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Cadbury Committee Report see CORPORATE GOVERNANCE.

called-up capital the amount of ISSUED SHARED CAPITAL that shareholders have been called upon to subscribe to date where a JOINT-STOCK COMPANY issues SHARES with phased payment terms. Called-up capital is usually equal to PAID-UP CAPITAL except where some shareholders have failed to pay instalments due (CALLS IN ARREARS). See SHARE ISSUE.

call money or money at call and short notice CURRENCY (notes and coins) loaned by the COMMERCIAL BANKS to DISCOUNT HOUSES. These can be overnight (24-hour) loans or one-week loans. Call money is included as part of the commercial banks’ RESERVE ASSET RATIO.

call option see OPTION.

calls in arrears the difference that arises between CALLED-UP CAPITAL and PAID-UP CAPITAL where a JOINT-STOCK COMPANY issues SHARES with phased payment terms and shareholders fail to pay an instalment. See SHARE ISSUE.

Cambridge equation see QUANTITY THEORY OF MONEY.

CAP see COMMON AGRICULTURAL POLICY.

capacity 1 the maximum amount of output that a firm or industry is physically capable of producing given the fullest and most efficient use of its existing plant. In microeconomic theory, the concept of full capacity is specifically related to the cost structures of firms and industries. Industry output is maximized (i.e. full capacity is attained) when all firms produce at the minimum point on their long-run average total cost curves (see PERFECT COMPETITION). If firms fail to produce at this point, then the result is EXCESS CAPACITY.

2 in macroeconomics, capacity refers to POTENTIAL GROSS NATIONAL PRODUCT. The percentage relationship of actual output in the economy to capacity (i.e. potential national income) shows capacity utilization. See also MONOPOLISTIC COMPETITION.

capital the contribution to productive activity made by INVESTMENT in physical capital (for example, factories, offices, machinery, tools) and in HUMAN CAPITAL (for example, general education, vocational training). Capital is one of the three main FACTORS OF PRODUCTION, the other two being LABOUR and NATURAL RESOURCES. Physical (and human) capital make a significant contribution towards ECONOMIC GROWTH. See CAPITAL FORMATION, CAPITAL STOCK, CAPITAL WIDENING, CAPITAL DEEPENING, GROSS FIXED CAPITAL FORMATION, CAPITAL ACCUMULATION.

capital account 1 the section of the NATIONAL INCOME ACCOUNTS that records INVESTMENT expenditure by government on infrastructure such as roads, hospitals and schools; and investment expenditure by the private sector on plant and machinery.

2 the section of the BALANCE OF PAYMENTS accounts that records movements of funds associated with the purchase or sale of long-term assets and borrowing or lending by the private sector.

capital accumulation or capital formation 1 the process of adding to the net physical CAPITAL STOCK of an economy in an attempt to achieve greater total output. The accumulation of CAPITAL GOODS represents foregone CONSUMPTION, which necessitates a reward to capital in the form of INTEREST, greater PROFITS or social benefit derived. The rate of accumulation of an economy’s physical stock of capital is an important determinant of the rate of growth of an economy and is represented in various PRODUCTION FUNCTIONS and ECONOMIC GROWTH models. A branch of economics, called DEVELOPMENT ECONOMICS, devotes much of its analysis to determining appropriate rates of capital accumulation, type of capital required and types of investment project to maximize ‘development’ in underdeveloped countries (see DEVELOPING COUNTRY). In developed countries, the INTEREST RATE influences SAVINGS and INVESTMENT (capital accumulation) decisions, to a greater or lesser degree, in the private sector (see KEYNESIAN ECONOMICS) and can therefore be indirectly influenced by government. Government itself invests in the economy’s INFRASTRUCTURE. This direct control over capital accumulation, and the indirect control over private investment, puts the onus of achieving the economy’s optimal growth path on to the government. The nature of capital accumulation (whether CAPITAL WIDENING or CAPITAL DEEPENING) is also of considerable importance. See also CAPITAL CONSUMPTION, INVENTION, INNOVATION, CAPITAL-OUTPUT RATIO. 2 the process of increasing the internally available CAPITAL of a particular firm by retaining earnings to add to RESERVES.

capital allowances ‘write-offs’ against CORPORATION TAX when a FIRM invests in new plant and equipment. In the UK currently (as at 2004/05) a 25% ‘writing-down allowance’ against tax is available for firms that invest in new plant and equipment. Additionally, in the case of small and medium-sized firms, a 40% ‘first-year allowance’ is available for investment in new plant and equipment and a 100% tax write-off for investment in computers and e-commerce.

Capital allowances are aimed at stimulating investment, thereby increasing the supply-side capabilities of the economy and the rate of ECONOMIC GROWTH. See CAPITAL GOODS, DEPRECIATION 2.

capital appreciation see APPRECIATION 2.

capital asset pricing model a model that relates the expected return on an ASSET or INVESTMENT to its risk. Assets that show greater variability in their annual returns generally need to earn higher expected average returns to compensate investors for the variability of returns. See RISK AND UNCERTAINTY.

capital budgeting the planning and control of CAPITAL expenditure within a firm. Capital budgeting involves the search for suitable INVESTMENT opportunities; evaluating particular investment projects; raising LONG-TERM CAPITAL to finance investments; assessing the COST OF CAPITAL; applying suitable expenditure controls to ensure that investment outlays conform with the expenditures authorized; and ensuring that adequate cash is available when required for investments. See INVESTMENT APPRAISAL, DISCOUNTED CASH FLOW, PAYBACK PERIOD, MARGINAL EFFICIENCY OF CAPITAL/INVESTMENT.

capital consumption the reduction in a country’s CAPITAL STOCK incurred in producing this year’s GROSS NATIONAL PRODUCT (GNP). In order to maintain (or increase) next year’s GNP, a proportion of new INVESTMENT must be devoted to replacing worn-out and obsolete capital stock. Effectively, capital consumption represents the aggregate of firms’ DEPRECIATION charges for the year.

capital deepening an increase in the CAPITAL input in the economy (see ECONOMIC GROWTH) at a faster rate than the increase in the LABOUR input so that proportionally more capital to labour is used to produce national output. See CAPITAL WIDENING, CAPITAL-LABOUR RATIO, PRODUCTIVITY.

capital employed see SHAREHOLDERS’ CAPITAL EMPLOYED, LONG-TERM CAPITAL EMPLOYED.

capital expenditure see INVESTMENT.

capital formation see CAPITAL ACCUMULATION.

capital gain the surplus realized when an ASSET (house, SHARE, etc.) is sold at a higher price than was originally paid for it. Because of INFLATION, however, it is important to distinguish between NOMINAL VALUES and REAL VALUES. Thus what appears to be a large nominal gain may, after allowing for the effects of inflation, turn out to be a very small real gain. Furthermore, in an ongoing business, provision has to be made for the REPLACEMENT COST of assets, which can be much higher than the HISTORIC COST of the assets being sold. See CAPITAL GAINS TAX, CAPITAL LOSS, REVALUATION PROVISION, APPRECIATION 2.

capital gains tax a TAX on the surplus obtained from the sale of an ASSET for more than was originally paid for it. In the UK, CAPITAL GAINS tax for business assets is based (as at 2005/06) on a sliding scale, falling from 40% on gains from assets held for under one year to 10% on gains realised after four years. For persons, capital gains on ‘chargeable’ assets (e.g. shares) up to £8,500 per year are exempt from tax; above this they are taxed at 40%.

capital gearing or leverage the proportion of fixed-interest LOAN CAPITAL to SHARE CAPITAL employed in financing a company. Where a company raises most of the funds that it requires by issuing shares and uses very few fixed-interest loans, it has a low capital gearing; where a company raises most of the funds that it needs from fixed-interest loans and few funds from SHAREHOLDERS, it is highly geared. Capital gearing is important to company shareholders because fixed-interest charges on loans have the effect of gearing up or down the eventual residual return to shareholders from trading profits. When the trading return on total funds invested exceeds the interest rate on loans, any residual surplus accrues to shareholders, enhancing their return. On the other hand, when the average return on total funds invested is less than interest rates, then interest still has to be paid, and this has the effect of reducing the residual return to shareholders. Thus, returns to shareholders vary more violently when highly geared.

The extent to which a company can employ fixed-interest capital as a source of long-term funds depends to a large extent upon the stability of its profits over time. For example, large retailing companies whose profits tend to vary little from year to year tend to be more highly geared than, say, mining companies whose profit record is more volatile.

capital goods the long-lasting durable goods, such as machine tools and furnaces, that are used as FACTOR INPUTS in the production of other products, as opposed to being sold directly to consumers. See CAPITAL, CONSUMER GOODS, PRODUCER GOODS.

capital inflow a movement of funds into the domestic economy from abroad, representing either the purchase of domestic FINANCIAL SECURITIES and physical ASSETS by foreigners, or the borrowing (see BORROWER) of foreign funds by domestic residents.

Capital inflows involve the receipt of money by one country, the host, from one or more foreign countries, the source countries. There are many reasons for the transfer of funds between nations:

(a) FOREIGN DIRECT INVESTMENT by MULTINATIONAL COMPANIES in physical assets such as the establishment of local manufacturing plant;

(b) the purchase of financial securities in the host country which are considered to be attractive PORTFOLIO investments;

(c) host-government borrowing from other governments or international banks to alleviate short-term BALANCE OF PAYMENTS deficits;

(d) SPECULATION about the future EXCHANGE RATE of the host country currency and interest rates, expectation of an appreciation of the currency leading to a capital inflow as speculators hope to make a capital gain after the APPRECIATION of the currency.

By contrast, a CAPITAL OUTFLOW is the payment of money from one country to another for the sort of reasons already outlined. See also FOREIGN INVESTMENT, HOT MONEY.

capital-intensive firm/industry a firm or industry that produces its output of goods or services using proportionately large inputs of CAPITAL equipment and relatively small amounts of LABOUR. The proportions of capital and labour that a firm uses in production depend mainly on the relative prices of labour and capital inputs and their relative productivities. This in turn depends upon the degree of standardization of the product. Where standardized products are sold in large quantities, it is possible to employ large-scale capital-intensive production methods that facilitate ECONOMICS OF SCALE. Aluminium smelting, oil refining and steelworks are examples of capital-intensive industries. See MASS PRODUCTION, CAPITAL-LABOUR RATIO.

capitalism see PRIVATE-ENTERPRISE ECONOMY.

capitalization issue or scrip issue the issue by a JOINT-STOCK COMPANY of additional SHARES to existing SHAREHOLDERS without any further payment being required. Capitalization issues are usually made where a company has ploughed back profits over several years, so accumulating substantial RESERVES, or has revalued its fixed assets and accumulated capital reserves. If the company wishes to capitalize the reserves, it can do so by creating extra shares to match the reserves and issue them as BONUS SHARES to existing shareholders in proportion to their existing shareholdings. See also RETAINED PROFIT.

capital-labour ratio the proportion of CAPITAL to LABOUR inputs in an economy. If capital inputs in the economy increase over time at the same rate as the labour input, then the capital-labour ratio remains unchanged (see CAPITAL WIDENING). If capital inputs increase at a faster rate than the labour input, then CAPITAL DEEPENING takes place. The capital-labour ratio is one element in the process of ECONOMIC GROWTH. See CAPITAL-INTENSIVE FIRM/INDUSTRY, LABOUR-INTENSIVE FIRM/INDUSTRY, AUTOMATION.

capital loss the deficit realized when an ASSET (house, SHARE, etc.) is sold at a lower price than was originally paid for it. Compare CAPITAL GAIN.

capital market the market for long-term company LOAN CAPITAL and SHARE CAPITAL and government BONDS. The capital market together with the MONEY MARKET (which provides short-term funds) are the main sources of external finance to industry and government. The financial institutions involved in the capital market include the CENTRAL BANK, COMMERCIAL BANKS, the saving-investing institutions (INSURANCE COMPANIES, PENSION FUNDS, UNIT TRUSTS and INVESTMENT TRUST COMPANIES), ISSUING HOUSES and MERCHANT BANKS.

New share capital is most frequently raised through issuing houses or merchant banks, which arrange for the sale of shares on behalf of client companies. Shares can be issued in a variety of ways, including: directly to the general public by way of an ‘offer for sale’ (or an ‘introduction’) at a prearranged fixed price; an ‘offer for sale by TENDER’, where the issue price is determined by averaging out the bid prices offered by prospective purchasers of the share subject to a minimum price bid; a RIGHTS ISSUE of shares to existing shareholders at a fixed price; a placing of the shares at an arranged price with selected investors, often institutional investors. See STOCK EXCHANGE.

capital movements the flows of FOREIGN CURRENCY between countries representing both short-term and long-term INVESTMENT in physical ASSETS and FINANCIAL SECURITIES and BORROWINGS. See CAPITAL INFLOW, CAPITAL OUTFLOW, BALANCE OF PAYMENTS, FOREIGN INVESTMENTS.

capital outflow a movement of domestic funds abroad, representing either the purchase of foreign FINANCIAL SECURITIES and physical ASSETS by domestic residents or the BORROWING of domestic funds by foreigners. See CAPITAL INFLOW, BALANCE OF PAYMENTS, FOREIGN INVESTMENT, HOT MONEY.

capital-output ratio a measure of how much additional CAPITAL is required to produce each extra unit of OUTPUT, or, put the other way round, the amount of extra output produced by each unit of added capital. The capital-output ratio indicates how ‘efficient’ new INVESTMENT is in contributing to ECONOMIC GROWTH. Assuming, for example, a 4:1 capital-output ratio, each four units of extra investment enables national output to grow by one unit. If the capital-output ratio is 2:1, however, then each two units of extra investment expands national income by one unit. See CAPITAL ACCUMULATION, PRODUCTIVITY. See also SOLOW ECONOMIC-GROWTH MODEL.

capital stock the net accumulation of a physical stock of CAPITAL GOODS (buildings, plant, machinery, etc.) by a firm, industry or economy at any one point in time (see POTENTIAL GROSS NATIONAL PRODUCT).

The measurements most frequently used for the value of a country’s capital stock are from the NATIONAL INCOME and expenditure statistics. These statistics take private and public expenditure on capital goods and deduct CAPITAL CONSUMPTION (see DEPRECIATION 2) to arrive at net accumulation (which may be positive or negative). The more relevant value of capital stock, from the economist’s point of view, is the present value of the stream of income such stock can generate. More broadly, the size of a country’s capital stock has an important influence on its rate of ECONOMIC GROWTH. See CAPITAL ACCUMULATION, CAPITAL WIDENING, CAPITAL DEEPENING, DEPRECIATION METHODS, PRODUCTIVITY, CAPITAL-OUTPUT RATIO.

capital transfer tax see WEALTH TAX.

capital widening an increase in the CAPITAL input in the economy (see ECONOMIC GROWTH) at the same rate as the increase in the LABOUR input so that the proportion in which capital and labour are combined to produce national output remains unchanged. See CAPITAL DEEPENING, CAPITAL-LABOUR RATIO, PRODUCTIVITY.

cardinal utility the (subjective) UTILITY or satisfaction that a consumer derives from consuming a product, measured on an absolute scale. This implies that the exact amount of utility derived from consuming a product can be measured, and early economists suggested that utility could be measured in discrete units referred to as UTILS. However, because it proved impossible to construct an accurate measure of cardinal utility, ORDINAL UTILITY measures replaced the idea of cardinal utility in the theory of CONSUMER EQUILIBRIUM. See DIMINISHING MARGINAL UTILITY.

cartel a form of COLLUSION between a group of suppliers aimed at suppressing competition between themselves, wholly or in part. Cartels can take a number of forms. For example, suppliers may set up a sole selling agency that buys up their individual output at an agreed price and arranges for the marketing of these products on a coordinated basis. Another variant is when suppliers operate an agreement (see RESTRICTIVE TRADE AGREEMENT) that sets uniform selling prices for their products, thereby suppressing price competition but with suppliers then competing for market share through PRODUCT DIFFERENTIATION strategies. A more comprehensive version of a cartel is the application not only of common selling prices and joint marketing but also restrictions on production, involving the assignment of specific output quotas to individual suppliers, and coordinated capacity adjustments, either removing over-capacity or extending capacity on a coordinated basis.

Cartels are usually established with the purpose of either exploiting the joint market power of suppliers to extract MONOPOLY profits or as a means of preventing cut-throat competition from forcing firms to operate at a loss, often resorted to in times of depressed demand (a so-called ‘crisis cartel’). In the former case, a central administration agency could determine the price and output of the industry, and the output quotas of each of the separate member firms, in such a way as to restrict total industry output and maximize the joint profits of the group. Price and output will thus tend to approximate those of a profit-maximizing monopolist. See Fig. 21.

A number of factors are crucial to the successful operation of a cartel, in particular the participation of all significant suppliers of the product and their full compliance with the policies of the cartel. Non-participation of some key suppliers and ‘cheating’ by cartel members, together with the ability of buyers to switch to substitute products, may well serve to undermine a cartel’s ability to control prices. In many countries, including the UK, the USA and the European Union, cartels concerned with price fixing, market sharing and restrictions on production and capacity are prohibited by law. See COMPETITION POLICY (UK), COMPETITION POLICY (EU), ORGANIZATION OF PETROLEUM-EXPORTING COUNTRIES (OPEC).

Fig. 21 Cartel. D is the industry demand curve, showing the aggregate quality that the combined group may sell over a range of possible prices and MR is the industry marginal revenue curve. The industry marginal cost curve ΣMC is constructed from the marginal cost curves of the individual firms making up the cartel. For any given level of industry output, the cartel is required to calculate the allocation of the output among member firms on the basis of their individual marginal costs to obtain the lowest possible aggregate cost of producing their output. To maximize industry profit, the cartel will set price OP and produce output OQ. Quotas of Q_A and Q_B are given to firms A and B respectively where a horizontal line drawn from the intersection of MR and ΣMC (the line of aggregate marginal costs) intersects MC_A and MC_B. Profit contributed by each firm is computed by multiplying the number of units produced by the difference between industry price and the firm’s average cost at that level of output. The aggregate profit is then divided among the member firms in some agreed manner, not necessarily, it is to be noted, in the same proportion as actually contributed by each of the individual firms. Disputes over the sharing of aggregate profit frequently lead to the break-up of cartels.

cash see CURRENCY.

cash and carry a form of wholesaling that requires customers (predominantly RETAILERS) to pay cash for products bought and to collect these products themselves from a warehouse. See DISTRIBUTION CHANNEL.

cash card see COMMERCIAL BANK.

cash discount see DISCOUNT.

cash drain a constraint on the expansion of the MONEY SUPPLY through BANK DEPOSIT CREATION, caused by individuals retaining larger amounts of cash than usual. This means that not all of the increase in cash calculated by using the reciprocal of the RESERVE ASSET RATIO is passed on from the public back into the banking system. For example, a new deposit of £100 is made into the banking system. Assuming a 10% reserve asset ratio, the average fraction of money held in cash form is one-tenth and the reciprocal 10. Thus ultimately a £1,000 increase in money supply is theoretically possible. If the public’s demand for cash grows, however, then the increase in the money supply will not be 10 times the initial deposit, but something less.

cash flow the money coming into a business from sales and other receipts and going out of the business in the form of cash payments to suppliers, workers, etc.

cash limits a means of controlling public sector spending by setting maximum expenditure totals for government departments or nationalized industries, deliberately making no allowance for inflation. See GOVERNMENT (PUBLIC) EXPENDITURE.

cash ratio see CASH RESERVE RATIO.

cash reserve ratio the proportion of a COMMERCIAL BANK’S total assets that it keeps in the form of highly liquid assets to meet day-to-day currency withdrawals by its customers and other financial commitments. The cash reserve ratio comprises TILL MONEY (notes and coins held by the bank) and its operational BALANCES WITH THE BANK OF ENGLAND. The cash reserve ratio is a narrowly defined RESERVE ASSET RATIO that can be used by the monetary authorities to control the MONETARY BASE of the economy. See BANK DEPOSIT CREATION, MONETARY BASE CONTROL, MONETARY POLICY.

CAT see COMPETITION APPEALS TRIBUNAL.

caveat emptor a Latin phrase meaning ‘let the buyer beware’. Put simply, this means that the supplier has no legal obligation to inform buyers about any defects in his goods or services. The onus is on the buyer to determine for himself or herself that the good or service is satisfactory. Compare CAVEAT VENDOR.

caveat vendor a Latin phrase meaning ‘let the seller beware’. In brief, this means that the supplier may be legally obliged to inform buyers of any defects in his goods or services. Compare CAVEAT EMPTOR.

census a comprehensive official survey of households or businesses undertaken at regular intervals in order to obtain socioeconomic information. In the UK, a population census has been carried out every 10 years since 1891 to provide information on demographic trends. This data is useful to the government in the planning of housing, education and welfare services. A production census is carried out annually to provide details of industrial production, employment, investment, etc. A distribution census provides data about wholesaling and retailing. This information can be used by the government in formulating its economic and industrial policies.

central bank a country’s leading BANK, generally responsible for overseeing the BANKING SYSTEM, acting as a ‘clearing’ banker for the COMMERCIAL BANKS (see CLEARING HOUSE SYSTEM) and for implementing MONETARY POLICY. In addition, many central banks are responsible for handling the government’s budgetary accounts and for managing the country’s external monetary affairs, in particular the EXCHANGE RATE.

Examples of central banks include the USA’s Federal Reserve Bank, Germany’s Deutsche Bundesbank, France’s Banque de France and the European Union’s EUROPEAN CENTRAL BANK. (For a more detailed discussion of a central bank’s activities see the BANK OF ENGLAND entry.)

centralization the concentration of economic decision-making centrally rather than diffusing such decision-making to many different decision-makers. In a country, this is achieved by the adoption of a CENTRALLY PLANNED ECONOMY where the state undertakes to own, control and direct resources into particular uses. In a firm, centralization involves top managers retaining authority to make all major decisions and issuing detailed instructions to particular divisions and departments. See U-FORM ORGANIZATION.

centrally planned economy or command economy or collectivism a method of organizing the economy to produce goods and services. Under this ECONOMIC SYSTEM, economic decision-making is centralized in the hands of the state with collective ownership of the means of production, (except labour). It is the state that decides what goods and services are to be produced in accordance with its centralized NATIONAL PLAN. Resources are allocated between producing units, and final outputs between customers by the use of physical quotas.

The main rationale underlying state ownership of industry is the view that the collective ownership of the means of production ‘by the people for the people’ is preferable to a situation in which the ownership of the means of production is in the hands of the ‘capitalist class’ who are able to exploit their élite position to the detriment of the populace at large. State control of industry enables the economy as a whole to be organized in accordance with some central plan, which by interlocking and synchronizing the input-output requirements of industry is able to secure an efficient allocation of productive resources. Critics of state-owned economic systems argue, however, that in practice they tend to be ‘captured and corrupted’ by powerful state officials, and that their top-heavy bureaucratic structures result in a highly inefficient organization of production and insensitivity to what customers actually want. See PRIVATE-ENTERPRISE ECONOMY, MIXED ECONOMY, NATIONALIZATION, COMMUNISM.

certificate a document signifying ownership of a FINANCIAL SECURITY (STOCK, SHARE, etc.). In the UK, such certificates are issued in the name of the person or company recorded in the company’s register of SHAREHOLDERS as the owner of these shares, new certificates being issued to buyers when shares are sold. In countries like the USA, where BEARER BONDS are used, stock certificates merely note the number of stocks or shares represented and do not include the name of the owners, the holder of the certificate being presumed to be the owner.

certificate of deposit a FINANCIAL SECURITY issued by BANKS, BUILDING SOCIETIES and other financial institutions as a means of borrowing money for periods ranging from one month to five years. Once issued, certificates of deposit may be bought and sold on the MONEY MARKET and are redeemable on their maturity for their face value plus accrued interest.

certificate of incorporation a certificate issued by the COMPANY REGISTRAR to a new JOINT-STOCK COMPANY whose MEMORANDUM OF ASSOCIATION and ARTICLES OF ASSOCIATION are acceptable to the Registrar. A company starts its legal existence from the date of its incorporation and thereafter is able to enter into contracts, etc., in its own name.

certificate of origin a document used to authenticate the country of origin of internationally traded goods. Most trading countries are prepared to accept certificates of origin issued by government departments of their trade partners or their appointees (CHAMBERS OF COMMERCE in the UK). However, complications as to their precise country of origin often arise in the case of goods that are assembled in one country using components that are in the main imported from others. See LOCAL CONTENT RULE, EXPORT.

ceteris paribus a Latin term meaning ‘other things being equal’ that is widely used in economic analysis as an expository technique. It allows us to isolate the relationship between two variables. For example, in demand analysis, the DEMAND CURVE shows the effect of a change in the price of a product on the quantity demanded on the assumption that all of the ‘other things’ (incomes, tastes, etc.) influencing the demand for that product remain unchanged.

chain store a multi-branch retail firm. All types of retailer, ranging from SPECIALIST SHOPS to DEPARTMENT STORES, can be organized to take advantage of the economics of HORIZONTAL INTEGRATION. Unlike single-shop concerns, chain stores are able to maximize their sales potential through geographical spread and maximize their competitive advantage by being able to secure BULK-BUYING price concessions from manufacturers and the supply of OWN LABEL BRANDS. See SUPERMARKET, DISCOUNT STORE, COOPERATIVE, DO-IT-YOURSELF STORE, RETAILER, DISTRIBUTION CHANNEL.

Chamberlin, Edward (1899–1967) an American economist who helped develop the theory of MONOPOLISTIC COMPETITION in his book The Theory of Monopolistic Competition. Prior to Chamberlin’s work, economists classified markets into two groups:

(a) perfect competition, where firm’s products are perfect substitutes;

(b) monopoly, where a firm’s product has no substitutes.

Chamberlin argued that in real markets goods are often partial substitutes for other goods, so that even in markets with many sellers the individual firm’s DEMAND CURVE might be downward sloping. He then proceeded to analyse the firm’s price and output decisions under such conditions and derive the implications for market supply and price. See also ROBINSON.

chamber of commerce an organization that operates primarily to serve the needs of the business community in an industrial city or area. Chambers of commerce provide a forum for local businessmen and traders to discuss matters of mutual interest and provide a range of services to their members, especially small businesses, including, for example, in the UK, information on business opportunities locally and nationally and, in conjunction with the DEPARTMENT OF TRADE AND INDUSTRY, export advisory services, export market intelligence, etc. See also BUSINESS LINK.

Chancellor of the Exchequer the UK government official heading the TREASURY whose main responsibility is the formulation and implementation of the government’s economic policy.

Chancellors of the Exchequer since 1970:

A. Barber 1970–74 (Conservative);

D. Healey 1974–79 (Labour);

G. Howe 1979–83 (Conservative);

N. Lawson 1983–89 (Conservative);

J. Major 1989–90 (Conservative);

N. Lamont 1990–93 (Conservative);

K. Clarke 1993–97 (Conservative) and

G. Brown 1997–to date (Labour).

change in demand see DEMAND CURVE (SHIFT IN).

change in supply see SUPPLY CURVE (SHIFT IN).

channel see DISTRIBUTION CHANNEL.

cheap money a government policy whereby the CENTRAL BANK is authorized to purchase government BONDS on the open market to facilitate an increase in the MONEY SUPPLY (see MONETARY POLICY).

The increase in money supply serves to reduce INTEREST RATES, which encourages INVESTMENT because previously unprofitable investments now become profitable as a result of the reduced cost of borrowing (see MARGINAL EFFICIENCY OF CAPITAL/INVESTMENT).

Cheap money policy, through MONEY SUPPLY/SPENDING LINKAGES, increases AGGREGATE DEMAND. Compare TIGHT MONEY. See LIQUIDITY TRAP.

cheque a means of transferring or withdrawing money from a BANK or BUILDING SOCIETY current account. In the former case, the drawer of a cheque creates a written instruction to his or her bank or building society to transfer funds to some other person’s or company’s bank or building society account (the ‘payee’). In the latter case, money may be withdrawn in cash by a person or company writing out a cheque payable to themselves. Cheques may be ‘open’, in which case they may be used to draw cash, or ‘crossed’ with two parallel lines, in which case they cannot be presented for cash but must be paid into the account of the payee. See COMMERCIAL BANK.

cheque card see COMMERCIAL BANK.

Chicago school a group of economists at Chicago University, most notable of whom is Milton FRIEDMAN, who have adopted and refined the QUANTITY THEORY OF MONEY, arguing the need for governments to control the growth of the MONEY SUPPLY over the long term. Within the broad parameters set by stable money growth, the Chicago school stresses the importance of the market system as an allocative mechanism, leaving consumers free to make economic decisions with minimal government interference. See MONETARISM.

Chinese wall the segregation of the stockbroking, jobbing (see MARKET MAKER), fund management, etc., activities of a financial institution in order to protect the interest of its clients. For example, the same institution could be responsible for making a market in a particular financial security while at the same time offering investment advice to clients to purchase this security, with the danger that the advice given will not be impartial. See CITY CODE.

choice the necessity for CENTRALLY PLANNED ECONOMIES and PRIVATE ENTERPRISE ECONOMIES to have to choose which goods and services to produce and in what quantities, arising from the relative SCARCITY of economic resources (FACTORS OF PRODUCTION) available to produce those goods and services. See ECONOMICS, PREFERENCES.

c.l.f. abbrev. for cost-insurance-freight, i.e. charges that are incurred in transporting imports and exports of goods from one country to another. In BALANCE-OF-PAYMENTS terms, c.i.f. charges are added to the basic prices of imports and exports of goods in order to compute the total foreign currency flows involved. See F.O.B.

circular flow of national income model a simplified exposition of money and physical or real flows through the economy that serves as the basis for macroeconomic analysis. In Fig. 22 (a) the solid lines show how, in monetary terms, HOUSEHOLDS purchase goods and services from BUSINESSES using income received from supplying factor inputs to businesses (CONSUMPTION EXPENDITURE). In physical terms (shown by the broken lines), businesses produce goods and services using factor inputs supplied to them by households.

The basic model can be developed to incorporate a number of ‘INJECTIONS’ to, and ‘WITHDRAWALS’ from, the income flow. In Fig. 22 (b), not all the income received by households is spent – some is saved, SAVINGS is a ‘withdrawal’ from the income flow. INVESTMENT expenditure ‘injects’ funds into the income flow. Part of the income accruing to households is taxed by the government and serves to reduce disposable income available for consumption expenditure. TAXATION is a ‘withdrawal’ from the income flow. GOVERNMENT EXPENDITURE on products and factor inputs ‘injects’ funds into the income flow. Households spend some of their income on imported goods and services. IMPORTS are a ‘withdrawal’ from the income flow. On the other hand, some output is sold to overseas customers. EXPORTS represent a demand for domestically produced goods and services and hence constitute an ‘injection’ into the income flow. See also AGGREGATE DEMAND, EQUILIBRIUM LEVEL OF NATIONAL INCOME MODEL.

Fig. 22 Circular flow of national income model. (a) The basic model of the relationship between money flows and physical flows. (b) A more complex model, incorporating injections to and withdrawals from the income flow.

City code a regulatory system operated voluntarily by interested parties to the UK STOCK EXCHANGE that lays down ‘rules of good conduct’ governing the tactics and procedures used in TAKEOVER BIDS and MERGERS. The general purpose of the code is to ensure that all SHAREHOLDERS (both the shareholders of the firm planning the takeover and those of the target firm) are treated equitably, and that the parties City (of London) involved in arranging a takeover bid do not abuse privileged ‘insider’ information, or misuse such tactics as CONCERT PARTIES, DAWN RAIDS and CHINESE WALLS.

The City code is administered by the City Panel on Takeovers and Mergers, which is responsible for formulating rules of practice and for investigating suspected cases of malpractice. See also INSIDER TRADING.

City (of London) the centre of the UK’s FINANCIAL SYSTEM, embracing the MONEY MARKETS (commercial banks, etc.), CAPITAL MARKET (STOCK EXCHANGE), FOREIGN EXCHANGE MARKET, COMMODITY MARKETS and INSURANCE MARKETS. The City of London is also a major international financial centre and earns Britain substantial amounts of foreign exchange on exports of financial services.

City Panel on Takeovers and Mergers see CITY CODE.

claimant count unemployment measure a UK measure of UNEMPLOYMENT that is based on the number of people claiming unemployment-related benefits (see JOBSEEKERS ALLOWANCE) at job centre offices. The unemployment rate is then expressed as a percentage of ‘workforce jobs’ (the number of persons recorded as being in full-time and part-time employment) plus claimant unemployment. In 2004 (third quarter) the unemployment rate was calculated at 2.7% using this measure. Compare INTERNATIONAL LABOUR ORGANIZATION UNEMPLOYMENT MEASURE. See REGISTERED UNEMPLOYMENT.

classical economics a school of thought or a set of economic ideas based on the writings of SMITH, RICARDO, MILL, etc., which dominated economic thinking until about 1870, when the ‘marginalist revolution’ occurred.

The classical economists saw the essence of the economic problem as one of producing and distributing the economic wealth created between landowners, labour and capitalists; and were concerned to show how the interplay of separate decisions by workers and capitalists could be harmonized through the market system to generate economic wealth. Their belief in the power of market forces led them to support LAISSEZ-FAIRE, and they also supported the idea of FREE TRADE between nations. After about 1870, classical economic ideas receded as the emphasis shifted to what has become known as NEOCLASSICAL ECONOMIC ANALYSIS, embodying marginalist concepts.

Classical economists denied any possibility of UNEMPLOYMENT caused by deficient AGGREGATE DEMAND, arguing that market forces would operate to keep aggregate demand and POTENTIAL GROSS NATIONAL PRODUCT in balance (SAY’S LAW). Specifically, they argued that business recessions would cause interest rates to fall under the pressure of accumulating savings, so encouraging businesses to borrow and invest more, and would cause wage rates to fall under the pressure of rising unemployment, so encouraging businessmen to employ more workers. See LABOUR THEORY OF VALUE, KEYNES, PRIVATE ENTERPRISE ECONOMY.

clearing bank see COMMERCIAL BANK.

clearing house system a centralized mechanism for settling indebtedness between financial institutions involved in money transmission and dealers in commodities and financial securities. For example, in the case of UK commercial banking, when a customer of Bank A draws a cheque in favour of a customer of Bank B, and the second customer pays in the cheque to Bank B, then Bank A is indebted to Bank B for the amount of that cheque. There will be many thousands of similar transactions going on day by day, creating indebtedness between all banks. The London Clearing House brings together all these cheques, cross-cancels them and determines at the end of each day any net indebtedness between the banks. This net indebtedness is then settled by transferring balances held by the COMMERCIAL BANKS at the CENTRAL BANK (BANK OF ENGLAND).

A similar ‘clearing’ function is performed in the commodities and financial securities market by, for example, the International Commodities Clearing House and the London Financial Futures Exchange. See STOCK EXCHANGE, FUTURES MARKET, COMMODITY MARKET.

closed economy an economy that is not influenced by any form of INTERNATIONAL TRADE, that is, there are no EXPORTS or IMPORTS of any kind. By concentrating on a closed economy, it is possible to simplify the CIRCULAR FLOW OF NATIONAL INCOME MODEL and focus upon income and expenditure within an economy.

In terms of the circular flow, AGGREGATE DEMAND in a closed economy is represented by:

		Y = C + I + G
where	Y	= national income
	C	= consumption expenditure
	I	= investment expenditure
	G	= government expenditure

By contrast, the OPEN ECONOMY allows for the influence of imports and exports and here aggregate demand is represented in the circular flow as:

	Y	= C + I + G + (X-M)
where	X	= exports
	M	= imports

closed shop a requirement that all employees in a given workplace or ORGANIZATION be members of a specified TRADE UNION. Closed shops are often imposed by powerful trade unions as a means of restricting the supply of labour and maintaining high wage rates for members. See SUPPLY-SIDE ECONOMICS.

club principle a means of allocating the common overhead costs incurred in providing a good or service to each individual consumer. For example, residents may create a club to arrange for the resurfacing of a private road. See COLLECTIVE PRODUCTS, FREE-RIDER.

clusters geographically proximate groups of interconnected companies, suppliers, service producers and associated institutions, linked by commodities and complementarities. Michael Porter identified clusters as being vital for competitiveness insofar as they improve productivity and flexibility, aid innovation and contribute to new business formation. Porter noted that national economics tend to specialise in certain industrial clusters and that if these clusters are internationally competitive then their export performance will be good. See COMPETITIVE ADVANTAGE OF COUNTRIES, EXTERNAL ECONOMIES OF SCALE.

Coase theorem see TRANSACTION COSTS.

Cobb-Douglas production function a particular physical relationship between OUTPUT of products and FACTOR INPUTS (LABOUR and CAPITAL) used to produce these outputs. This particular form of the PRODUCTION FUNCTION suggests that where there is effective competition in factor markets the ELASTICITY OF TECHNICAL SUBSTITUTION between labour and capital will be equal to one; that is, labour can be substituted for capital in any given proportions, and vice-versa, without affecting output.

The Cobb-Douglas production function suggests that the share of labour input and the share of capital input are relative constants in an economy, so that although labour and capital inputs may change in absolute terms, the relative share between the two inputs remains constant. See PRODUCTION POSSIBILITY BOUNDARY, CAPITAL-LABOUR RATIO, PRODUCTION FUNCTION, CAPITAL-INTENSIVE FIRM/INDUSTRY, ISOQUANT CURVE, ISOQUANT MAP.

cobweb theorem a theory designed to explain the path followed in moving toward an equilibrium situation when there are lags in the adjustment of either SUPPLY or DEMAND to changes in prices, COMPARATIVE STATIC EQUILIBRIUM ANALYSIS predicts the effect of demand or supply changes by comparing the original equilibrium price and quantity with the new equilibrium that results. The cobweb theorem focuses upon the dynamic process of adjustment in markets by tracing the path of adjustment of prices and output in moving from one equilibrium situation toward another (see DYNAMIC ANALYSIS).

Fig. 23 Cobweb theorem. See entry.

The cobweb theorem is generally used to describe oscillations in prices in agricultural markets where the delay between, for example, planting and harvesting means that supply reacts to prices with a time lag. The simplest case where current quantity demanded responds to current price while current quantity supplied depends upon price in the previous period is depicted in Fig. 23. In the figure, D_t denotes quantity demanded in the current period, S_t, denotes quantity supplied, while price is denoted by P_t, and price in the previous period is denoted by P_t–1. If demand were to fall rapidly, such that the demand curve shifted left from D_t to D¹_t, then comparative static analysis suggests that the market will eventually move from equilibrium point E (with price OP₁ and quantity OQ₁) to equilibrium point E¹ (with price OP₄ and quantity OQ₄). Dynamic analysis suggest that the path followed will be less direct than this.

Starting from the original equilibrium price OP₁, which has prevailed in years t–1 and t, farmers will have planned to produce quantity OQ₁. However, after the contraction in demand in year t, supply will exceed demand by QQ₁, and in order to sell all the quantity OQ₁ coming on to the market, price has to fall to OP₂. The lower price OP₂, which prevails in year t, will discourage farmers from producing and they will reduce acreage devoted to this crop so that in the next year t + 1 a much smaller quantity OQ₂ is supplied.

In year t + 1, and at price OP₂, demand now exceeds supply by the amount Q₁Q₂, and in order to ration the limited supply OQ₂ that is available, price will rise to OP₃. This higher price in year t + 1 will encourage farmers to increase their acreage planted so that in the following year t + 2, a larger quantity OQ₃ will be supplied, which means that in year t + 2 supply exceeds demand and price will fall below OP₃, which will discourage planting for the following year, and so on. The eventual result of this process of adjustment is that a new equilibrium is achieved at E¹ but only after a series of fluctuating prices in intermediate periods are experienced. See AGRICULTURAL POLICY.

coin the metallic CURRENCY that forms part of a country’s MONEY SUPPLY. Various metals have been used for coinage purposes. Formerly, gold and silver were commonly used but these have now been replaced in most countries by copper, brass and nickel. Coins in the main constitute the ‘low value’ part of the money supply. See MINT, LEGAL TENDER.

collateral security the ASSETS pledged by a BORROWER as security for a LOAN, for example, the title deeds of a house. In the event of the borrower defaulting on the loan, the LENDER can claim these assets in lieu of the sum owed. See DEBT, DEBTOR.

collective bargaining the negotiation of PAY, conditions of employment, etc., by representatives of the labour force (usually trade union officials) and management. Collective bargaining agreements are negotiated at a number of different levels, ranging from local union branches and a single factory to general unions and an entire industry.

Increasingly, plant- and company-level collective bargaining has dealt with PRODUCTIVITY as well as wages and conditions, with trade unions and the workforce offering to relax RESTRICTIVE LABOUR PRACTICES in return for improved wages and conditions. Such relaxations allow the firm to utilize labour more efficiently and flexibly, helping to improve the competitiveness of the firm.

Industry-wide bargaining can have inflationary consequences when trade unions use comparability arguments for wage increases with high percentage wage increases in industries that have experienced large productivity gains being extended on comparability grounds to other industries where the increases are not entirely justified on efficiency grounds. The selective use of comparability arguments for wage increases and pressures to maintain traditional WAGE DIFFERENTIALS can lead to COST-PUSH INFLATION. See TRADE UNION, INDUSTRIAL RELATIONS, INDUSTRIAL DISPUTE.

collective products any goods or services that cannot be provided other than on a group basis because the quantity supplied to any one individual cannot be independently varied. Such products are non-excludable since it is difficult or impossible to exclude any individual from enjoying their benefits, for example, television airwave transmissions. Such products are also non-rival, insofar as one person’s consumption of the product does not affect the consumption opportunities of anyone else. It is virtually impossible to get consumers to reveal their preferences regarding collective goods because rational consumers will attempt to become FREE-RIDERS, each understating his demand in the hope of avoiding his share of the cost without affecting the quantity he obtains. Consequently, such products cannot be marketed in the conventional way and we cannot use market prices to value them. Many goods and services supplied by government are of a collective nature, for example, national defence and police protection, and here government decides on the amounts of such products to provide and compels individuals to pay for them through taxation. See MARKET FAILURE, CLUB PRINCIPLE, SOCIAL PRODUCTS.

collectivism see CENTRALLY PLANNED ECONOMY.

collusion a form of INTERFIRM CONDUCT pattern in which firms arrive at an agreement or ‘understanding’ covering their market actions. Successful collusion requires the acceptance of a common objective for all firms (for example, JOINT-PROFIT MAXIMIZATION) and the suppression of behaviour inconsistent with the achievement of this goal (for example, price competition). Collusion may be either overt or tacit. Overt collusion usually takes the form of either an express agreement in writing or an express oral agreement arrived at through direct consultation between the firms concerned. Alternatively, collusion may take the form of an ‘unspoken understanding’ arrived at through firms’ repeated experiences with each other’s behaviour over time.

The purpose of collusion may be jointly to monopolize the supply of a product in order to extract MONOPOLY profits, or it may be a ‘defensive’ response to poor trading conditions, seeking to prevent prices from dropping to uneconomic levels. Because, however, of its generally adverse effects on market efficiency (cushioning inefficient, high-cost suppliers) and because it deprives buyers of the benefits of competition (particularly lower prices), collusion is either prohibited outright by COMPETITION POLICY or permitted to continue only in exceptional circumstances.

In the UK, under the COMPETITION ACT 1998, collusion in the form of an ANTI-COMPETITIVE AGREEMENT/RESTRICTIVE TRADE AGREEMENT is prohibited outright. Previously, under the RESTRICTIVE TRADE PRACTICES ACT, such agreements were allowed to continue, providing ‘net economic benefit’ could be established. See CARTEL, RESTRICTIVE TRADE AGREEMENT, ANTICOMPETITIVE AGREEMENT, OLIGOPOLY, DUOPOLY, INFORMATION AGREEMENT, RESTRICTIVE PRACTICES COURT.

collusive duopoly see DUOPOLY.

command economy see CENTRALLY PLANNED ECONOMY.

commercial bank or clearing bank a BANK that accepts deposits of money from customers and provides them with a payments transmission service (CHEQUES), together with saving and loan facilities.

Commercial banking in the UK is conducted on the basis of an interlocking ‘branch’ network system that caters for local and regional needs as well as allowing the major banks, such as Barclays and NatWest, to cover the national market. Increasingly, the leading banks have globalized their operations to provide traditional banking services to international companies as well as diversifying into a range of related financial services such as the provision of MORTGAGES, INSURANCE and UNIT TRUST investment and SHARE PURCHASE/SALE.

Bank deposits are of two types:

(a) sight deposits, or current account deposits, which are withdrawable on demand and which are used by depositors to finance day-to-day personal and business transactions as well as to pay regular commitments such as instalment credit repayments. Most banks now pay interest on outstanding current account balances;

(b) time deposits, or deposit accounts, which are usually withdrawable subject to some notice being given to the bank and which are held as a form of personal and corporate saving and to finance irregular, ‘one-off’ payments. Interest is payable on deposit accounts, normally at rates above those paid on current accounts, in order to encourage clients to deposit money for longer periods of time, thereby providing the bank with a more stable financial base.

Customers requiring to draw on their bank deposits may do so in a number of ways: direct cash withdrawals are still popular and have been augmented by the use of cheque/cash cards for greater convenience (i.e. cheque/cash cards can be used to draw cash from a dispensing machine outside normal business hours). However, the greater proportion of banking transactions is undertaken by cheque and CREDIT CARD payments and by such facilities as standing orders and direct debits. Payment by cheque is the commonest form of non-cash payment involving the drawer detailing the person or business to receive payment and authorizing his bank to make payment by signing the cheque, with the recipient then depositing the cheque with his own bank. Cheques are ‘cleared’ through an inter-bank CLEARING HOUSE SYSTEM, with customers’ accounts being debited and credited as appropriate (see also BACS). Credit cards enable a client of the bank to make a number of individual purchases of goods and services on CREDIT over a particular period of time, which are then settled by a single debit to the person’s current account or, alternatively, paid off on a loan basis (see below).

Under a standing order arrangement, a depositor instructs his bank to pay from his account a regular fixed sum of money into the account of a person or firm he is indebted to, again involving the respective debiting and crediting of the two accounts concerned. In the case of a direct debit, the customer authorizes the person or firm to whom he is indebted to arrange with his bank for the required regular payment to be transferred from his account.

Commercial banks make loans to personal borrowers to finance the purchase of a variety of products, while they are a major source of WORKING CAPITAL finance for businesses covering the purchase of short-term assets such as materials and components and the financing of work-in-progress and the stockholding of final products. Loans may be for a specified amount and may be made available for fixed periods of time at agreed rates of interest, or may take the form of an overdraft facility, where the person or firm can borrow as much as is required up to a pre-arranged total amount and is charged interest on outstanding balances.

A commercial bank has the dual objective of being able to meet currency withdrawals on demand and of putting its funds to profitable use. This influences the pattern of its asset holdings; a proportion of its funds are held in a highly liquid form (the RESERVE ASSET RATIO), including TILL MONEY, BALANCES WITH THE BANK OF ENGLAND, CALL MONEY with the DISCOUNT MARKET, BILLS OF EXCHANGE and TREASURY BILLS. These liquid assets enable the bank to meet any immediate cash requirements that its customers might make, thereby preserving public confidence in the bank as a safe repository for deposits. The remainder of the bank’s funds are used to earn profits from portfolio investments in public sector securities and fixed-interest corporate securities, together with loans and overdrafts.

In recent times, the commercial banks have been markedly affected by changes introduced by the FINANCIAL SERVICES ACT 1986, which has allowed other financial institutions to set themselves up as ‘financial supermarkets’, offering customers a banking service and a wide range of personal financial products, including insurance, mortgages, personal pensions, unit trusts and individual savings accounts (ISAs), etc. This development has introduced a powerful new competitive impetus into the financial services industry, breaking down traditional ‘demarcation’ boundaries in respect of ‘who does what’, allowing banks to ‘cross-sell’ these services and products in competition with traditional providers such as the BUILDING SOCIETIES, INSURANCE COMPANIES, UNIT TRUSTS, etc.

This and other developments (in particular, the globalization of investment banking) have in turn caused a number of structural changes. Intra- and inter-takeovers-mergers have occurred (e.g. the Lloyds-TSB Banks’ tie-up and their takeover of the Cheltenham and Gloucester building society); foreign banks have increasingly moved into the UK through either takeover (e.g. Hong Kong and Shanghai Banking Corp’s takeover of the Midland Bank and Deutsche Bank’s acquisition of the Morgan Grenfell investment house) or by setting up local offices; building societies such as the Abbey National, Woolwich and Halifax have converted themselves into banks. Direct banking services (via the telephone and the internet) have increasingly taken market share away from traditional branch networks. This has led to pressure on banks to cut costs by reducing the number of their branches. Another notable development has been the rapid rise in ATMs (AUTOMATIC TELLER MACHINES, referred to popularly as ‘hole in the wall’ machines).

The commercial banks play a unique role in a country’s monetary system through their capacity to engage in multiple BANK DEPOSIT CREATION by providing credit through loans and overdrafts. Bank deposits constitute by far the largest single component of the broad MONEY SUPPLY (especially M4) and as such are a crucial target for the application of MONETARY POLICY in controlling the economy. See MONEY SUPPLY DEFINITIONS, BANK OF ENGLAND. See also EFTPOS.

commission 1 payments to AGENTS for performing services on behalf of a seller or buyer. Commissions are usually based on the value of the product being sold or bought. Examples of commissions include salespersons’ commissions, estate agents’ fees and insurance brokers’ commissions. 2 a body that acts as an ‘official’ regulatory or administrative authority with respect to a specified activity. For example, the COMPETITION COMMISSION hears cases of monopolies, mergers and anti-competitive practices referred to it by the Office of Fair Trading under UK competition policy. The European Commission is the main body responsible for the day-to-day administration of the affairs of the EUROPEAN UNION.

commodity 1 see GOODS. 2 raw materials rather than goods in general: for example, tea, coffee, iron ore, aluminium, etc.

commodity broker a dealer in raw materials. See COMMODITY MARKET.

commodity market a market for the buying and selling of agricultural produce and minerals such as coffee and tin. Commodity business is conducted through various international commodity exchanges, some of the more prominent ones being based in London, for example the London Metal Exchange and the London International Financial Futures Exchange.

Commodity markets provide an organizational framework for the establishment of market prices and ‘clearing’ deals between buyers and sellers (see CLEARING HOUSE SYSTEM). Commodity dealers and brokers act as intermediaries between buyers and sellers wishing to conclude immediate spot transactions (see SPOT MARKET) or to buy or sell forward (see FUTURES MARKET).

commodity money products that can be used as a means of payment (see MONEY) but which are valuable in their own right, for example, cigarettes or alcoholic drinks. Commodity money is generally only used as a means of payment if confidence in money falls as a result of, say, rapid INFLATION.

Common Agricultural Policy (CAP) the policy of the EUROPEAN UNION (EU) for assisting the farm sector. The main aims of the CAP are fair living standards for farmers and an improvement in agricultural efficiency (see AGRICULTURAL POLICY).

The CAP is administered by the European Agricultural Guidance and Guarantee Fund, with major policy and operational decisions (e.g. the fixing of annual farm prices) residing in the hands of the Council of Ministers of the EU. The farm sector is assisted in four main ways:

(a) around 70–75% of EU farm produce benefits directly from the operation of a PRICE-SUPPORT system that maintains EU farm prices at levels in excess of world market prices. The prices of milk, cereals, butter, sugar, pork, beef, veal, certain fruits and vegetables and table wine are fixed annually and, once determined, are then maintained at this level by support-buying of output that is not bought in the market. MONETARY COMPENSATION AMOUNTS are used to convert the common price for each product into national currencies and to realign prices when the exchange rates of members’ currencies change;

(b) variable TARIFF rates are used to increase import prices to internal price-support levels in the cases of the products referred to above, thus ensuring that EU output is fully competitive. The 25% of EU farm produce that is not subject to direct price-support relies entirely on tariff protection to maintain high domestic prices;

(c) EXPORT SUBSIDIES are used to enable EU farmers to lower their export prices and thus compete successfully in world markets;

(d) grants are given to facilitate farm modernization and improvements as a means of improving agricultural efficiency.

The CAP is the largest single component of the EU’s total budget. In 2003 it accounted for 45% of total EU spending. Over 90% of the CAP’s budget in recent years has been spent on price-support and export subsidies.

Although the CAP can claim a number of successes, most notably the attainment of EU self-sufficiency in many food products, critics complain it has many drawbacks: consumers lose out because they are required to pay unnecessarily high prices for food products; resources are misallocated because inefficient, high-cost farmers are overprotected, and too little of the CAP’s resources are devoted to long-term structural reform and modernization of the sector; artificially high prices supported by intervention buying encourage gross overproduction and results in large surpluses (‘mountains’) of produce that are expensive to stockpile and difficult to sell off; subsidized exports from the EU can depress world farm prices, making life even more difficult for the less developed countries, many of which (specifically non-LOMÉ AGREEMENT countries) had already been hard hit by the trade diversionary effects of the EU (see TRADE DIVERSION).

However, the CAP has become less protectionist as a result of the ‘Uruguay Round’ of trade concessions (see WORLD TRADE ORGANIZATION). The EU committed itself (over a six-year period starting in 1995) to reduce its import levies by 36%, reduce its domestic subsidies by 20%, and reduce its export subsidies by 36%. Further reductions are currently being negotiated as part of the ‘Doha Round’. See INCOME SUPPORT.

common currency see EURO.

common external tariff see CUSTOMS UNION, COMMON MARKET.

common law the body of law built up over many years as a result of previous court decisions interpreting legislation. These establish legal precedents that then need to be followed consistently in subsequent court cases. Compare STATUTE LAW.

common market a form of TRADE INTEGRATION between a number of countries in which members eliminate all trade barriers (TARIFFS, etc.) amongst themselves on goods and services and establish a uniform set of barriers against trade with the rest of the world, in particular, a common external tariff (see CUSTOMS UNION). In addition, a common market provides for the free movement of labour and capital across national boundaries. The aim of a common market is to secure the benefits of international SPECIALIZATION, thereby improving members’ real living standards.

The short- and medium-term impact of the formation of a common market is mainly felt through an increase in trade between member countries. TRADE CREATION is typically associated with a reallocation of resources within the market favouring least-cost supply locations and a reduction in prices resulting from the elimination of tariffs and lower production costs. (See GAINS FROM TRADE.)

In addition, a common market can be expected to promote longer-term (dynamic) changes conducive to economic efficiency through:

(a) COMPETITION. The removal of tariffs, etc., can be expected to widen the area of effective competition; high-cost producers are eliminated, while efficient and progressive suppliers are able to exploit new market opportunities;

(b) ECONOMIES OF SCALE. A larger ‘home’ market enables firms to take advantage of economies of large-scale production and distribution, thereby lowering supply costs and enhancing COMPARATIVE ADVANTAGE;

(c) TECHNOLOGICAL PROGRESSIVENESS. Wider market opportunities and exposure to greater competition can be expected to encourage firms to invest and innovate new techniques and products;

(d) INVESTMENT and ECONOMIC GROWTH. Finally, the virtuous circle of rising income per head, growing trade, increased productive efficiency and investment may be expected to combine to produce higher growth rates and real standards of living.

The EUROPEAN UNION is one example of a common market. See ANDEAN PACT.

communism a political and economic doctrine that advocates that the state should own all property and organize all the functions of PRODUCTION and EXCHANGE, including LABOUR. Karl MARX succinctly stated his idea of communism as ‘from each according to his ability, to each according to his needs’. Communism involves a CENTRALLY PLANNED ECONOMY where strategic decisions concerning production and distribution are taken by government as opposed to being determined by the PRICE SYSTEM, as in a market-based PRIVATE ENTERPRISE ECONOMY. China still organizes its economy along communist lines, but in recent years Russia and other former Soviet Union countries and various East European countries have moved away from communism to more market-based economies.

community charge see LOCAL TAX.

company see FIRM.

company formation the process of forming a JOINT-STOCK COMPANY, which involves a number of steps:

(a) the drawing up of a MEMORANDUM OF ASSOCIATION;

(b) the preparation of ARTICLES OF ASSOCIATION;

(c) application to the COMPANY REGISTRAR for a CERTIFICATE OF INCORPORATION;

(d) the issue of SHARE CAPITAL;

(e) the commencement of trading.

company laws a body of legislation providing for the regulation of JOINT-STOCK COMPANIES. British company law encouraged the development of joint-stock companies by establishing the principle of LIMITED LIABILITY and providing for the protection of SHAREHOLDERS’ interests by controlling the formation and financing of companies. The major provisions of UK company law are the 1948, 1976 and 1989 Companies Acts. See ARTICLES OF ASSOCIATION, MEMORANDUM OF ASSOCIATION, FIRM.

company registrar the officer of a JOINT-STOCK COMPANY who is responsible for maintaining an up-to-date SHARE REGISTER and for issuing new SHARE CERTIFICATES and cancelling old share certificates as shares are bought and sold on the STOCK EXCHANGE. Many companies, however, have chosen to subcontract these tasks to specialist institutions, often departments of commercial banks.

The role of the company registrar identified above should not be confused with that of the role of the government’s REGISTRAR OF COMPANIES, who is responsible for supervising all joint-stock companies.

comparability an approach to WAGE determination in which levels or increases in wages for a particular group of workers or for an industry are sought or offered through COLLECTIVE BARGAINING, which maintains a relationship to those for other occupations or industries. Comparability can lead to COST-PUSH INFLATION.

Fig. 24 Comparative advantage. The physical output of X and Y from a given factor input, and the opportunity cost of X in terms of Y. The opportunity cost of producing one more unit of X is 1Y in country A, and ⅔Y in country B. The opportunity cost of producing one more unit of Y is 1X in country A, and 1½X in country B.

comparative advantage the advantage possessed by a country engaged in INTERNATIONAL TRADE if it can produce a given good at a lower resource input cost than other countries. Also called comparative cost principle. This proposition is illustrated in Fig. 24 with respect to two countries (A and B) and two GOODS (X and Y).

The same given resource input in both countries enables them to produce either the quantity of Good X or the quantity of Good Y indicated in Fig. 24. It can be seen that Country B is absolutely more efficient than Country A since it can produce more of both goods. However, it is comparative advantage not ABSOLUTE ADVANTAGE that determines whether trade is beneficial or not. Comparative advantage arises because the marginal OPPORTUNITY COSTS of one good in terms of the other differ as between countries (see HECKSCHER-OHLIN FACTOR PROPORTIONS THEORY).

It can be seen that Country B has a comparative advantage in the production of Good X for it is able to produce it at a lower factor cost than Country A; the resource or opportunity cost of producing an additional unit of X is only ⅔ Y in Country B, whereas in Country A it is 1Y.

Country A has a comparative advantage in the production of Good Y for it is able to produce it at lower factor cost than Country B; the resource or opportunity cost of producing an additional unit of Y is only 1X, whereas in Country B it is 1½X.

Both countries, therefore, stand to increase their economic welfare if they specialize (see SPECIALIZATION) in the production of the good in which they have a comparative advantage (see GAINS FROM TRADE for an illustration of this important proposition). The extent to which each will benefit from trade will depend upon the real terms of trade at which they agree to exchange X andY.

A basic assumption of this presentation is that factor endowments, and hence comparative advantages, are ‘fixed’. Dynamically, however, comparative advantage may well change. It may do so in response to a number of influences, including:

(a) the initiation by a country’s government of structural programmes leading to resource redeployment. For example, a country that seemingly has a comparative advantage in the supply of primary products such as cotton and wheat may nevertheless abandon or de-emphasize it in favour of a drive towards industrialization and the establishment of comparative advantage in higher value-added manufactured goods;

(b) international capital movements and technology transfer, and relocation of production by MULTINATIONAL COMPANIES. For example, Malaysia developed a comparative advantage in the production of natural rubber only after UK entrepreneurs established and invested in rubber-tree plantations there. See COMPETITIVE ADVANTAGE (OF COUNTRIES).

comparative cost principle see COMPARATIVE ADVANTAGE.

comparative static equilibrium analysis a method of economic analysis that compares the differences between two or more equilibrium states that result from changes in EXOGENOUS VARIABLES. Consider, for example, the effect of a change in export demand on the EQUILIBRIUM LEVEL OF NATIONAL INCOME as shown in Fig. 25. Assume that foreigners demand more of the country’s products. Exports rise and the aggregate demand schedule shifts upwards to a new level (AD₂), resulting in the establishment of a new equilibrium level of national income Y₂ (at point H). The effect of the increase in exports can then be measured by comparing the original level of national income with that of the new level of national income. See DYNAMIC ANALYSIS, EQUILIBRIUM MARKET PRICE (CHANGES IN).

compensation principle see WELFARE ECONOMICS.

competition 1 a form of MARKET STRUCTURE in which the number of firms supplying the market is used to indicate the type of market it is, e.g. PERFECT COMPETITION (many small competitors), OLIGOPOLY (a few large competitors). 2 a process whereby firms strive against each other to secure customers for their products, i.e. the active rivalry of firms for customers, using price variations, PRODUCT DIFFERENTIATION strategies, etc. From a wider public interest angle, the nature and strength of competition has an important effect on MARKET PERFORMANCE and hence is of particular relevance to the application of COMPETITION POLICY. See COMPETITION METHODS, MONOPOLISTIC COMPETITION, MONOPOLY.

Fig. 25 Comparative static equilibrium analysis. The initial level of national income is Y₁ (at point A) where the AGGREGATE DEMAND SCHEDULE (AD₁) intersects the AGGREGATE SUPPLY SCHEDULE (AS).

Competition Act 1980 a UK Act that extended UK COMPETITION LAW by giving the OFFICE OF FAIR TRADING (OFT) wider powers to deal with restraints on competition such as EXCLUSIVE DEALING, TIE-IN SALES, etc. Previously, these practices could be dealt with only in the context of a full-scale and lengthy monopoly probe, whereas the Act now allows the OFT to deal with them on a separate one-off basis. See COMPETITION POLICY (UK).

Competition Act 1998 a UK Act that consolidated existing competition laws but also contained new prohibitions, powers of investigation and penalties for infringements of the Act. The Act is designed to bring UK competition law into line with European Union competition law as currently enshrined in Articles 85 and 86 of the Treaty of Rome.

The Act covers two key areas of competition policy: anti-competitive agreements and market dominance.

(a) The Act prohibits outright agreements between firms (i.e. COLLUSION) and CONCERTED PRACTICES that prevent, restrict or distort competition within the UK (the Chapter 1 prohibition). This prohibition applies to both formal and informal agreements, whether oral or in writing, and covers agreements that contain provisions to jointly fix prices and terms and conditions of sale; to limit or control production, markets, technical development or investment; and to share markets or supply sources.

(b) The Act prohibits the ‘abuse’ of a ‘dominant position’ within the UK (the Chapter 2 prohibition). The Act specifies dominance as a situation where a supplier ‘can act independently of its competitors and customers’. As a general rule, a dominant position is defined as one where a supplier possesses a market share of 40% or above. Examples of ‘abuse’ of a dominant position specified in the Act include charging ‘excessive’ prices, imposing restrictive terms and conditions of sale to the prejudice of consumers and limiting production, markets and technical development to the prejudice of consumers.

The Act established a new regulatory authority, the COMPETITION COMMISSION, that took over the responsibilities previously undertaken by the Monopolies and Mergers Commission and the Restrictive Practices Court. Under the Act, the OFFICE OF FAIR TRADING (OFT) has the power to refer dominant firm cases and cases of suspected illegal collusion to the Competition Commission for investigation and report.

The Act gives the OFT wide-ranging powers to uncover malpractices. For example, if there are reasonable grounds for suspecting that firms are operating an illegal agreement, OFT officials can mount a ‘dawn raid’ – ‘entering business premises, using reasonable force where necessary, and search for incriminating documents’. The Act also introduces stiff new financial penalties. Firms found to have infringed either prohibitions may be liable to a financial penalty of up to 10% of their annual turnover in the UK (up to a maximum of three years). See COMPETITION POLICY, COMPETITION POLICY (UK), COMPETITION POLICY (EU), ANTICOMPETITIVE AGREEMENT, RESTRICTIVE TRADE AGREEMENT.

Competition Appeals Tribunal (CAT) a body established by the ENTERPRISE ACT 2002 to hear appeals in regard to ‘disputed’ merger cases. The OFFICE OF FAIR TRADING has the power to refer proposed mergers and takeovers to the COMPETITION COMMISSION for investigation if it believes that the merger/takeover would ‘substantially lessen competition’. If, in the OFT’s view, this is not the case, it can allow the merger/takeover to go ahead without reference. This is where the CAT comes in. An interested party (e.g. a competitor of the companies involved in the merger) may ‘appeal’ to the CAT that the OFT decision not to refer is ‘wrong’. The task of the CAT is to arbitrate and decide if there is indeed a case for reference and can ‘order’ a reference to the Competition Commission if it sees fit.

Competition Commission (CC) a regulatory body established by the COMPETITION ACT 1998 that was originally set up in 1948 as the Monopolies Commission (1948–65), then the Monopolies and Mergers Commission (1965–98) and that is responsible for the implementation of UK COMPETITION POLICY. The basic task of the Commission is to investigate and report on cases of MONOPOLY/MARKET DOMINANCE, MERGER/TAKEOVER and ANTI-COMPETITIVE PRACTICES referred to it by the OFFICE OF FAIR TRADING (OFT) to determine whether or not they unduly remove or restrict competition, thus producing harmful economic effects (i.e. economic results that operate against the ‘public interest’). The Commission is also required by the OFT to investigate cases of ‘illegal’ collusion between suppliers, i.e. cases where the OFT has good reason to suspect that an ANTICOMPETITIVE AGREEMENT/RESTRICTIVE TRADE AGREEMENT prohibited by the Competition Act 1998 is continuing to be operated ‘in secret’. (This task was formerly undertaken by the RESTRICTIVE PRACTICES COURT.)

Under UK COMPETITION LAW, monopoly/market dominance is defined as a situation where at least 40% of a reference good or service is supplied by one firm or a number of suppliers who restrict competition between themselves (CONCERTED PRACTICE or COMPLEX MONOPOLY situation). Mergers and takeovers fall within the scope of the legislation where the market share of the combined business exceeds 25% of the reference good or service or where the value of assets being merged or taken over exceeds £70 million. Anti-competitive practices are those that distort, restrict or eliminate competition in a market.

Cases referred to the Competition Commission are evaluated nowadays primarily in terms of whether or not the actions of suppliers (MARKET CONDUCT) or changes in the structure of the market (MARKET STRUCTURE) are detrimental to the potency of competition in the market and hence prejudicial to the interests of consumers and other suppliers (the so-called ‘public interest’ criterion found in earlier legislation). In cases of monopoly/market dominance, the Commission scrutinizes the actions of dominant firms for evidence of the ‘abuse’ of market power and invariably condemns predatory pricing policies that result in excessive profits. Practices such as EXCLUSIVE DEALING, AGGREGATED REBATES, TIE-IN SALES and FULL-LINE FORCING, whose main effect is to restrict competition, have been invariably condemned by the Commission, especially when used by a dominant firm to erect BARRIERS TO ENTRY and to undermine the market positions of smaller rivals. A merger or takeover involving the leading firms who already possess large market shares is likely to be considered detrimental. (See MARKET CONCENTRATION.)

In all cases, the Commission has powers only of recommendation. It can recommend, for example, price cuts to remove monopoly profits, the discontinuance of offending practices and the prohibition of anti-competitive mergers, but it is up to the Office of Fair Trading to implement the recommendations, or not, as it sees fit.

competition law a body of legislation providing for the control of monopolies/market dominance, mergers and takeovers, anti-competitive agreements/restrictive trade agreements and anti-competitive practices. UK legislation aimed at controlling ‘abusive’ MARKET CONDUCT by monopolistic firms and firms acting in COLLUSION was first introduced in 1948 (The Monopolies and Restrictive Practices (Inquiry and Control) Act), while powers to control undesirable changes in MARKET STRUCTURE were added in 1965 (The Monopolies and Mergers Act). Other notable legislation concerning the control of collusion were the Restrictive Trade Practice Acts of 1956, 1968 and 1976.

Current competition law in the UK is contained in a number of Acts:

FAIR TRADING ACT 1973

(applying to mergers and takeovers)

COMPETITION ACT 1980

(applying to anti-competitive practices)

COMPETITION ACT 1998

(applying to monopolies/market dominance and anti-competitive agreements/restrictive trade agreements)

RESALE PRICES ACTS 1964, 1976

(applying to resale price maintenance)

ENTERPRISE ACT 2002

(applying to mergers/takeovers and anti-competitive agreements)

These laws are currently administered by the OFFICE OF FAIR TRADING and the COMPETITION COMMISSION (formerly the MONOPOLIES AND MERGERS COMMISSION). See also RESTRICTIVE PRACTICES COURT.

In the EUROPEAN UNION, competition law is enshrined in Articles 85 and 86 of the Treaty of Rome (1958) and the 1980 Merger Regulation. These laws are administered by the European Com-mission’s Competition Directorate. See COMPETITION POLICY, COMPETITION POLICY (UK), COMPETITION POLICY (EU), COMPLEX MONOPOLY.

competition methods an element of MARKET CONDUCT that denotes the ways in which firms in a MARKET compete against each other. There are various ways in which firms can compete against each other:

(a) PRICE. Sellers may attempt to secure buyer support by putting their product on offer at a lower price than that of rivals. They must bear in mind, however, that rivals may simply lower their prices also, with the result that all firms finish up with lower profits;

(b) non-price competition, including:

(i) physical PRODUCT DIFFERENTIATION. Sellers may attempt to differentiate technically similar products by altering their quality and design, and by improving their performance. All these efforts are intended to secure buyer allegiance by causing buyers to regard these products as in some way ‘better’ than competitive offerings.

(ii) product differentiation via selling techniques. Competition in selling efforts includes media ADVERTISING, general SALES PROMOTION (free trial offers, money-off coupons), personal sales promotion (representatives) and the creation of distribution outlets. These activities are directed at stimulating demand by emphasizing real and imaginary product attributes relative to competitors.

(iii) New BRAND competition. Given dynamic change (advances in technology, changes in consumer tastes), a firm’s existing products stand to become obsolete. A supplier is thus obliged to introduce new brands or to redesign existing ones to remain competitive;

(c) low-cost production as a means of competition. Although cost-effectiveness is not a direct means of competition, it is an essential way to strengthen the market position of a supplier. The ability to reduce costs opens up the possibility of (unmatched) price cuts or allows firms to devote greater financial resources to differentiation activity. See also MONOPOLISTIC COMPETITION, OLIGOPOLY, MARKETING MIX, PRODUCT-CHARACTERISTICS MODEL, PRODUCT LIFE-CYCLE.

competition policy a policy concerned with promoting the efficient use of economic resources and protecting the interests of consumers. The objective of competition policy is to secure an optimal MARKET PERFORMANCE: specifically, least-cost supply, ‘fair’ prices and profit levels, technological advance and product improvement. Competition policy covers a number of areas, including the monopolization of a market by a single supplier (MARKET DOMINANCE), the creation of monopoly positions by MERGERS and TAKEOVERS, COLLUSION between sellers and ANTI-COMPETITIVE PRACTICES.

Competition policy is implemented mainly through the control of MARKET STRUCTURE and MARKET CONDUCT but also, on occasions, through the direct control of market performance itself (by, for example, the stipulation of maximum levels of profit).

There are two basic approaches to the control of market structure and conduct: the nondiscretionary approach and the discretionary approach. The non-discretionary approach lays down ‘acceptable’ standards of structure and conduct and prohibits outright any transgression of these standards. Typi-cal ingredients of this latter approach include:

(a) the stipulation of maximum permitted market share limits (say, no more than 20% of the market) in order to limit the degree of SELLER CONCENTRATION and prevent the emergence of a monopoly supplier. Thus, for example, under this ruling any proposed merger or takeover that would take the combined group’s market share above the permitted limit would be automatically prohibited;

(b) the outright prohibition of all forms of ‘shared monopoly’ (ANTI-COMPETITIVE AGREEMENT/RESTRICTIVE TRADE AGREEMENTS, CARTELS) involving price fixing, market sharing, etc;

(c) the outright prohibition of specific practices designed to reduce or eliminate competition, for example, EXCLUSIVE DEALING, REFUSAL TO SUPPLY, etc.

Thus, the nondiscretionary approach attempts to preserve conditions of WORKABLE COMPETITION by a direct attack on the possession and exercise of monopoly power as such.

By contrast, the discretionary approach takes a more pragmatic line, recognizing that often high levels of seller concentration and certain agreements between firms may serve to improve economic efficiency rather than impair it. It is the essence of the discretionary approach that each situation be judged on its own merits rather than be automatically condemned. Thus, under the discretionary approach, mergers, restrictive agreements and specific practices of the kind noted above are evaluated in terms of their possible benefits and detriments. If, on balance, they would appear to be detrimental, then, and only then, are they prohibited.

The USA by and large operates the nondiscretionary approach; the UK has a history of preferring the discretionary approach, while the European Union combines elements of both approaches. See COMPETITION POLICY (UK), COMPETITION POLICY (EU), PUBLIC INTEREST, WILLIAMSON TRADE-OFF MODEL, OFFICE OF FAIR TRADING, COMPETITION COMMISSION, RESTRICTIVE PRACTICES COURT, HORIZONTAL INTEGRATION, VERTICAL INTEGRATION, DIVERSIFICATION, CONCENTRATION MEASURES.

competition policy (EU) covers three main areas of application under European Union’s COMPETITION LAWS:

(a) CARTELS. Articles 85(1) and (2) of the Treaty of Rome prohibit cartel agreements and ‘CONCERTED PRACTICES’ (i.e. formal and informal collusion) between firms, involving price-fixing, limitations on production, technical developments and investment, and market sharing, whose effect is to restrict competition and trade within the European Union (EU). Certain other agreements (for example, those providing for joint technical research and specialization of production) may be exempted from the general prohibition contained in Articles 85(1) and (2), provided they do not restrict inter-state competition and trade;

(b) MONOPOLIES/MARKET DOMINANCE. Article 86 of the Treaty of Rome prohibits the abuse of a dominant position in the supply of a particular product if this serves to restrict competition and trade within the EU. What constitutes ‘abusive’ behaviour is similar to the criteria applied in the UK, namely, actions that are unfair or unreasonable towards customers (e.g. PRICE DISCRIMINATION between EU markets), retailers (e.g. REFUSAL TO SUPPLY) and other suppliers (e.g. selective price cuts to eliminate competitors). Firms found guilty by the European Commission of illegal cartelization and the abuse of a dominant position can be fined up to 10% of their annual sales turnover;

(c) MERGERS/TAKEOVERS. The Commission can investigate mergers involving companies with a combined world-wide turnover of over €5 billion (£3.7 bn) if the aggregate EU-wide turnover of the companies concerned is greater than €250 million. Again, the main aim is to prevent mergers likely adversely to affect competition and trade within the EU.

These thresholds still apply generally, but in 1998 they were reduced to €3.5 billion and €100 million, respectively, for mergers affecting the competitive situation in three (or more) EU countries in cases where the combined turnover of the companies exceed €25 million in each of the three countries.

Generally, where EU competition laws apply, they take precedence over the national competition laws of member countries. However, a subsidiarity provision can be invoked, which permits the competition authority of a member country to request permission from the EU Competition Directorate to investigate a particular dominant firm or merger case if it appears that the ‘European dimension’ is relatively minor compared to its purely local impact.

competition policy (UK) covers six main areas of application under UK COMPETITION LAWS:

(a) MONOPOLIES/MARKET DOMINANCE. The COMPETITION ACT 1998 prohibits actions that constitute the ‘abuse’ of a dominant position in a UK market. The OFFICE OF FAIR TRADING (OFT) is responsible for the referral of selected goods and services monopolies (both private and public sectors) to the COMPETITION COMMISSION for investigation and report and the implementation (where it sees fit) of the Commission’s recommendations.

A dominant position is defined as a situation where one firm controls 40% or more of the ‘reference’ good or service. (Under previous legislation, market dominance was defined in terms of a 25% market share). Abuse consists of acts that are harmful to the interests of consumers and other suppliers, e.g. charging excessive prices to secure monopoly profits and imposing restrictive terms and conditions on the supply of goods (see EXCLUSIVE DEALING, TIE-IN SALES, etc). The term ‘abuse’ can be broadly equated with that of conduct contrary to the ‘public interest’ – the benchmark used in previous legislation.

Defining the ‘reference’ market to establish evidence of market dominance can be problematic since it raises the issue of how widely or narrowly the boundaries of ‘the market’ are to be delineated (see MARKET, MARKET CONCENTRATION). Thus, the drinks market could be divided as between alcoholic and non-alcoholic drinks, and further divided into sub-markets as between, for example, the various types of alcoholic drink – the beer/lager market, spirits market, wine market, etc. Establishing abuse can also be a ‘grey area’. For example, high prices and profits may be condoned because they reflect exceptional innovation; on the other hand, low profits may not be a sign of effective competition but reflect the fact that the firm is grossly inefficient;

(b) ANTI-COMPETITIVE AGREEMENTS/RESTRICTIVE TRADE AGREEMENTS. The Competition Act 1998 prohibits outright agreements between firms (i.e. COLLUSION) and CONCERTED PRACTICES that prevent, restrict or distort competition within the UK. The Office of Fair Trading is responsible for monitoring ‘suspected’ cases of firms operating agreements illegally and can refer them for further investigation by the Competition Commission. The prohibition applies to both formal and informal agreements, whether oral or in writing, and covers agreements that involve joint price-fixing and common terms and conditions of sale, market-sharing and coordination of capacity adjustments, etc. (Under previous legislation it was possible to obtain exemption from prohibition if it could be demonstrated that an agreement conferred ‘net economic benefit’ – see RESTRICTIVE TRADE PRACTICES ACTS, RESTRICTIVE PRACTICES COURT.)

Although anti-competitive agreements are technically illegal, nonetheless there is much evidence that many such agreements have been driven ‘underground’ and are continuing to be operated in secret. This problem has been addressed by the authorities in encouraging ‘whistleblowers’ to come forward and supply them with information about illegal activities and also provisions in the Competition Act 1998 that allow officials to enter business premises without warning and to seize incriminating documentation. Under the ENTERPRISE ACT 2002, participation in illegal agreements has now been made a criminal offence, punishable by imprisonment;

(c) MERGERS AND TAKEOVERS. Originally, under the FAIR TRADING ACT 1973, the Office of Fair Trading (OFT), acting alongside the Secretary of State for Industry, could refer mergers and takeovers to the Competition Com-mission for investigation and report where (1) the combined firms already had or would have had a market share of 25% or over in a ‘reference’ good or service; (2) the value of assets being combined exceeded £70 million. Clause (1) effectively covered horizontal mergers and takeovers (see HORIZONTAL INTEGRATION) and clause (2) vertical and conglomerate mergers and takeovers (see VERTICAL INTEGRATION, DIVERSIFICATION/CONGLOMERATE INTEGRATION). Under the ENTERPRISE ACT 2002, the OFT was given sole responsibility for merger/takeover references but subject to an appeals procedure in disputed cases (see COMPETITION APPEALS TRIBUNAL).

Mergers and takeovers nowadays are mainly evaluated in terms of their likely competitive effects. Unlike in dealing with established monopolies, where past conduct can be scrutinised to establish harmful effects, mergers and takeovers are about the future, and predicting the likely future effects of a merger/takeover is problematic. Faced with this difficulty, the Commission tends to ‘play safe’ and recommend the blocking of most mergers/takeovers that reduce competition by significantly increasing the level of MARKET CONCENTRATION;

(d) RESALE PRICE MAINTENANCE (RPM). Manufacturers’ stipulation of the resale prices of their products is generally prohibited in the UK, although under the RESALE PRICES ACTS it is possible for a manufacturer to obtain exemption by satisfying the Competition Commission that, on balance, RPM confers net economic benefit. The OFT is responsible for monitoring manufacturers’ policies towards retail prices and can take action against ‘suspected’ cases of manufacturers attempting (illegally) to enforce RPM. Manufacturers can, however, take action against retailers who use their products as LOSS LEADERS;

(e) ANTI-COMPETITIVE PRACTICES. Various trade practices, such as EXCLUSIVE DEALING, REFUSAL TO SUPPLY, FULL-LINE FORCING, etc., may be investigated both by the OFT itself and (if necessary) by the Competition Commission, and prohibited if they are found to be unduly restrictive of competition;

(f) CONSUMER PROTECTION. The OFT is also charged with protecting consumers’ interests generally, both by taking action against unscrupulous trade practices, such as false descriptions of goods and weights and measures, denial of proper rights of guarantee to cover defective goods, etc., and by encouraging groups of suppliers to draw up voluntary codes of ‘good’ practice.

Where a particular dominant firm or merger case falls within the competition rules of both the UK and the European Union (see COMPETITION POLICY (EU)), EU law takes precedence. However, a subsidiarity provision can be invoked that permits the OFT to request permission from the EU competition authorities to investigate a particular dominant firm or merger case if it appears that the ‘European dimension’ is relatively minor compared to its purely local impact.

Fig. 26 Competitive advantage (of countries). The Porter ‘diamond’.

competitive advantage (of countries) the resources and capabilities possessed by a country that underpin its competitiveness in international trade (see COMPARATIVE ADVANTAGE). Countries per se do not trade – only persons and firms do. Persons and firms may possess their own unique resources and capabilities, which give them a competitive advantage over others. See COMPETITIVE ADVANTAGE (OF FIRMS). This can be enhanced by firms being able to contribute, and tap in, to a country’s resources and capabilities. Michael Porter has developed the so-called ‘diamond’ framework, which encapsulates this potential, consisting of four elements: factor endowments, demand conditions, infrastructure and firm strategy/structure/rivalry. See Fig. 26.

A basic starting point is a country’s factor endowments, such as plentiful (i.e. cheap) labour or skilled labour, raw materials and capital stock, together with its underlying scientific and technological infrastructure. With regard to demand conditions, it is not so much the size of the home market (although it is accepted that a large home base may be necessary to underpin economies of scale in lowering supply costs and prices) as its nature that matters. Porter emphasizes the importance of the presence of sophisticated and demanding buyers in stimulating the innovation and introduction of new products capable of being ‘transferred’ into global markets. The category of ‘related and supporting industries’ provides an important bedrock for competitive success through a network of suppliers and commercial infrastructure (see CLUSTERS). The final quadrant, ‘firm strategy, structure and rivalry’, Porter suggests, may be the most important of all, especially the element of fierce local competition. While international rivalries tend to be ‘analytical and distant’, local rivalries become intensively personal but nonetheless beneficial in providing a ‘springboard’ for international success. All these factors, it is suggested, are interrelated, creating a ‘virtuous circle’ of resource generation and application, and sensitivity in meeting customer demands.

competitive advantage (of firms) the possession by a firm of various assets and attributes (low-cost plants, innovative brands, ownership of raw material supplies, etc.) that give it a competitive edge over rival suppliers. To succeed against competitors in winning customers on a viable (profitable) and sustainable (long-run) basis, a firm must, depending on the nature of the market, be cost-effective and/or able to offer products that customers regard as preferable to the products offered by rival suppliers. The former enables a firm to meet and beat competitors on price, while the latter reflects the firm’s ability to establish PRODUCT DIFFERENTIATION advantage over competitors.

Cost advantages over competitors are of two major types:

(a) absolute cost advantages, that is, lower costs than competitors at all levels of output deriving from, for example, the use of superior production technology or from VERTICAL INTEGRATION of input supply and assembly operations;

(b) relative cost advantages, that is, cost advantages related to the scale of output accruing through the exploitation of ECONOMIES OF SCALE in production and marketing and through cumulative EXPERIENCE CURVE effects. Over time, investment in plant renewal, modernization and process innovation (either through in-house RESEARCH AND DEVELOPMENT or the early adoption of new technology developed elsewhere) is essential to maintain cost advantages.

Product differentiation advantages derive from:

(a) a variety of physical product properties and attributes (notably the ability to offer products that are regarded by customers as having unique qualities or as being functionally better than competitors’ products);

(b) the particular nuances and psychological images built into the firm’s product by associated advertising and sales promotion. Again, given the dynamic nature of markets, particularly product life cycle considerations, competitive advantage in this area needs to be sustained by an active programme of new product innovation and upgrading of existing lines. See COMPETITIVE STRATEGY, RESOURCE BASED THEORY OF THE FIRM, BARRIERS TO ENTRY, MOBILITY BARRIERS, VALUE-CREATED MODEL, VALUE CHAIN ANALYSIS.

competitive strategy an aspect of BUSINESS STRATEGY that involves the firm developing policies to meet and beat its competitors in supplying a particular product. This requires the firm to undertake an internal appraisal of its resources and capabilities relative to competitors to identify its particular strengths and weaknesses. It also requires the firm to undertake an external appraisal of the nature and strength of the various ‘forces driving competition’ in its chosen markets (see Fig 27), namely:

(a) rivalry amongst existing firms;

(b) bargaining power of input suppliers;

(c) bargaining power of customers;

(d) threat of new entrants; and

(e) the threat of substitute products.

The key to a successful competitive strategy is then:

(a) to understand fully what product attributes are demanded by buyers (whether it be low prices or product sophistication) with a view to;

(b) establishing, operationally, a position of COMPETITIVE ADVANTAGE that makes the firm less vulnerable to attack from established competitors and potential new entrants, and to erosion from the direction of buyers, suppliers and substitute products.

Fig. 27 Competitive strategy. (a) Forces driving competition in a market. (b) Three generic strategies. Source: Michael Porter.

There are three generic strategies for competitive success (Fig. 27 (b)): cost leadership, product differentiation and ‘focus’. Low costs, particularly in commodity-type markets, help the firm not only to survive price competition should it break out but, importantly, enable it to assume the role of market leader in establishing price levels that ensure high and stable levels of market profitability. The sources of cost-effectiveness are varied, including the exploitation of ECONOMIES OF SCALE, investment in best state-of-the-art technology and preferential access to raw materials or distribution channels. By adopting a PRODUCT DIFFERENTIATION strategy, a firm seeks to be unique in its market in a way that is valued by its potential customers. Product differentiation possibilities vary from market to market but are associated with the potential for distinguishing products by their physical properties and attributes and the experience of satisfaction – real and psychological – imparted by the product to consumers. General cost leadership and differentiation strategies seek to establish a COMPETITIVE ADVANTAGE over rival suppliers across the whole market. By contrast, ‘focus’ strategies aim to build competitive advantages in narrower segments of a market but, again, either in terms of cost or, more usually, differentiation characteristics, with ‘niche’ suppliers primarily catering for speciality product demands. See MARKET STRUCTURE, MARKET CONDUCT, MARKET PERFORMANCE, RESOURCE-BASED THEORY OF THE FIRM.

competitive tender an invitation for private sector firms to submit TENDERS (price bids) for contracts to supply goods or services to the public sector which the public sector has traditionally supplied for itself. Competitive tendering seeks to introduce competition in the provision of goods or services and thus reduce the costs to government departments, local authorities and health authorities. See DEREGULATION.

competitor a business rival of a firm supplying a good or service that offers buyers an identical or similar product. See COMPETITION, COMPETITIVE ADVANTAGE, COMPETITIVE STRATEGY, PRODUCT DIFFERENTIATION.

complementary products GOODS or SERVICES whose demands are interrelated (a joint demand) so that an increase in the price of one of the goods results in a fall in the demand for the other. For example, if the price of tennis rackets goes up, this results not only in a decrease in the demand for rackets but, because less tennis is now played, a fall also in the demand for tennis balls. See SUBSTITUTE PRODUCTS, CROSS-ELASTICITY OF DEMAND.

complete contract see CONTRACT.

complex monopoly a situation defined by UK COMPETITION POLICY as one in which two or more suppliers of a particular product restrict competition between themselves. ‘Complex monopoly’ in essence refers to an OLIGOPOLY situation where the firms concerned, although pursuing individual (i.e. non-collusive) policies, nonetheless behave in a uniform manner and produce a result that is non-competitive (i.e. similar to COLLUSION). The problem is that it is often difficult to distinguish between competitive and non-competitive situations. For example, if firms charge identical prices, is this reflective of competition (i.e. prices that are brought together because of competition) or a deliberate suppression of competition?

compound interest the INTEREST on a LOAN that is based not only on the original amount of the loan but the amount of the loan plus previous accumulated interest. This means that, over time, interest charges grow exponentially; for example, a £100 loan earning compound interest at 10% per annum would accumulate to £110 at the end of the first year and £121 at the end of the second year, etc., based on the formula: compound sum = principal (1 + interest rate) ^{number of periods}

that is, 121 = 100 (1 + 0.1)².

Compare SIMPLE INTEREST.

computer an electronic/electromechanical device that accepts alphabetical and numerical data in a predetermined form, stores and processes this data according to instructions contained in a computer program, and presents the analysed data.

Computers have dramatically improved the productivity of data processing in commerce and business; for example, computer-aided design and computer-aided manufacturing systems have improved the speed and cost with which new components or products can be assigned and subsequently scheduled for production; computer-aided distribution and stock control systems such as ELECTRONIC POINT OF SALE (EPOS) have helped to minimize stockholdings and have improved customer services; computers have rapidly taken over the manual tasks of keeping accounting records such as company sales and payroll. Computers have also played a prominent role in speeding up the response of commodity and financial markets to changing demand and supply conditions by processing and reporting transactions quickly.

In recent years computers have underpinned the rapid expansion of E-COMMERCE using the INTERNET. See STOCK EXCHANGE, AUTOMATION, MASS PRODUCTION.

concealed unemployment see DISGUISED UNEMPLOYMENT.

concentration measures

The measures of the size distribution of firms engaged in economic activities.

The broadest concentration measure is the aggregate concentration measure, which looks at the share of total activity in an economy accounted for by the larger firms, for example, the proportion of total industrial output accounted for by the largest 200 firms; or the share of total manufacturing output produced by the 100 largest companies. Various size criteria may be used for this measure, in particular, sales, output, numbers employed and capital employed, each of which can give slightly different results because of differences in capital intensity. Such measures serve to give an overall national view of concentration and how it is changing over time.

Although aggregate concentration measures are useful, they are generally too broad for purposes of economic analysis where interest focuses upon markets and performance in these markets. Consequently, economists have developed several measures of MARKET concentration that seek to measure SELLER or BUYER CONCENTRATION. The most common of these measures is the CONCENTRATION RATIO, which records the percentage of a market’s sales accounted for by a given number of the largest firms in that market. In the UK it has been usual to estimate the concentration ratio for the three or (more recently) five largest firms, whereas in the USA the four-firm concentration ratio tends to be employed.

Fig. 28 Concentration measures. (a) Cumulative concentration curves, showing the cumulative share of market size accounted for by various (cumulative) numbers of firms. (b) The Lorenz curve shows the cumulative share of market size on one axis accounted for by various (cumulative) percentages of the number of firms in the market.

The concentration ratio, however, records only seller concentration at one point along the cumulative concentration curve, as Fig. 28 (a) indicates. This makes it difficult to compare concentration curves for two different markets, like A and B in the figure, where their concentration curves intersect. For example, using a three-firm concentration ratio, market A is more concentrated while using a five-firm ratio shows market B to be more concentrated. An alternative concentration index, called the HERFINDAHL INDEX, gets around this problem by taking into account the number and market shares of all firms in the market. The Herfindahl index is calculated by summing the squared market shares of all firms. The index can vary between a value of zero (where there are a large number of equally sized firms) and one (where there is just one firm).

Concentration measures, like the concentration ratio and the Herfindahl index, are known as absolute concentration measures since they are concerned with the market shares of a given (absolute) number of firms. By contrast, relative concentration measures are concerned with inequalities in the share of total firms producing for the market. Such irregularities can be recorded in the form of a Lorenz curve as in Fig. 28 (b). The diagonal straight line shows what a distribution of complete equality in firm shares would look like, so the extent to which the Lorenz curve deviates from this line gives an indication of relative seller concentration. For example, the diagonal line shows how we might expect 50% of market sales to be accounted for by 50% of the total firms, whilst in fact 50% of market sales are accounted for by the largest 25% of total firms, as the Lorenz curve indicates. The Gini coefficient provides a summary measure of the extent to which the Lorenz curve for a particular market deviates from the linear diagonal. It indicates the extent of the bow-shaped area in the figure by dividing the shaded area below the Lorenz curve by the area above the line of equality. The value of the Gini coefficient ranges from zero (complete equality) to one (complete inequality).

In practice, most market concentration studies use concentration ratios calculated from data derived from the census of production.

Concentration measures are widely used in economic analysis and for purposes of applying COMPETITION POLICY to indicate the degree of competition or monopolization present in a market. They need to be treated with caution, however. On the one hand, they may overstate the extent of monopolization. First, the boundaries of the market may be defined too narrowly (for example, the ‘beer market’) when it might be more appropriate to adopt a wider interpretation of what constitutes the relevant market by including actual and potential substitutes (for example, the ‘alcoholic drink market’, which includes also spirits and wines). Thus, calculating a firm’s market share in terms of the beer market alone may make it seem more powerful than it actually is. Secondly, concentration ratios are usually compiled by reference to the output of domestic suppliers, thus ignoring the competition afforded by imports. Thirdly, market concentration is only one element of market structure. If BARRIERS TO ENTRY to the market are relatively low, or suppliers are confronted by powerful buyers, again the market may well be much more competitive than shown by the concentration ratio. On the other hand, concentration ratios may understate the degree of monopolization. First, the market may be defined too broadly when a narrower specification of the market’s boundaries may be more appropriate. This can be important in the context of suppliers who deliberately choose to ‘focus’ on a narrow segment of the market (see COMPETITIVE STRATEGY). Secondly, conduct elements as well as structure variables need to be considered. For example, while superficially a market with a low or moderate degree of seller concentration may appear to be competitive, in practice it may be highly monopolistic because the suppliers have set up a price-fixing CARTEL.

Thus, looked at ‘in the round’, concentration ratios are but one aspect in examining the dynamics of a market and whether or not it exhibits competitive or monopolistic tendencies.

concentration ratio a measure of the degree of SELLER CONCENTRATION in a MARKET. The concentration ratio shows the percentage of market sales accounted for by, for example, the largest four firms or largest eight firms. The concentration ratio is derived from the market concentration curve, which can be plotted on a graph, with the horizontal scale showing the number of firms cumulated from the largest size and the vertical scale showing the cumulative percentage of market sales accounted for by particular numbers of firms. See Fig. 29. See CONCENTRATION MEASURES, MARKET STRUCTURE.

Fig. 29 Concentration ratio. Market A is here highly concentrated, with the four largest firms accounting for 80% of market sales, while market B has a relatively low level of concentration.

concerted practica a situation defined by European Union and UK competition law as one where rival firms, without engaging in formal COLLUSION (see ANTI-COMPETITIVE AGREEMENT), nonetheless informally coordinate their behaviour in respect of selling prices and discounts, and engage in market-sharing and joint capacity adjustments.

Under the EU’s Article 85 of the Treaty of Rome and the UK’s COMPETITION ACT 1998, concerted practices are prohibited outright. See COMPETITION POLICY (EU), COMPETITION POLICY (UK).

concert party a group of individuals or firms that acts ‘in concert’, pooling its various resources in order to effect the TAKEOVER of a company. See TAKEOVER BID, CITY CODE.

conciliation a procedure for settling disputes, most notably INDUSTRIAL DISPUTES, in which a neutral third party meets with the disputants and endeavours to help them resolve their differences and reach agreement through continued negotiation. In the UK the ADVISORY CONCILIATION AND ARBITRATION SERVICE acts in this capacity. See MEDIATION, ARBITRATION, INDUSTRIAL RELATIONS, COLLECTIVE BARGAINING.

condition of entry an element of MARKET STRUCTURE that refers to the ease or difficulty new suppliers face in entering a market. Market theory indicates that, at one extreme, entry may be entirely ‘free’, with, as in PERFECT COMPETITION, new suppliers being able to enter the market and compete immediately on equal terms with established firms; at the other extreme, in OLIGOPOLY and MONOPOLY markets, BARRIERS TO ENTRY operate, which severely limit the opportunity for new entry. The significance of barriers to entry in market theory is that they allow established firms to secure a long-term profit return in excess of the NORMAL PROFIT equilibrium attained under fully competitive (‘free’ entry) conditions. See MARKET ENTRY, POTENTIAL ENTRANT, LIMIT PRICING.

Confederation of British Industry (CBI) a UK organization that represents the collective interests of member companies in dealings with government and TRADE UNIONS.

congestion charge see ROAD CONGESTION.

conglomerate firm see FIRM.

consolidated fund the UK government’s account at the BANK OF ENGLAND into which it pays its TAXATION and other receipts, and which it uses to make payments.

consols abbrev. of consolidated stock; government BONDS that have an indefinite life rather than a specific maturity date. People acquire consols in order to buy a future nominal annual income without any expectation of repayment of the issue, though they can be bought and sold on the STOCK EXCHANGE. Because they are never redeemed by the government, the market value of consols can vary greatly in order to bring their EFFECTIVE INTEREST RATE in line with their NOMINAL INTEREST RATE. For example, £100 of consols with a nominal rate of interest of 5% would yield a return of £5 per year. If current market interest rates were 10%, then the market price of the consols would need to fall to £50 so that a buyer would earn an effective return on them of £5/£50 = 10%.

consortium a temporary grouping of independent firms, organizations and governments brought together to pool their resources and skills in order to undertake a particular project such as a major construction programme or the building of an aircraft, or to combine their buying power in bulk-buying factor inputs.

conspicuous consumption the CONSUMPTION of goods and services not for the UTILITY derived from their use but for the utility derived from the ostentatious exhibition of such goods and services.

A person may buy and run a Rolls-Royce motor car not just as a vehicle for transportation but because it suggests to the outside world something about the owner. That person may wish to be seen as affluent or as a person of taste. This phenomenon (known as the VEBLEN EFFECT) can be viewed as an alternative to the more usual consumption theories where the quantity of a particular good varies inversely with its price (a downward-sloping DEMAND CURVE). A conspicuous consumption good may well have an UPWARD-SLOPING DEMAND CURVE so that the quantity demanded increases with its price.

constant returns 1 (in the SHORT RUN) constant returns to the VARIABLE FACTOR INPUT that occur when additional units of variable input added to a given quantity of FIXED FACTOR INPUT generate equal increments in output. With an unchanged price for variable factor inputs, constant returns will cause the short-run unit variable cost of output to stay the same over an output range. See RETURNS TO THE VARIABLE FACTOR INPUT.

2 (in the LONG RUN) constant returns that occur when successive increases in all factor inputs generate equal increments in output. In cost terms, this means the long-run unit cost of output remains constant so long as factor input prices stay the same. See MINIMUM EFFICIENT SCALE, ECONOMICS OF SCALE.

consumer the basic consuming/demanding unit of economic theory. In economic theory, a consuming unit can be either an individual purchaser of a good or service, a HOUSEHOLD (a group of individuals who make joint purchasing decisions) or a government. See BUYER.

consumer credit LOANS made available to buyers of products to assist them in financing purchases. Consumer credit facilities include HIRE PURCHASE, INSTALMENT CREDIT, BANK LOANS and CREDIT CARDS.

Consumer Credit Act 1974 a UK Act that provides for the licensing of persons and businesses engaged in the provision of consumer CREDIT (specifically, moneylenders, pawnbrokers and INSTALMENT CREDIT traders – but not banks, which are covered by separate legislation) and the regulation of DEBTOR-CREDITOR contracts. The Act contains important provisions protecting creditors from ‘extortionate’ rates of interest. The Act is administered by the OFFICE OF FAIR TRADING in conjunction with the DEPARTMENT OF TRADE AND INDUSTRY. See CONSUMER PROTECTION, APR.

consumer durables CONSUMER GOODS, such as houses, cars, televisions, that are ‘consumed’ over relatively long periods of time rather than immediately. See Fig. 158 (b) (PRODUCT LIFE CYCLE) for details of market penetration for a number of consumer durable products. Compare CONSUMER NONDURABLES.

consumer equilibrium the point at which the consumer maximizes his TOTAL UTILITY or satisfaction from the spending of a limited (fixed) income. The economic ‘problem’ of the consumer is that he has only a limited amount of income to spend and therefore cannot buy all the goods and services he would like to have. Faced with this constraint, demand theory assumes that the goal of the consumer is to select that combination of goods, in line with his preferences, that will maximize his total utility or satisfaction. Total utility is maximized when the MARGINAL UTILITY of a penny’s worth of good X is exactly equal to the marginal utility of a penny’s worth of all the other goods purchased; or, restated, when the prices of goods are different, the marginal utilities are proportional to their respective prices. For two goods, X and Y, total utility is maximized when:

Consumer equilibrium can also be depicted graphically using INDIFFERENCE CURVE analysis. See Fig. 30. See also REVEALED PREFERENCE THEORY, PRICE EFFECT, INCOME EFFECT, SUBSTITUTION EFFECT, ECONOMIC MAN, CONSUMER RATIONALITY, PARETO OPTIMALITY.

Fig. 30 Consumer equilibrium. The optimal combination of Good X and Good Y is at point E when the BUDGET LINE is tangential to indifference curve 1. At this point the slope of the budget line (the ratio of prices) is equal to the slope of the indifference curve (the ratio of marginal utilities), so the goods’ marginal utilities are proportional to their prices.

consumer goods any products, such as washing machines, beer, toys, that are purchased by consumers as opposed to businesses. Compare CAPITAL GOODS, PRODUCER GOODS.

consumerism an organized movement to protect the economic interests of CONSUMERS. The movement developed in response to the growing market power of large companies and the increasing technical complexity of products. It embraces bodies such as the Consumers’ Association in the UK, which is concerned with product testing and informing consumers through publications such as Which? Consumerism has been officially incorporated into British COMPETITION POLICY since the 1973 FAIR TRADING ACT. See CONSUMER PROTECTION.

consumer nondurables CONSUMER GOODS that yield up all their satisfaction or UTILITY at the time of consumption They include such items as beer, steak or cigarettes. Compare CONSUMER DURABLES.

consumer price index (CPI) a weighted average of the PRICES of a general ‘basket’ of goods and services bought by consumers. Each item in the index is weighted according to its relative importance in total consumers’ expenditure (see Fig. 31). Starting from a selected BASE YEAR (index value = 100), price changes are then reflected in changes in the index value over time. Thus, in the case of the UK’s CPI, the current base year is 1996 = 100; in February 2005 the index value stood at 112.2, indicating that consumer prices, on average, had risen 12% between the two dates.

Since December 2003 the CPI has been used by the UK government as a measure of the rate of INFLATION in the economy for the purposes of applying macroeconomic policy in general and monetary policy in particular (see MONETARY POLICY COMMITTEE). Previously, the RETAIL PRICE INDEX (RPI) was used for this purpose, but the CPI measure was adopted to harmonize the way the UK measured its inflation rate with that of other countries in the EUROPEAN UNION.

consumer protection measures taken by the government and independent bodies such as the Consumers’ Association in the UK to protect consumers against unscrupulous trade practices such as false descriptions of goods, incorrect weights and measures, misleading prices and defective goods. See TRADE DESCRIPTIONS ACT 1968, WEIGHTS AND MEASURES ACT 1963, CONSUMER CREDIT ACT 1974, PRICE MARKETING (BARGAIN OFFERS) ORDER 1979, OFFICE OF FAIR TRADING, COMPETITION POLICY, CONSUMERISM.

Fig. 31 Consumer price Index. Source: Office of National Statistics.

consumer rationality or economic rationality the assumption, in demand theory, that CONSUMERS attempt to obtain the greatest possible satisfaction from the money resources they have available when making purchases. Because economic theory tends to sum household demands in constructing market DEMAND CURVES, it is not important if a few households do not conform to rational behaviour as long as the majority of consumers or households act rationally. See ECONOMIC MAN.

consumer sovereignty the power of CONSUMERS to determine what is produced since they are the ultimate purchasers of goods and services. In general terms, if consumers demand more of a good then more of it will be supplied. This implies that PRODUCERS are ‘passive agents’ in the PRICE SYSTEM, simply responding to what consumers want. In certain kinds of market, however, notably, OLIGOPOLY and MONOPOLY, producers are so powerful vis-à-vis consumers that it is they who effectively determine the range of choice open to the consumer. See REVISED SEQUENCE.

consumers’ surplus the extra satisfaction or UTILITY gained by consumers from paying an actual price for a good that is lower than that which they would have been prepared to pay. See Fig. 32 (a). The consumers’ surplus is maximized only in PERFECT COMPETITION, where price is determined by the free play of market demand and supply forces and all consumers pay the same price. Where market price is not determined by demand and supply forces in competitive market conditions but is instead determined administratively by a profit-maximizing MONOPOLIST, then the resulting restriction in market output and the increase in market price cause a loss of consumer surplus, indicated by the shaded area PP_mXE in Fig. 32 (b). If a DISCRIMINATING MONOPOLIST were able to charge a separate price to each consumer that reflected the maximum amount that the consumer was prepared to pay, then the monopolist would be able to appropriate all the consumer surplus in the form of sales revenue.

Business strategists can use the concept of the consumers’ surplus to increase the firm’s profit (see VALUE-CREATED MODEL). To illustrate: you are a Manchester United football fan; tickets for a home game are currently priced at £50 but you would be willing to pay £75. Hence, you have ‘received’ as a consumer ‘perceived benefit’ or ‘surplus’ of £25 over and above the price actually charged. Manchester United, however, instead of charging a single price of £50 could segment its market by charging different prices for admission to different parts of the ground (see PRICE DISCRIMINATION, MARKET SEGMENTATION) in order to ‘capture’ more of the consumers’ surplus for itself. Thus, it could continue to charge the ‘basic’ price of £50 for admission to certain parts of the ground, £75 for seating in the main stand and £120 for an ‘executive box’ seat. Compare PRODUCERS’ SURPLUS. See DIMINISHING MARGINAL UTILITY, DEADWEIGHT LOSS.

Fig. 32 Consumers’ surplus. (a) At the EQUILIBRIUM PRICE OP, utility from the marginal unit of the good is just equal to its price; all previous units yield an amount of utility that is greater than the amount paid by the consumer, insofar as consumers would have been prepared to pay more for these intramarginal units than the market price. The total consumer surplus is represented by the shaded area PEP₁ (b)The loss of consumers’ surplus because of monopoly.

consumption the satisfaction obtained by CONSUMERS from the use of goods and services. Certain CONSUMER DURABLE products, like washing machines, are consumed over a longish period of time, while other products, like cakes, are consumed immediately after purchase. The DEMAND CURVE for a particular product reflects consumers’ satisfactions from consuming it. See WANTS, DEMAND.

consumption expenditure the proportion of NATIONAL INCOME or DISPOSABLE INCOME spent by HOUSEHOLDS on final goods and services. Consumption expenditure is the largest component of AGGREGATE DEMAND and spending in the CIRCULAR FLOW OF NATIONAL INCOME. It is one of the most stable components of aggregate demand, showing little fluctuation from period to period.

In 2003, consumption expenditure accounted for 52% of gross final expenditure (GFE) on domestically produced output (GFE minus imports = GROSS DOMESTIC PRODUCT). See Fig. 132 (b), NATIONAL INCOME ACCOUNTS. See CONSUMPTION SCHEDULE, VEBLEN EFFECT.

consumption function a statement of the general relationship between the dependent variable, CONSUMPTION EXPENDITURE, and the various independent variables that determine consumption, such as current DISPOSABLE INCOME and income from previous periods and WEALTH. See CONSUMPTION SCHEDULE, LIFE-CYCLE HYPOTHESIS, PERMANENT-INCOME HYPOTHESIS, WEALTH EFFECT.

consumption possibility line see BUDGET LINE.

consumption schedule a schedule depicting the relationship between CONSUMPTION EXPENDITURE and the level of NATIONAL INCOME or DISPOSABLE INCOME, also called consumption function. At low levels of disposable income, households consume more than their current income (see DISSAVING), drawing on past savings, borrowing or selling assets in order to maintain consumption at some desired minimum level (AUTONOMOUS CONSUMPTION). At higher levels of disposable income, they consume a part of their current income and save the rest (see SAVING). See Fig. 33. See INDUCED CONSUMPTION.

Fig. 33 Consumption schedule. A simple consumption schedule that takes the linear form C = a + bY, where C is consumption and a is the minimum level of consumption expenditure at zero-disposable income (autonomous consumption). Thereafter consumption expenditure increases as income rises (induced consumption), and b is the proportion of each extra £ (pound) of disposable income that is spent. The 45-degree line OE shows what consumption expenditure would have been had it exactly matched disposable income. The difference between OE and the consumption schedule indicates the extent of dissavings or SAVINGS at various income levels. The slope of the consumption schedule is equal to the MARGINAL PROPENSITY TO CONSUME. See SAVINGS SCHEDULE, LIEE-CYCIE HYPOTHESIS, PERMANENT-INCOME HYPOTHESIS.

contestable market a MARKET where new entrants face costs similar to those of established firms and where, on leaving, firms are able to recoup their capital costs, less depreciation. Consequently, it is not possible for established firms to earn ABOVE NORMAL PROFIT as this will be eroded by the entry of new firms, or, alternatively, the mere threat of such new entry may be sufficient to ensure that established firms set prices that yield them only a NORMAL PROFIT return. Perfectly competitive markets (see PERFECT COMPETITION) are all contestable, but even some oligopolistic markets (see OLIGOPOLY) may be contestable if entry and exit are easily affected.

In recent times many markets have been opened up by a number of developments, including increasing international competition as trade barriers have been reduced, the introduction of FLEXIBLE MANUFACTURING SYSTEMS and E-COMMERCE trading on the INTERNET. See WORKABLE COMPETITION, CONDITION OF ENTRY, BARRIERS TO ENTRY, BARRIERS TO EXIT.

contingency theory the proposition that the best organization structure for a particular firm depends upon the specific circumstances that it faces and that there is no uniformly best organization structure for all firms in all circumstances. The appropriate organizational structure for a firm in particular circumstances seeks to balance ECONOMIES OF SCALE and ECONOMIES OF SCOPE in production and distribution; TRANSACTION COSTS; AGENCY COSTS; and information flows.

contract a legally enforceable agreement between two or more people or firms generally relating to a TRANSACTION for the purchase or sale of goods and services. Contracts may take a standardized form, with the same conditions of exchange being applied to every one of a large number of contracts, for example, airline ticket contracts. Alternatively, contracts may be lengthy and complicated because they are carefully tailored to a specific transaction such as the contract to build an office block for a client.

A complete contract stipulates each party’s responsibilities and rights for every contingency that could conceivably arise during the transaction. Such a complete contract would bind the parties to particular courses of action as the transaction unfolds, with neither party having any freedom to exploit weaknesses in the other’s position. It is difficult to develop complete contracts since parties to the contract must be able to specify every possible contingency and the required responses by the contracting parties, to stipulate what constitutes satisfactory performance, to measure performance, to make the contract enforceable and to have access to complete information about circumstances surrounding the contract.

In practice, most contracts are incomplete contracts in which the precise terms of the contract relating to product specifications, supply or delivery terms cannot be fully specified. In such situations, one or other parties to the agreement may be tempted to take advantage of the open-endedness or ambiguity of the contract at the expense of the other party. See ADVERSE SELECTION, MORAL HAZARD, ASYMMETRY OF INFORMATION, ASSET SPECIFICITY.

contract curve see EDGEWORTH BOX.

contractor a person or firm that enters into a CONTRACT enforceable in law with another person or firm to supply goods or services. For example, a house builder may employ contractors to undertake the plumbing work involved in the construction of houses rather than do this work itself. The plumbing contractor would provide, for the contract price, all piping, wire, tanks, etc., needed, plus the specialist workers to install them. In turn, the plumber may enter into an agreement with a subcontractor to install the time clocks and electrical controls for the central heating system.

contribution the difference between a product’s SALES REVENUE and its VARIABLE COSTS. If total contributions are just large enough to cover FIXED COSTS then the producer BREAKS EVEN; if contributions are less than fixed costs, the producer makes a LOSS; while if contributions exceed fixed costs then the producer makes a PROFIT. See LOSS MINIMIZATION, MARGINAL COST PRICING.

control loss see AGENCY COST.

conventional sequence see REVISED SEQUENCE.

convertibility the extent to which one foreign currency or INTERNATIONAL RESERVE ASSET can be exchanged for some other foreign currency or international reserve asset.

International trade and investment opportunities are maximized when the currencies used to finance them are fully convertible, i.e. free of FOREIGN EXCHANGE CONTROL restrictions.

convertible loans long-term LOANS to a JOINT-STOCK COMPANY that may be converted at the option of the lender into ORDINARY SHARES at a predetermined share price.

conveyance a document that transfers the legal ownership of land and buildings from one person/business to another person/business. See MORTGAGE.

cooperation 1 the process whereby FIRMS seek to coordinate their pricing and output policies rather than compete with one another in order to achieve JOINT-PROFIT MAXIMIZATION. See MUTUAL INTERDEPENDENCE, OLIGOPOLY.

2 the process whereby individuals coordinate their work in TEAMS.

cooperative a form of business FIRM that is owned and run by a group of individuals for their mutual benefit. Examples of cooperatives include:

(a) worker or producer cooperatives: businesses that are owned and managed by their employees, who share in the net profit of the business.

(b) wholesale cooperatives: businesses whose membership comprises a multitude of small independent retailers. The prime objective of such a group is to use its combined BULK-BUYING power to obtain discounts and concessions from manufacturers, similar to those achieved by larger SUPERMARKET chains.

(c) retail cooperatives: businesses that are run in the interest of customers, who hold membership rights entitling them to receive an annual dividend or refund in proportion to their spending at the cooperative’s shops. See WHOLESALER, RETAILER, DISTRIBUTION CHANNEL.

coordination the process whereby the specialized (see SPECIALIZATION) activities of different participants in an economy are synchronized. Coordination of TRANSACTIONS may take place through MARKETS or within ORGANIZATIONS. Within organizations, coordination is necessary to try to ensure that decisions within subunits of the organization are consistent with each other and with the objectives of the organization as a whole. See INTERNAL MARKETS.

copyright the ownership of the rights to a publication of a book, manual, newspaper, etc., giving legal entitlement and powers of redress against theft and unauthorized publication or copying. See INTELLECTUAL PROPERTY RIGHT.

Copyright, Designs and Patents Act 1988 a UK Act that provides for the establishment and protection of the legal ownership rights of persons and businesses in respect of various classes of ‘intellectual property’, in particular COPYRIGHTS, DESIGN RIGHTS and PATENTS.

The Act is administered in part by the PATENTS OFFICE, with cases of unauthorized copying, patent infringements, etc., being handled by the courts.

core business the particular products supplied by a firm that constitute the heart of its business. These are generally products in which the firm has a competitive advantage. Over time the firm may begin to supply other products that may be associated with its core business but are more peripheral to the firm and its operations. See DIVERSIFICATION.

core competence a key resource, process or system possessed by a firm that allows it to gain a COMPETITIVE ADVANTAGE over rivals.

core product a basic product such as a motor car. See TOTAL PRODUCT.

corner vb. to buy or attempt to buy up all the supplies of a particular product on the MARKET, thereby creating a temporary MONOPOLY situation with the aim of exploiting the market.

corporate bond see BOND.

corporate control the ability to exercise control over a public JOINT-STOCK COMPANY. In countries where shares in a large company are freely traded, if the incumbent directors and senior managers fail to achieve good profit and dividend performance, the price of the company’s shares will fall, making it possible for managers of another company to buy a majority of shares in the underperforming company and to gain control of it. This market for corporate control can exercise a restraining effect upon incumbent managers of a firm who are aware that they can lose their jobs if their company underperforms to the extent of provoking a takeover bid by other managers who feel that they can run the company more profitably. See CORPORATE GOVERNANCE, TAKEOVER, PRINCIPAL-AGENT THEORY, DIVORCE OF OWNERSHIP FROM CONTROL.

corporate governance

The duties and responsibilities of a company’s BOARD OF DIRECTORS in managing the company and their relationship with the SHAREHOLDERS of the company. With the DIVORCE OF OWNERSHIP FROM CONTROL, salaried professional managers have acquired substantial powers in respect of the affairs of the company they are paid to run on behalf of their shareholders. However, directors have not always had the best interests of shareholders in mind when performing their managerial functions (see PRINCIPAL-AGENT THEORY), and this has led to attempts to make directors more accountable for their policies and actions.

A number of reports were published in the UK in the 1990s, prompted by the public’s concern at cases of gross mismanagement (for example, the collapse of the BCCI bank and Polly Peck and the misappropriation of employee’s pension monies at the Mirror Group) and ‘fat cat’ pay increases secured by executive directors. The Cadbury Committee Report (1992) recommended a ‘Code of Best Practice’ relating to the appointment and responsibilities of executive directors, the independence of nonexecutive directors and tighter internal financial controls and reporting procedures. The Greenbury Committee Report (1995) specifically addressed the issue of directors’ pay, recommending that executive directors’ pay packages should be determined by companies’ remuneration committees, consisting solely of nonexecutive directors, and that share awards under EXECUTIVE SHARE OPTION SCHEMES and LONG-TERM INCENTIVE PLANS (LTIPS) should be linked to companies’ financial performance. The Hempel Committee Report (1998) covered many of the same issues raised by these two earlier reports, recommending (‘Principles of Good Governance’) checks on the power of any one individual executive director (by, for example, separating the roles of chairman and chief executive), a more independent and stronger voice for nonexecutives (including the appointment of a ‘senior’ nonexecutive to offer guidance to, and check ‘empire building’ tendencies on the part of, executive directors and in liaising with shareholder interests) and more accountability to shareholders at the AGM (including the approval of options and LTIP schemes).

In 1998 the ‘Code of Best Practice’ and ‘Principles of Good Governance’ were combined and formally incorporated into the listing rules of the London STOCK EXCHANGE.

In 1999 the Turnbull Committee Report on ‘Internal Control’ proposed guidelines for regular internal controls not only on financial procedures but also on business and operational matters with a greater emphasis on ‘risk’ management and evaluation to ensure that these are compatible with the company’s business objectives.

More recently, the Higgs Committee Report (2003) envisaged a more prominent role for nonexecutives, including the following recommendations: the chairman should be a nonexecutive; the senior independent nonexecutive director should be given additional responsibilities, particularly in regard to liaising between the board and the companies’ shareholders; nomination committees should consist entirely of nonexecutives; at least half the board’s directors should be nonexecutive; no full-time executive director should take on more than one additional non-executive position in another company.

For UK and other MULTINATIONAL COMPANIES operating in the USA the Sarbanes-Oxley Act (2002) requires them to follow strict financial accounting procedures, audits and reporting to increase financial transparency and to prevent fraud. The Act was introduced following a number of financial scandals, notably those at Enron and World Com., and the failure of nonexecutives and major accountancy firms such as Arthur Anderson (now broken up) to detect malpractices. In the UK itself, financial reporting has been tightenend up following the recommendations of the Smith Committee Report (2003) on internal auditing practices.

While traditionally the issue of corporate governance has tended to focus on director-shareholder relationships, the stakeholder approach emphasizes that directors have wider responsibilities to other groups with an interest or ‘stake’ in the business: their employees, consumers, suppliers and the community at large. See FIRM OBJECTIVES, MANAGERIAL THEORIES OF THE FIRM, SOCIAL RESPONSIBILITY.

corporate reengineering the process whereby the ORGANIZATION structure of a corporation is changed. This may involve a movement away from a functional organization to a multidivisional organization or the elimination or restructuring of certain product divisions within a multidivisional organization. Such reengineering often involves dramatic changes for managers and employees and can be linked with DOWNSIZING.

corporate sector that part of the ECONOMY concerned with the transactions of BUSINESSES. Businesses receive income from supplying goods and services and influence the workings of the economy through their use of, and payment for, factor inputs and INVESTMENT decisions. The corporate sector, together with the PERSONAL SECTOR and FINANCIAL SECTOR, constitute the PRIVATE SECTOR. The private sector, PUBLIC (GOVERNMENT) SECTOR and FOREIGN SECTOR make up the national economy. See CIRCULAR FLOW OF NATIONAL INCOME MODEL.

corporation 1 a private enterprise FIRM incorporated in the form of a JOINT-STOCK COMPANY.

2 a publicly owned business such as a nationalized industry.

corporation tax a DIRECT TAX levied by the government on the PROFITS accruing to businesses. The rate of corporation tax charged is important to a firm insofar as it determines the amount of after-tax profit it has available to pay DIVIDENDS to shareholders or to reinvest in the business.

In the UK currently (as at 2005/06) the general corporation tax rate is 30% of taxable profits per annum, but there is also a smaller companies’ corporation tax. No tax is payable on taxable profits up to £10,000 per annum and 19% on taxable profits over £10,000 up to a maximum of £300,000 per annum. See TAXATION, FISCAL POLICY, RETAINED PROFIT.

correlation a statistical term that describes the degree of association between two variables. When two variables tend to change together, then they are said to be correlated, and the extent to which they are correlated is measured by means of the CORRELATION COEFFICIENT.

correlation coefficient a statistical term (usually denoted by r) that measures the strength of the association between two variables.

Where two variables are completely unrelated, then their correlation coeffcient will be zero; where two variables are perfectly related, then their correlation would be one. A high correlation coefficient between two variables merely indicates that the two generally vary together – it does not imply causality in the sense of changes in one variable causing changes in the other.

Where high values of one variable are associated with high values of the other (and vice-versa), then they are said to be positively correlated. Where high values of one variable are associated with low values of the other (and vice-versa), then they are said to be negatively correlated. Thus correlation coefficients can range from +1 for perfect positive association to –1 for perfect negative association, with zero representing the case where there is no association between the two.

The correlation coefficient also serves to measure the goodness of fit of a regression line (see REGRESSION ANALYSIS) which has been fitted to a set of sample observations by the technique of ordinary least squares. A large positive correlation coefficient will be found when the regression line slopes upward from left to right and fits closely with the observations; a large negative correlation coefficient will be found when the regression line slopes downward from left to right and closely matches the observations. Where the regression equation contains two (or more) independent variables, a multiple correlation coefficient can be used to measure how closely the three-dimensional plane, representing the multiple regression equation, fits the set of data points.

corset see SPECIAL DEPOSITS.

cost the payments (both EXPLICIT COSTS and IMPLICIT COSTS) incurred by a firm in producing its output. See TOTAL COST, AVERAGE COST, MARGINAL COST, PRODUCTION COST, SELLING COST.

cost-based pricing pricing methods that determine the PRICE of a product on the basis of its production, distribution and marketing costs. See AVERAGE-COST PRICING, FULL-COST PRICING, MARGINAL-COST PRICING.

cost-benefit analysis a technique for enumerating and evaluating the total SOCIAL COSTS and total social benefits associated with an economic project. Cost-benefit analysis is generally used by public agencies when evaluating large-scale public INVESTMENT projects, such as major new motorways or rail lines, in order to assess the welfare or net social benefits that will accrue to the nation from these projects. This generally involves the sponsoring bodies taking a broader and longer-term view of a project than would a commercial organization concentrating on project profitability alone.

The main principles of cost-benefit are encompassed within four key questions:

(a) which costs and which benefits are to be included. All costs and benefits should be enumerated and ranked according to their remoteness from the main purpose of the project so that more remote costs and benefits might be excluded. This requires careful definition of the project and estimation of project life, and consideration of EXTERNALITIES and SECONDARY BENEFITS;

(b) how these costs and benefits are to be valued. The values placed on costs and benefits should pay attention to likely changes in relative prices but not the general price level, since the general price level prevailing in the initial year should be taken as the base level. Although market prices are normally used to value costs and benefits, difficulties arise when investment projects are so large that they significantly affect prices, when monopoly elements distort relative prices, when taxes artificially inflate the resource costs of inputs, and when significant unemployment of labour or other resources means that labour or other resource prices overstate the social costs of using those inputs that are in excess supply. In such cases, SHADOW PRICES may be needed for costs and benefits. In addition, there are particular problems of establishing prices for INTANGIBLE PRODUCTS and COLLECTIVE PRODUCTS;

(c) the interest rate at which costs and benefits are to be discounted. This requires consideration of the extent to which social time preference will dictate a lower DISCOUNT RATE than private time preference because social time preference discounts the future less heavily and OPPORTUNITY COST considerations, which mitigate against using a lower discount rate for public projects for fear that mediocre public projects may displace good private sector projects if the former have an easier criterion to meet;

(d) the relevant constraints. This group includes legal, administrative and budgetary constraints, and constraints on the redistribution of income. Essentially, cost-benefit analysis concentrates on the economic efficiency benefits from a project and, providing the benefits exceed the costs, recommends acceptance of the project, regardless of who benefits and who bears the costs. However, where the decision-maker feels that the redistribution of income associated with a project is unacceptable, he may reject that project despite its net benefits.

There is always uncertainty surrounding the estimates of future costs and benefits associated with a public investment project, and cost-benefit analysis needs to allow for this uncertainty by testing the sensitivity of the net benefits to changes in such factors as project life and interest rates. See WELFARE ECONOMICS, COST EFFECTIVENESS, TIME PREFERENCE, ENVIRONMENTAL AUDIT, VALUE FOR MONEY AUDIT, ENVIRONMENTAL IMPACT ASSESSMENT.

cost centre an organizational subunit of a firm that is given responsibility for minimizing COSTS but has no control over its product pricing and revenues. Cost centres facilitate management control by helping to ascertain a unit’s operating costs. See PROFIT CENTRE, INVESTMENT CENTRE.

cost drivers the factors that cause COSTS to vary within an organization and between organizations. Cost drivers can be related to the various value-creating activities within an organization. The main cost drivers are: firm size or scope (ECONOMIES OF SCALE or SCOPE); cumulative experience; (LEARNING CURVE); organization of transactions (VERTICAL INTEGRATION); and other factors such as location, raw material prices and process efficiency. The ability to ‘drive’ or ‘manage’ costs down (or to contain cost increases) is an important strategic consideration where cost leadership is the key basis of the firm’s COMPETITIVE ADVANTAGE over rival suppliers. See VALUE-CREATED MODEL.

cost effectiveness the achievement of maximum provision of a good or service from given quantities of resource inputs. Cost effectiveness is often established as an objective when organizations have a given level of expenditure available to them and are seeking to provide the maximum amount of service in a situation where service outputs cannot be valued in money terms (e.g. the UK National Health Service). Where it is possible to estimate the money value of outputs as well as inputs, then COST-BENEFIT techniques can be applied. See VALUE FOR MONEY AUDIT.

cost function a function that depicts the general relationship between the COST of FACTOR INPUTS and the cost of OUTPUT in a firm. In order to determine the cost of producing a particular output it is necessary to know not only the required quantities of the various inputs but also their prices. The cost function can be derived from the PRODUCTION FUNCTION by adding the information about factor prices. It would take the general form:

Qc = f(p1 I1, p2, I2, … , pn In)

where Qc is the cost of producing a particular output, Q, and p1 ,p2, etc., are the prices of the various factors used, while I1, I2, etc., are the quantities of factors 1, 2, etc., required. The factor prices p1, p2, etc., which a firm must pay in order to attract units of these factors will depend upon the interaction of the forces of demand and supply in factor markets. See EFFICIENCY, ISOCOST LINE, ISOQUANT CURVE.

cost leadership competitive strategy see COMPETITIVE STRATEGY.

cost minimization production of a given OUTPUT at minimum cost by combining FACTOR INPUTS with due regard to their relative prices. See COST FUNCTION, ISOQUANT CURVE.

cost of capital the payments made by a firm for the use of long-term capital employed in its business. The average cost of capital to a firm that uses several sources of long-term funds (e.g. LOANS, SHARE CAPITAL (equity)) to finance its investments will depend upon the individual cost of each separate source of capital (for example, INTEREST on loans) weighted in accordance with the proportions of each source used. See CAPITAL GEARING, DISCOUNT RATE.

cost of goods sold or cost of sales the relevant cost that is compared with sales revenue in order to determine GROSS PROFIT in the PROFIT-AND-LOSS ACCOUNT. Where a trading company has STOCKS of finished goods, the cost of goods sold is not the same as purchases of finished goods. Rather, purchases of goods must be added to stocks at the start of the trading period to determine the goods available for sale, then the stocks left at the end of the trading period must be deducted from this to determine the cost of the goods that have been sold during the period. See STOCK EVALUATION.

cost of living the general level of prices of goods and services measured in terms of a PRICE INDEX. To protect people’s living standards from being eroded by price increases (INFLATION), wage contracts and old-age pensions, etc., sometimes contain cost-of-living adjustment provisions that automatically operate to increase wages, pensions, etc., in proportion to price increases. See INDEXATION.

cost-plus pricing a pricing method that sets the PRICE of a product by adding a profit mark-up to AVERAGE COST or unit total cost. This method is similar to that of FULL-COST PRICING insofar as the price of a product is determined by adding a percentage profit mark-up to the product’s unit total cost. Indeed, the terms are often used interchangeably. Cost-plus pricing, however, is used more specifically to refer to an agreed price between a purchaser and the seller, where the price is based on actual costs incurred plus a fixed percentage of actual cost or a fixed amount of profit per unit. Such pricing methods are often used for large capital projects or high technology contracts where the length of time of construction or changing technical specifications leads to a high degree of uncertainty about the final price.

Cost-plus pricing is frequently criticized for failing to give the supplier an incentive to keep costs down.

cost price a PRICE for a product that just covers its production and distribution COSTS with no PROFIT MARGIN added.

cost-push inflation a general increase in PRICES caused by increases in FACTOR INPUT costs. Factor input costs may rise because raw materials and energy costs increase as a result of world-wide shortages or the operation of CARTELS (oil, for example) and where a country’s EXCHANGE RATE falls (see DEPRECIATION 1), or because WAGE RATES in the economy increase at a faster rate than output per man (PRODUCTIVITY). In the latter case, institutional factors, such as the use of COMPARABILITY and WAGE DIFFERENTIAL arguments in COLLECTIVE BARGAINING and persistence of RESTRICTIVE LABOUR PRACTICES, can serve to push up wages and limit the scope for productivity improvements. Faced with increased input costs, producers try to ‘pass on’ increased costs by charging higher prices. In order to maintain profit margins, producers would need to pass on the full increased costs in the form of higher prices, but whether they are able to depends upon PRICE ELASTICITY OF DEMAND for their products. Important elements in cost-push inflation in the UK and elsewhere have been periodic ‘explosions’ in commodity prices (the increases in the price of oil in 1973, 1979 and 1989 being cases in point), but more particularly ‘excessive’ increases in wages/earnings. Wages/earnings account for around 77% of total factor incomes (see FUNCTIONAL DISTRIBUTION OF INCOME) and are a critical ingredient of AGGREGATE DEMAND in the economy. Any tendency for money wages/earnings to outstrip underlying PRODUCTIVITY growth (i.e. the ability of the economy to ‘pay for/absorb’ higher wages by corresponding increases in output) is potentially inflationary. In the past PRICES AND INCOMES POLICIES have been used to limit pay awards. At the present time, policy is mainly directed towards creating a low inflation economy (see MONETARY POLICY, MONETARY POLICY COMMITTEE), thereby reducing the imperative for workers, through their TRADE UNIONS, to demand excessive wage/earnings increases to compensate themselves for falls in their real living standards.

The Monetary Policy Committee, in monitoring inflation, currently operates a ‘tolerance threshold’ for wage/earnings growth of no more than 4½% as being compatible with low inflation (this figure assumes productivity growth of around 2¾–3%). See INFLATION, INFLATIONARY SPIRAL, COLLECTIVE BARGAINING.

council tax see LOCAL TAX.

countercyclical policy see DEMAND MANAGEMENT.

countertrade the direct or indirect exchange of goods for other goods in INTERNATIONAL TRADE. Countertrade is generally resorted to when particular FOREIGN CURRENCIES are in short supply or when countries apply FOREIGN EXCHANGE CONTROLS. There are various forms of countertrade, including:

(a) BARTER: the direct exchange of product for product;

(b) compensation deal: where the seller from the exporting country receives part payment in his own currency and the remainder in goods supplied by the buyer;

(c) buyback: where the seller of plant and equipment from the exporting country agrees to accept some of the goods produced by that plant and equipment in the importing country as part payment;

(d) counterpurchase: where the seller from the exporting country receives part payment for the goods in his own currency and the remainder in the local currency of the buyer, the latter then being used to purchase other products in the buyer’s country. See EXPORTING.

countervailing duty a TAX levied on an imported product (see IMPORTS) that raises the price in the domestic market as a means of counteracting ‘unfair’ trading practices by other countries. Countervailing duties are frequently employed against imported products that are deliberately ‘dumped’ (see DUMPING) or subsidized by EXPORT INCENTIVES. See TARIFF, IMPORT DUTY, BEGGAR-MY-NEIGHBOUR POLICY.

countervailing power the ability of large buyers to offset the market power of huge suppliers as in BILATERAL OLIGOPOLY. Large buyers usually have the upper hand in a vertical market chain (for example, multiple retailers buying from food manufacturers) because, unless suppliers collude (see COLLUSION), a large buyer is able to play one supplier off against another and obtain favourable discounts on bulk purchases. Provided that competition is strong in final selling markets, countervailing power can play an important role in checking monopolistic abuse.

The economist J. K. GALBRAITH uses the phrase ‘countervailing power’ in a slightly different way to refer to the growth of trade unions and consumer groups in response to the growth of large firms.

coupon 1 a document that shows proof of legal ownership of a FINANCIAL SECURITY and entitlement to payments thereon; for example, a SHARE certificate or BEARER BOND certificate.

2 a means of promoting the sale of a product by offering buyers of the product coupons that can be redeemed for cash, gifts or other goods.

coupon interest rate the INTEREST RATE payable on the face value of a BOND. For example, a £100 bond with a 5% coupon rate of interest would generate a nominal return of £5 per year. See EFFECTIVE INTEREST RATE.

Cournot, Augustin (1801–77) a French economist who explored the problems of price in conditions of competition and monopoly in his book The Mathematical Principles of the Theory of Wealth (1838). Cournot concentrated attention on the exchange values of products rather than their utilities, and he used mathematics to explore the relationship between the sale price of products and their costs, developing the idea of a MONOPOLY price. Cournot is also known for his work on DUOPOLY, his analysis showing that two firms would react to one another’s output changes until they eventually reached a stable output position from which neither would wish to depart.

covenant a specific condition in a legal agreement or CONTRACT. For instance, a formal agreement between a COMMERCIAL BANK and a JOINT-STOCK COMPANY to which it is loaning money might contain a covenant stipulating a limit on dividend distributions from profits.

covered interest arbitrage the borrowing and investing of foreign currencies to take advantage of differences in INTEREST RATES between countries. For example, a company could borrow an amount of one currency (say, the UK pound (£)), convert this into another currency (say, the US dollar ($)) and invest the proceeds in the USA. Concurrently, the company would sell $s for £s in the FUTURES MARKET for delivery at a future specified date. The company would earn a profit on such a transaction if the rate of return on its investment in the USA were greater than the combined expenses of interest payments on the amount of £s borrowed and the costs of concluding the forward exchange contract. Covered interest ARBITRAGE takes advantage of (and in the process tends to eliminate) any temporary discrepancies between relative interest rates in two countries and the forward exchange rate of the two countries’ currencies. See INTERNATIONAL FISHER EFFECT.

covering a means of protecting the domestic currency value of the future proceeds of an international trade transaction, usually by buying or selling the proceeds of the transaction in the FUTURES MARKET for foreign currencies.

CPI see CONSUMER PRICE INDEX.

crawling-peg exchange-rate system a form of FIXED EXCHANGE-RATE SYSTEM in which the EXCHANGE RATES between currencies are fixed (pegged) at particular values (for example £1 = $2) but which are changed frequently (weekly or monthly) by small amounts to new fixed values to reflect underlying changes in the FOREIGN EXCHANGE MARKETS: for example, £1 = $1.90 cents, the repegging of the pound at a lower dollar value (DEVALUATION), or £1 = $2.10 cents, the repegging of the pound at a higher dollar value (REVALUATION).

creative destruction see SCHUMPETER.

credibility 1 the extent to which individuals and firms believe that the government will carry out the macro-economic policies that it promises to pursue. Credibility is important in influencing the EXPECTATIONS that individuals and firms have about future economic policies, and these expectations in turn affect their current behaviour. 2 the extent to which potential market entrants believe that incumbent firms will react to their entry, for example, by cutting their prices. The credibility of such threats by incumbent firms will determine whether potential entrants decide to enter a market. See BARRIERS TO ENTRY, LIMIT PRICING, POTENTIAL ENTRANT.

credit a financial facility that enables a person or business to borrow MONEY to purchase (i.e. take immediate possession of) products, raw materials and components, etc., and to pay for them over an extended time period. Credit facilities come in a variety of forms, including BANK LOANS and OVERDRAFTS, INSTALMENT CREDIT, CREDIT CARDS and TRADE CREDIT. Interest charges on credit may be fixed or variable according to the type of facilities offered or, in some cases, ‘interest-free’ as a means of stimulating business.

In many countries CREDIT CONTROLS are used as an instrument of MONETARY POLICY, with the authorities controlling both the availability and terms of credit transactions. See CONSUMER CREDIT ACT 1974, INTEREST RATE.

credit card a plastic card or token used to finance the purchase of products by gaining point-of-sale CREDIT. Credit cards are issued by commercial banks, hotel chains and larger retailers. See EFTPOS.

credit controls 1 the regulation of borrowing from the FINANCIAL SYSTEM as part of MONETARY POLICY. OPEN MARKET OPERATIONS are one general means of limiting the expansion of credit. A more selective form of control is consumer INSTALMENT CREDIT regulation (hire purchase). Under this arrangement, the purchase of certain goods is regulated by the authorities stipulating the minimum down-payment and the maximum period of repayment.

2 the control that a firm exercises over its TRADE DEBTORS in order to ensure that customers pay their DEBTS promptly and to minimize the risk of bad debts. The purpose of credit control is to minimize the funds that a firm has to tie up in debtors, so improving profitability and LIQUIDITY. See FACTORING, WORKING CAPITAL.

credit creation see BANK-DEPOSIT CREATION.

creditor a person or business that is owed money by an individual or firm for goods, services or raw materials that they have supplied but for which they have not yet been paid (trade creditors) or because they have made LOANS. Creditors are also termed ‘accounts payable’. See DEBTORS, CREDIT.

creditor nation a country that has invested more abroad than has been invested internally. A creditor nation receives more interest and dividends on its investments abroad than it has to pay out on investments made in the country, with a consequent surplus on its BALANCE OF PAYMENTS. Many DEVELOPED COUNTRIES are creditor countries. Compare DEBTOR COUNTRY.

credit squeeze any action taken by the monetary authorities to reduce the amount of CREDIT granted by COMMERCIAL BANKS, FINANCE HOUSES, etc. Such action forms part of the government’s MONETARY POLICY directed towards reducing AGGREGATE DEMAND by making less credit available and forcing up INTEREST RATES.

creeping inflation small increases in the general level of prices in an economy. See INFLATION, HYPERINFLATION.

Crest see SHARE PURCHASE/SALE.

cross-elasticity of demand a measure of the degree of responsiveness of the DEMAND for one good to a given change in the PRICE of some other good.

(i) cross-elasticity of demand =

Products may be regarded by consumers as substitutes for one another, in which case a rise in the price of good B (tea, for example) will tend to increase the quantity demanded of good A (coffee, for example). Here the cross-elasticity of demand will be positive since as the price of B goes up the quantity demanded of A rises as consumers now buy more A in preference to the more expensive B.

(ii) cross-elasticity of demand =

Alternatively, products may be regarded by consumers as complements that are jointly demanded, in which case a rise in the price of good B (tea, for example) will tend to decrease not only the quantity demanded of good B but also another good, C (sugar, for example). Here the cross-elasticity of demand will be negative since a rise in the price of B serves to reduce the quantity demanded of C.

The degree of substitutability between products is reflected in the magnitude of the cross-elasticity measure. If a small increase in the price of good B results in a large rise in the quantity demanded of good A (highly cross-elastic), then goods B and A are close substitutes. Likewise, the degree of complementarity of products is reflected in the magnitude of the cross-elasticity measure. If a small increase in the price of good B results in a large fall in the quantity demanded of good C (highly cross-elastic), then goods C and B are close complements.

Cross-elasticities provide a useful indication of the substitutability of products, so helping to indicate the boundaries between markets. A group of products with high cross-elasticities of demand constitutes a distinct market, whether or not they share common technical characteristics; for example, mechanical and electronic watches are regarded by consumers as close substitutes. See MARKET.

cross-sectional data information gathered for the same period of time that is split into certain groupings based upon characteristics such as age, income, etc. Compare TIME SERIES DATA.

cross-subsidization the practice by firms of offering internal subsidies to certain products or departments within the firm financed from the profits generated by other products or departments. Cross-subsidization is often used by diversified and vertically integrated firms as a means of financing new product development; DIVERSIFICATION into new areas; or to facilitate price cuts to match intense competition in certain of its markets. See VERTICAL INTEGRATION, PRICE-SQUEEZE.

Fig. 34 Crowding-out effect. (a) An increase in government expenditure raises real NATIONAL INCOME and output (see EQUILIBRIUM LEVEL OF NATIONAL INCOME), which in turn increases the demand for money from D_m to D_m¹, with which to purchase the greater volume of goods and services being produced. (b) This causes the equilibrium INTEREST RATE to rise (from r to r¹), which then reduces – ‘crowds out’ – an amount of private INVESTMENT (ΔT). (c) An increase in government expenditure by itself would increase AGGREGATE DEMAND from AD to AD¹, but, allowing for the fall in private investment, the net result is to increase aggregate demand to only AD².

crowding-out effect an increase in GOVERNMENT EXPENDITURE that has the effect of reducing the level of private sector spending. Financial crowding-out of the type described in the captions to Fig. 34 would occur only to the extent that the MONEY SUPPLY is fixed, so that additional loanable funds are not forthcoming to finance the government’s additional expenditure. If money supply is fixed, then increases in the PUBLIC SECTOR BORROWING REQUIREMENT associated with additional government expenditure will tend to increase interest rates as the government borrows more, these higher interest rates serving to discourage private sector investment. On the other hand, if additional loanable funds were obtainable from, say, abroad, then additional government borrowing could be financed with little increase in interest rates or effect on private investment.

The term ‘crowding-out’ is also used in a broader sense to denote the effect of larger government expenditure in pre-empting national resources, leaving less for private consumption spending, private sector investment and for exports. Such real crowding-out would occur only to the extent that total national resources are fixed and fully employed so that expansion in public sector claims on resources contract the amount left for the private sector. Where unemployed resources can be brought into use, additional claims by both the public and private sectors can be met. See MONEY-SUPPLY/SPENDING LINKAGES, MARGINAL EFFICIENCY OF CAPITAL/INVESTMENT.

cum dividend adj. (of a particular SHARE) including the right to receive the DIVIDEND that attaches to the share. If shares are purchased on the STOCK EXCHANGE cum. div., the purchaser would be entitled to the dividend accruing to that share when the dividend is next paid. Compare EX DIVIDEND.

currency the BANK NOTES and coins issued by the monetary authorities that form part of an economy’s MONEY SUPPLY. The term ‘currency’ is often used interchangeably with the term cash in economic analysis and monetary policy.

currency appreciation see APPRECIATION 1.

currency depreciation see DEPRECIATION 1.

currency matching see EXCHANGE RATE EXPOSURE.

currency swap see SWAP.

current account 1 a statement of a country’s trade in goods (visibles) and services (invisibles) with the rest of the world over a particular period of time. See BALANCE OF PAYMENTS.

2 an individual’s or company’s account at a COMMERCIAL BANK or BUILDING SOCIETY into which the customer can deposit cash or cheques and make withdrawals on demand on a day-to-day basis. Current accounts (or sight deposits as they are often called) offer customers immediate liquidity with which to finance their transactions. Most banks and building societies pay INTEREST on current account balances that are in credit. See BANK DEPOSIT, DEPOSIT ACCOUNT.

current assets ASSETS, such as STOCKS, money owed by DEBTORS, and cash, that are held for short-term conversion within a firm as raw materials are bought, made up, sold as finished goods and eventually paid for. See FIXED ASSETS, WORKING CAPITAL.

current liabilities all obligations to pay out cash at some date in the near future, including amounts that a firm owes to trade CREDITORS and BANK LOANS/OVERDRAFTS. See WORKING CAPITAL.

current yield see YIELD.

Customs and Excise a government agency for the collection of INDIRECT TAXES levied in accordance with appropriate rates, rules and regulations. In the UK, Her Majesty’s Customs and Excise typically collects revenue from VALUE-ADDED TAX and EXCISE DUTY payable on alcoholic drink, tobacco and betting. The agency also enforces the laws regarding the import and export of certain goods, collects IMPORT DUTIES and seeks to prevent attempts to avoid paying import duties by smuggling. See also INLAND REVENUE.

customs duty a TAX levied on imported products (see IMPORTS). Unlike TARIFFS, customs duties are used primarily as a means of raising revenue for the government rather than as a means of protecting domestic producers from foreign competition. See TAXATION.

customs union a form of TRADE INTEGRATION between a number of countries in which members eliminate all trade barriers (TARIFFS, etc.) amongst themselves on goods and services, and establish a uniform set of barriers against trade with the rest of the world, in particular a common external tariff. The aim of a customs union is to secure the benefits of international SPECIALIZATION AND INTERNATIONAL TRADE, thereby improving members’ real living standards. See GAINS FROM TRADE, TRADE CREATION, EUROPEAN UNION, MERCOSUR.

cyclical fluctuation the short-term movements, both upwards and downwards, in some economic variable around a long-term SECULAR TREND line. See Fig. 35. See DEMAND MANAGEMENT.

cyclically adjusted public-sector borrowing requirement see PUBLIC-SECTOR BORROWING REQUIREMENT.

cyclical unemployment the demand-deficient UNEMPLOYMENT that occurs as a result of a fall in the level of AGGREGATE DEMAND and business activity during the RECESSION and DEPRESSION phases of the BUSINESS CYCLE.

cyclical variation see TIME-SERIES ANALYSIS.

Fig. 35 Cyclical fluctuation. The pronounced short-term swings in output growth rates over the course of the BUSINESS CYCLE, around a rising long-term trend growth line for the country’s GROSS NATIONAL PRODUCT.