Giffen’s paradox is an economic term named after the British economist and statistician Robert Giffen. The law of demand states that when the price of a commodity falls, the demand for it rises. However Giffen’s Paradox is an exception to this law. This is,…
Robert Giffen, 1837-1910, was a Scottish economist and statistician who also had a great reputation in the fields of finance and taxation. He also participated in the editing process in numerous publication, such as the Daily News, The Economist and The…
Gottfried von Haberler, 1900-1995, was an Austrian-American economist that specially known for his original contribution in the fields of international trade and business cycles.
He studied at the University of Vienna…
Abram Bergson, 1914-2003, was an American economist that worked for many governmental and federal agencies including the Russian Economic subdivision of the Office of Strategic Services. He was also a professor at Columbia University, Texas and Harvard. His main area of…
Roy Forbes Harrod, 1900-1978, was an English economist, friend and a follower of John Maynard Keynes. He published a wide variety of economic papers, many of which were on Abba Lerner
Abraham (Abba) Ptachya Lerner, 1903-1982, was a Russian-born British economist and professor. He entered the London School of Economics at the age of 26 where he learned from Friedrich Hayek, and where he…
A monetary union (also known as currency union) is an exchange rate regime where two or more countries use the same currency. However, in some special cases there may also be a monetary union even if there is more than a single currency, if…
A crawling peg is an exchange rate system mainly defined by two characteristics: a fixed par value of the currency which is frequently revised and adjusted due to market factors such as inflation; and a band of rates within…
A target zone arrangement is an agreed exchange rate system in which certain countries pledge to maintain their currency exchange rate within a specific fluctuation margin or band. This margins can be set vis-à-vis another currency, a cooperative…
Under a no separate legal tender regime, a country uses another one’s currency and thus gives away its capacity of using monetary policies. As stated by the IMF, under an exchange arrangement with no separate legal tender, “the currency of another country circulates as…
A currency board is an exchange rate regime based on the full convertibility of a local currency into a reserve one, by a fixed exchange rate and 100 percent coverage of the monetary supply backed up with…
A free floating exchange rate, sometimes referred to as clean or pure float, is a flexible exchange rate system solely determined by market forces of demand and supply of foreign and domestic currency, and where Managed float A managed or dirty float is a flexible exchange rate system in which the government or the country’s central bank may occasionally intervene in order to direct the country’s currency value into a certain direction. This is generally done in order to act…
Flexible exchange rates can be defined as exchange rates determined by global supply and demand of currency. In other words, they are prices of foreign exchange determined by the market, that can rapidly change due to supply and…
A fixed exchange rate, also referred to as pegged exchanged rate, is an exchange rate regime under which the currency of a country is fixed, either to another country’s currency, a basket of currencies or another measure of value, such as gold. A…
An exchange rate regime is the system that a country’s monetary authority, -generally the central bank-, adopts to establish the exchange rate of its own currency against other currencies. Each country is free to adopt the exchange-rate regime that it considers optimal, and will…
The Battle of the Bismarck Sea was a battle fought in February 1943 in Southeast Asia during World War II, between the Japanese Navy and the US Air Force. In game theory, its modeling was done by O. G. Haywood, Jr. in his article…
Richard George Lipsey is a Canadian economist born in 1928, who has been Professor at Simon Fraser University for most of his academic career. He has also held professorial posts at the London School of Economics, Essex University and Queen’s…
The Lagrange function is used to solve optimization problems in the field of economics. It is named after the Italian-French mathematician and astronomer, Joseph Louis Lagrange. Lagrange’s method of multipliers is used to derive the local maxima and minima in a function subject to equality constraints.
The existence of constraints…
Economic science makes a distinction between normative and positive economics. Positive economics is the branch of economics that focuses in the description and explanation of economic phenomena, while normative is concerned with the application of positive economics with the purpose of giving advice on…
Economic science makes a distinction between positive and normative economics. While the former is the branch of economics that focuses in the description and explanation of economic phenomena, the latter is concerned with the application of positive economics with the purpose of giving advice…
Merton Howard Miller, 1923-2000, was an American economist who taught at the London School of Economics, Carnegie Mellon University and lastly, and for most of his career, at the University of Chicago’s Booth School of Business….
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, most commonly referred to as The Nobel Prize in Economic Sciences, is the most prestigious prize that can be awarded in Economics. Every year the Laureates in Economics are selected by the Royal Swedish Academy of Science,…
Government intervention is any action carried out by the government or public entity that affects the market economy with the direct objective of having an impact in the economy, beyond the mere regulation of contracts and provision of public goods.
Government intervention advocates defend the…
Economic growth is defined as an increase in the real value of the goods and services that an economy produces. It is important to emphasize the word “real” in this definition, and to understand the difference when talking in nominal terms,…
International trade is the exchange of capital, goods and services between countries. Along with international finance it forms the larger branch of international economics. Although research on international trade has been carried out since the start of the study of the economic science, its importance…
Opportunity cost, in microeconomics, is defined as the value of the best possible economic alternative that you reject in order to dedicate your resources to another specific activity. Agents will have to face an opportunity cost in every decision made; therefore, the chosen activity will…
Elasticity is a concept introduced by British economist Alfred Marshall, and is used in order to measure the variation that a variable suffers when another variable is changed. We can distinguish between different types of elasticity depending on the variables we are using.
Probably the…
Net capital outflows (NCOs, also called net foreign investment) make reference to the difference between the acquisition of foreign assets by domestic residents and the acquisition of domestic assets by non-residents. Therefore, it has to do with savings and
Net capital outflows (NCOs, also called net foreign investment) make reference to the difference between the acquisition of foreign assetsby domestic residents and the acquisition of domestic assets by non-residents. Net capital outflows takes two forms: foreign direct investment, and portfolio investment. Foreign direct investment implies actively managing the…
Decision making under uncertainty is not only characterized by ignorance of the final outcome, as with risk, but also by the impossibility of assigning a probability of the outcome’s distribution, as this is also unknown. Both subjective and objective IS-LM-BP model The IS-LM-BP model (also known as IS-LM-BoP or Mundell-Fleming model) is an extension of the IS-LM model, which was formulated by the economists Robert Mundell and Marcus Fleming, who made almost simultaneously an analysis…
The financial account is one of the components of the balance of payments. It shows the net acquisition and disposal of both financial assets and liabilities. As stated in the sixth edition of the Balance of Payments Manual (BPM), by the International Monetary…
The capital account is one of the components of the balance of payments. It mainly reflects net foreign holdings of capital. When a country incurs on a deficit on current account, it needs to be financed by capital…
The current account is one of the components of the balance of payments. It mainly shows the value of movements in exports and imports and income derived form transactions related to net purchases of
The balance of payments consists of a series of accounts that reflect the transactions made between an open economy and the rest of the world. As stated in the sixth edition of the Balance of Payments Manual, by the International Monetary Fund, “the balance of payments a statement…
The transformation curve is defined, in international economics, as the maximum amount of commodity X obtainable for any given amount of commodity Y, and vice versa. This concept is basically the same as the production-possibility frontier studied in…
Terms of trade is used in international trade theory as a measure of the relative price of exports and imports. It is calculated as the ratio according to which two commodities are exchanged between two countries.
Ricardian trade theory David Ricardo developed this international trade theory based in comparative advantage and specialization, two concepts that broke with mercantilism that until then was the ruling economic doctrine. He introduced this…
The principle of comparative advantage explains why countries obtain gains from international trade. This term was first mentioned by Adam Smith when talking about specialization, and later by David Ricardo, who developed the concept…
The IS-LM (Investment Savings-Liquidity preference Money supply) model focuses on the equilibrium of the market for goods and services, and the money market. It basically shows the relationship between real…
In international trade theory we say a country has absolute advantage in the production of a good with regards to another country when it can produce more units of this good with fewer inputs. Logically it…
The exchange rate can be understood as the price of one currency in terms of another currency. It is the ratio between two currencies, the rate at which one can be exchanged for another. This ratio is very important since it is widely used when dealing with Purchasing power parity The purchasing-power parity (also known as PPP) theory states that a unit of any currency should purchase the same amount of goods in all countries. In the long run this theory may explain the behaviour of exchange rates. The base of…
The Big Mac index was invented in 1986 by the magazine The Economist, and considers the Big Mac hamburger sold in McDonald’s as its basket of reference. This index is based on the purchasing power parity theory. When analysing Degree of openness When defining the commercial relations that a country establishes with the rest of the world, we should look at its degree of openness. A closed economy is an economy that does not interact at all with other economies, which does not establish any exchange. Nowadays, closed economies are an…
Net exports (also known as balance of trade or commercial balance), are one of the components of the gross domestic product. Net exports of a country are the difference between that country’s exports and imports of goods and services….
Government spending, or government expenditure, is one of the components of a country’s gross domestic product. It includes all the spending on goods and services made by the government at all levels: local, regional, federal, national, etc. This component corresponds to the sum…
Investment is one of the four components of a country’s gross domestic product. It is the use of money in order to accumulate capital, which will be used by other entities. For this reason, it is called productive investment, because it is an…
Consumption is one of the components of a country’s gross domestic product. It can be defined as the spending on goods and services made by households. Consumption includes only the expenses for final use, not with the intention of…
Gross domestic product (GDP) is the market value of all final goods and services produced within an economy in a given period of time. This means that we take into account the market value of products of a given country,…
The circular-flow diagram (or circular-flow model) is a graphical representation of the flows of goods and money between two distinct parts of the economy:
-market for goods and services, where households purchase goods and services from firms in exchange for money;
-market for…
Pigouvian taxes are corrective taxes levied on each unit of output an externality-generator agent produces. It is named after economist Arthur C. Pigou, who developed the idea in his book “The Economics of Welfare”, 1920….
Externalities are the benefits or costs that arise when the decision to consume or to produce generates some positive or negative impact on the environment affecting the welfare of others in a way that is not transmitted through prices or via market mechanisms. When…
Nicholas Kaldor, 1908-1986, was a Hungarian born, British economist. He graduated from the London School of Economics and Political Science in 1930, and was there where he taught until 1947. Keynesianism influenced many of his ideas, especially…
A market system is in competitive equilibrium when prices are set in such a way that the market clears, or in other words, demand and supply are equalised. At this competitive equilibrium, firms’ profits will necessarily have to…
The Shaked-Sutton model derives from a series of papers written by Avner Shaked and John Sutton. This model is centred in studying vertical differentiation and its role when discriminating the market, in order for firms to absorb as many consumers’…
The Samuelson criterion, sometimes referred to as the Samuelson condition, was raised by the economist Paul A. Samuelson in his paper “Evaluation of Real National Income”, 1950, and belongs to the theory of welfare economics and used as a…
The Little criterion was developed by Ian M.D. Little in his paper “A Critique of Welfare Economics”, 1949, and it constitutes a further step for compensation principle theory. Little criticises the separation between efficiency and distribution and he demands as in
The Scitovsky criterion was developed by Tibor Scitosky in his paper “A Note on Welfare Propositions in Economics”, 1941, in order to solve the inconsistencies, -known as the Scitovsky paradox-, that Nicholas Kaldor’s and John Richard Hicks’ criteria…
The Hicks criterion is a compensation criterion developed by John Richard Hicks in his paper “The Valuation of the Social Income”, 1940. It is similar to that of Kaldor’s, with different implications although…
The Kaldor criterion is a compensation criterion developed by Nicholas Kaldor in his paper “Welfare Propositions of Economics and Interpersonal Comparisons of Utility”, 1939. This criterion is satisfied if state Y is preferred to state X and there is…
In welfare economics, compensation criteria or the compensation principle is known as a rule of decision for selecting between two alternative states. Two states will be compared; if one state provides an improvement for one part but causes deterioration in the state of the…
Salop’s circular city model is a variant of the Hotelling’s linear city model. Developed by Steven C. Salop in his article “Monopolistic Competition with Outside Goods”, 1979, this locational model is similar to its predecessor´s, but introduces two main differences: firms are located…
Hotelling’s linear city model was developed by Harold Hotelling in his article “Stability in Competition”, in 1929. In this model he introduced the notions of locational equilibrium in a duopoly in which two firms have to choose their location taking…
Public goods are those that are non-rival and non-excludable in consumption. Being non-rival implies that even if someone consumes it does not prevent someone else from doing it as well. Being non-excludable implies that no one will be prevented from consuming the good due to…
The Chamberlin´s model analyses and explains the short and long run equilibriums that occur under monopolistic competition, a market structure consisting of multiple producers acting as monopolists even though the market as a whole resembles…
Product differentiation is a marketing process that has the objective of making customers perceive the product of a specific firm as unique or superior to any other product belonging to the same group, and so creating a sense of value. Differentiation does not always imply changing the product, sometimes…
Harold Hotelling, 1895-1973, was an American statistician and an important economic theorist. He was Associate Professor at Stanford University and Professor at Columbia University and the University of North Carolina at Chapel Hill. Amongst his pupils we can highlight Thomas Bayes
Thomas Bayes, 1702-1761, was an English mathematician and reverend at the Presbyterian church. Nevertheless, his mathematical theorems on subjective probability have been very valuable and have had a great repercussion in science, economics and law.
He developed the Bayes’ theorem which is…
Ernst Engel, 1821-1896, was a Prussian statistician, founder of the International Statistical Institute and from 1860 to 1882 he was director of the Prussian statistical bureau in Berlin. However, he is best known for the formulation of his Engel’s law, deriving…
Macroeconomics is the study of the economy as a whole, by means of aggregate variables, this is, the part of economic theory that studies the behaviour of economic agents in large aggregates of demand and supply, monetary aggregates, gross…
Microeconomics is a branch of economic theory that is centred in modelling the interactions amongst market agents, specially between consumers, which are trying to maximise their utility, and firms, which try to maximise their profits. It analyses the underlying logic of the individual behaviour…
Frank Plumpton Ramsey, 1903-1930, was an English mathematician who applied his knowledge and interest to the disciplines of philosophy and economics, resulting in remarkable contributions. Regarding his works on Economics, he produced three master pieces which were, however, disregarded for…
Transaction costs are the associated costs that derive from the formalisation of complex relationships that necessarily exist for the production of goods and services. As an example, transactions cost can occur during the processes of negotiation, search, determination of prices, etc.
Market failures appear whenever a market is unable to work “successfully”, meaning it cannot achieve equilibrium with an efficient allocation of resources, which is known as Pareto efficiency. This imperfection in the price assignment…
Ceteris paribus is a Latin phrase that translates as “other things the same” and is a frequently used expression in economics. It refers to a phenomenon in which two or more variables intervene and for which it is assumed that, with the exception of the variable that is under…
Exit barriers (or barriers to exit) are obstacles that stop or prevent the exit of a firm from a specific market. It is associated with firms that are incurring in some form of losses, but cannot exit the market as a result of exit barriers that would further increase…
Entry barriers (or barriers to entry) are obstacles that stop or prevent the entrance of a firm in a specific market. It is associated with the situation in which a firm wants to enter a market due to high profits or increasing demand but cannot…
Contestable markets are those in which the short-term threats from potential competitors exert such a degree of pressure over the incumbents, that their behaviour is conditioned. Contestable markets are therefore in a competitive equilibrium even though the market can be considered to have a relatively…
The Edgeworth duopoly model, also known as Edgeworth solution, was developed by Francis Y. Edgeworth in his work “The Pure Theory of Monopoly”, 1897. It is a duopoly model similar to the duopoly model…
A two-part tariff is a price discrimination technique that consists in charging consumers with a lump sum fee for the right to purchase the product and then a price per unit consumed. This practice is specially used in places such as golf clubs and…
First-degree price discrimination, or perfect discrimination, is the highest level of price discrimination, in which each unit of production is sold at the maximum price that the consumer is willing to pay for that specific unit. The firm…
Second-degree price discrimination, or nonlinear pricing, involves setting prices subject to the amount bought, in an attempt to capture part of the consumer surplus. Revenues collected by the firm in this matter will be a nonlinear function. A bulk sale strategy, such as quantity…
Third-degree price discrimination, also referred to as market segmentation of price discrimination, consists of varying prices depending on what segment of the market the consumer belongs to. Each consumer will be charged with a different price, but it will remain constant whatever the amount…
Price discrimination, also referred to as price differentiation, occurs when a firm sells the same product at different prices, either to the same or different consumers. The study of this strategy comes naturally when dealing with monopolies as these seek to sell additional output to…
Natural monopolies occur in those industries in which the total costs of production are lower if a single firm produces the whole output instead of having production divided amongst more than one firm. Although this is the usual definition, which is attributed to William Baumol, who provided it in…
The Lerner index measures a firm’s level of market power by relating price to marginal cost. When either exact prices or information on the cost structure of the firm are hard to get, the Lerner index uses price
Bilateral monopoly is a market structure in which there is only a single buyer (monopsony) and a single seller (monopoly). Game theory is frequently used when analysing this kind of market…
Multiproduct monopolies are those monopolistic firms that sell, at least, more than one product. The firm will have to take into account how a change in the price of one of its products affects the demand of the rest of them, especially when they are…
A multiplant monopoly is given in monopolistic firms that have their production divided into more than one production plant, each one having its own cost structure. Different cost stuctures give place to different marginal costs…
Cobweb models explain irregular fluctuations in prices and quantities that may appear in some markets. The key issue in these models is time, since the way in which expectations of prices adapt determines the fluctuations in prices and quantities. Cobweb models have been analysed…
Comparative statics is a method used to analyse the result of changes in a model’s exogenous parameters by comparing the resulting equilibrium to the original one. However, this analysing method limits itself to comparing equilibriums, not analysing the reasons for the new equilibrium or…
Governments will choose to implement taxes to either individuals or firms in order to increase its revenue. When considering taxes to firms, it must be noted that these taxes will increase the price of goods being produced and sold, which translates into a Market clearing Market clearing occurs in those market situations in which the amount demanded by consumers equals the amount supplied by firms. In market clearing the equilibrium point has its corresponding equilibrium quantity and an equilibrium price. Economic science has developed several adjustment models to…
Firms’ cost structures will change over time, even when the quantity produced is kept constant. The price of an essential input for the production or the cost of rent may inevitably change. New costs will modify a firm’s equilibrium quantity and price. Once the differences between
Cost analysis in the long run is quite different from short run cost analysis. Period analysis tells us that in the long run all factors are variable; this flexibility of factors will consequently be reflected in the long-run cost curves….
Short run cost analysis would not be properly taught without the inclusion of demand and supply curves and their correct understanding, specially how its shifts may affect firms’ cost functions. The total supply of the industry is…
Surplus in economics refers to the profits (in terms of money or welfare) an individual or group of individuals is capable of extracting from the correct functioning of markets. Welfare economics analyses these surpluses in order to determine whether a market structure is…
Eli Filip Heckscher, 1879-1952, was a Swedish economist who was Professor at the Stockholm University College and Director of the Institute of Economic History. His attention was centred in economic history and political economy, and he was in favour of
Demand and supply are possibly the two most fundamental concepts used in economics. The concept of market is usually defined as a number of buyers and sellers of a given good or service that are willing to negotiate in order to exchange those goods. We will first explain them…
Monopoly (from the greek «mónos», single, and «polein», to sell) is a form of market structure of imperfect competition, mainly characterized by the existence of a sole seller and many buyers. This kind of market is normally associated with Bertrand duopoly In some cases, competition in terms of price changes seems more logical than quantity competition, especially in the short run. Besides, one of the assumptions of Cournot’s duopoly model is that firms supply a homogeneous product. Considering this, Bertrand proposed an alternative to…
Monopolistic competition is a market structure defined by four main characteristics: large numbers of buyers and sellers; perfect information; low entry and exit barriers; similar but differentiated goods. This last one is key to distinguish…
Duopoly (from the Greek «duo», two, and «polein», to sell) is a type of oligopoly. This kind of imperfect competition is characterized by having only two firms in the market producing a homogeneous good. For simplicity purposes,…
The Allais paradox was developed by Maurice Allais in his paper “Le Comportement de l’homme rationnel devant le risque: critique des postulats et axiomes de l’école américaine”, 1953 and it describes the empirically demonstrated fact that individuals’ decisions can be inconsistent with expected…
The Ellsberg’s paradox was developed by Daniel Ellsberg in his paper “Risk, Ambiguity, and the Savage Axioms”, 1961. It concerns subjective probability theory, which fails to follow the expected utility theory, and confirms Keynes’ 1921 previous formulation. This paradox is usually explained with…
Oligopoly (from the Greek «oligos», few, and «polein», to sell) is a form of market structure that is considered as half way between two extremes: perfect competition and monopolies. This kind of Oligopsony Oligopsony (from the greek «oligoi», few, and «opsõnía», purchase) is a market structure form of imperfect competition characterized by the existence of a relative small number of buyers, and many sellers. It is a similar case to Monopsony Monopsony (from the greek «mónos», single, and «opsõnía», purchase) is a market structure form of imperfect competition characterized by the existence of a unique buyer and many sellers. It is a similar case to monopoly but…
Joe Staten Bain, 1912-1991, was an American economist. He spent his whole career as a Professor at the University of California at Berkeley, although he obtained his Doctorate in Harvard under Joseph Schumpeter.
He was a prolific and…
Imperfect competition or imperfectly competitive markets is one in which some of the rules of perfect competition are not followed. Virtually, all real world markets follow this model, as in practice, all markets have some form of imperfection. When dealing with imperfect competition…
Perfect competition or competitive markets -also referred to as pure, or free competition-, expresses the idea of the combination of a wide range of firms, which freely enter or leave the market and which considers prices as information, since each bidder only provides a relative small share of the…
A market is a set of buyers and sellers, commonly referred to as agents, who through their interaction, both real and potential, determine the price of a good, or a set of goods. The concept of a market structure is therefore understood as those characteristics of…
Leonard Jimmie Savage, 1917-1971, was an American mathematician specialised in statistics, and was a Professor at the University of Michigan and Yale University. He also worked in some statistics research institutes at different American universities.
In Savage’s most famous work “Foundations…
Daniel Bernoulli, 1700-1782, was a Swiss mathematician and physicist. His prolific research and discoveries contributed to a wide range of fields, where we can highlight fluid mechanics, statistics and probability.
Furthermore, his contributions to statistics and probability have a great value in…
John von Neumann 1903-1957, was a Hungarian-born American mathematician, who made important contributions to numerous fields. Regarding economics, he is well known for his contribution to game theory and for the development, along with Oskar Morgenstern Oskar Morgenstern 1902-1977, was a German born, American economist. He was Professor of Economics first in the University of Vienna and after at Princeton University. His most important contribution to economics was his joint development of expected…
After John von Neumann and Oskar Morgenstern developed the expected utility theory in their “Theory of Games and Economic Behaviour”, 1944, various different approaches were developed. Although the expected utility function helps us understand the…
Oskar Morgenstern and John von Neumann’s expected utility theory, which analyses individuals’ risk aversion, proves that different individuals have different perspective towards risk. Risk averse individuals have, by definition,…
It is sometimes important to know how averse to risk a certain individual is. To this effect there are a set of tools to measure risk in a quantitative way. The most common and frequently used measure of risk aversion are…
Attitudes and behaviour towards risks have been, and still are, highly studied fields in psychology and their economic applications have been meaningful and of high importance. While some may be willing to assume risks in order to gain economic profits, others will prefer to avoid…
The expected utility theory deals with the analysis of situations where individuals must make a decision without knowing which outcomes may result from that decision, this is, decision making under uncertainty. These individuals will choose the act that will result in the highest expected utility,…
The term expected utility was first introduced by Daniel Bernoulli who used it to solve the St. Petersburg paradox, as the expected value was not sufficient for its resolution. He introduce the term in his paper “Commentarii Academiae Scientiarum Imperialis…
The theory of consumer choice under situations of risk and uncertainty belongs to the field of microeconomics. Risk and uncertainty are sometimes interchangeable terms but their meaning is easily misunderstood. Frank Knight in his “Risk, Uncertainty and Profit” 1921, treated…
The theory of consumer choice under situations of risk and uncertainty belongs to the field of microeconomics. Risk and uncertainty are sometimes interchangeable terms but their meaning is easily misunderstood. Frank Knight in his “Risk, Uncertainty and Profit” 1921, treated…
The Saint Petersburg paradox, is a theoretical game used in economics, to represent a classical example were, by taking into account only the expected value as the only decision criterion, the decision maker will be misguided into an irrational decision. This paradox was presented and solved in Frank Knight Frank Hyneman Knight, 1885-1972 was an American economist and Professor at Cornwell University, the University of Iowa, and the University of Chicago, where he is considered as one of the founding fathers of the Chicago School. Knight…
One option for mitigating problems derived from asymmetric information is designing your contract carefully so that whoever buys into it has less to gain from being a lemon. There are many practical implications for this, of which the most clear is probably in the Signalling Signalling is similar to screening, except it is the agent with complete information who decides to move first to mark themselves out as a ‘good’ agent, as a cherry. The most cited example is generally in the job market. When we examine most…
Screening is one of the main strategies for combating adverse selection. It is often confused with signalling, but there is one main difference: in both, ‘good’ agents (the cherries of this world) are set apart from the ‘bad’ agents, or
Economics of information, or information economics, belongs to the field of microeconomics and it studies the importance of information in Economics. The neoclassical theory was developed around the assumptions of perfect information and the absence of uncertainty,…
Moral hazard is a case of asymmetric information. It occurs when both parties (usually an agent and a principal) assign or are subject to a different probability of a same (normally adverse) event occurring. The behaviour of the agent changes…
Adverse selection is a case of asymmetric information. It occurs when both parties assign or are subject to a different probability of a same (normally adverse) event occurring. In this case, the agent that has the best information is clearly at an advantage. We say that…
Joseph Louis François Bertrand, 1822-1900, was a French mathematician and economist who was Professor at the École Polytechnique and a member of the Collège de France.
With regards to economics, Bertrand is mostly known for reviewing the articles “Théorie mathématique de…
In their 1981 paper, “Credit Rationing in Markets with Imperfect Information”, Joseph E. Stiglitz and Andrew Weiss define a situation similar to the case of The Market for Lemons, an article by George Akerlof, except in the financial markets….
“The Market for ‘Lemons’” is a key article written by George Akerlof in 1970, which aims to explain some of the market failures derived from imperfect information, in this case asymmetry. The paper itself is available on…
In sequential games, a series of decisions are made, the outcome of each of which affects successive possibilities. In game theory, the analysis of sequential games is of great interest because they usually model reality better than simultaneous games: producers will usually observe…
Folk theorems are used in Economics specially in the field of game theory and specifically to repeated games. This theorem is said to be satisfactorily fulfilled when the equilibrium outcome in a game that is repeated an infinity number of times, is the…
Collusion makes allusion to the cooperation between different firms. This cooperation leads to a restrain of market competition, in any of its forms, which translates into higher profits for the firms in detriment of consumer’s welfare. A cartel is an example of firms belonging to the…
In game theory, repeated games, also known as supergames, are those that play out over and over for a period of time, and therefore are usually represented using the extensive form. As opposed to one-shot games, repeated games introduce a new series of…
In game theory, a subgame is a subset of any game that includes an initial node (which has to be independent from any information set) and all its successor nodes. It’s quite easy to understand how subgames work using the extensive form when…
Stackelberg duopoly, also called Stackelberg competition, is a model of imperfect competition based on a non-cooperative game. It was developed in 1934 by Heinrich Stackelberg in his “Market Structure and Equilibrium” and represented a breaking point in the study of market structure, particularly…
Simultaneous games are those where decisions are simultaneous: both we and the other ‘player’ choose at the same time. The simplest example of this is probably ‘rock, paper, scissors’. Complete information means that we know what we stand to win or lose:…
Cournot duopoly, also called Cournot competition, is a model of imperfect competition in which two firms with identical cost functions compete with homogeneous products in a static setting. It was developed by Antoine A. Cournot in his “Researches Into the Mathematical…
In the battle of the sexes, a couple argues over what to do over the weekend. Both know that they want to spend the weekend together, but they cannot agree over what to do. The man prefers to go watch a boxing match, whereas the woman wants to go…
Mixed strategies need to be analysed in game theory when there are many possible equilibria, which is especially the case for coordination games. The battle of the sexes is a common example of a coordination game where two
Dominant strategies are considered as better than other strategies, no matter what other players might do. In game theory, there are two kinds of strategic dominance:
-a strictly dominant strategy is that strategy that always provides greater utility to a the player,…
The prisoner’s dilemma is probably the most widely used game in game theory. Its use has transcended Economics, being used in fields such as business management, psychology or biology, to name a few. Nicknamed in 1950 by Albert W. Tucker, who developed it from earlier works,…
In game theory, the extensive form is away of describing a game using a game tree. It’s simply a diagram that shows that choices are made at different points in time (corresponding to each node). The payoffs are represented at the end of each…
In game theory, the strategic form (or normal form) is a way of describing a game using a matrix. The game is defined by exhibiting on each side of the matrix the different players (here players 1 and 2), each strategy or choice they…
Game theory is the science of strategic reasoning, in such a way that it studies the behaviour of rational game players who are trying to maximise their utility, profits, gains, etc., in interaction with other players, and therefore in a context of strategic…
The agency theory is based in the relationship between principals and agents. In economics, this theory comes as a result of the separation between business ownership and its management.
The internalisation of a firm’s management instead of hiring external agents is a milestone in Oliver Williamson’s
Nash equilibria are defined as the combination of strategies in a game in such a way, that there is no incentive for players to deviate from their choice. This is the best option a player can make, taking into account the other players’ decision and where a change in…
Common knowledge is a condition usually required in game theory, so the model is completely specified and its analysis is coherently undertaken. It completes the notion of complete information, which requires all players to know the rules of the…
The perfection of information is an important notion in game theory when considering sequential and simultaneous games. It is a key concept when analysing the possibility of punishment strategies in collusion agreements.
Perfect information refers to the fact…
Complete information and incomplete information are terms widely used in economics, especially game theory and behavioural economics. We say that there is complete information when each agent knows the other agent’s utility function and the rules of the game. As Luce and Raiffa…
Heinrich von Stackelberg, 1905-1946, was a German neoclassical economist who contributed to many economic fields such as game theory and the study of market structures.
In his “Market Structure and Equilibrium”,…
Antoine Augustin Cournot, 1801-1877, was a French philosopher and mathematician and one of the precursors of marginalism. He was Professor of mathematical analysis at the Lyon University and later on became Rector of the Dijon Academy. Cournot…
Stagflation is a term that refers to the economic situation where there is a simultaneous combination of high unemployment levels and declining productivity growth, also known as stagnation, and high levels of inflation over long periods of time. This term was coined by…
Prospect theory belongs to behavioural economics and outstands as an alternative model to expected utility theory, as the neoclassical assumption of the rational agent is put into question. This theory was developed by Nobel laureate Daniel Kahneman…
Daniel Kahneman, born in 1934, is an Israeli-American psychologist and currently teaches at Princeton University. Even though Kahneman is a psychologist and he’s never attended an economic course, in 2002 he was awarded the Nobel Prize in…
Joseph Alois Schumpeter, 1883-1950, was an Austrian-American economist and political scientist. While studying at the University of Vienna, Schumpeter was disciple of the Austrian economists von Wieser and Böhm-Bawerk. Later he became Professor…
Hermann Heinrich Gossen, 1810 -1858, was a Prussian economist who also served as a public servant in the Prussian administration. Although he only wrote one book, that was also practically ignored until first Jevons and after Walras came across it, he became one…
Jeremy Bentham, 1748-1832, was a British jurist, philosopher and economist and he is also considered as a spiritual founder of the University College London. Bentham was tutor to John Stuart Mill as a personal favour to his…
Alban William Housego Phillips, 1914-1975 was a New Zealander economist and Professor at the London School of Economics. Phillips was a follower of Keynesianism and published several articles in which he used mathematically based models…
Economies of learning derive from the know-howpicked up through experience. The main difference between this and economies of scale or economies of scope is the fact that it is not correlated to production levels in the same way: it does…
The experience curve (not to be confused with learning curve) is a graphical representation of the phenomenon explained in the mid-1960s by Bruce D. Henderson, founder of the Boston Consulting Group. It refers…
The learning curve (not to be confused with experience curve) is a graphical representation of the phenomenon explained by Theodore P. Wright in his “Factors Affecting the Cost of Airplanes”, 1936. It refers to the effect…
Inflation is the economic term that refers to a continuous general rise in the level of prices over a period of time. This will consequently be translated into a fall in the value of money and a loss in purchasing power. The main measures to calculate inflation are Consumer…
George Joseph Stigler, 1911-1991, was an American economist and Professor at Brown University, Columbia and University of Chicago. Furthermore, and regarding the University of Chicago, he stands out as one of the most prominent members of the
Unemployment refers to the situation of a jobless worker. The unemployment rate measures the number of unemployed workers as a percentage of the labour force. Massive unemployment levels are the result of situations of economic crisis followed by depressions, and are the result of a large economic readjustment studied…
Laissez-faire, laissez-passer is a French expression that translates as “to let do, let pass”, that is letting things work on their own. In a sense it sums up the economic doctrine of physiocracy, expressing that there is a natural order of things, with its own laws,…
Money illusion refers to the situation in which some nominal income increases, can generate the mistaken feeling that a person, or a particular group is increasing its real purchasing power, when in fact monetary erosion due to inflation may be decreasing their purchasing power in real…
X-inefficiency is known as the result of inputs not producing their maximum output as a consequence of an “X” factor. This translates into both cost minimisation and production maximisation failure and, hence, implies a loss of efficiency. This term was first introduced by…
As a contribution to industrial organization, George Stigler developed his “own” theory on cost analysis in his article “Production and Distribution in the Short Run”, 1939, which moved slightly away from
Edward Hastings Chamberlin, 1899-1967, was an American economist and Professor at Harvard University. He performed a major innovation in modern microeconomic theory, specially regarding the study of the structure of markets, developing Structure, conduct, performance paradigm Structure, Conduct and Performance paradigm (SCP) is used as an analytical framework, to make relations amongst market structure, market conduct and market performance. It was developed in 1959 by Joe S. Bain Jr., who described it in his book “Industrial Organization”. The SCP…
Friedrich Freiherr von Wieser, 1851-1926, is one of the founding trio of the Austrian school along with Carl Menger and Böhm-Bawerk. He taught in the largest Austrian universities, mainly in…
Johan Gustav Knut Wicksell, 1851-1926, was a Swedish economist and Professor at Lund University. He is considered one of the most important founders of the school of Stockholm.
In his most influential contribution, “Interest and Prices”, 1898, Wicksell made the differentiation…
Industrial Organization is the economic field that studies the strategic behaviour of firms, and their interaction to determine the structure of markets. Knowing their evolution helps to understand them. The traditional neoclassical theory made the relation between “industrial” and “manufacturing”, making the manufacturing market the main…
The concept of economy of scope is very similar to that of economies of scale. When we talk about economies of scope, we mean that average costs are reduced by introducing another product into our portfolio that can share some of the infrastructure…
Ludwig Heinrich Edler von Mises, 1881-1973, was an Austrian economist and Professor at the universities of Vienna, Geneva and New York. Mises greatly contributed to neoclassical economics and was one of the leaders of the Long run cost analysis In the long run, no cost is fixed. We can determine our production level and adjust plant sizes, investment in capital and labour accordingly. As we can see in the diagrams below, this gives…
In the short run, fixed costs include capital, K, whereas labour, L, is considered variable. Fixed costs are represented as…
Eugen von Böhm-Bawerk, 1851-1917, was an Austrian economic theorist, a public servant and Professor in different Austrian universities. He is considered to belong to the Neoclassical school of economics and was a leading figure inside the
Average costs are those associated to one unit of production. Costs per unit grow quicker as production increases, so we find the arithmetic average as the sum of costs divided by the sum of production:
When analysing costs, the first thing to know is that there are fixed and variable costs:
Nikolai Dmitrievich Kondratiev, 1892-1938, was a Russian economist and founder and first director of The Institute of Conjecture between 1920 and 1928.
Kondradiev is mainly known for his studies on business cycles, specially for his major work “The…
Subadditivity is an important concept because it is often used to justify imperfect competition, the classic nemesis of neo-classicists. The only real way to justify less than perfect competition is the kind…
Joseph Kitchin, 1861-1932, was a British statistician and businessman. In his “Cycles and Trends in Economic Factors”, 1923, he carried out a study on business cycles, in Britain and in the United States, between 1890-1922. Kitchin was able to identify evidences of the existence of very…
Joseph Clemént Juglar, 1819-1905, was, as his compatriot François Quesnay, a physician turned economist. In 1862 he published his masterpiece “Des crises commerciales et leur retour périodique en France, en Angleterre, et aux États-Unis” in which…
John Marcus Fleming, 1911-1976, was a Scottish economist and public servant who worked in many well-known international organizations, including the International Monetary Fund and the United Nations.
His contributions to Economics are mostly in the field of
Eugen Slutsky, 1880-1948, was a Russian mathematician, statistician and economist. In economics he is best known for his formulation of the Slutsky’s equation. Slutsky found an equation that splits income and substitution effects based on
Ernst Louis Étienne Laspeyres, 1834-1913, was a German economist, statistician and Professor in various universities. His most notable contribution to economics was the development of the Laspeyres index, used for the formulation of weighted indexes, so that each…
Say´s Law is a classical economics‘ principle attributed to the French economist Jean-Baptiste Say, and it holds the apparently simple statement that “products are paid for with products”, as Say puts it in his “Traité d’économie politique”, 1803. One of the implications of this…
Jean Baptiste Say, 1767-1832, was a French economist and businessman, and considered as the French disciple of Adam Smith and one of the exponents of mercantilism and classical economics.
Say’s chief…
Joan Violet Robinson, 1903-1983, was a British economist and Professor at Cambridge University, and belonged to the Post-Keynesian doctrine. She was recognized as a contributor to Keynes‘ famous “The General Theory of Employment, Interest and…
Fiscal policies are demand-side economic policies through which the government acts over its income and expenditure in order to influence the levels of income, output and unemployment of the economy. The government may do this via income taxes and unemployment benefits, or by…
Monetary policies are demand-side economic policies through which the central bank of a country acts on the amount of money and interest rates in order to influence on the income levels, output and unemployment in the economy, being the interest rate the link binding money and…
The purpose of supply-side economic policies is to increase the amount of supply and therefore the productive potential that the economy is able to produce. This kind of policies shift rightward the long-run aggregate supply curve and outward the production…
Reducing unemployment and stimulating the economy has been one of the biggest, if not the only, concerns of governments since the dawn of economic science. Economic policies have been very much theorized, and by many doctrines. As a result, a rich and plentiful literature has been…
Andrew Michael Spence, born in 1943, is an American economist and has been Professor at Harvard University and Stanford University, amongst others. He is currently a lecturer at New York University. His researches and contributions have been mainly in…
Period analysis show the inter-temporal dimension of production theory. It was developed by Alfred Marshall in his “Principles of Economics”, 1890, and has remained practically unaltered since. It tries to explain how equilibrium is achieved and explains the adjustment processes to reach it,…
Christopher Antoniou Pissarides, born in 1943, is a Cypriot economist and a School Professor at the London School of Economics. His research has mainly been focussed in the field of macroeconomics, specially in job search frictions explaining
Production in the very long run differs from long run production in that there may be changes in technology. There are three main types of technological advances:
When dealing with long run production, the main change from short run production is that we can vary the levels of fixed inputs we use (capital, K), as well as variable inputs (labour, L). Our levels of production…
The short run is considered the period of time where fixed costs are still fixed, which basically means that, if you have a factory, you have to make do with it because you can neither sell it, nor make it bigger, nor rent…
Oliver Eaton Williamson, born in 1932, is an American Economist and has been a Professor at the University of Pennsylvania, Yale University and the University of California, Berkeley. In year 2009 he was awarded the Nobel Prize in…
Joseph Eugene Stiglitz, born in 1943, is an American economist and could be consider as a supporter New Keynesian Economics. In 2001, jointly with George A. Akerlof and Michael Spence, he…
Multi-product firms are firms that produce multiple goods, and therefore have to deal with allocating inputs more properly in order to attain higher production levels. This is a greater problem than the one single-product firms face, the production maximisation problem,…
Ronald Harry Coase, 1910-2013, was a British Economist and Professor Emeritus of Economics at the University of Chicago, where he also held the direction of the magazine “Journal of Law and Economics” from 1964 to 1982. Coase was awarded the
William Spencer Vickrey, 1914-1996, was a Canadian economist settled in the United States and Professor of economics at Columbia University. He shared the Nobel Prize in Economic Sciences in 1996 with the Scottish economist James Mirrlees, for…
Friedrich August von Hayek, 1899-1992, was an Austrian-Hungarian economist, philosopher and Professor from 1931 to 1950 at the London School of Economics and from 1950 to 1962 at the University of Chicago. He won the
New Keynesian Economics argue that menu costs are the reason for price stickiness. Price stickiness, the suboptimal adjustment of prices in response to demand shocks, can result in business cycles.
Paul Anthony Samuelson, 1915-2009, was an American economist and Professor at the Massachusetts Institute of Technology. He was the first American to win the Nobel Prize in Economic Sciences, in 1970; he was granted this…
Maurice Félix Charles Allais, 1911-2010, was a French economist, physicist and Professor of Economics at the École Nationale Supérieure des Mines de Paris (Mines ParisTech). His pioneer contributions to the theory of markets and to the efficient…
Bertil Gotthard Ohlin, 1899-1979, was a Swedish economist, politician and Professor of Economics at the University of Copenhagen and at the Stockholm School of Economics. Along with the British economist James Meade, he received the Nobel…
Menu costs are costs that result from price changes. An easy way to understand menu costs is by means of a typical example: restaurants. When a restaurant manager wants to change prices, the cost of changing the menus (in order to show the new prices) must be taken into…
Wassily Leontief, 1906-1999, was a Russian economist, naturalized an American citizen. He was Professor at the University of Kiel, Harvard University and New York University consecutively. He was awarded the Noble Prize in Economic Sciences in the…
Tjalling Charles Koopmans, 1910-1985, was an American, Dutch born, economist and Professor at the University of Chicago, from 1946 to1955, and at Yale University, since 1955. Koopmans is mostly known for his theoretical developments in the field of econometrics,…
The static theory of labour demand does not specify how, or how long adjustments between production factors take. It is therefore necessary to consider the notion of adjustment costs, such as costs incurred by a company to change the number of factors.
We will follow the lines followed in the…
Dale Thomas Mortensen, born in 1939, is an American economist and Professor of Economics at the Northwestern University. In 2010, Mortesen was awarded the Nobel Prize in Economic Sciences along with Christopher Pissarides…
As in consumer’s theory (where consumption duality is analysed), the firm´s input decision has a dual nature. Finding the optimum levels of inputs, can not only be seen as a question of choosing the lowest isocost line tangent to the…
Gérard Debreu, 1921-2004, was a French economist, mathematician and Professor of Economics at the University of California, Berkley. He was the winner of the Nobel Prize in Economic Sciences in 1983, for including new analytical methods into economic…
Gary Stanley Becker, born in 1930, is an American economist and Professor at the University of Chicago where he teaches economics and sociology. He won the Nobel Prize in Economic Sciences…
Cost minimisation tries to answer the fundamental question of how to select inputs in order to produce a given output at a minimum cost.
A firm’s isocost line shows the cost of hiring factor…
Production maximisation must be seen as an optimisation problem regarding the production function, represented by isoquants, and a constraint regarding production costs, represented by an isocost…
Harry Markowitz, born in 1927, is an American Economist and Professor of Finance at the University of California, San Diego. He is one of the many disciples that the renowned Chicago School has given. Due…
Rational expectation models are those where an agent’s future predictions affect the value they assign to a variable in their current time period. In this sort of self-fulfilling prophecy, expectations become truths, and errors in forecasting future variables become random. This makes those forecasts valid, because present expectations about…
Adaptive expectation models are ways of predicting an agent’s behaviour based on their past experiences and past expectations for that same event. They are first used by Irving Fisher in his book “The Purchasing Power of Money”, 1911, and further developed in the 1940s…
New Classical Macroeconomics takes expectations one step further than monetarists did when using adaptive expectations. Rather than supposing that agents will learn to adjust their behaviour based on past experiences, they apply rational…
William Forsyth Sharpe, born in 1934, is an American economist and Professor of Finance at Stanford University. In 1990 he won the Nobel Prize in Economic Sciences along with Harry Markowitz and
Franco Modigliani, 1918-2003, was an American, Italian born economist, and Professor at the Massachusetts Institute of Technology. He has mainly worked in the fields of savings and financial markets, and his pioneering analyses in these subjects granted him the
The term natural rate of unemployment was introduced by Milton Friedman in 1968, in his article “The Role of Monetary Policy”, following his presidential address delivered at the annual meeting of the American Economic Association, in 1967. It is based in…
The term NAIRU (non-accelerating inflation rate of unemployment) is a term first used by James Tobin in 1980, in his article “Stabilization Policy Ten Years After”. It refers to the level of unemployment at which the economy settles if Expectations-augmented Phillips curve The expectations-augmented Phillips curve introduces adaptive expectations into the Phillips curve. These adaptive expectations, which date from Irving Fisher’s book “The Purchasing Power of Money”, 1911, were introduced into the Phillips curve by monetarists,…
The law of returns to scale explains how output behaves in response to a proportional and simultaneous variation of inputs. Increasing all inputs by equal proportions and at the same time, will increase the scale of production. Returns to scale differ from one case to…
The Layard-Nickell NAIRU model emerged as a reply from New Keynesian Economics to the natural rate of unemployment, devised by Milton Friedman as a criticism of the
Business cycle, as Joseph Schumpeter saw it, is the economic activity fluctuation that occurs over time, and that comes from the succession of expansionary and contracting seasons. It is analysed comparing real GDP to potential GDP (Y*). There are a few common characteristics,…
The New Keynesian Economics seeks to provide Keynesianism with microeconomic foundation support. This contemporary economic doctrine comes as a response to the critiques that Keynesianism received from the New Classical Macroeconomics (NCM) advocates.
New Keynesian Economics can be traced back to…
Nicholas Gregory Mankiw, born in 1958, is an American economist and professor of Economics at Harvard University.
Mankiw has stood out as a well-known writer, whose best-selling and intermediate-level textbooks of economics, “Principles of Economics” and “Macroeconomics”, 2006, have sold over a…
Robert Emerson Lucas, Jr., born in 1937, is an American economist and Professor at the University of Chicago. For many, Lucas is probably one of the most notable economists of all times and one of…
Milton Friedman, 1912-2006, was an American economist, Professor at the University of Chicago and main figure of the Chicago School. He was awarded the Nobel Prize of Economic Sciences in the year 1976 for…
New Classical Macroeconomics (NCM) arise from the development of the neoclassical economics principles, such as market clearing and optimization behavior by economic agents, which relate this school to monetarism. Its rise as a doctrine can be traced to the…
Monetarism, a term first used by Brunner in 1968, can be understood in two ways. The first relates to the economic thought that sees in the quantity of money the major source of economic activity and its disruptions (especially inflation), as well as believing that targeting…
Revealed preference theory is attributable to Paul Samuelson in his article “Consumption Theory in Terms of Revealed Preference”, 1948. Consumer theory depends on the existence of preferences which materialise into utility functions. These utility functions are
Characteristics demand theory states that consumers derive utility not from the actual contents of the basket but from the characteristics of the goods in it. This theory was developed by Kelvin Lancaster in 1966 in his working paper “A New…
Neoclassical synthesis (NCS) refers to an economic doctrine that appeared in the U.S. in the early 1940s, and would remain the dominant paradigm until the late 1960s, when monetarism took over. It was Paul Samuelson, in his book “Economics”, 1955, who gave this…
Goods are something that provides its holder some kind of satisfaction, and therefore has a utility. There are different kinds of goods, and different classifications can be arranged and identified. We can differentiate between consumption goods (durable or perishable) and capital goods. Classification depending…
Price indices are used to monitor changes in prices levels over time. This is useful when separating real income from nominal income, as inflation is a drain on purchasing power. The two most basic indices are the Laspeyres index (named after Etienne Laspeyres) and the Paasche…
A production function shows how much can be produced with a certain set of resources. Generally, when looking at production, we assume there are two factors involved in production: capital (K) and labour (L), as this…
This economic phenomenon occurs when increasing output is translated into a decline of the firm´s average cost of production. Alfred Marshall was the first economist to distinguish economies of scale depending on…
John R. Hicks, in his article “Mr. Keynes and the Classical; a Suggested Interpretation”, published in 1937 in the journal Econometrica, developed a model known as IS-LL, which will later become IS-LM. The purpose of the article was to compare…
The economic region of production shows the combinations of factors at a certain cost that make economic sense. Areas outside the economic region of production mean that at least one of the inputs has negative marginal productivity. This region is marked by what are called ridge…
An isoquant shows the different combinations of K and L that produce a certain amount of a good or service. Mathematically, an isoquant shows:
f (K,L) = q0
Isocost lines show combinations of productive inputs which cost the same amount. They are the same concept as budget restrictions when looking at consumer behaviour. Mathematically, they can be expressed as:
rK + wL = C
Marshallian and Hicksian demands stem from two ways of looking at the same problem- how to obtain the utility we crave with the budget we have. Consumption duality expresses this problem as two sides…
Kenneth Joseph Arrow, born in 1921, is an American economist and Professor at Stanford University. In 1972 he was granted the Nobel Prize of Economic Sciences along with John Hicks for their pioneer contributions…
Lawrence Robert Klein, born in 1920, is an American Economist and was Professor at the Wharton School of the University of Pennsylvania. In 1980 he was awarded the Nobel Prize in Economic Sciences, for the creation of…
Simon Smith Kuznets, 1901-1985, was a Russian born American economist, Professor at Harvard University. His main works were related with the economic growth of nations. He won the Nobel Prize in Economic Sciences in 1971. Kuznets was…
Edmund Strother Phelps, born in 1933, is an American economist and an advocate of New Keynesian Economics. He is a Professor at Columbia University, where he imparts Political Economy. In 2006 Phelps won the Nobel Prize…
Thomas John Sargent, born in 1943, is an American economist who has been deeply involved in the new classical macroeconomics, researching the fields of macroeconomics, monetary economics and time…
Utility is the ‘satisfaction’ we get from using, owning or doing something. It is what allows us to choose between options. This can be plotted on a chart.
A preference function therefore assigns values to the…
The foundation for Economics is rationality. Rationality implies that people will act in ways that best suit their particular set of circumstances, including, but not limited to, the choices they face. In order to choose, you must necessarily have a set of preferences over the options you are presented…
Asymmetric information refers to transactions in which one of the parties has better information than the other one. Adverse selection and moral hazard can result from the worst cases of asymmetric information in transactions between economic agents.
A key article on this subject is…
The marginal rate of transformation (MRT) can be defined as how many units of good x have to stop being produced in order to produce an extra unit of good y, while keeping constant the use of production factors and the technology being used. It involves the relation between…
The marginal rate of technical substitution (MRTS) can be defined as, keeping constant the total output, how much input 1 have to decrease if input 2 increases by one extra unit. In other words, it shows the relation between inputs, and the trade-offs amongst them, without changing the level…
The marginal rate of substitution (MRS) can be defined as how many units of good x have to be given up in order to gain an extra unit of good y, while keeping the same level of utility. Therefore, it involves the trade-offs of…
Generally, if the price of something goes down, we buy more of it. This is down to two effects:
There are two ways to solve a consumer’s choice problem. That is, we can either fix a budget and obtain the maximum utility from it (primal demand) or set a level of utility we want to…
Cost minimisation is a way of solving the optimisation problem regarding the utility function and the budget constraint, even though the most common way of doing this is by means of utility maximisation.
Utility maximisation must be seen as an optimisation problem regarding the utility function and the budget constraint. These two sides of the problem, define Marshallian demand curves.
An individual is therefore faced with the following problem: faced with a…
Consumer behaviour is a maximisation problem. It means making the most of our limited resources to maximise our utility. As consumers are insatiable, and utility functions grow with quantity, the only thing that…
George Arthur Akerlof, born in 1940, is an American economist and professor at University of California, Berkeley. He was awarded the Nobel Prize in Economic Sciences in 2001 along with Michael Spence and
James Tobin, an American economist (1918-2002), and follower of Neo-Keynesian economics, thought that government intervention was necessary in order to stabilize the economy and to avoid recessions. He received the Nobel Prize in Economic…
John Forbes Nash (1928-2015) was an American mathematician that was Professor at Princeton University. In 1994 he received the Nobel Prize in Economic Sciences along with John Harsanyi and Reinhard Selten, for their works regarding Robert Mundell
Robert Mundell (born in 1932) is a Canadian economist and professor at Columbia University. He won the Noble Prize in Economic Sciences in 1999 for his theory in optimum currency areas, which focuses on a series of…
Robert Merton Solow, born in 1924, is an American economist, pupil of Wassily Leontief, and Professor at the Massachusetts Technological Institute (MIT). We can identify Solow as a supporter of the Neo-Keynesian ideas and a great user…
Paul Robin Krugman is an American economist born in 1953, who is identified with the New Keynesian Economics theories. He is an experimented lecturer and is actually working as Professor at Princeton University teaching both Economics and…
This efficiency criterion was developed by Vilfredo Pareto in his book “Manual of Political Economy”, 1906. An allocation of goods is Pareto optimal when there is no possibility of redistribution in a way where at least one individual would…
The production possibility frontier (PPF) represents the quantity of output that can be obtained for a certain quantity of inputs using a given technology. Depending on the technology, the PPF will have a certain shape.
There are two fundamental theorems of welfare economics.
-First fundamental theorem of welfare economics (also known as the “Invisible Hand Theorem”):
any competitive equilibrium leads to a Pareto efficient allocation of resources.
The main idea here is that markets lead to…
Kelvin Lancaster and Richard G. Lipsey, in their article “The General Theory of Second Best”, 1956, following an earlier work by James E. Meade, treated the problem of what to do when certain optimality conditions (which must be considered in order to arrive at a
Welfare economics are a part of normative economics which objective is to evaluate different situations of a given economic system, in order to choose the best one.
Its study can be traced back to Adam Smith, who related an increase of welfare with an…
In 1958, A. W. Phillips wrote a paper on Economica (London School of Economics), entitled “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957”. Analysing data concerning money wages and unemployment rates in the…
This school of economic thought, which focuses on macroeconomics, is mainly based on interpretations of John Maynard Keynes’ most important book, the “General Theory of Employment, Interest and Money”, 1936.
Keynes’ main thesis was that unemployment during the Great Depressionwas the result of a…
Hansen was an American economist (1887-1975), professor at Harvard University and one of the main precursor of the New Economic Science or Keynesianism, in the U.S. In fact, Hansen is known for popularizing the
John R. Hicks was a British economist (1904-1989), professor at the London School of Economics, Cambridge University and University of Oxford. He took special interest on issues concerning microeconomics,…
Keynes was a British economist (1883-1946), son of the economist and methodologist John Neville Keynes. J. M. Keynes first gained notoriety with his work during the Versailles Peace Conference, when he cleverly proposed in his book “The Economic…
From the University of Chicago, and opposing Keynesianism, a number of contributions and doctrinal attitudes of authors can be identified, which turn back to neoclassical economics, are in favour of laissez faire and Indifference curves Indifference curves are lines in a coordinate system for which each of its points express a particular combination of a number of goods or bundles of goods that the consumer is indifferent to consume. This is, the consumer will have no preference between two bundles located in the…
This school of thought, which appeared around 1870 in what is known as the marginal revolution, can be considered a development of the classical school of economics’ main ideas. Supporting the concept of marginalism, and being more…
In 1881, Francis Y. Edgeworth came up with a way of representing, using the same axis, indifference curves and the corresponding contract curve in his book “Mathematical Psychics: an Essay on the Application of Mathematics to the Moral Sciences”. However, the representation given, using as an example the work…
Thomas Robert Malthus stated this theory, which indicated that the population would increase geometrically, while food production would only increase in arithmetical proportion, thus creating the conditions for a shortage in the…
Turgot was a French abbot (1727-1781), Baron de l’Aulne, who after leaving the clergy became an economist and stateman, and author of the book “Reflections on the Formation and Distribution of Wealth” published in 1776. One of the great
Name given to British economist Alfred Marshall and his followers, who were also part of the neoclassical school of economics, such as Arthur C. Pigou and Francis Y. Edgeworth,…
Pigou was a British economist (1877-1959), disciple of Alfred Marshall, whom he succeeded as a professor at Cambridge. Pigou is remembered above all as a precursor of welfare economics, for…
Bullionism is the name given to the essential features of economic thought in the first mercantilist era, during the XVI century. According to this economic doctrine, the State acted directly, through laws and regulations on precious metals in order to make them enter the country…
First circulatory diagram explaining how a national economy works. It was a contribution to economics by French physician and economist François Quesnay. Contrary to the prevailing mercantilist thought at the time, which…
Quesnay was a French physician (1694-1774), who also studied economic issues, and was the true founder of the economic doctrine known as Physiocracy. His early works were written in the Encyclopédie of Diderot and d’Alembert (1756,1757). However,…
Alfred Marshall was an English economist (1842-1924), and the true founder of the neoclassical school of economics, which combined the study of wealth distribution of the classical school with the
Edgeworth was an Irish economist (1845-1926), professor of Political Economy at the University of Oxford, whose most important contributions to economic science were statistical in nature, primarily in the area of index numbers, highlighting also the mathematical apparatus…
Name that comes from the university in this Swiss city, in which marginalist economist Léon Walras taught and developed its main contributions to economics. Vilfredo Pareto, also a supporter of marginal analysis methods,…
Named essentially after the work of three economists that taught the same course at the University of Vienna:
–Carl Menger, whose main contribution to economic science is the theory of marginal utility;
–Friedrich von Wieser, who formulated the idea…
Pareto was an economist and sociologist of Italian origin, born in Paris (1848-1923), who taught at the University of Lausanne, as well as previously did his mentor, Léon Walras. They both were part of…
David Hume was a British philosopher (1711-1776), Scottish as his friend Adam Smith. In economics, his main contribution is the quantity theory of money, a subject on which he reformulated what was previously enunciated by his predecessors on the…
Irving Fisher was an American economist (1867-1947), professor of Political Economy at Yale University, known for his contributions to quantitative economics (works such as “The Nature of Capital and Income”, 1906, and “The Purchasing Power of Money”, 1911) and especially…
Influenced by mercantilism and physiocracy theories, it took place from the late XVIII century to the late XIX century. It is considered that its main authors were Adam Smith, David Ricardo and John Stuart Mill, and the fourth, the unorthodox
Léon Walras, a French economist (1834-1910), is considered, along with W. S. Jevons and Carl Menger, a co-founder of marginalism and theory of utility. He is regarded as the…
Jevons was a British economist (1835-1882), who is considered, along with Carl Menger and M.-E.-L. Walras, a co-founder of marginalism and theory of utility. Jevons is the…
Carl Menger, was an Austrian economist (1840-1921), who is considered to be, along with W. S. Jevons and M.-E.-L. Walras, a co-founder of marginalism and of the theory of…
Marginalism is a method of analysis used in microeconomics, which seeks to explain economic phenomena through mathematical functions (production, consumption, etc..). The term “marginal” was first used by Johann H. von Thünen in his “The Isolated State”, in 1826. The Marginal revolution, which took place a few decades later,…
Karl Marx was a German politician, philosopher, economist, and sociologist (1818-1883). He studied law and it was in his famous “Thesis on Feuerbach”, where he formulated the proposition that the philosopher must not be contented with the contemplation of…
Adam Smith was born in 1723. His father was a lawyer and civil servant, and during his years as a moral philosophy student at the University of Glasgow, Adam Smith developed an increasing interest in liberty, reason and free speech….
Ricardo, an English economist (1772-1823), from Dutch-Sephardi origins, became rich at a very young age on the stock market and devoted the rest of his life to the study of mathematics and natural sciences and, from 1799, Economics. He became…
The importance of David Ricardo‘s model is that it was one of the first models used in Economics, aimed at explaining how income is distributed in society.
-there is only one industry, agriculture; only one good, grain;
-there…
Physiocracy is an eighteenth-century neologism from the Greek “physis,” nature, “kratia” authority: government of nature. It is the name that François Quesnay and his followers, the Physiocrats, gave in France from 1750 to the new science that saw in nature, especially in agriculture, the…
John S. Mill was an English economist, (1806-1873), son of the also economist James Mill, who gave him a rigorous education. His “Principles of Political Economy”, which is considered one of the most important contributions made…
Malthus was an English reverend (1766-1843), who in his book “An Essay on the Principles of Population,” wrote an argument against his contemporary Mr. Godwin, who believed in unlimited population growth. Malthusian population…
Mercantilism is a pre-classical economic thought, according to which the prosperity of nations is reached by promoting agriculture and manufacturing. The aim is to increase exports and restrict imports, thus accumulating gold and precious metals, relevant as a sign of wealth. Bullionism, which is…
