universal economics

Universal Economicsarmen a. alchian and william r. allen

e d i t e d b y j e r ry l . j o r d a n

Foreword by William R. Allen

liberty fund

This book is published by Liberty Fund, Inc.,

a foundation established to encourage study of the

ideal of a society of free and responsible individuals.

The cuneiform inscription that serves as our logo and

as the design motif for our endpapers is the earliest- known

written appearance of the word “freedom” (amagi), or “liberty.”

It is taken from a clay document written about 2300 b.c.

in the Sumerian city- state of Lagash.

© 2018 by Pacifi c Academy for Advanced Studies (PAAS).

Published by permission.

All rights reserved

Printed in the United States of America

18 19 20 21 22 c 5 4 3 2 1

18 19 20 21 22 p 5 4 3 2 1

Library of Congress Cataloging- in- Publication Data

Names: Alchian, Armen Albert, 1914– author. | Allen, William Richard, 1924– author. |

Jordan, Jerry L., 1941– editor.

Title: Universal economics / Armen A. Alchian and William R. Allen ; edited by

Jerry L. Jordan ; foreword by William R. Allen.

Description: Carmel, Indiana : Liberty Fund, Inc., [2018] | Includes bibliographical references

and index. | Description based on print version record and CIP data provided by publisher;

resource not viewed.

Identifi ers: llcn 2017052105 (print) | lccn 2017054644 (ebook) | isbn 9781614876571

(Kindle) | isbn 9781614872818 (epub) | isbn 9781614879275 (pdf ) | isbn 9780865979055

(hardcover : alk. paper) | isbn 9780865979062 (pbk. : alk. paper)

Subjects: lcsh: Economics.

Classifi cation: lcc hb171.5 (ebook) | lcc hb171.5 .a339 2018 (print) | ddc 330—dc23

lc record available at https://lccn.loc.gov/2017052105

liberty fund, inc.

11301 North Meridian Street, Carmel, Indiana 46032-4564

concise contents

Detailed Contents vii Foreword xxiii

part one: Demand, Exchange, and Property Rights

1 Welcome to Economics 3 2 Your Economic Society 15 3 Choice and Cost 33 4 Gains from Exchange 50 5 Demands and the Laws of Demand 62 6 The Extent of Exchange 81 7 Keep Your Eye on the Marginals 97 8 More Features of Demand 109 9 Some Implications of the Laws of Demand 12510 Markets and Prices as Social Coordinators 13311 Illustrative Applications of Demand Principles 14612 Shortages, Surpluses, and Prices 15713 Markets and Property Rights 171

part two: Specialization, Production, Teams, and Firms

14 Productivity and Costs of Production 19715 Specialization and Exchange 21416 Market Supply and Price with Price-Takers 23117 Timing of Adjustments 25518 Facts of Life 27419 Price- Searchers 28520 Price- Searcher Pricing 31021 Pricing and Marketing Tactics 32422 Teamwork and Firms 34423 The Firm’s Control and Reward Structure 36324 Protecting Your Dependencies 37625 Dependency Assurance by Reputation and Predictable Price 38926 Prohibited Marketing Tactics 40227 The Corporate Firm 42028 Competition for Control of the Corporation 43629 The Demand for Productive Resources 449

vi concise contents

part three: Wealth, Rates of Return, and Risk

30 Arithmetic of Capital Values 47531 Series of Future Values and Annuities 49032 Wealth, Income, and Interest 51633 A Package Called the Rate of Interest 53234 Risk and Insurance 54335 The Full Equilibrium: Equalized Rates of Return 55836 Determinants of the Interest Rate 57137 Futures Markets 586

part four: Employment and Infl ation

38 Unemployment: What and Why 60339 Your Earnings: How and When 61440 Labor-Market Coalitions 62841 Labor-Market Constraints 64442 Money, Prices, and Infl ation 657

Glossary 681 Index 693

detailed contents

Concise Contents v Foreword, by William R. Allen xxiii

part one: Demand, Exchange, and Property Rights

1 Welcome to Economics 3Scarcity 4Goods: Economic or Free 4Self- Interest? 5Competition 5Our Intent 8Sequence of Exposition and Unsolicited Advice for Study 9Questions and Meditations 10

2 Your Economic Society 15Rights and Property Rights 16Private Property Rights 17The Rule against Perpetuities 20Capitalist or Socialist 20Alert! Free Speech Is Not “Free Resources” 21Effi ciency and the “Constrained Maximum” Concept 22Meaning of a “Theory” 24Economic Analysis Is Positive, Not Normative 24Increased or Reduced Probability and Refutable Implications 25Reported versus Verifi ed Event 25Transient Lucky Event versus Basic Difference:

The Ubiquitous Regression Effect 25Economics versus Economists 26Which Economic Theory? 26Economics and Biology 27The Basic Unit of Analysis Is the Individual, Not a Group 27Questions and Meditations 27

3 Choice and Cost 33Defi nition of Cost of a Chosen Action 33Personal Worth 33Some Confusions That Must Be Avoided 34Externalities: Uncompensated Effects Borne by Other People 36Costs and Effects of Actions 36

viii detailed contents

Choices Refl ect Principles of Personal Preferences 39The Personal Preference Principles 40Questions and Meditations 42Appendix to Chapter 3: Indifference Curves 44

4 Gains from Exchange 50Trade in a Refugee Camp 50Less Is More: Fewer Goods, More Satisfaction 51Thinking about the Trade 52More about Personal Worth 53To Have? 54Back at the Refugee Camp, Competition Develops 54Promises and Dependencies 56Reliable General Dependency: Essential in Every Economy and Society 56Trade Benefi ts Both Parties, Not Just One at the Expense of the Other 57Questions and Meditations 57

5 Demands and the Laws of Demand 62First Law of Demand 62“Quantity Demanded” versus “Demand” 63Negatively Sloped Demand 65Slide versus Shift 65Assumptions about Actions, Not about Thought Processes 66Direction of Relations, Not Exact Data, Is Pertinent 69Why So Much Concentration on “Marginals” Rather Than Totals

or Averages? 71Dollar Price and Relative Price 72Meaning of “Change in Price” 73Suggestive Labels 74Questions and Meditations 75

6 The Extent of Exchange 81Exchange 81Basis of National Policy on Market Competition 82Intermediaries and Transaction Costs 84Intermediaries’ Reduction of Full Price by Reducing Transaction Preparation

Costs 85Markets: Open or Constrained Access? 88Markets — Everywhere 90Implications of Market Exchanges, Not Judgments 90Contracts and Reliable Promises: The Binding Forces of Society 91Questions and Meditations 92

7 Keep Your Eye on the Marginals 97Totals, Marginals, and Averages 97Cost 97Revenue 97Use the Marginal or the Average? 99Relations among Totals, Marginals, and Averages 99

detailed contents ix

A Basic Principle: “The Equalization of Marginals at the Maximum Aggregated Return” 102

Cost Minimizing 105Questions and Meditations 105

8 More Features of Demand 109Why So Much Attention to Price? 109Changes in Money Prices and Changes in Relative Prices 109Which Demand? 109Elasticities of Demand: Responsiveness of Quantity Demanded to

the Price 110Remember: Elasticity of Demand Is a Measure of Movements along a Demand

Schedule, Not a Result of a Shift in the Demand Schedule 115The Second Law of Demand 116A Fan of Demand Curves 118Income, Wealth, and Demand 118Wealth and Income Effects of a Change of Price 119Precisely What Is Meant by the Demanded Amount? 120Rate of Demand versus Aggregate Volume Demanded 120Questions and Meditations 121

9 Some Implications of the Laws of Demand 125“Needed” or “Demanded” Amounts? 125Indirect Implications of the Laws of Demand 127Alleged Exceptions to the Laws of Demand 129Questions and Meditations 130

10 Markets and Prices as Social Coordinators 133A “Market- Clearing” Price? 133Market-Clearing Price for Allocation of a Fixed Supply of a Good 133“The Market” Sets the Price 134The Market Demand: The Sums of the Individual Demands at

Each Possible Price 134Irrelevance of Initial Allocation of Goods for Their Final Allocation to

Highest-Valuing Users 135Shortages Are Not Results of Reductions in Supply 136Markets and “Rights” 136Creation of Markets 137Reservation Demand to Own 137Rents 138Land Rent — A Pure Surplus? 138Quasi- Rent 139“Political Rent-Seeking” 139Questions and Meditations 141

11 Illustrative Applications of Demand Principles 146Marketing Arrangements: Buffer Stocks, Reserve Capacity, Stable

Prices, Waiting Times, and Price Response to Demand Uncertainty 146

x detailed contents

Speed of Detecting Changes in Demand or Supply: The Illusion That Cost Determines Price 148

Who Is Responsible for Higher Prices? Look in the Mirror 149What Made the Price Change? Always, the Initial Question 150Who Bears the Tax on Land Developments — Developers or Landowners? 150Tax on Economic Rent? 151Pollution and Land Values 151Questions and Meditations 153

12 Shortages, Surpluses, and Prices 157Shortages and Price Ceilings 157Shifts to Nonprice Competition 158Wealth Transfers versus Costly Competitive Activity 159Rationing by Coupons 159Price Controls on Inputs (Petroleum) Do Not Reduce the Price of

Outputs (Gasoline) 162Statement of a Basic Principle 162The Oil Industry Divided — Some Attacking and Others Defending Petroleum

Price Controls 163Surpluses and Price Floors 164Competitive Behavior during a “Surplus” 166Implications 167Questions and Meditations 167

13 Markets and Property Rights 171How Relative Preferences Are Impressed on the Owner 172Government Agencies and Private Property Rights 172Two False Issues 175The Rule of Private Property Rights 176Protection and Preservation of Alienability 177Shared Ownership 177How to Become a Member- Owner? 178Why Deliberately Suppress Private Property Rights of a College? 179Externalities 180“Public Goods” 181Government Control 182Public, or Group, Goods: Clubs 182Privately Supplied Public Goods Financed by Tie- Ins 183Charity 183Questions and Meditations 185

part two: Specialization, Production, Teams, and Firms

14 Productivity and Costs of Production 197Productive Ability versus Costs of Production, or Absolute Advantage versus

Comparative Advantage 197Measure of Cost 197

detailed contents xi

Costs versus Productive Ability 198No One Can Be the Lowest, or the Highest, Cost Producer of Every Good 198Absolute Productive Ability versus Lower Costs 198Marginal and Average Costs 199Marginal Costs 199Temporary Simplifying Assumptions 199Ricardian Superiority and Ricardian Rent 199Rates versus Volume of Production: An Important Distinction 200Marginal and Average Costs and Their Realistic Relation to Rates

of Production 200Arithmetic of Marginal Cost 202The Sum of the Marginal Costs Is the Total Cost 202The Marginal- Average Relationship 203Rate and Volumes of Production 203Choice of Production and Consumption by Self- Suffi cient Adam 203Marginal Costs Are Higher at Faster Rates of Production 204The Law of Diminishing Marginal Returns 205Price of Labor versus Labor Cost of Output 206Questions and Meditations 207

15 Specialization and Exchange 214Adam’s and Baker’s Production and Costs Compared 214Differences in Costs and Marginal Worths Create Opportunities for Trade 217Two’s Company, Three’s Even Better: Effects and Objections to

New Entrants 218An Economically Complete Analysis 219Reduced Cost, Profi t, and Dispersion of the Profi t 221Improved Quality and the Dispersion of the Benefi t 221Two Meanings of Specialization in Production and Several Sources

of Benefi ts 223No Free Benefi ts: Increased Dependence 225Questions and Meditations 225

16 Market Supply and Price with Price- Takers 231Sunk Investment or Set- Up Cost 231What Rate of Production? 231Price- Taker/Sellers 232Price- Taker/Seller Sees a Horizontal Demand Curve at the Market Price 233No Rivalry among Price- Takers 233Aggregated Demand and Aggregated Supply in the Market 234Marginal Costs, Profi ts, and a Price-Taker’s Supply Response to the Market Price:

A Price-Taker’s Marginal Revenue Is Equal to the Market Price 235Determining the Rate of Production and Supply 236Two Types of Constant Costs: 1) Constant Total Daily Costs Regardless of Daily

Rate of Production (Even If Zero); 2) Constant Costs per Unit of Production 236

The Planned Output Rate for Profi t Maximizing 237A Graph Showing Price- Takers’ Response to the Market Price 238

xii detailed contents

Profi t-Maximizing Rates of Output at Other Market Prices 238Why Analyze Profi t-Maximizing Rate of Production through Marginal Revenues

and Marginal Costs? 239A Role for Average Cost 239The Long- Run Average Cost 240The Short- Run Average Cost 240Market Supply Curve of Price- Taker/Suppliers Is the Horizontal Sum of the

Marginal Cost Curves 240An Upward- Sloping Market Supply Curve 241Industry- Wide Cost Minimization of the Profi t- Maximizing Output 241Is the Profi t Test of Survival “Socially Desirable”? 242Competition for Profi table Resources Converts Profi t into Cost 243A Person, Rather Than Equipment, as the Responsible Resource 244Profi ts Are Increases in Wealth — Not Transfers of Wealth from One Person

to Another 245Productive Resources That Enter after a New Tax 249Depreciation versus Capital Value Changes 249Obsolescence versus Depreciation 249Why Do Accounting Records Show Depreciation as Erosion of Initial Cost of

Resource, Rather Than of Current Value? 250Questions and Meditations 250

17 Timing of Adjustments 255Tax It: Demand and Supply 255Deadweight Welfare Loss 257Mobile versus Less- Mobile Resources 258Comparison of Short- Run and Long- Run Effects 258After the Long- Run Adjustments, Consumers Pay All the Tax; New Investors

Pay None 260Only Present and Future Costs Are Really Costs 261Quasi- Rent: A Temporary Surplus 261Infi nite Elasticity of Supply 262The Longer- Run Responses and Effects 262For What Is the Tax Used? 263Reducing Negative- Worth Externalities 264Adjustments before Predicted Event Occurs 264Gasoline and Oil Prices 265Competitive Pricing Response to New Entrants: Is It Predatory? 267Questions and Meditations 270

18 Facts of Life 274The Missing Entrepreneur 275Example of Effect of Creative Destruction 276Many Producers of a Consumer Product 276Managers Don’t Know Their Costs as Accurately as Those Shown in

the Examples 277Allocating Common Costs to Joint Products 278Supply in Terms of Mass Production and the Volume Produced 280

detailed contents xiii

Summary of Cost and Volume Output Relations 281Warning 282Demand in Terms of Volume Demanded 282The Historical Pattern of Prices of a Product 282Questions and Meditations 283

19 Price- Searchers 285Price- Takers and Price- Searchers 285Differences for Customers because of Differences among

Competing Sellers 286Price- Searchers Search for the Best Price to Maximize Profi ts 286Price- Searchers Must Set the Prices for Their Products 287Signals to Price- Searchers 288Pricing at a Uniform Price to the Entire Public 288Price versus Marginal Revenue 288The Profi t- Maximizing Price and Quantity: Marginal Revenue Equality to

Marginal Cost 289Price- Searcher with Increasing Marginal Costs 289Increasing Marginal Costs and the Profi t- Maximizing Output 291Knowing Patterns of Marginal Costs and Marginal Revenues 291Sellers Aren’t Naive 292Closed, Restricted, and Open Markets 293Who Is Restricted by a Restriction on the Seller? 294Categories of Sellers 294Who Is a Monopolist? 295Cartels 296Personal Services? 296Objectives of the Language of Economics and the Language of Litigation 296Objections to (1) Closed Markets and (2) Price- Searchers in Open Markets 297Normative Standard for the Laws: Open Markets and Forgone

Consumer Worth? 298“Monopoly” Distortion: Ineffi cient Output Ratio 298Is It Really Wasteful or Ineffi cient? 300Long- Run Response: Capacity and Cost Response to Demand Changes 300The Meaning of Consumer Worth and to Whom It Belongs 302Questions and Meditations 303

20 Price- Searcher Pricing 310Charging Different Prices among Customers to Equalize

Marginal Revenues 310What Rate of Production? 311Marginal Revenue Equalization: Price Discrimination? 312Dumping Is Not Selling Below Cost. It’s Simply Marginal Revenue 313College Tuition Scholarships? 313Discount Coupons 314Free and Special Services: A Free Tie- In 314Is Marginal Revenue Equalization Really Price Discrimination? 314

xiv detailed contents

Price- Searcher Buyer — Monopsonist 315Why Higher Wage Rates to All Employees? 316Differentiating Benefi ts 317Questions and Meditations 318

21 Pricing and Marketing Tactics 324Tie- Ins 324Basing- Point Pricing 329Effi cient, Competitive Pricing Response to New Entrants, Misconstrued as

Predatory Pricing 331Dominant Firm, with Market Power 333Price Leaders? 336Oligopoly 336Networks, Monopoly Lock- Ins? 337Patents and Copyrights: Confl icting Objectives and Ambiguous Policies of

Reward to Inventors 338Questions and Meditations 340

22 Teamwork and Firms 344No Defi nable, Separable, Individual Products for Each Team Member 344Intrateam Dependencies 345Are You Paid What You Add to the Total Value? A Futile Question 346Hazards to Effective, Viable Teams: Dependencies, Moral Hazard, Uncertainty

of Team Value, and a Risk- Accepting Owner 347The Saga of Codlandia 348National Development 358Questions and Meditations 359

23 The Firm’s Control and Reward Structure 363The Boss 364What Is the Meaning of “Owning a Firm”? 364Management Rewards 365Shirking as Moral Hazard or Opportunistic Hold- Ups 366Monitoring and Deterring Shirking 366Loyalty and Shirking 366Customers, Rather Than the Employer, May Monitor and Restrain Employee

Shirking: “Tips” 367Firms Not Owned by Full Private Property Rights 370Questions and Meditations 372

24 Protecting Your Dependencies 376Dependent Investments 376Integrated Ownership 377Reciprocal Dependency 378Exclusive Service Contracts to Protect Reliability and Investments in

a Person 378Example: The Controversial Baseball Reserve Clause 379Voluntary Maximum Retail Price 379

detailed contents xv

Publisher versus Distributor Confl ict about Retail Price 380Integration? 380More Examples of Price Ceilings Imposed on Retail Distributors 381Minimum Permissible Retailer Prices, Known as Retail Price

Maintenance (RPM), to Avoid Free Riding of Discounters 381Self- Enforcing Hostage Value That Depends on Performance 382The Case of Coors Beer: How a Manufacturer Enhances the Reliability

of Distributors 383Exclusive Territories Protected by Resale Price Maintenance 384End of Coors Dominance — New Technology 384Government Regulation to Protect Dependent Customers of Closed

Monopoly Supplier 384Public Utilities and Natural Monopolies 384Owning a Firm or Lending to It? 385Questions and Meditations 385

25 Dependency Assurance by Reputation and Predictable Price 389Brand Names: Reducing Costs of Prepurchase Information and Shopping 389Cost of Maintaining Brand-Name Value 389Reputation as Self- Enforcer of Reliability 390Franchises Rely on Reputation of Brand Names 390Hostages to the Franchiser to Assure Reliable Performance by

the Franchisee 390Advertising — Reducing Search Costs 391Good Samaritan: Am I My Brother’s Keeper? 391Personal Shame 392The Value of Predictability of Price 392Predictability and Assurance of Future Prices 392Announcing Reliable Prices 394Voluntarily Tolerated Queues: Inventories and Rationing 394Preferred Customers among Those Who Differ in Volume and Rate

of Demand 395No Surprise and No Haggling: Same Announced Price to All Customers 395Blind Blocks to Economize on Duplicative Inspection and Sorting 396Professional Codes of Ethics 398Questions and Meditations 398

26 Prohibited Marketing Tactics 402What Is Antitrust? 402The Clayton Antitrust Act of 1914 403The Federal Trade Commission Act of 1914 404Remedies and Enforcement Agencies 404Specialization and Dependency 404Meaning of a Benign and a Malign Effect? 405The Basic Criterion: Maximizing Consumer Worth 405Effects on Competitors 406Surrogate Criteria for Permissible Actions: Rule of Reason 407Per Se Illegality 407

xvi detailed contents

Vertical or Horizontal Agreements 408Concentration Ratios 408Coalition versus Collusion 410Purpose of Collusion 411Obstacles to Effective Collusion 411Vulnerability of Government Agencies as Less- Careful Buyers 413Government- Enforced Cartels: For Whose Benefi t? 413Farm Support Programs 414Labor Unions 415Politicians: Agents of the Public in the Competition for Government Aid 415Questions and Meditations 417

27 The Corporate Firm 420Forms of Ownership of Firms 420The Corporate Form of Business 420Shares of Ownership 421Management Structure 421Characteristics of Ownership of Corporations — Sharing in

Large Investments 421Nondiscriminatory Sale of Shares of Ownership 421Evolution of the Corporate Ownership Structure 422Historical Evidence of the Effects of the Corporate Entity 423Legislation to Constrain Corporate Form of Organizations 424Differences between Large and Small Firms 424Why Very Large Firms? 425New Tax on Existing Corporations 427New Investments in Corporations after the Tax 427Questions and Meditations 428Appendix to Chapter 27: Interpreting Financial Statements 429

28 Competition for Control of the Corporation 436Who Owns the Corporation? 436Separation of Ownership from Control Can Be a Way to Specialize 437Control of Behavior of Manager by Owners: The Universal

Moral Hazard Phenomenon 437Competition for Achievable Gains by Superior Control 438Obstacles to Stockholder Control of Management: Legislation 438Entrenched Management’s Resistance 439Displacement of Owners and Managers by New Sets of Owners and Managers by

Purchase of Complete Ownership 439Takeovers Benefi ting Stockholders by Transferring Wealth from Other Members

of the Firm 441Indirect Takeovers 442Charity Is Better than Coercion 443Shareholders or Stakeholders? Promises and Agreements? 443Survival of the Corporate Organization 444Managers and Consumers 444Questions and Meditations 444

detailed contents xvii

29 The Demand for Productive Resources 449Homogeneous, Uniform Units of a Productive Resource versus

Nonuniform Units 449The Demand for Productive Services of Uniform Inputs 449The Long- Run Elasticity of Demand for Productive Inputs Exceeds the

Short- Run Elasticity 453Cross- Price Elasticity of Demand for Productive Resources 454Input Substitutions in Production Caused by Consumer Substitutions among

Consumer Goods 454Substitutes and Complements 454Generalization and Similarity to Demand for Consumption Goods 455Summary of Principles of Demand for Amounts of a Kind of

Productive Resources 455Lagged Substitutions Tend to Be Veiled by Interim Events 455The Fallacy of Energy Effi ciency — Other Inputs Are Not Free 456More Capital Increases Productivity, but Who Benefi ts? 456Labor and Capital: Is There a Real Difference? Is It Current versus

Earlier Labor? 457Human Capital 457Social and Cultural Resources as Productive Inputs 458If Resources Are Not Owned, Less Attention Is Focused on Market Values 458A Market for Labor or a Market for Persons 458Individual Supply of Labor 460What Is a Unit of Labor Service? The Value of the Service Is Critical 461Questions and Meditations 461Appendix to Chapter 29: Output and Input Equilibria of the Firm 468

part three: Wealth, Rates of Return, and Risk

30 Arithmetic of Capital Values 475Essential Concepts for Your Future 475Current and Future Services of Durable Resources 475Principles of Capital Valuations 478Tables of Future Values of Present Amounts 479The “Present Value” of a Future Amount, the “Principal” or

“Maturity Value” 481The Rule of Seventy- Two Is a Convenient Quick Aid 484Questions and Meditations 484

31 Series of Future Values and Annuities 490Annuity: Present Capital Value of a Series of Future Values 490Table of Present Values of Annuities 491The Low- Interest- Rate Bias 492Perpetuities — A Special Constant Annuity, Lasting Forever 493A Distant Future Service’s Contribution to Present Capital Value 493How Large Is a Gift? 494Present Values of Annuities of Varied Annual Future Amounts 494

xviii detailed contents

Honor Thy Father and Thy Mother 494Current Actions, Long- Run Effects, and Immediate Changes in Prices 495The Words in Financial Markets: Lending Is “Buying” and Borrowing

Is “Selling” 495The Signifi cance of Interest as a Cost — Even Without Debts 496If the Interest Rate Is 7 Percent 498Some Hidden Presumptions Deserving Suspicion 498Questions and Meditations 499Appendix to Chapter 31: Applications of Capital Value Principles 502Questions and Meditations 509

32 Wealth, Income, and Interest 516Earnings: Personal Service Yields 516Consumption 516Profi ts, Losses, and Uncertainty 517Saving 517Income 518More Meanings of “Income” 518A Race to Acquire Private Property Rights of Lumber 525Questions and Meditations 525Appendix to Chapter 32: Balance Sheets and Budgets 528

33 A Package Called the Rate of Interest 532The Nominal and the Pure Rate of Interest 532Premiums in the Package Called the Nominal Interest Rate 532Add- Ons Specifi c to Individuals 533The Market Risk: Economy- Wide Factors for All People and

Financial Securities 534Liquidity: A Subtraction in the Nominal Money Interest Rate Package 536Very Short- Term Bonds Have More Liquidity and Smaller Market Risk Than

Longer- Term Bonds 536The “Real” versus the Realized Real Rate of Interest 536Can Not Reliably Measure the Rate of Interest by Relative Prices of

Resources 538Investment Effects of Changes in Resource Prices, Rather Than in Cost

of Borrowing 539Competitive Equalizing of Pure Interest Rates on All Bonds and Resources 539Questions and Meditations 539

34 Risk and Insurance 543Loss Spreading for Reduction of Private Loss 543What Kind of Catastrophes Are Insurable? 544Some Necessary Conditions for Voluntary Insurance 545Moral Hazard of Employee Behavior 548What Else Do You Get When You Buy Insurance? 548Insurance That Was Not Insurance 549Transformation of Insurance to Damage Compensation 550Relief from Losses Is Not the Sole Purpose of Insurance 550Lotteries — Increased Risk 551

detailed contents xix

Insurance, Assurance, and Gambling: A Play on Words? 551Questions and Meditations 552Appendix to Chapter 34: Viable Insurance 556

35 The Full Equilibrium: Equalized Rates of Return with Intermediaries 558Elimination of Sure- Profi t Arbitrage 558Unbiased Estimator 559News, Not Events, Is Random and Always Surprises 559Risk 560Trade- Off between Mean and Variance 560Random Walk: The Path of Successive Prices — Martingales 562An Effi cient Market Portfolio 564Specialization and Intermediation in the Capital Markets 565Questions and Meditations 567

36 Determinants of the Interest Rate 571Demand for More Current Income Relative to Future Income 571The Price of Current Income: The Rate of Interest 571Whether for Consumption or Investment Is Not Pertinent 573The Supply of Current Relative to Future Income 573Borrowing Is Selling Future Income; Lending Is Buying Future Income 574The Markets for Current Income Relative to Future Income 574Adjustments in Prices of Resources 576The Money Supply and the Interest Rate 577The Language of Buying and Selling Money — Instead of Lending and

Borrowing Income 577Lending, Borrowing, or Renting? 577When Is the Rent Paid? 578Changing the Supply of Money to Affect the Rate of Interest 579Increasing the Money Supply Randomly 579Increasing the Money Supply by Purchasing Bonds 579Questions and Meditations 580

37 Futures Markets 586Control and Smoothing of Consumption between Harvests 586Hedges 587What Is a Futures Contract? 588Example of Hedging against Changes in the Price of Wheat 588The Seller of the Futures Contract 589Structure of Futures Contracts and Intermediaries 589Gamblers in Futures Contract Markets? 590Example of a Foreign Exchange Futures Contract 590What Determines the Price of the Futures Contract? 591Predictor of the Price in the Future 591Variety of Futures Markets 592Price- Forecasting Errors and Risks in Futures Markets 594Questions and Meditations 595

xx detailed contents

part four: Employment and Infl ation

38 Unemployment: What and Why 603Search for Best Job in a World of Changing Tastes, Demands,

and Capabilities 604Unemployment Insurance of Nonhuman Resources 606Job Creation: The Nonsense of Creating Jobs to Reduce Unemployment 606Creative Destruction 607New Entrants to Labor Force 607A Meaning of the Measured Rate of Unemployment 607Transition to and from the Market Labor Force and to and from Employment and

Unemployment 608Personal and Gender Differences in Unemployment Rates 609Spells of Unemployment or Reduced Employment 609A Rise of Nonrecession Normal Rate of Unemployment: Changed Composition

and Unemployment Benefi ts 609Unemployment — A Benefi cial Phenomenon? 610Questions and Meditations 611

39 Your Earnings: How and When 614Full Earnings versus Money Earnings 614Tying Earnings to Performance: Pay Later When Worth of the Work

Is Known 615Pitfalls in Perceptions of How Much Everyone Else Earns 618Age- Related Annual Earnings versus Total Lifetime Earnings 619Shifting Demand and Supply 619Ricardian Superiority 620Sensitivity of Earnings to Differences in Talent 620Why Large- Firm CEOs Earn More Than Small- Firm CEOs 620Replicability of Services Concentrates Rewards to the Best of

the Competitors 621Prize for Being the Best 621Gender- Related Earnings 622Human and Nonhuman Wealth 622Poverty 623Nonmoney Forms of Income and Aid 623Poverty, How Long? Transitions to and from Poverty Status 623Feminization of Poverty? 624Questions and Meditations 624

40 Labor- Market Coalitions 628History and Organization 628Rise of Unions 629The National Labor Relations Board (NLRB) 630Union Objectives via Monopoly Status 631Labor Union Effects on Wages 631Protection from Employer Opportunistic Expropriation 632How Does Unionization Achieve Its Objectives? 632

detailed contents xxi

Selective Monopolization: Labor and Wage Effects 634Why Do Private Employers Resist Unionization? 635Diffi culty of Maintaining Contrived Monopoly Rent: The Value of Monopoly Rent

Is Competed Away Even If Price and Supply Are Effectively Controlled 636Closed- Market Monopsonies of Buyers of Labor 637Questions and Meditations 638

41 Labor- Market Constraints 644Minimum Legal Wages or Living Wage 644Nonmoney Productivity and Nonmoney Components of Full Wages 645Substitution by Demanders of Labor Services 646Other Motives for Advocating Higher Minimum Legal Wage Rates 646Equal Pay for Equal Work 647Fair Employment Laws 647Legislatively Mandated Benefi ts 648Examples of Evidence of the Deduced Implications 649Why Would Employees or Employers Object to Mandated Benefi ts? 650Comparable Worth as a Basis of Wage Rates? 650Questions and Meditations 651

42 Money, Prices, and Infl ation 657Money and Prices 657Infl ation 658How Is Infl ation Measured? 660The Cause of Infl ation 660The Cause of the Increased Money Supply 662How Infl ation Is Disruptive and Confusing 663Mistaken Beliefs about Causes of Infl ation 664Wealth Transfers by Infl ation 665Why Lend If Infl ation Is Expected? 667Interpersonal Wealth Transfers as a Result of Incorrectly

Anticipated Infl ation 667Summary 668Questions and Meditations 668Appendix A to Chapter 42: Adapting to Infl ation 674Appendix B to Chapter 42: Generalization of Interpersonal Wealth 676

Glossary 681

Index 693