COMPETITION

Competition is a favourite word for economist, and one which has a very specific definition. When used bu itself, competition refers to a pure situation-more formally called perfect competition. Here, there are four conditions necessary to produce a perfectly competitive structure :
1) A market place made up of many buyers and sellers, each buying or selling just a tiny fraction of the particular product being bought and sold.
2) A product that is homogeneous: that is, the product sold by any one firm is distinguishable from the products sold by other firms.
3) An economic situation that permits would-be sellers to set up shop, and current sellers to close up shop, with relative case.
4) Good information and communication so that all buyers and sellers are informed about prices and sources of supply.

Consider, for example, the soybean industry, which is very close to being perfectly competitive. Millions of farmers produce and sell soy to millions of buyers, the soy is pretty much the same no matter who grows it, farmers can grow soy one year and wheat the next, and information on prices is easily attainable.

Taken together, all these conditions create a situation in which no body has control over prices. Both sellers and buyers must do business at whatever prices is determined by the market, the price that result when all the farmers and all consumers get together. A farmer cannot charge more for her soybeans than her neighbour does and still find willing buyers, and a buyer cannot offer less than other buyers do and still find willing sellers.

Competition, as outlined above, is hardly a situation jampacked with excitement and intrigue. No clever advertising campaigns for Brand X soy no corporate battles between farmers A and B. Indeed, one might wonder how the notion of competition came to be so firmly associated with capitalism, with firm slugging it out and rewards going to the toughest or brightest.

Well, the answer is that perfect competition is hardly the way of the real world. Capitalism is more correctly associated with the terms imperfect competition or monopolistic competition, terms that describe market structures that do not meet those four, somewhat ideal, conditions.

Typically, for example, sellers can distinguish their products by using packaging and advertising to convince buyers that Brand X beer is not only different from Brand Y, but better-higher quality, snappier taste, or preferred by glamorous people. Sellers who are able o differentiate their products can, in turn, exercise some control over prices. Beer drinkers might be willing to pay more for a brew consumed by hunky he-men.

 

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Comparative Advantage

Comparative Advantage is a standard notion in international trade talk meaning that every country, no matter how lowly, can produce something for less relative cost than any other country. It explains why a superior country-say, one that can produce almost everything-specializes in exporting only a few things.

The principle of comparative advantage was first enunciated by the British economist David Ricardo (1972-1823). Ricardo’s example, involving Portugal and England, wine and cloth, still lives as the standard textbook expanation. Briefly, the Ricardo illustration assumes that both countries make both products. Portugal, however, is able to produce wine and textiles cheaper than England. It takes Portugal 80 labor hours. Using trade lingo, Portugal is said to have an absolute advantage in making wine and cloth.

We can draw a conclusion that Portugal has comparative advantage in wine.

The best thing for Portugal to do is to trade its wine for English cloth. In other words, because portuguese wine buys relatively more English textiles than anything else, it better for Portugal to specialize in making wine and exporting it to England. Thus, comparative advantage leads countries to specialize in their lowest relative cost products and trade among each other.

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Ceteris Paribus

Ceteris Paribus is a handy latin phrase meaning all other things being equal. Economists find ceteris paribus indispensable for pronouncing certain laws of economic behavior. (To sit through a semester of introductory economics is to hear that little phrase repeated endlessly.)

Take the law of downward-sloping curve, for example. If the price of a good fails, then more of the good will be bought-ceteris paribus. That is, if tastes, income, and prices of other goods are held constant. However, if there is no ceteris paribus, and taste, income, or prices of other goods are free to change, then the tidy law of downward sloping demand becomes very messy to explain. Say the price of quiche goes down but, at the same time, ceases to be a fashionable dish. Then less quiche, not more will be bought. (You can see why the utterance of ceteris paribus is so handy and so frequent).

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CARTEL

Cartel is a group of otherwise independent firms that band together in order to control their industry, usually by cutting back production to raise prices.

Their motivation is straightforward: to transform a competitive situation (many producers making decisions individually) into a monopoly (many producers making decisions as if they were entity). Cartels can operate in several ways, but for a general idea of how they work, consider the (in)famous Organization of Petroleum Exporting Countries (OPEC). The oil industry is relatively easy to organize or to use the buzzword, cartelize. While only a handful of countries in the world are endowed with the natural resources to produce oil, almost every country in the world needs oil. In other words, there are few sellers and lots of needy buyers.

Before OPEC, each oil-producing country churned up as much as it could and competed with one another on prices. After OPEC was formed, however, most oil-producing countries agreed to reduce their individual output in order to achieve new, higher prices. When OPEC got going in 1973, the price of oil was about $3 a barrel. But with OPEC setting production quotas for each of its members, the price rose to over $30 a barrel within a decade. Not bad.

But OPEC has been subject to one of the classic problems encountered by cartels-being killed by its own succes. High prices create a strong incentive for members to cheat on the cartel by producing more than the agreed amount. The members figure they can increase their own revenues by selling more output at the higher prices. As these sneaky members increase production, however, they bring more output into the market which, of course, pushes prices back down. And so, when some OPEC members gave in to the temptation to cheat on the cartel, they helped cause steep price declines.

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CAPITAL FORMATION

Capital formation is the net addition to the capital stock in a given period. Capital formation is positive when expenditures on new goods exceed the consumption of old ones.

Both capital expenditure and consumption go on all the time. Businesses, especially growing ones, add new capital when they expand production facilities, update equipment or replace worn-out machinery. Businesses also run down existing capital when they use it for production (depreciation) or junk it entirely. What economists call a positive rate of capital formation-a good sign for the economy-means that capital stock is being added faster than it is depreciating.

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CAPITAL MARKET

Capital market is the financial market for the long-term investment and savings. Just like other markets, the capital market serves to link up buyers and sellers. In this case, sellers are individuals, businesses, and governments wishing to raise funds (capital) and buyers are individuals, businesses, and governments wishing to save money.

The instruments through which this linkage takes place are varied. They include corporate stocks and bonds; residental, commercial, and farm mortages; federal, state, and local government bonds; and even consumer and business loans. These instruments also vary in the length of time for which the loan is made-form a year to several decades-making the capital market distinct from the money market where instrument are very short-term, some times overnight.

A healthy capital market-one with lots of buying and selling of many different instruments-is essential to a healthy economy.

Take, for example, a corporation wanting to build a new factory. First, it would be mighty unusual to have the necesary cash on hand, so the money must be borrowed. Second, the company wants to make the best use of its resources, so it needs flexibility in the way it borrows. Third, such a constraction project takes a long time, so the company needs to be sure that the money won’t run out before the project is completed. And fourth, lenders want to be assured that their investment is liquid (somebody will buy the company’s loan instrument if need be), so they want a market with lots of buyers. In other words, the corporation needs a market in which a large chunk of money can be raised, in a number of ways, for a long-term investment.

Just as corporations need an efficient capital market, so do the economy. Absent a capital market, corporations might not expand production, thus they would not create new jobs and so on and so forth. See capital.

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CAPITAL

Capital is any physical item to poduce things. Capital covers a broad range: from humble implements like hoes and hammers to huge factories, complicated machinery, nd sophisticated equipment.

A most intoductory textbooks will tell you, capital is one of the three factors of production; the other two are land and labor. A classic example of this trio describes how a garden plot (land), a farmer (labor), and a hoe (capital) are combined to produce tomatoes. The hoe is important in the production process because it enhances the productivity of land and labor: Sure, the farmer could scratch out a tomato garden without a hoe, but he can produce more tomatoes, in the same amount of time, using a hoe.

The act of producing capital goods is itself a form of investment because it uses resources to make goods that are not consumable, but are used to make other goods (machine tools, for example). Hence the origin of the phrases “seed capital” to describe an economy’s investment in future productivity. If an economy consumes its seed capital, it diminishes its chance to grow in the future. Thus, the amount of capital goods or, the size of the capital stock-in an economy is an important measure of viability.

Like any other investment, the value of capital goods depends on the income they generate in the future. The value of the farmer’s hoe, for example, is not is purchase price, but how much more income the hoe will earn during its useful life, discounted by the interest rate or the carrying cost of the hoe.

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