This is the simplest yardstick of economic performance. If one person, firm or country can produce more of something with the same amount of effort and resources, they have an absolute advantage over other producers. Being the best at something does not mean that doing that thing is the best way to use your scarce economic resources. The question of what to specialise in--and how to maximise the benefits from international trade--is best decided according to comparative advantage. Both absolute and comparative advantage may change significantly over time.
A theory of how people form their views about the future that assumes they do so using past trends and the errors in their own earlier predictions. Contrast with rational expectations .
When you do business with people you would be better off avoiding. This is one of two main sorts of market failure often associated with insurance. The other is moral hazard. Adverse selection can be a problem when there is asymmetric information between the seller of insurance and the buyer; in particular, insurance will often not be profitable when buyers have better information about their risk of claiming than does the seller. Ideally, insurance premiums should be set according to the risk of a randomly selected person in the insured slice of the population (55-year-old male smokers, say). In practice, this means the average risk of that group. When there is adverse selection, people who know they have a higher risk of claiming than the average of the group will buy the insurance, whereas those who have a below-average risk may decide it is too expensive to be worth buying. In this case, premiums set according to the average risk will not be sufficient to cover the claims that eventually arise, because among the people who have bought the policy more will have above-average risk than below-average risk. Putting up the premium will not solve this problem, for as the premium rises the insurance policy will become unattractive to more of the people who know they have a lower risk of claiming. One way to reduce adverse selection is to make the purchase of insurance compulsory, so that those for whom insurance priced for average risk is unattractive are not able to opt out.
Many firms advertise their goods or services, but are they wasting economic resources? Some economists reckon that advertising merely manipulates consumer tastes and creates desires that would not otherwise exist. By increasing product differentiation and encouraging brand loyalty advertising may make consumers less price sensitive, moving the market further from perfect competition towards imperfect competition (see monopolistic competition ) and increasing the ability of firms to charge more than marginal cost. Heavy spending on advertising may also create a barrier to entry, as a firm entering the market would have to spend a lot on advertising too.
However, some economists argue that advertising is economically valuable because it increases the flow of information in the economy and reduces the asymmetric information between the seller and the consumer. This intensifies competition, as consumers can be made aware quickly when there is a better deal on offer.
These can arise when somebody (the principal) hires somebody else (the agent) to carry out a task and the interests of the agent conflict with the interests of the principal. An example of such principal-agent problems comes from the relationship between the shareholders who own a public company and the managers who run it. The owners would like managers to run the firm in ways that maximise the value of their shares, whereas the managers' priority may be, say, to build a business empire through rapid expansion and mergers and acquisitions. which may not increase their firm's share price.
One way to reduce agency costs is for the principal to monitor what the agent does to make sure it is what he has been
hired to do. But this can be costly, too. It may be impossible to define the agent's job in a way that can be monitored effectively. For instance, it is hard to know whether a manager who has expanded a firm through an acquisition that reduced its share price was pursuing his own empire-building interests or, say, was trying to maximise shareholder value but was unlucky.
Another way to lower agency costs, especially when monitoring is too expensive or too difficult, is to make the interests of the agent more like those of the principal. For instance, an increasingly common solution to the agency costs arising from the separation of ownership and management of public companies is to pay managers partly with shares and share options in the company. This gives the managers a powerful incentive to act in the interests of the owners by maximising shareholder value. But even this is not a perfect solution. Some managers with lots of share options have engaged in accounting fraud in order to increase the value of those options long enough for them to cash some of them in, but to the detriment of their firm and its other shareholders. See, for example, Enron .
Countries often provide support for their farmers using trade barriers and subsidy because, for example:
*domestic agriculture, even if it is inefficient by world standards, can be an insurance policy in case it becomes difficult (as it does, for example, in wartime) to buy agricultural produce from abroad;
*farmers groups have proved adept at lobbying;
*politicians have sought to slow the depopulation of rural areas;
*agricultural prices can be volatile, as a result of unpredictable weather, among other things; and
*financial support can provide a safety net in unexpectedly severe market conditions.
Broadly speaking, governments have tried two methods of subsidising agriculture. The first, used in the United States during the 1930s and in the UK before it joined the European Union, is to top up farmers' incomes if they fall below a level deemed acceptable. Farmers may be required to set aside some of their land in return for this support. The second is to guarantee a minimum level of farm prices by buying up surplus supply and storing or destroying it if prices would otherwise fall below the guaranteed levels. This was the approach adopted by the EU when it set up its Common Agricultural Policy. To keep down the direct cost of this subsidy the EU used trade barriers, including import levies, to minimise competition to EU farmers from produce available more cheaply on world agriculture markets. Recent American farm-support policy has combined income top-ups and some guaranteed prices.
As most governments have become more committed to international trade, such agricultural policies have come under increasing attack, although the free trade rhetoric has often run far ahead of genuine reform. In 2003, rich countries together spent over $300 billion a year supporting their farmers, more than six times what they spent on foreign AID. Finding a way to end agricultural support had become by far the biggest remaining challenge for those trying to negotiate global free trade .
Farming around the world continues to become more productive while generally accounting for a smaller share of employment and national income. although in some poor countries it remains the sector on which the country and its people depend. Farming, forestry and fishing in 1913 accounted for 28% of employment in the United States, 41% in France and 60% in Japan, but only 12% in the UK. Now the proportion of the workforce employed in such activities has dropped below 6% in these and most other industrialised countries.
The total value of international trade in agriculture has risen steadily. But the global agriculture market remains severely distorted by trade barriers and government subsidy, such as the european union 's Common agricultural policy .