A2Z Economic Terminologies

Continuing with the A2Z Economic Terminologies, today I am posting about O's & P's wordings...

Okun's law

A description of what happens to UNEMPLOYMENT when the rate of GROWTH of GDP changes, based on empirical research by Arthur Okun (1928–80). It predicts that if GDP grows at around 3% a year, the jobless rate will be unchanged. If it grows faster, the unemployment rate will fall by half of what the growth rate exceeds 3% by; that is, if GDP grows by 5%, unemployment will fall by 1 percentage point. Likewise, a lesser, say 2%, increase in GDP would be associated with a half a percentage point increase in the jobless rate. This relationship is not carved in stone, as it merely reflects the American economy during the period studied by Okun. Even so, in most econo mies Okun’s Law is a reasonable rule of thumb for estimating the likely impact on jobs of changes in OUTPUT.

Open-market operations

CENTRAL BANKS buying and selling SECURITIES in the open market, as a way of controlling INTEREST rates or the GROWTH of the MONEY SUPPLY. By selling more securities, they can mop up surplus MONEY; buying securities adds to the money supply. The securities traded by central banks are mostly GOVERNMENT BONDS and TREASURY BILLS, although they sometimes buy or sell commercial securities.

Opportunity cost

The true cost of something is what you give up to get it. This includes not only the money spent in buying the something, but also the economic benefits that you did without because you bought that particular something and thus can no longer buy something else. For example, the opportunity cost of choosing to train as a lawyer is not merely the tuition fees, PRICE of books, and so on, but also the fact that you are no longer able to spend your time holding down a salaried job or developing your skills as a footballer. These lost opportunities may represent a significant loss of utility. Going for a walk may appear to cost nothing, until you consider the opportunity forgone to use that time earning money. Everything you do has an opportunity cost. ECONOMICS is primarily about the efficient use of scarce resources, and the notion of opportunity cost plays a crucial part in ensuring that resources are indeed being used efficiently.

Pareto efficiency

A situation in which nobody can be made better off without making somebody else worse off. Named after Vilfredo Pareto (1843–1923), an Italian economist. If an economy’s resources are being used inefficiently, it ought to be possible to make somebody better off without anybody else becoming worse off. In reality, change often produces losers as well as winners. Pareto efficiency does not help judge whether this sort of change is economically good or bad.

Permanent income hypothesis

Over their lives, people try to spread their spending more evenly than their INCOME. The permanent income hypothesis, developed by MILTON FRIEDMAN, says that a person’s spending decisions are guided by what they think over their lifetime will be their AVERAGE income. A sharp increase in short-term income will not result in an equally sharp increase in short-term CONSUMPTION. What if somebody unexpectedly comes into money, say by winning the lottery? The permanent income hypothesis suggests that people will save most of any such WINDFALL GAINS. Reality may be somewhat different.

Phillips curve

In 1958, an economist from New Zealand, A.W.H. Phillips (1914–75), proposed that there was a trade-off between INFLATION and UNEMPLOYMENT: the lower the unemployment rate, the higher was the rate of inflation. Governments simply had to choose the right balance between the two evils. He drew this conclusion by studying nominal wage rates and jobless rates in the UK between 1861 and 1957, which seemed to show the relationship of unemployment and inflation as a smooth curve.

Pigou effect

Named after Arthur Pigou (1877–1959), a sort of WEALTH EFFECT resulting from DEFLATION. A fall in the PRICE level increases the REAL VALUE of people’s SAVINGS, making them feel wealthier and thus causing them to spend more. This increase in DEMAND can lead to higher employment.

Purchasing power parity

A method for calculating the correct value of a currency, which may differ from its current market value. It is helpful when comparing living standards in different countries, as it indicates the appropriate EXCHANGE RATE to use when expressing incomes and PRICES in different countries in a common currency.

By correct value, economists mean the exchange rate that would bring DEMAND and SUPPLY of a currency into EQUILIBRIUM over the long-term. The current market rate is only a short-run equilibrium. Purchasing power parity (PPP) says that goods and SERVICES should cost the same in all countries when measured in a common currency.