ kynsCP. html) at The
        Library of Economics and Liberty
    [84] Keynes (1919) Chapter III (http:/ / www. econlib. org/ library/ YPDBooks/ Keynes/ kynsCP3. html#Chapter 3), para 20
    [85] Keynes (1919) Chapter V (http:/ / www. econlib. org/ library/ YPDBooks/ Keynes/ kynsCP. html), para 43
    [86] Keynes (1919) Chapter VI (http:/ / www. econlib. org/ library/ YPDBooks/ Keynes/ kynsCP6. html#Chapter 6), para 4
    [87] Keynes (1919) Chapter VII (http:/ / www. econlib. org/ library/ YPDBooks/ Keynes/ kynsCP7. html#Chapter 7), para 7
    [88] Keynes (1919) Chapter VII, para 30
    [89] Keynes (1919) Chapter VII, para 48
    [90] Keynes (1919) Chapter VII, para 58
    [91] e.g. Etienne Mantioux (1946) The Carthaginian Peace, or the Economic Consequences of Mr. Keynes
    [92] Keynes (1923) Chapter 3
    [93] This was not accepted by the United States Congress at the time, but arose later through the General Agreement on Tariffs and Trade of
        1947 and the World Trade Organisation of 1994
    [94] Stabile, Donald R. "Veblen and the Political Economy of the Engineer: the radical thinker and engineering leaders came to technocratic
        ideas at the same time", American Journal of Economics and Sociology (45:1) 1986, 43–44.
    [95] The Engineers and the Price System, 1921. (http:/ / socserv2. mcmaster. ca/ ~econ/ ugcm/ 3ll3/ veblen/ Engineers. pdf)
    [96] Berle (1967) p. xxiii
    [97] http:/ / www. youtube. com/ watch?v=jNgfIH5pyxg
    [98] Galbraith (1958) Chapter 2; n.b. though Galbraith claimed to coin the phrase "conventional wisdom", the phrase is used several times in
        Thorstein Veblen's book The Instinct of Workmanship.
    [99] Galbraith (1958) Chapter 11
    [100] http:/ / www. youtube. com/ watch?v=muUjNWIeDZg
    [101] Kenneth Arrow, "A Difficulty in the Concept of Social Welfare" (1950).
    [102] In 1971, announcing wage and price controls. This was actually lifted from a comment by Milton Friedman in 1965 which formed a Time
        article (http:/ / www. time. com/ time/ magazine/ article/ 0,9171,842353-3,00. html) title, Friday, Dec. 31, 1965. See below.
    [103] Sturges v Bridgman (1879) 11 Ch D 852
    [104] Coase (1960) IV, 7
    [105] Coase (1960) V, 9
    [106] Coase (1960) VIII, 23
    [107] Friedman (1967) p.
    [108] "Charlie Rose Show". 2005-12-26.
    [109] http:/ / www. youtube. com/ watch?v=UzhD7KVs-R4
    [110] Stiglitz (1996) p.5
    [111] Manikw, N. Greg. "A Quick Refresher Course in Macroeconomics." Journal of Economic Literature, Vol. 28, No. 4. (Dec., 1990), pp.
    [112] Mankiw, 1647–1648.
    [113] Mankiw, 1649.
    [114] Mankiw, 1653.
    [115] Mankiw, 1655.
    [116] Mankiw, 1657.


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          5th ed. ISBN 1-57766-486-8. Description. (
        • Fusfeld, Daniel R. (1994). The Age of the Economist, Harper Collins, 7th Ed. ISBN 0-673-46805-4
        • Hague, William (2004). William Pitt the Younger Harper Perennial ISBN 0-00-714720-1
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        • Lee, Frederic S. (2009). A History of Heterodox Economics: Challenging the Mainstream in the Twentieth
          Century, Routledge. Description (
        • Macfie, Alec Lawrence (1955). "The Scottish Tradition in Economic Thought". Econ Journal Watch 6(3):
          389–410. Reprinted from Scottish Journal of Political Economy 2(2): 81–103 (
        • Markwell, Donald (2006). John Maynard Keynes and International Relations: Economic Paths to War and
          Peace, Oxford University Press.
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        • Mochrie, Robert (2005). Justice in Exchange: The Economic Philosophy of John Duns Scotus (http://64.233.
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    • Nicola, PierCarlo (2000). Mainstream Mathermatical Economics in the 20th Century (
      ?id=KR0Rbi8o4QQC). Springer. ISBN 978-3-540-67084-1.
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    • From The New Palgrave Dictionary of Economics (2008), 2nd Edition. Abstract links for:
                "United States, economics in (1776–1885) (http:/ / www. dictionaryofeconomics. com/
                article?id=pde2008_U000071& edition=current& q=united states& topicid=& result_number=4)" by
                Stephen Meardon.
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    •     European Journal of the History of Economic Thought (http:/ /      •   History of Economic Thought (http:/ / jshet. net/ old/ / / annals/ annals.
          www. tandf. co. uk/ journals/ titles/ 09672567. asp) (U.K.)            html) (Japan)
    •     History of Economic Ideas (http:/ / www. historyofeconomicideas.   •   History of Political Economy (http:/ / www. dukeupress. edu/ Catalog/
          com/ ) (Italy)                                                         ViewProduct. php?viewby=journal& productid=45614) (U.S.)
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          historyeconreview. html) (Australia)                                   cambridge. org/ action/ displayJournal?jid=HET) (U.K.)

        Further reading
        • "A History of Behavioural Finance in Published Research: 1944–1988" (
          blog/Admin/read/50567/a-history-of-behavioural-finance-in-published-research-1944-1988) (a short
          bibliography focused on quantitative finance)

        External links
        • Pioneers of the social sciences London School of Economics and Political Science (
        • The History of Economic Thought website (

        • Archive for the History of Economic Thought (
        • Biographies of economists (
        • Library of Economics and Liberty (
        • Overview: History of Economic Thought (
Economic methodology                                                                                                           69

    Economic methodology
    Economic methodology is the study of methods, especially the scientific method, in relation to economics,
    including principles underlying economic reasoning.[1] In contemporary English, 'methodology' may reference
    theoretical or systematic aspects of a method (or several methods). Philosophy and economics also takes up
    methodology at the intersection of the two subjects.

    General methodological issues include similarities and contrasts to the natural sciences and to other social sciences
    and, in particular, to:
    •   the definition of economics[2]
    •   the scope of economics as defined by its methods[3]
    •   fundamental principles and operational significance of economic theory[4]
    •   methodological individualism versus holism in economics[5]
    •   the role of simplifying assumptions such as rational choice and profit maximizing in explaining or predicting
    •   descriptive/positive, prescriptive/normative, and applied[7] uses of theory[8]
    •   the scientific status[9] and expanding domain of economics[10]
    •   issues critical to the practice and progress of econometrics[11]
    •   the balance of empirical and philosophical approaches[12]
    •   the role of experiments in economics[13]
    •   the role of mathematics and mathematical economics in economics[14]
    •   the writing[15] and rhetoric of economics[16]
    •   the relation between theory, observation, application, and methodology in contemporary economics.[17]
    Economic methodology has gone from periodic reflections of economists on method to a distinct research field in
    economics since the 1970s. In one direction, it has expanded to the boundaries of philosophy, including the relation
    of economics to the philosophy of science, the theory of knowledge[18] In another direction of philosophy and
    economics, additional subjects are treated include decision theory and ethics.[19]

    A historical sample of general methodological statements, not all of them subsequently accepted, include the
           Happily there is nothing in the laws of value which remains for the present or any future writer to clear up; the
           theory of the subject is complete.
           —John Stuart Mill,  1848 [1965], The Principles of Political Economy Book 3. University of Toronto Press, p.
           So far no chemist has discovered exchange value either in a pearl or a diamond.
           —Karl Marx, 1867 [1967]. Capital, Volume I, New York, International Publishers, p. 87
           Economic doctrine is ... not a body of concrete truth but an engine for the discovery of concrete truth, similar
           say to the theory of mechanics.
           —Alfred Marshall, 1885. "The Present Position of Economics", reprinted in A.C. Pigou, ed., 1925, Memorials
           of Alfred Marshall, Macmillan, p. 159.
           The Theory of Economics does not furnish a body of settled conclusions immediately applicable to policy. It is
           a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to
Economic methodology                                                                                                                                    70

           draw correct conclusions.
           —John Maynard Keynes, 1922 "Introduction to the Cambridge Economic Handbooks Series", in D. H.
           Robertson, 1922, Money, p. v
           [A]lmost every statement which we — or for that matter anyone else — runs afoul of some existing opinion,
           and, by the very nature of things, most opinions thus far could hardly have been proved or disproved within
           the field of social theory. It is therefore a great help that all our assertions can be borne out by specific
           examples from the theory of games and strategy.
           —John von Neumann and Oskar Morgenstern,  1944. Theory of Games and Economic Behavior, Princeton
           University Press, p. 43.
           The fact that economics is not physics does not mean that we should not aim to apply the same fundamental
           standards for what constitutes legitimate argument; we can insist that the ultimate criterion for judging
           economic ideas is the degree to which they help us order and summarize data, that it is not legitimate to try to
           protect attractive theories from the data.
           —Christopher A. Sims, 1996. "Macroeconomics and Methodology                                 ", Journal of Economic Perspectives,
           10(1), p. 111.

    [1] :Press + button to enlarge small-text links below.
           • Roger E. Backhouse, 2008. "methodology of economics", The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ /
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           • Lawrence A. Boland, 1987. "methodology", The New Palgrave: A Dictionary of Economics, v. 3, pp. 455-56.
           • Daniel M. Hausman, 1989. "Economic Methodology in a Nutshell", Journal of Economic Perspectives, 3(2), pp. 115-127. (http:/ / manoa.
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           • Kevin D. Hoover, 1995. "Review Article: Why Does Methodology Matter for Economics?" Economic Journal, 105(430), pp. 715-734.
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    [2] • John Stuart Mill, 1844. "On the Definition of Political Economy; and on the Method of Investigation Proper to It" (http:/ / www. econlib.
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           • _____. 2009. "Retrospectives: On the Definition of Economics", Journal of Economic Perspectives, 23(1), pp. 221–33 (http:/ / pubs.
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           • Lawrence A. Boland, 2008. "instrumentalism and operationalism", The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
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           • _____, 2003. The Foundations of Economic Method, 2nd Edition. Description (http:/ / books. google. com/ books?id=q-Umw-h2T98C&
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          • Edward J. Nell, 1998. General Theory of Transformational Growth, Part I. Cambridge University Press.
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Economic methodology                                                                                                                                      71

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       (http:/ / books. google. com/ books?id=dSJQn8egXvUC& lr=& source=gbs_navlinks_shttp:/ / books. google. com/ books?hl=en& lr=&
       id=dSJQn8egXvUC& oi=fnd& pg=PR7=false#v=onepage& q& f=false) and preview. (http:/ / books. google. com/ books?hl=en& lr=&
       id=dSJQn8egXvUC& oi=fnd& pg=PR7=false#v=onepage& q& f=false)
          • Shiozawa, Y. 2004 Evolutinary Economics in the 21st Century: A Manifest, Evolutionary and Institutional Economics Review, 1(1): 5-47.
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        dictionaryofeconomics. com/ article?id=pde2008_A000231& q=assumptions& topicid=& result_number=1)
           • Milton Friedman, 1953. "The Methodology of Positive Economics" in Essays in Positive Economics.
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        231-236. Reprinted in J.C. Wood & R.N. Woods, ed., 1990, Milton Friedman: Critical Assessments, v. I, pp. 107-13. Preview. (http:/ / books.
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           • Stanley Wong, 1973. "The 'F-Twist' and the Methodology of Paul Samuelson", American Economic Review, 63(3) p p. 312 (http:/ / www.
        jstor. org/ pss/ 1914363)-325. Reprinted in J.C. Wood & R.N. Woods, ed., Milton Friedman: Critical Assessments, v. II, pp. 224-43 (http:/ /
        books. google. com/ books?hl=en& lr=& id=t4-nLZRU_GAC& oi=fnd& pg=PA224& ots=dObA3ipzQI&
        sig=B3nSJhVES31I6QHFDAKEonIve1M#v=onepage& q& f=false).
           • Shaun Hargreaves Heap, 2008. "economic man", The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_E000020& q=rationality& topicid=& result_number=24)
           • Kenneth J. Arrow, [1987] 1989. "Economic theory and the hypothesis of rationality", in The New Palgrave: Utility and Probability, pp.
        25-39. (http:/ / books. google. com/ books?hl=en& lr=& id=EBCCa8HtfkUC& oi=fnd& pg=PA25& dq==q-64UY5FMB&
           • Duncan K. Foley, 2004. "Rationality and Ideology in Economics", Social Research, pp. 329-342. Pre-publication version (http:/ /
        homepage. newschool. edu/ ~foleyd/ ratid. pdf).
           • Thomas J. Sargent, 1994. Bounded Rationality in Macroeconomics, Oxford. Description (http:/ / www. oup. com/ us/ catalog/ general/
        subject/ Economics/ MacroeconomicTheory/ ?view=usa& ci=9780198288695) and chapter-preview 1st-page links. (http:/ / www. questia.
        com/ library/ book/ bounded-rationality-in-macroeconomics-thomas-j-sargent-by-thomas-j-sargent. jsp)
           • Vernon L. Smith, 2008. Rationality in Economics: Constructivist and Ecological Forms, Cambridge. Description/contents links (http:/ /
        www. cambridge. org/ gb/ knowledge/ isbn/ item1174232/ ?site_locale=en_GB) and preview (http:/ / books. google. com/
        books?id=0E-aFJ09nPAC& printsec=find& pg=PR7=#v=onepage& q& f=false).
    [7] • David Colander (1992). "Retrospectives: The Lost Art of Economics", Journal of Economic Perspectives, 6(3), pp. 191-198 (http:/ /
        community. middlebury. edu/ ~colander/ articles/ retrospectives_lost_art. pdf).
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        books?id=5GcVAAAAYAAJ& pg=PP20& dq="Keynes"+ "Scope+ *+ Method+ *+ Political") 4th ed., 1917 [1999]. Full Contents. (http:/ /
        socserv. mcmaster. ca/ econ/ ugcm/ 3ll3/ keynesjn/ Scope. pdf#page=3)
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        com/ books?id=u8GPYeT1qAUC& printsec=fnd& pg=PA432& dq=#v=onepage& q& f=false)-449.
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        socserv. mcmaster. ca/ econ/ ugcm/ 3ll3/ keynesjn/ Scope. pdf#page=3)
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        1811088?searchUrl=/ sici?sici=0002-8282(1969)59%3A1%3C%3E1. 0. CO%3B2-X& origin=repec& Search=yes)–12.
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Economic methodology                                                                                                                                     72

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                 David F. Hendry. "Econometric Methodology: A Personal Perspective", pp. 29- (http:/ / books. google. com/
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        A Companion to the History of Economic Thought, Wiley, pp. 395- (http:/ / books. google. com/ books?hl=en& lr=& id=oEG74UiYP10C&
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        e-elgar. com/ Print_product_detail. lasso?id=1719) and preview (http:/ / books. google. com/ books?id=d-jZBhjpSC8C& printsec=find&
        pg=PP11=#v=onepage& q& f=false).
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        dictionaryofeconomics. com/ article?id=pde2008_M000372& edition=current& q=& topicid=& result_number=1).
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        Catalog/ ViewProduct. php?productid=6807& viewby=series& categoryid=47& sort=newest), preview (http:/ / books. google. com/
        books?hl=en& lr=& id=ntc_Fs36AoQC& oi=fnd& pg=PR7& dq=& f=false#v=onepage& q& f=false), and review (http:/ / www. nd. edu/
        ~pmirowsk/ pdf/ Weintraub_review_Isis. pdf) extract (http:/ / www. jstor. org/ pss/ 3132446).
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           • Amartya K. Sen, 1970 [1984]. Collective Choice and Social Welfare ISBN 0-444-85127-5.
           • _____, 2008. "social choice", The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www. dictionaryofeconomics.
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Economic methodology                                                                                                                                   74

    [15] • William Thomson, 1999. "The Young Person's Guide to Writing Economic Theory," Journal of Economic Literature, 37(1), pp. 157-183.
        (http:/ / web. cenet. org. cn/ upfile/ 70156. pdf)
           • _____, 2001. A Guide for the Young Economist: Writing and Speaking Effectively about Economics. Chapter-preview links. (http:/ / books.
        google. com/ books?id=GuDcMokIZaQC& printsec=find& pg=PR7#v=onepage& q& f=false)
           • Eric Rasmusen, 2001. "Aphorisms on Writing, Speaking, and Listening", in E. Rasmusen, ed., Readings in Games and Information, pp.
        389-420. PDF. (http:/ / works. bepress. com/ cgi/ viewcontent. cgi?article=1033& amp;context=rasmusen)
           • Donald McCloskey, 1985. "Economical Writing", Economic Inquiry, 23(2), pp. 187-222. (http:/ / business. nmsu. edu/ ~mhyman/
        M610_Articles/ McCloskey_EconInquiry_1985. pdf)
           • David N. Laband and Christopher N. Taylor, 1992. "The Impact of Bad Writing in Economics", Economic Inquiry, 30(4), pp. 673-688.
        (http:/ / onlinelibrary. wiley. com/ doi/ 10. 1111/ j. 1465-7295. 1992. tb01289. x/ abstract. )
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        deirdremccloskey. com/ docs/ pdf/ Article_110. pdf)
           • _____, [1985] 1998, 2nd ed. The Rhetoric of Economics. Chapter-preview links. (http:/ / books. google. com/
        books?id=RDwsPG2KmXYC& printsec=find& pg=PR7=onepage& q& f=false#v=onepage& q& f=false)
           • Roger Backhouse, T. Dudley-Evans, and Willie Henderson, 1993. "Exploring the Language and Rhetoric of Economics", in Willie
        Henderson et al., Economics and Language, pp. 1-20 (http:/ / books. google. com/ books?id=y7MOAAAAQAAJ& printsec==fnd&
        pg=PA1=gbs_atb#v=onepage& q& f=false) (preview)
           • John Kenneth Galbraith, 1962. "The Language of Economics", Fortune, LXVI(6), Dec. pp. 12-30, 169, 31. Excerpt at [CNN] "FORTUNE:
        John Kenneth Galbraith, excerpts from his writing" (http:/ / money. cnn. com/ 2006/ 05/ 17/ news/ newsmakers/ galbraith_fortune_052906/
        index. htm), May 17, 2006.
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        Leontief, 1977, Essays in Economics, v. 1, ch. III, pp. 24-34. (http:/ / books. google. com/ books?id=OPGg2K2ZJ6MC& pg=PA24&
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        ved=0CBoQ6AEwAQ#v=onepage& q="Theoretical Assumptions and Nonobserved Facts"& f=false)
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        cambridge. org/ gb/ knowledge/ isbn/ item1143239/ ?site_locale=en_GB) and Preview. (http:/ / books. google. com/
        books?id=T4y7HyduGnIC& dq="The+ Methodology+ of+ Economics,+ or+ How+ Economists+ Explain"& lr=& source=gbs_summary_s&
           • Roger Backhouse and Mark Blaug, 1994. New Directions in Economic Methodology, Routledge. Contents preview. (http:/ / books. google.
        com/ books?id=T4y7HyduGnIC& printsec=find& pg=PR7#v=onepage& q& f=false)
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        (http:/ / www. e-elgar. co. uk/ bookentry_mainUS. lasso?id=1360) & preview links. (http:/ / books. google. com/ books?id=nSdX1zjn1aYC&
        printsec=find& pg=PR5=false#v=onepage& q& f=false)
           • D. Wade Hands, 2001. Without Rules: Economic Methodology and Contemporary Science Theory, Oxford. Description (http:/ / books.
        google. com/ books?id=FUZZAXGF7qsC& dq=methodology+ OR+ methodological+ economic& lr=& source=gbs_navlinks_s) and contents
        preview. (http:/ / books. google. com/ books?id=FUZZAXGF7qsC& printsec=find& pg=PR7#v=onepage& q& f=false)
           • Christopher A. Sims, 1996. "Macroeconomics and Methodology", Journal of Economic Perspectives, 10(1), pp. 105-120. (http:/ /
        wolfweb. unr. edu/ homepage/ pingle/ Teaching/ Sims 1996. pdf)
           • Kevin D. Hoover, 2001. The Methodology of Empirical Macroeconomics, Oxford. Description (http:/ / books. google. com/
        books?id=lCG9PQqCf_UC& source=gbs_navlinks_s) and preview. (http:/ / books. google. com/ books?id=hkTjC7SlRTcC& printsec=find&
        pg=PR9#v=onepage& q& f=false)
           • Bruno S. Frey, 2001. "Why Economists Disregard Economic Methodology, Journal of Economic Methodology, 8(1), pp. 41–47 (http:/ /
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        books?hl=en& lr=& id=udfyv7humtoC& oi=fnd& pg=PA222& dq=false#v=onepage& q=false& f=false)", in Karl Popper: A Centenary
        Assessment, v. 3, ed. Ian Charles Jarvie et al., pp. 219
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        oi=fnd& pg=PA3& dq=F1FK11cwip& sig=0_AvdUDfdfMJaP7gmiGj8LDDKJ0#v=onepage& q=& f=false), 2nd ed. New York, Cambridge
        University Press. ISBN 0521558506
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Economic methodology                                                                                             75

    • John Bryan Davis, D. Wade Hands, Uskali Mäki (1998). Handbook of Economic Methodology, E. Elgar
    • Hands, D. Wade, ed. (1993). The Philosophy And Methodology Of Economics, Duke University
    • Hausman, Daniel M. (1984). The Philosophy of Economics: An Anthology (
      books?id=NqNGaJBahWoC&lpg=PR5&hl=bg&pg=PP1#v=onepage&q&f=false). New York: Cambridge
      University Press, ISBN 052145929X
    • Boland, L. (1982) The Foundations of Economic Method, London: Geo. Allen & Unwin.
    • Boland, L. (1989) The Methodology of Economic Model Building: Methodology after Samuelson (http://books. Methodology of Economic Model Building&
      hl=bg&pg=PP1#v=onepage&q&f=false), London: Routledge.
    • Boland, L. (1997) Critical Economic Methodology: A Personal Odyssey (
      books?id=Shmckd6oVSQC&lpg=PP1&dq=Economic Methodology&hl=bg&pg=PP1#v=onepage&q&
      f=false), London: Routledge
    • Boland, L. (2003) The Foundations of Economic Method: A Popperian Perspective, London: Routledge
    • D.N. McCloskey (1983). The Rhetoric of Economics (
      lpg=PP1&dq=The Rhetoric of Economics&hl=bg&pg=PP1#v=onepage&q&f=false), Univ of Wisconsin
      Press, 1998
    • Daniel M. Hausman (1992). Essays on Philosophy and Economic Methodology (
      books?id=pM57-DJ2yDcC&lpg=PP1&dq=Essays on Philosophy and Economic Methodology&hl=bg&
      pg=PP1#v=onepage&q&f=false), Cambridge University Press, 1992
    • Nell, E.J. and Errouaki, K. (2011) Rational Econometric Man. Edward Elgar.

    External links
    • Journal of Economic Methodology ( - page @ EconPapers
    • Daniel M. Hausman, Philosophy of Economics ( (with focus on
      methodology), Stanford Encyclopedia of Philosophy
    • Milton Friedman, "The Methodology of Positive Economics" (
      Friedman Positive.htm)
Heterodox economics                                                                                                            76

    Heterodox economics
    Heterodox economics refers to methodologies or schools of economic thought that are considered outside of
    "mainstream economics", often represented by expositors as contrasting with or going beyond neoclassical
    economics.[1][2] "Heterodox economics" is an umbrella term used to cover various approaches, schools, or traditions.
    These include socialist, Marxian, institutional, evolutionary, Georgist, Austrian, feminist,[3] social,
    post-Keynesian,[2] and ecological economics among others.[4] In the JEL classification codes developed by the
    Journal of Economic Literature, heterodox economics is in the second of the 19 primary categories at:
          JEL: B - History of Economic Thought, Methodology, and Heterodox Approaches.
    Mainstream economics may be called orthodox or conventional economics by its critics.[5] Alternatively, mainstream
    economics deals with the "rationality-individualism-equilibrium nexus" and heterodox economics is more "radical"
    in dealing with the "institutions-history-social structure nexus".[6] Mainstream economists sometimes assert that it
    has little or no influence on the vast majority of academic economists in the English speaking world.[7]
    A recent review documents several prominent groups of heterodox economists since at least the 1990s as working
    together with a resulting increase in coherence across different constituents.[2] Along these lines, the International
    Confederation of Associations for Pluralism in Economics (ICAPE) does not define "heterodox economics" and has
    avoided defining its scope. ICAPE defines its mission as "promoting pluralism in economics."
    In defining a common ground in the "critical commentary," one writer described fellow heterodox economists as
    trying to do three things: (1) identify shared ideas that generate a pattern of heterodox critique across topics and
    chapters of introductory macro texts; (2) give special attention to ideas that link methodological differences to policy
    differences; and (3) characterize the common ground in ways that permit distinct paradigms to develop common
    differences with textbook economics in different ways.[8]
    One study suggests four key factors as important to the study of economics by self-identified heterodox economists:
    history, natural systems, uncertainty, and power.[9]

    A number of heterodox schools of economic thought challenged the dominance of neoclassical economics after the
    neoclassical revolution of the 1870s. In addition to socialist critics of capitalism, heterodox schools in this period
    included advocates of various forms of mercantilism, such as the American School dissenters from neoclassical
    methodology such as the historical school, and advocates of unorthodox monetary theories such as Social credit.
    Other heterodox schools active before and during the Great Depression included Technocracy and Georgism.
    Physical scientists and biologists were the first individuals to use energy flows to explain social and economic
    development. Joseph Henry, an American physicist and first secretary of the Smithsonian Institution, remarked that
    the "fundamental principle of political economy is that the physical labor of man can only be ameliorated by… the
    transformation of matter from a crude state to a artificial expending what is called power or
    The rise, and absorption into the mainstream of Keynesian economics, which appeared to provide a more coherent
    policy response to unemployment than unorthodox monetary or trade policies contributed to the decline of interest in
    these schools.
    After 1945, the neoclassical synthesis of Keynesian and neoclassical economics resulted in a clearly defined
    mainstream position based on a division of the field into microeconomics (generally neoclassical but with a newly
    developed theory of market failure) and macroeconomics (divided between Keynesian and monetarist views on such
    issues as the role of monetary policy). Austrians and post-Keynesians who dissented from this synthesis emerged as
    clearly defined heterodox schools. In addition, the Marxist and institutionalist schools remained active.
Heterodox economics                                                                                                            77

    Up to 1980 the most notable themes of heterodox economics in its various forms included:
    1. rejection of the atomistic individual conception in favor of a socially embedded individual conception;
    2. emphasis on time as an irreversible historical process;
    3. reasoning in terms of mutual influences between individuals and social structures.
    From approximately 1980 mainstream economics has been significantly influenced by a number of new research
    programs, including behavioral economics, complexity economics, evolutionary economics, experimental
    economics, and neuroeconomics. As a consequence, some heterodox economists, such as John B. Davis, proposed
    that the definition of heterodox economics has to be adapted to this new, more complex reality:[12]
                ...heterodox economics post-1980 is a complex structure, being composed out of two broadly different
                kinds of heterodox work, each internally differentiated with a number of research programs having
                different historical origins and orientations: the traditional left heterodoxy familiar to most and the 'new
                heterodoxy' resulting from other science imports.[12]

    Rejection of neoclassical economics
    There is no single "heterodox economic theory"; there are many different "heterodox theories" in existence. What
    they all share, however, is a rejection of the neoclassical orthodoxy as representing the appropriate tool for
    understanding the workings of economic and social life. The reasons for this rejection may vary. Some of the
    elements commonly found in heterodox critiques are listed below.

    Criticism of the neoclassical model of individual behavior
    One of the most broadly accepted principles of neoclassical economics is the assumption of the "rationality of
    economic agents". Indeed, for a number of economists, the notion of rational maximizing behavior is taken to be
    synonymous with economic behavior (Becker 1976, Hirshleifer 1984). When some economists' studies do not
    embrace the rationality assumption, they are seen as placing the analyses outside the boundaries of the Neoclassical
    economics discipline (Landsberg 1989, 596). Neoclassical economics begins with the a priori assumptions that
    agents are rational and that they seek to maximize their individual utility (or profits) subject to environmental
    constraints. These assumptions provide the backbone for rational choice theory.
    Many heterodox schools are critical of the homo economicus model of human behavior used in standard neoclassical
    model. A typical version of the critique is that of Satya Gabriel[13]:
          Neoclassical economic theory is grounded in a particular conception of human psychology, agency or
          decision-making. It is assumed that all human beings make economic decisions so as to maximize
          pleasure or utility. Some heterodox theories reject this basic assumption of neoclassical theory, arguing
          for alternative understandings of how economic decisions are made and/or how human psychology
          works. It is possible to accept the notion that humans are pleasure seeking machines, yet reject the idea
          that economic decisions are governed by such pleasure seeking. Human beings may, for example, be
          unable to make choices consistent with pleasure maximization due to social constraints and/or coercion.
          Humans may also be unable to correctly assess the choice points that are most likely to lead to
          maximum pleasure, even if they are unconstrained (except in budgetary terms) in making such choices.
          And it is also possible that the notion of pleasure seeking is itself a meaningless assumption because it is
          either impossible to test or too general to refute. Economic theories that reject the basic assumption of
          economic decisions as the outcome of pleasure maximization are heterodox.
    Shiozawa emphasizes that economic agents act in a complex world and therefore impossible for them to attain
    maximal utility point. They instead behave as if there are a repertories of many ready made rules, one of which they
    chose according to relevant situation.[14]
Heterodox economics                                                                                                           78

    Criticism of the neoclassical model of market equilibrium
    In microeconomic theory, cost-minimization by consumers and by firms implies the existence of supply and demand
    correspondences for which market clearing equilibrium prices exist, if there are large numbers of consumers and
    producers. Under convexity assumptions or under some marginal-cost pricing rules, each equilibrium will be Pareto
    efficient: In large economies, non-convexity also leads to quasi-equilibria that are nearly efficient.
    However, the concept of market equilibrium has been criticized by Austrians, post-Keynesians and others, who
    object to applications of microeconomic theory to real-world markets, when such markets are not usefully
    approximated by microeconomic models. Heterodox economists assert that micro-economic models rarely capture
    Mainstream microeconomics may be defined in terms of optimization and equilibrium, following the approaches of
    Paul Samuelson and Hal Varian. On the other hand, heterodox economics may be labeled as falling into the nexus of
    institutions, history, and social structure.[4][15]

    Most recent developments
    Over the past two decades, the intellectual agendas of heterodox economists have taken a decidedly pluralist turn.
    Leading heterodox thinkers have moved beyond the established paradigms of Austrian, Feminist,
    Institutional-Evolutionary, Marxian, Post Keynesian, Radical, Social, and Sraffian economics—opening up new
    lines of analysis, criticism, and dialogue among dissenting schools of thought. This cross-fertilization of ideas is
    creating a new generation of scholarship in which novel combinations of heterodox ideas are being brought to bear
    on important contemporary and historical problems, such as socially-grounded reconstructions of the individual in
    economic theory; the goals and tools of economic measurement and professional ethics; the complexities of
    policymaking in today's global political economy; and innovative connections among formerly separate theoretical
    traditions (Marxian, Austrian, feminist, ecological, Sraffian, institutionalist, and post-Keynesian) (for a review of
    post-Keynesian economics, see Lavoie (1992); Rochon (1999)).
    David Colander, an advocate of complexity economics, argues that the ideas of heterodox economists are now being
    discussed in the mainstream without mention of the heterodox economists, because the tools to analyze institutions,
    uncertainty, and other factors have now been developed by the mainstream. He suggests that heterodox economists
    should embrace rigorous mathematics and attempt to work from within the mainstream, rather than treating it as an
    Energy economics relating to thermoeconomics, is a broad scientific subject area which includes topics related to
    supply and use of energy. Thermoeconomists argue that economic systems always involve matter, energy, entropy,
    and information.[17] Thermoeconomics is based on the proposition that the role of energy in biological evolution
    should be defined and understood through the second law of thermodynamics but in terms of such economic criteria
    as productivity, efficiency, and especially the costs and benefits of the various mechanisms for capturing and
    utilizing available energy to build biomass and do work.[18][19] As a result, thermoeconomics are often discussed in
    the field of ecological economics, which itself is related to the fields of sustainability and sustainable development.
Heterodox economics                                                                                                                                79

    Fields or schools of heterodox economics
    •   American Institutionalist School
    •   Austrian economics # (partly within, and partly outside mainstream economics)[20]
    •   Binary Economics
    •   Bioeconomics
    •   Complexity economics
    •   Ecological economics §
    •   Evolutionary economics # §(partly within mainstream economics)
    •   Feminist economics # §
    •   Georgism
    •   Green Economics
    •   Gesellian economics
    •   Institutional economics # §
    •   Islamic economics
    •   Marxian economics #
    •   Mutualism
    •   Neuroeconomics
    •   Participatory economics
    •   Post-Keynesian economics,§ including Modern Monetary Theory and Circuitism
    •   Post scarcity
    •   Socialist economics #
    •   Social economics (partially heterodox usage)
    •   Supply-side economics
    •   Sraffian economics #
    •   Technocracy (Energy Accounting)
    •   Thermoeconomics
    •   Mouvement Anti-Utilitariste dans les Sciences Sociales
    # Listed in Journal of Economic Literature codes scrolled to at JEL: B5 - Current Heterodox Approaches.
    § Listed in The New Palgrave Dictionary of Economics, 2nd Edition, v. 8, Appendix IV, p. 856, searchable by
    clicking (the JEL classification codes JEL:) radio button B5, B52, or B59, then the Search button (or Update Search
    Results button) at http:/ / www. dictionaryofeconomics. com/ search_results?edition=all& field=content& q=&
    Some schools in the social sciences aim to promote certain perspectives: classical and modern political economy;
    economic sociology and anthropology; gender and racial issues in economics; and so on.

    [1] Fred E. Foldvary, ed., 1996. Beyond Neoclassical Economics: Heterodox Approaches to Economic Theory, Edward Elgar. Description and
        contents B& links (http:/ / www. barnesandnoble. com/ w/ beyond-neoclassical-economics-fred-e-foldvary/
    [2] Frederic S. Lee, 2008. "heterodox economics," The New Palgrave Dictionary of Economics, 2nd Edition, v. 4, pp. 2-65. Abstract. (http:/ /
        www. dictionaryofeconomics. com/ article?id=pde2008_H000175& q=heterodox economics& topicid=& result_number=1)
    [3] In the order listed at JEL classification codes#History of economic thought, methodology, and heterodox approaches JEL: B Subcategories,
        JEL: B5 - Current Heterodox Approaches.
    [4] Lawson, T. (2005). "The nature of heterodox economics" (http:/ / cas. umkc. edu/ econ/ economics/ faculty/ wray/ papers/
        lawson_on_heterdoxy. pdf). Cambridge Journal of Economics 30 (4): 483–505. doi:10.1093/cje/bei093. .
    [5] C. Barry, 1998. Political-economy: A comparative approach. Westport, CT: Praeger.
    [6] John B. Davis (2006). "Heterodox Economics, the Fragmentation of the Mainstream, and Embedded Individual Analysis", in Future
        Directions in Heterodox Economics, p. 57 (http:/ / books. google. com/ books?id=VVmBSpZV07AC& pg=PA57=false#v=onepage& q&
Heterodox economics                                                                                                                                  80

        f=false). Ann Arbor: University of Michigan Press.
    [7] Among these economists, Robert M. Solow names Austrian, Post-Keynesian, Marxist, and neo-Ricardian schools as on "dissenting fringes of
        academic economics". Solow continued that "In economics, nevertheless, there is usually a definite consensus — there is one now." Further:

           Marx was an important and influential thinker, and Marxism has been a doctrine with intellectual and
           practical influence. The fact is, however, that most serious English-speaking economists regard Marxist
           economics as an irrelevant dead end.
       (Solow 1988)

    George Stigler similarly noted the professional marginality of the "neo-Ricardian" economists (who follow Piero
    Sraffa): "economists working in the Marxian-Sraffian tradition represent a small minority of modern economists, and
    ... their writings have virtually no impact upon the professional work of most economists in major English-language
    universities." (Stigler 1988, p. 1733)
    [8] Cohn, Steve (2003). "Common Ground Critiques of Neoclassical Principles Texts" (http:/ / www. paecon. net/ PAEReview/
        heterodoxeconomics/ Cohn18. htm). Post-Autistic Economics Review (18, article 3). .
    [9] Mearman, Andrew (2011). "Who Do Heterodox Economists Think They Are?" American Journal of Economics and Sociology, 70(2):
        480–510 (http:/ / onlinelibrary. wiley. com/ doi/ 10. 1111/ j. 1536-7150. 2011. 00774. x/ full).
    [10] Cutler J. Cleveland, "Biophysical economics" (http:/ / www. eoearth. org/ article/ Biophysical_economics), Encyclopedia of Earth, Last
        updated: September 14, 2006.
    [11] Eric Zencey, 2009. "Mr. Soddy’s Ecological Economy",] The New York Times, April 12, p. WK 9. (http:/ / www. nytimes. com/ 2009/ 04/
        12/ opinion/ 12zencey. html?_r=1& ref=opinion)
    [12] Davis, John B. (2006). "The Nature of Heterodox Economics" (http:/ / www. paecon. net/ PAEReview/ issue40/ Davis40. pdf). Post-Autistic
        Economics Review (40): 23–30. .
    [13] Satya J. Gabriel 2003. "Introduction to Heterodox Economic Theory." (blog), June 4, (http:/ / www. mtholyoke. edu/ courses/ sgabriel/
        heterodox_defined. htm) Satya J. Gabriel is a Professor of Economics at Mount Holyoke College}
    [14] Shiozawa, Y. 2004 Evolutinary Economics in the 21st Century: A Manifest, Evolutionary and Institutional Economics Review, 1(1): 5-47.
    [15] Dow, S. C. (2000). "Prospects for the Progress in Heterodox Economics". Journal of the History of Economic Thought 22 (2): 157–170.
    [16] David Colander, 2007. Pluralism and Heterodox Economics: Suggestions for an “Inside the Mainstream” Heterodoxy (http:/ / ideas. repec.
        org/ p/ mdl/ mdlpap/ 0724. html)
    [17] Stefan Baumgarter, 2004. Thermodynamic Models (http:/ / www. eco. uni-heidelberg. de/ ng-oeoe/ research/ papers/ Baumgaertner 2004
        ModEE. pdf), Modeling in Ecological Economics (Ch. 18)
    [18] Corning, Peter A.; Kline, Stephen J. (1998). "Thermodynamics, information and life revisited, Part II: 'Thermoeconomics' and 'Control
        information'". Systems Research and Behavioral Science 15 (6): 453–482.
    [19] Peter A. Corning. 2002. “ Thermoeconomics – Beyond the Second Law (http:/ / www. complexsystems. org/ abstracts/ thermoec. html)” –
    [20] 2003. A Companion to the History of Economic Thought. Blackwell Publishing. ISBN 0-631-22573-0 p. 452

    Further reading

    • Flaherty, Diane, 1987. "radical political economy," The New Palgrave: A Dictionary of Economics, v, 4.
      pp. 36–39.
    • _____, 2008. "radical economics," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:// economics&topicid=&
    • Lee, Frederic. S. 2008. "heterodox economics", The New Palgrave Dictionary of Economics, 2nd Edition.
      Abstract. ( economics&
Heterodox economics                                                                                                 81

    • Gerber, Julien-Francois and Steppacher, Rolf, ed., 2012. Towards an Integrated Paradigm in Heterodox
      Economics: Alternative Approaches to the Current Eco-Social Crises (
      title.aspx?pid=521017). Palgrave Macmillan. ISBN 978-0-230-30358-4
    • Lee, Frederic S. 2009. A History of Heterodox Economics Challenging the Mainstream in the Twentieth Century
      ( London and New York: Routledge. 2009
    • Harvey, John T. and Garnett, Jr., Robert F., ed., 2007. Future Directions for Heterodox Economics, Series
      Advances in Heterodox Economics, The University of Michigan Press, . ( ISBN 978-0-472-03247-1
    • McDermott, John, 2003. Economics in Real Time: A Theoretical Reconstruction, Series Advances in Heterodox
      Economics, The University of Michigan Press. ISBN 978-0-472-11357-6
    • Rochon, Louis-Philippe and Rossi, Sergio, editors, 2003. Modern Theories of Money: The Nature and Role of
      Money in Capitalist Economies. Edward Elgar Publishing. ISBN 1-84064-789-2 (http://www.economics.
    • Solow, Robert M. (20 March 1988). "The Wide, Wide World Of Wealth (The New Palgrave: A Dictionary of
      Economics'. Edited by John Eatwell, Murray Milgate and Peter Newman. Four volumes. 4,103 pp. New York:
      Stockton Press. $650)" (
      html?scp=1). New York Times.
    • Stigler, George J. (December 1988). "Palgrave's Dictionary of Economics". Journal of Economic Literature
      (American Economic Association) 26 (4): 1729–1736. JSTOR 2726859.

    Articles, conferences, papers
    • Lavoie, Marc, 2006. Do Heterodox Theories Have Anything in Common? A Post-Keynesian Point of View. (http:/
    • Lawson, Tony, 2006. "The Nature of Heterodox Economics," Cambridge Journal of Economics, 30(4),
      pp. 483–505. Pre-publication copy. (

    • Evolutionary and Institutional Economics Review ( (Freely
    • Journal of Institutional Economics

    External links
    • Heterodox Economics Research Centre (
    • Association for Heterodox Economics (
    • Heterodox Economics Newsletter (
    • Heterodox Economics Directory (Graduate and Undergraduate Programs, Journals, Publishers and Book Series,
      Associations, Blogs, and Institutions and Other Web Sites) (
    • The Association for Evolutionary Economics (AFEE) (
    • The International Confederation of Associations for Pluralism in Economics (ICAPE) (
Mathematical economics                                                                                                         82

    Mathematical economics
    Mathematical economics is the application of mathematical methods to represent theories and analyze problems in
    economics. An advantage claimed for the approach is its allowing formulation of theoretical relationships with rigor,
    generality, and simplicity.[1] By convention, the applied methods refer to those beyond simple geometry, such as
    differential and integral calculus, difference and differential equations, matrix algebra, mathematical programming,
    and other computational methods.[2][3]
    It is argued that mathematics allows economists to form meaningful, testable propositions about wide-ranging and
    complex subjects which could less easily be expressed informally. Further, the language of mathematics allows
    economists to make specific, positive claims about controversial or contentious subjects that would be impossible
    without mathematics.[4] Much of economic theory is currently presented in terms of mathematical economic models,
    a set of stylized and simplified mathematical relationships asserted to clarify assumptions and implications.[5]
    Broad applications include:
    • optimization problems as to goal equilibrium, whether of a household, business firm, or policy maker
    • static (or equilibrium) analysis in which the economic unit (such as a household) or economic system (such as a
      market or the economy) is modeled as not changing
    • comparative statics as to a change from one equilibrium to another induced by a change in one or more factors
    • dynamic analysis, tracing changes in an economic system over time, for example from economic growth.[3][6][7]
    Formal economic modeling began in the 19th century with the use of differential calculus to represent and explain
    economic behavior, such as utility maximization, an early economic application of mathematical optimization.
    Economics became more mathematical as a discipline throughout the first half of the 20th century, but introduction
    of new and generalized techniques in the period around the Second World War, as in game theory, would greatly
    broaden the use of mathematical formulations in economics.[8][7]
    This rapid systematizing of economics alarmed critics of the discipline as well as some noted economists. John
    Maynard Keynes, Robert Heilbroner, Friedrich Hayek and others have criticized the broad use of mathematical
    models for human behavior, arguing that some human choices are irreducible to mathematics.

    The use of mathematics in the service of social and economic analysis dates back to the 17th century. Then, mainly
    in German universities, a style of instruction emerged which dealt specifically with detailed presentation of data as it
    related to public administration. Gottfried Achenwall lectured in this fashion, coining the term statistics. At the same
    time, a small group of professors in England established a method of "reasoning by figures upon things relating to
    government" and referred to this practice as Political Arithmetick.[9] Sir William Petty wrote at length on issues that
    would later concern economists, such as taxation, Velocity of money and national income, but while his analysis was
    numerical, he rejected abstract mathematical methodology. Petty's use of detailed numerical data (along with John
    Graunt) would influence statisticians and economists for some time, even though Petty's works were largely ignored
    by English scholars.[10]
    The mathematization of economics began in earnest in the 19th century. Most of the economic analysis of the time
    was what would later be called classical economics. Subjects were discussed and dispensed with through algebraic
    means, but calculus was not used. More importantly, until Johann Heinrich von Thünen's The Isolated State in 1826,
    economists did not develop explicit and abstract models for behavior in order to apply the tools of mathematics.
    Thünen's model of farmland use represents the first example of marginal analysis.[11] Thünen's work was largely
    theoretical, but he also mined empirical data in order to attempt to support his generalizations. In comparison to his
    contemporaries, Thünen built economic models and tools, rather than applying previous tools to new problems.[12]
Mathematical economics                                                                                                                    83

    Meanwhile a new cohort of scholars trained in the mathematical methods of the physical sciences gravitated to
    economics, advocating and applying those methods to their subject,[13] and described today as moving from
    geometry to mechanics.[14] These included W.S. Jevons who presented paper on a "general mathematical theory of
    political economy" in 1862, providing an outline for use of the theory of marginal utility in political economy.[15] In
    1871, he published The Principles of Political Economy, declaring that the subject as science "must be mathematical
    simply because it deals with quantities." Jevons expected the only collection of statistics for price and quantities
    would permit the subject as presented to become an exact science.[16] Others preceded and followed in expanding
    mathematical representations of economic problems.

    Marginalists and the roots of neoclassical economics
    Augustin Cournot and Léon Walras built the tools
    of the discipline axiomatically around utility,
    arguing that individuals sought to maximize their
    utility across choices in a way that could be
    described mathematically.[17] At the time, it was
    thought that utility was quantifiable, in units
    known as utils.[18] Cournot, Walras and Francis
    Ysidro Edgeworth are considered the precursors
    to modern mathematical economics.[19]

    Augustin Cournot

    Cournot, a professor of Mathematics, developed a
    mathematical treatment in 1838 for duopoly—a
    market condition defined by competition between
    two sellers.[19] This treatment of competition, first
    published in Researches into the Mathematical
    Principles of Wealth,[20] is referred to as Cournot
                                                             Equilibrium quantities as a solution to two reaction functions in Cournot
    duopoly. It is assumed that both sellers had equal      duopoly. Each reaction function is expressed as a linear equation dependent
    access to the market and could produce their                                    upon quantity demanded.
    goods without cost. Further, it assumed that both
    goods were homogeneous. Each seller would vary her output based on the output of the other and the market price
    would be determined by the total quantity supplied. The profit for each firm would be determined by multiplying
    their output and the per unit Market price. Differentiating the profit function with respect to quantity supplied for
    each firm left a system of linear equations, the simultaneous solution of which gave the equilibrium quantity, price
    and profits.[21] Cournot's contributions to the mathematization of economics would be neglected for decades, but
    eventually influenced many of the marginalists.[21][22] Cournot's models of duopoly and Oligopoly also represent one
    of the first formulations of non-cooperative games. Today the solution can be given as a Nash equilibrium but
    Cournot's work preceded modern Game theory by over 100 years.[23]

    Léon Walras
    While Cournot provided a solution for what would later be called partial equilibrium, Léon Walras attempted to
    formalize discussion of the economy as a whole through a theory of general competitive equilibrium. The behavior
    of every economic actor would be considered on both the production and consumption side. Walras originally
    presented four separate models of exchange, each recursively included in the next. The solution of the resulting
    system of equations (both linear and non-linear) is the general equilibrium.[24] At the time, no general solution could
    be expressed for a system of arbitrarily many equations, but Walras's attempts produced two famous results in
Mathematical economics                                                                                                         84

    economics. The first is Walras' law and the second is the principle of tâtonnement. Walras' method was considered
    highly mathematical for the time and Edgeworth commented at length about this fact in his review of Éléments
    d'économie politique pure (Elements of Pure Economics).[25]
    Walras' law was introduced as a theoretical answer to the problem of determining the solutions in general
    equilibrium. His notation is different from modern notation but can be constructed using more modern summation
    notation. Walras assumed that in equilibrium, all money would be spent on all goods: every good would be sold at
    the market price for that good and every buyer would expend their last dollar on a basket of goods. Starting from this
    assumption, Walras could then show that if there were n markets and n-1 markets cleared (reached equilibrium
    conditions) that the nth market would clear as well. This is easiest to visualize with two markets (considered in most
    texts as a market for goods and a market for money). If one of two markets has reached an equilibrium state, no
    additional goods (or conversely, money) can enter or exit the second market, so it must be in a state of equilibrium as
    well. Walras used this statement to move toward a proof of existence of solutions to general equilibrium but it is
    commonly used today to illustrate market clearing in money markets at the undergraduate level.[26]
    Tâtonnement (roughly, French for groping toward) was meant to serve as the practical expression of Walrasian
    general equilibrium. Walras abstracted the marketplace as an auction of goods where the auctioneer would call out
    prices and market participants would wait until they could each satisfy their personal reservation prices for the
    quantity desired (remembering here that this is an auction on all goods, so everyone has a reservation price for their
    desired basket of goods).[27]
    Only when all buyers are satisfied with the given market price would transactions occur. The market would "clear" at
    that price—no surplus or shortage would exist. The word tâtonnement is used to describe the directions the market
    takes in groping toward equilibrium, settling high or low prices on different goods until a price is agreed upon for all
    goods. While the process appears dynamic, Walras only presented a static model, as no transactions would occur
    until all markets were in equilibrium. In practice very few markets operate in this manner.[28]

    Francis Ysidro Edgeworth
    Edgeworth introduced mathematical elements to Economics explicitly in Mathematical Psychics: An Essay on the
    Application of Mathematics to the Moral Sciences, published in 1881.[29] He adopted Jeremy Bentham's felicific
    calculus to economic behavior, allowing the outcome of each decision to be converted into a change in utility.[30]
    Using this assumption, Edgeworth built a model of exchange on three assumptions: individuals are self-interested,
    individuals act to maximize utility, and individuals are "free to recontract with another independently of...any third
Mathematical economics                                                                                                                     85

    Given two individuals, the set of
    solutions where the both individuals
    can maximize utility is described by
    the contract curve on what is now
    known as an Edgeworth Box.
    Technically, the construction of the
    two-person solution to Edgeworth's
    problem was not developed graphically
    until 1924 by Arthur Lyon Bowley.[33]
    The contract curve of the Edgeworth
    box (or more generally on any set of
    solutions to Edgeworth's problem for
    more actors) is referred to as the core
    of an economy.[34]

    Edgeworth devoted considerable effort
                                                    An Edgeworth box displaying the contract curve an economy with two participants.
    to insisting that mathematical proofs         Referred to as the "core" of the economy in modern parlance, there are infinitely many
    were appropriate for all schools of                                                                                   [32]
                                                            solutions along the curve for economies with two participants
    thought in economics. While at the
    helm of The Economic Journal, he published several articles criticizing the mathematical rigor of rival researchers,
    including Edwin Robert Anderson Seligman, a noted skeptic of mathematical economics.[35] The articles focused on
    a back and forth over tax incidence and responses by producers. Edgeworth noticed that a monopoly producing a
    good that had jointness of supply but not jointness of demand (such as first class and economy on an airplane, if the
    plane flies, both sets of seats fly with it) might actually lower the price seen by the consumer for one of the two
    commodities if a tax were applied. Common sense and more traditional, numerical analysis seemed to indicate that
    this was preposterous. Seligman insisted that the results Edgeworth achieved were a quirk of his mathematical
    formulation. He suggested that the assumption of a continuous demand function and an infinitesimal change in the
    tax resulted in the paradoxical predictions. Harold Hotelling later showed that Edgeworth was correct and that the
    same result (a "diminution of price as a result of the tax") could occur with a discontinuous demand function and
    large changes in the tax rate).[36]

    Modern mathematical economics
    From the later-1930s, an array of new mathematical tools from the differential calculus and differential equations,
    convex sets, and graph theory were deployed to advance economic theory in a way similar to new mathematical
    methods earlier applied to physics.[8][37] The process was later described as moving from mechanics to

    Differential calculus
    Vilfredo Pareto analyzed microeconomics by treating decisions by economic actors as attempts to change a given
    allotment of goods to another, more preferred allotment. Sets of allocations could then be treated as Pareto efficient
    (Pareto optimal is an equivalent term) when no exchanges could occur between actors that could make at least one
    individual better off without making any other individual worse off.[39] Pareto's proof is commonly conflated with
    Walrassian equilibrium or informally ascribed to Adam Smith's Invisible hand hypothesis.[40] Rather, Pareto's
    statement was the first formal assertion of what would be known as the first fundamental theorem of welfare
    economics.[41] These models lacked the inequalities of the next generation of mathematical economics.
Mathematical economics                                                                                                       86

    In the landmark treatise Foundations of Economic Analysis (1947), Paul Samuelson identified a common paradigm
    and mathematical structure across multiple fields in the subject, building on previous work by Alfred Marshall.
    Foundations took mathematical concepts from physics and applied them to economic problems. This broad view (for
    example, comparing Le Chatelier's principle to tâtonnement) drives the fundamental premise of mathematical
    economics: systems of economic actors may be modeled and their behavior described much like any other system.
    This extension followed on the work of the marginalists in the previous century and extended it significantly.
    Samuelson approached the problems of applying individual utility maximization over aggregate groups with
    comparative statics, which compares two different equilibrium states after an exogenous change in a variable. This
    and other methods in the book provided the foundation for mathematical economics in the 20th century.[7][42]

    Linear models
    Restricted models of general equilibrium were formulated by John von Neumann in 1937.[43] Unlike earlier versions,
    the models of von Neumann had inequality constraints. For his model of an expanding economy, von Neumann
    proved the existence and uniqueness of an equilibrium using his generalization of Brouwer's fixed point theorem.
    Von Neumann's model of an expanding economy considered the matrix pencil  A - λ B with nonnegative matrices A
    and B; von Neumann sought probability vectors p and q and a positive number λ that would solve the
    complementarity equation
          pT (A - λ B) q = 0,
    along with two inequality systems expressing economic efficiency. In this model, the (transposed) probability vector
    p represents the prices of the goods while the probability vector q represents the "intensity" at which the production
    process would run. The unique solution λ represents the rate of growth of the economy, which equals the interest
    rate. Proving the existence of a positive growth rate and proving that the growth rate equals the interest rate were
    remarkable achievements, even for von Neumann.[44][45][46] Von Neumann's results have been viewed as a special
    case of linear programming, where von Neumann's model uses only nonnegative matrices.[47] The study of von
    Neumann's model of an expanding economy continues to interest mathematical economists with interests in
    computational economics.[48][49][50]

    Input-output economics
    In 1936, the Russian–born economist Wassily Leontief built his model of input-output analysis from the 'material
    balance' tables constructed by Soviet economists, which themselves followed earlier work by the physiocrats. With
    his model, which described a system of production and demand processes, Leontief described how changes in
    demand in one economic sector would influence production in another.[51] In practice, Leontief estimated the
    coefficients of his simple models, to address economically interesting questions. In production economics, "Leontief
    technologies" produce outputs using constant proportions of inputs, regardless of the price of inputs, reducing the
    value of Leontief models for understanding economies but allowing their parameters to be estimated relatively
    easily. In contrast, the von Neumann model of an expanding economy allows for choice of techniques, but the
    coefficients must be estimated for each technology.[52][53]
Mathematical economics                                                                                                             87

    Mathematical optimization
    In mathematics, mathematical optimization (or optimization or
    mathematical programming) refers to the selection of a best element
    from some set of available alternatives.[54] In the simplest case, an
    optimization problem involves maximizing or minimizing a real
    function by selecting input values of the function and computing the
    corresponding values of the function. The solution process includes
    satisfying general necessary and sufficient conditions for optimality.
    For optimization problems, specialized notation may be used as to the
    function and its input(s). More generally, optimization includes finding
                                                                                Red dot in z direction as maximum for paraboloid
    the best available element of some function given a defined domain
                                                                                             function of (x, y) inputs
    and may use a variety of different computational optimization

    Economics is closely enough linked to optimization by agents in an economy that an influential definition relatedly
    describes economics qua science as the "study of human behavior as a relationship between ends and scarce means"
    with alternative uses.[56] Optimization problems run through modern economics, many with explicit economic or
    technical constraints. In microeconomics, the utility maximization problem and its dual problem, the expenditure
    minimization problem for a given level of utility, are economic optimization problems.[57] Theory posits that
    consumers maximize their utility, subject to their budget constraints and that firms maximize their profits, subject to
    their production functions, input costs, and market demand.[58]

    Economic equilibrium is studied in optimization theory as a key ingredient of economic theorems that in principle
    could be tested against empirical data.[7][59] Newer developments have occurred in dynamic programming and
    modeling optimization with risk and uncertainty, including applications to portfolio theory, the economics of
    information, and search theory.[58]
    Optimality properties for an entire market system may be stated in mathematical terms, as in formulation of the two
    fundamental theorems of welfare economics[60] and in the Arrow–Debreu model of general equilibrium (also
    discussed below).[61] More concretely, many problems are amenable to analytical (formulaic) solution. Many others
    may be sufficiently complex to require numerical methods of solution, aided by software.[55] Still others are complex
    but tractable enough to allow computable methods of solution, in particular computable general equilibrium models
    for the entire economy.[62]
    Linear and nonlinear programming have profoundly affected microeconomics, which had earlier considered only
    equality constraints.[63] Many of the mathematical economists who received Nobel Prizes in Economics had
    conducted notable research using linear programming: Leonid Kantorovich, Leonid Hurwicz, Tjalling Koopmans,
    Kenneth J. Arrow, and Robert Dorfman, Paul Samuelson, and Robert Solow.[64] Both Kantorovich and Koopmans
    acknowledged that George B. Dantzig deserved to share their Nobel Prize for linear programming. Economists who
    conducted research in nonlinear programming also have won the Nobel prize, notably Ragnar Frisch in addition to
    Kantorovich, Hurwicz, Koopmans, Arrow, and Samuelson.
Mathematical economics                                                                                                        88

    Linear optimization
    Linear programming was developed to aid the allocation of resources in firms and in industries during the 1930s in
    Russia and during the 1940s in the United States. During the Berlin airlift (1948), linear programming was used to
    plan the shipment of supplies to prevent Berlin from starving after the Soviet blockade.[65][66]

    Nonlinear programming
    Extensions to nonlinear optimization with inequality constraints were achieved in 1951 by Albert W. Tucker and
    Harold Kuhn, who considered the nonlinear optimization problem:
          Minimize           (       ) subject to    (   ) ≤ 0 and      (     ) = 0 where
                                                    i                  j
            ( ) is the function to be minimized
             ()(         = 1, ...,       ) are the functions of the         inequality constraints
                ()(      = 1, ...,     ) are the functions of the     equality constraints.
    In allowing inequality constraints, the Kuhn–Tucker approach generalized the classic method of Lagrange
    multipliers, which (until then) had allowed only equality constraints.[67] The Kuhn–Tucker approach inspired further
    research on Lagrangian duality, including the treatment of inequality constraints.[68][69] The duality theory of
    nonlinear programming is particularly satisfactory when applied to convex minimization problems, which enjoy the
    convex-analytic duality theory of Fenchel and Rockafellar; this convex duality is particularly strong for polyhedral
    convex functions, such as those arising in linear programming. Lagrangian duality and convex analysis are used
    daily in operations research, in the scheduling of power plants, the planning of production schedules for factories,
    and the routing of airlines (routes, flights, planes, crews).[69]

    Variational calculus and optimal control
    Economic dynamics allows for changes in economic variables over time, including in dynamic systems. The problem
    of finding optimal functions for such changes is studied in variational calculus and in optimal control theory. Before
    the Second World War, Frank Ramsey and Harold Hotelling used the calculus of variations to that end.
    Following Richard Bellman's work on dynamic programming and the 1962 English translation of L. Pontryagin et
    al.'s earlier work,[70] optimal control theory was used more extensively in economics in addressing dynamic
    problems, especially as to economic growth equilibrium and stability of economic systems,[71] of which a textbook
    example is optimal consumption and saving.[72] A crucial distinction is between deterministic and stochastic control
    models.[73] Other applications of optimal control theory include those in finance, inventories, and production for

    Functional analysis
    It was in the course of proving of the existence of an optimal equilibrium in his 1937 model of economic growth that
    John von Neumann introduced functional analytic methods to include topology in economic theory, in particular,
    fixed-point theory through his generalization of Brouwer's fixed-point theorem.[8][43][75] Following von Neumann's
    program, Kenneth Arrow and Gérard Debreu formulated abstract models of economic equilibria using convex sets
    and fixed–point theory. In introducing the Arrow–Debreu model in 1954, they proved the existence (but not the
    uniqueness) of an equilibrium and also proved that every Walras equilibrium is Pareto efficient; in general, equilibria
    need not be unique.[76] In their models, the ("primal") vector space represented quantitites while the "dual" vector
    space represented prices.[77]
    In Russia, the mathematician Leonid Kantorovich developed economic models in partially ordered vector spaces,
    that emphasized the duality between quantities and prices.[78] Oppressed by communism, Kantorovich renamed
    prices as "objectively determined valuations" which were abbreviated in Russian as "o. o. o.", alluding to the
    difficulty of discussing prices in the Soviet Union.[77][79][80]
Mathematical economics                                                                                                       89

    Even in finite dimensions, the concepts of functional analysis have illuminated economic theory, particularly in
    clarifying the role of prices as normal vectors to a hyperplane supporting a convex set, representing production or
    consumption possibilities. However, problems of describing optimization over time or under uncertainty require the
    use of infinite–dimensional function spaces, because agents are choosing among functions or stochastic

    Differential decline and rise
    John von Neumann's work on functional analysis and topology in broke new ground in mathematics and economic
    theory.[43][84] It also left advanced mathematical economics with fewer applications of differential calculus. In
    particular, general equilibrium theorists used general topology, convex geometry, and optimization theory more than
    differential calculus, because the approach of differential calculus had failed to establish the existence of an
    However, the decline of differential calculus should not be exaggerated, because differential calculus has always
    been used in graduate training and in applications. Moreover, differential calculus has returned to the highest levels
    of mathematical economics, general equilibrium theory (GET), as practiced by the "GET-set" (the humorous
    designation due to Jacques H. Drèze). In the 1960s and 1970s, however, Gérard Debreu and Stephen Smale led a
    revival of the use of differential calculus in mathematical economics. In particular, they were able to prove the
    existence of a general equilibrium, where earlier writers had failed, because of their novel mathematics: Baire
    category from general topology and Sard's lemma from differential topology. Other economists asssociated with the
    use of differential analysis include Egbert Dierker, Andreu Mas-Colell, and Yves Balasko.[85][86] These advances
    have changed the traditional narrative of the history of mathematical economics, following von Neumann, which
    celebrated the abandonment of differential calculus.

    Game theory
    John von Neumann, working with Oskar Morgenstern on the theory of games, broke new mathematical ground in
    1944 by extending functional analytic methods related to convex sets and topological fixed-point theory to economic
    analysis.[8][84] Their work thereby avoided the traditional differential calculus, for which the maximum–operator did
    not apply to non-differentiable functions. Continuing von Neumann's work in cooperative game theory, game
    theorists Lloyd S. Shapley, Martin Shubik, Hervé Moulin, Nimrod Megiddo, Bezalel Peleg influenced economic
    research in politics and economics. For example, research on the fair prices in cooperative games and fair values for
    voting games led to changed rules for voting in legislatures and for accounting for the costs in public–works
    projects. For example, cooperative game theory was used in designing the water distribution system of Southern
    Sweden and for setting rates for dedicated telephone lines in the USA.
    Earlier neoclassical theory had bounded only the range of bargaining outcomes and in special cases, for example
    bilateral monopoly or along the contract curve of the Edgeworth box.[87] Von Neumann and Morgenstern's results
    were similarly weak. Following von Neumann's program, however, John Nash used fixed–point theory to prove
    conditions under which the bargaining problem and noncooperative games can generate a unique equilibrium
    solution.[88] Noncooperative game theory has been adopted as a fundamental aspect of experimental economics,[89]
    behavioral economics,[90] information economics,[91] industrial organization,[92] and political economy.[93] It has
    also given rise to the subject of mechanism design (sometimes called reverse game theory), which has private and
    public-policy applications as to ways of improving economic efficiency through incentives for information
    In 1994, Nash, John Harsanyi, and Reinhard Selten received the Nobel Memorial Prize in Economic Sciences their
    work on non–cooperative games. Harsanyi and Selten were awarded for their work on repeated games. Later work
    extended their results to computational methods of modeling.[95]
Mathematical economics                                                                                                        90

    Agent-based computational economics
    Agent-based computational economics (ACE) as a named field is relatively recent, dating from about the 1990s as to
    published work. It studies economic processes, including whole economies, as dynamic systems of interacting agents
    over time. As such, it falls in the paradigm of complex adaptive systems.[96] In corresponding agent-based models,
    agents are not real people but "computational objects modeled as interacting according to rules" ... "whose
    micro-level interactions create emergent patterns" in space and time.[97] The rules are formulated to predict behavior
    and social interactions based on incentives and information. The theoretical assumption of mathematical
    optimization by agents markets is replaced by the less restrictive postulate of agents with bounded rationality
    adapting to market forces.[98]
    ACE models apply numerical methods of analysis to computer-based simulations of complex dynamic problems for
    which more conventional methods, such as theorem formulation, may not find ready use.[99] Starting from specified
    initial conditions, the computational economic system is modeled as evolving over time as its constituent agents
    repeatedly interact with each other. In these respects, ACE has been characterized as a bottom-up culture-dish
    approach to the study of the economy.[100] In contrast to other standard modeling methods, ACE events are driven
    solely by initial conditions, whether or not equilibria exist or are computationally tractable. ACE modeling, however,
    includes agent adaptation, autonomy, and learning.[101] It has a similarity to, and overlap with, game theory as an
    agent-based method for modeling social interactions.[95] Other dimensions of the approach include such standard
    economic subjects as competition and collaboration,[102] market structure and industrial organization,[103] transaction
    costs,[104] welfare economics[105] and mechanism design,[106] information and uncertainty,[107] and
    The method is said to benefit from continuing improvements in modeling techniques of computer science and
    increased computer capabilities. Issues include those common to experimental economics in general[110] and by
    comparison[111] and to development of a common framework for empirical validation and resolving open questions
    in agent-based modeling.[112] The ultimate scientific objective of the method has been described as "test[ing]
    theoretical findings against real-world data in ways that permit empirically supported theories to cumulate over time,
    with each researcher's work building appropriately on the work that has gone before."[113]
Mathematical economics                                                                                                                      91

    Mathematicization of economics
    Over the course of the 20th century, articles in
    "core journals"[115] in economics have been
    almost exclusively written by economists in
    academia. As a result, much of the material
    transmitted in those journals relates to economic
    theory, and "economic theory itself has been
    continuously          more      abstract      and
    mathematical."        A subjective assessment of
    mathematical techniques[117] employed in these
    core journals showed a decrease in articles that
    use neither geometric representations nor
    mathematical notation from 95% in 1892 to 5.3%
    in 1990.[118] A 2007 survey of ten of the top
    economic journals finds that only 5.8% of the
    articles published in 2003 and 2004 both lacked
    statistical analysis of data and lacked displayed
                                                            The surface of the Volatility smile is a 3-D surface whereby the current
    mathematical expressions that were indexed with
                                                           market implied volatility (Z-axis) for all options on the underlier is plotted
    numbers at the margin of the page.[119]                      against strike price and time to maturity (X & Y-axes).

    Between the world wars, advances in mathematical statistics and a cadre of mathematically trained economists led to
    econometrics, which was the name proposed for the discipline of advancing economics by using mathematics and
    statistics. Within economics, "econometrics" has often been used for statistical methods in economics, rather than
    mathematical economics. Statistical econometrics features the application of linear regression and time series
    analysis to economic data.
    Ragnar Frisch coined the word "econometrics" and helped to found both the Econometric Society in 1930 and the
    journal Econometrica in 1933.[120][121] A student of Frisch's, Trygve Haavelmo published The Probability Approach
    in Econometrics in 1944, where he asserted that precise statistical analysis could be used as a tool to validate
    mathematical theories about economic actors with data from complex sources.[122] This linking of statistical analysis
    of systems to economic theory was also promulgated by the Cowles Commission (now the Cowles Foundation)
    throughout the 1930s and 1940s.[123]

    Earlier work in econometrics
    The roots of modern econometrics can be traced to the American economist Henry L. Moore. Moore studied
    agricultural productivity and attempted to fit changing values of productivity for plots of corn and other crops to a
    curve using different values of elasticity. Moore made several errors in his work, some from his choice of models
    and some from limitations in his use of mathematics. The accuracy of Moore's models also was limited by the poor
    data for national accounts in the United States at the time. While his first models of production were static, in 1925
    he published a dynamic "moving equilibrium" model designed to explain business cycles—this periodic variation
    from overcorrection in supply and demand curves is now known as the cobweb model. A more formal derivation of
    this model was made later by Nicholas Kaldor, who is largely credited for its exposition.[124]
Mathematical economics                                                                                                                 92

    Much of classical economics can be
    presented in simple geometric terms or
    elementary       mathematical       notation.
    Mathematical       economics,       however,
    conventionally makes use of calculus and
    matrix algebra in economic analysis in order
    to make powerful claims that would be more
    difficult without such mathematical tools.
    These tools are prerequisites for formal
    study, not only in mathematical economics
    but in contemporary economic theory in
    general. Economic problems often involve
    so many variables that mathematics is the
    only practical way of attacking and solving
    them. Alfred Marshall argued that every
    economic problem which can be quantified,
    analytically expressed and solved, should be
    treated by means of mathematical work.[126]

    Economics has become increasingly                  The IS/LM model is a Keynesian macroeconomic model designed to make
                                                      predictions about the intersection of "real" economic activity (e.g. spending,
    dependent upon mathematical methods and
                                                   income, savings rates) and decisions made in the financial markets (Money supply
    the mathematical tools it employs have           and Liquidity preference). The model is no longer widely taught at the graduate
    become more sophisticated. As a result,               level but is common in undergraduate macroeconomics courses.
    mathematics has become considerably more
    important to professionals in economics and finance. Graduate programs in both economics and finance require
    strong undergraduate preparation in mathematics for admission and, for this reason, attract an increasingly high
    number of mathematicians. Applied mathematicians apply mathematical principles to practical problems, such as
    economic analysis and other economics-related issues, and many economic problems are often defined as integrated
    into the scope of applied mathematics.[17]

    This integration results from the formulation of economic problems as stylized models with clear assumptions and
    falsifiable predictions. This modeling may be informal or prosaic, as it was in Adam Smith's The Wealth of Nations,
    or it may be formal, rigorous and mathematical.
    Broadly speaking, formal economic models may be classified as stochastic or deterministic and as discrete or
    continuous. At a practical level, quantitative modeling is applied to many areas of economics and several
    methodologies have evolved more or less independently of each other.[127]
    • Stochastic models are formulated using stochastic processes. They model economically observable values over
      time. Most of econometrics is based on statistics to formulate and test hypotheses about these processes or
      estimate parameters for them. Between the World Wars, Herman Wold developed a representation of stationary
      stochastic processes in terms of autoregressive models and a determinist trend. Wold and Jan Tinbergen applied
      time-series analysis to economic data. Contemporary research on time series statistics consider additional
      formulations of stationary processes, such as autoregressive moving average models. More general models
      include autoregressive conditional heteroskedasticity (ARCH) models and generalized ARCH (GARCH) models.
    • Non-stochastic mathematical models may be purely qualitative (for example, models involved in some aspect of
      social choice theory) or quantitative (involving rationalization of financial variables, for example with hyperbolic
      coordinates, and/or specific forms of functional relationships between variables). In some cases economic
Mathematical economics                                                                                                          93

       predictions of a model merely assert the direction of movement of economic variables, and so the functional
       relationships are used only in a qualitative sense: for example, if the price of an item increases, then the demand
       for that item will decrease. For such models, economists often use two-dimensional graphs instead of functions.
    • Qualitative models are occasionally used. One example is qualitative scenario planning in which possible future
      events are played out. Another example is non-numerical decision tree analysis. Qualitative models often suffer
      from lack of precision.

    Criticisms and defences

    Adequacy of mathematics for qualitative and complicated economics
    Friedrich Hayek contended that the use of formal techniques projects a scientific exactness that does not
    appropriately account for informational limitations faced by real economic agents. [128]
    In an interview, the economic historian Robert Heilbroner stated:[129]
          I guess the scientific approach began to penetrate and soon dominate the profession in the past twenty to thirty
          years. This came about in part because of the "invention" of mathematical analysis of various kinds and,
          indeed, considerable improvements in it. This is the age in which we have not only more data but more
          sophisticated use of data. So there is a strong feeling that this is a data-laden science and a data-laden
          undertaking, which, by virtue of the sheer numerics, the sheer equations, and the sheer look of a journal page,
          bears a certain resemblance to science . . . That one central activity looks scientific. I understand that. I think
          that is genuine. It approaches being a universal law. But resembling a science is different from being a science.
    Heilbroner stated that "some/much of economics is not naturally quantitative and therefore does not lend itself to
    mathematical exposition."[130]

    Testing predictions of mathematical economics
    Philosopher Karl Popper discussed the scientific standing of economics in the 1940s and 1950s. He argued that
    mathematical economics suffered from being tautological. In other words, insofar that economics became a
    mathematical theory, mathematical economics ceased to rely on empirical refutation but rather relied on
    mathematical proofs and disproof.[131] According to Popper, falsifiable assumptions can be tested by experiment and
    observation while unfalsifiable assumptions can be explored mathematically for their consequences and for their
    consistency with other assumptions.[132]
    Sharing Popper's concerns about assumptions in economics generally, and not just mathematical economics, Milton
    Friedman declared that "all assumptions are unrealistic". Friedman proposed judging economic models by their
    predictive performance rather than by the match between their assumptions and reality.[133]

    Mathematical economics as a form of pure mathematics
    Considering mathematical economics, J.M. Keynes wrote in The General Theory:[134]
          It is a great fault of symbolic pseudo-mathematical methods of formalising a system of economic analysis ...
          that they expressly assume strict independence between the factors involved and lose their cogency and
          authority if this hypothesis is disallowed; whereas, in ordinary discourse, where we are not blindly
          manipulating and know all the time what we are doing and what the words mean, we can keep ‘at the back of
          our heads’ the necessary reserves and qualifications and the adjustments which we shall have to make later on,
          in a way in which we cannot keep complicated partial differentials ‘at the back’ of several pages of algebra
          which assume they all vanish. Too large a proportion of recent ‘mathematical’ economics are merely
          concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the
          complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.
Mathematical economics                                                                                                        94

       Defense of mathematical economics
       In response to these criticisms, Paul Samuelson argued that mathematics is a language, repeating a thesis of Josiah
       Willard Gibbs. In economics, the language of mathematics is sometimes necessary for representing substantive
       problems. Moreover, mathematical economics has led to conceptual advances in economics.[135] In particular,
       Samuelson gave the example of microeconomics, writing that "few people are ingenious enough to grasp [its] more
       complex parts... without resorting to the language of mathematics, while most ordinary individuals can do so fairly
       easily with the aid of mathematics."[136]
       Some economists state that mathematical economics deserves support just like other forms of mathematics,
       particularly its neighbors in mathematical optimization and mathematical statistics and increasingly in theoretical
       computer science. Mathematical economics and other mathematical sciences have a history in which theoretical
       advances have regularly contributed to the reform of the more applied branches of economics. In particular,
       following the program of John von Neumann, game theory now provides the foundations for describing much of
       applied economics, from statistical decision theory (as "games against nature") and econometrics to general
       equilibrium theory and industrial organization. In the last decade, with the rise of the internet, mathematical
       economicists and optimization experts and computer scientists have worked on problems of pricing for on-line
       services --- their contributions using mathematics from cooperative game theory, nondifferentiable optimization, and
       combinatorial games.
       Robert M. Solow concluded that mathematical economics was the core "infrastructure" of contemporary economics:
             Economics is no longer a fit conversation piece for ladies and gentlemen. It has become a technical
             subject. Like any technical subject it attracts some people who are more interested in the technique than
             the subject. That is too bad, but it may be inevitable. In any case, do not kid yourself: the technical core
             of economics is indispensable infrastructure for the political economy. That is why, if you consult [a
             reference in contemporary economics] looking for enlightenment about the world today, you will be led
             to technical economics, or history, or nothing at all.[137]

       Mathematical economists
       Prominent mathematical economists include, but are not limited to, the following (by century of birth).

       19th century

   •     Enrico Barone                   •   Francis Ysidro Edgeworth       •   Irving Fisher    •   William Stanley Jevons
   •     Antoine Augustin Cournot

       20th century
Mathematical economics                                                                                                                                       95

   •     Charalambos D. Aliprantis             •   Nicholas Georgescu-Roegen              •   Andreu Mas-Colell              •   Leonard J. Savage
   •     R. G. D. Allen                        •   Roger Guesnerie                        •   Eric Maskin                    •   Herbert Scarf
   •     Maurice Allais                        •   Frank Hahn                             •   Nimrod Megiddo                 •   Reinhard Selten
   •     Kenneth J. Arrow                      •   John C. Harsanyi                       •   James Mirrlees                 •   Amartya Sen
   •     Robert J. Aumann                      •   John R. Hicks                          •   Roger Myerson                  •   Lloyd S. Shapley
   •     Yves Balasko                          •   Werner Hildenbrand                     •   John Forbes Nash, Jr.          •   Stephen Smale
   •     David Blackwell                       •   Harold Hotelling                       •   John von Neumann               •   Robert Solow
   •     Lawrence E. Blume                     •   Leonid Hurwicz                         •   Edward C. Prescott             •   Hugo F. Sonnenschein
   •     Graciela Chichilnisky                 •   Leonid Kantorovich                     •   Roy Radner                     •   Albert W. Tucker
   •     George B. Dantzig                     •   Tjalling Koopmans                      •   Frank Ramsey                   •   Hirofumi Uzawa
   •     Gérard Debreu                         •   David M. Kreps                         •   Donald John Roberts            •   Robert B. Wilson
   •     Jacques H. Drèze                      •   Harold W. Kuhn                         •   Paul Samuelson                 •   Hermann Wold
   •     David Gale                            •   Edmond Malinvaud                       •   Thomas Sargent                 •   Nicholas C. Yannelis

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Mathematical economics                                                                                                                                         101

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Mathematical economics                                                                                                      103

    External links
    • Journal of Mathematical Economics Aims & Scope (
    • Mathematical Economics and Financial Mathematics (
      Mathematical_Economics_and_Financial_Mathematics//) at the Open Directory Project

    Microeconomics (from Greek prefix mikro- meaning "small" and economics) is a branch of economics that studies
    the behavior of individual households and firms in making decisions on the allocation of limited resources.[1]
    Typically, it applies to markets where goods or services are bought and sold. Microeconomics examines how these
    decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how
    prices, in turn, determine the quantity supplied and quantity demanded of goods and services.[2][3]
    This is in contrast to macroeconomics, which involves the "sum total of economic activity, dealing with the issues of
    growth, inflation, and unemployment."[2] Microeconomics also deals with the effects of national economic policies
    (such as changing taxation levels) on the aforementioned aspects of the economy.[4] Particularly in the wake of the
    Lucas critique, much of modern macroeconomic theory has been built upon 'microfoundations'—i.e. based upon
    basic assumptions about micro-level behavior.
    One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods
    and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market
    failure, where markets fail to produce efficient results, and describes the theoretical conditions needed for perfect
    competition. Significant fields of study in microeconomics include general equilibrium, markets under asymmetric
    information, choice under uncertainty and economic applications of game theory. Also considered is the elasticity of
    products within the market system.
Microeconomics                                                                                                                          104

    Assumptions and definitions
    The theory of supply and demand usually assumes that markets are
    perfectly competitive. This implies that there are many buyers and
    sellers in the market and none of them have the capacity to
    significantly influence prices of goods and services. In many real-life
    transactions, the assumption fails because some individual buyers or
    sellers have the ability to influence prices. Quite often, a sophisticated
    analysis is required to understand the demand-supply equation of a
    good model. However, the theory works well in situations meeting
    these assumptions.

    Mainstream economics does not assume a priori that markets are
    preferable to other forms of social organization. In fact, much analysis
    is devoted to cases where so-called market failures lead to resource            The supply and demand model describes how
                                                                                     prices vary as a result of a balance between
    allocation that is suboptimal by some standard (defense spending is the
                                                                                  product availability at each price (supply) and the
    classic example, profitable to all for use but not directly profitable for     desires of those with purchasing power at each
    anyone to finance). In such cases, economists may attempt to find             price (demand). The graph depicts a right-shift in
    policies that will avoid waste, either directly by government control,        demand from D1 to D2 along with the consequent
                                                                                  increase in price and quantity required to reach a
    indirectly by regulation that induces market participants to act in a
                                                                                    new market-clearing equilibrium point on the
    manner consistent with optimal welfare, or by creating "missing                               supply curve (S).
    markets" to enable efficient trading where none had previously existed.

    This is studied in the field of collective action and public choice theory. "Optimal welfare" usually takes on a
    Paretian norm, which in its mathematical application of Kaldor–Hicks method. This can diverge from the Utilitarian
    goal of maximising utility because it does not consider the distribution of goods between people. Market failure in
    positive economics (microeconomics) is limited in implications without mixing the belief of the economist and their
    The demand for various commodities by individuals is generally thought of as the outcome of a utility-maximizing
    process, with each individual trying to maximise their own utility. The interpretation of this relationship between
    price and quantity demanded of a given good assumes that, given all the other goods and constraints, the set of
    choices which emerges is that one which makes the consumer happiest.

    Modes of operation
    It is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output.
    Given this assumption, there are four categories in which a firm's profit may be considered to be.
    • A firm is said to be making an economic profit when its average total cost is less than the price of each additional
      product at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the
      difference between the average total cost and the price.
    • A firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total
      cost equals price at the profit-maximizing output.
    • If the price is between average total cost and average variable cost at the profit-maximizing output, then the firm
      is said to be in a loss-minimizing condition. The firm should still continue to produce, however, since its loss
      would be larger if it were to stop producing. By continuing production, the firm can offset its variable cost and at
      least part of its fixed cost, but by stopping completely it would lose the entirety of its fixed cost.
    • If the price is below average variable cost at the profit-maximizing output, the firm should go into shutdown.
      Losses are minimized by not producing at all, since any production would not generate returns significant enough
      to offset any fixed cost and part of the variable cost. By not producing, the firm loses only its fixed cost. By losing
Microeconomics                                                                                                                     105

       this fixed cost the company faces a challenge. It must either exit the market or remain in the market and risk a
       complete loss.

    Opportunity cost
    Opportunity cost of an activity (or goods) is equal to the best next alternative foregone. Although opportunity cost
    can be hard to quantify, the effect of opportunity cost is universal and very real on the individual level. In fact, this
    principle applies to all decisions, not just economic ones. Since the work of the Austrian economist Friedrich von
    Wieser, opportunity cost has been seen as the foundation of the marginal theory of value.
    Opportunity cost is one way to measure the cost of something. Rather than merely identifying and adding the costs
    of a project, one may also identify the next best alternative way to spend the same amount of money. The forgone
    profit of this next best alternative is the opportunity cost of the original choice. A common example is a farmer that
    chooses to farm their land rather than rent it to neighbors, wherein the opportunity cost is the forgone profit from
    renting. In this case, the farmer may expect to generate more profit alone. This kind of reasoning is a very important
    part of the calculation of discount rates in discounted cash flow investment valuation methodologies. Similarly, the
    opportunity cost of attending university is the lost wages a student could have earned in the workforce, rather than
    the cost of tuition, books, and other requisite items (whose sum makes up the total cost of attendance).
    Note that opportunity cost is not the sum of the available alternatives, but rather the benefit of the single, best
    alternative. Possible opportunity costs of a city's decision to build a hospital on its vacant land are the loss of the land
    for a sporting center, or the inability to use the land for a parking lot, or the money that could have been made from
    selling the land, or the loss of any of the various other possible uses — but not all of these in aggregate. The true
    opportunity cost would be the forgone profit of the most lucrative of those listed.
    One question that arises here is how to determine a money value for each alternative to facilitate comparison and
    assess opportunity cost, which may be more or less difficult depending on the things we are trying to compare. For
    example, many decisions involve environmental impacts whose monetary value is difficult to assess because of
    scientific uncertainty. Valuing a human life or the economic impact of an Arctic oil spill involves making subjective
    choices with ethical implications.
    It is imperative to understand that no decision on allocating time is free. No matter what one chooses to do, they are
    always giving something up in return. An example of opportunity cost is deciding between going to a concert and
    doing homework. If one decides to go the concert, then they are giving up valuable time to study, but if they choose
    to do homework then the cost is giving up the concert. Any decision in allocating capital is likewise: there is an
    opportunity cost of capital, or a hurdle rate, defined as the expected rate one could get by investing in similar
    projects on the open market. Opportunity cost is vital in understanding microeconomics and decisions that are made.

    Applied microeconomics
    Applied microeconomics includes a range of specialized areas of study, many of which draw on methods from other
    fields. Industrial organization examines topics such as the entry and exit of firms, innovation, and the role of
    trademarks. Labor economics examines wages, employment, and labor market dynamics. Financial economics
    examines topics such as the structure of optimal portfolios, the rate of return to capital, econometric analysis of
    security returns, and corporate financial behavior. Public economics examines the design of government tax and
    expenditure policies and economic effects of these policies (e.g., social insurance programs). Political economy
    examines the role of political institutions in determining policy outcomes. Health economics examines the
    organization of health care systems, including the role of the health care workforce and health insurance programs.
    Urban economics, which examines the challenges faced by cities, such as sprawl, air and water pollution, traffic
    congestion, and poverty, draws on the fields of urban geography and sociology. Law and economics applies
    microeconomic principles to the selection and enforcement of competing legal regimes and their relative efficiencies.
Microeconomics                                                                                                               106

    Economic history examines the evolution of the economy and economic institutions, using methods and techniques
    from the fields of economics, history, geography, sociology, psychology, and political science.

    The modern field of microeconomics arose as an effort of neoclassical economics school of thought to put economic
    ideas into mathematical mode. An early attempt was made by Antoine Augustine Cournot Researches on the
    Mathematical Principles of the Theory of Wealth[5] (1838) in describing a spring water duopoly that now bears his
    name. Latter William Stanley Jevons's Theory of Political Economy[6] (1871), Carl Menger's Principles of
    Economics[7] (1871), and Léon Walras's Elements of Pure Economics (1874–77) gave way to what was called the
    Marginal Revolution. Some common ideas behind those works were models or arguments characterized by rational
    economic agents maximizing utility under a budget constrain. This arose as a necessity of arguing against the labour
    theory of value associated with classical economists such as Adam Smith, David Ricardo and Karl Marx.
    Walras also went as far as developing the concept of general equilibrium of an economy.
    Alfred Marshall's textbook, Principles of Economics[8] was published in 1890 and became the dominant textbook in
    England for a generation. His main point was that Jevons went too far in emphasizing utility as an attempt to explain
    prices over costs of production. In the book he writes:
          "There are few writers of modern times who have approached as near to the brilliant originality of Ricardo as
          Jevons has done. But he appears to have judged both Ricardo and Mill harshly, and to have attributed to them
          doctrines narrower and less scientific than those which they really held. And his desire to emphasize an aspect
          of value to which they had given insufficient prominence, was probably in some measure accountable for his
          saying, "Repeated reflection and inquiry have led me to the somewhat novel opinion that value depends
          entirely upon utility" (Theory, p. 1). This statement seems to be no less one-sided and fragmentary, and much
          more misleading, than that into which Ricardo often glided with careless brevity, as to the dependence of value
          on cost of production; but which he never regarded as more than a part of a larger doctrine, the rest of which
          he had tried to explain. "
    In the same appendix[9] he further states:
          "Perhaps Jevons' antagonism to Ricardo and Mill would have been less if he had not himself fallen into the
          habit of speaking of relations which really exist only between demand price and value as though they held
          between utility and value; and if he had emphasized as Cournot had done, and as the use of mathematical
          forms might have been expected to lead him to do, that fundamental symmetry of the general relations in
          which demand and supply stand to value, which coexists with striking differences in the details of those
          relations. We must not indeed forget that, at the time at which he wrote, the demand side of the theory of value
          had been much neglected; and that he did excellent service by calling attention to it and developing it. There
          are few thinkers whose claims on our gratitude are as high and as various as those of Jevons: but that must not
          lead us to accept hastily his criticisms on his great predecessors."
    Marshall's idea of solving the controversy was that the demand curve could be derived by aggregating individual
    consumer demand curves, which were themselves based on the consumer problem of maximizing utility. The supply
    curve could be derived by aggregating individual producer supply curves, which depended first on constructing cost
    curves and then analyzing how much each producer was willing to sell his goods at a given price level. The cost
    curves depended on solving a producer problem of minimizing costs under a given production function. He also
    introduced the notion of different market periods: mainly short run and long run. This set of ideas gave way to what
    economists call perfect competition, now found in the standard microeconomics texts, even thought Marshall himself
    had stated:[10]
          "The process of substitution, of which we have been discussing the tendencies, is one form of competition; and
          it may be well to insist again that we do not assume that competition is perfect. Perfect competition requires a
Microeconomics                                                                                                                 107

          perfect knowledge of the state of the market; and though no great departure from the actual facts of life is
          involved in assuming this knowledge on the part of dealers when we are considering the course of business in
          Lombard Street, the Stock Exchange, or in a wholesale Produce Market; it would be an altogether
          unreasonable assumption to make when we are examining the causes that govern the supply of labour in any
          of the lower grades of industry. For if a man had sufficient ability to know everything about the market for his
          labour, he would have too much to remain long in a low grade. The older economists, in constant contact as
          they were with the actual facts of business life, must have known this well enough; but partly for brevity and
          simplicity, partly because the term "free competition" had become almost a catchword, partly because they had
          not sufficiently classified and conditioned their doctrines, they often seemed to imply that they did assume this
          perfect knowledge. "
    A new impetus was given to field when around 1933. Joan Robinson and Edward H. Chamberlin, published
    respectively, The Economics of Imperfect Competition (1933) and The Theory of Monopolistic Competition (1933),
    introducing models of imperfect competition. Although Marshall himself had already considered both the monopoly
    case and Cournot had built his duopoly model, a whole new set of models grew out of this new literature. In
    particular the monopolistic competition model results in a non efficient equilibrium. Chamberlin defined
    monopolistic competition as "challenge to traditional viewpoint of economics that competition and monopoly are
    alternatives and that individual prices are to be explained in terms of one or the otherby other". He continues: "By
    contrast it is held that most economic situations are composite of both competition and monopoly, and that, wherever
    this is the case, a false view is given by neglecting either one of the two forces and regarding the situation as made
    up entirely of the other".[11]
    Later on some market models were built using game theory, particularly regarding oligopolies. A good example of
    how microeconomics started to incorporate game theory, is the Stackelberg competition model published in 1934[12]
    which can be characterized as a dynamic game with a leader and a follower, and then be solved to find a Nash
    In 1937 The Nature of the Firm[13] was published by Ronald Coase introducing the notion of transaction costs (the
    term itself was coined in the fifties), which explained why firms have an advantage over a group of independent
    contractors working with each other. The idea was that there were transaction costs in the use of the market: search
    and information costs, bargaining costs, etc. which give an advantage to a firm which can internalize the production
    process required to deliver a certain good to the market. A related result was published by Coase in his “The Problem
    of Social Cost”[14] (1960) which deals with problem of externalities: the presence of transaction costs prevents agents
    from bargaining among themselves to arrive at mutually beneficial agreement. This then becomes relevant in context
    of regulations.
    Around the seventies the study of market failures came again into focus with the study of information asymmetry. In
    particular three authors emerged from this period: George Akerlof, Michael Spence and Joseph Stiglitz. Akerlof
    considered the problem of bad quality cars driving good quality cars out of the market in his classic “The Market for
    Lemons” (1970) because of the presence of asymmetrical information between buyers and sellers. Spence explained
    that signaling was fundamental in the labour market, because since employers cant know beforehand which of the
    candidates are the most productive, a college degree becomes a signaling device which allows a firm to hire new
    Kahneman and Tversky published their paper "Prospect Theory: An Analysis of Decision under Risk" in 1979
    criticizing the very idea of the rational economic agent. The main point is that there an asymmetry in the psychology
    of the economic agent which gives a much higher value to losses than to gains. This article[15] is usually regarded as
    the beginning of behavioral economics and has consequences particularly regarding the world of finance. The
    authors summed the idea in the abstract as follows:
          "...In particular, people underweight outcomes that are merely probable in comparison with outcomes that are
          obtained with certainty. This tendency, called certainty effect, contributes to risk aversion in choices involving
Microeconomics                                                                                                                                             108

            sure gains and to risk seeking in choices involving sure losses. In addition, people generally discard
            components that are shared by all prospects under consideration. This tendency, called the isolation effect,
            leads to inconsistent preferences when the same choice is presented in different forms."
    More recently, the continuing Great Recession brought the principal agent problem again to the center of debate, in
    particular regarding corporate governance.[16]

    [1] Marchant, Mary A.; Snell, William M.. "Macroeconomic and International Policy Terms" (http:/ / www. ca. uky. edu/ agc/ pubs/ aec/ aec75/
        aec75. pdf). University of Kentucky. . Retrieved 2007-05-04.
    [2] "Economics Glossary" (http:/ / www. mcwdn. org/ ECONOMICS/ EcoGlossary. html). Monroe County Women's Disability Network. .
        Retrieved 2008-02-22.
    [3] "Social Studies Standards Glossary" (http:/ / web. archive. org/ web/ 20070808200604/ http:/ / nmlites. org/ standards/ socialstudies/ glossary.
        html). New Mexico Public Education Department. Archived from the original (http:/ / nmlites. org/ standards/ socialstudies/ glossary. html) on
        2007-08-08. . Retrieved 2008-02-22.
    [4] "Glossary" (http:/ / www. econ100. com/ eu5e/ open/ glossary. html). ECON100. . Retrieved 2008-02-22.
    [5] A. Cournot, Researches into the mathematical principles of the theory of wealth, 1838 http:/ / archive. org/ details/
    [6] S. Jevon, The Theory of Political Economy,1871 http:/ / www. econlib. org/ library/ YPDBooks/ Jevons/ jvnPE. html
    [7] C.Menger,Principles of Economics, 1871 http:/ / mises. org/ etexts/ menger/ principles. asp
    [8] A. Marshall, Principles of Economics, 1890 http:/ / www. econlib. org/ library/ Marshall/ marP. html
    [9] A.Marshall, Principles of Economics, 1890, APPENDIX I:RICARDO'S THEORY OF VALUE http:/ / www. econlib. org/ library/ Marshall/
        marP64. html
    [10] A.Marshall, Principles of Economics, 1890, BOOK VI, CHAPTER II: PRELIMINARY SURVEY OF DISTRIBUTION, CONTINUED.
        http:/ / www. econlib. org/ library/ Marshall/ marP44. html#Bk. VI,Ch. II
    [11] E.H Chamberlin, Monopolistic or Imperfect Competition?, The Quarterly Journal of Economics Vol. 51, No. 4, Aug., 1937
    [12] H.F von Stackelberg, Market Structure and Equilibrium, 1934
    [13] http:/ / onlinelibrary. wiley. com/ doi/ 10. 1111/ j. 1468-0335. 1937. tb00002. x/
        abstract;jsessionid=E7F2EDA312C1AF4790FFF1BFFF7D5C74. d03t01?systemMessage=Wiley+ Online+ Library+ will+ be+ disrupted+
        on+ 23+ February+ from+ 10%3A00-12%3A00+ BST+ %2805%3A00-07%3A00+ EDT%29+ for+ essential+ maintenance
    [14] http:/ / www. jstor. org/ discover/ 10. 2307/ 724810?uid=19290& uid=3738296& uid=19287& uid=2& uid=3& uid=67& uid=5909816&
        uid=62& sid=21101705755341
    [15] D.Kahneman, A. Tversky,Prospect Theory: An Analysis of Decision Under Risk, Econometrica 1979
    [16] http:/ / www. dailyfinance. com/ 2010/ 10/ 22/ joseph-stiglitz-corporate-crooks-to-jail/

    Further reading
    • Bade, Robin; Michael Parkin (2001). Foundations of Microeconomics. Addison Wesley Paperback 1st Edition.
    • Bouman, John: Principles of Microeconomics - free fully comprehensive Principles of Microeconomics and
      Macroeconomics texts ( Columbia, Maryland, 2011
    • Colander, David. Microeconomics. McGraw-Hill Paperback, 7th Edition: 2008.
    • Dunne, Timothy, J. Bradford Jensen, and Mark J. Roberts (2009). Producer Dynamics: New Evidence from Micro
      Data. University of Chicago Press. ISBN 978-0-226-17256-9.
    • Eaton, B. Curtis; Eaton, Diane F.; and Douglas W. Allen. Microeconomics. Prentice Hall, 5th Edition: 2002.
    • Frank, Robert A.; Microeconomics and Behavior. McGraw-Hill/Irwin, 6th Edition: 2006.
    • Friedman, Milton. Price Theory. Aldine Transaction: 1976
    • Hagendorf, Klaus: Labour Values and the Theory of the Firm. Part I: The Competitive Firm. Paris: EURODOS;
      2009. (
    • Harberger, Arnold C., 2008. "Microeconomics," (
      The Concise Encyclopedia of Economics.
    • Hicks, John R. Value and Capital. Clarendon Press. [1939] 1946, 2nd ed.
    • Hirshleifer, Jack., Glazer, Amihai, and Hirshleifer, David, Price theory and applications: Decisions, markets, and
      information. Cambridge University Press, 7th Edition: 2005.
Microeconomics                                                                                                       109

    • Jehle, Geoffrey A.; and Philip J. Reny. Advanced Microeconomic Theory. Addison Wesley Paperback, 2nd
      Edition: 2000.
    • Katz, Michael L.; and Harvey S. Rosen. Microeconomics. McGraw-Hill/Irwin, 3rd Edition: 1997.
    • Kreps, David M. A Course in Microeconomic Theory. Princeton University Press: 1990
    • Landsburg, Steven. Price Theory and Applications. South-Western College Pub, 5th Edition: 2001.
    • Mankiw, N. Gregory. Principles of Microeconomics. South-Western Pub, 2nd Edition: 2000.
    • Mas-Colell, Andreu; Whinston, Michael D.; and Jerry R. Green. Microeconomic Theory. Oxford University
      Press, US: 1995.
    • McGuigan, James R.; Moyer, R. Charles; and Frederick H. Harris. Managerial Economics: Applications, Strategy
      and Tactics. South-Western Educational Publishing, 9th Edition: 2001.
    • Nicholson, Walter. Microeconomic Theory: Basic Principles and Extensions. South-Western College Pub, 8th
      Edition: 2001.
    • Perloff, Jeffrey M. Microeconomics. Pearson - Addison Wesley, 4th Edition: 2007.
    • Perloff, Jeffrey M. Microeconomics: Theory and Applications with Calculus. Pearson - Addison Wesley, 1st
      Edition: 2007
    • Pindyck, Robert S.; and Daniel L. Rubinfeld. Microeconomics. Prentice Hall, 7th Edition: 2008.
    • Ruffin, Roy J.; and Paul R. Gregory. Principles of Microeconomics. Addison Wesley, 7th Edition: 2000.
    • Varian, Hal R. (1987). "microeconomics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 461–63.
    • Varian, Hal R. Intermediate Microeconomics: A Modern Approach. W. W. Norton & Company, 7th Edition:
    • Varian, Hal R. Intermediate Microeconomics: A Modern Approach. W. W. Norton & Company, 8th Edition:
    • Varian, Hal R. Microeconomic Analysis. W. W. Norton & Company, 3rd Edition: 1992.

    External links
    • Open Source Introduction to Microeconomics ( (see wiki article) by R. Preston
      McAfee – California Institute of Technology
    • homepage ( – online economics
    • X-Lab: A Collaborative Micro-Economics and Social Sciences Research Laboratory (
    • Micro Economics ( – the role of microeconomics in
      supporting the social fabric of macro economies
    • Simulations in Microeconomics (
    • - a brief history of microeconomics
Macroeconomics                                                                                                             110

    Macroeconomics (from the Greek prefix
    makro- meaning "large" and economics) is a
    branch of economics dealing with the
    performance, structure, behavior, and
    decision-making of an economy as a whole,
    rather than individual markets. This includes
    national,       regional,    and       global
    economies.           With microeconomics,
    macroeconomics is one of the two most
    general fields in economics.

    Macroeconomists          study     aggregated
    indicators such as GDP, unemployment
    rates, and price indices to understand how
    the      whole       economy        functions.
    Macroeconomists develop models that
    explain the relationship between such
    factors as national income, output,                                    Circulation in macroeconomics
    consumption, unemployment, inflation,
    savings, investment, international trade and international finance. In contrast, microeconomics is primarily focused
    on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and
    quantities in specific markets. While macroeconomics is a broad field of study, there are two areas of research that
    are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in
    national income (the business cycle), and the attempt to understand the determinants of long-run economic growth
    (increases in national income). Macroeconomic models and their forecasts are used by both governments and large
    corporations to assist in the development and evaluation of economic policy and business strategy.

    Basic macroeconomic concepts
    Macroeconomics encompasses a variety of concepts and variables, but there are three central topics for
    macroeconomic research.[3] Macroeconomic theories usually relate the phenomena of output, unemployment, and
    inflation. Outside of macroeconomic theory, these topics are also extremely important to all economic agents
    including workers, consumers, and producers.

    Output and income
    National output is the total value of everything a country produces in a given time period. Everything that is
    produced and sold generates income. Therefore, output and income are usually considered equivalent and the two
    terms are often used interchangeably. Output can be measured as total income, or, it can be viewed from the
    production side and measured as the total value of final goods and services or the sum of all value added in the
    economy.[4] Macroeconomic output is usually measured by Gross Domestic Product (GDP) or one of the other
    national accounts. Economists interested in long-run increases in output study economic growth. Advances in
    technology, accumulation of machinery and other capital, and better education and human capital all lead to
    increased economic output over time. However, output does not always increase consistently. Business cycles can
    cause short-term drops in output called recessions. Economists look for macroeconomic policies that prevent
    economies from slipping into recessions and that lead to faster long-term growth.
Macroeconomics                                                                                                                        111

    Increasing business profits do not necessarily lead to increased
    economic growth, especially when they do not result in greater
    aggregate demand. When businesses and banks lack incentives to
    spend accumulated capital, for instance because of repatriation taxes
    from profits in overseas tax havens, or interest on excess reserves paid
    to banks, increased profits can lead to decreasing growth.[5][6]

                                                                                    Red: corporate profits after tax and inventory
    The amount of unemployment in an economy is measured by the                    valuation adjustment. Blue: nonresidential fixed
    unemployment rate, the percentage of workers without jobs in the labor             investment (roughly speaking, business
                                                                                     investment), both as fractions of U.S. GDP,
    force. The labor force only includes workers actively looking for jobs.
    People who are retired, pursuing education, or discouraged from
    seeking work by a lack of job prospects are excluded from the labor

                                                    Unemployment can be generally broken down into several types that
                                                    are related to different causes. Classical unemployment occurs when
                                                    wages are too high for employers to be willing to hire more workers.
                                                    Wages may be too high because of minimum wage laws or union
                                                    activity. Consistent with classical unemployment, frictional
                                                    unemployment occurs when appropriate job vacancies exist for a
                                                    worker, but the length of time needed to search for and find the job
                                                    leads to a period of unemployment.[7] Structural unemployment covers
                                                    a variety of possible causes of unemployment including a mismatch
       Chart using US data showing the relationship
       between economic growth and unemployment     between workers' skills and the skills required for open jobs.[8] Large
         expressed by Okun's law. The relationship  amounts of structural unemployment can occur when an economy is
      demonstrates cyclical unemployment. Economic  transitioning industries and workers find their previous set of skills are
        growth leads to a lower unemployment rate.
                                                    no longer in demand. Structural unemployment is similar to frictional
                                                    unemployment since both reflect the problem of matching workers
    with job vacancies, but structural unemployment covers the time needed to acquire new skills not just the short term
    search process.[9] While some types of unemployment may occur regardless of the condition of the economy,
    cyclical unemployment occurs when growth stagnates. Okun's law represents the empirical relationship between
    unemployment and economic growth.[10] The original version of Okun's law states that a 3% increase in output
    would lead to a 1% decrease in unemployment.[11]

    Inflation and deflation
    A general price increase across the entire economy is called inflation. When prices decrease, there is deflation.
    Economists measure these changes in prices with price indexes. Inflation can occur when an economy becomes
    overheated and grows too quickly. Similarly, a declining economy can lead to deflation. Central bankers, who
    control a country's money supply, try to avoid changes in price level by using monetary policy. Raising interest rates
    or reducing the supply of money in an economy will reduce inflation. Inflation can lead to increased uncertainty and
    other negative consequences. Deflation can lower economic output. Central bankers try to stabilize prices to protect
    economies from the negative consequences of price changes.
Macroeconomics                                                                                                                       112

    Changes in price level may be result of several factors. The quantity
    theory of money holds that changes in price level are directly related to
    changes in the money supply. Most economists believe that this
    relationship explains long-run changes in the price level. Short-run
    fluctuations may also be related to monetary factors, but changes in
    aggregate demand and aggregate supply can also influence price level.
    For example, a decrease in demand because of a recession can lead to
    lower price levels and deflation. A negative supply shock, like an oil
    crisis, lowers aggregate supply and can cause inflation.
                                                                                   Chart showing the ten year moving averages of
                                                                                     changes in price level and growth in money
                                                                                   supply (using the measure of M2, the supply of
    Macroeconomic models                                                           hard currency and money held in most types of
                                                                                  bank accounts) in the United States from 1875 to
                                                                                   2011. Over the long run, the two series show a
    Aggregate Demand-Aggregate Supply                                                             close relationship.

    The AD-AS model has become the standard textbook model for
    explaining the macroeconomy.[12] This model shows the price level and level of real output given the equilibrium in
    aggregate demand and aggregate supply. The aggregate demand curve's downward slope means that more output is
    demanded at lower price levels. The downward slope is the result of three effects: the Pigou or real balance effect,
    which states that as real prices fall, real wealth increases, so consumers demand more goods; the Keynes or interest
    rate effect, which states that as prices fall the demand for money declines causing interest rates to decline and
    borrowing for investment and consumption to increase; and the net export effect, which states that as prices rise,
    domestic goods become comparatively more expensive to foreign consumers and thus exports decline.[13] In the
    conventional Keynesian use of the AS-AD model, the aggregate supply curve is horizontal at low levels of output
    and becomes inelastic near the point of potential output, which corresponds with full-employment.[12] Since the
    economy cannot produce beyond more than potential output, any AD expansion will lead to higher price levels
    instead of higher output.

                                                     The AD-AS diagram can model a variety of macroeconomic
                                                     phenomena including inflation. When demand for goods exceeds
                                                     supply there is an inflationary gap where demand-pull inflation occurs
                                                     and the AD curve shifts upward to a higher price level. When the
                                                     economy faces higher costs, cost-push inflation occurs and the AS
                                                     curve shifts upward to higher price levels.[14] The AS-AD diagram is
                                                     also widely used as pedagogical tool to model the effects of various
                                                     macroeconomic policies.[15]

     Traditional AS-AD diagram showing an shift in   IS/LM
     AD and the AS curve becoming inelastic beyond
                    potential output.            The IS/LM model represents the equilibrium in interest rates and
                                                 output given by the equilibrium in the goods and money markets.[16]
    The goods market is represented by the equilibrium in investment and saving (IS), and the money market is
    represented by the equilibrium between the money supply and liquidity preference.[17] The IS curve consists of the
    points where investment, given the interest rate, is equal to savings, given output.[18] The IS curve is downward
    sloping because output and the interest rate have an inverse relationship in the goods market: As output increases
    more money is saved, which means interest rates must be lower to spur enough investment to match savings.[18] The
    LM curve is upward sloping because interest rates and output have a positive relationship in the money market. As
    output increases, the demand for money increases, and interest rates increase.[19]
Macroeconomics                                                                                                                             113

    The IS/LM model is often used to demonstrate the
    effects of monetary and fiscal policy.[16]
    Textbooks frequently use the IS/LM model, but it
    does not feature the complexities of most modern
    macroeconomic models.[16] Nevertheless, these
    models still feature similar relationships to those in

    Macroeconomic policy
    Macroeconomic policy is usually implemented
    through two sets of tools: fiscal and monetary
    policy. Both forms of policy are used to stabilize
    the economy, which usually means boosting the
    economy to the level of GDP consistent with full

                                                             In this example of an IS/LM chart, the IS curve moves to the right, causing
    Monetary policy                                          higher interest rates (i) and expansion in the "real" economy (real GDP, or
    Central banks implement monetary policy by
    controlling the money supply through several
    mechanisms. Typically, central banks take action by issuing money to buy bonds (or other assets), which boosts the
    supply of money and lowers interest rates, or, in the case of contractionary monetary policy, banks sell bonds and
    takes money out of circulation. Usually policy is not implemented by directly targeting the supply of money. Banks
    continuously shift the money supply to maintain a fixed interest rate target. Some banks allow the interest rate to
    fluctuate and focus on targeting inflation rates instead. Central banks generally try to achieve high output without
    letting loose monetary policy create large amounts of inflation.

    Conventional monetary policy can be ineffective in situations such as a liquidity trap. When interest rates and
    inflation are near zero, the central bank cannot loosen monetary policy through conventional means. Central banks
    can use unconventional monetary policy such as quantitative easing to help increase output. Instead of buying
    government bonds, central banks implement quantitative easing by buying other assets such as corporate bonds,
    stocks, and other securities. This allows lowers interest rates for broader class of assets beyond government bonds. In
    other case of unconventional monetary policy, the United States Federal Reserve recently made an attempt at such as
    policy with Operation Twist. Unable to lower current interest rates, the Federal Reserve lowered long-term interest
    rates by buying long-term bonds and selling short-term bonds to create a flat yield curve.

    Fiscal policy
    Fiscal spending is the use of government spending and taxation to influence the economy. If the economy producing
    less than potential output, government spending can be used to employ idle resources and boost output. Government
    spending does not have to make up for the entire output gap. There is a multiplier effect that boosts the impact of
    government spending. For example, when the government pays for a bridge, the project not only adds the value of
    the bridge to output, it also allows the bridge workers to increase their consumption and investment, which also help
    close the output gap.
    The effects of fiscal policy can be limited by crowding out. When government takes on spending projects, it limits
    the amount of resources available for the private sector to use. Crowding out occurs when government spending
    simply replaces private sector output instead of adding additional output to the economy. Crowding out also occurs
    when government spending raises interest rates which limits investment. Defenders of fiscal stimulus argue that
Macroeconomics                                                                                                               114

    crowding out is not a concern when the economy is depressed, plenty of resources are left idle, and interest rates are
    Fiscal policy can be implemented through automatic stabilizers. Automatic stabilizers do not suffer from the policy
    lags of discretionary fiscal policy. Automatic stabilizers use conventional fiscal mechanisms but take effect as soon
    as the economy takes a downturn: spending on unemployment benefits automatically increases when unemployment
    rises and, in a progressive income tax system, the effective tax rate automatically falls when incomes decline.

    Economists usually favor monetary over fiscal policy because it has two major advantages. First, monetary policy is
    generally implemented by independent central banks instead of the political institutions that control fiscal policy.
    Independent central banks are less likely to make decisions based on political motives.[21] Second, monetary policy
    suffers fewer lags than fiscal. Central banks can quickly make and implement decisions while discretionary fiscal
    policy may take time to pass and even longer to carry out.[22]


    Macroeconomics descended from the once divided fields of business cycle theory and monetary theory.[23] The
    quantity theory of money was particularly influential prior to World War II. It took many forms including the version
    based on the work of Irving Fisher:

    In the typical view of the quantity theory, money velocity (V) and the quantity of goods produced (Q) would be
    constant, so any increase in money supply (M) would lead to a direct increase in price level (P). The quantity theory
    of money was a central part of the classical theory of the economy that prevailed in the early twentieth century.

    Austrian School
    Ludwig Von Mises work Theory of Money and Credit published in 1912 was one of the first books from the
    Austrian School to deal with macroeconomic topics.

    Keynes and his followers
    Macroeconomics, at least in its modern form,[24] began with the publication of John Maynard Keynes's General
    Theory of Employment, Interest and Money.[23] When the Great Depression struck, classical economists had
    difficulty explaining how goods could go unsold and workers could be left unemployed. In classical theory, prices
    and wages would drop until the market cleared, and all goods and labor were sold. Keynes offered a new theory of
    economics that explained why markets might not clear, which would evolve (later in the 20th century) into a group
    of macroeconomic schools of thought known as Keynesian economics - also called Keynesianism or Keynesian
    In Keynes's theory, the quantity theory broke down because people and businesses tend to hold on to their cash in
    tough economic times, a phenomenon he described in terms of liquidity preferences. Keynes also explained how the
    multiplier effect would magnify a small decrease in consumption or investment and cause declines throughout the
    economy. Keynes also noted the role uncertainty and animal spirits can play in the economy.[24]
    The generation following Keynes combined the macroeconomics of the General Theory with neoclassical
    microeconomics to create the neoclassical synthesis. By the 1950s, most economists had accepted the synthesis view
    of the macro economy.[24] Economists like Paul Samuelson, Franco Modigliani, James Tobin, and Robert Solow
    developed formal Keynesian models, and contributed formal theories of consumption, investment, and money
Macroeconomics                                                                                                               115

    demand that fleshed out the Keynesian framework.[25]

    Milton Friedman updated the quantity theory of money to include a role for money demand. He argued that the role
    of money in the economy was sufficient to explain the Great Depression and aggregate demand oriented
    explanations were not necessary. Friedman argued that monetary policy was more effective than fiscal policy;
    however, Friedman doubted the government has ability to "fine-tune" the economy with monetary policy. He
    generally favored a policy of steady growth in money supply instead of frequent intervention.[26] Friedman also
    challenged the Phillips Curve relationship between inflation and unemployment. Friedman and Edmund Phelps (who
    was not a monetarist) proposed an "augmented" version of the Phillips Curve that excluded the possibility of a
    stable, long-run tradeoff between inflation and unemployment. When the oil shocks of the 1970s created a high
    unemployment and high inflation, Friedman and Phelps were vindicated. Monetarism was particularly influential in
    the early 1980s. Monetarism fell out of favor when central banks found it difficult to target money supply instead of
    interest rates as monetarists recommended. Monetarism also became politically unpopular when the central banks
    created recessions in order to slow inflation.

    New classicals
    New classical macroeconomics further challenged the Keynesian school. A central development in new classical
    thought came when Robert Lucas introduced rational expectations to macroeconomics. Prior to Lucas, economists
    had generally used adaptive expectations where agents were assumed to look at the recent past to make expectations
    about the future. Under rational expectations, agents are assumed to be more sophisticated. A consumer will not
    simply assume a 2% inflation rate because that has been the average the past few years; he will look at current
    monetary policy and economic conditions to make an informed forecast. When new classical economists introduced
    rational expectations into their models, they showed that monetary policy could only have a limited impact.
    Lucas also made an influential critique of Keynesian empirical models. He argued that forecasting models based on
    empirical relationships would be unstable. He advocated models based on fundamental economic theory that would,
    in principle, be more stable as economies changed. Following Lucas's critique, new classical economists, led by
    Edward C. Prescott and Finn E. Kydland created real business cycle (RBC) models of the macroeconomy. RBC
    models were created by combining fundamental equations from neo-classical microeconomics. RBC models
    explained recessions and unemployment with changes in technology instead changes in the markets for goods or
    money. Critics of RBC models argue that money clearly plays an important role in the economy, and the idea that
    technological regress can explain recent recessions is also implausible.[27] Despite questions about the theory behind
    RBC models, they have clearly been influential in economic methodology.

    New Keynesian response
    New Keynesian economists responded to the new classical school by adopting rational expectations and focusing on
    developing micro-founded models that are immune to the Lucas critique. Stanley Fischer and John B. Taylor
    produced early work in this area by showing that monetary policy could be effective even in models with rational
    expectations when contracts locked-in wages for workers. Other new Keynesian economists expanded on this work
    and demonstrated other cases where inflexible prices and wages led to monetary and fiscal policy having real effects.
    Like classical models, new classical models had assumed that prices would be able to adjust perfectly and monetary
    policy would only lead to price changes. New Keynesian models investigated sources of sticky prices and wages,
    which would not adjust, allowing monetary policy to impact quantities instead of prices.
    By the late 1990s economists had reached a rough consensus. The rigidities of new Keynesian theory were combined
    with rational expectations and the RBC methodology to produce dynamic stochastic general equilibrium (DSGE)
    models. The fusion of elements from different schools of thought has been dubbed the new neoclassical synthesis.
Macroeconomics                                                                                                                                       116

    These models are now used by many central banks and are a core part of contemporary macroeconomics.[28]

    [1] Blaug, Mark (1985), Economic theory in retrospect, Cambridge, UK: Cambridge University Press, ISBN 0-521-31644-8
    [2] Sullivan, Arthur; Steven M. Sheffrin (2003), Economics: Principles in action (http:/ / www. pearsonschool. com/ index.
        cfm?locator=PSZ3R9& PMDbSiteId=2781& PMDbSolutionId=6724& PMDbCategoryId=& PMDbProgramId=12881& level=4), Upper
        Saddle River, New Jersey 07458: Pearson Prentice Hall, p. 57, ISBN 0-13-063085-3,
    [3] Blanchard (2011), 32.
    [4] Blanchard (2011), 22.
    [5] "Profits and Business Investment" (http:/ / krugman. blogs. nytimes. com/ 2013/ 02/ 09/ profits-and-business-investment/ ) Paul Krugman,
        New York Times", February 9, 2013
    [6] "Still Say’s Law After All These Years" (http:/ / krugman. blogs. nytimes. com/ 2013/ 02/ 10/ still-says-law-after-all-these-years/ ) Paul
        Krugman, New York Times, February 10, 2013
    [7] Dwivedi, 443.
    [8] Freeman (2008). http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_S000311.
    [9] Dwivedi, 444-445.
    [10] Dwivedi, 445-446.
    [11] Neely, Christopher J. "Okun's Law: Output and Unemployment. Economic Synopses. Number 4. 2010. http:/ / research. stlouisfed. org/
        publications/ es/ 10/ ES1004. pdf.
    [12] Healey 2002, p. 12
    [13]   Healey 2002, p. 13
    [14]   Healey 2002, p. 14
    [15]   Colander 1995, p. 173
    [16]   Durlauf & Hester 2008
    [17]   Peston 2002, p. 386-387
    [18]   Peston 2002, p. 387
    [19]   Peston 2002, p. 387-388
    [20]   Mayer, 495.
    [21]   Mayer, 495.
    [22]   Mayer, 495.
    [23]   Dimand (2008).
    [24]   Blanchard (2011), 580.
    [25]   Blanchard (2011), 581.
    [26]   Blanchard (2011), 582-583.
    [27]   Blanchard (2011), 587.
    [28]   Blanchard (2011), 590.

    • Blanchard, Olivier (2000), Macroeconomics, Prentice Hall, ISBN 0-13-013306-X.
    • Blanchard, Olivier (2011). Macroeconomics Updated (5th ed.). Englewood Cliffs: Prentice Hall.
      ISBN 978-0-13-215986-9.
    • Blaug, Mark (1986), Great Economists before Keynes, Brighton: Wheatsheaf.
    • Boettke, Peter (2001), Calculation and Coordination: Essays on Socialism and Transitional Political Economy,
      Routledge, ISBN 0-415-77109-9.
    • Bouman, John: Principles of Macroeconomics - free fully comprehensive Principles of Microeconomics and
      Macroeconomics texts ( Columbia, Maryland, 2011
    • Dimand, Robert W. (2008). Durlauf, Steven N.; Blume, Lawrence E.. eds. "Macroeconomics, origins and history
      of" ( The New Palgrave Dictionary of
      Economics (Palgrave Macmillan). doi:10.1057/9780230226203.1009.
    • Durlauf, Steven N.; Hester, Donald D. (2008). "IS–LM" (
      article?id=pde2008_I000303). In Durlauf, Lawrence E.; Blume. The New Palgrave Dictionary of Economics
      (Second ed.). Palgrave Macmillan. doi:10.1057/9780230226203.0855. Retrieved 5 June 2012.
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    • Dwivedi, D.N. (2001). Macroeconomics : theory and policy. New Delhi: Tata McGraw-Hill.
      ISBN 978-0-07-058841-7.
    • Friedman, Milton (1953), Essays in Positive Economics, London: University of Chicago Press,
      ISBN 0-226-26403-3.
    • Haberler, Gottfried (1937), Prosperity and depression, League of Nations.
    • Leijonhufvud, Axel The Wicksell Connection: Variation on a Theme (
      workingpapers/wp165.pdf). UCLA. November, 1979.
    • Healey, Nigel M. (2002). "AD-AS model". In Snowdon, Brian; Vane, Howard. An Encyclopedia of
      Macroeconomics. Northhampton, Massachusetts: Edward Elgar Publishing. pp. 11–18. ISBN 978-1-84542-180-9.
    • Heijdra, B. J.; Ploeg, F. van der (2002), Foundations of Modern Macroeconomics, Oxford University Press,
      ISBN 0-19-877617-9.
    • Mises, Ludwig Von (1912), Theory of Money and Credit, Yale University Press.
    • Mayer, Thomas (2002). "Monetary polic: role of". In Snowdon, Brian; Vane, Howard. An Encyclopedia of
      Macroeconomics. Northhampton, Massachusetts: Edward Elgar Publishing. pp. 495–499.
      ISBN 978-1-84542-180-9.
    • Mishkin, Frederic S. (2004), The Economics of Money, Banking, and Financial Markets, Boston:
      Addison-Wesley, p. 517
    • Peston, Maurice (2002). "IS-LM model: closed economy". In Snowdon, Brian; Vane, Howard R.. An
      Encyclopedia of Macroeconomics. Edward Elgar.
    • Snowdon, Brian, and Howard R. Vane, ed. (2002). An Encyclopedia of Macroeconomics, Description (http:// & scroll to Contents-preview links. (http://books.
    • Snowdon, Brian; , Howard R. Vane (2005), Modern Macroeconomics: Its Origins, Development And Current
      State, Edward Elgar Publishing, ISBN 1-84376-394-X.
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    • Warsh, David (2006), Knowledge and the Wealth of Nations, Norton, ISBN 978-0-393-05996-0.
Monetary economics                                                                                                             118

    Monetary economics
    Monetary economics is a branch of economics that historically prefigured and remains integrally linked to
    macroeconomics.[1] Monetary economics provides a framework for analyzing money in its functions as a medium of
    exchange, store of value, and unit of account. It considers how money, for example fiat currency, can gain
    acceptance purely because of its convenience as a public good.[2] It examines the effects of monetary systems,
    including regulation of money and associated financial institutions[3] and international aspects.[4]
    Modern analysis has attempted to provide a micro-based formulation of the demand for money[5] and to distinguish
    valid nominal and real monetary relationships for micro or macro uses, including their influence on the aggregate
    demand for output.[6] Its methods include deriving and testing the implications of money as a substitute for other
    assets[7] and as based on explicit frictions.[8]
    Research areas have included:
    • empirical determinants and measurement of the money supply, whether narrowly-, broadly-, or index-aggregated,
      in relation to economic activity[9]
    • debt-deflation and balance-sheet theories, which hypothesize that over-extension of credit associated with a
      subsequent asset-price fall generate business fluctuations through the wealth effect on net worth.[10] and the
      relationship between the demand for output and the demand for money[11]
    • monetary implications of the asset-price/macroeconomic relation[12]
    • the quantity theory of money,[13] monetarism,[14] and the importance and stability of the relation between the
      money supply and interest rates, the price level, and nominal and real output of an economy.[15]
    • monetary impacts on interest rates and the term structure of interest rates[16]
    • lessons of monetary/financial history[17]
    • transmission mechanisms of monetary policy as to the macroeconomy[18]
    • the monetary/fiscal policy relationship to macroeconomic stability[19]
    • neutrality of money vs. money illusion as to a change in the money supply, price level, or inflation on output[20]
    • tests, testability, and implications of rational-expectations theory as to changes in output or inflation from
      monetary policy[21]
    • monetary implications of imperfect and asymmetric information[22] and fraudulent finance[23]
    • game theory as a modeling paradigm for monetary and financial institutions[24]
    • the political economy of financial regulation and monetary policy[25]
    • possible advantages of following a monetary-policy rule to avoid inefficiencies of time inconsistency from
      discretionary policy[26]
    • "anything that central bankers should be interested in."[27]

    Current state of monetary economics
    Since 1990, the classical form of monetarism has been questioned. This is because of events which many economists
    interpret as inexplicable in monetarist terms, especially the unhinging of the money supply growth from inflation in
    the 1990s and the failure of pure monetary policy to stimulate the economy in the 2001-2003 period. Alan
    Greenspan, former chairman of the Federal Reserve, argued that the 1990s decoupling may be explained by a
    virtuous cycle of productivity and investment on one hand, and a certain degree of "irrational exuberance" in the
    investment sector.
    Economist Robert Solow of MIT suggested that the 2001-2003 failure of the expected economic recovery should be
    attributed not to monetary policy failure, but rather to the breakdown in productivity growth in crucial sectors of the
    economy, most particularly retail trade. He noted that five sectors produced all of the productivity gains of the 1990s,
    and that while the growth of retail and wholesale trade produced the smallest growth, they were by far the largest
Monetary economics                                                                                                                                        119

    sectors of the economy experiencing net increase of productivity. "2% may be peanuts, but being the single largest
    sector of the economy, that's an awful lot of peanuts."

    [1] :Press + button or Ctrl++ to enlarge small-text links below.
          • Robert W. Dimand, 2008. "macroeconomics, origins and history of" (abstract) (http:/ / www. dictionaryofeconomics. com/
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        www. dictionaryofeconomics. com/ article?id=pde2008_M000394& q=monetary economics & topicid=& result_number=1) The New
        Palgrave Dictionary of Economics. 2nd Edition.
          • David Hume, 1752. "Of Money," (http:/ / www. econlib. org/ library/ LFBooks/ Hume/ hmMPL26. html) "Of Interest," (http:/ / www.
        econlib. org/ library/ LFBooks/ Hume/ hmMPL27. html#Part II, Essay IV, OF INTEREST) and "Of the Balance of Trade" (http:/ / www.
        econlib. org/ library/ LFBooks/ Hume/ hmMPL28. html#Part II, Essay V, OF THE BALANCE OF TRADE) in Essays, Moral, Political, and
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        Rotwein ed., linked Table of Contents. (http:/ / books. google. com/ books?id=W00DP4Lx0BgC& pg=PR5& source=gbs_selected_pages&
          • Thomas Mayer, 1980. "David Hume and Monetarism," Quarterly Journal of Economics, 95(1), pp. 89 (http:/ / www. jstor. org/ discover/
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        libertyfund. org/ index. php?option=com_staticxt& staticfile=show. php?title=2041& Itemid=28) Introduction (http:/ / oll. libertyfund. org/
        ?option=com_staticxt& staticfile=show. php?title=2041& chapter=145565& layout=html& Itemid=27) by Friedrich Hayek, 1938.
          • W. Stanley Jevons, 1876 [1919]. Money and the Mechanism of Exchange. Chapter-preview links. (http:/ / books. google. com/
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          • Carl Menger, 1892. "On the Origin of Money," Economic Journal, 2(6), pp. 239–255. (http:/ / mason. gmu. edu/ ~tfemino/ Files/
        Menger-Origin-Money. pdf)
          • Knut Wicksell, [1898] 1936. Interest and Prices, tr. R.F. Kahn. Macmillan, Chapter links, pp. v (http:/ / books. google. com/
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          • _____, [1906] 1929. Lectures on Political Economy, v. 2 (http:/ / mises. org/ books/ LPEvol2. pdf): Money, tr. E. Classen, 1935. Discussed
        in Lionel Robbins' Introduction to v. 1 (http:/ / mises. org/ books/ LPEvol1. pdf): General Theory, pp. xv-xviii.
          • A.C. Pigou, 1917. "The Value of Money." Quarterly Journal of Economics, 32 ( 1), pp. 38 (http:/ / www. jstor. org/ pss/ 1885078)-65.
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        pg=PA175& =false) 204.
          • Fisher, Irving, [1911] 1922, 2nd ed.. The Purchasing Power of Money: Its Determination and Relation to Credit, Interest, and Crises,
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          • John Maynard Keynes, 1923. A Tract on Monetary Reform. Macmillan. Reviews, 1924 (http:/ / www. jstor. org/ pss/ 2223164) & 1996
        (http:/ / econ161. berkeley. edu/ Econ_Articles/ Reviews/ monetaryreform. html).
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        jstor. org/ pss/ 133641)-302.
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        is_n4_v60/ ai_n28638753/ )
          • Bennett T. McCallum, 1989. Monetary Economics: Theory and Policy. Macmillan. Preview (http:/ / www. scribd. com/ doc/ 54703339/
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          • JEL classification codes#Macroeconomics and monetary economics JEL: E Subcategories.
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        Dictionary of Economics. 2nd Edition. Table of Contents (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_M000217&
        q=money& topicid=& result_number=5) and Abstract. (http:/ / www. inomics. com/ cgi/ repec?handle=RePEc:cwl:cwldpp:1013) Reprinted in
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       Tobin, 1996, Essays in Economics, v. 4, pp. 139 (http:/ / books. google. com/ books?id=BIWEt8hRH2kC& pg=PA699& lpg=PA699& dq=&
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       ct=result#PPA163,M1) MIT Press.
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       resnum=1& ct=result#PPA227,M1) MIT Press.
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        Intermediation, 13(2), pp. 205-248. Abstract. (http:/ / www. sciencedirect. com/ science?_ob=ArticleURL& _udi=B6WJD-4B28V79-3&
        _user=10& _coverDate=04/ 30/ 2004& _rdoc=1& _fmt=high& _orig=search& _sort=d& _docanchor=& view=c& _rerunOrigin=scholar.
        google& _acct=C000050221& _version=1& _urlVersion=0& _userid=10& md5=3638046c9e4aceeb65e1815b46330d81)
           • Carlos M. Peláez and Carlos A. Peláez, 2009. Regulation of Banks and Finance: Theory and Policy after the Credit Crisis, Palgrave.
        Description. (http:/ / www. palgrave. com/ resources/ catalogue/ pdfs/ 2009/ Economics2009. pdf#page=12)
           • Centre for Economic Policy Research, London:
                 Mathias Dewatripont, Xavier Freixas, and Richard Portes, ed., 2009. Macroeconomic Stability and Financial Regulation. (http:/ / www.
        voxeu. org/ reports/ G20_ebook. pdf)
                 Thorsten Beck, Diane Coyle, Mathias Dewatripont, Xavier Freixas, and Paul Seabright, 2010. Bailing out the Banks: Reconciling
        Stability and Competition (http:/ / www. cepr. org/ pubs/ other/ Bailing_out_the_banks. pdf), ch. 7, "Preventing Future Crises: Reforming
        Prudential Regulation," pp. 67-83.
           • Robert E. Hall, 1982. "Monetary Trends in The United States and The United Kingdom: A Review from The Perspective of New
        Developments in Monetary Economics," Journal of Economic Literature, 20(4), pp. 1552-1556. (http:/ / www. stanford. edu/ ~rehall/
Monetary economics                                                                                                                                       128

       Monetary Trends JEL 1982. pdf)
          • Robert C. Merton, 1995. "Financial Innovation and the Management and Regulation of Financial Institutions," Journal of Banking &
       Finance, 19(3-4), pp. 461-481. (http:/ / www. people. hbs. edu/ rmerton/ financial innovation management and regulation. pdf)
          • Lawrence J. White, 1991 The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation, Oxford. Chapter-preview links. (http:/ /
       www. questia. com/ library/ book/ the-sandl-debacle-public-policy-lessons-for-bank-and-thrift-regulation-by-lawrence-j-white. jsp) Review
       (http:/ / www. minneapolisfed. org/ publications_papers/ pub_display. cfm?id=3768) by J.H. Boyd.
          • Randall S. Kroszner and Philip E. Strahan, 1999. "What Drives Deregulation? Economics and Politics of the Relaxation of Bank
       Branching Restrictions," Quarterly Journal of Economics, 114(4), pp. 1437 (http:/ / www. jstor. org/ pss/ 2586968)-1467.fragility of financial
          • Ben Bernanke and Mark Gertler, 1990. "Financial Fragility and Economic Performance," Quarterly Journal of Economics, 105(1), pp. 87
       (http:/ / www. jstor. org/ pss/ 2937820)-114.
          • Thomas F. Hellmann, Kevin C. Murdock and Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential
       Regulation: Are Capital Requirements Enough?" American Economic Review, 90(1), pp. 147 (http:/ / www. jstor. org/ pss/ 117285)-165.
          • Ross Levine, Norman Loayza, and Thorsten Beck, 2000. "Financial Intermediation and Growth: Causality and Causes," Journal of
       Monetary Economics, 46, pp. 31-77 (http:/ / siteresources. worldbank. org/ DEC/ Resources/ FinancialDevelopmentandGrowth. pdf) (close
       Pages tab at left).
          • Asli Demirgüç-Kunt and Enrica Detragiache, 2002. "Does Deposit Insurance Increase Banking System Stability? An Empirical
       Investigation," Journal of Monetary Economics, 49(7), pp. 1373-1406. Abstract & TOC. (http:/ / www. sciencedirect. com/
       science?_ob=ArticleURL& _udi=B6VBW-46YGNWB-3& _user=10& _coverDate=10/ 31/ 2002& _rdoc=1& _fmt=high& _orig=search&
       _sort=d& _docanchor=& view=c& _searchStrId=1229510575& _rerunOrigin=scholar. google& _acct=C000050221& _version=1&
       _urlVersion=0& _userid=10& md5=4e943cd6c3a1cdf468152a5cec378968)
          • Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, 92(4 ), pp. 874 (http:/
       / www. jstor. org/ pss/ 3083285)-888.
          • Thorsten Beck, Aslı Demirgu¨ Kunt, and Ross Levine 2006. "Bank Supervision and Corruption in Lending," Journal of Monetary
       Economics, 53(8), pp. 2131–2163. Abstract. (http:/ / michau. nazwa. pl/ aska/ uploads/ Studenci/ EPF_10nov2. pdf)
          • Raghuram G. Rajan, 2005. "Has Financial Development Made the World Riskier?" in Economic Symposium Conference Proceedings
       (http:/ / www. kansascityfed. org/ publications/ research/ escp/ archive. cfm), Federal Reserve Bank of Kansas City, Aug., pp. 313-369. (http:/
       / www. kansascityfed. org/ publicat/ sympos/ 2005/ pdf/ rajan2005. pdf) Abstract. (http:/ / www. nber. org/ papers/ w11728)
          • In Mark Carey & René M. Stulz, ed., 2007. The Risks of Financial Institutions (http:/ / books. google. com/ books?id=mTWtpwkGYGgC&
       printsec=frontcover& source=gbs#v=onepage& q=& f=false), Chicago:
                Thorsten Beck, Asli Demirguc-Kunt, and Ross Levine. "Bank Concentration and Fragility: Impact and Mechanics," ch. 5, pp. 193-
       (http:/ / books. google. com/ books?id=mTWtpwkGYGgC& printsec=find& pg=PA193=gbs#v=onepage& q& f=false) 231. Abstract. (http:/ /
       papers. ssrn. com/ sol3/ papers. cfm?abstract_id=775990)
                Franklin Allen and Douglas Gale. "Systemic Risk and Regulation," ch. 7. pp. 341-368.
          • Carl E. Walsh, 2009. "Using Monetary Policy to Stabilize Economic Activity," in Financial Stability and Macroeconomic Policy (http:/ /
       www. kansascityfed. org/ publications/ research/ escp/ escp-2009. cfm), FRBKC, Aug., pp. 245-96. (http:/ / www. kansascityfed. org/
       publicat/ sympos/ 2009/ papers/ Walsh. 09. 11. 09. pdf)
          • Ben S. Bernanke, 2010. "Monetary Policy and the Housing Bubble," (http:/ / www. federalreserve. gov/ newsevents/ speech/
       bernanke20100103a. htm) American Economic Association meeting. Atlanta. January 3.
          • Frontline, 2009. "The Warning," PBS, October 20. Brooksley Born's efforts as CFTC chair (1996-1999) to regulate OTC derivatives.
       Transcript (http:/ / www. pbs. org/ wgbh/ pages/ frontline/ warning/ etc/ script. html) and arrow- link (http:/ / www. pbs. org/ wgbh/ pages/
       frontline/ warning/ view/ ) to broadcast.
          • Charlie Rose, 2011. Paul Volcker interview, Oct 24, PBS. On current financial regulatory reform in the U.S., Europe, and Japan. Click on
       picture to play (http:/ / www. charlierose. com/ view/ interview/ 11964).
    [26] • From The New Palgrave Dictionary of Economics, 2008. 2nd Edition:
                 "monetary policy, history of" by Michael D. Bordo. Abstract (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_H000180& q=monetary policy& topicid=& result_number=2) and pre-publication copy. (http:/ / michael. bordo.
        googlepages. com/ TheHistoryofMonetaryPolicy. pdf)
                 "Taylor rules," v. 8, pp. 200-04, by Athanasios Orphanides. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_T000215& q=taylor rules& topicid=& result_number=1)
                 "time consistency of monetary and fiscal policy," by Paul Klein. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_T000219& q=Time inconsistency)& topicid=& result_number=1)
                 "epistemic game theory: incomplete information" by Aviad Heifetz. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_G000191& q=information& topicid=& result_number=6)
           • Finn E. Kydland and Edward C. Prescott, 1977. "Rules Rather than Discretion: The Inconsistency of Optimal Plans," Journal of Political
        Economy, 85(3), pp. 473–92. (http:/ / www. sfu. ca/ ~kkasa/ prescott_77. pdf)
           • Robert J. Barro and David B. Gordon, 1983. “Rules, Discretion and Reputation in a Model of Monetary Policy,” Journal of Monetary
        Economics, 12(1), pp. 101–21. (http:/ / dss. ucsd. edu/ ~jlbroz/ Courses/ POLI200C/ syllabus/ barro_gordon. pdf)
           • John B. Taylor, 1993. "Discretion versus Policy Rules in Practice," Carnegie-Rochester Conference Series on Public Policy, 39, pp.
Monetary economics                                                                                                                                        129

        195-214. (http:/ / www. stanford. edu/ ~johntayl/ Papers/ Discretion. PDF)
           • Michael Woodford, 2003. Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press. Description,
        (http:/ / press. princeton. edu/ titles/ 7603. html) table of contents (http:/ / press. princeton. edu/ TOCs/ c7603. html), and chapter-1 ["The
        Return of Monetary Rules"] link. (http:/ / press. princeton. edu/ chapters/ s7603. pdf) Reviews by Robert Formaini (http:/ / www. cato. org/
        pubs/ journal/ cj25n2/ cj25n2-18. pdf) and Bennett T. McCallum. (http:/ / books. google. com/ books?id=Q-23z2f57rgC& pg=PA10&
        lpg=PA10& dq="Michael+ Woodford’s+ Contributions+ to+ Monetary+ Economics,”& source=bl& ots=l_zlIQSEA6&
        sig=iL_w69Y8ntPQi4AT4n0CKM_-OvY& hl=en& ei=SzIMTOCcFYKKlwfCoNiRDg& sa=X& oi=book_result& ct=result& resnum=3&
        ved=0CBoQ6AEwAg#v=onepage& q="Michael Woodford’s Contributions to Monetary Economics,”& f=false)
    [27] • From Christina D. Romer and David H. Romer, 2007:2. "Monetary Economics," NBER Reporter, p. 1 (http:/ / www. nber. org/ reporter/
        2007number2/ 2007number2. pdf) (press +).
           • Alan S. Blinder, 1997. "What Central Bankers Could Learn from Academics — and Vice Versa," Journal of Economic Perspectives,
        11(2), pp. 3-19. (http:/ / www. ukzn. ac. za/ economics/ viegi/ teaching/ uct/ blinder. pdf)

    General references
    • Handbook of Monetary Economics, Elsevier.
            Friedman, Benjamin M., and Frank H. Hahn, ed. , 1990. v. 1 links for description & contents (http:/ / www.
            elsevier. com/ wps/ find/ bookdescription. cws_home/ 601125/ description#toc) and chapter-outline previews
            (http:/         /          www.          sciencedirect.       com/          science?_ob=PublicationURL&
            _tockey=#TOC#24616#1990#999989999#576735#FLP#& _cdi=24616& _pubType=HS& _auth=y&
            _acct=C000050221&                     _version=1&                _urlVersion=0&                 _userid=10&
            _____, 1990. v. 2 links for description & contents (http:/ / www. elsevier. com/ wps/ find/ bookdescription.
            cws_home/ 601126/ description#description) and chapter-outline previews. (http:/ / www. sciencedirect. com/
            science?_ob=PublicationURL& _tockey=#TOC#24616#1990#999979999#576734#FLP#& _cdi=24616&
            _pubType=HS& _auth=y& _acct=C000050221& _version=1& _urlVersion=0& _userid=10&
            Friedman, Benjamin, and Michael Woodford, 2010. v. 3A & 3B links for description (http:/ / www. elsevier.
            com/ wps/ find/ bookdescription. cws_home/ 724415/ description#description) & and chapter abstract & TOC.
    • Boughton, James R., and Elmus R. Wicker, 1975. The Principles of Monetary Economics.
    • Brunner, Karl, and Allan H. Meltzer, 1993. Money and the Economy: Issues in Monetary Analysis, Cambridge.
      Description ( and
      chapter previews, pp. ix ( x.
    • Clower, Robert W., ed., 1969. Monetary Theory: Selected Readings, Harmondsworth, Penguin.
    • Eden, Benjamin, 2005. A Course in Monetary Economics: Sequential Trade, Money, and Uncertainty.
      Description. (
    • Gale, Douglas, 1982. Money: in Equilibrium, Cambridge University Press, Cambridge Economic H andbooks,
      349 pp. ISBN 978-0-521-28900-9. Description (
      and preview (
    • _____, 1983. Money: in Disequilibrium, Cambridge Economic Handbooks, 382 pp. ISBN 978-0-521-26917-9.
      Description ( and preview (
    • Goodhart, Charles, 1989. Money, Information and Uncertainty, 2nd Ed. MIT Press. Description (http://mitpress. and chapter titles. (
Monetary economics                                                                                                      130

    • Grandmont, Jean-Michel, 1985. Money and Value: A Reconsideration of Classical and Neoclassical Monetary
      Economics, Econometric Society Monographs, v. 5, Cambridge University Press. ISBN 978-0-521-31364-3.
      Description (
      q&f=false) and preview (
      printsec=frontcover#v=onepage&q&f=false) .
    • Handa, Jagdish, 2007. Monetary Economics, 2nd ed. Routledge. Description (
      books/details/9780415772099/) and preview (
    • Harris, Laurence, 1981. Monetary Theory. New York: McGraw-Hill.
    • Hicks, John R., 1967. Critical Essays in Monetary Theory, Chapter preview links. (
      books?id=qVqeJP9DhvYC&printsec=toc&dq=gbs_summary_s&cad=0) Oxford.
    • The New Palgrave Dictionary of Finance and Money, 1992. 3 v. Description. (
    • The New Palgrave Dictionary of Economics Online, 2008. Abstract links for "Monetary Economics" (http:// (alphabetical) and "monetary".
    • Rabin, Alan A., 2004. Monetary Theory MPG Books: London. Arrow-page-searchable chapter (http://books."Rabin"+"Monetary+Theory"&
      source=gbs_summary_s&cad=0) previews.
    • Starr, Ross M., ed. (1989). General equilibrium models of monetary economies: Studies in the static foundations
      of monetary theory. Economic theory, econometrics, and mathematical economics. Academic Press. pp. 351.
      ISBN 0-12-663970-1, ISBN 978-0-12-663970-4.
    • Walsh, Carl E., 2003. Monetary Theory and Policy, 2nd ed., MIT Press. ISBN 0-262-23231-6. Description (http:/
      / and chapter-preview links. (http://books.
    • Woodford, Michael (2003). Interest and prices: Foundations of a theory of monetary policy (http://press. Princeton, New Jersey: Princeton University Press. ISBN 0-691-01049-8.

    External links
    • Journal of Money, Credit and Banking (
    • Journal of Monetary Economics (
    • NBER Working Papers: Links to JEL classes of abstracts or downloads for Macroeconomics and Monetary
      Economics (, including:
          (JEL: E4) Money and Interest Rates (
          (JEL: E5) Monetary Policy, Central Banking, and the Supply of Money and Credit (http:/ / www. nber. org/
          Presentation of Money, credit and finance an slideshow (http:/ / www. slideshare. net/ BabasabPatil/
          What is money? an slideshow
International economics                                                                                                         131

    International economics
    International economics is concerned with the effects upon economic activity of international differences in
    productive resources and consumer preferences and the institutions that affect them. It seeks to explain the patterns
    and consequences of transactions and interactions between the inhabitants of different countries, including trade,
    investment and migration.
    • International trade studies goods-and-services flows across international boundaries from supply-and-demand
      factors, economic integration, international factor movements, and policy variables such as tariff rates and trade
    • International finance studies the flow of capital across international financial markets, and the effects of these
      movements on exchange rates.[2]
    • International monetary economics and macroeconomics studies money and macro flows across countries.[3]
    • International political economy from international relations studies issues and impacts from for example
      international conflicts, international negotiations, and international sanctions; national security and economic
      nationalism; and international agreements and observance.[4]

    International trade

    Scope and methodology
    The economic theory of international trade differs from the remainder of economic theory mainly because of the
    comparatively limited international mobility of the capital and labour .[5] In that respect, it would appear to differ in
    degree rather than in principle from the trade between remote regions in one country. Thus the methodology of
    international trade economics differs little from that of the remainder of economics. However, the direction of
    academic research on the subject has been influenced by the fact that governments have often sought to impose
    restrictions upon international trade, and the motive for the development of trade theory has often been a wish to
    determine the consequences of such restrictions.
    The branch of trade theory which is conventionally categorized as "classical" consists mainly of the application of
    deductive logic, originating with Ricardo’s Theory of Comparative Advantage and developing into a range of
    theorems that depend for their practical value upon the realism of their postulates. "Modern" trade theory, on the
    other hand, depends mainly upon empirical analysis.

    Classical theory
    The law of comparative advantage provides a logical explanation of international trade as the rational consequence
    of the comparative advantages that arise from inter-regional differences - regardless of how those differences arise.
    Since its exposition by John Stuart Mill[6] the techniques of neo-classical economics have been applied to it to model
    the patterns of trade that would result from various postulated sources of comparative advantage. However,
    extremely restrictive (and often unrealistic) assumptions have had to be adopted in order to make the problem
    amenable to theoretical analysis.
    The best-known of the resulting models, the Heckscher-Ohlin theorem (H-O)[7] depends upon the assumptions of no
    international differences of technology, productivity, or consumer preferences; no obstacles to pure competition or
    free trade and no scale economies. On those assumptions, it derives a model of the trade patterns that would arise
    solely from international differences in the relative abundance of labour and capital (referred to as factor
    endowments). The resulting theorem states that, on those assumptions, a country with a relative abundance of capital
    would export capital-intensive products and import labour-intensive products. The theorem proved to be of very
    limited predictive value, as was demonstrated by what came to be known as the "Leontief Paradox" (the discovery
International economics                                                                                                             132

    that, despite its capital-rich factor endowment, America was exporting labour-intensive products and importing
    capital-intensive products[8]) Nevertheless the theoretical techniques (and many of the assumptions) used in deriving
    the H-O model were subsequently used to derive further theorems.
    The Stolper-Samuelson theorem,[9] which is often described as a corollary of the H-O theorem, was an early
    example. In its most general form it states that if the price of a good rises (falls) then the price of the factor used
    intensively in that industry will also rise (fall) while the price of the other factor will fall (rise). In the international
    trade context for which it was devised it means that trade lowers the real wage of the scarce factor of production, and
    protection from trade raises it.
    Another corollary of the H-O theorem is Samuelson's factor price equalisation theorem[10] which states that as trade
    between countries tends to equalise their product prices, it tends also to equalise the prices paid to their factors of
    production. Those theories have sometimes been taken to mean that trade between an industrialised country and a
    developing country would lower the wages of the unskilled in the industrialised country. (But, as noted below, that
    conclusion depends upon the unlikely assumption that productivity is the same in the two countries). Large numbers
    of learned papers have been produced in attempts to elaborate on the H-O and Stolper-Samuelson theorems, and
    while many of them are considered to provide valuable insights, they have seldom proved to be directly applicable to
    the task of explaining trade patterns.
    (See also the Rybczynski theorem[11][12])

    Modern theory
    Modern trade theory moves away from the restrictive assumptions of the H-O theorem and explores the effects upon
    trade of a range of factors, including technology and scale economies. It makes extensive use of econometrics to
    identify from the available statistics, the contribution of particular factors among the many different factors that
    affect trade. The contribution of differences of technology have been evaluated in several such studies. The
    temporary advantage arising from a country’s development of a new technology is seen as contributory factor in one
    Other researchers have found research and development expenditure, patents issued, and the availability of skilled
    labor, to be indicators of the technological leadership that enables some countries to produce a flow of such
    technological innovations[14] and have found that technology leaders tend to export hi-tech products to others and
    receive imports of more standard products from them. Another econometric study also established a correlation
    between country size and the share of exports made up of goods in the production of which there are scale
    economies.[15] It is further suggested in that study that internationally traded goods fall into three categories, each
    with a different type of comparative advantage:
       • goods that are produced by the extraction and routine processing of available natural resources – such as coal,
         oil and wheat, for which developing countries often have an advantage compared with other types of
         production – which might be referred to as "Ricardo goods";
       • low-technology goods, such as textiles and steel, that tend to migrate to countries with appropriate factor
         endowments - which might be referred to as "Heckscher-Ohlin goods"; and,
       • high-technology goods and high scale-economy goods, such as computers and aeroplanes, for which the
         comparative advantage arises from the availability of R&D resources and specific skills and the proximity to
         large sophisticated markets.
    = There is a strong presumption that any exchange that is freely undertaken will benefit both parties, but that does
    not exclude the possibility that it may be harmful to others. However (on assumptions that included constant returns
    and competitive conditions) Paul Samuelson has proved that it will always be possible for the gainers from
    international trade to compensate the losers.[16] Moreover, in that proof, Samuelson did not take account of the gains
    to others resulting from wider consumer choice, from the international specialisation of productive activities - and
    consequent economies of scale, and from the transmission of the benefits of technological innovation. An OECD
International economics                                                                                                         133

    study has suggested that there are further dynamic gains resulting from better resource allocation, deepening
    specialisation, increasing returns to R&D, and technology spillover. The authors found the evidence concerning
    growth rates to be mixed, but that there is strong evidence that a 1 per cent increase in openness to trade increases the
    level of GDP per capita by between 0.9 per cent and 2.0 per cent.[17] They suggested that much of the gain arises
    from the growth of the most productive firms at the expense of the less productive. Those findings and others[18]
    have contributed to a broad consensus among economists that trade confers very substantial net benefits, and that
    government restrictions upon trade are generally damaging.

    Factor price equalisation
    Nevertheless there have been widespread misgivings about the effects of international trade upon wage earners in
    developed countries. Samuelson‘s factor price equalisation theorem indicates that, if productivity were the same in
    both countries, the effect of trade would be to bring about equality in wage rates. As noted above, that theorem is
    sometimes taken to mean that trade between an industrialised country and a developing country would lower the
    wages of the unskilled in the industrialised country. However, it is unreasonable to assume that productivity would
    be the same in a low-wage developing country as in a high-wage developed country. A 1999 study has found
    international differences in wage rates to be approximately matched by corresponding differences in productivity.[19]
    (Such discrepancies that remained were probably the result of over-valuation or under-valuation of exchange rates,
    or of inflexibilities in labour markets.) It has been argued that, although there may sometimes be short-term pressures
    on wage rates in the developed countries, competition between employers in developing countries can be expected
    eventually to bring wages into line with their employees' marginal products. Any remaining international wage
    differences would then be the result of productivity differences, so that there would be no difference between unit
    labour costs in developing and developed countries, and no downward pressure on wages in the developed

    Terms of trade
    There has also been concern that international trade could operate against the interests of developing countries.
    Influential studies published in 1950 by the Argentine economist Raul Prebisch[21] and the British economist Hans
    Singer[22] suggested that there is a tendency for the prices of agricultural products to fall relative to the prices of
    manufactured goods; turning the terms of trade against the developing countries and producing an unintended
    transfer of wealth from them to the developed countries.
    Their findings have been confirmed by a number of subsequent studies, although it has been suggested[23] that the
    effect may be due to quality bias in the index numbers used or to the possession of market power by manufacturers.
    The Prebisch/Singer findings remain controversial, but they were used at the time - and have been used subsequently
    - to suggest that the developing countries should erect barriers against manufactured imports in order to nurture their
    own “infant industries” and so reduce their need to export agricultural products. The arguments for and against such a
    policy are similar to those concerning the protection of infant industries in general.

    Infant industries
    The term "infant industry" is used to denote a new industry which has prospects of becoming profitable in the
    long-term, but which would be unable to survive in the face of competition from imported goods. That is a situation
    that can occur because time is needed either to achieve potential economies of scale, or to acquire potential learning
    curve economies. Successful identification of such a situation followed by the temporary imposition of a barrier
    against imports can, in principle, produce substantial benefits to the country that applies it – a policy known as
    “import substitution industrialization”. Whether such policies succeed depends upon governments’ skills in picking
    winners, and there might reasonably be expected to be both successes and failures. It has been claimed that South
    Korea’s automobile industry owes its existence to initial protection against imports,[24] but a study of infant industry
    protection in Turkey reveals the absence of any association between productivity gains and degree of protection,
International economics                                                                                                           134

    such as might be expected of a successful import substitution policy. .[25]
    Another study provides descriptive evidence suggesting that attempts at import substitution industrialisation since
    the 1970s have usually failed,[26] but the empirical evidence on the question has been contradictory and
    inconclusive.[27] It has been argued that the case against import substitution industrialisation is not that it is bound to
    fail, but that subsidies and tax incentives do the job better.[28] It has also been pointed out that, in any case, trade
    restrictions could not be expected to correct the domestic market imperfections that often hamper the development of
    infant industries[29]

    Trade policies
    Economists’ findings about the benefits of trade have often been rejected by government policy-makers, who have
    frequently sought to protect domestic industries against foreign competition by erecting barriers, such as tariffs and
    quotas, against imports. Average tariff levels of around 15 per cent in the late 19th century rose to about 30 percent
    in the 1930s, following the passage in the United States of the Smoot-Hawley Act.[30] Mainly as the result of
    international agreements under the auspices of the General Agreement on Tariffs and Trade (GATT) and
    subsequently the World Trade Organisation (WTO), average tariff levels were progressively reduced to about 7 per
    cent during the second half of the 20th century, and some other trade restrictions were also removed. The restrictions
    that remain are nevertheless of major economic importance: among other estimates[31] the World Bank estimated in
    2004 that the removal of all trade restrictions would yield benefits of over $500 billion a year by 2015.[32]
    The largest of the remaining trade-distorting policies are those concerning agriculture. In the OECD countries
    government payments account for 30 per cent of farmers’ receipts and tariffs of over 100 per cent are common.[33]
    OECD economists estimate that cutting all agricultural tariffs and subsidies by 50% would set off a chain reaction in
    realignments of production and consumption patterns that would add an extra $26 billion to annual world income.[34]
    Quotas prompt foreign suppliers to raise their prices toward the domestic level of the importing country. That
    relieves some of the competitive pressure on domestic suppliers, and both they and the foreign suppliers gain at the
    expense of a loss to consumers, and to the domestic economy, in addition to which there is a deadweight loss to the
    world economy. When quotas were banned under the rules of the General Agreement on Tariffs and Trade (GATT),
    the United States, Britain and the European Union made use of equivalent arrangements known as voluntary
    restraint agreements (VRAs) or voluntary export restraints (VERs) which were negotiated with the governments of
    exporting countries (mainly Japan) - until they too were banned. Tariffs have been considered to be less harmful than
    quotas, although it can be shown that their welfare effects differ only when there are significant upward or
    downward trends in imports.[35] Governments also impose a wide range of non-tariff barriers[36] that are similar in
    effect to quotas, some of which are subject to WTO agreements.[37] A recent example has been the application of the
    precautionary principle to exclude innovatory products .[38]

    International finance

    Scope and methodology
    The economics of international finance do not differ in principle from the economics of international trade but there
    are significant differences of emphasis. The practice of international finance tends to involve greater uncertainties
    and risks because the assets that are traded are claims to flows of returns that often extend many years into the future.
    Markets in financial assets tend to be more volatile than markets in goods and services because decisions are more
    often revised and more rapidly put into effect. There is the share presumption that a transaction that is freely
    undertaken will benefit both parties, but there is a much greater danger that it will be harmful to others.
    For example, mismanagement of mortgage lending in the United States led in 2008 to banking failures and credit
    shortages in other developed countries, and sudden reversals of international flows of capital have often led to
    damaging financial crises in developing countries. And, because of the incidence of rapid change, the methodology
International economics                                                                                                           135

    of comparative statics has fewer applications than in the theory of international trade, and empirical analysis is more
    widely employed. Also, the consensus among economists concerning its principal issues is narrower and more open
    to controversy than is the consensus about international trade. Given by Mahendra

    Exchange rates and capital mobility
    A major change in the organisation of international finance occurred in the latter years of the twentieth century, and
    economists are still debating its implications. At the end of the second world war the national signatories to the
    Bretton Woods Agreement had agreed to maintain their currencies each at a fixed exchange rate with the United
    States dollar, and the United States government had undertaken to buy gold on demand at a fixed rate of $35 per
    ounce. In support of those commitments, most signatory nations had maintained strict control over their nationals’
    use of foreign exchange and upon their dealings in international financial assets.
    But in 1971 the United States government announced that it was suspending the convertibility of the dollar, and there
    followed a progressive transition to the current regime of floating exchange rates in which most governments no
    longer attempt to control their exchange rates or to impose controls upon access to foreign currencies or upon access
    to international financial markets. The behaviour of the international financial system was transformed. Exchange
    rates became very volatile and there was an extended series of damaging financial crises. One study estimated that
    by the end of the twentieth century there had been 112 banking crises in 93 countries ,[39] another that there had been
    26 banking crises, 86 currency crises and 27 mixed banking and currency crises[40] - many times more than in the
    previous post-war years.
    The outcome was not what had been expected. In making an influential case for flexible exchange rates in the 1950s,
    Milton Friedman had claimed that if there were any resulting instability, it would mainly be the consequence of
    macroeconomic instability,[41] but an empirical analysis in 1999 found no apparent connection.[42] Economists began
    to wonder whether the expected advantages of freeing financial markets from government intervention were in fact
    being realised.[43]
    Neoclassical theory had led them to expect capital to flow from the capital-rich developed economies to the
    capital-poor developing countries - because the returns to capital there would be higher. Flows of financial capital
    would tend to increase the level of investment in the developing countries by reducing their costs of capital, and the
    direct investment of physical capital would tend to promote specialisation and the transfer of skills and technology.
    However, theoretical considerations alone cannot determine the balance between those benefits and the costs of
    volatility, and the question has had to be tackled by empirical analysis.
    A 2006 International Monetary Fund working paper offers a summary of the empirical evidence.[44] The authors
    found little evidence either of the benefits of the liberalisation of capital movements, or of claims that it is
    responsible for the spate of financial crises. They suggest that net benefits can be achieved by countries that are able
    to meet threshold conditions of financial competence but that for others, the benefits are likely to be delayed, and
    vulnerability to interruptions of capital flows is likely to be increased.

    Policies and institutions
    Although the majority of developed countries now have "floating" exchange rates, some of them – together with
    many developing countries – maintain exchange rates that are nominally "fixed", usually with the US dollar or the
    euro. The adoption of a fixed rate requires intervention in the foreign exchange market by the country’s central bank,
    and is usually accompanied by a degree of control over its citizens’ access to international markets.
    A controversial case in point is the policy of the Chinese government who had, until 2005, maintained the renminbi
    at a fixed rate to the dollar, but have since "pegged" it to a basket of currencies. It is frequently alleged that in doing
    so they are deliberately holding its value lower than if it were allowed to float (but there is evidence to the
International economics                                                                                                       136

    Some governments have abandoned their national currencies in favour of the common currency of a currency area
    such as the "eurozone" and some, such as Denmark, have retained their national currencies but have pegged them at
    a fixed rate to an adjacent common currency. On an international scale, the economic policies promoted by the
    International Monetary Fund (IMF) have had a major influence, especially upon the developing countries.
    The IMF was set up in 1944 to encourage international cooperation on monetary matters, to stabilise exchange rates
    and create an international payments system. Its principal activity is the payment of loans to help member countries
    to overcome balance of payments problems, mainly by restoring their depleted currency reserves. Their loans are,
    however, conditional upon the introduction of economic measures by recipient governments that are considered by
    the Fund's economists to provide conditions favourable to recovery.
    Their recommended economic policies are broadly those that have been adopted in the United States and the other
    major developed countries (known as the "Washington Consensus") and have often included the removal of all
    restrictions upon incoming investment. The Fund has been severely criticised by Joseph Stiglitz and others for what
    they consider to be the inappropriate enforcement of those policies and for failing to warn recipient countries of the
    dangers that can arise from the volatility of capital movements.

    International financial stability
    From the time of the Great Depression onwards, regulators and their economic advisors have been aware that
    economic and financial crises can spread rapidly from country to country, and that financial crises can have serious
    economic consequences. For many decades, that awareness led governments to impose strict controls over the
    activities and conduct of banks and other credit agencies, but in the 1980s many governments pursued a policy of
    deregulation in the belief that the resulting efficiency gains would outweigh any systemic risks. The extensive
    financial innovations that followed are described in the article on financial economics.
    One of their effects has been greatly to increase the international inter-connectedness of the financial markets and to
    create an international financial system with the characteristics known in control theory as "complex-interactive".
    The stability of such a system is difficult to analyse because there are many possible failure sequences. The
    internationally systemic crises that followed included the equity crash of October 1987,[46] the Japanese asset price
    collapse of the 1990s[47] the Asian financial crisis of 1997[48] the Russian government default of 1998[49](which
    brought down the Long-Term Capital Management hedge fund) and the 2007-8 sub-prime mortgages crisis.[50] The
    symptoms have generally included collapses in asset prices, increases in risk premiums, and general reductions in
    Measures designed to reduce the vulnerability of the international financial system have been put forward by several
    international institutions. The Bank for International Settlements made two successive recommendations (Basel I and
    Basel II[51]) concerning the regulation of banks, and a coordinating group of regulating authorities, and the Financial
    Stability Forum, that was set up in 1999 to identify and address the weaknesses in the system, has put forward some
    proposals in an interim report.[52]

    Elementary considerations lead to a presumption that international migration results in a net gain in economic
    welfare. Wage differences between developed and developing countries have been found to be mainly due to
    productivity differences[19] which may be assumed to arise mostly from differences in the availability of physical,
    social and human capital. And economic theory indicates that the move of a skilled worker from a place where the
    returns to skill are relatively low to a place where they are relatively high should produce a net gain (but that it
    would tend to depress the wages of skilled workers in the recipient country).
    There have been many econometric studies intended to quantify those gains. A Copenhagen Consensus study
    suggests that if the share of foreign workers grew to 3% of the labour force in the rich countries there would be
International economics                                                                                                          137

    global benefits of $675 billion a year by 2025.[53] However, a survey of the evidence led a House of Lords
    committee to conclude that any benefits of immigration to the United Kingdom are relatively small.[54] Evidence
    from the United States also suggests that the economic benefits to the receiving country are relatively small ,[55] and
    that the presence of immigrants in its labour market results in only a small reduction in local wages.[56]
    From the standpoint of a developing country, the emigration of skilled workers represents a loss of human capital
    (known as brain drain), leaving the remaining workforce without the benefit of their support. That effect upon the
    welfare of the parent country is to some extent offset by the remittances that are sent home by the emigrants, and by
    the enhanced technical know-how with which some of them return. One study introduces a further offsetting factor
    to suggest that the opportunity to migrate fosters enrolment in education thus promoting a "brain gain" that can
    counteract the lost human capital associated with emigration .[57]
    Whereas some studies suggest that parent countries can benefit from the emigration of skilled workers,[58] generally
    it is emigration of unskilled and semi-skilled workers that is of economic benefit to countries of origin, by reducing
    pressure for employment creation. Where skilled emigration is concentrated in specific highly skilled sectors, such as
    medicine, the consequences are severe and even catastrophic in cases where 50% or so of trained doctors have
    emigrated. The crucial issues, as recently acknowledged by the OECD, is the matter of return and reinvestment in
    their countries of origin by the migrants themselves: thus, government policies in Europe are increasingly focused
    upon facilitating temporary skilled migration alongside migrant remittances.
    Unlike movement of capital and goods, since 1973 government policies have tried to restrict migration flows, often
    without any economic rationale. Such restrictions have had diversionary effects, channeling the great majority of
    migration flows into illegal migration and "false" asylum-seeking. Since such migrants work for lower wages and
    often zero social insurance costs, the gain from labour migration flows is actually higher than the minimal gains
    calculated for legal flows; accompanying side-effects are significant, however, and include political damage to the
    idea of immigration, lower unskilled wages for the host population, and increased policing costs alongside lower tax

    The term globalization has acquired a variety of meanings, but in economic terms it refers to the move that is taking
    place in the direction of complete mobility of capital and labour and their products, so that the world's economies are
    on the way to becoming totally integrated. The driving forces of the process are reductions in politically imposed
    barriers and in the costs of transport and communication (although, even if those barriers and costs were eliminated,
    the process would be limited by inter-country differences in social capital).
    It is a process which has ancient origins, which has gathered pace in the last fifty years, but which is very far from
    complete. In its concluding stages, interest rates, wage rates and corporate and income tax rates would become the
    same everywhere, driven to equality by competition, as investors, wage earners and corporate and personal taxpayers
    threatened to migrate in search of better terms. In fact, there are few signs of international convergence of interest
    rates, wage rates or tax rates. Although the world is more integrated in some respects, it is possible to argue that on
    the whole it is now less integrated than it was before the first world war.,[59] and that many middle-east countries are
    less globalised than they were 25 years ago.[60]
    Of the moves toward integration that have occurred, the strongest has been in financial markets, in which
    globalisation is estimated to have tripled since the mid-1970s.[61] Recent research has shown that it has improved
    risk-sharing, but only in developed countries, and that in the developing countries it has increased macroeconomic
    volatility. It is estimated to have resulted in net welfare gains worldwide, but with losers as well as gainers. .[62]
    Increased globalisation has also made it easier for recessions to spread from country to country. A reduction in
    economic activity in one country can lead to a reduction in activity in its trading partners as a result of its consequent
    reduction in demand for their exports, which is one of the mechanisms by which the business cycle is transmitted
    from country to country. Empirical research confirms that the greater the trade linkage between countries the more
International economics                                                                                                                                   138

    coordinated are their business cycles.[63]
    Globalisation can also have a significant influence upon the conduct of macroeconomic policy. The
    Mundell–Fleming model and its extensions[64] are often used to analyse the role of capital mobility (and it was also
    used by Paul Krugman to give a simple account of the Asian financial crisis[65]). Part of the increase in income
    inequality that has taken place within countries is attributable - in some cases - to globalisation. A recent IMF report
    demonstrates that the increase in inequality in the developing countries in the period 1981 to 2004 was due entirely
    to technological change, with globalisation making a partially offsetting negative contribution, and that in the
    developed countries globalisation and technological change were equally responsible.[66]

    Globalisation is seen as contributing to economic welfare by most economists – but not all. Professor Joseph
    Stiglitz[67] of the Columbia Business School has advanced the infant industry case for protection in developing
    countries and criticised the conditions imposed for help by the International Monetary Fund.[68] And Professor Dani
    Rodrik of Harvard[69] has noted that the benefits of globalisation are unevenly spread, and that it has led to income
    inequalities, and to damaging losses of social capital in the parent countries and to social stresses resulting from
    immigration in the receiving countries.[70] An extensive critical analysis of these contentions has been made by
    Martin Wolf,[71] and a lecture by Professor Jagdish Bhagwati has surveyed the debate that has taken place among

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International economics                                                                                               141

    • This article incorporates material from the Citizendium article "International economics", which is licensed
      under the Creative Commons Attribution-ShareAlike 3.0 Unported License but not under the GFDL.
    • Stanley W. Black (2008). "international monetary institutions," The New Palgrave Dictionary of Economics. 2nd
      Edition. Abstract. (
    • M. June Flanders (2008). "international economics, history of," The New Palgrave Dictionary of Economics. 2nd
      Edition. Abstract. (
    • James Rauch (2008). "growth and international trade," The New Palgrave Dictionary of Economics. 2nd Edition.
      Abstract. ( trade&
    • Smith, Charles (2007). International Trade and Globalisation, 3rd edition. Stocksfield: Anforme.
      ISBN 1-905504-10-1.

    External links
    • Alan Deardorff. Glossary of International Economics. (
      Links for A-Z with much micro/macro too.
    • Carnegie Endowment for International Peace. " International Economics Bulletin. (http://www." Analysis on the Global Economy.
    • Council on Foreign Relations. " IIGG Interactive Guide to Global Finance ("
    • International Economics: The Great Outsourcing Shift. " The essential guide to understanding why domestic
      companies will soon change their outsourcing focus from China to Mexico. (http://www.
    • Historical documents on international trade, finance, and economics (
      ?tid=81) available on FRASER
Financial economics                                                                                                         142

    Financial economics
    Financial economics is the branch of economics concerned with "the allocation and deployment of economic
    resources, both spatially and across time, in an uncertain environment".[1] It is additionally characterised by its
    "concentration on monetary activities", in which "money of one type or another is likely to appear on both sides of a
    trade".[2] The questions within financial economics are typically framed in terms of "time, uncertainty, options, and
    • Time: money now is traded for money in the future.
    • Uncertainty (or risk): The amount of money to be transferred in the future is uncertain.
    • Options: one party to the transaction can make a decision at a later time that will affect subsequent transfers of
    • Information: knowledge of the future can reduce, or possibly eliminate, the uncertainty associated with future
      monetary value (FMV).
    A topic of general interest studied in recent years has been financial crises.[3]
    The subject is usually taught at a postgraduate level; see Master of Financial Economics.

    Subject matter
    Financial economics is the branch of economics studying the interrelation of financial variables, such as prices,
    interest rates and shares, as opposed to those concerning the real economy. Financial economics concentrates on
    influences of real economic variables on financial ones, in contrast to pure finance.
    It studies the following:
    • Valuation - Determination of the fair value of an asset
       •   How risky is the asset? (identification of the asset appropriate discount rate)
       •   What cash flows will it produce? (discounting of relevant cash flows)
       •   How does the market price compare to similar assets? (relative valuation)
       •   Are the cash flows dependent on some other asset or event? (derivatives, contingent claim valuation)
    • Financial markets and instruments
       •   Commodities - topics
       •   Stocks - topics
       •   Bonds - topics
       •   Money market instruments- topics
       •   Derivatives - topics
    • Financial institutions and regulation
    Financial econometrics is the branch of Financial Economics that uses econometric techniques to parameterise the
    In the Journal of Economic Literature classification codes, Financial Economics is one of the 19 primary
    classifications, at JEL: G. It follows Monetary and International Economics and precedes Public Economics.
    Detailed subclassifications are linked in the following footnote.[4]
    The New Palgrave Dictionary of Economics (2008, 2nd ed.) also uses the JEL codes to classify its entries in v. 8,
    Subject Index, including Financial Economics at pp. 863-64. The corresponding footnotes below have links to entry
    abstracts of The New Palgrave Online [5] for each primary or secondary JEL category (10 or fewer per page, similar
    to Google searches):
           JEL: G – Financial Economics [6]
Financial economics                                                                                                                                                143

            JEL: G0 – General[7]
            JEL: G1 – General Financial Markets[8]
            JEL: G2 – Financial institutions and Services[9]
            JEL: G3 – Corporate finance and Governance[10]
    Tertiary category entries can be also be searched.[11]

    Models in financial economics
    Financial economics is primarily concerned with building models to derive testable or policy implications from
    acceptble assumptions. Some fundamental ideas in financial economics are portfolio theory, the Capital Asset
    Pricing Model. Portfolio theory studies how investors should balance risk and return when investing in many assets
    or securities. The Capital Asset Pricing Model describes how markets should set the prices of assets in relation to
    how risky they are. The Modigliani-Miller Theorem describes conditions under which corporate financing decisions
    are irrelevant for value, and acts as a benchmark for evaluating the effects of factors outside the model that do affect
    A common assumption is that financial decision makers act rationally (see Homo economicus; efficient market
    hypothesis). However, recently, researchers in experimental economics and experimental finance have challenged
    this assumption empirically. They are also challenged, theoretically, by behavioral finance, a discipline primarily
    concerned with the limits to rationality of economic agents.
    Other common assumptions include market prices following a random walk or asset returns being normally
    distributed. Empirical evidence suggests that these assumptions may not hold and that in practice, traders, analysts
    and particularly risk managers frequently modify the "standard models".

    [1] "Robert C. Merton - Nobel Lecture" (http:/ / nobelprize. org/ nobel_prizes/ economics/ laureates/ 1997/ merton-lecture. pdf) (PDF). .
        Retrieved 2009-08-06.
    [2] "Financial Economics" (http:/ / www. stanford. edu/ ~wfsharpe/ mia/ int/ mia_int2. htm). . Retrieved 2009-08-06.
    [3] From The New Palgrave Dictionary of Economics, Online Editions, 2011, 2012, with abstract links:
           • "regulatory responses to the financial crisis: an interim assessment" (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2012_F000330& edition=1) by Howard Davies
           • "Credit Crunch Chronology: April 2007–September 2009" (http:/ / www. dictionaryofeconomics. com/ article?id=pde2011_C000621&
        edition=) by The Statesman's Yearbook team
           • "Minsky crisis" (http:/ / www. dictionaryofeconomics. com/ article?id=pde2011_M000430& edition=current& q=) by L. Randall Wray
           • "euro zone crisis 2010" (http:/ / www. dictionaryofeconomics. com/ article?id=pde2011_E000326& edition=current& q=) by Daniel Gros
        and Cinzia Alcidi.
           • Carmen M. Reinhart and Kenneth S. Rogoff, 2009. This Time Is Different: Eight Centuries of Financial Folly, Princeton. Description
        (http:/ / press. princeton. edu/ titles/ 8973. html), ch. 1 ("Varieties of Crises and their Dates," pp. 3-20) (http:/ / press. princeton. edu/ chapters/
        s8973. pdf), and chapter-preview links. (http:/ / books. google. com/ books?id=ak5fLB24ircC& printsec=frontcover& source=find&
        pg=PR7gbs_atb#v=onepage& q& f=false)
    [4] JEL classification codes — Financial economics JEL: G Subcategories
    [5] http:/ / www. dictionaryofeconomics. com/ dictionary
    [6] All entries under JEL: G: http:/ / www. dictionaryofeconomics. com/ search_results?,q=& field=content& edition=all& topicid=G
    [7] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=G0
    [8] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=G1
    [9] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=G2
    [10] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=G3
    [11] In particular by clicking to Advanced searches from http:/ / www. dictionaryofeconomics. com/ , which brings up http:/ / www.
        dictionaryofeconomics. com/ advanced_search, drilling to the secondary category, then to the tertiary category, followed by clicking the
        Search button at the bottom. For example, from secondary code JEL: G0, http:/ / www. dictionaryofeconomics. com/ search_results?,q=&
        field=content& edition=all& topicid=G0, then to the JEL: G00, then pressing the Search button to bring up the entry links at http:/ / www.
        dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=G00.
Financial economics                                                                                               144

    External links

    • Great Moments in Financial Economics I (, II (, "III" (http://web.archive.
      doc). Archived from the original ( Short-Sales and Stock Prices.
      doc) on 2007-09-27.; IVa (
      artandpap/IV+Fundamental+Theorem+-+Part+I.doc); "IVb" (
      Archived from the original ( Fundamental Theorem - Part II.doc)
      on 2007-09-27.. Prof. Mark Rubinstein, Haas School of Business
    • Microfoundations of Financial Economics ( Prof. André
      Farber Solvay Business School
    • Handbook of the Economics of Finance (, G.M.
      Constantinides, M. Harris, R. M. Stulz
    • An introduction to investment theory (
      classnotes/notes.html), Prof. William Goetzmann, Yale School of Management

    Context and history
    • "A Short History of Investment Forecasting" ( Archived from the original (http://roundtable.informs.
      org/public-access/min061a.htm) on 2007-10-12., Professor Michael Phillips, California State University,

    Links and portals
    • "Books on Financial Economics": list on (
Public economics                                                                                                             145

    Public economics
    Public economics (or economics of the public sector) is the study of government policy through the lens of
    economic efficiency and equity. At its most basic level, public economics provides a framework for thinking about
    whether or not the government should participate in economics markets and to what extent its role should be. In
    order to do so, microeconomic theory is utilized to assess whether the private market is likely to provide efficient
    outcomes in the absence of governmental interference. Inherently, this study involves the analysis of government
    taxation and expenditures. This subject encompasses a host of topics including market failures, externalities, and the
    creation and implementation of government policy. Public economics builds on the theory of welfare economics and
    is ultimately used as a tool to improve social welfare.
    Broad methods and topics include:
    •   analysis and design of public policy[1]
    •   public-finance theory and its application[2]
    •   distributional effects of taxation and government expenditures[3]
    •   analysis of market failure and government failure.[4]
    Emphasis is on analytical and scientific methods and normative-ethical analysis, as distinguished from ideology.
    Examples of topics covered are tax incidence[5], optimal taxation,[6] and the theory of public goods.[7]

    Subject range
    The Journal of Economic Literature (JEL) classification codes are one way categorizing the range of economics
    subjects. There, Public Economics, one of 19 primary classifications, has 8 categories. They are listed below with
    footnote links to their respective subcategories[8] and with JEL-code links to corresponding available article-preview
    links of The New Palgrave Dictionary of Economics Online (2008):
           JEL: H (all) [9] – Public Economics
           JEL: H0 [10] – General
           JEL: H1 [11] – Structure and Scope of Government[12]
           JEL: H2 [13] – Taxation, Subsidies, and Revenue[14]
           JEL: H3 [15] – Fiscal Policies and Behavior of Economic Agents[16]
           JEL: H4 [17] – Publicly Provided Goods[18]
           JEL: H5 [19] – National Government Expenditures and Related Policies[20]
           JEL: H6 [21] – National Budget, Deficit, and Debt[22]
           JEL: H7 [23] – State and Local Government; Intergovernmental Relations[24]
           JEL: H8 [25] – Miscellaneous Issues.[26]

    Public goods
    Public goods, or collective consumption goods, exhibit two properties; non-rivalry and non-excludability. Something
    is non-rivaled if one person's consumption of it does not deprive another person, (to a point) a firework display is
    non-rivaled - since one person watching a firework display does not prevent another person from doing so.
    Something is non-excludable if its use is cannot be limited to a certain group of people. Again, since one cannot
    prevent people from viewing a firework display it is non-excludable.[7]
Public economics                                                                                                                146

    Cost-benefit analysis
    While the origins of cost-benefit analysis can be traced back to Jules Dupuit's classic
    article "On the Measurement of the Utility of Public Works" (1844), much of the
    subsequent scholarly development occurred in the United States and arose from the
    challenges of water-resource development. In 1950, the U.S. Federal Interagency River
    Basin Committee’s Subcommittee on Benefits and Costs published a report entitled,
    Proposed Practices for Economic Analysis of River Basin Projects (also known as the
    Green Book), which became noteworthy for bringing in the language of welfare
    economics.[27] In 1958, Otto Eckstein published Water-Resource Development: The
    Economics of Project Evaluation, and Roland McKean published his Efficiency in
    Government Through Systems Analysis: With Emphasis on Water Resources                         Jules Dupuit (1804-1866).
    Development. The latter book is also considered a classic in the field of operations
    research. In subsequent years, several other important works appeared: Jack Hirshleifer, James DeHaven, and Jerome
    W. Milliman published a volume entitled Water Supply: Economics, Technology, and Policy (1960); and a group of
    Harvard scholars including Robert Dorfman, Stephen Marglin, and others published Design of Water-Resource
    Systems: New Techniques for Relating Economic Objectives, Engineering Analysis, and Governmental Planning


    Diamond-Mirrlees Efficiency Theorem
    In 1971, Peter A. Diamond and James A. Mirrlees published a seminal paper which showed that even when
    lump-sum taxation is not available, production efficiency is still desirable. This finding is known as the
    Diamond-Mirrlees efficiency theorem, and it is widely credited with having modernized Ramsey's analysis by
    considering the problem of income distribution with the problem of raising revenue. Joseph E. Stiglitz and Partha
    Dasgupta (1971) have criticized this theorem as not being robust on the grounds that production efficiency will not
    necessarily be desirable if certain tax instruments cannot be used.

    Pigouvian taxes
    One of the achievements for which the great English economist A.C. Pigou is known,
    was his work on the divergences between marginal private costs and marginal social
    costs (externalities). In his book, The Economics of Welfare (1932), Pigou describes how
    these divergences come about:
 person A, in the course of rendering some service, for which payment
          is made, to a second person B, incidentally also renders services or
          disservices to other persons (not producers of like services), of such a sort
          that payment cannot be extracted from the benefited parties or compensation
          enforced on behalf of the injured parties (Pigou p. 183).
    In particular, Pigou is known for his advocacy of what are known as corrective taxes, or          A.C. Pigou (1877-1959).
    Pigouvian taxes:

          It is plain that divergences between private and social net product of the kinds we have so far been
          considering cannot, like divergences due to tenancy laws, be mitigated by a modification of the
          contractual relation between any two contracting parties, because the divergence arises out of a service
          or disservice to persons other than the contracting parties. It is, however, possible for the State, if it so
Public economics                                                                                                                                        147

           chooses, to remove the divergence in any field by "extraordinary encouragements" or "extraordinary
           restraints" upon investments in that field. The most obvious forms which these encouragements and
           restraints may assume are, of course, those of bounties and taxes (Pigou p. 192).
    Pigou describes as positive externalities, examples such as resources invested in private parks that improve the
    surrounding air, and scientific research from which discoveries of high practical utility often grow. Alternatively, he
    describes negative externalities, such as the factory that destroys a great part of the amenities of neighboring sites.
    In 1960, the economist Ronald H. Coase proposed an alternative scheme whereby negative externalities are dealt
    with through the appropriate assignment of property rights. This result is known as the Coase Theorem.

    Fiscal federalism
    Wallace E. Oates defines the central problem of fiscal federalism as “the determination of the optimal structure of the
    public sector in terms of the assignment of decision-making responsibility for specified functions to representatives
    of the interests of the proper geographical subsets of society (Oates p. 19).”

    [1] • B. Douglas Bernheim and Antonio Rangel, 2008. "behavioural public economics," The New Palgrave Dictionary of Economics, 2nd Edition
        Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_B000331& q="public economics"& topicid=& result_number=1)
           • Dani Rodrik, 1996. "Understanding Economic Policy Reform," Journal of Economic Literature, 34(1), pp. 9–41. (http:/ / relooney. fatcow.
        com/ rodrik. pdf)
    [2] • Richard A. Musgrave, 2008. "public finance," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_P000244& edition=current& q=)
           • _____, 1959. The Theory of Public Finance: A Study in Public Economy. J.M. Buchanan review, 1st page. (http:/ / www. jstor. org/ pss/
    [3] The New Palgrave Dictionary of Economics, 2008, 2nd Edition. Abstract links for:
          • "consumption taxation" (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_C000320& edition=current& q=) by James M.
           • "tax expenditures" (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_T000240& edition=) by Daniel N. Shaviro
           • "taxation and poverty" (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_T000236& edition=current& q=) by John Karl
           • "welfare state" (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_W000053& edition=current& q=) by Assar Lindbeck.
    [4] • Mrinal Datta-Chaudhuri, 1990. "Market Failure and Government Failure." Journal of Economic Perspectives, 4(3) , pp. 25-39 (http:/ /
        netdrive. montclair. edu/ ~lebelp/ DattaChaudMktFailJEP1990. pdf) (press +).
           • Kenneth J. Arrow, 1969. "The Organization of Economic Activity: Issues Pertinent to the Choice of Market versus Non-market
        Allocations," in Analysis and Evaluation of Public Expenditures: The PPP System. Washington, D.C., Joint Economic Committee of
        Congress. PDF reprint as pp. 1-16 (http:/ / www. econ. ucsb. edu/ ~tedb/ Courses/ UCSBpf/ readings/ ArrowNonMktActivity1969. pdf) (press
           • Joseph E. Stiglitz, 2009. "Regulation and Failure," in David Moss and John Cisternino (eds.), New Perspectives on Regulation, ch. 1, pp.
        11-23. (http:/ / www. tobinproject. org/ twobooks/ pdf/ New_Perspectives_Ch1_Stiglitz. pdf) Cambridge: The Tobin Project.
    [5] Gilbert E. Metcalf, 2008. "tax incidence," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_T000019& edition=current& q=)
    [6] Louis Kaplow, 2008. "optimal taxation," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_O000034& edition=current& q=)
    [7] • Agnar Sandmo, 2008."public goods," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_P000245& edition=)
           • Serge-Christophe Kolm, 1987. "public economics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 1047-48.
           • Anthony B. Atkinson and Joseph E. Stiglitz, 1980. Lectures in Public Economics, McGraw-Hill, pp. vii-xi.
           • Mancur Olson, 1971, 2nd ed.The Logic of Collective Action: Public Goods and the Theory of Groups, Harvard University Press,
        Description (http:/ / books. google. com/ books?id=jzTeOLtf7_wC& dq=frontcover& source=bn& hl=en& ei=MEbjSfrNEaHUlQf8lsDgDg&
        sa=X& oi=book_result& ct=result& resnum=4#PPR9,M1) and chapter-previews links, pp. ix (http:/ / books. google. com/
        books?id=jzTeOLtf7_wC& printsec=frontcover& dq=frontcover#PPR9,M1)- x. (http:/ / books. google. com/ books?id=jzTeOLtf7_wC&
        printsec=frontcover& dq=frontcover#PPR10,M1)
    [8] Of which a complete list with Wikipedia links is at JEL classification codes#Public economics JEL: H Subcategories
    [9] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H
    [10] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H0
Public economics                                                                                                                                   148

    [11] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H1
    [12] JEL: H11 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H11) – Structure, Scope,
        and Performance of Government
        JEL: H12 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H12) - Crisis management
    [13] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H2
    [14] JEL: H21 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H21) – Efficiency; Optimal
        JEL: H22 – Incidence
        JEL: H23 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H23) – Externalities;
        Redistributive Effects; Environmental taxes and Subsidies
        JEL: H24 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H24) – Personal Income and
        Other Nonbusiness Taxes and Subsidies
        JEL: H25 – Business Taxes and Subsidies
        JEL: H26 – Tax Evasion
    [15] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H3
    [16] JEL: H31 – Household
        JEL: H32 – Firm
    [17] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H4
    [18] JEL: H40 – General
        JEL: H41 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H41) – Public goods
        JEL: H42 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H42) – Publicly Provided
        Private Goods
        JEL: H43 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H43) – Project Evaluation;
        Social Discount Rate
        JEL: H44 - Publicly Provided Goods: Mixed Markets
    [19] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H5
    [20] JEL: H51 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H51) – Government
        Expenditures and Health
        JEL: H52 – Government Expenditures and Education
        JEL: H53 – Government Expenditures and Welfare Programs
        JEL: H54 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H54) – Infrastructures; Other
        Public Investment and Capital Stock
        JEL: H55 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H55) – Social security and
        Public Pensions
        JEL: H56 – National Security and War
        JEL: H57 – Procurement
    [21] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H6
    [22] JEL: H60 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H60) – General
        JEL: H61 – Budget; Budget Systems
        JEL: H62 – Deficit; Surplus
        JEL: H63 - Debt; Debt Management; Sovereign Debt
        JEL: H68 – Forecasts of Budgets, Deficits, and Debt
        JEL: H69 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H69) – Other
    [23] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H7
    [24] JEL: H71 – State and Local Taxation, Subsidies, and Revenue
        JEL: H72 – State and Local Budget and Expenditures
        JEL: H73 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H73) – Interjurisdictional
        Differentials and Their Effects
        JEL: H74 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H74) – State and Local
        JEL: H75 - State and Local Government: Health; Education; Welfare; Public Pensions
        JEL: H76 - State and Local Government: Other Expenditure Categories
        JEL: H77 - Intergovernmental Relations; Federalism; Secession
    [25] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=H8
    [26] JEL: H80 – General
        JEL: H81 – Governmental Loans, Loan Guarantees, Credits, and Grants; Bailouts
        JEL: H82 – Governmental Property
        JEL: H83 – Public administration; Public Sector Accounting and Audits
        JEL: H84 - Disaster Aid
Public economics                                                                                                                    149

        JEL: H87 – International Fiscal Issues; International Public Goods
    [27] A.R. Prest and R. Turvey, 1965. "Cost-Benefit Analysis: A Survey" The Economic Journal, 75(300) pp. 683-735.
    [28] Introduction to Benefit-Cost Analysis (http:/ / yosemite. epa. gov/ ee/ epa/ eed. nsf/ 2602a2edfc22e38a8525766200639df0/

    • Atkinson, Anthony B., and Joseph E. Stiglitz, 1980. Lectures in Public Economics, McGraw-Hill
    • Auerbach, Alan J., and Martin S. Feldstein, ed. Handbook of Public Economics. Elsevier.
           1985, v. 1. Description (http:/ / www. elsevier. com/ wps/ find/ bookdescription. cws_home/ 601133/
           description#description) and preview. (
           oi=fnd&            pg=PR5&              dq="public+           economics"&           ots=5fzZTNwxQ9&
           1987, v. 2. Description. (
           2002. v. 3. Description. (http:/ / www. elsevier. com/ wps/ find/ bookdescription. cws_home/ 601135/
           2007. v. 4. Description. (http:/ / www. elsevier. com/ wps/ find/ bookdescription. cws_home/ 601136/
    • Barr, Nicholas, 2004. Economics of the Welfare State, 4th ed., Oxford University Press.
    • Buchanan, James M., [1967] 1987. Public Finance in Democratic Process: Fiscal Institutions and Individual
      Choice, UNC Press. Description (, scrollable preview, (http://
      and back cover. (
    • _____ and Musgrave, Richard A., 1999. Public Finance and Public Choice: Two Contrasting Visions of the State.
      MIT Press. Description ( and scrollable
      preview links. (
    • Coase, Ronald. "The Problem of Social Cost" Journal of Law and Economics Vol. 3 (Oct. 1960) 1-44
    • Diamond, Peter A. and James A. Mirrlees. "Optimal Taxation and Public Production I: Production Efficiency"
      The American Economic Review Vol. 61 No. 1 (Mar. 1971) 8-27
    • Diamond, Peter A. and James A. Mirrlees. "Optimal Taxation and Public Production II: Tax Rules" The American
      Economic Review Vol. 61 No. 3 (Jun. 1971) 261-278
    • Drèze Jacques H., 1995. "Forty Years of Public Economics: A Personal Perspective," Journal of Economic
      Perspectives, 9(2), pp. 111-130. (
    • Dupuit, Jules. "On the Measurement of the Utility of Public Works" in Readings in Welfare Economics, ed.
      Kenneth J. Arrow and Tibor Scitovsky (1969)
    • Haveman, Robert 1976. The Economics of the Public Sector.
    • Kolm, Serge-Christophe, 1987. "public economics," The New Palgrave: A Dictionary of Economics, v. 3,
      pp. 1047–55.
    • Feldstein, Martin S., and Robert P. Inman, ed., 1977. The Economics of Public Services. Palgrave Macmillan.
    • Musgrave, Richard A., 1959. The Theory of Public Finance: A Study in Public Economy, McGraw-Hill. 1st-page
      reviews of J.M. Buchanan ( & C.S. Shoup (
    • _____ and Alan T. Peacock, ed., [1958] 1994. Classics in the Theory of Public Finance, Palgrave Macmillan.
      Description ( and contents.
Public economics                                                                                                         150

    • Laffont, Jean-Jacques, 1988. Fundamentals of Public Economics, MIT Press. Description. (
    • Myles, Gareth D., 1995. Public Economics, Cambridge. Description (
      books?id=2jtvmYDrhoQC&source=gbs_navlinks_s) and scroll to chapter-preview links. (
    • Oates, Wallace E., 1972. Fiscal Federalism, Harcourt Brace Jovanovich, Inc.
    • Pigou, A.C. "Divergences Between Marginal Social Net Product and Marginal Private Net Product" in The
      Economics of Welfare, A.C. Pigou (1932) (
      html#Part II, Chapter 9)
    • Ramsey, Frank P. "A Contribution to the Theory of Taxation" in Classics in the Theory of Public Finance, ed.
      R.A. Musgrave and A.T. Peacock (1958)
    • Stigler, George J. and Paul A. Samuelson, 1963. "A Dialogue on the Proper Economic Role of the State." Selected
      Papers, No.7. Chicago: University of Chicago Graduate School of Business.
    • Starrett, David A., 1988. Foundations of Public Economics, Cambridge. Description. (
      books?hl=en&lr=&id=R35yljdyyIkC&oi=fnd&pg=PR11&dq=onepage&q&f=false) Scroll to
      chapter-preview links. (
    • Stiglitz, Joseph E., 1994. 'Rethinking the Economic Role of the State: Publicly Provided Private Goods' (http://
      1994_Rethinking_the_Economic_Role_ofthe_State.pdf) Unpublished.
    • _____, 1998. "The Role of Government in the Contemporary World," in Vito Tanzi and Ke-Young Chu, Income
      Distribution and High-Quality Growth, pp. 211-54. (
    • _____, 2000. Economics of the Public Sector, 3rd ed., Norton.
    • Tinbergen, Jan, 1958. On the Theory of Economic Policy.

    Further reading
    • Arrow, Kenneth J. Social Choice and Individual Values. (1970)
    • Atkinson, Anthony B. "On the Measurement of Inequality" Journal of Economic Theory 2 (1970) 244-263 (http:/
    • Auerbach, Alan J. and Laurence J. Kotlikoff. Dynamic Fiscal Policy. (1987)
    • Boiteux, Marcel. "On the Management of Public Monopolies Subject to Budgetary Constraints" Journal of
      Economic Theory 3 (1971) 219-240
    • Buchanan, James M. and Gordon Tullock. The Calculus of Consent: Logical Foundations of Constitutional
      Democracy. (2010) (
    • Corlett, W.J. and D.C. Hague. "Complementarity and the Excess Burden of Taxation" The Review of Economic
      Studies Vol. 21 No. 1 (1953–1954) 21-30
    • Dalton, Hugh. "The Measurement of Inequality of Incomes" The Economics Journal Vol. 30, No. 119 (Sep. 1920)
    • Edgeworth, F.Y. "The Pure Theory of Taxation" The Economic Journal Vol. 7 No. 25 (Mar. 1897) 46-70 (http:// 07/edgeworth 1897.pdf)
    • Feldstein, Martin. "Social Security, Induced Retirement, and Aggregate Capital Accumulation" The Journal of
      Political Economy Vol. 82 No. 5 (Sep.-Oct. 1974) 905-926
    • Fisher, Irving. "Income in Theory and Income Taxation in Practice" Econometrica Vol. 5 No. 1 (Jan. 1937) 1-55
    • Fisher, Irving. "The Double Taxation of Savings" The American Economic Review Vol. 29 No. 1 (Mar. 1939)
Public economics                                                                                                           151

    • Gini, Corrado. "Variability and Mutability" in Memorie di Metodologica Statistica, ed. E. Pizetti and T. Salvemini
    • Harberger, Arnold. "The Incidence of the Corporation Income Tax" The Journal of Political Economy Vol. 70
      No. 3 (Jun. 1962) 215-240 (
    • Lihndahl, Erik. "Just Taxation: A Positive Solution" in Classics in the Theory of Public Finance, ed. R.A.
      Musgrave and A.T. Peacock (1958) (
    • Lorenz, M.O. "Methods of Measuring the Concentration of Wealth" American Statistical Association Vol. 9 No.
      70 (Jun. 1905) 209-219
    • Musgrave, Richard A. "A Multiple Theory of Budget Determination" (1957) (
    • Niskanen, William A. "The Peculiar Economics of Bureaucracy" The American Economic Review Vol. 58, No. 2
      (May 1968) 293-305 (
    • Niskanen, William A. Bureaucracy and Representative Government. (2007)
    • Orshansky, Mollie. "Children of the Poor" Social Security Bulletin Vol. 26 No. 7 (July 1963)
    • Orshansky, Mollie. "Counting the Poor: Another Look at the Poverty Profile" Social Security Bulletin Vol. 28 No.
      1 (Jan. 1965)
    • Samuelson, Paul. "The Pure Theory of Public Expenditure" Review of Economics and Statistics, XXXVI (1954),
      387-89 ( LS 2011 DISK 2/CITANKA textu/5 Vererejne statky a
      externality/Samuelson 1954 The pure theory of public expenditure.pdf)
    • Tiebout, Charles M. "A Pure Theory of Local Expenditure" The Journal of Political Economy Vol. 64, No. 5
      (Oct. 1956), 416-424 ( finance/media/document/papers/54 A Pure Theory of
      Local Expenditures.pdf)
    • Wicksell, Knut. "A New Principle of Just Taxation" in Classics in the Theory of Public Finance, ed. R.A.
      Musgrave and A.T. Peacock (1958)

    External links
    • Journal of Public Economics (
    • NBER papers in Public Economics (
Health economics                                                                                                               152

    Health economics
    Health economics is a branch of economics concerned with issues related to efficiency, effectiveness, value and
    behavior in the production and consumption of health and health care. In broad terms, health economists study the
    functioning of the health care systems as well as health-affecting behaviors such as smoking.
    A seminal 1963 article by Kenneth Arrow, often credited with giving rise to the health economics as a discipline,
    drew conceptual distinctions between health and other goods.[1] Factors that distinguish health economics from other
    areas include extensive government intervention, intractable uncertainty in several dimensions, asymmetric
    information, barriers to entry, externalities and the presence of a third-party agent.[2] In healthcare, the third-party
    agent is the physician, who makes purchasing decisions (e.g., whether to order a lab test, prescribe a medication,
    perform a surgery, etc.) while being insulated from the price of the product or service.
    Health economists evaluate multiple types of financial information: costs, charges and expenditures.
    Uncertainty is intrinsic to health, both in patient outcomes and financial concerns. The knowledge gap that exists
    between a physician and a patient creates a situation of distinct advantage for the physician, which is called
    asymmetric information.
    Externalities arise frequently when considering health and health care, notably in the context of infectious disease.
    For example, making an effort to avoid catching the common cold affects people other than the decision

    The scope of health economics is neatly encapsulated by Alan Williams' "plumbing diagram"[7] dividing the
    discipline into eight distinct topics:
    •   What influences health? (other than health care)
    •   What is health and what is its value
    •   The demand for health care
    •   The supply of health care
    •   Micro-economic evaluation at treatment level
    •   Market equilibrium
    •   Evaluation at whole system level; and,
    •   Planning, budgeting and monitoring mechanisms.
Health economics                                                                                                              153

    Health care demand
    The demand for health care is a derived demand from the demand for health. Health care is demanded as a means for
    consumers to achieve a larger stock of "health capital." The demand for health is unlike most other goods because
    individuals allocate resources in order to both consume and produce health.
    The above description gives three roles of persons in health economics. The World Health Report (p. 52) states that
    people take four roles in the health care: 1. Contributors 2. Citizens (stewardship) 3. Providers 4. Consumers
    Michael Grossman's 1972 model of health production[8] has been extremely influential in this field of study and has
    several unique elements that make it notable. Grossman's model views each individual as both a producer and a
    consumer of health. Health is treated as a stock which degrades over time in the absence of "investments" in health,
    so that health is viewed as a sort of capital. The model acknowledges that health is both a consumption good that
    yields direct satisfaction and utility, and an investment good, which yields satisfaction to consumers indirectly
    through increased productivity, fewer sick days, and higher wages. Investment in health is costly as consumers must
    trade off time and resources devoted to health, such as exercising at a local gym, against other goals. These factors
    are used to determine the optimal level of health that an individual will demand. The model makes predictions over
    the effects of changes in prices of health care and other goods, labour market outcomes such as employment and
    wages, and technological changes. These predictions and other predictions from models extending Grossman's 1972
    paper form the basis of much of the econometric research conducted by health economists.
    In Grossman's model, the optimal level of investment in health occurs where the marginal cost of health capital is
    equal to the marginal benefit. With the passing of time, health depreciates at some rate δ. The interest rate faced by
    the consumer is denoted by r. The marginal cost of health capital can be found by adding these variables:
                        . The marginal benefit of health capital is the rate of return from this capital in both market and
    non-market sectors. In this model, the optimal health stock can be impacted by factors like age, wages and education.
    As an example, increases with age, so it becomes more and more costly to attain the same level of health capital
    or health stock as one ages. Age also decreases the marginal benefit of health stock. The optimal health stock will
    therefore decrease as one ages.
    Beyond issues of the fundamental, "real" demand for medical care derived from the desire to have good health (and
    thus influenced by the production function for health) is the important distinction between the "marginal benefit" of
    medical care (which is always associated with this "real demand" curve based on derived demand), and a separate
Health economics                                                                                                                 154

    "effective demand" curve, which summarizes the amount of medical care demanded at particular market prices.
    Because most medical care is not purchased from providers directly, but is rather obtained at subsidized prices due to
    insurance, the out-of-pocket prices faced by consumers are typically much lower than the market price. The
    consumer sets MB=MC out of pocket, and so the "effective demand" will have a separate relationship between price
    and quantity than will the "marginal benefit curve" or real demand relationship. This distinction is often described
    under the rubric of "ex-post moral hazard" (which is again distinct from ex-ante moral hazard, which is found in any
    type of market with insurance).

    Economic Evaluation in Germany and in the United Kingdom
    A large focus of health economics, is the microeconomic evaluation of the value of individual treatments. The states
    in Europe appraise certain new and existing pharmaceuticals and devices using economic evaluations by health
    technology assesments by different national institutions. In Europe's largest health market Germany the Institute for
    Quality and Economy in Health Services (Institut für Qualität und Wirtschaftlichkeit im Gesundheitswesen —
    IQWiG) is responsible,[9] while it is the National Institute for Health and Clinical Excellence NICE in the United
    Economic evaluation is the comparison of two or more alternative courses of action in terms of both their costs and
    consequences (Drummond et al.). Economists usually distinguish several types of economic evaluation, differing in
    how consequences are measured:
    •   Cost-minimization analysis
    •   Cost benefit analysis
    •   Cost-effectiveness analysis
    •   Cost-utility analysis
    In cost minimization analysis (CMA), the effectiveness of the comparators in question must be proven to be
    equivalent. The 'cost-effective' comparator is simply the one which costs less (as it achieves the same outcome). In
    cost-benefit analysis (CBA), costs and benefits are both valued in cash terms. Cost effectiveness analysis (CEA)
    measures outcomes in 'natural units', such as mmHg, symptom free days, life years gained. Finally cost-utility
    analysis (CUA) measures outcomes in a composite metric of both length and quality of life, the Quality-adjusted life
    year (QALY). (Note there is some international variation in the precise definitions of each type of analysis).
    A final approach which is sometimes classed an economic evaluation is a cost of illness study. This is not a true
    economic evaluation as it does not compare the costs and outcomes of alternative courses of action. Instead, it
    attempts to measure all the costs associated with a particular disease or condition. These will include direct costs
    (where money actually changes hands, e.g. health service use, patient co-payments and out of pocket expenses),
    indirect costs (the value of lost productivity from time off work due to illness), and intangible costs (the 'disvalue' to
    an individual of pain and suffering). (Note specific definitions in health economics may vary slightly from other
    branches of economics.)
Health economics                                                                                                              155

    Market equilibrium

    Health care markets
    The five health markets typically analyzed are:
    •   Health care financing market
    •   Physician and nurses services market
    •   Institutional services market
    •   Input factors market
    •   Professional education market
    Although assumptions of textbook models of economic markets apply reasonably well to health care markets, there
    are important deviations. Many states have created risk pools in which relatively healthy enrollees subsidise the care
    of the rest. Insurers must cope with adverse selection which occurs when they are unable to fully predict the medical
    expenses of enrollees; adverse selection can destroy the risk pool. Features of insurance market risk pools, such as
    group purchases, preferential selection ("cherry-picking"), and preexisting condition exclusions are meant to cope
    with adverse selection.
    Insured patients are naturally less concerned about health care costs than they would if they paid the full price of
    care. The resulting moral hazard drives up costs, as shown by the famous RAND Health Insurance Experiment.
    Insurers use several techniques to limit the costs of moral hazard, including imposing copayments on patients and
    limiting physician incentives to provide costly care. Insurers often compete by their choice of service offerings, cost
    sharing requirements, and limitations on physicians.
    Consumers in health care markets often suffer from a lack of adequate information about what services they need to
    buy and which providers offer the best value proposition. Health economists have documented a problem with
    supplier induced demand, whereby providers base treatment recommendations on economic, rather than medical
    criteria. Researchers have also documented substantial "practice variations", whereby the treatment aols on service
    availability to rein in inducement and practice variations.
    The U.S. health care market has relied extensively on competition to control costs and improve quality. Critics
    question whether problems with adverse selection, moral hazard, information asymmetries, demand inducement, and
    practice variations can be addressed by private markets. Competition has fostered reductions in prices, but
    consolidation by providers and, to a lesser extent, insurers, has tempered this effect.
    Though the market for health care in the U.S. is primarily coordinated by competition, there is an abundance of
    regulations that inhibit market efficiency. A classic example is medical licenses. Some economists argue that
    requiring doctors to have a medical license constrains inputs, inhibits innovation, and increases cost to consumers
    while largely only benefiting the doctors themselves.[10]

    Competitive equilibrium in the five health markets
    While the nature of health care as a private good is preserved in the last three markets, market failures occur in the
    financing and delivery markets due to two reasons: (1) Perfect information about price products is not a viable
    assumption (2) Various barriers of entry exist in the financing markets (i.e. monopoly formations in the insurance

    Ideological bias in the debate about the financing and delivery health markets
    The health care debate in public policy is often informed by ideology and not sound economic theory. Often,
    politicians subscribe to a moral order system or belief about the role of governments in public life that guides biases
    towards provision of health care as well. The ideological spectrum spans: individual savings accounts and
    catastrophic coverage, tax credit or voucher programs combined with group purchasing arrangements, and
Health economics                                                                                                               156

    expansions of public-sector health insurance. These approaches are advocated by health care conservatives,
    moderates and liberals, respectively.

    Other issues

    Medical economics
    Often used synonymously with Health Economics, Medical economics, according to Culyer,[11] is the branch of
    economics concerned with the application of economic theory to phenomena and problems associated typically with
    the second and third health market outlined above. Typically, however, it pertains to cost-benefit analysis of
    pharmaceutical products and cost-effectiveness of various medical treatments. Medical economics often uses
    mathematical models to synthesise data from biostatistics and epidemiology for support of medical decision making,
    both for individuals and for wider health policy.

    Behavioral economics
    Peter Orszag has suggested that behavioral economics is an important factor for improving the health care system,
    but that relatively little progress has been made when compared to retirement policy.[12]

    Mental Health Economics
    Mental health economics incorporates a vast array of subject matters, ranging from pharmacoeconomics to labor and
    welfare economics. Mental health can be directly related to economics by the potential of affected individuals to
    contribute as human capital. In 2009 Currie and Stabile published "Mental Health in Childhood and Human Capital"
    in which they assessed how common childhood mental health problems may alter the human capital accumulation of
    affected children.[13] Externalities may include the influence that affected individuals have on surrounding human
    capital, such as at the workplace or in the home.[14] In turn, the economy also affects the individual, particularly in
    light of globalization. For example, studies in India, where there is an increasingly high occurrence of western
    outsourcing, have demonstrated a growing hybrid identity in young professionals who face very different
    sociocultural expectations at the workplace and in at home.[15]
    Mental health economics presents a unique set of challenges to researchers. In health economics, the health status of
    an individual may be given a value such as HYE (Health Year Equivalents); however, in mental health economics,
    valuations may not be the same for affected individuals. For instance a suicidal individual may place higher utility on
    death than life. Additionally, individuals with cognitive disabilities may not be able to communicate preferences.
    These factors represent challenges in terms of placing value on the mental health status of an individual, especially in
    relation to the individual's potential as human capital. Further, employment statistics are often used in mental health
    economic studies as a means of evaluating individual productivity; however, these statistics do not capture
    "presenteeism", when an individual is at work with a lowered productivity level, quantify the loss of non-paid
    working time, or capture externalities such as having an affected family member. Also, considering the variation in
    global wage rates or in societal values, statistics used may be contextually, geographically confined, and study
    results may not be internationally applicable.[14]
    Though studies have demonstrated mental health care to reduce overall health care costs, demonstrate efficacy, and
    reduce employee absenteeism while improving employee functioning, the availability of comprehensive mental
    health services is in decline. Petrasek and Rapin (2002) cite the three main reasons for this decline as (1) stigma and
    privacy concerns, (2) the difficulty of quantifying medical savings and (3) physician incentive to medicate without
    specialist referral.[16] Evers et al. (2009) have suggested that improvements could be made by promoting more active
    dissemination of mental health economic analysis, building partnerships through policy-makers and researchers, and
    employing greater use of knowledge brokers.[14]
Health economics                                                                                                                                     157

    [1] Arrow 1963
    [2] Phelps, Charles E. (2003), Health Economics (3rd ed.), Boston: Addison Wesley, ISBN 0-321-06898-X Description (http:/ / www. lavoisier.
        fr/ notice/ frLWOS6SXAORW32O. html) and 2nd ed. preview (http:/ / books. google. com/ books?hl=en& lr=& id=JajjFgTXwP8C&
        oi=fnd& pg=PT18& dq=onepage& q=& f=false).
    [3] Fuchs, Victor R. (1987). "health economics" The New Palgrave: A Dictionary of Economics, v. 2, pp. 614–19.
    [4] Fuchs, Victor R. (1996). “Economics, Values, and Health Care Reform,” American Economic Review, 86(1), pp. 1-24 (http:/ / jay-pcor.
        stanford. edu/ Readings/ Lecture01/ fuchs_health_survey. pdf) (press +).
    [5] Fuchs, Victor R. ([1974] 1998). Who Shall Live? Health, Economics, and Social Choice, Expanded edition. Chapter-preview links (http:/ /
        books. google. com/ books?hl=en& lr=& id=hDoIlCu7wKgC& oi=fnd& pg=PR11& dq="health+ economics"+ fuchs& ots=Vax-lRjOOZ&
        sig=WbHxq1kxPjPcD6M8J2f0Q6nPnhw#v=onepage& q=& f=false), pp. vii-xi.
    [6] Wolfe, Barbara (2008). "health economics." The New Palgrave Dictionary of Economics', 2nd Edition. Abstract & TOC. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_H000031& q=health & topicid=& result_number=1)
    [7] Williams, A. (1987), "Health economics: the cheerful face of a dismal science", in Williams, A., Health and Economics, London: Macmillan
    [8] Grossman, Michael (1972), "On the Concept of Health Capital and the Demand for Health", Journal of Political Economy 80 (2): 223–255,
    [9] Institut für Qualität und Wirtschaftlichkeit im Gesundheitswesen → https:/ / de. wikipedia. org/ wiki/ IQWiG
    [10] Svorny, Shirley (2004), "Licensing Doctors: Do Economists Agree?" (http:/ / www. aier. org/ ejw/ archive/ complete-issues/ doc_view/
        3685-ejw-200408?tmpl=component& format=raw), Econ Journal Watch 1 (2): 279–305,
    [11] A.J. Culyer (1989) "A Glossary of the more common terms encountered in health economics" in MS Hersh-Cochran and KP Cochran (Eds.)
        Compendium of English Language Course Syllabi and Textbooks in Health Economics, Copenhagen, WHO, 215-234
    [12] Peter Orszag, "Behavioral Economics: Lessons from Retirement Research for Health Care and Beyond," (http:/ / www. cbo. gov/ ftpdocs/
        96xx/ doc9673/ 08-07-Presentation_RRC. pdf) Presentation to the Retirement Research Consortium, August 7, 2008
    [13] Currie, Janet and Mark Stabile. "Mental Health in Childhood and Human Capital". The Problems of Disadvantaged Youth: An Economic
        Perspective ed. J. Gruber. Chicago: University of Chicago Press, 2009.
    [14] Evers, S.; Salvador-Curulla, L.; Halsteinli, V.; McDavid, D.; MHEEN Group (April 2007), "Implementing mental health economic
        evaluation evidence: Building a Bridge between theory and practice" (http:/ / informahealthcare. com/ doi/ abs/ 10. 1080/
        09638230701279881), Journal of Mental Health 16 (2): 223–241, doi:10.1080/09638230701279881,
    [15] Bhavsar, V.; Bhugra, D. (December 2008), "Globalization: Mental health and social economic factors" (http:/ / gsp. sagepub. com/ content/
        8/ 3/ 378. short), Global Social Policy 8 (3): 378–396, doi:10.1177/1468018108095634,
    [16] Petrasek M, Rapin L (2002), "The mental health paradox", Benefits Q 18 (2): 73–7, PMID 12004583

    Further reading
    • Alastair M. Gray, Philip M. Clarke, Jane Wolstenholme, Sarah Wordsworth (2010) Applied Methods of
      Cost-effectiveness Analysis in Healthcare, Oxford University Press. Preview (
      Cost-effectiveness-Analysis-Healthcare-Handbooks-Evaluation/dp/0199227284) ISBN 0-19-922728-4
    • Arrow, K. (December 1963), "Uncertainty and the welfare economics of medical care" (
      ellisrp/EC387/Papers/1963Arrow_AER.pdf) (PDF), American Economic Review 53 (5): 941–973
    • Drummond, Michael F. (2005) Methods for the Economic Evaluation of Health Care Programmes, Oxford
      University Press. Preview. (
      pg=PA1&dq=Drummond+2005+&ots=oqnoQH2WTB&sig=lddhhWvJ1zexoWNOffMvilmWF1c) ISBN
    • Fuchs, Victor R. (1998) Who Shall Live? Health, Economics, and Social Choice, Wspc.
    • Mahar, Maggie, Money-Driven Medicine: The Real Reason Health Care Costs So Much (
      com/books?id=pOfrTRPgv_kC&printsec=frontcover), Harper/Collins, 2006. ISBN 978-0-06-076533-0
    • Starr, Paul, The Social Transformation of American Medicine, Basic Books, 1982. ISBN 0-465-07934-2
    • Wennberg J, Gittelsohn (December 1973), "Small area variations in health care delivery" (http://www., Science 182 (4117): 1102–8, PMID 4750608
    • Whittington, Ruth (2008). Introduction to Health Economics: A Beginners Guide (
      dp/0954549457) Preview. (
      dq=ruth+whittington&lr=&ei=p6mSSaGaKZX8ygTvyb30CQ#PPP1,M1) ISBN 978-0-9545494-5-9.
Health economics                                                                                                     158

    • Wise, David A. (2009). Developments in the Economics of Aging. University of Chicago Press.
      ISBN 978-0-226-90335-4.
    • A.J. Culyer and J.P. Newhouse, ed. (2000). Handbook of Health Economics, Elsevier. 1A. Description. (http:// Elsevier.
    • _____ (2000). Handbook of Health Economics, 1B. Description. ( Elsevier.

    • Health Economics. Aims & scope (
      ProductInformation.html) and links ( back-issue titles
      and abstracts.
    • Journal of Health Economics Aims & scope (
      505560/description) and links ( to back-issue titles
      and abstracts.
    • Review of Economics of the Household

    External links
    • International Health Economics Association (
    • Colombian Health Economics Association (
    • Health Economics education (HEe) ( — UK-based site for
      teachers of Health Economics
    • International Society for Pharmacoeconomics and Outcomes Research (
    • ISPOR-CO, Colombian Chapter of The International Society for Pharmacoeconomics and Outcomes Research
    • Paying More, Getting Less ( from Dollars
      & Sense magazine
    • Health Economics Network (; a research network from the Social Science
      Research Network
    • What is Health Economics?: Definition (
    • Masters in Health Economics and Decision Modelling (
      prospective_students/masters/hedm) University of Sheffield UK
    • Health Economics Online Glossary of Terms ( — maintained by the University
      of Groningen, The Netherlands
    • Small Businesses for Health Care Reform (
    • HealthEconomics.Com (
    • (
Education economics                                                                                                          159

    Education economics
    Education economics or the economics of education is the study of economic issues relating to education,
    including the demand for education and the financing and provision of education. From early works on the
    relationship between schooling and labor market outcomes for individuals, the field of the economics of education
    has grown rapidly to cover virtually all areas with linkages to education.

    Demand for education

    Liberal approaches
    The dominant model of the demand for education is based on human capital theory. The central idea is that
    undertaking education is investment in the acquisition of skills and knowledge which will increase earnings, or
    provide long-term benefits such as an appreciation of literature (sometimes referred to as cultural capital).[1] An
    increase in human capital can follow technological progress as knowledgeable employees are in demand due to the
    need for their skills, whether it be in understanding the production process or in operating machines. Studies from
    1958 attempted to calculate the returns from additional schooling (the percent increase in income acquired through
    an additional year of schooling). Later results attempted to allow for different returns across persons or by level of
    Statistics have shown that countries with high enrollment/graduation rates have grown faster than countries without.
    The United States has been the world leader in educational advances, beginning with the high school movement
    (1910–1950). There also seems to be a correlation between gender differences in education with the level of growth;
    more development is observed in countries which have an equal distribution of the percentage of women versus men
    who graduated from high school. When looking at correlations in the data, education seems to generate economic
    growth; however, it could be that we have this causality relationship backwards. For example, if education is seen as
    a luxury good, it may be that richer households are seeking out educational attainment as a symbol of status, rather
    than the relationship of education leading to wealth.
    Educational advance is not the only variable for economic growth, though, as it only explains about 14% of the
    average annual increase in labor productivity over the period 1915-2005. From lack of a more significant correlation
    between formal educational achievement and productivity growth, some economists see reason to believe that in
    today’s world many skills and capabilities come by way of learning outside of tradition education, or outside of
    schooling altogether.[3]
    An alternative model of the demand for education, commonly referred to as screening, is based on the economic
    theory of signalling. The central idea is that the successful completion of education is a signal of ability.[4]

    Marxist critique
    Although Marx and Engels did not write widely about education the social functions of education, their concepts and
    methods are theorized and criticized by the infuence of Marx as education being used in reproduction of capitalist
    societies. Marx and Engels approached scholarship as "revolutionary scholarship" where education should serve as a
    propaganda for the struggle of the working class.[5] The classical Marxian paradigm sees education as serving the
    interest of capital and is seeking alternative modes of education that would prepare students and citizens for more
    progressive socialist mode of social organizations. Marx and Engels understood education and free time as essential
    to developing free individuals and creating many-sided human beings, thus for them education should become a
    more essential part of the life of people unlike capitalist society which is organized mainly around work and the
    production of commodities.[5]
Education economics                                                                                                                                  160

    Financing and provision
    In most countries school education is predominantly financed and provided by governments. Public funding and
    provision also plays a major role in higher education. Although there is wide agreement on the principle that
    education, at least at school level, should be financed mainly by governments, there is considerable debate over the
    desirable extent of public provision of education. Supporters of public education argue that universal public
    provision promotes equality of opportunity and social cohesion. Opponents of public provision advocate alternatives
    such as vouchers.[6][7][8]

    Education production function
    An education production function is an application of the economic concept of a production function to the field of
    education. It relates various inputs affecting a student’s learning (schools, families, peers, neighborhoods, etc.) to
    measured outputs including subsequent labor market success, college attendance, graduation rates, and, most
    frequently, standardized test scores. The original study that eventually prompted interest in the idea of education
    production functions was by a sociologist, James S. Coleman. The Coleman Report, published in 1966, concluded
    that the marginal effect of various school inputs on student achievement was small compared to the impact of
    families and friends.[9] Later work, by Eric A. Hanushek, Richard Murnane, and other economists introduced the
    structure of "production" to the consideration of student learning outcomes.
    A large number of successive studies, increasingly involving economists, produced inconsistent results about the
    impact of school resources on student performance, leading to considerable controversy in policy discussions.[10][11]
    The interpretation of the various studies has been very controversial, in part because the findings have directly
    influenced policy debates. Two separate lines of study have been particularly widely debated. The overall question
    of whether added funds to schools are likely to produce higher achievement (the “money doesn’t matter” debate) has
    entered into legislative debates and court consideration of school finance systems.[12][13][14] Additionally, policy
    discussions about class size reduction heightened academic study of the relationship of class size and

    [1] Daniele Checchi, 2006. The Economics of Education: NYUMBANI Human Capital, Family Background and Inequality, Cambridge. ISBN
        0-521-79310-6 ISBN 978-0-521-79310-0 Description. (http:/ / www. cambridge. org/ catalogue/ catalogue. asp?isbn=9780521793100)
    [2] David Card "returns to schooling," The New Palgrave Dictionary of Economics , 2nd Edition. Abstract. (http:/ / www. dictionaryofeconomics.
        com/ article?id=pde2008_R000240)
    [3] Kling, Arnold and John Merrifield. 2009." Goldin and Katz and Education Policy Failings in Historical Perspective". Econ Journal Watch
        6(1): 2-20. (http:/ / econjwatch. org/ articles/ goldin-and-katz-and-education-policy-failings-in-historical-perspective)
    [4] Johannes Hörner, 2008. "signalling and screening." The New Palgrave Dictionary of Economics, 2nd Edition, Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_S000129)
    [5] Douglas Kellner, Marxian Perspectives on Educational Philosophy: From Classical Marxism to Critical Pedagogy (http:/ / gseis. ucla. edu/
        faculty/ kellner/ essays/ marxianperspectivesoneducation. pdf)
    [6] William A. Fischel, 2008. "educational finance," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_E000237& q=education finance& topicid=& result_number=3)
    [7] Caroline Hoxby, 2008. "school choice and competition," The New Palgrave Dictionary of Economics, 2nd Edition, Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_V000064)
    [8] Daniele Checchi, 2006. The Economics of Education: Human Capital, Family Background and Inequality, ch. 5, "Education Financing."
    [9] Coleman, James S., Ernest Q. Campbell, Carol J. Hobson, James McPartland, Alexander M. Mood, Frederic D. Weinfeld, and Robert L.
        York. 1966. Equality of Educational Opportunity. Washington, D.C.: U.S. Government Printing Office.
    [10] Eric A. Hanushek, 2008. "education production functions," The New Palgrave Dictionary of Economics , 2nd Edition. Abstract. (http:/ /
        www. dictionaryofeconomics. com/ article?id=pde2008_E000238)
    [11] Eric A. Hanushek 1986. "The Economics of Schooling: Production and Efficiency in Public Schools." Journal of Economic Literature
        24,no.3 (September), p p.1141- (http:/ / www. jstor. org/ stable/ 2725865) 1177.
    [12] Gary Burtless, ed., 1996. Does Money Matter? The Effect of School Resources on Student Achievement and Adult Success. Washington,
        D.C.: The Brookings Institution. Description (http:/ / books. google. com/ books?id=N3UIwF9P1WUC& dq=Burtless,+ Gary,+ ed. + 1996. +
Education economics                                                                                                                                 161

        "Does+ Money+ Matter?"& lr=& source=gbs_navlinks_s) and scroll to chapter preview links. (http:/ / books. google. com/
        books?id=N3UIwF9P1WUC& printsec=frontcover& source=gbs_v2_summary_r& cad=0#v=onepage& q& f=false)
    [13] Greenwald, Rob, Larry V. Hedges, and Richard D. Laine. 1996. "The Effect of School Resources on Student Achievement." Review of
        Educational Research, 66(3), pp. 361-396.
    [14] Eric A. Hanushek, 1996. "A More Complete Picture of School Resource Policies." Review of Educational Research, 66(3), p p. 397 (http:/ /
        www. jstor. org/ pss/ 1170529)-409.
    [15] Lawrence Mishel, and Richard Rothstein, eds., 2002. The Class Size Debate. Link. (http:/ / edpro. stanford. edu/ hanushek/ admin/ pages/
        files/ uploads/ classsizedebate. full volume. pdf) Washington, DC: Economic Policy Institute.
    [16] Ehrenberg, Ronald G., Dominic J. Brewer, Adam Gamoran, and J. Douglas Willms, 2001. "Class size and student achievement,"
        Psychological Science in the Public Interest, 2(1), pp. 1-30.

    • Roland Bénabou, 1996."Heterogeneity, Stratification, and Growth: Macroeconomic Implications of Community
      Structure and School Finance," American Economic Review,86(3) p p. 584- (
      2118213) 609.
    • Mark Blaug, 1985. "Where Are We Now in the Economics of Education?" Economics of Education Review, 4(1),
      pp. 17–28. Abstract. (
    • Clive R. Belfield, ed., 2006.Modern Classics In The Economics Of Education, Elgar. Description. (http://www.
    • Eric A. Hanushek, 1986. "The economics of schooling: Production and efficiency in public schools." Journal of
      Economic Literature 24, no. 3 (September): 1141-1177.
    • Eric A. Hanushek, 1992. "The Trade-off between Child Quantity and Quality," Journal of Political Economy,
      100(1), p p. 84 (
    • Stephen A. Hoenack, 1996. "The Economics of Education in Developing Countries: An Assessment of the State
      of the Art," Economics of Education Review, 15(4), pp. 327–338. Abstract. (
    • Caroline M. Hoxby, 1999. "The Productivity of Schools and Other Local Public Goods Producers," Journal of
      Public Economics, 74(1), pp. 1–30 Abstract. (
    • _____, 2000. "Does Competition among Public Schools Benefit Students and Taxpayers?" American Economic
      Review, 90(5), p p. 1209- ( 1238.
    • Geraint Johnes and Jill Johnes, ed., 2004. International Handbook on the Economics of Education, Elgar. Chapter
      titles. (
    • George Psacharopoulos and Harry A. Patrinos, 2004. "Returns to Investment in Education: A Further Update,"
      Education Economics, 12(2), pp. 111–134. Abstract. (
    • Steven G. Rivkin, Eric A. Hanushek, and John F. Kain, 2005. "Teachers, Schools, and Academic Achievement,"
      Econometrica, 73(2), pp. 417–458. Abstract. (
    • Sherwin Rosen, 1987. "human capital," The New Palgrave: A Dictionary of Economics, v. 2, pp. 681–90.
    Selected entries on education from The New Palgrave Dictionary of Economics, 2008), 2nd Edition:
    • "education in developing countries" by Paul Glewwe. Abstract. (
Education economics                                                                                                           162

    • "human capital, fertility and growth" by Oded Galor. Abstract. (
    • "intergenerational transmission" by Lance Lochner. Abstract. (
      article?id=pde2008_F000317&q=intergenerational transmission&topicid=&result_number=1)
    • "local public finance" by John M. Quigley. Abstract. (
    • "population health, economic implications of" by David Canning and David E. Bloom. Abstract. (http://www.

    External links
    • Economics of Education Review Description (
      cws_home/743/description#description) & links (
      to article titles.
    • Education Economics Aims & Scope ( & links (http:// to article titles.
    • World Bank, "Economics of Education" (

    Welfare is the provision of a minimal level of well-being and social support for all citizens, sometimes referred to as
    public aid. In most developed countries, welfare is largely provided by the government, in addition to charities,
    informal social groups, religious groups, and inter-governmental organizations.

    Welfare can take a variety of forms, such as monetary payments, subsidies and vouchers (i.e. food stamps, or
    housing programs such as Section 8). Welfare can be provided by governments, non-governmental organizations
    such as Catholic Charities, or a combination of the two. Welfare programs may be funded directly by governments,
    or in social insurance models, by the members of the Welfare scheme.
    Welfare systems differ from country to country, but Welfare is commonly provided to individuals who are
    unemployed, those with illness or disability, the elderly, those with dependent children, and veterans. A person's
    eligibility for Welfare may also be constrained by means testing or other conditions.
    Subsidy Subsidizing a good is one way of redistributing the good to the poor. It is money that is paid usually by a
    government to keep the price of a product or service low or to help a business or organization to continue to
    function. In a budget constraint between ‘all other goods’ and a ‘subsidized good’, the maximum amount of ‘all other
    goods will remain the same but the budget constraint will shift outward for the ‘subsidized good' can lead to an over
    consumption of the good.
    Voucher A voucher is like a subsidy that can only be consumed in a specific way like a school voucher or section 8
    housing. For instance, families who receive school vouchers may only use them to send their children to schools to
    help pay tuition costs. Schools then exchange the voucher for cash. Similarly, in section 8 housing, families with this
    voucher can only use the voucher to pay a portion of their living costs in specified units or in a private sector. In a
    budget constraint between ‘all other goods’ and a ‘voucher good’ our budget constraint will shift out parallel to an
    amount equal to the amount of the voucher but the money we have to spend on ‘all other goods’ remains capped at
    the same amount we had to spend before the voucher. Voucher programs can make us worse off because of the cap
Welfare                                                                                                                       163

    on our ability to spend on ‘all other goods’ our indifference curves could limit us.
    Direct Cash This is straight cash with no restrictions on how it can be consumed. Direct cash may cause greater
    budget constraint because the recipient can spend the cash subsidy on all ‘other goods’ or on a ‘subsidized good’.
    Direct cash increases the entire budget constraint and shifts the indifference curves outward allowing us to maximize
    individual utility.

    Provision and funding
    Welfare may be provided directly by governments or their agencies, by private organizations, or by a combination.
    Welfare may be funded by governments out of general revenue, typically by way of redistributive taxation. Social
    insurance-type Welfare schemes are funded on a contributory basis by the members of the scheme. Contributions
    may be pooled to fund the scheme as a whole, or reserved for the benefit of a particular member. Participation in
    such schemes is either compulsory, or the program is subsidized heavily enough that most eligible individuals
    choose to participate.
    Examples of social insurance programs include the Social Security and Medicare programs in the United States.[1]

    In the Roman Empire, the first emperor Augustus provided the 'congiaria' or corn dole for citizens who could not
    afford to buy food. Social welfare was enlarged by the Emperor Trajan.[2] Trajan's program brought acclaim from
    many, including Pliny the Younger.[3]
    In Jewish tradition, charity (represented by tzedakah) is a matter of religious obligation rather than benevolence.
    Contemporary charity is regarded as a continuation of the Biblical Maaser Ani, or poor-tithe, as well as Biblical
    practices, such as permitting the poor to glean the corners of a field and harvest during the Shmita (Sabbatical year).
    Voluntary charity, along with prayer and repentance, is believed to ameliorate the consequences of bad acts.
    The Song dynasty (c.1000AD) government supported multiple forms
    of social Welfare programs, including the establishment of retirement
    homes, public clinics, and pauper's graveyards. [4]
    According to Robert Henry Nelson, "The medieval Roman Catholic
    Church operated a far-reaching and comprehensive Welfare system for
    the poor..."[5][6]
    In the Islamic world, Zakat (charity), one of the Five Pillars of Islam,
    has been collected by the government since the time of the Rashidun
    caliph Umar in the 7th century. The taxes were used to provide income        Distributing alms to the poor, abbey of
    for the needy, including the poor, elderly, orphans, widows, and the            Port-Royal des Champs c. 1710

    disabled. According to the Islamic jurist Al-Ghazali (Algazel,
    1058–1111), the government was also expected to store up food supplies in every region in case a disaster or famine
    occurred.[7][8] (See Bayt al-mal for further information.)

    There is relatively little statistical data on Welfare transfer payments before the High Middle Ages. In the medieval
    period and until the Industrial Revolution, the function of Welfare payments in Europe was principally achieved
    through private giving or charity. In those early times, there was a much broader group considered to be in poverty
    as compared to the 21st century.
    Early Welfare programs in Europe included the English Poor Law of 1601, which gave parishes the responsibility
    for providing Welfare payments to the poor.[9] This system was substantially modified by the 19th-century Poor Law
    Amendment Act, which introduced the system of workhouses.
Welfare                                                                                                                        164

    It was predominantly in the late 19th and early 20th centuries that an organized system of state Welfare provision
    was introduced in many countries. Otto von Bismarck, Chancellor of Germany, introduced one of the first Welfare
    systems for the working classes. In Great Britain the Liberal government of Henry Campbell-Bannerman and David
    Lloyd George introduced the National Insurance system in 1911,[10] a system later expanded by Clement Attlee. The
    United States did not have an organized Welfare system until the Great Depression, when emergency relief measures
    were introduced under President Franklin D. Roosevelt. Even then, Roosevelt's New Deal focused predominantly on
    a program of providing work and stimulating the economy through public spending on projects, rather than on cash

    Welfare systems

    Solidarity is a strong value of the French Social Protection system. The first article of the French Code of Social
    Security describes the principle of solidarity. Solidarity is commonly comprehended in relations of similar work,
    shared responsibility and common risks. Existing solidarities in France caused the expansion of health and social

    The Welfare state has a long tradition in Germany dating back to the industrial revolution. Due to the pressure of the
    workers' movement in the late 19th century, Reichskanzler Otto von Bismarck introduced the first rudimentary state
    social insurance scheme. Today, the social protection of all its citizens is considered a central pillar of German
    national policy. 27.6 percent of Germany's GDP is channeled into an all-embracing system of health, pension,
    accident, longterm care and unemployment insurance, compared to 16.2 percent in the US. In addition, there are
    tax-financed services such as child benefits (Kindergeld, beginning at €184 per month for the first and second
    children, €190 for the third and €215 for each child thereafter, until they attain 25 years or receive their first
    professional qualification),[11] and basic provisions for those unable to work or anyone with an income below the
    poverty line.[12]
    Since 2005, reception of full unemployment pay (60-67% of the previous net salary) has been restricted to 12 months
    in general and 18 months for those over 55. This is now followed by (usually much lower) Arbeitslosengeld II (ALG
    II) or Sozialhilfe, which is independent of previous employment (Hartz IV concept).
    Under ALG II, a single person receives €382 per month plus the cost of 'adequate' housing and health insurance.
    ALG II can also be paid partially to supplement a low work income.

    Canada has a Welfare state in the European tradition; however, it is not referred to as "Welfare", but rather as "social
    programs". In Canada, "Welfare" usually refers specifically to direct payments to poor individuals (as in the
    American usage) and not to healthcare and education spending (as in the European usage).[13]
    The Canadian social safety net covers a broad spectrum of programs, and because Canada is a federation, many are
    run by the provinces. Canada has a wide range of government transfer payments to individuals, which totaled $145
    billion in 2006.[14] Only social programs that direct funds to individuals are included in that cost; programs such as
    medicare and public education are additional costs.
    Generally speaking, before the Great Depression, most social services were provided by religious charities and other
    private groups. Changing government policy between the 1930s and 1960s saw the emergence of a Welfare state,
    similar to many Western European countries. Most programs from that era are still in use, although many were
    scaled back during the 1990s as government priorities shifted towards reducing debt and deficits.
Welfare                                                                                                                              165

    United States
    In the United States, “welfare” is most often used to refer to
    means-tested cash benefits, especially the Aid to Families with
    Dependent Children (AFDC) program and its successor, the
    Temporary Assistance for Needy Families Block Grant. Sometimes,
    especially by critics of government social spending, it is used to refer
    to all means tested programs, including for example, healthcare
    through Medicaid and food and nutrition programs (SNAP).[15]

    AFDC (originally called Aid to Dependent Children) ADC was created
    during the Great Depression to alleviate the burden of poverty of
    families with children and allow widowed mothers to maintain their       President Roosevelt signs the Social Security Act,
                                                                                            August 14, 1935
    households. (New Deal employment program such as the Progress
    Administration [16] primarily served men.) Prior to the New Deal,
    anti-poverty programs were primarily operated by private charities or state or local governments; however, these
    programs were overwhelmed by the depth of need during the Depression.[17] The United States has no national
    program of cash assistance for non-disabled poor individuals who are not raising children. The exception to this is
    permanent alimony, which is still administered in a handful of states including New Jersey, Florida and Oregon.
    Alimony Reform movements in these states are attempting to end this form of private welfare.http:/ / money.

    In 1996, the Personal Responsibility and Work
    Opportunity Reconciliation Act changed the structure
    of Welfare payments and added new criteria to states
    that received Welfare funding. After reforms, which
    President Clinton said would "end Welfare as we know
    it",[19] amounts from the federal government were
    given out in a flat rate per state based on population.[20]
    Each state must meet certain criteria to ensure
    recipients are being encouraged to work themselves out      Overall decline in monthly welfare benefits (in 2006 dollars)
    of Welfare. The new program is called Temporary
    Assistance for Needy Families (TANF).[21][22] It encourages states to require some sort of employment search in
    exchange for providing funds to individuals, and imposes a five-year lifetime limit on cash assistance.[19][21][23] In
    FY 2010, 31.8% of TANF families were white, 31.9% were African-American, and 30.0% were Hispanic.[22]

    In a 2011 op-ed in Forbes, Peter Ferrara stated that, "The best estimate of the cost of the 185 federal means tested
    Welfare programs for 2010 for the federal government alone is nearly $700 billion, up a third since 2008, according
    to the Heritage Foundation. Counting state spending, total Welfare spending for 2010 reached nearly $900 billion, up
    nearly one-fourth since 2008 (24.3%)".[24]
    According to the U.S. Census Bureau data released September 13, 2011, the nation's poverty rate rose to 15.1% (46.2
    million) in 2010,[25] up from 14.3% (approximately 43.6 million) in 2009 and to its highest level since 1993. In
    2008, 13.2% (39.8 million) Americans lived in relative poverty.[26]
Welfare                                                                                                                        166

    The Italian welfare state's foundations were laid along the lines of the corporatist-conservative model, or of its
    Mediterranean variant. Later, in the 1960s and 1970s, increases in public spending and a major focus on universality
    brought it on the same path as social-democratic systems. In 1978, a universalistic welfare model was introduced in
    Italy, offering a number of universal and free services such as a National Health Fund.[27]

    Social welfare in Sweden is made up of several organizations and systems dealing with welfare. It is mostly funded
    by taxes, and executed by the public sector on all levels of government as well as private organisations. It can be
    separated into three parts falling under three different ministries; social welfare, falling under the responsibility of
    Ministry of Health and Social Affairs; education, under the responsibility of the Ministry of Education and Research
    and labour market, under the responsibility of Ministry of Employment.[28]
    Government pension payments are financed through an 18.5% pension tax on all taxed incomes in the country,
    which comes partly from a tax category called a public pension fee (7% on gross income), and 30% of a tax category
    called employer fees on salaries (which is 33% on a netted income). Since January 2001 the 18.5% is divided in two
    parts: 16% goes to current payments, and 2.5% goes into individual retirement accounts, which were introduced in
    2001. Money saved and invested in government funds, and IRAs for future pension costs, are roughly 5 times annual
    government pension expenses (725/150).

    Social welfare, assistance for the ill or otherwise disabled and for the old, has long been provided in Japan by both
    the government and private companies. Beginning in the 1920s, the government enacted a series of welfare
    programs, based mainly on European models, to provide medical care and financial support. During the postwar
    period, a comprehensive system of social security was gradually established.[29][30]

    Latin America

    The 1980s marked a change in the structure of Latin American social protection programs. Social protection
    embraces three major areas: social insurance, financed by workers and employers; social assistance to the
    population’s poorest, financed by the state; and labor market regulations to protect worker rights.[31] Although
    diverse, recent Latin American social policy has tended to concentrate on social assistance.
    The 1980s had a significant effect on social protection policies. Prior to the 1980s, most Latin American countries
    focused on social insurance policies involving formal sector workers, assuming that the informal sector would
    disappear with economic development. The economic crisis of the 1980s and the liberalization of the labor market
    led to a growing informal sector and a rapid increase in poverty and inequality. Latin American countries did not
    have the institutions and funds to properly handle such a crisis, both due to the structure of the social security
    system, and to the previously implemented structural adjustment policies (SAPs) that had decreased the size of the
    New Welfare programs have integrated the multidimensional, social risk management, and capabilities approaches
    into poverty alleviation. They focus on income transfers and service provisions while aiming to alleviate both long-
    and short-term poverty through, among other things, education, health, security, and housing. Unlike previous
    programs that targeted the working class, new programs have successfully focused on locating and targeting the very
    The impacts of social assistance programs vary between countries, and many programs have yet to be fully
    evaluated. According to Barrientos and Santibanez, the programs have been more successful in increasing
Welfare                                                                                                                       167

    investment in human capital than in bringing households above the poverty line. Challenges still exist, including the
    extreme inequality levels and the mass scale of poverty; locating a financial basis for programs; and deciding on exit
    strategies or on the long-term establishment of programs.[31]

    Latin America’s most recent shift in social policies
    The economic crisis of the 1980s led to a shift in social policies, as understandings of poverty and social programs
    evolved (24). New, mostly short-term programs emerged. These include:[32]
    •   Argentina: Jefes y Jefas de Hogar
    •   Bolivia: Bonosol
    •   Brazil: Bolsa Escola and Bolsa Familia
    •   Chile: Chile Solidario
    •   Ecuador: Bono de Desarollo Humano
    •   Honduras: Red Solidaria
    •   Mexico: Oportunidades (earlier known as Progresa)
    •   Panama: Red de Oportunidades
    •   Peru: Juntos

    Major aspects of current social assistance programs
    • Conditional cash transfer (CCT) combined with service provisions. Transfer cash directly to households, most
      often through the women of the household, if certain conditions are met (e.g. children’s school attendance or
      doctor visits) (10). Providing free schooling or healthcare is often not sufficient, because there is an opportunity
      cost for the parents in, for example, sending children to school (lost labor power), or in paying for the
      transportation costs of getting to a health clinic.
    • Household. The household has been the focal point of social assistance programs.
    • Target the poorest. Recent programs have been more successful than past ones in targeting the poorest. Previous
      programs often targeted the working class.
    • Multidimensional. Programs have attempted to address many dimensions of poverty at once. Chile Solidario is
      the best example.

    New Zealand
    New Zealand is often regarded as having one of the first comprehensive welfare systems in the world. During the
    1890s a Liberal government adopted many social programmes to help the poor who had suffered from a long
    economic depression in the 1880s. One of the most far reaching was the passing of tax legislation that made it
    difficult for wealthy sheep farmers to hold onto their large land holdings. This and the invention of refrigeration led
    to a farming revolution where many sheep farms were broken up and sold to become smaller dairy farms. This
    enabled thousands of new farmers to buy land and develop a new and vigorous industry that has become the
    backbone of New Zealand's economy to this day. This liberal tradition flourished with increased enfranchisement for
    indigenous Maori in the 1880s and women. Pensions for the elderly, the poor and war casualties followed, with State
    run schools, hospitals and subsidized medical and dental care. BY 1960 New Zealand was able to afford one of the
    most well developed and comprehensive welfare systems in the world supported by a well developed and stable
Welfare                                                                                                                                           168

    Income transfers can be either conditional or unconditional. There is no substantial evidence that conditional
    transfers are more effective than unconditional ones. Conditionalities are sometimes critiqued for being paternalistic
    and unnecessary.
    Current programs have been built as short-term rather than as permanent institutions, and many of them have rather
    short time spans (around five years). Some programs have time frames that reflect available funding. One example of
    this is Bolivia’s Bonosol, which is financed by proceeds from the privatization of utilities—an unsustainable funding
    source. Some see Latin America’s social assistance programs as a way to patch up high levels of poverty and
    inequalities, partly brought on by the current economic system.
    Some opponents of Welfare argue that it affects work incentives. They also argue that the taxes levied can also affect
    work incentives. A good example of this would be the reform of the Aid to Families with Dependent Children
    (AFDC) program. Per AFDC, some amount per recipeint is guaranteed. However, for every dollar the recipient earns
    the monthly stipend is decreased by an equivalent amount. For most persons, this reduces their incentive to work.
    This program was replaced by Temporary Aid to Needy Families (TANF). Under TANF, people were required to
    actively seek employment while receiving aid and they could only receive aid for a limited amount of time.
    However, states can choose the amount of resources they will devote to the program.

    • R.M. Blank (2001). "Welfare Programs, Economics of," International Encyclopedia of the Social & Behavioral
      Sciences, pp. 16426–16432, Abstract. [33]
    • Sheldon Danziger, Robert Haveman, and Robert Plotnick (1981). "How Income Transfer Programs Affect Work,
      Savings, and the Income Distribution: A Critical Review," Journal of Economic Literature 19(3), pp. 975-1028
    • R.H. Haveman (2001). "Poverty: Measurement and Analysis," International Encyclopedia of the Social &
      Behavioral Sciences, pp. 11917–11924. Abstract. [35]
    • Steven N. Durlauf et al., ed. (2008) The New Palgrave Dictionary of Economics, 2nd Edition:
           "social insurance" by Stefania Albanesi. Abstract. [36]
           "social insurance and public policy" by Jonathan Gruber Abstract. [37]
           "Welfare state" by Assar Lindbeck. Abstract. [38]
    • Nadasen, Premilla, Jennifer Mittelstadt, and Marisa Chappell, Welfare in the United States: A History with
      Documents, 1935–1996. (New York: Routledge, 2009). 241 pp. ISBN 978-0-415-98979-4

    [1] "Social Insurance," (http:/ / www. actuarialstandardsboard. org/ pdf/ asops/ asop032_062. pdf) Actuarial Standard of Practice No. 32,
        Actuarial Standards Board, January 1998
    [2] (http:/ / www. britannica. com/ EBchecked/ topic/ 602150/ Trajan#tab=active~checked,items~checked& title=Trajan --
        Britannica Online Encyclopædia)
    [3] (http:/ / www. pbs. org/ empires/ romans/ empire/ nerva_trajan. html)
    [4] Song Dynasty
    [5] Robert Henry Nelson (2001). " Economics as religión: from Samuelson to Chicago and beyond (http:/ / books. google. com/
        books?id=Rw-bHEGNqqcC& pg=PA103& dq& hl=en#v=onepage& q=& f=false)". Penn State Press. p.103. ISBN 0-271-02095-4
    [6] " Chapter1: Charity and Welfare (http:/ / libro. uca. edu/ charity/ cw1. htm)", the American Academy of Research Historians of Medieval
    [7] Crone, Patricia (2005). Medieval Islamic Political Thought (http:/ / books. google. com/ ?id=6u13vgHhSdgC& pg=PA308& dq#v=onepage&
        q& f=false). Edinburgh University Press. pp. 308–9. ISBN 0-7486-2194-6. .
    [8] Shadi Hamid (August 2003). "An Islamic Alternative? Equality, Redistributive Justice, and the Welfare State in the Caliphate of Umar".
        Renaissance: Monthly Islamic Journal 13 (8). (see online (http:/ / www. renaissance. com. pk/ Augvipo2y3. html))
    [9] The Poor Laws of England (http:/ / eh. net/ encyclopedia/ article/ boyer. poor. laws. england) at EH.Net
Welfare                                                                                                                                               169

    [10] Liberal Reforms (http:/ / www. bbc. co. uk/ schools/ gcsebitesize/ history/ mwh/ britain/ liberalreformsrev2. shtml) at BBC Bitesize
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        stimulus-bill-abolishes-welfare-reform-and-adds-new-welfare-spending). The Heritage Foundation. . Retrieved 10 January 2013.
    [16] http:/ / en. wikipedia. org/ wiki/ Works_Progress_Administration|Works
    [17] Katz, Michael B. (1988). In the Shadow Of the Poorhouse: A Social History Of Welfare In America. New York: Basic Books.
    [18] 2008 Indicators of Welfare Dependence (http:/ / aspe. hhs. gov/ hsp/ indicators08/ apa. shtml#ftanf2) Figure TANF 2.
    [19] Deparle, Jason (2009-02-02). "Welfare Aid Isn't Growing as Economy Drops Off" (http:/ / www. nytimes. com/ 2009/ 02/ 02/ us/
        02Warfare. html?partner=rss& emc=rss& pagewanted=all). The New York Times. . Retrieved 2009-02-12.
    [20] "Ending Welfare Reform as We Knew It" (http:/ / article. nationalreview. com/
        ?q=NTY3NzZhNDBkNjU5MjAzZTE4YmQ4MmU5MTk2YTIxNTQ=n). The National Review. 2009-02-12. . Retrieved 2009-02-12.
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        cfm). Heritage Foundation. 2009-02-11. . Retrieved 2009-02-12.
    [22] " Characteristics and Financial Circumstances of TANF Recipients - Fiscal Year 2010 (http:/ / www. acf. hhs. gov/ programs/ ofa/ resource/
        character/ fy2010/ fy2010-chap10-ys-final)". United States Department of Health and Human Services.
    [23] Goodman, Peter S. (2008-04-11). "From Welfare Shift in '96, a Reminder for Clinton" (http:/ / www. nytimes. com/ 2008/ 04/ 11/ us/
        politics/ 11Welfare. html?fta=y). The New York Times. . Retrieved 2009-02-12.
    [24] Ferrara, Peter (2011-04-22). "America's Ever Expanding Welfare Empire" (http:/ / www. forbes. com/ sites/ peterferrara/ 2011/ 04/ 22/
        americas-ever-expanding-welfare-empire/ ). Forbes. . Retrieved 2012-04-10.
    [25] " Revised govt formula shows new poverty high: 49.1M (http:/ / news. yahoo. com/
        revised-govt-formula-shows-poverty-high-49-1m-135427317. html)". Yahoo! News. November 7, 2011
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        Latin American Studies. Cambridge University Press 41, 1–26
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Labour economics                                                                                                                 170

    Labour economics
    Labour economics seeks to understand the functioning and dynamics of the markets for labour. Labour markets
    function through the interaction of workers and employers. Labour economics looks at the suppliers of labour
    services (workers), the demands of labour services (employers), and attempts to understand the resulting pattern of
    wages, employment, and income.
    In economics, labour is a measure of the work done by human beings. It is conventionally contrasted with such
    other factors of production as land and capital. There are theories which have developed a concept called human
    capital (referring to the skills that workers possess, not necessarily their actual work), although there are also counter
    posing macro-economic system theories that think human capital is a contradiction in terms.

    Compensation and measurement
    Wage is a basic compensation for paid labour, and the compensation for labour per period of time is referred to as
    the wage rate. Other frequently used terms include:
    • wage = payment per unit of time (typically an hour)
    • earnings = payment accrued over a period (typically a week, a month, or a year)
    • total compensation = earnings + other benefits for labour
    • income = total compensation + unearned income
    • economic rent = total compensation - opportunity cost
    Economists measure labour in terms of hours worked, total wages, or efficiency.
    • total cost = fixed cost + variable cost

    Demand for labour and wage determination
    Labour demand is a derived demand; that is, hiring labour is not desired for its own sake but rather because it aids in
    producing output, which contributes to an employer's revenue and hence profits. The demand for an additional
    amount of labour depends on the Marginal Revenue Product (MRP) and the marginal cost (MC) of the worker. The
    MRP is calculated by multiplying the price of the end product or service by the Marginal Physical Product of the
    worker. If the MRP is greater than a firm's Marginal Cost, then the firm will employ the worker since doing so will
    increase profit. The firm only employs however up to the point where MRP=MC, and not beyond, in economic
    Wage differences exist, particularly in mixed and fully/partly flexible labour markets. For example, the wages of a
    doctor and a port cleaner, both employed by the NHS, differ greatly. But why? There are many factors concerning
    this issue. This includes the MRP (see above) of the worker. A doctor's MRP is far greater than that of the port
    cleaner. In addition, the barriers to becoming a doctor are far greater than that of becoming a port cleaner. For
    example to become a doctor takes a lot of education and training which is costly, and only those who excel in
    academia can succeed in becoming doctors. The port cleaner however requires minimal training. The supply of
    doctors therefore would be much more inelastic than the supply of port cleaners. The demand would also be inelastic
    as there is a high demand for doctors and medical care is a necessity, so the NHS will pay higher wage rates to
    attract the profession.
    The MRP of the worker is affected by other inputs to production with which the worker can work (e.g. machinery),
    often aggregated under the term "capital". It is typical in economic models for greater availability of capital for a
    firm to increase the MRP of the worker, all else equal. The education and training noted in the last paragraph are
    counted as "human capital". Since the amount of physical capital affects MRP, and since financial capital flows can
    affect the amount of physical capital available, MRP and thus wages can be affected by financial capital flows within
Labour economics                                                                                                             171

    and between countries, and the degree of capital mobility within and between countries.[1]

    Macro and micro analysis of labour markets
    There are two sides to labour economics. Labour economics can generally be seen as the application of
    microeconomic or macroeconomic techniques to the labour market. Microeconomic techniques study the role of
    individuals and individual firms in the labour market. Macroeconomic techniques look at the interrelations between
    the labour market, the goods market, the money market, and the foreign trade market. It looks at how these
    interactions influence macro variables such as employment levels, participation rates, aggregate income and Gross
    Domestic Product.

    The macroeconomics of labour markets
    The labour force is defined as the number of individuals age 16 and over, excluding those in the military, who are
    either employed or actively looking for work. The participation rate is the number of people in the labour force
    divided by the size of the adult civilian noninstitutional population (or by the population of working age that is not
    institutionalised). The nonlabour force includes those who are not looking for work, those who are institutionalised
    such as in prisons or psychiatric wards, stay-at home spouses, children, and those serving in the military. The
    unemployment level is defined as the labour force minus the number of people currently employed. The
    unemployment rate is defined as the level of unemployment divided by the labour force. The employment rate is
    defined as the number of people currently employed divided by the adult population (or by the population of
    working age). In these statistics, self-employed people are counted as employed.
    Variables like employment level, unemployment level, labour force, and unfilled vacancies are called stock
    variables because they measure a quantity at a point in time. They can be contrasted with flow variables which
    measure a quantity over a duration of time. Changes in the labour force are due to flow variables such as natural
    population growth, net immigration, new entrants, and retirements from the labour force. Changes in unemployment
    depend on: inflows made up of non-employed people starting to look for jobs and of employed people who lose their
    jobs and look for new ones; and outflows of people who find new employment and of people who stop looking for
    employment. When looking at the overall macroeconomy, several types of unemployment have been identified,
    • Frictional unemployment — This reflects the fact that it takes time for people to find and settle into new jobs. If
      12 individuals each take one month before they start a new job, the aggregate unemployment statistics will record
      this as a single unemployed worker. Technological advancement often reduces frictional unemployment, for
      example: internet search engines have reduced the cost and time associated with locating employment.
    • Structural unemployment — This reflects a mismatch between the skills and other attributes of the labour force
      and those demanded by employers. If 4 workers each take six months off to re-train before they start a new job,
      the aggregate unemployment statistics will record this as two unemployed workers. Rapid industry changes of a
      technical and/or economic nature will usually increase levels of structural unemployment, for example:
      widespread implementation of new machinery or software will require future employees to be trained in this area
      before seeking employment. The process of globalisation has contributed to structural changes in labour, some
      domestic industries such as textile manufacturing have expanded to cope with global demand, whilst other
      industries such as agricultural products have contracted due to greater competition from international producers.
    • Natural rate of unemployment — This is the summation of frictional and structural unemployment, that
      excludes cyclical contributions of unemployment e.g. recessions. It is the lowest rate of unemployment that a
      stable economy can expect to achieve, seeing as some frictional and structural unemployment is inevitable.
      Economists do not agree on the natural rate, with estimates ranging from 1% to 5%, or on its meaning — some
      associate it with "non-accelerating inflation". The estimated rate varies from country to country and from time to
Labour economics                                                                                                                      172

    • Demand deficient unemployment — In Keynesian economics, any level of unemployment beyond the natural
      rate is most likely due to insufficient demand in the overall economy. During a recession, aggregate expenditure
      is deficient causing the underutilisation of inputs (including labour). Aggregate expenditure (AE) can be
      increased, according to Keynes, by increasing consumption spending (C), increasing investment spending (I),
      increasing government spending (G), or increasing the net of exports minus imports (X−M).
      {AE = C + I + G + (X−M)}

    Neoclassical microeconomics of labour markets
    Neo-classical economists view the labour market as similar to other markets in that the forces of supply and demand
    jointly determine price (in this case the wage rate) and quantity (in this case the number of people employed).
    However, the labour market differs from other markets (like the markets for goods or the money market) in several
    ways. Perhaps the most important of these differences is the function of supply and demand in setting price and
    quantity. In markets for goods, if the price is high there is a tendency in the long run for more goods to be produced
    until the demand is satisfied. With labour, overall supply cannot effectively be manufactured because people have a
    limited amount of time in the day, and people are not manufactured.
    The labour market also acts as a non-clearing market.Whereas most markets have a point of equilibrium without
    excess surplus or demand, the labour market is expected to have a persistent level of unemployment. Contrasting the
    labour market to other markets also reveals persistent compensating differentials among similar workers. The
    competitive assumption leads to clear conclusions — workers earn their marginal product of labour.[2]

    Neoclassical microeconomic model — Supply
    Households are suppliers of labour. In microeconomics theory, people
    are assumed to be rational and seeking to maximise their utility
    function. In this labour market model, their utility function is
    determined by the choice between income and leisure. However, they
    are constrained by the working hours available to them.
    Let w denote hourly wage. Let k denote total working hours. Let L
    denote working hours. Let π denote other incomes or benefits. Let A
    denote leisure hours.
    The utility function and budget constraint can be expressed as
          max U(w L + π, A) such that L + A ≤ k.
    This can be shown in a graph that illustrates the trade-off between
    allocating your time between leisure activities and income generating
    activities. The linear constraint line indicates that there are only 24
    hours in a day, and individuals must choose how much of this time to               An advertisement for labour from Sabah and
                                                                                     Sarawak, seen in Jalan Petaling, Kuala Lumpur.
    allocate to leisure activities and how much to working. (If multiple
    days are being considered the maximum number of hours that could be
    allocated towards leisure or work is about 16 due to the necessity of sleep) This allocation decision is informed by
    the curved indifference curve labelled IC. The curve indicates the combinations of leisure and work that will give the
    individual a specific level of utility. The point where the highest indifference curve is just tangent to the constraint
    line (point A), illustrates the short-run equilibrium for this supplier of labour services.
Labour economics                                                                                                              173

                                          The Income/Leisure trade-off in the short run
    If the preference for consumption is measured by the value of income obtained, rather than work hours, this diagram
    can be used to show a variety of interesting effects. This is because the slope of the budget constraint becomes the
    wage rate. The point of optimisation (point A) reflects the equivalency between the wage rate and the marginal rate
    of substitution, leisure for income (the slope of the indifference curve). Because the marginal rate of substitution,
    leisure for income, is also the ratio of the marginal utility of leisure (MUL) to the marginal utility of income (MUY),
    one can conclude:

                                                  Effects of a wage increase
    If wages increase, this individual's constraint line pivots up from X,Y1 to X,Y2. He/she can now purchase more
    goods and services. His/her utility will increase from point A on IC1 to point B on IC2. To understand what effect
    this might have on the decision of how many hours to work, you must look at the income effect and substitution
Labour economics                                                                                                                 174

    The wage increase shown in the previous diagram can be decomposed into two separate effects. The pure income
    effect is shown as the movement from point A to point C in the next diagram. Consumption increases from YA to YC
    and — assuming leisure is a normal good — leisure time increases from XA to XC (employment time decreases by
    the same amount; XA to XC).

                                    The Income and Substitution effects of a wage increase
    But that is only part of the picture. As the wage rate rises, the worker will substitute work hours for leisure hours,
    that is, will work more hours to take advantage of the higher wage rate, or in other words substitute away from
    leisure because of its higher opportunity cost. This substitution effect is represented by the shift from point C to point
    B. The net impact of these two effects is shown by the shift from point A to point B. The relative magnitude of the
    two effects depends on the circumstances. In some cases the substitution effect is greater than the income effect (in
    which case more time will be allocated to working), but in other cases the income effect will be greater than the
    substitution effect (in which case less time is allocated to working). The intuition behind this latter case is that the
    worker has reached the point where his marginal utility of leisure outweighs his marginal utility of income. To put it
    in less formal (and less accurate) terms: there is no point in earning more money if you don't have the time to spend
Labour economics                                                                                                              175

                                                    The Labour Supply curve
    If the substitution effect is greater than the income effect, the labour supply curve (diagram to the left) will slope
    upwards to the right, as it does at point E for example. This individual will continue to increase his supply of labour
    services as the wage rate increases up to point F where he is working HF hours (each period of time). Beyond this
    point he will start to reduce the amount of labour hours he supplies (for example at point G he has reduced his work
    hours to HG). Where the supply curve is sloping upwards to the right (positive wage elasticity of labour supply), the
    substitution effect is greater than the income effect. Where it slopes upwards to the left (negative elasticity), the
    income effect is greater than the substitution effect. The direction of slope may change more than once for some
    individuals, and the labour supply curve is likely to be different for different individuals.
    Other variables that affect this decision include taxation, welfare, work environment, and income as a signal of
    ability or social contribution.

    Neoclassical microeconomic model — Demand
    This article has examined the labour supply curve which illustrates at every wage rate the maximum quantity of
    hours a worker will be willing to supply to the economy per period of time. Economists also need to know the
    maximum quantity of hours an employer will demand at every wage rate. To understand the quantity of hours
    demanded per period of time it is necessary to look at product production. That is, labour demand is a derived
    demand: it is derived from the output levels in the goods market.
    A firm's labour demand is based on its marginal physical product of labour (MPPL). This is defined as the additional
    output (or physical product) that results from an increase of one unit of labour (or from an infinitesimally small
    increase in labour). If you are not familiar with these concepts, you might want to look at production theory basics
    before continuing with this article.
Labour economics                                                                                                             176

                                           The Marginal Physical Product of Labour
    In most industries, and over the relevant range of outputs, the marginal physical product of labour is declining. That
    is, as more and more units of labour are employed, their additional output begins to decline. This is reflected by the
    slope of the MPPL curve in the diagram to the right. If the marginal physical product of labour is multiplied by the
    value of the output that it produces, we obtain the Value of marginal physical product of labour:

    The value of marginal physical product of labour (             ) is the value of the additional output produced by an
    additional unit of labour. This is illustrated in the diagram by the VMPPL curve that is above the MPPL.
    In competitive industries, the VMPPL is in identity with the marginal revenue product of labour (MRPL). This is
    because in competitive markets price is equal to marginal revenue, and marginal revenue product is defined as the
    marginal physical product times the marginal revenue from the output (MRP = MPP * MR).

                                         A Firm's Labour Demand in the Short Run
    The marginal revenue product of labour can be used as the demand for labour curve for this firm in the short run. In
    competitive markets, a firm faces a perfectly elastic supply of labour which corresponds with the wage rate and the
    marginal resource cost of labour (W = SL = MFCL). In imperfect markets, the diagram would have to be adjusted
    because MFCL would then be equal to the wage rate divided by marginal costs. Because optimum resource allocation
    requires that marginal factor costs equal marginal revenue product, this firm would demand L units of labour as
Labour economics                                                                                                              177

    shown in the diagram.

    Neoclassical microeconomic model — Equilibrium
    The demand for labour of this firm can be summed with the demand for labour of all other firms in the economy to
    obtain the aggregate demand for labour. Likewise, the supply curves of all the individual workers (mentioned above)
    can be summed to obtain the aggregate supply of labour. These supply and demand curves can be analysed in the
    same way as any other industry demand and supply curves to determine equilibrium wage and employment levels.

    Personnel economics: hiring and incentives
    At the micro level, one sub-discipline eliciting increased attention in recent decades is analysis of internal labour
    markets, that is, within firms (or other organisations), studied in personnel economics from the perspective of
    personnel management. By contrast, external labor markets "imply that workers move somewhat fluidly between
    firms and wages are determined by some aggregate process where firms do not have significant discretion over wage
    setting."[3] The focus is on "how firms establish, maintain, and end employment relationships and on how firms
    provide incentives to employees," including models and empirical work on incentive systems and as constrained by
    economic efficiency and risk/incentive tradeoffs relating to personnel compensation.[4]

    Information approaches
    In many real-life situations this is far from the case. The firm does not necessarily know how hard a worker is
    working or how productive they are. This provides an incentive for workers to shirk from providing their full effort
    — since it is difficult for the employer to identify the hard-working and the shirking employees, there is no incentive
    to work hard and productivity falls overall, leading to more workers being hired and a lower unemployment rate.
    One solution used recently (stock options) grants employees the chance to benefit directly from the firm's success.
    However, this solution has attracted criticism as executives with large stock option packages have been suspected of
    acting to over-inflate share values to the detriment of the long-run welfare of the firm. Another solution,
    foreshadowed by the rise of temporary workers in Japan and the firing of many of these workers in response to the
    financial crisis of 2008, is more flexible job contracts and terms that encourage employees to work less than full-time
    by partially compensating for the loss of hours, relying on workers to adapt their working time in response to job
    requirements and economic conditions instead of the employer trying to determine how much work is needed to
    complete a given task and overestimating.
    Another aspect of uncertainty results from the firm's imperfect knowledge about worker ability. If a firm is unsure
    about a worker's ability, it pays a wage assuming that the worker's ability is the average of similar workers. This
    wage undercompenstates high ability workers and may drive them away from the labour market. Such phenomenon
    is called adverse selection and can sometimes lead to market collapse.
    There are many ways to overcome adverse selection in labour market. One important mechanism is called signalling,
    pioneered by Michael Spence. In his classical paper on job signalling, Spence showed that even if education does not
    increase productivity, high ability workers may still acquire it just to signal their abilities. Employers can then use
    education as a signal to infer worker ability and pay higher wages to better educated workers.
Labour economics                                                                                                                                     178

    Search models
    One of the major research achievements of the last 20 years has been the development of a framework with dynamic
    search, matching, and bargaining.

    Many sociologists, political economists, and Austrian School economists claim that labour economics tends to lose
    sight of the complexity of individual employment decisions. These decisions, particularly on the supply side, are
    often loaded with considerable emotional baggage and a purely numerical analysis can miss important dimensions of
    the process, such as social benefits of a high income or wage rate regardless of the marginal utility from increased
    consumption or specific economic goals.
    Also missing from most labour market analyses is the role of unpaid labour. Even though this type of labour is
    unpaid it can nevertheless play an important part in society. The most dramatic example is child raising. However,
    over the past 25 years an increasing literature, usually designated as the economics of the family, has sought to study
    within household decision making, including joint labour supply, fertility, child raising, as well as other areas of
    what is generally referred to as home production.[5]

    [1] Hacker, R. Scott (2000). "The Impact of International Capital Mobility on the Volatility of Labour Income". Annals of Regional Science 34
        (2): 157–172. doi:10.1007/s001689900005.
    [2] Gustav Ranis (February 1997). "The Micro-Economics of Surplus Labour" (http:/ / www. econ. yale. edu/ growth_pdf/ cdp772. pdf). Yale
        University. .
    [3] • Edward P. Lazear and Paul Oyer, 2004. "Internal and External Labor Markets: A Personnel Economics Approach," Labour Economics,
        11(5), pp. 527 and 528. [Pp. 527–554 (http:/ / faculty-gsb. stanford. edu/ oyer/ wp/ ports. pdf).]
           • JEL Classification Codes Guide: M (http:/ / www. aeaweb. org/ jel/ guide/ jel. php?class=M) per JEL:M5].
    [4] Paul Oyer and Scott Schaefer, 2011. "Personnel Economics: Hiring and Incentives," ch. 20, Handbook of Labor Economics, v. 4B, pp.
        1769-1823. Abstract (http:/ / www. sciencedirect. com/ science/ article/ pii/ S016972181102418X) and pre-pub PDF (http:/ / www. utah-wbec.
        org/ ~schaefer/ Research/ schaefer_hiring01. pdf).
    [5] (Sandiaga S. Unno, Anindya N Bakrie, Rosan Perkasa, Morendy Octora : The Young Strategic Renaissance's In Asia)

    • Handbook of Labor Economics. Elsevier. Amsterdam: North-Holland. Links to one-page chapter previews for
      each volume:
           Orley C. Ashenfelter and Richard Layard, ed., 1986, v. 1 (http:/ / www. sciencedirect. com/ science/
           handbooks/15734463/1) & 2 (;
           Orley Ashenfelter and David Card, ed., 1999, v. 3A (http:/ / www. sciencedirect. com/ science/ handbooks/
           15734463/ 3/ part/ PA), 3B (http:/ / www. sciencedirect. com/ science/ handbooks/ 15734463/ 3/ part/ PB),
           and 3C (
           Orley Ashenfelter and David Card, ed., 2011, v. 4A (http:/ / www. sciencedirect. com/ science/ handbooks/
           15734463/4/part/PA) & 4B (
    • Richard Blundell and Thomas MaCurdy, 2008. "labour supply," The New Palgrave Dictionary of Economics, 2nd
      Edition Abstract. ( of
      production demand supply&topicid=&result_number=4)
    • Glen G. Cain, 1976. "The Challenge of Segmented Labor Market Theories to Orthodox Theory: A Survey,"
      Journal of Economic Literature, 14(4), pp. 1215-1257 (
    • Freeman, R.B., 1987. "Labour economics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 72–76.
Labour economics                                                                                                     179

    • John R. Hicks, 1932, 2nd ed., 1963. The Theory of Wages. London, Macmillan.
    • Mark R. Killingsworth, 1983. Labour Supply. Cambridge: Cambridge Surveys of Economic Literature.
    • Assar Lindbeck and Dennis J. Snower 1986. "Wage Setting, Unemployment, and Insider-Outsider Relations,"
      American Economic Review, 76(2), pp. 235 (
    • Jacob Mincer, 1974. Schooling, Experience, and Earnings. New York: Columbia University Press.
    • Anindya Bakrie & Morendy Octora, 2002. Schooling, Experience, and Earnings. New York, Singapore National
      University : Columbia University Press.
    • Simon Head, The New Ruthless Economy. Work and Power in the Digital Age, Oxford UP 2005, ISBN
    • L. Ali Khan, The Dignity of Labour (

    External links
    • Ageing workers ( EU-OSHA
    • The Labour Economics Gateway ( - Collection of Internet sites that are of interest to
      labour economists
    • Labour & Worklife Program at Harvard Law School, Changing Labour Markets Project (
    • W.E. Upjohn Institute for Employment Research
    • ILO: Key Indicators of the Labour Market (KILM). 5. ed. Sept. 2007 (
    • LabourFair Resources ( - Link to Fair Labour Practices
    • Labour Research Network ( - Labour research
      programme treating various fields
Demographic economics                                                                                                                                   180

    Demographic economics
    Demographic economics or population economics is the application of economics to demography, the study of
    human populations, including size, growth, density, distribution, and vital statistics.[1]
    Analysis includes economic determinants and consequences of:
    •   marriage and fertility,[2]
    •   the family,[3]
    •   divorce,[4]
    •   morbidity[5] and life expectancy/mortality,[6]
    •   dependency ratios,[7]
    •   migration,[8]
    •   population growth,[9]
    •   population size,[10]
    •   public policy,[11] and the
    •   demographic transition from "population explosion" to (dynamic) stability[12] or decline.[13]
    Other subfields include the measuring the value of life[14] and the economics of the elderly[15] and the
    handicapped[16] and of gender,[17] race, minorities, and non-labor discrimination.[18] In coverage and subfields, it
    complements labor economics[19] and implicates a variety of other economics subjects.[20]

    [1] • Allen C. Kelley and Robert M. Schmidt, 2008. "economic demography," The New Palgrave Dictionary of Economics, 2nd Edition.
        Abstract. (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_D000075& q=Population economics & topicid=&
           • Bernard van Praag, 1988. "The Notion of Population Economics," Journal of Population Economics, 1(1), p p. 5 (http:/ / www. jstor. org/
        pss/ 20007247)-16. Abstract. (http:/ / www. ncbi. nlm. nih. gov/ pubmed/ 12342564)
    [2] • Mark Montgomery and James Trussell, 1986. "Models of Marital Status and Childbearing," Handbook of Labor Economics, v. 1 (http:/ / 64.
        233. 169. 104/ search?q=cache:lYeSodoHfNcJ:www. elsevier. com/ wps/ product/ cws_home/ 601122+ "Handbook+ of+ Labor+
        Economics",& hl=en& ct=clnk& cd=4& gl=us), , p p. 205 (http:/ / www. sciencedirect. com/ science/ article/ B7P5V-4FDF0FK-6/ 2/
        7878d3015691ad2884a8c7f815e6cc9e)-71F. Elsevier.
           • T. Paul Schultz, 2008. "fertility in developing countries," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics.
        com/ article?id=pde2008_F000287)
           • Alicia Adsera, 2008. "fertility in developed countries," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics.
        com/ article?id=pde2008_F000289& q=demography& topicid=& result_number=9)
           • Oded Galor., 2005. "The Demographic Transition and the Emergence of Sustained Economic Growth." Journal of the European Economic
        Association, 3, 494-504. Abstract (http:/ / www. mitpressjournals. org/ doi/ abs/ 10. 1162/ jeea. 2005. 3. 2-3. 494) and draft PDF (http:/ /
        www. brown. edu/ Departments/ Economics/ Papers/ Papers/ 2004/ 2004-13_paper. pdf) (press +).
           • Eric A Hanushek, 1992. "The Trade-Off between Child Quantity and Quality," Journal of Political Economy, 100(1), pp. 84-117. (http:/ /
        edpro. stanford. edu/ Hanushek/ admin/ pages/ files/ uploads/ child quality. JPE. pdf)
           • Evelyn L. Lehrer, 1996. "Religion as a Determinant of Marital Fertility," Journal of Population Economics 9(2), p p. 173 (http:/ / www.
        jstor. org/ pss/ 20007500)-196.
    [3] • Gary S. Becker, 1987. "family," The New Palgrave: A Dictionary of Economics, v. 2, pp. 281-86. Reprinted in, 1989), Social Economics:
        The New Palgrave, pp. 65 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA64& lpg=PP1& dq="social+ economics"+
        "new+ palgrave")- 76. (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA76& lpg=PP1)
           • _____, 1981, Enlarged ed., 1991. A Treatise on the Family. Cambridge, MA: Harvard University Press. ISBN 0-674-90698-5. Publisher's
        description (http:/ / www. hup. harvard. edu/ catalog/ BECTRR. html) & links to chapter previews. (http:/ / books. google. com/
        books?id=NLB1Ty75DOIC& printsec=toc& lr=& source=gbs_summary_s& cad=0)
           • _____, 1988. "Family Economics and Macro Behavior," American Economic Review, 78(1) , pp. 1-13. (http:/ / www2. um. edu. uy/ acid/
        Family_Economics/ FAmily Economics and MAcro Behaviour. pdf)
           • John Ermisch, 2008. "family economics," The New Palgrave Dictionary. Abstract (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_F000292& q=family & topicid=& result_number=1)
           • _____, 2003. An Economic Analysis of the Family, Princeton. Description (http:/ / press. princeton. edu/ titles/ 7519. html), Chapter 1
        "Introduction" (http:/ / press. princeton. edu/ chapters/ i7519. pdf) (press +), chapter-preview links. (http:/ / books. google. com/
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        books?id=xOGrHSN-1pQC& pg=PP15& lpg=PP1)
           • Evelyn Lehrer, 2007. Religion, Economics and Demography: The Effects of Religion on Education, Work, and the Family, Routledge.
        978-0-415-70194-5 Description. (http:/ / www. routledgepolitics. com/ books/ Religion-Economics-and-Demography-ISBN)
           • _____, 2004. “Religion as a Determinant of Economic and Demographic Behavior in the United States,” Population and Development
        Review, 30(4), p p. 707 (http:/ / www. jstor. org/ pss/ 3657335)-26. Pre-publication copy. (ftp:/ / ftp. iza. org/ dps/ dp1390. pdf)
    [4] • Yoram Weiss, 2008. "marriage and divorce," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_M000367& q=divorce& topicid=& result_number=1)
           • Evelyn L. Lehrer and Carmel U. Chiswick, 1993. "Religion as a Determinant of Marital Stability," Demography, 30(3), p p. 385 (http:/ /
        www. jstor. org/ pss/ 2061647)-404.
    [5] David Canning and David E. Bloom, 2008. "population health, economic implications of," The New Palgrave Dictionary. Abstract. (http:/ /
        www. dictionaryofeconomics. com/ article?id=pde2008_E000259& q=demography& topicid=& result_number=43)
    [6] • James W. Vaupel, Kristín G. von Kistowski, and Roland Rau, 2008. "mortality," The New Palgrave Dictionary, Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_M000263& q=public policy demography& topicid=& result_number=8)
           • Samuel H. Preston, 1975. "The Changing Relation between Mortality and Level of Economic Development," Population Studies, 29(2),
        pp. 231-248 (http:/ / www. scielosp. org/ pdf/ bwho/ v81n11/ v81n11a11. pdf) (press Rotate button, 2 to right of Select button).
           • David E. Bloom and David Canning, 2007. "Commentary: The Preston Curve 30 Years on: Still Sparking Fires," International Journal of
        Epidemiology, 36(3), pp. 498–499. link. (http:/ / ije. oxfordjournals. org/ cgi/ reprint/ 36/ 3/ 498)
    [7] • Allen C. Kelley and Robert M. Schmidt, 1996. "Saving, Dependency and Development," Journal of Population Economics, 9(4), pp.
        365-86. Abstract. (http:/ / www. ncbi. nlm. nih. gov/ pubmed/ 12292225)
           • David N. Weil, 1999. "Population Growth, Dependency, and Consumption," American Economic Review, 89(2), pp. 251-255. (http:/ /
        www. rau. ro/ intranet/ Aer/ 1999/ 8902/ 89020251. pdf)
           • Frank T. Denton and Byron G. Spencer, 2000. "Population Aging and Its Economic Costs: A Survey of the Issues and Evidence,"
        Canadian Journal on Aging, 19(Suppl. 1) pp. 1-31. Abstract. (http:/ / econpapers. repec. org/ paper/ mcmsedapp/ 1. htm)
    [8] • Yannis M. Ioannides and Esteban Rossi-Hansberg, 2009. "urban growth," The New Palgrave Dictionary. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_U000060& edition=& field=keyword& q=population density& topicid=&
           • James R. Walker, 2008. "internal migration," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_M000358& q=migration& topicid=& result_number=1)
           • George J. Borjas, 2008. "international migration," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_I000182& q=migration& topicid=& result_number=4)
    [9] • Ronald D. Lee, 2008. "population dynamics," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_P000124& q=population& topicid=& result_number=1)
           • Oded Galor, 2008. "human capital, fertility and growth," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics.
        com/ article?id=pde2008_H000166& q=declining population& topicid=& result_number=10)
           • _____ and David N. Weil, 2000. "Population, Technology, and Growth: From the Malthusian Regime to the Demographic Transition and
        Beyond," American Economic Review, 90(4), pp. 806-828 (http:/ / qed. econ. queensu. ca/ pub/ faculty/ lloyd-ellis/ econ835/ readings/ galor.
        pdf) (close Bookmarks tab).
           • D. Gale Johnson and Ronald D. Lee, ed., 1987. Population Growth and Economic Development: Issues and Evidence. University of
        Wisconsin Press, Description. (http:/ / www. popline. org/ docs/ 0768/ 269777. html) Input for NRC, 1986.
           • Allen C. Kelley, 1988. "Economic Consequences of Population Change in the Third World," Journal of Economic Literature, 26(4), pp.
        1685-1728. (http:/ / are. berkeley. edu/ courses/ ARE298/ Readings/ Kelly1998. pdf).
           • James A. Brander1 and Steve Dowrick, 1994. "The Role of Fertility and Population in Economic Growth," Journal of Population
        Economics, 7(1), pp. 1-25. Abstract. (http:/ / www. springerlink. com/ content/ m82j53r3823317u6/ )
           • Michael Kremer, 1993. "Population Growth and Technological Change: One Million B.C. to 1990," Quarterly Journal of Economics,
        108(3), p p. 681 (http:/ / www. jstor. org/ pss/ 2118405)-716.
           • Partha Dasgupta, 1995. "The Population Problem: Theory and Evidence," Journal of Economic Literature, 33(4), pp. 1879-1902. (http:/ /
        qed. econ. queensu. ca/ pub/ faculty/ lloyd-ellis/ econ835/ readings/ dasgupta. pdf).
    [10] * Joel E. Cohen, 1985. How Many People Can the Earth Support? Norton. Description (http:/ / books. google. com/
        books?id=TDe9Vp0dNUgC& dq="Joel+ E. + Cohen"+ "How+ Many+ People+ Can+ the+ Earth+ Support?%)& chapter-preview links, pp.
        vii (http:/ / books. google. com/ books?id=TDe9Vp0dNUgC& pg=PR7& lpg=PP1)- x. (http:/ / books. google. com/
        books?id=TDe9Vp0dNUgC& pg=PR10& lpg=PP1)
           • _____, 1995. "Population Growth and Earth's Human Carrying Capacity," Science, 269(5222), pp. 341-346. (http:/ / www. homepage.
        montana. edu/ ~wwwbi/ staff/ creel/ bio480/ cohen. pdf)
    [11] • National Research Council, 1986. Population Growth and Economic Development: Policy Questions. National Academies Press. Links to
        each chapter. (http:/ / www. nap. edu/ catalog. php?record_id=620)
           • Theodore W. Schultz, 1981. Investing in People: The Economics of Population Quality, University of California Press. Description (http:/ /
        books. google. com/ books?id=2ixF0UF45acC& dq=Economics+ of+ Population"& lr=& source=gbs_navlinks_s) and chapter-preview links.
        (http:/ / books. google. com/ books?id=2ixF0UF45acC& printsec=find& pg=PR5=false#v=onepage& q& f=false)
           • Amartya Sen, 1995. "Authoritarianism versus Cooperation," pp. pp. 3-29. (http:/ / www. abep. nepo. unicamp. br/ docs/ PopPobreza/
Demographic economics                                                                                                                                   182

        AmartyaSen. pdf) International Lecture Series on Population Issues, John D. and Catherine T. MacArthur Foundation, also in 1997, Journal of
        Population Economics, 10(1), p p. 3 (http:/ / www. jstor. org/ pss/ 20007525)-22.
           • Janet Currie, 2008. "child health and mortality," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
           • Nancy Birdsall, Allen C. Kelley, Steven W. Sinding, 2001. Population Matters: Demographic Change, Economic Growth, and Poverty in
        the Developing World. Oxford. Description (http:/ / books. google. com/ books?id=3FuvC6kHKFAC& dq="demography+ matters"+
        birdsall& source=gbs_summary_s& cad=0) & chapter-preview links (http:/ / books. google. com/ books?id=3FuvC6kHKFAC&
        printsec=frontcover& source=gbs_v2_summary_r& cad=0), pp. xi-xii.
           • Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of
        Political Economy, 66(6), pp. 467-82. (http:/ / www. econ. upenn. edu/ ~hfang/ teaching/ socialinsurance/ readings/ Samuelson58(6. 3). pdf)
           • Jagadeesh Gokhale , 2008. "generational accounting," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_G000203& q=generational accounting& topicid=& result_number=1)
    [12] • Shripad Tuljapurkar, 2008. "stable population theory" The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_S000226& q=stable population theory& topicid=& result_number=1)
    [13] • Jeremy Greenwood, Ananth Seshadri, and Vandenbroucke, 2005. "The Baby Boom and Baby Bust," American Economic Review, 95(1), ,
        pp. 183-207. Abstract. (http:/ / www. ingentaconnect. com/ content/ aea/ aer/ 2005/ 00000095/ 00000001/ art00009)
           • Carl Mosk, 2008) "historical demography," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_H000143& q=demography& topicid=& result_number=2)
           • Ronald D. Lee, 2008. "demographic transition," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_D000074& q=population& topicid=& result_number=19)
    [14] • W. Kip Viscusi, 2008. "value of life," The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_V000005& q= value of life& topicid=& result_number=1)
           • Gary S. Becker, Tomas J. Philipson, and Rodrigo R. Soares, 2005. “The Quantity and Quality of Life and the Evolution of World
        Inequality,” American Economic Review, 95{1), pp. 277-291 (http:/ / www. rau. ro/ intranet/ Aer/ 2005/ 9501/ 95010277. pdf) (close
        Bookmarks tab & press +).
    [15] • Michael Hurd, 2008. "retirement,' The New Palgrave Dictionary. Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_A000225& q=elderly& topicid=& result_number=38)
           • David N. Weil, 2008. "population ageing," The New Palgrave Dictionary, Abstract. (http:/ / www. dictionaryofeconomics. com/
        article?id=pde2008_A000224& q=elderly& topicid=& result_number=1)
           • Robert L. Clark and Joseph J. Spengler, 1998. The Economics of Individual and Population Aging. Description (http:/ / books. google.
        com/ books?id=LkE5AAAAIAAJ& source=gbs_navlinks_s) and scroll to chapter-preview links. (http:/ / books. google. com/
        books?id=LkE5AAAAIAAJ& printsec=frontcover& source=gbs_v2_summary_r& cad=0#v=onepage& q& f=false)
    [16] • Didier Blanchet and Marc Fleurbaey, 2006. "Selfishness, Altruism and Normative Principles in the Economic Analysis of Social
        Transfers," Ch. 24, in Handbook on the Economics of Giving, Reciprocity and Altruism, v. 2, pp. 1465-1503. Abstract. (http:/ / www.
        sciencedirect. com/ science?_ob=ArticleURL& _udi=B7P5K-4KFT70D-H& _user=10& _coverDate=12/ 31/ 2006& _rdoc=1& _fmt=high&
        _orig=search& _origin=search& _sort=d& _docanchor=& view=c& _searchStrId=1482358564& _rerunOrigin=scholar. google&
        _acct=C000050221& _version=1& _urlVersion=0& _userid=10& md5=ad1759256ad18c54d6f3f66f67198ee7& searchtype=a)
           • Sally Tomlinson, 1985. "The Expansion of Special Education," Oxford Review of Education, 11(2), p p. 157 (http:/ / www. jstor. org/ pss/
           • Margaret M. Bubolz and Alice P. Whiren, 1984. "The Family of the Handicapped: An Ecological Model for Policy and Practice," Family
        Relations, 33(1) [The Family with Handicapped Members], p p. 5 (http:/ / www. jstor. org/ pss/ 584584)-12.
    [17] • Oded Galor and David N. Weil, 1996. "The Gender Gap, Fertility, and Growth,” American Economic Review, 86, 374-387.
           • Joyce P. Jacobsen, 2008. "gender roles and division of labour," The New Palgrave Dictionary. Abstract. (http:/ / www.
        dictionaryofeconomics. com/ article?id=pde2008_G000185& q=gender & topicid=& result_number=1)
           • Joyce P. Jacobsen, 1998. Economics of Gender. Blackwell. Description & chapter previews. (http:/ / books. google. com/
        books?id=DYWd8TACgpEC& dq=Joyce+ P. + Jacobsen+ (1998). + 'Economics+ of+ Gender,+ 2nd+ Edition. & source=gbs_summary_s&
    [18] • Thomas Sowell, 1975. Race and Economics, McKay.
           • _____, 1995. Race and Culture: A World View. Basic Books. Description & chapter previews. (http:/ / books. google. com/
        books?id=oMMab6JiwtAC& dq=race+ economics& lr=& source=gbs_summary_s& cad=0)
    [19] • JEL classification codes#Labor and demographic economics JEL: J Subcategories.
           • Labor and Demographic Economics: Demographic Economics (http:/ / www. nber. org/ jel/ J1. html), NBER Working Paper abstract links
        from the National Bureau of Economic Research.
    [20] • Assaf Razin and Efraim Sadka, 1996. Population Economics. MIT Press. Description & chapter previews. (http:/ / books. google. com/
        books?id=8svrMQuhUE8C& dq="Population+ economics"& source=gbs_summary_s& cad=0)
           • Mark R. Rosenzweig and Oded Stark, ed., 1997. Handbook of Population and Family Economics. lst-page ch. links, v. 1A (http:/ / www.
        sciencedirect. com/ science?_ob=PublicationURL& _tockey=#TOC#24618#1997#999989999. 7998#584868#FLP#& _cdi=24618&
        _pubType=HS& _auth=y& _prev=y& _acct=C000050221& _version=1& _urlVersion=0& _userid=10&
        md5=be6a4f0970a890b57834768dad25dd88) & v. 1B (http:/ / www. sciencedirect. com/ science/ handbooks/ 1574003X), pp. 1422. Elsevier.
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      Description (http:/ / books. google. com/ books?id=yJbG4avfHXwC& source=gbs_navlinks_s), v. 1A preview (http:/ / books. google. com/
      books?id=yJbG4avfHXwC& printsec=frontcover& source=gbs_atb#v=onepage& q& f=false), and ch. 1 link. (http:/ / books. google. com/
      books?id=yJbG4avfHXwC& pg=PA1& lpg=PA1& dq="Handbook+ of+ Population+ and+ Family+ Economics"& source=bl&
      ots=8ZzJO2b4XC& sig=6OC1ID3TkmJuVhTlOtwhIo0w7aA& hl=en& ei=ej73StysJY3klAeb5IDyCg& sa=X& oi=book_result& ct=result&
      resnum=6& ved=0CBcQ6AEwBQ#v=onepage& q=& f=false)
         • Search of The New Palgrave Dictionary of Economics Online, "population OR demography". (http:/ / www. dictionaryofeconomics. com/
      search_results?q=population+ OR+ demography& button_search=Search)

    • John Eatwell, Murray Milgate, and Peter Newman, ed. ([1987] 1989. Social Economics: The New Palgrave, p p. v
      dq="social+economics"+"new+palgrave")- vi. (
      pg=PR6&lpg=PP1&ots=wvV_b6AUQo&dq="social+economics"+"new+palgrave") Arrow-page searchable
      links to entries for:
          "Ageing Populations," p p. 1 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA1&
          lpg=PP1&dq="social+economics"+"new+palgrave")-3, by Robert L. Clark
          "Declining Population," p p. 10 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA10&
          lpg=PP1&dq="social+economics"+"new+palgrave")-15, by Robin Barlow
          "Demographic Transition," p p. 16 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA16&
          lpg=PP1&dq="social+economics"+"new+palgrave")-23, by Ansley J. Coale
          "Extended Family," p p. 58 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA58&
          lpg=PP1&dq="social+economics"+"new+palgrave")-63, by Oliva Harris
          "Family," p p. 65 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA64& lpg=PP1&
          dq="social+economics"+"new+palgrave")-76, by Gary S. Becker
          "Fertility," p p. 77 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA77& lpg=PP1&
          dq="social+economics"+"new+palgrave")-89, by Richard A. Easterlin
          "Gender," p p. 95 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA95& lpg=PP1&
          dq="social+economics"+"new+palgrave")-108, by Francine D. Blau
          "Race and Economics," p p. 215 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA215&
          lpg=PP1&dq="social+economics"+"new+palgrave")-218, by H. Stanback
          "Value of Life," p p. 289 (http:/ / books. google. com/ books?id=PTmXshBmTUAC& pg=PA269&
          lpg=PA269&       dq=+      Thomas+    C.      +    Schelling&    source=bl& ots=wvZWf3zUPu&
          sig=Ohuyy7LAHsJjW4TRvL2UBk8u5oY&               hl=en&     ei=qYdsS8WWJM2PtgeFld2EBg&    sa=X&
          oi=book_result& ct=result& resnum=6& ved=0CCgQ6AEwBQ#v=onepage& q="Value of Life" Thomas C.
          Schelling&f=false)-76, by Thomas C. Schelling
    • Nathan Keyfitz, 1987. "demography," The New Palgrave: A Dictionary of Economics, v. 1, pp. 796–802.
    • T. Paul Schultz, 1981. Economics of Population. Addison-Wesley. Abstract. (
    • John B. Shoven, ed., 2011. Demography and the Economy, University of Chicago Press. Scroll-down description
      ( and
    preview. (
    • Julian L. Simon, 1977. The Economics of Population Growth. Princeton,
    • _____, [1981] 1996. The Ultimate Resource 2, rev. and expanded. Princeton. Description. (
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        • Dennis A. Ahlburg, 1998. "Julian Simon and the Population Growth Debate," Population and Development
           Review, 24(2), pp. 317-327 ( (press +).
    •   Julian L. Simon, ed., 1997. The Economics Of Population: Key Modern Writings. Description. (http://www.
    •   _____, ed., 1998. The Economics of Population: Classic Writings. Description (
        books?id=VEu9EwQ9vTcC&dq=gbs_navlinks_s) and scroll to chapter-preview links. (
    •   Joseph J. Spengler 1951. "The Population Obstacle to Economic Betterment," American Economic Review, 41(2),
        p p. 343 (
    •   _____, 1966. "The Economist and the Population Question," American Economic Review, 56(1/2), pp. 1–24.

    • Demography — Scope and links to issue contents & abstracts. (
    • Journal of Population Economics — Aims and scope ( and 20th
      Anniversary statement (
      print=true(1988)), 2006.
    • Population and Development Review — Aims and abstract & supplement links. (
    • Population Bulletin — Each issue on a current population topic. (
    • Population Studies — Aims and scope. (
    • Review of Economics of the Household
Law and economics                                                                                                                185

    Law and economics
    Law and economics or economic analysis of law is the application of economic methods to analysis of law.
    Economic concepts are used to explain the effects of laws, to assess which legal rules are economically efficient, and
    to predict which legal rules will be promulgated.[1][2]

    Relationship to other disciplines and approaches
    As used by lawyers and legal scholars, the phrase "law and economics" refers to the application of the methods of
    economics to legal problems. Because of the overlap between legal systems and political systems, some of the issues
    in law and economics are also raised in political economy, constitutional economics and political science.
    Approaches to the same issues from Marxist and critical theory/Frankfurt School perspectives usually do not identify
    themselves as "law and economics". For example, research by members of the critical legal studies movement and
    the sociology of law considers many of the same fundamental issues as does work labeled "law and economics".
    The one wing that represents a non-neoclassical approach to "law and economics" is the Continental (mainly
    German) tradition that sees the concept starting out of the governance and public policy (Staatswissenschaften)
    approach and the German Historical school of economics; this view is represented in the Elgar Companion to Law
    and Economics (2nd ed. 2005) and—though not exclusively—in the European Journal of Law and Economics. Here,
    consciously non-neoclassical approaches to economics are used for the analysis of legal (and
    administrative/governance) problems.

    Origin and history
    As early as in the 18th century, Adam Smith discussed the economic effect of mercantilist legislation. However, to
    apply economics to analyze the law regulating nonmarket activities is relatively new. In 1961, Ronald Coase and
    Guido Calabresi independently from each other published two groundbreaking articles: "The Problem of Social
    Cost"[3] and "Some Thoughts on Risk Distribution and the Law of Torts".[4] This can be seen as the starting point for
    the modern school of law and economics.[5]
    In the early 1970s, Henry Manne (a former student of Coase) set out to build a Center for Law and Economics at a
    major law school. He began at Rochester, worked at Miami, but was soon made unwelcome, moved to Emory, and
    ended at George Mason. The latter soon became a center for the education of judges—many long out of law school
    and never exposed to numbers and economics. Manne also attracted the support of the John M. Olin Foundation,
    whose support accelerated the movement. Today, Olin centers (or programs) for Law and Economics exist at many

    Positive and normative law and economics
    Economic analysis of law is usually divided into two subfields, positive and normative.

    Positive law and economics
    Positive law and economics uses economic analysis to predict the effects of various legal rules. So, for example, a
    positive economic analysis of tort law would predict the effects of a strict liability rule as opposed to the effects of a
    negligence rule. Positive law and economics has also at times purported to explain the development of legal rules,
    for example the common law of torts, in terms of their economic efficiency.
Law and economics                                                                                                              186

    Normative law and economics
    Normative law and economics goes one step further and makes policy recommendations based on the economic
    consequences of various policies. The key concept for normative economic analysis is efficiency, in particular,
    allocative efficiency.
    A common concept of efficiency used by law and economics scholars is Pareto efficiency. A legal rule is Pareto
    efficient if it could not be changed so as to make one person better off without making another person worse off. A
    weaker conception of efficiency is Kaldor-Hicks efficiency. A legal rule is Kaldor-Hicks efficient if it could be made
    Pareto efficient by some parties compensating others as to offset their loss.

    Important scholars
    Important figures include the Nobel Prize winning economists Ronald Coase and Gary Becker, U.S. Court of
    Appeals for the Seventh Circuit judges Frank Easterbrook and Richard Posner, Andrei Shleifer and other
    distinguished scholars such as Robert Cooter, Henry Manne, William Landes, and A. Mitchell Polinsky. Guido
    Calabresi, judge for the U.S. Court of Appeals for the Second Circuit, author of the 1970 book, The Costs of
    Accidents: A Legal and Economic Analysis, wrote in depth on this subject, with Costs of Accidents being cited as
    influential in its extensive treatment of the proper incentives and compensation required in accident situations.[6]
    Calabresi took a different approach in his 1985 book, Ideals, Beliefs, Attitudes, and the Law, where he argued, "who
    is the cheapest avoider of a cost, depends on the valuations put on acts, activities and beliefs by the whole of our law
    and not on some objective or scientific notion (69)."

    In the United States, economic analysis of law has been extremely influential. Judicial opinions utilize economic
    analysis and the theories of law and economics with some regularity. The influence of law and economics has also
    been felt in legal education. Many law schools in North America, Europe, and Asia have faculty members with a
    graduate degree in economics. In addition, many professional economists now study and write on the relationship
    between economics and legal doctrines. Anthony Kronman, former dean of Yale Law School, has written that "the
    intellectual movement that has had the greatest influence on American academic law in the past quarter-century [of
    the 20th Century]" is law and economics.[7]

    Despite its influence, the law and economics movement has been criticized from a number of directions. This is
    especially true of normative law and economics. Because most law and economics scholarship operates within a
    neoclassical framework, fundamental criticisms of neoclassical economics have been drawn from other, competing
    frameworks and applied to the work of law and economics.

    Rational choice theory
    Critics of the law and economics movements have argued that normative economic analysis does not capture the
    importance of human rights and concerns for distributive justice. Some of the heaviest criticisms of the "classical"
    law and economics come from the critical legal studies movement, in particular Duncan Kennedy[8] and Mark
Law and economics                                                                                                               187

    Pareto efficiency
    Relatedly, additional critique has been directed toward the assumed benefits of law and policy designed to increase
    allocative efficiency when such assumptions are modeled on "first-best" (Pareto optimal) general-equilibrium
    conditions. Under the theory of the second best, for example, if the fulfillment of a subset of optimal conditions
    cannot be met under any circumstances, it is incorrect to conclude that the fulfillment of any subset of optimal
    conditions will necessarily result in an increase in allocative efficiency.[9]
    Consequently, any expression of public policy whose purported purpose is an unambiguous increase in allocative
    efficiency (for example, consolidation of research and development costs through increased mergers and acquisitions
    resulting from a systematic relaxation of anti-trust laws) is, according to critics, fundamentally incorrect, as there is
    no general reason to conclude that an increase in allocative efficiency is more likely than a decrease.
    Essentially, the "first-best" neoclassical analysis fails to properly account for various kinds of general-equilibrium
    feedback relationships that result from intrinsic Pareto imperfections.[9]
    Another critique comes from the fact that there is no unique optimal result. Warren Samuels in his 2007 book, The
    Legal-Economic Nexus, argues, "efficiency in the Pareto sense cannot dispositively be applied to the definition and
    assignment of rights themselves, because efficiency requires an antecedent determination of the rights (23-4)."

    Law and economics has adapted to some of these criticisms (see "contemporary developments," below). One critic,
    Jon D. Hanson [10] of Harvard Law School, argues that our legal, economic, political, and social systems are unduly
    influenced by an individualistic model that assumes "dispositionism"—the idea that outcomes are the result of our
    "dispositions" (economists would say "preferences"). Instead, Hanson argues, we should look to the "situation" [11],
    both inside of us (including cognitive biases) and outside of us (family, community, social norms, and other
    environmental factors) that have a much larger impact on our actions than mere "choice." Hanson has written many
    law review articles [12] on the subject and has books forthcoming.

    Contemporary developments
    Law and economics has developed in a variety of directions. One important trend has been the application of game
    theory to legal problems. Other developments have been the incorporation of behavioral economics into economic
    analysis of law, and the increasing use of statistical and econometrics techniques. Within the legal academy, the term
    socio-economics has been applied to economic approaches that are self-consciously broader than the neoclassical

    Universities with law and economics programs
    Almost every major American law school, and most leading economics departments, offer courses in law and
    economics and has faculty working in the field.
    Two of the leading law schools focusing on Law and Economics are the University of Chicago Law School, whose
    faculty includes Judge Richard A. Posner, Ronald Coase and Gary Becker, and the George Mason University School
    of Law, whose faculty used to include Nobel laureate Vernon Smith (though Smith and his team have since moved
    to Chapman University), and perennial Nobel finalist Gordon Tullock. In the spring of 2006, Vanderbilt University
    Law School announced the creation of a new program to award a Ph.D. in Law & Economics. A ranking of law and
    economics Ph.D. programs was published in the Southern Economics Journal in 2008, and also includes among the
    top 10 programs (based on publications in the field) the economics departments at UC Berkeley, Harvard University,
    University of Connecticut, UC San Diego, Princeton University, MIT, University of Wisconsin - Madison, Florida
    State University, Central Michigan University, and the University of Michigan.[13]
Law and economics                                                                                                           188

    In Europe, a consortium of universities from ten different countries is running the European Master Program in Law
    and Economics, also known as EMLE, which is a European program in the field since 1990. This programme offers
    the unique opportunity for interdisciplinary studies of law and economics at two or even three European and
    Non-European universities. Each partner university awards a Master degree (LL.M. / M.A. / M.Sc.). The programme
    also provides students with an advanced understanding of the economic effects of divergent laws and prepares
    students for a professional career, for example, in public organisations, in multinational law firms or consultancy
    firms. Graduates are also well prepared for doctorate research in a PhD programme such as the European Doctorate
    in Law and Economics (EDLE), which is operated by three European centers in Law and Economics. [14]
    The University of Toronto's Faculty of Law offers a combined J.D./M.A. Economics, as well as a J.D./Ph.D.
    Since 2009 there has been created a new PhD program in Law and Economics of Finance and Money from Goethe
    University in Frankfurt am Main/Germany. The program is entirely created for the purpose of research in fields such
    as regulation of Financial Institutions and Market Regulation. The program is thought to be finished within four
    years and is entirely taught in English.
    The Collegio Carlo Alberto in Turin, Italy hosts an International Ph.D. Program in Institutions, Economics and Law
    within the Centre for the Comparative Analysis of Law and Economics, Economics of Law, Economics of
    Institutions. Members of the teaching staff come from various academic institutes in Europe and the United States. A
    separate Doctoral Program in Law and Economics is currently run by the School of Economics at the University of
    Siena. Also in Italy, the International University College of Turin, with students and faculty from worldwide, runs a
    biennial Master of Sciences in Comparative Law, Economics and Finance, which challenges mainstream views on
    the subject. In 2012 the Università Cattolica del Sacro Cuore opened the first faculty of economics and law in Italy.
    Central European University in Budapest, Hungary offers both an MA and LLM in Law and Economics. The
    program is offered in both the university's Economics Department, as well as in its Legal Studies Department. This
    program is registered in the United States by the Commission on Higher Education of the Middle States Association
    of Colleges and Schools.
    Switzerland's University of St. Gallen has a Law and Economics Program on both the undergraduate (Bachelor of
    Arts in Law and Economics) and graduate levels (Master of Arts in Law and Economics). The graduate program was
    initiated in October 2005 at the first international scientific conference on Law and Economics by the President of
    the University, Ernst Mohr and the St. Gallen Professor and leading business lawyer Peter Nobel. The Law and
    Economics Program is supported by an International Academic Council lead by leading experts in the field of law
    and economics, such as Richard A. Posner, Ronald J. Gilson, Victor Goldberg or Geoffrey P. Miller.
    Operating outside this particular framework, Utrecht University offers students the possibility to major in law and
    economics as part of their undergraduate studies, or to specialize in law and economics in a one-year post-graduate
    University of Economics, Prague, specifically the Department of Institutional Economics at the Faculty of
    Economics and Public Administration, offers Law and Economics as a possible specialization for graduate students,
    while a complete graduate program is being prepared.
    The University of Leicester runs a degree program called "Economics and Law", with various modules taught in the
    specific area.The University of Cambridge offers the option of a 'Law and Economics' paper within the Land
    Economy Tripos.[15] The University of Manchester Law School, Nottingham University Business School and City
    University Law School, London have undergraduate courses in Law and Economics. University College London
    offers undergraduate courses in Law and Economics in its Economics Faculty and post-graduate courses in its Law
    The Centre for Economic Studies and Planning, Jawaharlal Nehru University, was the first to introduce a
    Post-graduate Optional course in Law and Economics in India. In the past few years Law and economics has also
Law and economics                                                                                                                                      189

    become one of the major research areas at the centre. The Delhi School of Economics also offers law and economics
    courses at the post graduate level. The National University of Juridical Sciences (NUJS) offers two courses in Law
    and Economics to its undergraduate students, as does NALSAR University of Law. A Post-graduate Optional Course
    is now offered in University of Hyderabad by the Department of Economics, School of Social Sciences.
    Bilkent University Faculty of Law in Turkey has also launched a graduate degree program on September 2010, titled
    "Law and Economics". The program runs for one year, containing courses and seminars on conventional economic
    analyses of law, along with the application of these analyses on the energy and telecommunication sectors of Turkey.
    Seminars and courses are taught in both Turkish and English.
    In the National University of Singapore, a Double Honours Programme in Law and Economics was launched in
    2005, whereby students complete two Bachelors' degrees in five years. Similarly, the Singapore Management
    University offers a Double Degree Programme in Law and Economics whereby students graduate with Bachelor's
    degrees in both subjects.[16] Economic Analysis of Law is also offered as a module for students in the School of Law
    at Singapore Management University.[17]
    The University of Bonn has recently founded a Center for the Advanced Studies of Law and Economics (CASTLE).
    The International Max Planck Research School for Competition and Innovation is a PhD program offered jointly by
    the Max Planck Institute for Intellectual Property and Competition Law and the Ludwig Maximilians University in
    Munich (Germany). The program selects outstanding candidates from the fields of law and economics to produce
    doctoral research in the area of the law and economics of intellectual property and competition law.[18]
    China University of Political Science and Law provides a Master/PhD program of Law and Economics. Its Center
    for Law and Economics, which was established in 2005, hold lectures and exchange activities regularly.
    The University of Reading has launched a new LLM/MSc in Law and Economics providing a critical approach to
    the interrelation between the two disciplines. The programme shall enable law students to understand the economic
    effects of legal rules and economics students to understand the institutional legal framework of market economies.

    [1] David Friedman (1987). "law and economics," The New Palgrave: A Dictionary of Economics, v. 3, p. 144.
    [2] Mohammad Amin & Jamal Haidar, 2012. " The cost of registering property: does legal origin matter? (http:/ / papers. ssrn. com/ sol3/ papers.
        cfm?abstract_id=1287217)," Empirical Economics, Springer, vol. 42(3), pages 1035-1050, June
    [3] Coase, Ronald (1960). "The Problem of Social Cost". The Journal of Law and Economics 3 (1): 1–44. doi:10.1086/466560. This issue was
        actually published in 1961.
    [4] Calabresi, Guido (1961). "Some Thoughts on Risk Distribution and the Law of Torts". Yale Law Journal (The Yale Law Journal Company,
        Inc.) 70 (4): 499. doi:10.2307/794261. JSTOR 794261.
    [5] Posner, Richard (1983). The Economics of Justice. Cambridge: Harvard University Press. p. 4. ISBN 0-674-23525-8.
    [6] Litan, Robert (1988). Liability: Perspectives and Policy. Brookings Institution Press. ISBN 0-8157-5271-7.
    [7] Anthony T. Kronman, The Lost Lawyer 166 (1993).
    [8] http:/ / www. duncankennedy. net/ topics/ law_economics. html
    [9] Markovits, Richard (Vol. 73, 1998). Second-Best Theory and Law & Economics: An Introduction. Chicago-Kent Law Review.
    [10] http:/ / www. law. harvard. edu/ faculty/ directory/ index. html?id=25
    [11] http:/ / thesituationist. wordpress. com/ about-situationism/
    [12] http:/ / papers. ssrn. com/ sol3/ papers. cfm?abstract_id=938005#PaperDownload
    [13] "A guide to graduate study in economics: ranking economics departments by fields of expertise. - Free Online Library" (http:/ / www.
        thefreelibrary. com/ A+ guide+ to+ graduate+ study+ in+ economics:+ ranking+ economics+ departments. . . -a0179073418). 2008-04-01. . Retrieved 2012-02-05.
    [14] http:/ / www. edle-phd. eu
    [15] http:/ / www. landecon. cam. ac. uk/
    [16] (http:/ / www. law. smu. edu. sg/ blaw/ DoubleDP. asp)
    [17] (http:/ / www. law. smu. edu. sg/ blaw/ corecourses_description. asp#economic)
    [18] "Max-Planck-Institut für Immaterialgüter- und Wettbewerbsrecht- Aktuelles" (http:/ / www. ip. mpg. de/ ww/ de/ pub/ mikroseiten/
        imprs_ci/ home. cfm;target=mainFrame). . Retrieved 2012-02-05.
Law and economics                                                                                                         190

    Further reading
    • Bouckaert, Boudewijn, and Gerrit De Geest, eds. (2000). Encyclopedia of Law and Economics (Edward Elgar,
      Online version. (
    • Coase, Ronald (1990). The Firm, The Market, and the Law (Chicago: University of Chicago Press, reprint ed.)
      ISBN 0-226-11101-6.
    • Cooter, Robert and Thomas Ulen (2012). Law and Economics (Addison Wesley Longman, 6th edition). ISBN
    • Friedman, David (1987). "law and economics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 144–48.
    • _____ (2000). Law's Order. (Princeton University Press). Chapter links. links. (http://www.daviddfriedman.
    • Georgakopoulos, Nicholas L. (2005). Principles and Methods of Law and Economics: Basic Tools for Normative
      Reasoning (Cambridge University Press, ISBN 0-521-82681-0).
    • Kennedy, Duncan (1998). "Law-and-Economics from the Perspective of Critical Legal Studies" (from The New
      Palgrave Dictionary of Economics and the Law PDF ( and
      Economics from the Perspective of cls.pdf)
    • Kornhauser, Lewis (2006). "The Economic Analysis of Law," (
      legal-econanalysis/) Stanford Encyclopedia of Philosophy.
    • Mestmäcker, Ernst-Joachim (2007). A Legal Theory without Law: Posner v. Hayek on Economic Analysis of Law.
      Tübingen: Mohr. ISBN 978-3-16-149276-1.
    • Polinsky, A. Mitchell, and Steven Shavell (2008). "law, economic analysis of," The New Palgrave Dictionary of
      Economics, 2nd Edition. Abstract (
      q=Law&topicid=&result_number=4) and pre-publication copy (
    • Posner, Richard A. (2007). Economic Analysis of Law (Aspen, 7th edition). ISBN 978-0-7355-6354-4.
    • _____ (2006). "A Review of Steven Shavell's Foundations of Economic Analysis of Law," Journal of Economic
      Literature, 44(2), pp. 405-414 ( Of Economic lietratur/Content/
      2006/jun/articles/jun06_posner.pdf) (press +).
    • Shavell, Steven (2004). Foundations of Economic Analysis of Law. Harvard University Press. Description (http:// and scroll to chapter-preview links. (http://books."Foundations+of+Economic+Analysis+of+Law"&
    • Robé, Jean-Philippe, The Legal Structure of the Firm, Accounting, Economics, and Law: Vol. 1 : Iss. 1, Article 5,
      Available at: (2011).
Industrial organization                                                                                                           191

     Industrial organization
     Industrial organization is the field of economics that builds on the theory of the firm in examining the structure of,
     and boundaries between, firms and markets.[1]
     The subject has been described as concerned with markets that "cannot easily be analyzed using the standard
     textbook competitive model."[2] Industrial organization adds to the perfectly competitive model real-world frictions
     such as transaction costs,[3] limited information, and barriers to entry of new firms that may be associated with
     imperfect competition. It analyzes determinants of firm and market organization and behavior as between
     competition and monopoly,[4] including from government actions.
     There are different approaches to the subject. One is descriptive in providing an overview of industrial organization,
     such as measures of competition and the size-concentration of firms in an industry. A second uses microeconomic
     models to explain internal firm organization and market strategy.[5] As to strategic firm interaction, non-cooperative
     game theory has become the standard unifying method of analysis.[6] A third aspect is oriented to public policy as to
     economic regulation[7] and antitrust law.[8][9]
     The development of industrial organization as a separate field owes much to Edward Chamberlin,[10] Edward S.
     Mason,[11] and particularly Joe S. Bain[12] among others.[13][14]
     Assessments of the subject have differed over time. The preface to a related research volume in 1972 remarked on
     Whither industrial organization?: "That all is not well with this in this once flourishing field is readily apparent."[15]
     A response came 15 years later: "[T]oday's verdict is that industrial organization is alive and well and the queen of
     applied microeconomics."[16]

     The Journal of Economic Literature (JEL) classification codes are one way of categorizing the range of economics
     subjects. Industrial Organization, one of 19 primary classifications, has 9 categories. They are listed below with
     footnote links to their respective subareas[17] and with JEL-code links to corresponding available article-preview
     links of The New Palgrave Dictionary of Economics Online.
           JEL: L1 [18] – Market Structure, Firm Strategy, and Market Performance[19]
           JEL: L2 [20] – Firm Objectives, Organization, and Behavior[21]
           JEL:L3 [22] – Non-profit organizations and Public enterprise[23]
           JEL: L4 [24] – Antitrust Issues and Policies[25]
           JEL: L5 [26] – Regulation and Industrial policy[27]
           JEL: L6 [28] – Industry Studies: Manufacturing[29]
           JEL: L7 – Industry Studies: Primary Products and Construction[30]
           JEL: L8 [31] – Industry Studies: Services[32]
           JEL: L9 [33] – Industry Studies: Transportation and Utilities[34]

     Structure, conduct, performance
     According to the structure-conduct-performance approach, an industry's performance (the success of an industry in
     producing benefits for the consumer) depends on the conduct of its firms, which then depends on the structure
     (factors that determine the competitiveness of the market). The structure of the industry then depends on basic
     conditions, such as technology and demand for a product.[35] For example: in an industry with technology that the
     average cost of production falls as output increases, the industry tends to have one firm, or possibly a small number
     of firms.
Industrial organization                                                                                                            192

     Components that make up the structure, conduct, and performance model for industrial organization include:
     • basic conditions: consumer demand, production, elasticity of demand, technology, substitutes, raw materials,
       seasonality, unionization, rate of growth, product durability, location, lumpiness of orders, scale of economies,
       method of purchase, scope economies
     • structure: number of buyers and sellers, barriers to entry of new firms, product differentiation, vertical
       integration, diversification
     • conduct: advertising, research and development, pricing behavior, plant investment, legal tactics, product choice,
       collusion, merger and contracts
     • performance: price, production efficiency, allocative efficiency, equity, product quality, technical progress,
     • government policy: government regulation, antitrust, barriers to entry, taxes and subsidies, investment
       incentives, employment incentives, macroeconomic policies
     Industrial organization The subject of industrial organization applies the economics’ model of price theory to the
     real world industries. The goal of industrial organization study is to increase the understanding of how industries
     operate, improve the industries contribution to the economic welfare, and to improve government policy toward
     these industries.
     Structure Conduct Performance Paradigm (SCPP) SCPP is an approach used to analyze the relation among
     market performance, market conduct, and market structure. The SCPP indicates that market structure determines the
     market conduct, and thereby sets the level of market performance. Working backward, we find that market
     performance is determined by market conduct, which in return depends on market structure. SCP has been applied to
     a diverse range of problems, from helping businesses become more profitable to helping understand the subprime
     mortgage crisis in the United States.[36]
     Economists are especially interested in studying the SCPP because they tend to believe that seller concentration
     affects the industry’s social performance. The economic theorists express that effect in terms of higher profits earned
     by the monopoly. On the other hand, Industrial Organization economists express the effect in terms of locative
     inefficiency. However, economists who use the Structure Conduct Performance (SCP) approach disagree on the
     emphases that they give to each of the three elements. Some give market structure and market conduct an equal
     importance in determining market performance. Others argue that market conduct is largely determined by market
     structure, hence, market performance depends heavily on market structure, and that leads them to pay little attention
     to market conduct.
     Market Structure Conduct and Performance SCP framework was derived from the neo-classical analysis of markets.
     The SCPP was the brainchild of the Harvard school of thought and popularized during 1940-60 with its empirical
     work involving the identification of correlations between industry structure and performance. This SCP hypothesis
     has led to the implementation of most anti-trust legislation. The Chicago school of thought followed this from 1960
     to 1980. They emphasized on the rationale for firms becoming big, price theory and econometric estimation. During
     1980-90 game theory took center stage with emphasis on strategic decision-making and Nash equilibrium concept.
     After 1990, empirical industrial organization with the use of economic theory and econometrics led to complex
     empirical modeling of technological changes, merger analysis, entry-exit and identification of market power.
     Market structure The Market structure consists of the relatively stable features of the market environment that
     influence rivalry among the buyers and sellers operating within this market. The main elements that influence market
     structure are, seller concentration, product differentiation, barriers to entry, barriers to exit, buyer concentration, and
     the growth rate of market demand. Other elements of market structure exist, but they are usually unstable and
     therefore ignored either because they can’t be measured or because they are hard to observe.
     Elements of market structure
     Seller concentration
Industrial organization                                                                                                           193

     Refers to the number and size distribution of firms in the market. The most widely used device is determining seller
     concentration is the Concentration Ratio. To compute the concentration ratio, the firms are ranked in order of size
     “usually measured in terms of sale”, starting from the largest in the industry at the top and going down to the smallest
     firm at the bottom. Concentration ratios are usually given for the largest 4, largest 8, and sometimes the largest 20
     firms. Usually industries that are highly concentrated in one advanced economy tend to be highly concentrated in
     Product differentiation A differentiation or distinguishing a product from the products of other competing firms.
     Differentiation of products along key features and minor details is an important strategy for firms to defend their
     price from leveling down to marginal cost.
     Horizontal differentiation When products are different according to features that can't be ordered in an objective
     way, or in other words, at the same price, some consumers would prefer the product while others would prefer a
     different substitute Horizontal differentiation can be differentiation in colors (different color version for the same
     good), in styles (e.g. modern/antique), or in tastes. A typical example is the ice cream offered in different tastes.
     Chocolate is not better than Mango.
     Vertical differentiation Vertical differentiation occurs in a market where the several goods that are present can be
     ordered according to their objective quality from the highest to the lowest. It's possible to say in this case that one
     good is "better" than another.
     Mixed differentiation Certain markets are characterized by both horizontal and vertical differentiation. For instance,
     apparel, and shoes have a rich combination of shapes, colors, materials, and appropriateness to social events. In such
     markets, the differences in colors or shapes are horizontal differentiation, while the quality of the materials is usually
     perceived as vertical differentiation.
     Barriers to entry A set of economic forces that create a disadvantage to new competitors attempting to enter the
     market. These forces could be government regulation such as IP rights, or patent, or they could be large economies
     of scale in a specific industry, or high sunk costs required to enter the market. Sometimes firms within a specific
     industry adopt certain pricing strategies to create barriers to entry, one of the most widely adopted strategy is limit
     pricing by lowering prices to a level that would force any new entrants to operate at a loss, this strategy is especially
     effective when the existing firms have a cost advantage over potential entrants.[37]
     Barriers to exit A set of economics forces that influence the firms decision of exiting the market, such forces make
     it cheaper for the existing firm to stay in the market than to exit the market. Although sunk costs could be barriers to
     entry, especially when the sunk costs are too large, sunk costs could be a huge barrier to exit as well, because large
     investments in fixed plant and equipment commits the firm to stay in the market. Barriers to exit increase the
     intensity of competition in an industry because existing firms have little choice but to stay and fight when market
     conditions have deteriorated. The loss of business reputation and consumer goodwill, could be a barrier to exit
     especially if the firm is planning on reentering the market later, or when the firm exits a specific market but still
     operating in other markets. In such a situation, the decision to leave the market can seriously hurt the reputation of
     the firm among current consumers in other markets, and affect the goodwill among previous customers, not least
     those who have bought a product which is then withdrawn and for which replacement parts become difficult or
     impossible to obtain.
     Buyer concentration The number of buyers in a market. Buyer concentration is as equally important as seller
     concentration, especially in markets with a few buyers. The term was used by Michael E. Porter in 1979 in his “Five
     Forces Analysis”. Porter’s analysis proposes that in markets with high buyer concentration, the firms earn lower level
     of profits than in markets with low buyer concentration
     The growth rate of market demand The market structure in industries with a relatively static demand or low
     growth rate of demand is different from the market structure in industries with an accelerated demand growth. That’s
     because when the demand grows fast enough, the firms have their hands full just expanding their production
     capacities, in this case, if new entrants are coming in, there will be little incentive to fight for market share. Also,
Industrial organization                                                                                                            194

     firms are likely to honor oligopolistic agreements with each other, and profits tend to be high. All these elements of
     market structure tend to be stable over time. However, they are all interrelated. Any change in one tends to bring
     about changes in another. By realizing this relation among the different elements of market structure, it becomes
     easier to understand why market structures change over time.
     Conduct Conduct means what firms do to compete with each other. It includes pricing, advertising, research and
     development investment, decisions on product dimensions, merger and acquisition, etc. Conduct also can include
     collusion both explicit or tacit.
     Performance The performance of an industry or firm is measured by profitability. Profit is the difference between
     revenue and cost, and revenue is determined by price. Thus performance can be influenced through changing costs or
     prices. Profitability can also be affected by a firm’s agility (i.e. ability to adjust to things like changes in market
     demand). Research and development, and availability of capitol and resources are factors that greatly influence
     whether or not a firm is agile. The ability to measure performance between industries is important in understanding
     the SCP relationships. For example, if an industry is dominated by one firm or cartel does not see higher costs than a
     competitive industry yet has monopoly prices, then that non-competitive industry will see higher profits, whereas if
     costs increase, then profitability levels will be relatively similar. This comparison is the driving force behind
     anti-trust legislation. SCPP predicts that performance increases with concentration of the industry. This is in contrast
     with the efficiency hypothesis that states that a firms performance is based on how well and efficiently it produces its
     product for the consumer.
     SCP Interaction Overview There are two competing hypotheses in the SCP paradigm: the traditional “structure
     performance hypothesis” and “efficient structure hypothesis”.
     The structure performance hypothesis states that the degree of market concentration is inversely related to the degree
     of competition. This is because market concentration encourages firms to collude. This hypothesis will be supported
     if positive relationship between market concentration (measured by concentration ratio) and performance (measured
     by profits) exist, regardless of efficiency of the firm (measured by market share). Thus firms in more concentrated
     industries will earn higher profits than firms operating in less concentrated industries, irrespective of their efficiency.
     The efficiency structure hypothesis states that performance of the firm is positively related to its efficiency. This is
     because market concentration emerges from competition where firms with low cost structure increase profits by
     reducing prices and expanding market share. A positive relationship between firm profits and market structure is
     attributed to the gains made in market share by more efficient firms, but not to the collusive activities, as the
     traditional SCP paradigm would suggest (Molyneux and Forbes, 1995).
     Relationship of structure to performance
     Early studies by Bain (1951; 1956) hypothesized a positive relationship between industry concentration, barriers to
     entry and profits. Though his studies are flawed in the measurement of profit rates and choice of industries (Brozen
     1971), later papers supported this hypothesis (Mann 1966; Weiss 1974).
     However, the differential in the performance measures between concentrated and non-concentrated industries fell
     substantially overtime (Brozen 1971; Hubbard and Petersen 1986). Moreover, studies based on more recent data tend
     to find only a weak relationship or no relationship between the structural variables and performance (Salinger 1984;
     Kwoka and Ravenscraft 1985). As a result, some econometric studies began to look at other factors impacting
     industry performance. These studies commonly found that high rates of return and industry growth are related.
     Other researchers studied the structure-performance relationship using alternative measures of performance, for
     example, the speed of adjustment of capital. They found that the capital-output ratio is positively related to
     concentration. The explanation for this phenomenon has not been verified, but it is possible that in highly
     concentrated markets, there are more specialized capital which is more difficult to adjust, thus in these markets high
     profits take longer to fall back to the industry average. Similarly, if concentrated industries take longer time to react
     to demand changes, then, all else equal, good economic news should raise the value of a company more in a
Industrial organization                                                                                                           195

     concentrated industry than in an non-concentrated industry (Lustgarten and Thomadakis 1980).
     Relationship between structure and conduct
     Conduct is influenced by market structure since firm strategies differ with competition. Inversely, conduct can
     influence market structure because firms can make entry cost endogenous by choosing different levels of quality,
     advertising and so on, thus affect the potential entrant number.
     Relationship between conduct and performance
     Conduct is related to performance. For example, advertising expenditure is usually higher in highly profitable
     industries, because firms with more profits can afford higher advertising costs, and in order to keep their profits and
     prevent new entrants into the profitable market, these firms would use advertising investments as endogenous sunk
     costs. Econometric studies linking profit to market structure often conclude that measured profitability is correlated
     with the advertising-to-sales ratio and with the R&D expenditures-to-sales ratio.
     In essence, with the SCPP we seek to find the answer to how firms interact and compete with each other in different
     situations, and the results of these interactions, and are these results consistent with an ideal competition or not. That
     way, an argument can be supported on whether or not action should be taken to alter the market structure or regulate
     market conduct. It is interesting there is such a debate on the emphasis on market structure vs. market conduct on the
     influence of performance since it is clear that structure and conduct are themselves influenced by each other. Joseph
     Bain was one of the first to realize this and his work led to the re-evaluation of public policy that had been fostered
     by the SCP framework. In industrial organization, real world, imperfect competition is studied, and there are so
     many different examples that the way markets are evaluated is continually evolving and changing. Thus every school
     of thought must be constantly re-evaluated as more data is generated.
     Carlton and Perloff, 2005, Modern Industrial Organization, 4th Edition, Pearson, Addison Wesley.
     Charles C. Fisher. “What can economics learn from marketing’s market structure analysis?”. Contribution of
     Marketing MSA to Economics MSA.
     Caves, E Richard (January 1992). “American Industry: Structure, Conduct, Performance”. Prentice Hall, 7th E. pp
     Edwards, Allen and Shaik (2006), "Market Structure Conduct Performance (SCP) Hypothesis Revisited using
     Stochastic Frontier Efficiency Analysis," presentation at the American Agricultural Economics Association Annual
     Meeting, Long Beach, California.
     Marion, Bruce. "Structure, Conduct, Performance Paradigm to Subsector Ananlysis." : Print.
     Michael E. Porter, Interbrand Choice, strategy, and bilateral market power (Cambridge, MA: Harvard University
     Press, 1976).
     Pepall, Lynne, Dan Richards, and George Norman. Industrial Organization Contemporary Theory and Empirical
     Applications. 4th ed. Malden, MA: Blackwll Publishing, 2008. Print.
     Piana, Valentino. “Product differentiation.”
     Weiss, Leonard W. “The Structure-Conduct-Performance Paradigm and Antitrust.” Apr., 1979 pp. 1104–1140. The
     University of Pennsylvania Law Review.
Industrial organization                                                                                                                               196

     Market structures
     The common market structures studied in this field are the following:
     •   Perfect competition
     •   Monopolistic competition
     •   Oligopoly
     •   Oligopsony
     •   Monopoly
     •   Monopsony

     Areas of study
     Industrial organization investigates the outcomes of these market structures in environments with
     •   Price discrimination
     •   Product differentiation
     •   Durable goods
     •   Experience goods
     •   Secondary markets or second-hand markets, which can affect the behaviour of firms in primary markets.
     •   Collusion
     •   Signalling, such as warranties and advertising.
     •   Mergers and acquisitions
     •   Entry and Exit
     A competitive market structure has the performance outcome of lower costs and lower prices, (Shepherd, W:
     The subject has a theoretical side and a practical side. According to one text book: "On one plane the field is abstract,
     a set of analytical concepts about competition and monopoly. On a second plane the topic is about real markets,
     teeming with the excitement and drama of struggles among real firms" (Shepherd, W.; 1985; 1).
     The extensive use of game theory in industrial economics has led to the export of this tool to other branches of
     microeconomics, such as behavioral economics and corporate finance. Industrial organization has also had
     significant practical impacts on antitrust law and competition policy.

     History of the field
     A 2009 book Pioneers of Industrial Organization traces the development of the field from Adam Smith to recent
     times and includes dozens of short biographies of major figures in Europe and North America who contributed to the
     growth and development of the discipline.[38]
     Other reviews by publication year and earliest available cited works those in 1970/1937,[13] 1972/1933,[39] 1974,[40]
     1987/7 from 1968 on, 3 from 1937 to 1956,[41] and 2009/c. 1900.[42]

     [1] • G.C. Archibald, 1987 (2008) (http:/ / www. dictionaryofeconomics. com/ article?id=pde2008_F000114& edition=current& q= theory of the
         firm& topicid=& result_number=2). "firm, theory of the," The New Palgrave: A Dictionary of Economics, v. 2, pp. 357-63. Keywords (http:/ /
         www. dictionaryofeconomics. com/ article?id=pde2008_F000114& edition=current& q=" firm, theory of the"& topicid=& result_number=1).
           • Jean Tirole, 1988. The Theory of Industrial Organization. "The Theory of the Firm," pp. 15–60. (http:/ / books. google. com/
         books?id=HIjsF0XONF8C& pg=PR7=false) MIT Press.
            • Bengt R. Holmström and John Roberts, 1998. "The Boundaries of the Firm Revisited," Journal of Economic Perspectives, 12(4), pp.
         73–94 (http:/ / pages. stern. nyu. edu/ ~wgreene/ entertainmentandmedia/ Holmstrom. pdf) (close Pages tab).
     [2] Richard Schmalensee, 1987. "Industrial Organization," The New Palgrave: A Dictionary of Economics, v. 2, p. 803.
Industrial organization                                                                                                                                     197

     [3] • R. H. Coase, 1937. "The Nature of the Firm," Economica, N.S., 4(16), pp. 386–405 (http:/ / www. sonoma. edu/ users/ e/ eyler/ 426/ coase1.
            •_____, 1988. "The Nature of the Firm: Influence," Journal of Law, Economics, & Organization, 4(1), pp. 33 (http:/ / www. jstor. org/ pss/
         765013)-47. Reprinted in The Nature of the Firm: Origins, Evolution, and Development, 1993, O. E. Williamson and S, G. Winter, ed., pp.
         61-74 (http:/ / books. google. com/ books?hl=en& lr=& id=VXIDgGjLHVgC& oi=fnd& pg=PA61& ots=RFe6lqpPv0&
         sig=7C6VuEwnEcuBa-E5HS8yWJ0LC_I#v=onepage& q& f=false).
            • _____, 1991. " The Institutional Structure of Production (http:/ / www. nobelprize. org/ nobel_prizes/ economics/ laureates/ 1991/
         coase-lecture. html)," Nobel Lecture, reprinted in 1992, American Economic Review, 82(4), pp. 713 (http:/ / www. jstor. org/ pss/
            • Oliver E. Williamson, 1981. "The Economics of Organization: The Transaction Cost Approach," The American Journal of Sociology,
         87(3), pp. 548-577 (http:/ / glenn. osu. edu/ faculty/ brown/ home/ Org Theory/ Readings/ Williamson1981. pdf).
            • _____, 2009. " Transaction Cost Economics: The Natural Progression (http:/ / nobelprize. org/ nobel_prizes/ economics/ laureates/ 2009/
         williamson_lecture. pdf)," Nobel Lecture. Reprinted in 2010, American Economic Review, 100(3), pp. 673–90.
     [4] • Luigi Zingales, 2008. "corporate governance," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract. (http:/ / www.
         dictionaryofeconomics. com/ article?id=pde2008_C000370& edition=current& q=governance & topicid=& result_number=1)
            • Oliver E. Williamson, 2002. "The Theory of the Firm as Governance Structure: From Choice to Contract," Journal of Economic
         Perspectives, 16(3), pp. 171-195. (http:/ / groups. haas. berkeley. edu/ bpp/ oew/ FirmAsGovernanceStructure. pdf)
            • Frederic M. Scherer and David Ross, 1990. Industrial Market Structure and Economic Performance, 3rd ed. Description (http:/ / papers.
         ssrn. com/ sol3/ papers. cfm?abstract_id=1496716) and 1st ed. review extract (http:/ / www. jstor. org/ pss/ 3003013).
            • Dennis W. Carlton and Jeffery M. Perloff, 2004. Modern Industrial Organization, 4th edition, pp. 2-3. Description. (http:/ / www.
         lavoisier. fr/ notice/ frSWORK23A3RW32O. html)
     [5] • Frederic M. Scherer and David Ross, 1990. Industrial Market Structure and Economic Performance, 3rd ed. Description (http:/ / papers.
         ssrn. com/ sol3/ papers. cfm?abstract_id=1496716) and 1st ed. review extract (http:/ / www. jstor. org/ pss/ 3003013).
            • Dennis W. Carlton and Jeffery M. Perloff, 2004. Modern Industrial Organization, 4th edition, pp. 2-3. Description. (http:/ / www.
         lavoisier. fr/ notice/ frSWORK23A3RW32O. html)
            • Jean Tirole, 1988. The Theory of Industrial Organization, MIT Press. Description (http:/ / mitpress. mit. edu/ catalog/ item/ default.
         asp?ttype=2& tid=8224), p. 3 (http:/ / books. google. com/ books?id=HIjsF0XONF8C& printsec=find& pg=PA3=gbs_atb#v=onepage& q&
         f=false), and [Part] I (http:/ / books. google. com/ books?id=HIjsF0XONF8C& printsec=find& pg=PR7=onepage& q& f=false#v=onepage&
         q& f=false), "The Exercise of Monopoly Power."
     [6] • Jean Tirole, 1988. The Theory of Industrial Organization, p. 3 (http:/ / books. google. com/ books?id=HIjsF0XONF8C& printsec=find&
         pg=PA3=gbs_atb#v=onepage& q& f=false) and [Part] II (http:/ / books. google. com/ books?id=HIjsF0XONF8C& printsec=find&
         pg=PR8=gbs_atb#v=onepage& q& f=false), "Strategic Interaction."
            • Drew Fudenberg and Jean Tirole, 1989. "Noncooperative Game Theory for Industrial Organization: An Introduction and Overview," ch. 5,
         Handbook of Industrial Organization, Elsevier, v. 1, pp. 259 (http:/ / www. sciencedirect. com/ science/ article/ pii/
            • Carl Shapiro, 1989. "The Theory of Business Strategy," RAND Journal of Economics, 20(1), pp. 125 (http:/ / www. jstor. org/ pss/
            • Kyle Bagwell and Asher Wolinsky (2002). "Game theory and Industrial Organization," ch. 49, Handbook of Game Theory with Economic
         Applications, v. 3, pp. 1851 (http:/ / www. sciencedirect. com/ science/ article/ pii/ S1574000502030126)-1895.
            • Martin Shubik, 1987. A Game-Theoretic Approach to Political Economy, Part II. MIT Press. Description (http:/ / mitpress. mit. edu/
         catalog/ item/ default. asp?tid=5086& ttype=2).
     [7] Richard Schmalensee and Robert Willig, eds., 1989. Handbook of Industrial Organization, Elsevier, v. 2, Part 5, Government Intervention in
         the Marketplace, ch. 22-26, abstract links. (http:/ / www. sciencedirect. com/ science/ handbooks/ 1573448X/ 2)
     [8] • Richard A. Posner, 2001. Antitrust Law, 2nd ed. University of Chicago Press. Preview. (http:/ / books. google. com/ books?hl=en& lr=&
         id=vV3i8XCzc8cC& oi=fnd& pg=PR5& dq==false)
            • D. L. Rubinfeld, 2001. "Antitrust Policy," International Encyclopedia of the Social & Behavioral Sciences, pp. 553–560. Abstract. (http:/ /
         www. sciencedirect. com/ science?_ob=ArticleURL& _udi=B7MRM-4MT09VJ-408& _rdoc=1& _hierId=151000135& _refWorkId=21&
         _explode=151000131,151000135& _fmt=high& _orig=na& _docanchor=& _idxType=SC& view=c& _ct=14& _acct=C000050221&
         _version=1& _urlVersion=0& _userid=10& md5=59512311cd68599ca6b13b23e9da8ed7)
     [9] • George J. Stigler, 1983. The Organization of Industry, University of Chicago Press. Description and contents links (http:/ / www. press.
         uchicago. edu/ presssite/ metadata. epl?isbn=9780226774329) and preview. (http:/ / books. google. com/ books?id=j6SOJv8OeHAC&
         printsec=find& pg=PA1=gbs_atb#v=onepage& q& f=false)
            • Richard Schmalensee, 1988. "Industrial Economics: An Overview," Economic Journal, 98(392), pp. 643 (http:/ / www. jstor. org/ pss/
         2233907)-681. Working paper link (http:/ / dspace. mit. edu/ bitstream/ handle/ 1721. 1/ 48172/ industrialeconom00schm. pdf?s. ).
            • Handbook of Industrial Organization, Elsevier:

            Richard Schmalensee and Robert Willig, ed., 1989. v. 1. Links to description & contents (http:/ / www.
            elsevier. com/ wps/ find/ bookdescription. cws_home/ 601119/ description#description) & (partial) chapter
            outlines. (
Industrial organization                                                                                                                                  198

            _____, ed., 1989. v. 2. Links to description & contents (http:/ / www. elsevier. com/ wps/ find/
            bookdescription. cws_home/ 601120/ description#description) and chapter outlines. (http:/ / www.
            Mark Armstrong and Robert Porter, ed., 2007. v. 3. Links to description (http:/ / books. google. com/
            books?id=bvrn72h8dDwC), chapter-content descriptions (http:/ / www. elsevier. com/ wps/ find/
            bookdescription. cws_home/ 601121/ description#description), chapter outlines (http:/ / www. sciencedirect.
            com/       science?_ob=PublicationURL&          _tockey=#TOC#24610#2007#999969999#667353#FLA#&
            _cdi=24610& _pubType=HS& _auth=y& _acct=C000050221& _version=1& _urlVersion=0& _userid=10&
            md5=a5b1e4caee2574c6b4cc7ba37c5de3f7),         and    preview.     (http:/ / books. google. com/
     [10] • Edward Hastings Chamberlin, 1933. The Theory of Monopolistic Competition: A Re-orientation of the Theory of Value, 1965, 8th ed.
         Harvard University Press.
            • R. Rothschild, 1987. "The Theory of Monopolistic Competition: E.H. Chamberlin's Influence on Industrial Organisation Theory over Sixty
         Years," Journal of Economic Studies, 14(1), pp.34-54. Abstract (http:/ / www. emeraldinsight. com/ journals. htm?articleid=1709405).
            • William L. Baldwin, 2007. "Edward Hastings Chamberlin," in Pioneers of Industrial Organization, H. W. de Jong, W. G. Shepherd, ed.,
         pp. 199- (http:/ / books. google. com/ books?id=TpfrPPOFWUIC& pg=PA199=false#v=onepage& q& f=false).
     [11] Edward S. Mason, 1939. "Price and Production Policies of Large-Scale Enterprise," American Economic Review, 29(1, Supplement), pp. 61
         (http:/ / www. jstor. org/ pss/ 1806955)-74.
            • _____, 1949. "The Current Status of the Monopoly Problem in the United States," 'Harvard Law Review, 62(8), pp. 1265 (http:/ / www.
         jstor. org/ pss/ 1336466)-1285.
            • _____, 1957. Economic Concentration and the Monopoly Problem, Harvard University Press. Review extract (http:/ / www. jstor. org/ pss/
            • William G. Shepherd, 2007. "Edward S. Mason," in Pioneers of Industrial Organization, H. W. de Jong, W. G. Shepherd, ed.
     [12] • Joe S. Bain, 1956. Barriers to New Competition: Their Character and Consequences in Manufacturing, Harvard University Press. Review
         extracts (http:/ / www. jstor. org/ discover/ 10. 2307/ 1811245?uid=3739936& uid=2& uid=4& uid=3739256& sid=21101828169287) (http:/ /
         www. jstor. org/ discover/ 10. 2307/ 2097589?uid=3739936& uid=2& uid=4& uid=3739256& sid=21101828169287).
            • _____, 1959, 2nd ed., 1968. Industrial Organization: A Treatise, John Wiley.
            • Richard E. Caves, 2007. "Joe S. Bain," in Pioneers of Industrial Organization, H. W. de Jong, W. G. Shepherd, ed., pp. 224-231 (http:/ /
         books. google. com/ books?id=TpfrPPOFWUIC& pg=PA224& lpg=PA224& f=false#v=onepage& q& f=false).
     [13] E. T. Grether, 1970. "Industrial Organization: Past History and Future Problems," American Economic Review, 60(2), pp. 83 (http:/ / www.
         jstor. org/ pss/ 1815790)-89.
     [14] Oliver E. Williamson, ed., 1990. Industrial Organization, Edward Elgar. Description (http:/ / www. e-elgar. co. uk/
         Bookentry_DESCRIPTION. lasso?id=593) and article list. (http:/ / www. e-elgar. co. uk/ Bookentry_contents. lasso?id=593) 23 articles,
         dating from 1937 to 1987.
     [15] Victor R. Fuchs, ed., 1972. "Preface" (http:/ / www. nber. org/ chapters/ c7614. pdf) (scrollable down), Policy Issues and Research
         Opportunities in Industrial Organization, NBER, p. xv.
     [16] Oliver E. Williamson, 1987. "Delimiting Antitrust," Georgetown University Law Review, December 76, p. 303. Reprinted in Williamson
         (1996), The Mechanisms of Governance, p. 306 (snippet). (http:/ / books. google. com/ books?id=meERBVysP6YC& pg=PA295&
         lpg=PA295& dq="Delimiting+ Antitrust"& source=bl& ots=0r_Ln2o-7A& sig=gw5UbeefiJp4jQFHC7wWl4gh640& hl=en& sa=X&
         ei=k_cXUYjRHYyq0AGs5IHgCw& ved=0CD4Q6AEwAg#v=snippet& q=queen applied& f=false)
     [17] Of which a complete list with Wikipedia links is at JEL classification codes#Industrial organization JEL: L Subcategories.
     [18] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L1
     [19] JEL: L10 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L10) – General
         JEL: L11 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L11) – Production, Pricing,
         and Market structure; Size Distribution of Firms
         JEL: L12 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L12) – Monopoly;
         Monopolization Strategies
         JEL: L13 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L13) – Oligopoly and Other
         Imperfect Markets
         JEL: L14 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L14) – Transactional
         Relationships; Contracts and Reputation; Networks
         JEL: L15 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L15) – Information and
         Product Quality; Standardization and Compatibility
         JEL: L16 – Industrial Organization and Macroeconomics: Industrial Structure and Structural Change; Industrial Price Indices
         JEL: L17 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L17) - Open Source Products
         and Markets
Industrial organization                                                                                                                             199

     [20] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L2
     [21] JEL: L20 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L20) – General
         JEL: L21 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L21) – Business Objectives
         of the Firm
         JEL: L22 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L22) – Firm Organization and
         Market Structure
         JEL: L23 – Organization of Production
         JEL: L24 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L24) – Contracting Out; Joint
         Ventures; Technology licensing
         JEL: L25 – Firm Performance: Size, Diversification, and Scope
         JEL: L26 – Entrepreneurship
     [22] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L3
     [23] JEL: L31 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L31) – Nonprofit
         Institutions; NGOs
         JEL: L32 – Public enterprises; Public-Private Enterprises
         JEL: L33 – Comparison of Public and Private Enterprises; Privatization; Contracting out
     [24] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L4
     [25] JEL: L40 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L40) – General
         JEL: L41 – Monopolization; Horizontal Anticompetitive Practices
         JEL: L42 – Vertical Restraints; Resale Price Maintenance; Quantity Discounts
         JEL: L43 – Legal Monopolies and Regulation or Deregulation
         JEL: L44 – Antitrust Policy and Public Enterprise, Nonprofit Institutions, and Professional Organizations
     [26] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L
     [27] JEL: L51 – Economics of Regulation
         JEL: L52 – Industrial Policy; Sectoral Planning Methods
         JEL: L53] – Enterprise Policy
     [28] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L6
     [29] JEL: L61 – Metals and Metal Products; Cement; Glass; Ceramics
         JEL: L62 – Automobiles; Other Transportation Equipment
         JEL: L63 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L63) – Microelectronics;
         Computers; Communications Equipment
         JEL: L64 – Other Machinery; Business Equipment; Armaments
         JEL: L65 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L65) – Chemicals; Rubber;
         Drugs; Biotechnology
         JEL: L66 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L66) – Food; Beverages;
         Cosmetics; Tobacco; Wine and Spirits
         JEL: L67 – Other Consumer Nondurables: Clothing, Textiles, Shoes, and Leather
         JEL: L68 – Appliances; Other Consumer Durables
     [30] JEL: L71 – Mining, Extraction, and Refining: Hydrocarbon Fuels
         JEL: L72 – Mining, Extraction, and Refining: Other Nonrenewable Resources
         JEL: L73 – Forest Products
         JEL: L74 – Construction
         JEL: L78 – Government Policy
     [31] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L8
     [32] JEL: L80 (http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L80) – General
         JEL: L81 – Retail and Wholesale Trade; e-Commerce
         JEL: L82 – Entertainment; Media (Performing Arts, Visual Arts, Broadcasting, Publishing, etc.)
         JEL: L83 – Sports; Gambling; Recreation; Tourism
         JEL: L84 – Personal, Professional, and Business Services
         JEL: L85 – Real Estate Services
         JEL: L86 – Information and Internet Services; Computer Software
         JEL: L87 – Postal and Delivery Services
         JEL: L88 – Government Policy
     [33] http:/ / www. dictionaryofeconomics. com/ search_results?q=& field=content& edition=all& topicid=L9
     [34] JEL: L91 – Transportation: General
         JEL: L92 – Railroads and Other Surface Transportation
         JEL: L93 – Air transportation
         JEL: L94 – Electric utilities
         JEL: L95 – Gas Utilities; Pipelines; Water Utilities
Industrial organization                                                                                                                                     200

         |JEL: L96 – Telecommunications
         JEL: L97 – Utilities: General
         JEL: L98 – Government Policy
     [35] • Frederic M. Scherer and David Ross, 1990. Industrial Market Structure and Economic Performance, 3rd ed. Description (http:/ / papers.
         ssrn. com/ sol3/ papers. cfm?abstract_id=1496716) and 1st ed. review extract (http:/ / www. jstor. org/ pss/ 3003013).
            • Dennis W. Carlton and Jeffery M. Perloff, 2004. Modern Industrial Organization, 4th edition, pp. 2-3. Description. (http:/ / www.
         lavoisier. fr/ notice/ frSWORK23A3RW32O. html)
     [36] Michael Simkovic, Competition and Crisis in Mortgage Securitization (http:/ / ssrn. com/ abstract=1924831)
     [37] Paul Milgrom and John Roberts, 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," Econometrica,
         50(2). pp. 443-459. (http:/ / levine. sscnet. ucla. edu/ archive/ refs4245. pdf)
     [38] Henry W. de Jong and William G. Shepherd, ed., 2007. Pioneers of Industrial Organization. Cheltenham, UK: Elgar . Description and
         content links (http:/ / www. e-elgar. com/ Bookentry_DESCRIPTION. lasso?id=3125) and preview (http:/ / books. google. com/
         books?id=TpfrPPOFWUIC& printsec=find& pg=PA3=gbs_atb#v=onepage& q& f=false).
     [39] James W. McKie, 1972. "Industrial Organization: Boxing the Compass," ch. 1 in V. R. Fuchs, ed., Policy Issues and Research Opportunities
         in Industrial Organization, NBER, pp. 1-15 (http:/ / www. nber. org/ chapters/ c7615. pdf).
     [40] Almarin Phillips and Rodney E. Stevenson, 1974. "The Historical Development of Industrial Organization," History of Political Economy,
         6(3), pp. 324-342. In Papers from the First Conference of the History of Economics Society. Citation (http:/ / hope. dukejournals. org/ content/
         6/ 3/ 324. citation).
     [41] Timothy F. Bresnahan and Richard Schmalensee, 1987. "The Empirical Renaissance in Industrial Economics: An Overview," Journal of
         Industrial Economics, 35(4), pp. 371 (http:/ / www. jstor. org/ pss/ 2098578)-378.
     [42] Lefteris Tsoulfidis, 2009. "Between Competition and Monopoly," Competing Schools of Economic Thought, ch. 9, pp. 213 (http:/ / books.
         google. com/ books?id=8L2Zoui099UC& printsec=find& pg=PA213=onepage& q& f=false#v=onepage& q& f=false)-42. Springer (http:/ /
         www. springerlink. com/ content/ 978-3-540-92692-4)

     • Paul Belleflamme and Martin Peitz, 2010. Industrial Organization: Markets and Strategies. Cambridge
       University Press. Summary (
       ?site_locale=en_GB) and Resources (
     • Cabral, Luís M. B., 2000. Introduction to Industrial Organization. MIT Press. Links to Description (http:// and chapter-preview links. (http://books.
     • Shepherd, William, 1985. The Economics of Industrial Organization, Prentice-Hall. ISBN 0-13-231481-9
     • Shy, Oz, 1995. Industrial Organization: Theory and Applications. Description (
       item/default.asp?ttype=2&tid=4262) and chapter-preview links. (
       books?id=tr4CjJ5LlRcC&printsec=find&pg=PR7=gbs_atb#v=onepage&q&f=false) MIT Press.
     • Vives, Xavier, 2001. Oligopoly Pricing: Old Ideas and New Tools. MIT Press. Description (
       edu/catalog/item/default.asp?ttype=2&tid=8556) and scroll to chapter-preview links. (
     • Jeffrey Church & Roger Ware, 2005. "Industrial Organization: A Strategic Approach," (aka IOSA (http://”, Free Textbook
     • Nicolas Boccard, 2010. "Industrial Organization, a Contract Based approach (aka IOCB (”,
       Open Source Textbook
Industrial organization                                                                                                        201

     • International Journal of the Economics of Business (
       aboutThisJournal?journalCode=cijb20) and issue preview links (
     • International Journal of Industrial Organization (
       cws_home/505551/description#description) and issue-preview links (
     • Journal of Industrial Economics (, Aims and Scope
       (, and issue-preview links. (http://onlinelibrary.
     • Journal of Law, Economics, and Organization ( and issue-preview links. (http:/
     • Review of Industrial Organization (
       11151) and issue-preview links. (

     Business administration
     The administration of a business is interchangeable with the performance or management of business operations,
     maybe including important decision making. Thus it is likely to include the efficient organization of people and other
     resources so as to direct activities toward common goals and objectives.
     The word is derived from the Middle English word administracioun, which is in turn derived from the French
     administration, itself derived from the Latin administratio — a compounding of ad ("to") and ministrare ("give
     Administrator can occasionally serve as the title of the general manager or company secretary who reports to a
     corporate board of directors. This title is archaic, but, in many enterprises, the general management function,
     including the associated Finance, Personnel and management information systems services, is what is meant by the
     term "administration".
     In some organizational analyses, management is viewed as a subset of administration, specifically associated with
     the technical and mundane elements within an organization's operation. It stands distinct from executive or strategic
     Alternatively, administration can refer to the bureaucratic or operational performance of routine office tasks, usually
     internally oriented and reactive rather than proactive.
     The world's first business school, the ESCP Europe with campuses in Paris, London, Berlin, Madrid and Torino, was
     established in 1819.[1] The first business school in the United States, the Wharton School of the University of
     Pennsylvania, was founded in 1881. Anecdotically, top French business school HEC was also created in 1881, while
     Harvard Business School, founded in 1908, was born just one year after France's prestigious ESSEC Business
     Administrative functions Administrators, broadly speaking, engage in a common set of functions to meet the
     organization's goals. These "functions" of the administrator were described by Henri Fayol as "the 5 elements of
     administration" (in bold below).
     • Planning - is deciding in advance what to do, how to do it, when to do it, and who should do it. It maps the path
       from where the organization is to where it wants to be. The planning function involves establishing goals and
       arranging them in a logical order. Administrators engage in both short-range and long-range planning.
     • Organizing - involves identifying responsibilities to be performed, grouping responsibilities into departments or
       divisions, and specifying organizational relationships. The purpose is to achieve coordinated effort among all the
Business administration                                                                                                                 202

        elements in the organization (Coordinating). Organizing must take into account delegation of authority and
        responsibility and span of control within supervisory units.
    •   Staffing - means filling job positions with the right people at the right time. It involves determining staffing
        needs, writing job descriptions, recruiting and screening people to fill the positions.
    •   Directing (Commanding) - is leading people in a manner that achieves the goals of the organization. This
        involves proper allocation of resources and providing an effective support system. Directing requires exceptional
        interpersonal skills and the ability to motivate people. One of the crucial issues in directing is to find the correct
        balance between emphasis on staff needs and emphasis on economic production.
    •   Controlling - is a function that evaluates quality in all areas and detects potential or actual deviations from the
        organization's plan. This ensures high-quality performance and satisfactory results while maintaining an orderly
        and problem-free environment. Controlling includes information management, measurement of performance, and
        institution of corrective actions.
    •   Budgeting - exempted from the list above, incorporates most of the administrative functions, beginning with the
        implementation of a budget plan through the application of budget controls...

    [1] "Focus On - Generation Europe Foundation - Career Guidance (page 5)" (http:/ / www. generation-europe. eu/ assets/ resources/
        youth_centre/ career_development_and_employment/ career_guidance/ FocusOn2012-09Career-GuidanceUK. pdf). .

    This article incorporates text from a publication now in the public domain: Chisholm, Hugh, ed. (1911).
    Encyclopædia Britannica (11th ed.). Cambridge University Press.

    Business economics
    Business economics as a field in applied economics uses economic theory and quantitative methods to analyze
    business enterprises and the factors contributing to the diversity of organizational structures and the relationships of
    firms with labour, capital and product markets.[1] A professional focus of the journal Business Economics has been
    expressed as providing "practical information for people who apply economics in their jobs."[2]

    Subject matter
    Business economics is concerned with economic issues and problems related to business organization, management,
    and strategy. Issues and problems include: an explanation of why firms emerge and exist; why they expand:
    horizontally, vertically and spacially; the role of entrepreneurs and entrepreneurship; the significance of
    organizational structure; the relationship of firms with the employees, the providers of capital, the customers, the
    government; the interactions between firms and the business environment.[1]

    Ambiguity in the use of term
    The term 'business economics' is used in a variety of ways. Sometimes it is used as synonymously with industrial
    economics/industrial organisation, managerial economics, and economics for business. Still, there may be substantial
    differences in the usage of 'economics for business' and 'managerial economics' with the latter used more narrowly.
    One view of the distinctions between these would be that business economics is wider in its scope than industrial
    economics in that it would be concerned not only with "industry" but also businesses in the service sector.
    Economics for business looks at the major principles of economics but focuses on applying these economic
    principles to the real world of business.[3] Managerial economics is the application of economic methods in the
    managerial decision-making process.[4]
Business economics                                                                                                                              203

    Interpretations of business economics from various universities
    Many universities offer courses in Business Economics and offer a range of interpretations as to the meaning of the
    term. [5]. The program at Harvard University uses economic methods to analyze practical aspects of business,
    including business administration, management, and related fields of business economics.[6]
    The University of Miami defines Business Economics as involving the study of how we use our resources for the
    production, distribution, and consumption of goods and services. This requires business economists to analyze social
    institutions, banks, the stock market, the government and their relationships with labor negotiations, taxes,
    international trade, and urban and environmental issues.[7]
    Courses at the University of Manchester interpret Business Economics to be concerned with the economic analysis
    of how businesses contribute to welfare of society rather than on the welfare of an individual or a business. This is
    done via an examination of the relationship between ownership, control and firm objectives; theories of the growth
    of the firm; the behavioural theory of the firm; theories of entrepreneurship; the factors that influence the structure,
    conduct and performance of business at the industry level.[8]
    Italian Universities borrow their concept of business economics from the tradition of Gino Zappa, for example a
    standard course [9] at the Politecnico di Milano involves studying corporate governance,accounting, investment
    analysis, budgeting and business strategy.

    [1] Moschandreas, Maria (2000). Business Economics, 2nd Edition, Thompson Learning, Description (http:/ / books. google. com/
        books?id=ncVfjhTULyAC& printsec=find& pg=PA410#v=onepage& q& f=false) and chapter-preview links (http:/ / books. google. com/
        books?id=ncVfjhTULyAC& printsec=find& pg=PR5#v=onepage& q& f=false).
    [2] National Association for Business Economics, Business Economics (http:/ / www. nabe. com/ busecon. htm)®
    [3] Sloman, J and Sutcliffe (2004) Economics for Business, Financial Times/ Prentice Hall; 3 edition
    [4] • Jones, Trefor, 2004 Business Economics and Managerial Decision Making, Wiley. Description (http:/ / www. wiley. com/ WileyCDA/
        WileyTitle/ productCd-EHEP000988. html) and chapter-preview links (http:/ / books. google. com/ books?id=qr7TORfhBwQC&
        printsec=find& pg=PR7#v=onepage& q& f=false).
           • Wilkinson, Nick (2005). Managerial Economics: A Problem-Solving Approach, Cambridge University Press. Description (http:/ / www.
        cambridge. org/ gb/ knowledge/ isbn/ item1170271/ ?site_locale=en_GB) and preview. (http:/ / books. google. com/
        books?id=O-Fv7B4J-6EC& printsec=find& pg=PR5#v=onepage& q& f=false)
    [5] http:/ / www. uel. ac. uk/ programmes/ business/ undergraduate/ summary/ businesseco. htm
    [6] http:/ / www. gsas. harvard. edu/ programs_of_study/ business_economics_4. php
    [7] http:/ / www. miami. muohio. edu/ academics/ majorsminors/ majors/ businesseconomics. cfm
    [8] http:/ / www. socialsciences. manchester. ac. uk/ undergraduate/ courses/ modules/ modulelist. html?department=3& newcode=ECON2
    [9] https:/ / www4. ceda. polimi. it/ manifesti/ manifesti/ controller/ ManifestoPublic. do?EVN_DETTAGLIO_RIGA_MANIFESTO=evento&
        aa=2012& k_cf=28& k_corso_la=394& k_indir=GND& codDescr=061190& lang=IT& semestre=1& anno_corso=2&
        idItemOfferta=100460& idRiga=147497

    • Business Economics: Description ( and archived article-abstract links

    External links
    • National Association for Business Economics (NABE, United States): Homepage (
    • Canadian Association for Business Economics (CABE) (
    • Australian Business Economists (
    • Directory of Business Economics and Finance links with relevant news (
Marketing                                                                                                                                              204

    Marketing is the process of communicating the value of a product or service to customers. Marketing might
    sometimes be interpreted as the art of selling products, but sales is only one part of marketing. As the term
    "Marketing" may replace "Advertising" it is the overall strategy and function of promoting a product or service to the
    From a societal point of view, marketing is the link between a society’s material requirements and its economic
    patterns of response. Marketing satisfies these needs and wants through exchange processes and building long term
    relationships. The process of communicating the value of a product or service through positioning to customers.
    Marketing can be looked at as an organizational function and a set of processes for creating, delivering and
    communicating value to customers, and managing customer relationships in ways that benefit the organization and
    its shareholders. Marketing is the science of choosing target markets through market analysis and market
    segmentation, as well as understanding consumer buying behavior and providing superior customer value.
    There are five competing concepts under which organizations can choose to operate their business; the production
    concept, the product concept, the selling concept, the marketing concept, and the holistic marketing concept. The
    four components of holistic marketing are relationship marketing, internal marketing, integrated marketing, and
    socially responsive marketing. The set of engagements necessary for successful marketing management includes,
    capturing marketing insights, connecting with customers, building strong brands, shaping the market offerings,
    delivering and communicating value, creating long-term growth, and developing marketing strategies and plans.[2]

    Marketing concepts

    Earlier approaches
    The marketing orientation evolved from earlier orientations, namely, the production orientation, the product
    orientation and the selling orientation.[3][4]

    Orientation       Profit driver     Western                                                Description

                [4]    Production       until the   A firm focusing on a production orientation specializes in producing as much as possible of a
                        methods          1950s      given product or service. Thus, this signifies a firm exploiting economies of scale until the
                                                    minimum efficient scale is reached. A production orientation may be deployed when a high
                                                    demand for a product or service exists, coupled with a good certainty that consumer tastes will
                                                    not rapidly alter (similar to the sales orientation).

               [4]    Quality of the    until the   A firm employing a product orientation is chiefly concerned with the quality of its own product.
                        product          1960s      A firm would also assume that as long as its product was of a high standard, people would buy
                                                    and consume the product.

            [4]         Selling        1950s and    A firm using a sales orientation focuses primarily on the selling/promotion of a particular
                        methods          1960s      product, and not determining new consumer desires as such. Consequently, this entails simply
                                                    selling an already existing product, and using promotion techniques to attain the highest sales
                                                    Such an orientation may suit scenarios in which a firm holds dead stock, or otherwise sells a
                                                    product that is in high demand, with little likelihood of changes in consumer tastes that would
                                                    diminish demand.
Marketing                                                                                                                                                   205

               [4]     Needs and       1970s to the   The 'marketing orientation' is perhaps the most common orientation used in contemporary
                        wants of       present day    marketing. It involves a firm essentially basing its marketing plans around the marketing concept,
                       customers                      and thus supplying products to suit new consumer tastes. As an example, a firm would employ
                                                      market research to gauge consumer desires, use R&D (research and development) to develop a
                                                      product attuned to the revealed information, and then utilize promotion techniques to ensure
                                                      persons know the product exists.

                       Everything      21st century   The holistic marketing concept looks at marketing as a complex activity and acknowledges that
               [2]     matters in                     everything matters in marketing - and that a broad and integrated perspective is necessary in
                       marketing                      developing, designing and implementing marketing programs and activities. The four
                                                      components that characterize holistic marketing are relationship marketing, internal marketing,
                                                      integrated marketing, and socially responsive marketing.

    Contemporary approaches
    Recent approaches in marketing include relationship marketing with focus on the customer, business marketing or
    industrial marketing with focus on an organization or institution and social marketing with focus on benefits to
    society.[5] New forms of marketing also use the internet and are therefore called internet marketing or more
    generally e-marketing, online marketing, "digital marketing", search engine marketing, or desktop advertising. It
    attempts to perfect the segmentation strategy used in traditional marketing. It targets its audience more precisely, and
    is sometimes called personalized marketing or one-to-one marketing. Internet marketing is sometimes considered to
    be broad in scope, because it not only refers to marketing on the Internet, but also includes marketing done via
    e-mail, wireless media as well as driving audience from traditional marketing methods like radio and billboard to
    internet properties or landing page.

         Orientation                Profit driver          Western                                         Description

                              Building and keeping         1960s to      Emphasis is placed on the whole relationship between suppliers and
   Relationship marketing
                                 good customer            present day    customers. The aim is to provide the best possible customer service and build
       / Relationship
                   [5]              relations                            customer loyalty.

    Business marketing /      Building and keeping         1980s to      In this context, marketing takes place between businesses or organizations.
    Industrial marketing      relationships between       present day    The product focus lies on industrial goods or capital goods rather than
                                   organizations                         consumer products or end products. Different forms of marketing activities,
                                                                         such as promotion, advertising and communication to the customer are used.

                        [5]     Benefit to society         1990s to      Similar characteristics to marketing orientation but with the added proviso
    Societal marketing
                                                          present day    that there will be a curtailment of any harmful activities to society, in either
                                                                         product, production, or selling methods.

            Branding                Brand value            1980s to      In this context, "branding" refers to the main company philosophy and
                                                          present day    marketing is considered to be an instrument of branding philosophy.
Marketing                                                                                                                       206

    Customer orientation
    A firm in the market economy survives by producing goods that
    persons are willing and able to buy. Consequently, ascertaining
    consumer demand is vital for a firm's future viability and even
    existence as a going concern. Many companies today have a customer
    focus (or market orientation). This implies that the company focuses its
    activities and products on consumer demands. Generally, there are
    three ways of doing this: the customer-driven approach, the market
    change identification approach and the product innovation approach.

    In the consumer-driven approach, consumer wants are the drivers of all       Constructive criticism helps marketers adapt
    strategic marketing decisions. No strategy is pursued until it passes the    offerings to meet changing customer needs.
    test of consumer research. Every aspect of a market offering, including
    the nature of the product itself, is driven by the needs of potential consumers. The starting point is always the
    consumer. The rationale for this approach is that there is no reason to spend R&D funds developing products that
    people will not buy. History attests to many products that were commercial failures in spite of being technological

    A formal approach to this customer-focused marketing is known as SIVA[7] (Solution, Information, Value, Access).
    This system is basically the four Ps renamed and reworded to provide a customer focus. The SIVA Model provides a
    demand/customer-centric alternative to the well-known 4Ps supply side model (product, price, placement,
    promotion) of marketing management.

                                                Product           → Solution

                                                Promotion         → Information

                                                Price             → Value

                                                Place (Distribution) → Access

    If any of the 4Ps were problematic or were not in the marketing factor of the business, the business could be in
    trouble and so other companies may appear in the surroundings of the company, so the consumer demand on its
    products will decrease. However, in recent years service marketing has widened the domains to be considered,
    contributing to the 7P's of marketing in total. The other 3P's of service marketing are: process, physical environment
    and people.
    Some consider there to be a fifth "P": positioning. See Positioning (marketing).
    Some qualifications or caveats for customer focus exist. They do not invalidate or contradict the principle of
    customer focus; rather, they simply add extra dimensions of awareness and caution to it.
    The work of Christensen and colleagues[8] on disruptive technology has produced a theoretical framework that
    explains the failure of firms not because they were technologically inept (often quite the opposite), but because the
    value networks in which they profitably operated included customers who could not value a disruptive innovation at
    the time and capability state of its emergence and thus actively dissuaded the firms from developing it. The lessons
    drawn from this work include:
    • Taking customer focus with a grain of salt, treating it as only a subset of one's corporate strategy rather than the
      sole driving factor. This means looking beyond current-state customer focus to predict what customers will be
      demanding some years in the future, even if they themselves discount the prediction.
    • Pursuing new markets (thus new value networks) when they are still in a commercially inferior or unattractive
      state, simply because their potential to grow and intersect with established markets and value networks looks like
      a likely bet. This may involve buying stakes in the stock of smaller firms, acquiring them outright, or incubating
Marketing                                                                                                                    207

       small, financially distinct units within one's organization to compete against them.
    Other caveats of customer focus are:
    • The extent to which what customers say they want does not match their purchasing decisions. Thus surveys of
      customers might claim that 70% of a restaurant's customers want healthier choices on the menu, but only 10% of
      them actually buy the new items once they are offered. This might be acceptable except for the extent to which
      those items are money-losing propositions for the business, bleeding red ink. A lesson from this type of situation
      is to be smarter about the true test validity of instruments like surveys. A corollary argument is that "truly
      understanding customers sometimes means understanding them better than they understand themselves." Thus
      one could argue that the principle of customer focus, or being close to the customers, is not violated here—just
      expanded upon.
    • The extent to which customers are currently ignorant of what one might argue they should want—which is dicey
      because whether it can be acted upon affordably depends on whether or how soon the customers will learn, or be
      convinced, otherwise. IT hardware and software capabilities and automobile features are examples. Customers
      who in 1997 said that they would not place any value on internet browsing capability on a mobile phone, or 6%
      better fuel efficiency in their vehicle, might say something different today, because the value proposition of those
      opportunities has changed.

    Organizational orientation
    In this sense, a firm's marketing department is often seen as of prime importance within the functional level of an
    organization. Information from an organization's marketing department would be used to guide the actions of other
    departments within the firm. As an example, a marketing department could ascertain (via marketing research) that
    consumers desired a new type of product, or a new usage for an existing product. With this in mind, the marketing
    department would inform the R&D department to create a prototype of a product/service based on consumers' new
    The production department would then start to manufacture the product, while the marketing department would
    focus on the promotion, distribution, pricing, etc. of the product. Additionally, a firm's finance department would be
    consulted, with respect to securing appropriate funding for the development, production and promotion of the
    product. Inter-departmental conflicts may occur, should a firm adhere to the marketing orientation. Production may
    oppose the installation, support and servicing of new capital stock, which may be needed to manufacture a new
    product. Finance may oppose the required capital expenditure, since it could undermine a healthy cash flow for the

    Herd behavior
    Herd behavior in marketing is used to explain the dependencies of customers' mutual behavior. The Economist
    reported a recent conference in Rome on the subject of the simulation of adaptive human behavior.[9] It shared
    mechanisms to increase impulse buying and get people "to buy more by playing on the herd instinct." The basic idea
    is that people will buy more of products that are seen to be popular, and several feedback mechanisms to get product
    popularity information to consumers are mentioned, including smart card technology and the use of Radio Frequency
    Identification Tag technology. A "swarm-moves" model was introduced by a Florida Institute of Technology
    researcher, which is appealing to supermarkets because it can "increase sales without the need to give people
    discounts." Other recent studies on the "power of social influence" include an "artificial music market in which some
    19,000 people downloaded previously unknown songs" (Columbia University, New York); a Japanese chain of
    convenience stores which orders its products based on "sales data from department stores and research companies;" a
    Massachusetts company exploiting knowledge of social networking to improve sales; and online retailers who are
    increasingly informing consumers about "which products are popular with like-minded consumers" (e.g., Amazon,
Marketing                                                                                                                        208

    Further orientations
    • An emerging area of study and practice concerns internal marketing, or how employees are trained and managed
      to deliver the brand in a way that positively impacts the acquisition and retention of customers, see also employer
    • Diffusion of innovations research explores how and why people adopt new products, services, and ideas.
    • With consumers' eroding attention span and willingness to give time to advertising messages, marketers are
      turning to forms of permission marketing such as branded content, custom media and reality marketing.

    Marketing research
    Marketing research involves conducting research to support marketing activities, and the statistical interpretation of
    data into information. This information is then used by managers to plan marketing activities, gauge the nature of a
    firm's marketing environment and attain information from suppliers. Marketing researchers use statistical methods
    such as quantitative research, qualitative research, hypothesis tests, Chi-squared tests, linear regression, correlations,
    frequency distributions, poisson distributions, binomial distributions, etc. to interpret their findings and convert data
    into information. The marketing research process spans a number of stages, including the definition of a problem,
    development of a research plan, collection and interpretation of data and disseminating information formally in the
    form of a report. The task of marketing research is to provide management with relevant, accurate, reliable, valid,
    and current information.
    A distinction should be made between marketing research and market research. Market research pertains to
    research in a given market. As an example, a firm may conduct research in a target market, after selecting a suitable
    market segment. In contrast, marketing research relates to all research conducted within marketing. Thus, market
    research is a subset of marketing research.

    Marketing environment
    Staying ahead of the consumer is an important part of a marketer's job. It is important to understand the "marketing
    environment" in order to comprehend the consumers concerns, motivations and to adjust the product according to the
    consumers needs. Marketers use the process of marketing environmental scans, which continually acquires
    information on events occurring out side the organization to identify trends, opportunities and threats to a business.
    The six key elements of a marketing scan are the demographic forces, socio-cultural forces, economic forces,
    regulatory forces, competitive forces, and technological forces. Marketers must look at were the threats and
    opportunities stem from the world around the consumer to maintain a productive and profitable business. [10]
    The market environment is a marketing term and refers to factors and forces that affect a firm’s ability to build and
    maintain successful relationships with customers.Three levels of the environment are: Micro (internal) environment -
    forces within the company that affect its ability to serve its customers. Meso environment – the industry in which a
    company operates and the industry’s market(s). Macro (national) environment - larger societal forces that affect the

    Market segmentation
    Market segmentation pertains to the division of a market of consumers into persons with similar needs and wants.
    For instance, Kellogg's cereals, Frosties are marketed to children. Crunchy Nut Cornflakes are marketed to adults.
    Both goods denote two products which are marketed to two distinct groups of persons, both with similar needs,
    traits, and wants. In another example, Sun Microsystems can use market segmentation to classify its clients
    according to their promptness to adopt new products.[12]
    Market segmentation allows for a better allocation of a firm's finite resources. A firm only possesses a certain
    amount of resources. Accordingly, it must make choices (and incur the related costs) in servicing specific groups of
Marketing                                                                                                                        209

    consumers. In this way, the diversified tastes of contemporary Western consumers can be served better. With
    growing diversity in the tastes of modern consumers, firms are taking note of the benefit of servicing a multiplicity
    of new markets.
    Market segmentation can be defined in terms of the STP acronym, meaning Segment, Target and Position.

    Types of Market Research
    Market research, as a sub-set aspect of marketing activities, can be divided into the following parts:
    • Primary research (also known as field research), which involves the conduction and compilation of research for a
      specific purpose.
    • Secondary research (also referred to as desk research), initially conducted for one purpose, but often used to
      support another purpose or end goal.
    By these definitions, an example of primary research would be market research conducted into health foods, which is
    used solely to ascertain the needs/wants of the target market for health foods. Secondary research in this case would
    be research pertaining to health foods, but used by a firm wishing to develop an unrelated product.
    Primary research is often expensive to prepare, collect and interpret from data to information. Nevertheless, while
    secondary research is relatively inexpensive, it often can become outdated and outmoded, given that it is used for a
    purpose other than the one for which it was intended. Primary research can also be broken down into quantitative
    research and qualitative research, which, as the terms suggest, pertain to numerical and non-numerical research
    methods and techniques, respectively. The appropriateness of each mode of research depends on whether data can be
    quantified (quantitative research), or whether subjective, non-numeric or abstract concepts are required to be studied
    (qualitative research).
    There also exist additional modes of marketing research, which are:
    •   Exploratory research, pertaining to research that investigates an assumption.
    •   Descriptive research, which, as the term suggests, describes "what is".
    •   Predictive research, meaning research conducted to predict a future occurrence.
    •   Conclusive research, for the purpose of deriving a conclusion via a research process.

    Marketing planning
    The marketing planning process involves forging a plan for a firm's marketing activities. A marketing plan can also
    pertain to a specific product, as well as to an organization's overall marketing strategy. Generally speaking, an
    organization's marketing planning process is derived from its overall business strategy. Thus, when top management
    are devising the firm's strategic direction or mission, the intended marketing activities are incorporated into this plan.
    There are several levels of marketing objectives within an organization. The senior management of a firm would
    formulate a general business strategy for a firm. However, this general business strategy would be interpreted and
    implemented in different contexts throughout the firm.

    Marketing strategy
    The field of marketing strategy considers the total marketing environment and its impacts on a company or product
    or service. The emphasis is on "an in depth understanding of the market environment, particularly the competitors
    and customers."[13]
    A given firm may offer numerous products or services to a marketplace, spanning numerous and sometimes wholly
    unrelated industries. Accordingly, a plan is required in order to effectively manage such products. Evidently, a
    company needs to weigh up and ascertain how to utilize its finite resources. For example, a start-up car
    manufacturing firm would face little success should it attempt to rival Toyota, Ford, Nissan, Chevrolet, or any other
    large global car maker. Moreover, a product may be reaching the end of its life-cycle. Thus, the issue of divest, or a
Marketing                                                                                                                        210

    ceasing of production, may be made. Each scenario requires a unique marketing strategy. Listed below are some
    prominent marketing strategy models.
    A marketing strategy differs from a marketing tactic in that a strategy looks at the longer term view of the products,
    goods, or services being marketed. A tactic refers to a shorter term view. Therefore, the mailing of a postcard or sales
    letter would be a tactic, but a campaign of several postcards, sales letters, or telephone calls would be a strategy.

    Marketing specializations
    With the rapidly emerging force of globalization, the distinction between marketing within a firm's home country
    and marketing within external markets is disappearing very quickly. With this in mind, firms need to reorient their
    marketing strategies to meet the challenges of the global marketplace, in addition to sustaining their competitiveness
    within home markets.[14]

    Marketing Promotion strategies
    Marketing promotion is divided in to two parts. Above the line promotion and below the line promotion.

    Above the line
    Above the line promotions primarily include mass media advertising; in mediums such as TV, radio, press, online

    Below the line
    Below the line promotion uses more niche focused mediums; such as email, community marketing, sms campaigns,
    personal sales, POS

    Buying behavior
    A marketing firm must ascertain the nature of customers' buying behavior if it is to market its product properly. In
    order to entice and persuade a consumer to buy a product, marketers try to determine the behavioral process of how a
    given product is purchased. Buying behavior is usually split into two prime strands, whether selling to the consumer,
    known as business-to-consumer (B2C), or to another business, known as business-to-business (B2B).

    B2C buying behavior
    This mode of behavior concerns consumers and their purchase of a given product. For example, if one imagines a
    pair of sneakers, the desire for a pair of sneakers would be followed by an information search on available
    types/brands. This may include perusing media outlets, but most commonly consists of information gathered from
    family and friends. If the information search is insufficient, the consumer may search for alternative means to satisfy
    the need/want. In this case, this may mean buying leather shoes, sandals, etc. The purchase decision is then made, in
    which the consumer actually buys the product. Following this stage, a post-purchase evaluation is often conducted,
    comprising an appraisal of the value/utility brought by the purchase of the sneakers. If the value/utility is high, then a
    repeat purchase may be made. This could then develop into consumer loyalty to the firm producing the sneakers.
Marketing                                                                                                                      211

    B2B buying behavior
    Relates to organizational/industrial buying behavior.[15] Business buy either wholesale from other businesses or
    directly from the manufacturer in contracts or agreements. B2B marketing involves one business marketing a
    product or service to another business. B2C and B2B behavior are not precise terms, as similarities and differences
    exist, with some key differences listed below:
    In a straight re-buy, the fourth, fifth and sixth stages are omitted. In a modified re-buy scenario, the fifth and sixth
    stages are precluded. In a new buy, all stages are conducted.

    Use of technologies
    Marketing management can also rely on various technologies within the scope of its marketing efforts.
    Computer-based information systems can be employed, aiding in better processing and storage of data. Marketing
    researchers can use such systems to devise better methods of converting data into information, and for the creation of
    enhanced data gathering methods. Information technology can aid in enhancing an MKIS' software and hardware
    components, and improve a company's marketing decision-making process.
    In recent years, the notebook personal computer has gained significant market share among laptops, largely due to its
    more user-friendly size and portability. Information technology typically progresses at a fast rate, leading to
    marketing managers being cognizant of the latest technological developments. Moreover, the launch of smartphones
    into the cellphone market is commonly derived from a demand among consumers for more technologically advanced
    products. A firm can lose out to competitors should it ignore technological innovations in its industry.
    Technological advancements can lessen barriers between countries and regions. Using the World Wide Web, firms
    can quickly dispatch information from one country to another without much restriction. Prior to the mass usage of
    the Internet, such transfers of information would have taken longer to send, especially if done via snail mail, telex,
    Recently, there has been a large emphasis on data analytics. Data can be mined from various sources such as online
    forms, mobile phone applications and more recently, social media.

    Services marketing
    Services marketing relates to the marketing of services, as opposed to tangible products. A service (as opposed to a
    good) is typically defined as follows:
    • The use of it is inseparable from its purchase (i.e., a service is used and consumed simultaneously)
    • It does not possess material form, and thus cannot be touched, seen, heard, tasted, or smelled.
    • The use of a service is inherently subjective, meaning that several persons experiencing a service would each
      experience it uniquely.
    For example, a train ride can be deemed a service. If one buys a train ticket, the use of the train is typically
    experienced concurrently with the purchase of the ticket. Although the train is a physical object, one is not paying for
    the permanent ownership of the tangible components of the train.
    Services (compared with goods) can also be viewed as a spectrum. Not all products are either pure goods or pure
    services. An example would be a restaurant, where a waiter's service is intangible, but the food is tangible.
Marketing                                                                                                                                      212

    [1] The Definition of Marketing. American Marketing Association. http:/ / www. marketingpower. com/ AboutAMA/ Pages/
        DefinitionofMarketing. aspx. Retrieved 2011-04-04. This definition is part of the ongoing Common Language: Marketing Activities and
        Metrics Project (http:/ / www. themasb. org/ projects/ underway/ ).
    [2] Kotler, Philip & Keller, L. Kevin (2012). Marketing Management 14e. Pearson Education Limited 2012
    [3] "1". A Framework for Marketing Management (4th ed.). Pearson Prentice Hall. 2009. ISBN 0-13-602660-5.
    [4] Adcock, Dennis; Al Halborg, Caroline Ross (2001). "Introduction" (http:/ / books. google. com/ books?id=hQ8XfLd1cGwC& lpg=PP1&
        pg=PA15#v=onepage& q=& f=true). Marketing: principles and practice (4th ed.). p. 15. . Retrieved 2009-10-23.
    [5] Adcock, Dennis; Al Halborg, Caroline Ross (2001). "Introduction" (http:/ / books. google. com/ books?id=hQ8XfLd1cGwC& lpg=PP1&
        pg=PA16#v=onepage& q=& f=true). Marketing: principles and practice. p. 16. . Retrieved 2009-10-23.
    [6] "Marketing Management: Strategies and Programs", Guiltinan et al., McGraw Hill/Irwin, 1996
    [7] Dev, Chekitan S.; Don E. Schultz (January/February 2005). "In the Mix: A Customer-Focused Approach Can Bring the Current Marketing
        Mix into the 21st Century". Marketing Management 14 (1).
    [8] Christensen 1997.
    [9] "Swarming the shelves: How shops can exploit people's herd mentality to increase sales". The Economist. 2006-11-11. p. 90.
    [10] Kerin, Roger A. (2012). Marketing: The Core. McGaw-Hill Ryerson. pp. 31.
    [11] Kotler, Armstrong, Philip, Gary. Principles of Marketing. pearson education.
    [12] D.S. Hochbaum, E. Moreno-Centeno, P. Yelland, and R.A. Catena. Rating Customers According to Their Promptness to Adopt New
        Products (http:/ / or. journal. informs. org/ content/ 59/ 5/ 1171. short), Operations Research 59(5): 1171-1183, 2011
    [13] Developing Business Strategies, David A. Acker, John Wiley and Sons, 1988
    [14] Joshi, Rakesh Mohan, (2005) International Marketing, Oxford University Press, New Delhi and New York ISBN 0-19-567123-6
    [15] "Chapter 6: Organizational markets and buyer behavior" (http:/ / www-rohan. sdsu. edu/ ~renglish/ 370/ notes/ chapt06/ index. htm). . Retrieved 2010-03-06.


    Works cited
    • Christensen, Clayton M. (1997), The innovator's dilemma: when new technologies cause great firms to fail (http:/
      /, Boston, Massachusetts, USA: Harvard Business School
      Press, ISBN 978-0-87584-585-2.
Accountancy                                                                                                                    213

    Accountancy, or accounting, is the production of information about an enterprise and the transmission of that
    information from those who have it to those who need it.[1] The communication is generally in the form of financial
    statements that show in money terms the economic resources under the control of management; the art lies in
    selecting the information that is relevant to the user and is representationally faithful. The principles of accountancy
    are applied to business entities in three divisions of practical art, named accounting, bookkeeping, and auditing.[2]
    The American Institute of Certified Public Accountants (AICPA) defines accountancy as "...the art of recording,
    classifying, and summarizing in a significant manner and in terms of money..." transactions and events that are at
    least partly financial in character, and interpreting the results.[3]
    Accounting is thousands of years old; the earliest accounting records, which date back more than 7,000 years, were
    found in Mesopotamia (Assyrians). The people of that time relied on primitive accounting methods to record the
    growth of crops and herds. Accounting evolved, improving over the years and advancing as business advanced.[4]
    Early accounts served mainly to assist the memory of the businessperson and the audience for the account was the
    proprietor or record keeper alone. Cruder forms of accounting were inadequate for the problems created by a
    business entity involving multiple investors, so double-entry bookkeeping first emerged in northern Italy in the 14th
    century, where trading ventures began to require more capital than a single individual was able to invest. The
    development of joint stock companies created wider audiences for accounts, as investors without firsthand
    knowledge of their operations relied on accounts to provide the requisite information.[5] This development resulted in
    a split of accounting systems for internal (i.e. management accounting) and external (i.e. financial accounting)
    purposes, and subsequently also in accounting and disclosure regulations and a growing need for independent
    attestation of external accounts by auditors.[6]
    Today, accounting is called "the language of business"[7] because it is the vehicle for reporting financial information
    about a business entity to many different groups of people. Accounting that concentrates on reporting to people
    inside the business entity is called management accounting and is used to provide information to employees,
    managers, owner-managers and auditors. Management accounting is concerned primarily with providing a basis for
    making management or operating decisions. Accounting that provides information to people outside the business
    entity is called financial accounting and provides information to present and potential shareholders, creditors such as
    banks or vendors, financial analysts, economists, and government agencies. Because these users have different
    needs, the presentation of financial accounts is very structured and subject to many more rules than management
    accounting. The body of rules that governs financial accounting in a given jurisdiction is called Generally Accepted
    Accounting Principles, or GAAP. Other rules include International Financial Reporting Standards, or IFRS,[8] or US

    The basic accounting equation is assets = liabilities + equity. This is the Statement of Financial Position (It is the
    new name of Balance Sheet according to IFRS). The foundation for the balance sheet begins with the income
    statement, which is revenues - expenses = net income or net loss. This is followed by the retained earnings statement,
    which is beginning retained earnings + net income + additional capital(capital contribution) - dividends/drawings =
    ending retained earnings.
Accountancy                                                                                                                   214

    The word "Accountant" is derived from the French word Compter, which took its origin from the Latin word
    Computare. The word was formerly written in English as "Accomptant", but in process of time the word, which was
    always pronounced by dropping the "p", became gradually changed both in pronunciation and in orthography to its
    present form[9] (see also comptroller).


    Ocher plaque accounting in ancient South Africa
    The Smithsonian Museum now has a systematically engraved ocher plaque, from the Blombos Cave in South Africa.
    It is about 76,000 years old, with marks that may have been used to count or store information. A close-up look
    shows that the markings are clearly organized. This suggests, to some researchers, that they represent information
    rather than decoration. This could mean accounting is far older than previously thought.[10]

    Token accounting in ancient Mesopotamia
    The earliest accounting records were found amongst the ruins of
    ancient Babylon, Assyria and Sumeria, which date back more than
    7,000 years. The people of that time relied on primitive accounting
    methods to record the growth of crops and herds. Because there is a
    natural season to farming and herding, it is easy to count and determine
    if a surplus had been gained after the crops had been harvested or the
    young animals weaned.[4]

    Clay-token accounting in ancient Iran
    Between the 4th millennium BC and the 3rd millennium BC, in ancient
    Iran, new socioeconomic situations resulted in unequal distribution of
    wealth and in such conditions leaders and priests started to rule. They
    had people to look after the financial matters. In Godin Tepe (‫)ﮔﺪﯾﻦ ﺗﭙﻪ‬
    and also Tepe Yahya (‫ ,)ﺗﭙﻪ ﻳﺤﻴﯽ‬buildings were discovered with large         Map of the Middle East showing the Fertile
    rooms for storage of crops. Cylindrical tokens were found in these               Crescent circa 3rd millennium BC.

    buildings, which were used for bookkeeping on clay scripts. In Godin
    Tepe's findings, the scripts only contained tables with figures. In Tepe Yahya's findings, the scripts also contained
    graphical representations.[11]
 Accountancy                                                                                                                   215

                                                        The invention of a form of bookkeeping using clay tokens represented
                                                        a huge cognitive leap for mankind.[12]

           Accounting tokens made of clay, from Susa,
           Uruk period, circa 3500 BC. Department of
                 Oriental Antiquities, Louvre.

    Globular token envelope with a cluster of                                 Economic tablet with numeric signs.
accounting tokens. Clay, Susa, Uruk period (4000                         Proto-Elamite script in clay, Susa, Uruk period
to 3100 BC). Department of Oriental Antiquities,                         (3200 BC to 2700 BC). Department of Oriental
                    Louvre.                                                          Antiquities, Louvre.
Accountancy                                                                                                                            216

                                                    The Res Gestae Divi Augusti (Latin: "The Deeds of the Divine
                                                    Augustus") is a remarkable account to the Roman people of the
                                                    Emperor Augustus' stewardship. It listed and quantified his public
                                                    expenditure, which encompassed distributions to the people, grants of
                                                    land or money to army veterans, subsidies to the aerarium (treasury),
                                                    building of temples, religious offerings, and expenditures on theatrical
                                                    shows and gladiatorial games. It was not an account of state revenue
                                                    and expenditure, but was designed to demonstrate Augustus'
                                                    munificence. The significance of the Res Gestae Divi Augusti from an
                                                    accounting perspective lies in the fact that it illustrates that the
                                                    executive authority had access to detailed financial information,
                                                    covering a period of some forty years, which was still retrievable after
                                                    the event. The scope of the accounting information at the emperor's
                                                    disposal suggests that its purpose encompassed planning and

                                                     The Roman historians Suetonius and Cassius Dio record that in 23 BC,
        Part of the Res Gestae Divi Augusti from the Augustus prepared a rationarium (account) which listed public
       Monumentum Ancyranum (Temple of Augustus      revenues, the amounts of cash in the aerarium (treasury), in the
      and Rome) at Ancyra, built between 25 BCE - 20 provincial fisci (tax officials), and in the hands of the publicani (public
                                                     contractors); and that it included the names of the freedmen and slaves
                                                     from whom a detailed account could be obtained. The closeness of this
    information to the executive authority of the emperor is attested by Tacitus' statement that it was written out by
    Augustus himself.[14]

    Records of cash, commodities, and transactions were kept
    scrupulously by military personnel of the Roman army. An
    account of small cash sums received over a few days at the fort of
    Vindolanda circa 110 AD shows that the fort could compute
    revenues in cash on a daily basis, perhaps from sales of surplus
    supplies or goods manufactured in the camp, items dispensed to
    slaves such as cervesa (beer) and clavi caligares (nails for boots),
    as well as commodities bought by individual soldiers. The basic
    needs of the fort were met by a mixture of direct production,
                                                                               Roman writing tablet from the Vindolanda Roman fort
    purchase and requisition; in one letter, a request for money to buy        of Hadrian's Wall, in Northumberland (1st-2nd century
    5,000 modii (measures) of braces (a cereal used in brewing) shows          AD) requesting money to buy 5,000 measures of cereal
    that the fort bought provisions for a considerable number of                used for brewing beer. Department of Prehistory and
                                                                                             Europe, British Museum.

    The Heroninos Archive is the name given to a huge collection of papyrus documents, mostly letters, but also
    including a fair number of accounts, which come from Roman Egypt in 3rd century AD. The bulk of the documents
    relate to the running of a large, private estate[16] is named after Heroninos because he was phrontistes (Koine Greek:
    manager) of the estate which had a complex and standarised system of accounting which was followed by all its
    local farm managers.[17] Each administrator on each sub-division of the estate drew up his own little accounts, for
    the day-to-day running of the estate, payment of the workforce, production of crops, the sale of produce, the use of
    animals, and general expenditure on the staff. This information was then summarized as pieces of papyrus scroll into
    one big yearly account for each particular sub-division of the estate. Entries were arranged by sector, with cash
Accountancy                                                                                                                        217

    expenses and gains extrapolated from all the different sectors. Accounts of this kind gave the owner the opportunity
    to take better economic decisions because the information was purposefully selected and arranged.[18]
    Simple accounting is mentioned in the Christian Bible (New Testament) in the Book of Matthew, in the Parable of
    the Talents.[19]

    Luca Pacioli and double-entry bookkeeping
    When medieval Europe moved to a monetary economy in the 13th century, sedentary merchants depended on
    bookkeeping to oversee multiple simultaneous transactions financed by bank loans. One important breakthrough
    took place around that time: the introduction of double-entry bookkeeping,[20] which is defined as any bookkeeping
    system in which there was a debit and credit entry for each transaction, or for which the majority of transactions
    were intended to be of this form.[21] The historical origin of the use of the words 'debit' and 'credit' in accounting
    goes back to the days of single-entry bookkeeping in which the chief objective was to keep track of amounts owed
    by customers (debtors) and amounts owed to creditors. 'Debit,' is Latin for 'he owes' and 'credit' Latin for 'he
    The earliest extant evidence of full double-entry bookkeeping is the Farolfi ledger of 1299-1300.[20] Giovanno
    Farolfi & Company were a firm of Florentine merchants whose head office was in Nîmes who also acted as
    moneylenders to the Archbishop of Arles, their most important customer.[23] The oldest discovered record of a
    complete double-entry system is the Messari (Italian: Treasurer's) accounts of the city of Genoa in 1340. The
    Messari accounts contain debits and credits journalised in a bilateral form, and contain balances carried forward
    from the preceding year, and therefore enjoy general recognition as a double-entry system.[24]
    Luca Pacioli's "Summa de Arithmetica, Geometria,
    Proportioni et Proportionalità" (early Italian: "Review
    of Arithmetic, Geometry, Ratio and Proportion") was
    first printed and published in Venice in 1494. It
    included a 27-page treatise on bookkeeping,
    "Particularis de Computis et Scripturis" (Latin:
    "Details of Calculation and Recording"). It was written
    primarily for, and sold mainly to, merchants who used
    the book as a reference text, as a source of pleasure
    from the mathematical puzzles it contained, and to aid
    the education of their sons. It represents the first known
    printed treatise on bookkeeping; and it is widely
    believed to be the forerunner of modern bookkeeping
    practice. In Summa Arithmetica, Pacioli introduced         Portrait of Luca Pacioli, attributed to Jacopo de' Barbari, 1495,
    symbols for plus and minus for the first time in a                           (Museo di Capodimonte).

    printed book, symbols that became standard notation in
    Italian Renaissance mathematics. Summa Arithmetica was also the first known book printed in Italy to contain

    Although Luca Pacioli did not invent double-entry bookkeeping,[26] his 27-page treatise on bookkeeping contained
    the first known published work on that topic, and is said to have laid the foundation for double-entry bookkeeping as
    it is practiced today.[27] Even though Pacioli's treatise exhibits almost no originality, it is generally considered as an
    important work, mainly because of its wide circulation, it was written in the vernacular Italian language, and it was a
    printed book.[28]
    According to Pacioli, accounting is an ad hoc ordering system devised by the merchant. Its regular use provides the
    merchant with continued information about his business, and allows him to evaluate how things are going and to act
Accountancy                                                                                                                   218

    accordingly. Pacioli recommends the Venetian method of double-entry bookkeeping above all others. Three major
    books of account are at the direct basis of this system: the memoriale (Italian: memorandum), the giornale (Journal),
    and the quaderno (ledger). The ledger is considered as the central one and is accompanied by an alphabetical
    Pacioli's treatise gave instructions in how to record barter transactions and transactions in a variety of currencies –
    both of which were far more common than they are today. It also enabled merchants to audit their own books and to
    ensure that the entries in the accounting records made by their bookkeepers complied with the method he described.
    Without such a system, all merchants who did not maintain their own records were at greater risk of theft by their
    employees and agents: it is not by accident that the first and last items described in his treatise concern maintenance
    of an accurate inventory.[30]
    The nature of double-entry can be grasped by recognizing that this system of bookkeeping did not simply record the
    things merchants traded so that they could keep track of assets or calculate profits and losses; instead as a system of
    writing, double-entry produced effects that exceeded transcription and calculation. One of its social effects was to
    proclaim the honesty of merchants as a group; one of its epistemological effects was to make its formal precision
    based on a rule bound system of arithmetic seem to guarantee the accuracy of the details it recorded. Even though the
    information recorded in the books of account was not necessarily accurate, the combination of the double entry
    system's precision and the normalizing effect that precision tended to create, produced the impression that books of
    account were not only precise, but accurate as well. Instead of gaining prestige from numbers, double entry
    bookkeeping helped confer cultural authority on numbers.[31]
    Double entry accounting means that each transaction requires the use of at least
    two accounts.

    Accounting in the internet era
    In the IETF RFCs the act of accounting is usually defined as the act of
    collecting information on resource usage for the purpose of trend analysis,
    auditing, billing, or cost allocation.
    For example when a user uses a connectivity service paid with a pay-per-view
    approach the accounting process is based on a metering of the resource usage by
    the user (usually time spent with an active connection or the amount of data
    transferred using that connection). The accounting is hence the recording of this
    connectivity service consumption for subsequent charging of the service itself.             William Welch Deloitte

    Accounting scandals
    The year 2001 witnessed a series of financial information frauds involving Enron Corporation, auditing firm Arthur
    Andersen, the telecommunications company WorldCom, Qwest and Sunbeam, among other well-known
    corporations. These problems highlighted the need to review the effectiveness of accounting standards, auditing
    regulations and corporate governance principles. In some cases, management manipulated the figures shown in
    financial reports to indicate a better economic performance. In others, tax and regulatory incentives encouraged
    over-leveraging of companies and decisions to bear extraordinary and unjustified risk.[32]
    The Enron scandal deeply influenced the development of new regulations to improve the reliability of financial
    reporting, and increased public awareness about the importance of having accounting standards that show the
    financial reality of companies and the objectivity and independence of auditing firms.[32]
Accountancy                                                                                                                                                 219

    In addition to being the largest bankruptcy reorganization in American history, the Enron scandal undoubtedly is the
    biggest audit failure.[33] It involved a financial scandal of Enron Corporation and their auditors Arthur Andersen,
    which was revealed in late 2001. The scandal caused the dissolution of Arthur Andersen, which at the time was one
    of the five largest accounting firms in the world. After a series of revelations involving irregular accounting
    procedures conducted throughout the 1990s, Enron filed for Chapter 11 bankruptcy protection in December 2001.[34]
    One consequence of these events was the passage of Sarbanes–Oxley Act in 2002, as a result of the first admissions
    of fraudulent behavior made by Enron. The act significantly raises criminal penalties for securities fraud, for
    destroying, altering or fabricating records in federal investigations or any scheme or attempt to defraud
    Another example of corporate fraud was the case of Australian telecommunications company One-tel. The financial
    manager, Jodee Rich, was subsequently charged with fraud and spent several years in jail after fraudulently
    misrepresenting the company's financial position to encourage investment by some of Australia's richest people,
    including James Packer and Lachlan Murdoch.[36] When it collapsed in 2001, One-tel lost its shareholders more than
    920 million dollars.

    Notes and references
    [1] Lo and Fisher: Intermediate Accounting, 2nd edition, Pearson, Toronto 2014, ISBN 978-0-13-296588-0, p. 2, (http:/ / www. amazon. com/
        Intermediate-Accounting-Vol-MyAccountingLab-Edition/ dp/ 0133098648/ ref=sr_1_7?ie=UTF8& qid=1360122690& sr=8-7&
        keywords=intermediate+ accounting+ pearson+ Lo)
    [2] Goodyear, Lloyd Earnest: Principles of Accountancy, Goodyear-Marshall Publishing Co., Cedar Rapids, Iowa, 1913, p.7 (http:/ /
        www. archive. org/ download/ principlesofacco00goodrich/ principlesofacco00goodrich. pdf)
    [3] Singh Wahla, Ramnik. AICPA committee on Terminology. Accounting Terminology Bulletin No. 1 Review and Résumé.
    [4] Friedlob, G. Thomas & Plewa, Franklin James, Understanding balance sheets, John Wiley & Sons, NYC, 1996, ISBN 0-471-13075-3, p.1
    [5] Carruthers, Bruce G., & Espeland, Wendy Nelson, Accounting for Rationality: Double-Entry Bookkeeping and the Rhetoric of Economic
        Rationality, American Journal of Sociology, Vol. 97, No. 1, July 1991, pp. 40-41,44 46,
    [6] Lauwers, Luc & Willekens, Marleen: "Five Hundred Years of Bookkeeping: A Portrait of Luca Pacioli" (Tijdschrift voor Economie en
        Management, Katholieke Universiteit Leuven, 1994, vol:XXXIX issue 3, p.302), (https:/ / lirias. kuleuven. be/ bitstream/
        123456789/ 119065/ 1/ TEM1994-3_289-304p. pdf)
    [7] The quote "accounting is the language of business" is a common phrase in 20th century books on accounting. One of the first to use this
        phrase, Thomas Orrin McGrath (1921) in Mine accounting and cost principles, stated:
        As accounting is the language of business, there is great need of standardization in the use of all accounting terms and a clear definition as to
        the meaning of each term in order to do away with the present ambiguity in the statements of business and to fill the lack of uniform business
        data. (p.5)
    [9] Pixley, Francis William: Accountancy—constructive and recording accountancy (Sir Isaac Pitman & Sons, Ltd, London, 1900), p4
    [10] "Smithsonian Blombos Ocher Plaque"
    [11] ‫( )0891( ﮐﯿﺨﺴﺮﻭ ,ﮐﺸﺎﻭﺭﺯﯼ‬in Persian). ‫( ﺗﺎﺭﯾﺦ ﺍﯾﺮﺍﻥ ﺍﺯ ﺯﻣﺎﻥ ﺑﺎﺳﺘﺎﻥ ﺗﺎ ﺍﻣﺮﻭﺯ‬Translated from Russian by Grantovsky, E.A.). pp. 39-40.
    [12] Oldroyd, David & Dobie, Alisdair: Themes in the history of bookkeeping, The Routledge Companion to Accounting History, London, July
        2008, ISBN 978-0-415-41094-6, Chapter 5, p. 96
    [13] Oldroyd, David: The role of accounting in public expenditure and monetary policy in the first century AD Roman Empire, Accounting
        Historians Journal, Volume 22, Number 2, Birmingham, Alabama, December 1995, p.124, (http:/ / umiss. lib. olemiss. edu:82/
        articles/ 1028395. 3253/ 1. PDF)
    [14] Oldroyd, David: The role of accounting in public expenditure and monetary policy in the first century AD Roman Empire, Accounting
        Historians Journal, Volume 22, Number 2, Birmingham, Alabama, December 1995, p.123, (http:/ / umiss. lib. olemiss. edu:82/
        articles/ 1028395. 3253/ 1. PDF)
    [15] Bowman, Alan K., Life and letters on the Roman frontier: Vindolanda and its people Routledge, London, January 1998, ISBN
        978-0-415-92024-7, p. 40-41,45
    [16] Farag, Shawki M., The accounting profession in Egypt: Its origin and development, University of Illinois, 2009, p.7 (http:/ /
        www. aucegypt. edu/ academics/ facultyresearch/ Profiles/ Documents/ Science paper, Shawki Farag. pdf)
    [17] Rathbone, Dominic: Economic Rationalism and Rural Society in Third-Century AD Egypt: The Heroninos Archive and the Appianus Estate,
        Cambridge University Press, ISBN 0-521-03763-8, 1991, p.4
    [18] Cuomo,Serafina: Ancient mathematics, Routledge, London, ISBN 978-0-415-16495-5, July 2001, p.231
    [19] Matt. 25:19
Accountancy                                                                                                                                            220

    [20] Heeffer, Albrecht (November 2009). "On the curious historical coincidence of algebra and double-entry bookkeeping" (http:/ / logica. ugent.
        be/ albrecht/ thesis/ FOTFS2008-Heeffer. pdf). Foundations of the Formal Sciences. Ghent University. p. 11. .
    [21] Mills, Geofrey T. "Early accounting in Northern Italy: The role of commercial development and the printing press in the expansion of
        double-entry from Genoa, Florence and Venice" (Critical Perspectives on Accounting, Vol. 4 No. 2, June 1993, pp. 113-140)
    [22] Thiéry, Michel: Did you say Debit?, Assumption University (Thailand), AU-GSB e-Journal, Vol. 2 No. 1, June 2009, p.35, (http:/ /
        gsbejournal. au. edu/ 2V/ Journal/ DID YOU SAY DEBIT. pdf)
    [23] Lee, Geoffrey A., The Coming of Age of Double Entry: The Giovanni Farolfi Ledger of 1299-1300, Accounting Historians Journal, Vol. 4,
        No. 2, 1977 p.80 University of Mississippi (http:/ / 130. 74. 92. 202:82/ record=b1000778)
    [24] Lauwers, Luc & Willekens, Marleen: "Five Hundred Years of Bookkeeping: A Portrait of Luca Pacioli" (Tijdschrift voor Economie en
        Management, Katholieke Universiteit Leuven, 1994, vol:XXXIX issue 3, p.300), (https:/ / lirias. kuleuven. be/ bitstream/
        123456789/ 119065/ 1/ TEM1994-3_289-304p. pdf)
    [25] Alan Sangster, Greg Stoner & Patricia McCarthy: "The market for Luca Pacioli's Summa Arithmetica" (Accounting, Business & Financial
        History Conference, Cardiff, September 2007) p.1–2, (http:/ / www. cardiff. ac. uk/ carbs/ conferences/ abfh07/ summa. pdf)
    [26] Carruthers, Bruce G., & Espeland, Wendy Nelson, Accounting for Rationality: Double-Entry Bookkeeping and the Rhetoric of Economic
        Rationality, American Journal of Sociology, Vol. 97, No. 1, July 1991, pp. 37
    [27] vSangster, Alan: "The printing of Pacioli's Summa in 1494: how many copies were printed?" (Accounting Historians Journal, John Carroll
        University, Cleveland, Ohio, June 2007)
    [28] Lauwers, Luc & Willekens, Marleen: "Five Hundred Years of Bookkeeping: A Portrait of Luca Pacioli" (Tijdschrift voor Economie en
        Management, Katholieke Universiteit Leuven, 1994, vol:XXXIX issue 3, p.292), (https:/ / lirias. kuleuven. be/ bitstream/
        123456789/ 119065/ 1/ TEM1994-3_289-304p. pdf)
    [29] Lauwers, Luc & Willekens, Marleen: "Five Hundred Years of Bookkeeping: A Portrait of Luca Pacioli" (Tijdschrift voor Economie en
        Management, Katholieke Universiteit Leuven, 1994, vol:XXXIX issue 3, p.296), (https:/ / lirias. kuleuven. be/ bitstream/
        123456789/ 119065/ 1/ TEM1994-3_289-304p. pdf)
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        p.9, (http:/ / www. cardiff. ac. uk/ carbs/ conferences/ abfh2008/ sangster2. pdf)
    [31] Poovey, Mary "A history of the modern fact" (University of Chicago Press, 1998) Ch.2 p.30, 58 & 54
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        Management of Value, Universidad Francisco Marroquín, March 2006) p. 41, (http:/ / www. mba. ufm. edu. gt/
        journalofmanagement/ content/ ENG_MarketProposal. pdf)
    [33] Bratton, William W. "Enron and the Dark Side of Shareholder Value" (Tulane Law Review, New Orleans, May 2002) p. 61
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    [35] Aiyesha Dey, and Thomas Z. Lys: "Trends in Earnings Management and Informativeness of Earnings Announcements in the Pre- and
        Post-Sarbanes Oxley Periods (Kellogg School of Management, Evanston, Illinois, February, 2005) p. 5
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        Daily Telegraph. .
Economic history                                                                                                                          221

    Economic history
    Economic history is the study of economies or economic phenomena in the past. Analysis in economic history is
    undertaken using a combination of historical methods, statistical methods, and by applying economic theory to
    historical situations and institutions. The topic includes business history, financial history and overlaps with areas of
    social history such as demographic history and labor history. Quantitative (econometric) economic history is also
    referred to as Cliometrics.[1]

    Development as a separate field
    Treating economic history as a discrete academic discipline has been a contentious issue for many years. Academics
    at the London School of Economics and the University of Cambridge had numerous disputes over the separation of
    economics and economic history in the interwar era. Cambridge economists believed that pure economics involved a
    component of economic history and that the two were inseparably entangled. Those at the LSE believed that
    economic history warranted its own courses, research agenda and academic chair separated from mainstream
    In the initial period of the subject's development, the LSE position of separating economic history from economics
    won out. Many universities in the UK developed independent programmes in economic history rooted in the LSE
    model. Indeed, the Economic History Society had its inauguration at LSE in 1926 and the University of Cambridge
    eventually established its own economic history programme. However, the past twenty years have witnessed the
    widespread closure of these separate programmes in the UK and the integration of the discipline into either history or
    economics departments. Only the LSE and the University of Glasgow retain separate economic history departments
    and stand-alone undergraduate and graduate programmes in economic history. The LSE, Glasgow and the University
    of Oxford together train the vast majority of economic historians coming through the British higher education
    In the US, economic history has for a long time been regarded as a form of applied economics. As a consequence,
    there are no specialist economic history graduate programs at any mainstream university anywhere in the country.
    Instead economic history is taught as a special field component of regular economics PhD programs in some places,
    including at University of California, Berkeley, Harvard University, Northwestern University and Yale University.
    In recent decades economic historians, following Douglass North, have tended to move away from narrowly
    quantitative studies toward institutional, social, and cultural history affecting the evolution of economies.[2][3]
    However, this trend has been criticized, most forcefully by Francesco Boldizzoni, as a form of economic imperialism
    "extending the neoclassical explanatory model to the realm of social relations."[4] Conversely, economists in other
    specializations have started to write on topics concerning economic history.[5]

    Relationship between economics and economic history
    Have a very healthy respect for the study of economic history, because that's the raw material out of which any of your conjectures
    or testings will come.
    - Paul Samuelson (2009)

    Yale University economist Irving Fisher wrote in 1933 on the relationship between economics and economic history
    in his "Debt-Deflation Theory of Great Depressions" (Econometrica, Vol. 1, No. 4: 337–338): 'The study of
    dis-equilibrium may proceed in either of two ways. We may take as our unit for study an actual historical case of
    great dis-equilibrium, such as, say, the panic of 1873; or we may take as our unit for study any constituent tendency,
    such as, say, deflation, and discover its general laws, relations to, and combinations with, other tendencies. The
    former study revolves around events, or facts; the latter, around tendencies. The former is primarily economic
    history; the latter is primarily economic science. Both sorts of studies are proper and important. Each helps the other.
Economic history                                                                                                               222

       The panic of 1873 can only be understood in light of the various tendencies involved—deflation and other; and
       deflation can only be understood in the light of various historical manifestations—1873 and other."
       There is a school of thought among economic historians that splits economic history—the study of how economic
       phenomena evolved in the past—from historical economics—testing the generality of economic theory using
       historical episodes. US economic historian Charles P. Kindleberger explained this position in his 1990 book
       Historical Economics: Art or Science?.[7] One of the professional societies for economic historians in Europe is also
       called the European Historical Economics Society to reflect this emphasis.
       The new economic history, also known as cliometrics, refers to the systematic use of economic theory and/or
       econometric techniques to the study of economic history. The term cliometrics was originally coined by Jonathan R.
       T. Hughes and Stanley Reiter in 1960 and refers to Clio, who was the muse of history and heroic poetry in Greek
       mythology. Cliometricians argue their approach is necessary because the application of theory is crucial in writing
       solid economic history, while historians generally oppose this view warning against the risk of generating
       anachronisms. Early cliometrics was a type of counterfactual history. However, counterfactualism is no longer its
       distinctive feature. Some have argued that cliometrics had its heyday in the 1960s and 1970s and that it is now
       neglected by economists and historians.[8]

       Nobel Prize winning economic historians
       • Milton Friedman won the Nobel Memorial Prize in Economic Sciences in 1976 for "his achievements in the fields
         of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization
       • Robert Fogel and Douglass North won the Nobel in 1993 for "having renewed research in economic history by
         applying economic theory and quantitative methods in order to explain economic and institutional change".
       • Merton Miller, who started his academic career teaching economic history at the LSE, won the Nobel in 1990
         with Harry Markowitz and William Sharpe.

       Notable economic historians
   •     Moses Abramovitz                 •   Roland Findlay                         •   Larry Neal
   •     T. S. Ashton                     •   Roderick Floud                         •   Douglass North
   •     Dudley Baines                    •   Robert Fogel                           •   Cormac Ó Gráda
   •     Correlli Barnett                 •   Milton Friedman                        •   Kevin H. O'Rourke
   •     Maxine Berg                      •   Claudia Goldin                         •   Henri Pirenne
   •     Ben Bernanke                     •   John Habakkuk                          •   Karl Polanyi
   •     Michael Bordo                    •   Earl J. Hamilton                       •   Erik S. Reinert
   •     Fernand Braudel                  •   Eli Heckscher                          •   Christina Romer
   •     Stephen Broadberry               •   Philip T. Hoffman                      •   Jean-Laurent Rosenthal
   •     Rondo Cameron                    •   Eric Hobsbawm                          •   W. W. Rostow
   •     Sydney Checkland                 •   Leo Huberman                           •   Murray Rothbard
   •     Carlo M. Cipolla                 •   Harold James                           •   Ram Sharan Sharma
   •     Gregory Clark                    •   Ibn Khaldun                            •   Adam Smith
   •     Thomas C. Cochran                •   Charles P. Kindleberger                •   Anna Jacobson Schwartz
   •     Dora Costa                       •   Emmanuel Le Roy Ladurie                •   Robert Skidelsky
   •     Nicholas Crafts                  •   David Landes                           •   Graeme Snooks
   •     Louis Cullen                     •   Tim Leunig                             •   R. H. Tawney
   •     Brad DeLong                      •   Peter Lindert                          •   Peter Temin
   •     Mauricio Drelichman              •   Friedrich List                         •   Adam Tooze
   •     Barry Eichengreen                •   Robert Sabatino Lopez                  •   Hans-Joachim Voth
   •     Stanley Engerman                 •   Angus Maddison                         •   Jan de Vries
Economic history                                                                                                                                                     223

   •     Andreas Exenberger                            •   Karl Marx                                             •   Eberhard Wächtler
   •     Charles Feinstein                             •   Ellen McArthur                                        •   Eugene White
   •     Niall Ferguson                                •   Deirdre McCloskey                                     •   Jeffrey Williamson
   •     Marc Flandreau                                •   Joel Mokyr                                            •   Tony Wrigley
                                                                                                                 •   Larry Schweikart

       [1] Robert Whaples (2008). "Cliometrics" in S. Durlauf and L. Blume, eds. The New Palgrave Dictionary of Economics, 2nd ed. Abstract (http:/ /
           www. dictionaryofeconomics. com/ article?id=pde2008_C000173& edition=current& q=Economic history& topicid=& result_number=7).
       [2] Douglass C. North (1965). "The State of Economic History," American Economic Review, 55(1/2), pp. 86 (http:/ / www. jstor. org/ pss/
             •    _____ (1994)."Economic Performance through Time," American Economic Review, 84(3), p p. 359 (http:/ / www. jstor. org/ pss/
                  2118057)-368. Also published as Nobel Prize Lecture. (http:/ / nobelprize. org/ nobel_prizes/ economics/ laureates/ 1993/ north-lecture.
       [3]    For example:
                • Gregory Clark (2006), A Farewell to Alms: A Brief Economic History of the World, Description (http:/ / press. princeton. edu/ titles/ 8461.
             html), contents (http:/ / press. princeton. edu/ TOCs/ c8461. html), ch. 1 link (http:/ / press. princeton. edu/ chapters/ s8461. pdf), and Google
             preview (http:/ / books. google. com/ books?hl=en& lr=& id=i-PLg2PsNd4C& oi=fnd& pg=PT1& dq=+ Long-run+ equilibrium&