Economics & Incentives

Labor-intensive services rise in cost despite stagnant productivity.

Baumol's 1966 example: a Beethoven quartet needs the same four musicians for the same minutes as in 1800, so as economy-wide wages rise, its cost rises with no productivity offset. This is why healthcare, education and live performance persistently outpace general inflation.

In practice

• A string quartet and a haircut cost more each decade relative to a television, though neither has got faster.
• A council's social care bill rises faster than inflation while its printing costs fall, and the budget debate treats both as management failures.

Attributed to

William Baumol

Standing

In higher education its rival explanation is Bowen's revenue theory of cost, which puts rising costs down to appetite rather than productivity.

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A poorly fitting or unsuccessful extension weakens the associations that made the parent brand valuable.

The finding qualifies the case for extensions, which are attractive because they borrow existing awareness. Where the extension fits badly or performs poorly, the borrowing runs both ways and the parent's specific associations blur. Dilution is strongest where the parent's value rested on a narrow and specific claim.

In practice

• A premium marque that launches a budget line finds its premium line harder to price.
• A consultancy known for one thing that offers everything is known for nothing within five years.

Attributed to

Brand extension research

Also called

Extension backlash

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Using social indicators for decision-making corrupts them and the processes they monitor.

Campbell stated it in 1976. Standardised testing is the canonical case: once scores determine funding, teaching narrows to the test and the score stops measuring learning.

In practice

• A university department told that graduate employment determines funding begins counting six-month internships as employment.
• A police force measured on response times logs the arrival of the first car and lets the second-arriving specialist go uncounted.

Attributed to

Donald T. Campbell

Also called

Teaching to the test; juking the stats

Further reading

Wikipedia

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Unit cost falls with volume until coordination cost rises faster than the savings.

The curve turns where the cost of coordinating the organisation exceeds the savings from volume. It is the economic statement of Brooks's law and of span-of-control limits.

In practice

• A support organisation of forty people answers tickets faster than the same function at four hundred, where a ticket now passes three queues.
• A restaurant kitchen that works beautifully at sixty covers is chaotic at two hundred with four times the staff.

Attributed to

Classical economics

Further reading

Wikipedia

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Revealing mandatory fees late in the purchase raises completion rates relative to disclosing the true total upfront.

Now restricted under consumer law in several jurisdictions after regulators concluded the effect was reliable enough to constitute a harm. The mechanism is sunk effort: by the fee reveal, the buyer has already invested in the transaction.

In practice

• A booking site shows £59, then a service fee, then a card fee, then a seat fee, and most buyers complete anyway.
• A gym membership advertised at £19 a month collects a joining fee, an admin fee and a minimum term at the point of signature.

Attributed to

Consumer-protection research

Also called

Partitioned pricing

Standing

Now restricted by consumer law in several jurisdictions.

Further reading

Wikipedia

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Brands share customers in proportion to market share, so competitors are rarely the ones a brand thinks they are.

Ehrenberg's finding overturns most brand positioning: a small brand's buyers are mostly light buyers of the category who also buy the leader, so the leader is always the main competitor.

In practice

• A challenger coffee brand positions against the artisanal independent and loses most of its shoppers to the supermarket own-label.
• A boutique gym benchmarks itself against other boutiques while its members' other membership is the budget chain.

Attributed to

Andrew Ehrenberg

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A resource boom lifts the exchange rate and wages, hollowing out other tradable sectors.

Named by The Economist in 1977 for the Netherlands after the Groningen gas find. Manufacturing employment fell as the guilder rose — the boom sector's success is what damages the others.

In practice

• A region where a large plant raises local wages finds its restaurants, hauliers and builders unable to recruit at any price.
• A city where finance salaries set the rent means every other employer in it is competing for staff who cannot afford to live there.

Attributed to

The Economist, 1977

Further reading

Wikipedia

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Small brands suffer twice: they have fewer buyers, and those buyers are also less loyal.

Small brands' apparent loyalty problem is a mathematical consequence of their size, not a failure of their marketing. It is the most consistently replicated finding in marketing science.

In practice

• A challenger brand's low repeat-purchase rate is read as a loyalty failure, and is what a brand of that size mathematically must show.
• A small charity's donor retention looks poor against a national one, and would look identical however well it was run.

Attributed to

Andrew Ehrenberg

Standing

Loyalty is largely a consequence of market share, not a route to it.

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As income rises the share spent on food falls, even as absolute food spending rises.

Engel's 1857 finding, and one of the most robust regularities in economics. The food share is still used as a poverty measure precisely because it falls so reliably with income.

In practice

• A household on £20,000 spends a third of it on food; on £80,000 it spends more in absolute terms and a tenth of the total.
• A country's rising food-delivery spending coexists with a falling share of income going on food overall.

Attributed to

Ernst Engel

Further reading

Wikipedia

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In the early decades of Britain's industrial revolution, output per worker rose while real wages stagnated, so the gains went to profits.

Allen named it in 2009 after Engels's Condition of the Working Class in England (1845). Using reconstructed series for roughly 1790 to 1840, he found output per worker rising while real wages barely moved and the profit share climbing; wages began to follow productivity only after about 1840.

In practice

• A factory doubles its output with new machinery, and its operators' pay stays where it was for a decade.
• Economists arguing about whether new automation will raise wages cite the pause as the precedent for a long delay.

Attributed to

Robert Allen, after Friedrich Engels

Possible explanations

One explanation is that new technology displaced skilled labour faster than it created new demand for workers. Another is that industrial expansion was financed from profits, so a rising profit share was how accumulation paid for itself until capital became plentiful.

In its favour

Rests on reconstructed wage and output series and is widely cited in economic history; it offers a concrete case of technology raising output for a generation without raising wages.

Against it

Wage and price data for the period are uncertain, and other historians estimate some real wage growth before 1840. How far the pattern generalises beyond early industrial Britain is debated.

Standing

Disputed in its measurement rather than its existence. Compare the productivity paradox and Piketty's r > g inequality.

Further reading

Wikipedia

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Drug discovery becomes slower and more expensive over time.

Moore spelled backwards, and deliberately named as a counter-trend to Moore's law. Scannell and colleagues found drugs approved per billion dollars of R&D halved roughly every nine years from 1950: output per inflation-adjusted dollar fell exponentially even as many enabling technologies improved.

In practice

• A pharmaceutical company spends more per approved compound each decade while every input technology gets cheaper.
• A research organisation's output per pound falls steadily as its screening, review and compliance layers each add a defensible step.

Attributed to

Scannell, Blanckley, Boldon & Warrington

Also called

Inverse Moore's law

Standing

Moore spelled backwards.

Further reading

Wikipedia

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Firm and city growth rates are independent of size, which generates a lognormal size distribution.

Gibrat's 1931 finding. If growth is proportional and random, the size distribution becomes lognormal automatically, which is why firm and city sizes look the way they do without anyone designing it.

In practice

• A firm of 30 and one of 3,000 both grow around 8% in a good year, so the gap widens in absolute terms and holds in proportion.
• A city of 40,000 and one of four million grow at similar rates, which is why the size distribution stays the same shape for a century.

Attributed to

Robert Gibrat

Also called

Law of proportionate effect

Further reading

Wikipedia

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When a measure becomes a target, it ceases to be a good measure.

Goodhart's original 1975 form was that an observed statistical regularity tends to collapse once pressure is placed on it for control, stated about monetary aggregates: as soon as the Bank targeted a measure of money supply, the relationship it had relied on broke down. The familiar wording is Strathern's 1997 generalisation.

In practice

• A support team measured on average handling time closes conversations before the problem is solved.
• A hospital measured on ambulance handover times holds patients in the ambulance, and the measure improves.

Attributed to

Charles Goodhart; wording from Marilyn Strathern

Also called

When a measure becomes a target

Standing

The Chinese administrative idiom shang you zhengce, xia you duice states the implementation half of the same mechanism.

Further reading

Wikipedia

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Higher income inequality is associated with lower mobility between generations.

Krueger's 2012 plot of inequality against intergenerational elasticity across countries. Denmark sits low on both axes, the United States high on both, and the relationship is tight enough to be uncomfortable.

In practice

• A country where the top decile has pulled away shows children's outcomes tracking their parents' more tightly than in flatter neighbours.
• A city with a wide income spread has schools whose intakes sort by postcode, which is the mechanism the curve describes.

Attributed to

Alan Krueger

Further reading

Wikipedia

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Where two moneys circulate at a fixed legal rate that overvalues one, the overvalued money circulates and the undervalued is hoarded, melted or exported.

Named for Gresham by Macleod in 1858, though Copernicus stated it earlier. It requires a fixed legal or customary exchange rate: absent one, good money simply commands a premium and Thiers's law applies instead.

In practice

• Where two currencies are legal tender at a fixed rate, the undervalued one disappears into savings and the overvalued one circulates.
• A firm that treats two grades of component as interchangeable at one price finds only the cheaper grade in the stores.

Attributed to

Named for Thomas Gresham by Henry Dunning Macleod

Also called

Bad money drives out good

Further reading

Wikipedia

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US federal tax revenue is claimed to hover near a fixed share of GDP regardless of statutory rates.

US-specific and disputed; federal receipts have in fact ranged from about 14% to 20% of GDP. The pattern is looser than the claim requires.

In practice

• A government raises the top rate of income tax and finds receipts move by far less than the rate change implies, because the base moves too.
• A finance ministry forecasting revenue from a rate rise alone, with no estimate of the behavioural response, produces a number nobody in the building believes.

Attributed to

Kurt Hauser

Possible explanations

The proposed explanation is behavioural: higher statutory rates induce avoidance, deferral and shifts in the form of income, so the effective tax base shrinks as rates rise.

In its favour

Federal receipts have moved in a fairly narrow band over long periods, which is the observation behind the claim, and the avoidance mechanism it invokes is real.

Against it

American receipts have ranged from roughly 14 to 20 per cent of output, which is a wide band for a supposed constant, the pattern is specific to one country, and revenue also tracks the business cycle rather than rates alone.

Standing

US-specific and disputed; the ratio has in fact varied materially.

Further reading

Wikipedia

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A country can have at most two of a fixed exchange rate, free capital movement, and independent monetary policy.

Mundell and Fleming's result. The euro shows the trade-off live: members fixed the rate and kept capital mobility, so they gave up independent monetary policy, which is what made the 2010-12 crisis intractable.

In practice

• A country pegs its currency and opens its capital account, then finds it cannot cut rates in a downturn without breaking the peg.
• A firm that fixes internal transfer prices and lets divisions trade freely externally loses control of its own margin policy.

Attributed to

Mundell & Fleming

Also called

Mundell–Fleming trilemma

Further reading

Wikipedia

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Increasing supply of a resource induces additional demand for that resource.

Downs and others. Adding a lane fills the lane: Houston's Katy Freeway reconstruction, completed in 2008, gave six general-purpose lanes in each direction plus two managed lanes, and commute times rose. Popular 26-lane counts include frontage and other lanes at the widest cross-section, and the project illustrates the mechanism rather than proving it alone.

In practice

• A council opens a new car park and finds the town centre no easier to park in within a year.
• A team given a second on-call engineer finds the alert volume rises to fill both.

Attributed to

Anthony Downs and others

Also called

Lewis–Mogridge position

Further reading

Wikipedia

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Sustained inflation is always and everywhere caused by money growing faster than output.

The strong form is disputed after decades in which the money-inflation link loosened badly. Supply shocks and expectations are the main rival explanations, and the 2021-23 episode was argued on all three grounds.

In practice

• A central bank facing rising prices must decide whether it is looking at money growth, a shipping bottleneck or wage expectations, and the three call for different responses.
• A government that prints money to cover its deficit for four years gets inflation whatever its shipping costs did.

Attributed to

Milton Friedman

Possible explanations

The explanation is quantity theory: if money grows faster than output over long periods, prices adjust, since the extra money must be held at a lower value.

In its favour

The long-run relationship holds across countries and across high-inflation episodes, and it disciplined the loose accounts of inflation that preceded it.

Against it

The short-run link loosened badly after financial deregulation, money aggregates became poor guides for central banks, and the strongest rival accounts, supply shocks and expectations, explained episodes such as 2021 to 2023 better.

Standing

The strong form is disputed after decades in which the money-inflation link loosened; supply shocks and expectations are the main rival explanations.

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Buyers who were exceptionally heavy or light purchasers in one period move toward the average in the next, whatever is done to them.

The regularity is robust across categories and follows from the statistics of purchase incidence rather than from any change in loyalty. Its practical importance is that loyalty programmes and win-back campaigns targeted at extreme buyers will appear to work, because the extremes were going to moderate anyway, and almost no evaluation controls for it.

In practice

• A campaign aimed at lapsed heavy buyers reports a recovery that would have occurred without it.
• A branch flagged as worst-performing improves after intervention, and so do the worst branches nobody visited.

Attributed to

Andrew Ehrenberg and colleagues

Also called

Regression to the mean in purchasing

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Trade benefits arise when actors specialize in what they do best.

Ricardo's 1817 argument, and the counterintuitive part is that trade benefits both parties even when one is worse at everything. The gain comes from relative rather than absolute cost.

In practice

• A hospital where the consultant is better than the registrar at both diagnosis and paperwork still gains from the registrar doing the paperwork.
• A two-person business where one partner is better at everything still divides tasks by relative advantage, and the output rises.

Attributed to

David Ricardo

Further reading

Wikipedia

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Each additional unit of input eventually yields less output.

Turgot's 1767 statement, and the most robust regularity in production economics. Adding fertiliser raises yield, then raises it less, then poisons the crop.

In practice

• A field yields more with the first hundred kilos of fertiliser, less with the second, and less again with the third.
• A support team improves resolution times markedly with the second member, slightly with the fifth, and not at all with the ninth.

Attributed to

Classical economics, Turgot and Ricardo

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Prices are encoded from the leftmost digit, so 3.99 registers as materially cheaper than 4.00.

Thomas and Morwitz's 1997 finding. The effect is in the encoding, not the arithmetic — $3.99 and $4.00 differ by a cent and register as differing by a dollar.

In practice

• A subscription at £9.99 is perceived as materially cheaper than £10.00, though the difference will never be noticed on a statement.
• A house listed at £499,000 draws searches that £500,000 does not, and the search filter is doing the work.

Attributed to

Thomas & Morwitz

Also called

Charm pricing; nine-ending pricing

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People tolerate about an hour of daily commuting regardless of era or technology, so faster transport spreads cities rather than saving time.

Marchetti's finding from travel surveys across centuries and cultures. It predicts that faster transport enlarges cities rather than shortening commutes, which is what happened with rail, cars and now remote work.

In practice

• An hour's commute by horse defined a city of three miles; by train, thirty; by car, forty.
• A city that builds a faster rail link finds its commuter belt extend rather than its commuters gain an hour.

Attributed to

Cesare Marchetti

Also called

Travel time budget

Further reading

Wikipedia

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Unemployment rises roughly in proportion to the shortfall of output below potential.

Okun's 1962 rule of thumb: a one-point rise in unemployment corresponds to roughly two points of output below potential. The coefficient varies by country and era but the relationship persists.

In practice

• A treasury watching unemployment rise two points knows roughly how much output has gone missing before any GDP figure is published.
• The coefficient varies by country and era, which is why it is a rule of thumb for reading a downturn rather than a parameter to forecast with.

Attributed to

Arthur Okun

Further reading

Wikipedia

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Prematurely announcing future products can cannibalize sales of current products.

Named for Osborne Computer, which announced its next machines in 1983 while still selling the current one. Whether the collapse was caused chiefly by the premature announcement is disputed: competition and other business problems also mattered, and Osborne himself disputed the account.

In practice

• A software vendor announces the next version's release date and watches this quarter's sales stop.
• A car dealer's forthcoming model announcement empties the forecourt of interest in the one on it.

Attributed to

Named for Osborne Computer Corporation

Possible explanations

The explanation is anticipation: buyers who learn that a better version is coming defer purchase, and revenue falls before the new product can replace it.

In its favour

The mechanism is real and measurable in pre-announcement studies, and firms now manage announcements with it in mind.

Against it

Whether Osborne's own collapse was caused chiefly by the announcement is disputed, since the company also faced competition, delays and financial trouble, so the founding case may not illustrate the law named after it.

Standing

The mechanism is plausible; whether Osborne's collapse was caused chiefly by the announcement is disputed.

Further reading

Wikipedia

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Payment methods that make cost salient reduce spending, so friction in payment is a behavioural lever.

Prelec and Loewenstein's 1998 work. Cash is felt, cards less, one-click purchase least — which is why the same person spends differently by payment method without noticing any change in preference.

In practice

• A team that switches from an invoice to a corporate card increases spend without any policy change.
• A subscription paid by direct debit is cancelled less often than an identical one requiring a monthly click.

Attributed to

Prelec & Loewenstein

Further reading

Wikipedia

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Expenditure rises to meet income.

Parkinson's second law, and the personal version of the same mechanism. It is why lifestyle inflation absorbs raises and why departmental budgets are spent down before year end.

In practice

• A department that receives a 6% budget increase finds 6% more essential expenditure by the second quarter.
• A household that gets a raise reports the same monthly pressure within a year, and could not say what changed.

Attributed to

C. Northcote Parkinson

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Unemployment and wage inflation trade off against each other in the short run.

Phillips documented a relationship between unemployment and money-wage inflation in UK data in 1958, and later work translated it into price-inflation curves. The stable relation broke down in the 1970s, when unemployment and inflation rose together; Friedman and Phelps had predicted the breakdown by adding expectations, and modern short-run versions incorporate expected inflation and other variables. There is no stable long-run trade-off to exploit.

In practice

• A chancellor running the economy hot to cut unemployment gets rising wages, then finds everyone has priced the next rise in, and ends with the inflation and not the jobs.
• A firm setting next year's pay bargains against the inflation it expects rather than the inflation just recorded, which is why the surprise matters and the level does not.

Attributed to

William Phillips

Possible explanations

The explanation is capacity: when unemployment is low, workers can bid wages up, and firms pass the cost on. Expectations then matter, since a rate of inflation that is anticipated is built into wage bargains in advance.

In its favour

The short-run relation reappears in modern expectations-augmented forms, and it remains central to how central banks describe the trade-off they face.

Against it

The stable relation broke down in the 1970s, when inflation and unemployment rose together, and the curve has looked flat for long periods since, so its slope is unstable rather than a constant.

Standing

The stable relation broke down in the 1970s; modern versions add expectations.

Further reading

Wikipedia

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Where quality cannot be assessed directly, price is read as its proxy, so cutting price can cut demand.

Consumer research. The practical consequence is that price cuts can reduce demand for goods whose quality is unverifiable — wine, consulting, medical services — which inverts the usual demand curve logic.

In practice

• A consultancy that halves its day rate loses enquiries, because the rate was the only quality signal available.
• A wine priced at £7 sells less than the identical wine at £14, and the buyer has no other way to judge.

Attributed to

Consumer research

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Meeting a target raises next period's target, so agents suppress output to avoid being ratcheted.

Berliner's finding from Soviet enterprises, and it applies wherever this year's performance sets next year's quota. The rational response is to hit the target and never exceed it visibly.

In practice

• Meeting a target raises next period's target, so agents suppress output to avoid being ratcheted.
• A team that delivers 130% of its quarterly goal is given a higher goal, and delivers exactly 100% thereafter.

Attributed to

Joseph Berliner

Further reading

Wikipedia

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A price is evaluated against a remembered or contextual reference rather than in absolute terms, so the same price reads as cheap or dear depending on what preceded it.

Reference prices form from past prices paid, prices seen nearby and advertised comparisons, and they adapt. The commercial consequence is that discounting teaches the reference: a product repeatedly promoted establishes the promoted price as the reference and the list price as an imposition, which is why habitual discounting is hard to reverse.

In practice

• A brand that ran a sale every quarter for two years cannot sell at full price to anyone who noticed.
• A service whose price rises after a long freeze is resented more than one that rose annually to the same level.

Attributed to

Consumer pricing research

Also called

Internal reference price

Standing

Related to anchoring and to transaction utility, which describe the mechanism from the judgement side.

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Retail gravitation follows an inverse square relationship with distance.

Reilly's 1931 formulation. It survives in retail siting models and is the ancestor of the gravity models used for migration and trade flows.

In practice

• A town of 60,000 draws shoppers from villages twice as far out as a town of 15,000 does, and the boundary between them sits nearer the smaller.
• A supermarket's catchment is not a circle but a shape determined by where the next supermarket is, which is what the inverse-square form captures.

Attributed to

William J. Reilly

Also called

Law of retail gravitation

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Most buyers split purchases across a small set of acceptable brands rather than being loyal to one, so brands compete for share of a repertoire.

Panel data consistently show that sole-brand buyers are rare and usually light buyers, while heavy buyers hold repertoires. Brands of similar size therefore have similar loyalty metrics, and differences in market share come mainly from differences in how many people include the brand at all, not from how devoted those people are.

In practice

• A brand chasing exclusive loyalty is pursuing a customer type that barely exists.
• A supplier with high satisfaction scores and flat share is inside the repertoire and not winning more of it.

Attributed to

Andrew Ehrenberg and colleagues

Also called

Polygamous loyalty; brand repertoires

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Resource-rich countries often have worse economic outcomes than resource-poor ones.

Sachs and Warner's 1995 finding. The mechanisms are Dutch disease, revenue volatility, and the fact that resource rents can be captured without governing well — Botswana and Norway are the counterexamples.

In practice

• A government that can fund itself from one export terminal has no reason to bargain with taxpayers, and does not.
• Botswana and Norway are the standing counterexamples, which is why the curse is about institutions rather than about geology.

Attributed to

Richard Auty

Further reading

Wikipedia

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The capital cost of a semiconductor fabrication plant roughly doubles every four years.

Arthur Rock's observation. It is why fabrication has consolidated to a handful of firms worldwide — the capital cost now exceeds what most national economies will underwrite.

In practice

• A chip designer with a better architecture and no plant licenses it to one of the three firms that can still afford to build one.
• A government offering to subsidise a domestic fabrication plant finds the figure has doubled between the feasibility study and the decision.

Attributed to

Arthur Rock

Also called

Moore's Second Law

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A hospital bed built is a bed filled, regardless of need.

Roemer's 1961 finding, and one of the foundations of health economics. It is supply-induced demand in its clearest form, and the reason bed capacity is regulated rather than left to providers.

In practice

• A region that opens 200 additional beds fills them within the year, and it is the admission threshold that moved rather than the population.
• A firm that adds a second meeting room finds both booked solid within a month, and nobody was previously unable to meet.

Attributed to

Milton Roemer

Also called

A built bed is a filled bed

Further reading

Wikipedia

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Niche products collectively can have significant market share.

Anderson's 2004 argument, and it has aged unevenly. Digital distribution did enlarge the tail, and attention concentrated further at the head than he predicted, so both halves of the market grew more extreme.

In practice

• A high street bookshop stocks three thousand titles and an online retailer lists eight million, and the bestseller list is shorter and more dominant than it was.
• A streaming catalogue of forty million tracks finds most listening on a few thousand, and also sustains artists who could not have existed at all in 1995.

Attributed to

Chris Anderson

Further reading

Wikipedia

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When one distortion cannot be removed, removing another can make things worse, so partial reform is not reliably an improvement.

Lipsey and Lancaster's 1956 result. It is why partial trade liberalisation or partial deregulation can reduce welfare, and why "at least it is a step in the right direction" is not a safe assumption.

In practice

• A country removes the tariff on components and keeps the tariff on finished goods, and its assembly industry closes.
• A hospital shortens waits in one department while the discharge lounge is untouched, and the wards block instead.

Attributed to

Lipsey & Lancaster

Further reading

Wikipedia

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Under fiat inflation good money drives out bad, reversing Gresham's law.

Thiers's observation from the assignat inflation. When the bad money is depreciating fast enough, people spend it and hoard the good, which reverses Gresham entirely.

In practice

• In a country whose currency loses a tenth of its value a month, wages are spent the day they arrive and savings are held in dollars.
• A firm paying suppliers in a rapidly devaluing currency finds suppliers demanding the stable one, and the legal tender rule is what decides which law applies.

Attributed to

Adolphe Thiers

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The policy that is optimal to announce is not optimal to carry out, so discretion without commitment produces worse outcomes than rules.

Kydland and Prescott's 1977 result, which won the 2004 Nobel. It is the formal argument behind central bank independence and behind Elster's Ulysses contracts.

In practice

• A university that says extensions will not be granted grants them in week eleven, and next year's cohort plans on that.
• A government that promises never to bail out a failing bank has an incentive to break the promise on the day it matters, which is why the promise is not believed.

Attributed to

Kydland & Prescott

Also called

Rules versus discretion

Standing

The formal result behind central bank independence and Elster's Ulysses contracts.

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For some goods demand rises with price, because the price itself is the signal being bought.

Veblen's 1899 analysis. It is distinct from the bandwagon effect, where popularity rather than price is the signal, and both were named by Leibenstein in 1950.

In practice

• A handbag whose price rise is announced sells more, and sells less again when it is discounted.
• A wine that sells poorly at £30 sells well at £70, and the buyers are not mistaken about what they are buying.

Attributed to

Thorstein Veblen

Also called

Snob effect

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Public expenditure tends to rise relative to national income as an economy develops.

Wagner proposed in 1883 that public expenditure rises relative to national income with economic development. Empirical support varies by country, period and specification, and the mechanism is disputed: whether it reflects demand for public goods or the supply-side dynamics of state growth.

In practice

• A country spending a tenth of national income through the state in 1900 is spending two-fifths a century later, having added pensions, schooling and health on the way.
• A neighbour at the same income per head sits at little more than a quarter, which is why this is a tendency rather than a rate.

Attributed to

Adolph Wagner

Also called

Law of increasing state activity

Possible explanations

Proposed explanations include rising demand for services such as health and education as incomes rise, the administrative complexity of industrial economies, and political competition for programmes once the tax base can bear them.

In its favour

The long-run rise in public spending relative to income across industrialising countries is well documented.

Against it

Support varies by country, period and specification, the direction of causation is disputed, and several countries have held or reduced the ratio for long stretches, which a law would not permit.

Standing

Empirical support varies by country, period and specification, and the mechanism is disputed.

Further reading

Wikipedia

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For every cumulative doubling of units produced, costs fall by a constant percentage.

Wright's 1936 aircraft data showed about a 20% reduction in direct labour input for each doubling of cumulative output, an 80% progress ratio. Observed progress ratios vary widely across technologies and organisations, with 80 to 85% a common range rather than a constant. Swanson's solar law is a specific case.

In practice

• A manufacturer that has built four thousand units makes the next thousand with about a fifth less labour than the first thousand took.
• Swanson's solar law is a specific case, which is why cumulative volume rather than time is the variable that predicts cost.

Attributed to

Theodore Wright

Also called

Learning curve; experience curve

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Demand jumps disproportionately at a price of zero, beyond what the small saving warrants.

Shampanier, Mazar and Ariely's 2007 chocolate study. Demand jumped disproportionately at zero, far beyond what the one-cent saving warranted, which is why free tiers behave unlike cheap ones.

In practice

• A £1 delivery charge suppresses more orders than adding £3 to the price of the item.
• A museum that drops a £2 admission charge more than doubles attendance, and £2 was never an obstacle worth that much.

Attributed to

Shampanier, Mazar & Ariely

Standing

Why free tiers behave differently from cheap ones.

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When the better-informed side self-selects, the pool worsens and prices must rise, worsening it further.

Health insurance is the textbook case: as premiums rise, the healthy drop out, the remaining pool is sicker, premiums rise again. This is why mandates and open-enrolment windows exist.

In practice

• A repair warranty priced for the average appliance attracts owners of the worst ones, so claims rise, so the price rises, so the careful owners drop out.
• An open salary band set at the market average recruits the people who cannot get more elsewhere.

Attributed to

Michael Rothschild & Joseph Stiglitz

Further reading

Wikipedia

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When sellers know more about quality than buyers, good goods are driven out and the market can unravel.

A used car worth $4,000 to its owner cannot be distinguished from one worth $2,000, so buyers offer the average, good sellers withdraw, and the average falls again. Akerlof's 1970 paper was rejected by three journals before publication.

In practice

• A freelance market fills with cheap unvetted work until buyers assume anything cheap is bad, and the competent freelancers leave for agencies.
• A neighbourhood's landlords cannot show their flats are damp-free, so tenants discount every listing and the good landlords stop advertising.

Attributed to

George Akerlof

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Markets select surviving firms as if they maximised profit whether or not managers actually optimise, so the outcome does not require the assumption.

Alchian's 1950 point was methodological: you need not assume businesses calculate optimally, only that the market kills the ones that do not. It rescues economic prediction from an implausible psychology.

In practice

• A restaurant owner who has never heard the word "margin" prices by instinct, survives ten years, and behaves indistinguishably from one who optimises.
• Two shops on the same street price identically; one ran the numbers and one copied the neighbour.

Attributed to

Armen Alchian

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Narratives and animal spirits drive economic decisions.

Keynes coined the term in 1936 for the spontaneous urge to action rather than inaction. Akerlof and Shiller revived it in 2009 to explain what standard models missed about the financial crisis.

In practice

• A property market rises because everyone expects it to rise, and the expectation is the whole of the mechanism until it reverses.
• A company's share price moves on a narrative about its founder that no line of the accounts supports.

Attributed to

Akerlof & Shiller; term from Keynes

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Only the visible gain from spending gets counted; the unseen alternative forgone is the actual cost.

Bastiat's 1850 essay: a broken window employs a glazier, but the shopkeeper's forgone shoes are invisible, and the town is a window down. It remains the standard reply to arguments that disasters stimulate economies.

In practice

• A council counts the jobs created by a stadium and never counts the businesses that did not open on the land it occupies.
• A subsidy for one industry is measured in that industry's employment, never in the workers the higher tax bill kept out of another.

Attributed to

Frédéric Bastiat

Also called

That which is seen and that which is not seen

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Extrinsic incentives can undermine civic-spirited motives in institutions.

Bénabou and Tirole formalised what field data kept showing: paying for blood donation reduces supply. The payment reframes an act of civic identity as a low-wage transaction.

In practice

• A council pays residents to report fly-tipping and finds reports rise while tipping does not fall, because the reporting was already being done for nothing.
• A school introduces a reward for reading and the children who read anyway begin asking what they get.

Attributed to

Bénabou & Tirole

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Favour exchange substituting for absent markets: access obtained through acquaintance rather than price.

Ledeneva's interviews with Soviet-era participants describe an economy in which scarce goods moved through networks of mutual obligation rather than through purchase, and in which participants did not regard it as corruption because no money changed hands. Blat was how a shortage economy actually allocated, and it was invisible in every official figure.

In practice

• A hospital that cannot buy a part obtains one from a colleague at another hospital who will need something later.
• A company with a formal procurement process runs on the buyer who knows which supplier will answer at the weekend.

Attributed to

Soviet informal practice; documented by Alena Ledeneva

Also called

The economy of favours; pull

Further reading

Wikipedia

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Population pressure induces agricultural intensification, so density can raise productivity rather than only straining it.

Boserup's 1965 argument against Malthus: farmers move to shorter fallow, then to irrigation and multi-cropping, precisely because there are more people to feed. Density supplies both the pressure and the labour.

In practice

• A village with more mouths to feed terraces the hillside it had left alone, and yields per hectare rise.
• A team given more work than the process allows invents a better process, which the previous headcount never needed.

Attributed to

Ester Boserup

Standing

The direct counterweight to the Malthusian trap.

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New money raises prices unevenly, benefiting whoever receives it first.

Cantillon wrote it around 1730. Whoever spends new money first buys at old prices; by the time it reaches wage earners, prices have already risen. It is the mechanism behind arguments about asset-price inflation.

In practice

• A construction lending programme raises prices for builders and materials suppliers first; the wage earner meets the higher house price a year later with the same salary.
• A subsidy paid to producers reaches consumers as a higher price for the thing the subsidy was meant to make affordable.

Attributed to

Richard Cantillon

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In a market economy, relations between people appear as relations between things, so a good's price seems to belong to the good rather than to the work and social arrangements behind it.

Marx set it out in the first volume of Capital in 1867: a coat's value looks like a fact about the coat, when it records the labour of the tailor and the conditions of that labour. Buyers see the product and its price, and the people who made it drop out of view.

In practice

• A shopper compares two T-shirts by price and fabric, and nothing on either label says who sewed it or what they were paid.
• A trader speaks of the coffee market's mood as though the market were a person, and the growers never enter the conversation.

Attributed to

Karl Marx

Also called

Fetishism of commodities

Possible explanations

One explanation is distance: long supply chains separate producers from consumers, so the only information that travels is the price. Another is that markets coordinate through prices precisely so that participants need not know one another, which makes the relations invisible by design.

In its favour

Describes a real feature of how goods are perceived, and underlies later movements for supply-chain transparency, fair-trade labelling and ethical sourcing.

Against it

Many economists reply that prices condense information usefully and that the invisibility is the market's strength rather than a mystification. The concept is tied to the labour theory of value, which most economists reject.

Standing

Disputed along the line between Marxian and mainstream economics. Compare Hayek's knowledge problem, which reads the same invisibility as the market's great advantage.

Further reading

Wikipedia

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The returns to an innovation often go to whoever controls the manufacturing, distribution or service assets it needs, rather than to the inventor.

Teece's 1986 paper explains why inventors so often lose. Where intellectual property is weak and the complementary assets are specialised and held by others, the innovator must either acquire them, which is slow and expensive, or contract for them, which transfers the margin. The question of who profits is settled by the asset position, not by who had the idea.

In practice

• A startup with the better technology is acquired cheaply because only three firms can manufacture it.
• An author's returns are set by who controls distribution, and the manuscript is the same either way.

Attributed to

David Teece

Also called

Who profits from innovation

Further reading

Wikipedia

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Concentrated economic power calls into being organised opposing power, and the balance rather than competition does the regulating.

Galbraith's 1952 argument that large retailers, unions and regulators arose in response to concentrated industry, and that the balance rather than atomistic competition supplies the discipline.

In practice

• A dominant retailer's terms are answered not by a competitor but by a supplier cooperative and a regulator.
• A single large employer in a town is met by a union rather than by a second employer.

Attributed to

John Kenneth Galbraith

Further reading

Wikipedia

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Growth comes from new methods destroying incumbent firms and industries, not from incremental improvement within them.

Schumpeter's 1942 phrase. His awkward corollary is that the process cannot be made painless: preserving the incumbent firms is preserving the thing growth requires destroying.

In practice

• A payments company destroys a bank's fee income and employs a tenth of the people, and the aggregate is better and the transition is not.
• A town's retail high street is hollowed out by a distribution model that produces cheaper goods and no obvious replacement for the jobs.

Attributed to

Joseph Schumpeter

Also called

Schumpeter's gale

Further reading

Wikipedia

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Public borrowing or provision can displace private investment or private charity rather than adding to it.

Crowding out is well established in some settings, and its magnitude, mechanism and even direction vary. In charitable funding, studies have found partial crowd-out, effects mediated by reduced fundraising, and in some samples crowd-in.

In practice

• A council opens a free advice service and the three charities providing it lose their donors within two years.
• A firm's new internal design team displaces the agency relationships that were producing better work.

Attributed to

Classical and Keynesian macroeconomics

Possible explanations

Explanations differ by setting: public borrowing can raise interest rates, public spending can compete for real resources when capacity is full, and public provision can reduce the felt need to give privately.

In its favour

The mechanism is well established where capacity is tight, and charitable studies do find partial crowd-out of private giving by public grants.

Against it

With slack capacity the financial effect is small or absent, and some studies find crowd-in, where public funding signals that an organisation is worth supporting. Magnitude and direction vary by setting.

Standing

Magnitude, mechanism and even direction vary by setting; charitable studies find partial crowd-out, and in some samples crowd-in.

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Advantage and disadvantage reinforce themselves: a group or region that falls behind tends to fall further behind, unless something breaks the circle.

Myrdal set out the principle of cumulation in An American Dilemma (1944), his study of race in the United States: discrimination depressed Black living standards, and the lower living standards were then cited to justify discrimination. In 1957 he extended it to regions and nations, arguing that markets tend to concentrate growth where it has already begun.

In practice

• A town that loses its main employer loses tax revenue, then services, then the residents who can leave, and the decline accelerates.
• A pupil who falls behind in reading avoids reading, and falls further behind.

Attributed to

Gunnar Myrdal

Also called

Principle of cumulation; vicious circle

Possible explanations

One explanation is feedback: outcomes become inputs, so an initial gap alters the conditions that produce the next round. Another is migration, since the most mobile leave declining places and take skills and spending with them.

In its favour

Consistent with evidence of persistent regional divergence and with Merton's Matthew effect; it shaped development economics and anti-discrimination policy.

Against it

Convergence also happens: poorer regions and countries have caught up in many periods, as neoclassical growth theory predicts. The principle says that circles exist without saying when they reverse.

Standing

Compare Merton's Matthew effect and the Matthew effect in reading.

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In an affluent economy the process of producing goods also produces the wants they satisfy, so meeting those wants adds less to welfare than it appears to.

Galbraith named it in The Affluent Society (1958): if advertising and emulation create the desires that production then satisfies, rising output cannot be read as rising wellbeing. Hayek replied in 1961 in 'The Non Sequitur of the Dependence Effect', arguing that nearly all wants beyond the most basic are culturally acquired, and none the less real for it.

In practice

• A new category of gadget arrives with a campaign explaining why life without it is incomplete.
• A family's idea of a normal kitchen rises each time a neighbour renovates.

Attributed to

J. K. Galbraith

Possible explanations

One explanation is advertising, which shapes preferences. Another is social comparison, in which wants rise with what others have. A third is habituation, which resets satisfaction to each new level of consumption.

In its favour

Consistent with evidence that advertising shifts demand and that satisfaction adapts to consumption, and a forerunner of work on the hedonic treadmill.

Against it

Hayek's objection persuades many economists: where a want came from does not make it less valuable, and art, literature and education also create the wants they satisfy. Some empirical work finds advertising mostly moves demand between brands rather than creating it.

Standing

Contested between Galbraith's followers and Hayek's. Compare conspicuous consumption and the Easterlin paradox.

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Splitting production into specialised tasks raises output far beyond the sum of individual efforts, but narrows the worker.

Smith's 1776 pin factory: ten workers dividing eighteen operations produced 48,000 pins a day, against perhaps twenty each working alone. Smith also warned in Book V that the divided worker becomes as stupid as it is possible for a human to become.

In practice

• A software team where one person writes the schema, one the API and one the tests ships more than three generalists, and none of them can now do the others' work.
• A restaurant with a dedicated prep cook, line cook and plater serves four times the covers, and the prep cook has stopped learning to cook.

Attributed to

Adam Smith

Also called

The pin factory

Further reading

Wikipedia

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Producing several products together can cost less than producing each separately, because some inputs serve more than one output.

Panzar and Willig formalised the condition in 1982. The savings come from shared inputs that are not exhausted by one use: a distribution network, a brand, a customer relationship, a body of knowledge. It is the analytical basis for most diversification arguments, and the test is whether the shared input is genuinely shareable or merely adjacent.

In practice

• A firm that adds a second product using the same sales force has scope economies; one that adds a second sales force has a second business.
• A university that teaches and researches with the same staff is cheaper than two institutions doing one each.

Attributed to

John Panzar & Robert Willig

Also called

Joint production savings

Standing

Distinct from economies of scale, which concern volume of one output rather than breadth across several.

Further reading

Wikipedia

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Prices incorporate the information in a specified information set, so persistent abnormal risk-adjusted returns from that information are hard to earn.

Fama's 1970 framing distinguishes weak, semi-strong and strong forms by the information set they assume. The strong form concerns private information and has been tested; strict strong-form efficiency is not generally supported. The practically useful finding is that most active managers underperform index funds after fees.

In practice

• A fund manager who beats the index for three years attracts inflows and reverts, and the fees are the only reliable part.
• A commentator who correctly called one crash is invited back for the next decade, having called nine others that did not happen.

Attributed to

Eugene Fama

Also called

EMH

Possible explanations

The explanation is competition: if information implies a profit, traders act on it until the price moves, so the information stops being profitable.

In its favour

Prices do respond to news within minutes, and the long record of active managers underperforming index funds after costs is what the hypothesis predicts.

Against it

Documented anomalies such as momentum and value persist, bubbles and crashes are hard to reconcile with it, and the joint hypothesis problem means any test is a test of the hypothesis and a pricing model together.

Standing

Weak, semi-strong and strong forms differ by information set; strict strong-form efficiency is not generally supported.

Further reading

Wikipedia

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Growth comes from deliberate investment in ideas, and because ideas are non-rival the returns to them need not diminish.

Romer's 1990 model. The key property is non-rivalry: a formula can be used by everyone at once, so investment in ideas escapes the diminishing returns that bound capital accumulation.

In practice

• A firm that licences its process to two hundred others loses nothing by the licensing, which is what makes ideas different from machinery.
• A country that educates researchers finds the returns compound rather than diminish, because each result is usable by everyone at once.

Attributed to

Paul Romer

Also called

New growth theory

Standing

The successor to Solow–Swan, which left technological progress unexplained.

Further reading

Wikipedia

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Early entrants can secure durable advantages through pre-emption, switching costs and learning, though the advantage is conditional and frequently absent.

Lieberman and Montgomery set out the mechanisms in 1988 and the conditions under which each holds. The popular version dropped the conditions. Where imitation is cheap, where the technology is unsettled, or where the pioneer must educate a market that a follower then serves, moving first is a cost rather than an advantage.

In practice

• A firm that opened the category and exited it is absent from every study of who wins categories.
• A second entrant learns from the first's mistakes at none of the first's expense.

Attributed to

Marvin Lieberman & David Montgomery

Also called

Order-of-entry advantage

Possible explanations

The proposed mechanisms are pre-emption of scarce assets, buyer switching costs, and learning that lowers cost faster than a follower can match.

In its favour

Each mechanism is real where its conditions hold, notably where switching costs are high or a resource can be locked up early.

Against it

Survivorship inflates the apparent advantage, since failed pioneers are missing from the samples, and where imitation is cheap and the technology unsettled, fast followers frequently win. The authors themselves cautioned against the popular reading.

Standing

The authors themselves later cautioned against the popular reading. Survivorship inflates the apparent advantage, since failed pioneers are absent from the samples, and fast followers often do better.

Further reading

Wikipedia

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Taxpayers underperceive burdens that are indirect, withheld, or fragmented, so revenue systems drift towards opacity.

Puviani's 1903 analysis. Withholding, indirect taxation and inflation all reduce perceived burden without reducing actual burden, and revenue systems drift toward whichever forms are least visible.

In practice

• A tax collected at source is resented far less than the identical amount billed annually.
• A subscription that takes £14 monthly is cancelled less often than one billing £168 once a year.

Attributed to

Amilcare Puviani

Further reading

Wikipedia

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Where benefits cannot be withheld, individuals let others bear the cost and the good is underprovided.

The lighthouse is the textbook case, and a poor one — Coase showed British lighthouses were privately funded for centuries. The reliable examples are clean air and herd immunity.

In practice

• A shared kitchen where nobody buys the washing-up liquid runs out of washing-up liquid.
• An open-source library depended on by four thousand companies is maintained by two unpaid people.

Attributed to

Public goods economics

Further reading

Wikipedia

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People spend their own money on themselves carefully, their own money on others economically, other people's money on themselves lavishly, and other people's money on others carelessly.

Milton Friedman set it out in Free to Choose (1980): spending your own money on yourself, you watch both cost and value; your own on someone else, you watch the cost; someone else's on yourself, you watch the value; someone else's on someone else, you watch neither. He used the fourth case to explain why government spending tends to be inefficient.

In practice

• A department's year-end surplus is spent in the final week on equipment nobody asked for, because an unspent budget shrinks next year.
• A traveller on expenses books a hotel she would never choose with her own money.

Attributed to

Milton Friedman

Also called

Other people's money on other people

Possible explanations

One explanation is the principal-agent problem: people spending on others' behalf bear neither the full cost nor the full benefit. Another is information, since those who spend other people's money on others know less about what the recipients want.

In its favour

Consistent with principal-agent theory and with Liebman and Mahoney's 2017 finding that American federal agencies spend heavily in the last week of the fiscal year, on projects rated lower in quality.

Against it

Professional procurement, audit and competition can make spending other people's money careful, and people spending their own money on themselves also waste it. The categories describe incentives rather than outcomes.

Standing

Compare the principal-agent problem and Bowen's revenue theory of cost.

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Marginal enjoyment of a good declines with consumption, and a person allocates spending so that the last unit of each purchase yields equal satisfaction.

Gossen published in 1854, was ignored, and destroyed most copies. Jevons and Menger rediscovered both laws independently twenty years later, which makes it a clean case of multiple discovery.

In practice

• A subscriber pays for a service they use twice a month and would not pay again at the margin, though the first month was worth it.
• A department allocating its remaining budget across four needs stops when the last pound of each buys the same amount of relief.

Attributed to

Hermann Heinrich Gossen

Further reading

Wikipedia

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If a rational counterparty is willing to trade with you, their willingness is itself information that should make you unwilling.

Groucho resigned from a Hollywood club by telegram, declining to belong to "any club that will accept me as a member". Milgrom and Stokey proved the formal version in 1982: with common knowledge and no noise traders, an offer reveals the offerer's private information before anyone accepts, so no profitable trade occurs. Thaler uses the joke as the name for it, noting the economist's version is less funny.

In practice

• A seller unusually eager to close before a survey has told the buyer something the survey would have.
• A candidate available at short notice and below market rate is a fact about the market, not only about the candidate.

Attributed to

Groucho Marx; formalised by Paul Milgrom & Nancy Stokey

Also called

The no-trade theorem; the club paradox

Standing

The joke is the name economists use for the no-trade theorem. Real trading volumes are enormous, so the theorem's assumptions do not hold in practice; what survives is the habit of asking why the other side is selling.

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Because contracts can't specify everything, governance matters.

Hart and Holmström's Nobel work. Since no contract can specify every contingency, what matters is who holds the residual right to decide — which is why ownership matters at all.

In practice

• A software contract cannot enumerate every defect, so what matters is who decides when something counts as a defect.
• A joint venture's value turns on which partner controls the decisions the agreement did not anticipate.

Attributed to

Hart & Holmström

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The information needed for coordination is dispersed, tacit, and local, so no central body can assemble it however capable or well-intentioned.

Hayek's 1945 essay used the tin market: a shortage anywhere raises the price, and every user economises without knowing why. No planner could gather what the price conveys.

In practice

• A central purchasing team cannot know that one depot's loading bay floods in October, and the depot manager cannot explain why it matters until it does.
• A national curriculum cannot encode which explanation works for the four pupils in one classroom who are stuck.

Attributed to

Friedrich Hayek

Also called

Local knowledge problem; the use of knowledge in society

Standing

The core epistemic argument against central planning, and the counterweight to Munger's unicorn fallacy.

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Low assessments early in a dynasty yield more revenue than high assessments late, because high rates destroy the activity being taxed.

The Muqaddimah states it plainly: at the beginning of the dynasty, taxation yields a large revenue from small assessments; at the end, a small revenue from large assessments. The mechanism Ibn Khaldun gives is behavioural rather than arithmetic — when the hope of profit is destroyed, business withdraws — and he ties the cycle to the dynasty's growing costs.

In practice

• A city that doubles its trading levy finds the merchants have moved to the next city and the receipts have fallen.
• A treasury projecting revenue from a rate rise without estimating the withdrawal it causes will overstate the take.

Attributed to

Ibn Khaldun

Also called

The Khaldun curve; Ibn Khaldun's tax theory

Standing

Laffer credited Ibn Khaldun rather than claiming originality; the ledger's Laffer Curve entry is the later restatement.

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One party in a transaction has more or better information than the other.

Akerlof, Spence and Stiglitz shared the 2001 Nobel for the three mechanisms it produces: adverse selection, signalling and screening. Nearly every institution in insurance, credentialing and warranty exists because of it.

In practice

• A buyer knows the delivery date is firm and the seller knows it is not, and the whole negotiation is about that gap.
• A landlord knows the boiler's history and the tenant does not, which is what the deposit and the survey exist to price.

Attributed to

Akerlof, Spence & Stiglitz

Further reading

Wikipedia

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Those already employed have bargaining power that those seeking work do not, so labour institutions can protect one group at the other's expense.

Lindbeck and Snower's 1986 model. It explains why unemployment persists after a recession ends: those in work bargain over their own terms, and the unemployed are not at the table.

In practice

• A firm's permanent staff negotiate a pay settlement and a recruitment freeze in the same agreement, and neither side represents the people not hired.
• A profession that raises its licensing requirements protects its current members and prices out the next cohort, and both effects are in the same rule.

Attributed to

Lindbeck & Snower

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Smith used the metaphor for the unintended social effects of individual action; the modern market-efficiency reading is a later interpretation.

Smith used the phrase only three times across his whole work, and never as the slogan it became. The modern claim that competitive markets generally turn self-interest into efficient social outcomes is a later interpretation rather than Smith's 1776 doctrine, and his own conditions matter: he devoted much of the book to cases where competition fails.

In practice

• A bakery opens at five because that is when it can sell bread, and the street has fresh bread at six without anyone having planned for the street.
• A commodity market clears efficiently with no coordinator; a market for medical care with one informed side and one desperate one does not, and Smith would have said so.

Attributed to

Adam Smith

Possible explanations

One explanation for the modern reading is that the welfare theorems gave it a formal version, under conditions of competition, complete markets and no external effects. Another is rhetorical: a short image travels further than Smith's qualified argument.

In its favour

Where its conditions roughly hold, decentralised prices do coordinate production without anyone planning it, which is among the best-established results in economics.

Against it

Smith used the phrase three times and never as a general doctrine, and the conditions the formal version needs fail wherever there are external effects, market power or missing information, which is much of any economy.

Standing

Chandler's Visible Hand was written as the deliberate counterpart to this.

Further reading

Wikipedia

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Wages are claimed to gravitate towards subsistence, since any surplus induces population growth that competes it away.

Two centuries of rising real wages ran against it, and it is retained for its place in the history of economic thought. Ricardo and Malthus supplied the classical precursors; Lassalle named and formulated the iron law around 1863. Marx explicitly rejected Lassalle's formulation as false and obsolete, though his own wage theory engaged the same classical debates.

In practice

• Note this was falsified: real wages rose more than tenfold in the two centuries after it was stated.
• It is retained for its historical role — both Ricardo's followers and Marx built on it, and the failure of the premise matters for what they concluded.

Attributed to

Classical wage theory; named by Ferdinand Lassalle

Possible explanations

The classical explanation combined Malthus on population with Ricardo on rent: any wage above subsistence was expected to raise the number of workers until competition drove it back down.

In its favour

It described the world its authors saw, where wages had been near subsistence for centuries, and the mechanism it names still operates where labour is abundant and unorganised.

Against it

Two centuries of rising real wages run against it. Productivity growth and falling birth rates at higher incomes both break the loop it assumed, which is why it survives as history rather than as economics.

Standing

Two centuries of rising real wages ran against it; retained for its role in the history of economic thought.

Further reading

Wikipedia

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Managers' interests can diverge from owners', requiring monitoring and incentives.

Jensen and Meckling's 1976 paper, one of the most cited in economics. Its practical legacy is stock-based compensation, which solved the alignment problem and created new ones in earnings management.

In practice

• A chief executive paid in shares vesting in three years makes different decisions from one paid a salary, and neither set matches the owners' interests exactly.
• A letting agent paid on transactions recommends more transactions than a landlord would choose.

Attributed to

Jensen & Meckling

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Business leaders tend to oppose sustained full employment even when it raises profits, because it weakens the threat of dismissal and shifts power towards workers.

Kalecki argued in 'Political Aspects of Full Employment' (1943) that the obstacles to keeping full employment were political rather than economic. He listed three sources of business opposition: dislike of government intervention in employment as such, dislike of the direction of public spending, and dislike of the social changes full employment brings, above all that the sack stops working as a discipline. He predicted a cycle of expansion before elections and retrenchment after.

In practice

• A tight labour market raises quit rates and pay demands, and employers' groups warn of overheating before inflation has moved.
• A manager who once ended arguments with a remark about the queue of applicants finds that the remark no longer works.

Attributed to

Michał Kalecki

Also called

Political aspects of full employment; the discipline of the sack

Possible explanations

One explanation is bargaining power: when jobs are plentiful, workers can leave, so employers lose leverage over pay and conditions. Another is political: an economy that depends on business confidence gives business a veto that publicly guaranteed full employment would remove.

In its favour

Anticipated the political business cycle literature, and is consistent with evidence that quit rates and worker bargaining power rise in tight labour markets. It accounts for opposition to full-employment policy that purely economic arguments do not.

Against it

Businesses have often supported expansion, and several post-war economies sustained low unemployment for decades. Mainstream economists attribute retrenchment to inflation risk rather than to class interest, and claims about motive are hard to test.

Standing

Accepted in post-Keynesian and Marxian economics and disputed in the mainstream. Compare the reserve army of labour and the political business cycle, Nordhaus's electoral version.

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Demand creates its own supply in the short run (counterpoint to Say's Law).

Formulated against Say's law rather than by Keynes as a law. The dispute is about the short run: whether demand shortfalls persist long enough to warrant intervention.

In practice

• A council that cuts spending in a downturn finds local businesses fail and its tax base falls further.
• A factory idles machines and lays off staff with its warehouse full, because nobody is buying, and capacity was never the constraint.

Attributed to

After John Maynard Keynes

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Economy-wide efficiency gains raise total energy use, the macroeconomic form of Jevons's paradox.

Khazzoom and Brookes's macroeconomic version of Jevons. The policy consequence is uncomfortable: efficiency standards alone do not reduce total consumption, which is the case for pricing carbon rather than mandating efficiency.

In practice

• A country that doubles its vehicle fleet efficiency finds total fuel use higher a decade later, because driving became cheaper.
• An efficiency standard for appliances lowers running costs and raises ownership, and the aggregate demand rises.

Attributed to

Khazzoom & Brookes

Also called

Rebound effect; backfire effect

Further reading

Wikipedia

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Policy-created scarcity invites unproductive competition for favors (rents).

Krueger's 1974 paper coined rent-seeking. The waste is not the transfer itself but the resources spent competing for it: lobbying, queuing and licensing effort that produces nothing.

In practice

• A licensing regime worth £50m a year to holders attracts £45m of lobbying, consultancy and legal effort that produces nothing.
• A queue for a rationed permit consumes weeks of applicants' time, and the time is a pure loss to everyone including the issuer.

Attributed to

Anne Krueger

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Inequality is claimed to rise then fall as an economy industrialises.

Not borne out in late-twentieth-century data, where inequality rose again in developed economies. Kuznets himself hedged it heavily, calling the paper five per cent empirical information and ninety-five per cent speculation.

In practice

• A country industrialising fast sees inequality widen as farm labour moves to the cities, and an adviser forecasts the fall the curve promises.
• Thirty years on the fall has not arrived, and the same adviser is explaining why this economy is the exception.

Attributed to

Simon Kuznets

Possible explanations

The proposed mechanism is migration: industrialisation first moves a few workers into higher-paid sectors, which widens the gap, and later moves most of them, which narrows it again.

In its favour

The pattern fits several countries' industrialising decades, and the underlying migration mechanism is real and documented.

Against it

Inequality rose again across developed economies after the 1970s, which the curve does not predict, and Kuznets himself described the paper as mostly speculation.

Standing

Not borne out in late-twentieth-century data; Kuznets himself hedged it.

Further reading

Wikipedia

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Tax revenue falls to zero at both a zero rate and a confiscatory rate, so a revenue-maximising rate exists between them.

The shape is uncontroversial and the location is not. Where any real economy sits on the curve is an empirical question, and most estimates put revenue-maximising top rates well above current US levels. The curve is a restatement: Ibn Khaldun set out the same relationship in 1377, and Laffer credited him for it.

In practice

• A finance minister told that a rate cut will pay for itself asks at what rate revenue peaks, and finds nobody in the room has an estimate.
• A 98% top rate and a 0% top rate both raise nothing, which settles the shape and says nothing about whether 45% sits above or below the peak.

Attributed to

Arthur Laffer

Possible explanations

The mechanism is behavioural: higher rates reduce the taxed activity through less work, more avoidance and relocation, so revenue rises and then falls rather than climbing without limit.

In its favour

The shape follows from its endpoints and is not disputed, and estimates of a revenue-maximising top rate do exist, which is what the curve asserts.

Against it

Most estimates put that rate far above the top rates in current American and European law, and budget offices have repeatedly found large rate cuts losing revenue, so the claim that cuts pay for themselves has little support.

Standing

The shape is uncontroversial; where real economies sit on it is heavily disputed. Ibn Khaldun stated the relationship in the Muqaddimah in 1377, and Laffer credited him rather than claiming originality.

Further reading

Wikipedia

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Demand responsiveness varies with price changes.

Marshall's formalisation. Its practical use is diagnostic: whether a tax falls on the seller or the buyer depends entirely on the relative elasticity of each side, not on who legally pays it.

In practice

• A tax on cigarettes falls mainly on smokers, whose demand barely moves; a tax on a substitutable snack falls mainly on the manufacturer.
• A rent rise in a town with no alternative housing is paid; the same rise where a new development opened is not.

Attributed to

Alfred Marshall

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Satisfaction gained from additional units decreases with consumption.

Gossen, Jevons and Menger's independent discovery. It resolved the diamond-water paradox that had defeated classical economics: value tracks the last unit, not the total.

In practice

• The first glass of water on a hot day is worth a great deal; the fourth is not, which is why water is cheap and diamonds are not.
• A department's first analyst transforms its capability; its sixth is useful, and its eleventh needs managing.

Attributed to

Gossen, Jevons & Menger

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Prices adjust to balance supply and demand.

The core model of price economics, and the standing caveat is that it describes competitive markets with many buyers and sellers. Most interesting cases — labour, healthcare, housing — violate at least one condition.

In practice

• A glut of a crop drops the farm-gate price within a season and the supermarket price barely moves, because the two markets have different numbers of buyers.
• The standing caveat matters: housing, healthcare and labour each violate a condition of the model, which is why the simple version misleads about all three.

Attributed to

Classical economics

Further reading

Wikipedia

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An early lead becomes a later handicap, because the leader has committed to an arrangement that latecomers can skip.

Romein, a Dutch historian, published the principle in 1937 from the observation that societies and firms that led in one period were frequently overtaken by those that arrived later with newer infrastructure and no sunk commitments. The leader's disadvantage is not complacency but investment: the earlier system works, is paid for, and must be written off before the better one can be adopted.

In practice

• A country with comprehensive copper telephone lines is slower to fibre than one with almost no lines at all.
• A firm with a functioning system from 2005 is competing with a firm that started last year on current tools.

Attributed to

Jan Romein

Also called

Wet van de remmende voorsprong; the penalty of taking the lead

Standing

Compare path dependence, lock-in and core rigidities, which describe the same mechanism from different disciplines.

Further reading

Wikipedia

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Rank-based pay induces effort and risk-taking, but also sabotage.

Lazear and Rosen's 1981 model explains why chief executives earn multiples of their deputies: the pay gap motivates everyone below, so it is priced as an incentive rather than as a wage.

In practice

• A firm with a large gap between director and manager pay gets effort from every manager and a director who is briefed against by four of them.
• A sales team on a winner-takes-all quarterly bonus hits its number and stops sharing leads.

Attributed to

Lazear & Rosen

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Sell one item below cost to acquire traffic whose other purchases carry the margin.

The grocery model: milk and eggs at the back, discounted staples at the front. It works only where the loss-leader buyer cannot cherry-pick, which is why online retail changed the calculation.

In practice

• A supermarket prices milk below cost and recovers it on everything in the basket.
• A software vendor gives the editor away and charges for the collaboration server, and the editor is the reason anyone is in the building.

Attributed to

Retail practice

Further reading

Wikipedia

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Policy evaluations fail if they ignore expectation changes.

Lucas's 1976 critique: any relationship estimated under one policy regime may break when the regime changes, because people were optimising against the old rule. The breakdown of simple Phillips-curve relationships in the 1970s helped motivate the shift towards models in which expectations and policy rules affect behaviour.

In practice

• A model of consumer behaviour estimated before a tax change predicts badly after it, because consumers optimised against the old rule.
• A credit-scoring model that works well becomes public knowledge, applicants optimise against it, and it stops discriminating.

Attributed to

Robert Lucas Jr.

Further reading

Wikipedia

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Where output gains raise population rather than living standards, per-capita income returns to subsistence.

Malthus's 1798 argument. Malthusian models capture important features of many pre-industrial economies, especially the long-run interaction between wages, population and fixed resources, though economic historians disagree about how strong and universal the feedback was and when it broke down. Boserup's counter-argument is the standing objection.

In practice

• Note it described most of human history accurately and stopped applying within decades of publication.
• Boserup's counter-argument is why: population pressure induced intensification, so the density Malthus feared supplied both the problem and the labour to solve it.

Attributed to

Thomas Malthus

Also called

Malthusian catastrophe

Possible explanations

The explanation is a feedback loop: higher output raises the number surviving to reproduce, which spreads the same output over more people until income returns to subsistence.

In its favour

Malthusian models fit long stretches of pre-industrial data, where wages and population move in the predicted opposition, and the mechanism is not in doubt for populations without contraception or productivity growth.

Against it

Historians disagree about how strong and universal the feedback was and when it ceased to bind, and the trap failed to close after industrialisation, when income and population rose together for two centuries.

Standing

Historians disagree about how strong and universal the feedback was, and about when it ceased to bind.

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People sort money into notional accounts and treat fungible funds as non-fungible, which drives otherwise irrational choices.

Thaler's 1985 work. A household will carry credit card debt at 20% while holding savings at 2%, because the money sits in different notional accounts. Tax refunds get spent differently from identical salary increases.

In practice

• A household will not touch the holiday fund to clear a credit card at 22%, because the two are different pots.
• A team ringfences an underspent training budget it cannot use while cutting a role it needs, because the money lives in different lines.

Attributed to

Richard Thaler

Further reading

Wikipedia

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Stability breeds leverage, and leverage eventually forces a sudden collapse in asset prices.

Minsky's financial-instability hypothesis went largely unread until 2007, when the phrase entered common use; McCulley coined the term in 1998. Minsky's sequence, from hedge finance to speculative to Ponzi, describes the run-up to 2008 closely.

In practice

• A firm that has not had a bad year in a decade borrows against the record, and the borrowing is what makes the next bad year fatal.
• A team with a long green dashboard reduces its testing, and the reduction is invisible until the outage.

Attributed to

Hyman Minsky; term coined by Paul McCulley

Further reading

Wikipedia

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Without market prices there is no way to compare the value of alternative uses of resources, so rational allocation becomes impossible in principle.

Mises's 1920 argument, distinct from Hayek's: this concerns valuation rather than information. Without prices for capital goods, there is no common unit in which to compare a steel mill against a railway.

In practice

• A planner allocating steel between a railway and a hospital has no common unit in which to compare them, however good the data.
• An internal transfer-pricing system that sets prices administratively finds no division can say whether a project is worth doing.

Attributed to

Ludwig von Mises

Also called

Economic calculation problem

Standing

Distinct from Hayek's knowledge problem: this concerns valuation, Hayek's concerns information.

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Insulation from the consequences of a risk increases the taking of it.

Deposit insurance and bailouts are the standing cases. The dilemma is that the insulation is usually there for good reason, so the hazard cannot be removed without giving up the protection.

In practice

• A comprehensive warranty produces customers who stop reading the maintenance schedule.
• A team indemnified against every deployment failure by an automatic rollback stops testing before deploying.

Attributed to

Insurance economics

Further reading

Wikipedia

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Any objective rule that decides who qualifies for a social programme will exclude some people who deserve help and include some who do not.

Charles Murray stated it as the first of three laws of social programmes in Losing Ground (1984), his study of American welfare policy from 1950 to 1980. Eligibility has to be defined by rules that can be checked, such as income thresholds, and any line drawn through a continuous population leaves people just above it who resemble those just below.

In practice

• A housing grant capped at a fixed income excludes a family earning a few pounds more than one that qualifies.
• A scholarship awarded on a test score passes over a candidate one mark short who was stronger in every other respect.

Attributed to

Charles Murray, Losing Ground

Possible explanations

One explanation is that need is continuous while rules are discrete, so any threshold creates arbitrary cases at its edge. Another is that the information needed to judge each case individually is expensive or unavailable.

In its favour

Close to a logical consequence of rule-based eligibility, and accepted by designers of benefit systems across the political spectrum, who respond with tapered withdrawal and appeals.

Against it

Critics accept the point but dispute the conclusion Murray drew from it, arguing that imperfect targeting calls for better design rather than fewer programmes. Discretionary systems avoid rigid thresholds but introduce bias of their own.

Standing

Compare Murray's law of unintended rewards and Goodhart's law.

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The less likely an unwanted behaviour is to change voluntarily, the more likely a programme designed to change it is to cause net harm.

The third law in Losing Ground (1984). Murray reasoned that behaviour which people will not change on their own needs strong incentives to change, and strong incentives also reach, and reward, people who would have behaved well anyway.

In practice

• A programme paying bonuses to former offenders who stay out of trouble makes its largest payments to those who would have gone straight without it.
• A school rewards previously disruptive pupils for good behaviour, and the pupils who were always well behaved notice.

Attributed to

Charles Murray, Losing Ground

Possible explanations

One explanation is that inducements large enough to move resistant behaviour distort the choices of everyone else who can qualify. Another is selection: programmes attract those who gain most from them, not those who most need to change.

In its favour

Consistent with principal-agent reasoning and with evaluations in which generous inducements produced perverse responses.

Against it

Many programmes aimed at hard-to-change behaviour, such as intensive early-childhood or addiction treatment, show net benefits in controlled evaluations. The law names a risk without showing how often it is realised.

Standing

Stated as a law but not tested as one; the evaluations cut both ways. Compare Murray's law of unintended rewards and the cobra effect.

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Any social transfer increases the net value of being in the condition that prompted the transfer.

The second law in Losing Ground (1984). Murray argued that American welfare rules of the 1960s and 1970s made unemployment and single parenthood less costly relative to work and marriage, and that both rose as a result. The claim became central to the debates that led to the American welfare reform of 1996.

In practice

• A disability benefit that stops entirely on a return to work makes trying a job a financial gamble.
• A child who gets extra attention whenever he is ill learns, without anyone intending it, that illness pays.

Attributed to

Charles Murray, Losing Ground

Possible explanations

One explanation is incentive: anything that lowers the cost of a condition makes it slightly more attractive at the margin. Another is that transfers are conditioned on the very state the programme hopes to reduce.

In its favour

Consistent with basic price theory and with the income-maintenance experiments of the 1970s, in which a guaranteed income reduced hours worked. Programme designers widely accept the need to limit such effects with tapers and work requirements.

Against it

Ellwood and Summers showed in 1986 that real welfare benefits fell during the 1970s while single-parent families kept increasing, which cuts against the causal story Murray told. Measured behavioural responses are often small, and some transfers improve long-run outcomes.

Standing

The mechanism is widely accepted; its size and Murray's account of American welfare history are disputed. Compare the cobra effect.

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Effort intensifies inside a system that cannot expand, so inputs rise and returns per unit do not.

Geertz used involution in 1963 for Javanese agriculture absorbing ever more labour without raising output per head. The Chinese usage from about 2020 applies it to education and office work: everyone studies or works longer, relative position is unchanged, and the additional effort buys nothing but the right to keep pace.

In practice

• A cohort of applicants all acquire the same additional qualification, and the threshold moves to include it.
• A team where nobody may leave before the manager works twelve-hour days and ships what it shipped at eight.

Attributed to

Term from Goldenweiser and Geertz; applied to Chinese society from c. 2020

Also called

Involution; the treadmill

Possible explanations

One explanation is a fixed prize: where the number of places is capped, extra effort by everyone raises the cost of competing without raising anyone's chance. Another is signalling, since effort is visible and ability is not.

In its favour

The underlying structure is a well-understood competition, in which effort dissipates the prize, and the anthropological original documents the same pattern in agriculture.

Against it

The popular application to Chinese schooling and office work is recent and largely undocumented, resting on commentary rather than measurement, so the scale of the phenomenon is unknown.

Standing

The anthropological term is far older than the Chinese usage, and the popular application to schooling and white-collar work is recent and largely undocumented empirically.

Further reading

Wikipedia

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If everyone saves more at once in a depressed economy, spending falls, incomes fall, and total saving may end no higher.

Keynes made it central to the General Theory in 1936, with Mandeville and others anticipating it. One household's saving is prudent; every household saving at the same moment removes the demand that paid their wages. The claim is conditional on an economy running below capacity and on the absence of an offsetting fall in interest rates or rise in investment, which is exactly where the argument between schools of economics lives.

In practice

• A recession begins, every firm cuts its budget at once, and the cuts remove the customers those budgets were meant to protect.
• A family stops spending to rebuild its savings and finds its income falls when its employer's customers do the same.

Attributed to

J. M. Keynes; anticipated by Mandeville

Also called

Paradox of saving

Possible explanations

The explanation is circular flow: one household's spending is another's income, so simultaneous saving removes the demand that paid the wages the saving came from.

In its favour

It holds where output is demand-constrained, and the pattern was visible in the recessions of the 1930s and after 2008, when private saving rose as incomes fell.

Against it

Economists who hold that saving is channelled into investment through interest rates reject it, and where an economy is at capacity the mechanism does not apply, so the claim is conditional rather than general.

Standing

Contested across schools: accepted in demand-side macroeconomics for an economy below capacity, rejected by economists who hold that saving is automatically channelled into investment. Compare the tragedy of the commons for the general shape.

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Consumption responds more to perceived permanent income than to purely transitory income.

Friedman's 1957 hypothesis, and the standard reason for doubting one-off stimulus payments. In practice many households spend substantial fractions of temporary rebates, and the marginal propensity to consume is highest among liquidity-constrained households.

In practice

• A one-off £400 rebate is largely saved; a £30 monthly increase that is expected to persist is spent.
• A contractor with lumpy income spends against the annual average, and a salaried colleague with the same average spends against the month.

Attributed to

Milton Friedman

Possible explanations

The explanation is smoothing: a household that expects a temporary change in income borrows or saves to keep consumption steady, so only lasting changes should move spending much.

In its favour

It explains why consumption is far smoother than income, which simple models could not, and it remains the baseline in macroeconomics.

Against it

Many households spend substantial fractions of one-off rebates, especially those with little liquid wealth, so the strict version fails where borrowing is constrained.

Standing

Many households spend substantial fractions of temporary rebates, especially those holding little liquid wealth.

Further reading

Wikipedia

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When the return on capital exceeds the growth rate, inherited wealth compounds faster than earned income and inequality widens.

Piketty's 2013 central inequality. The historical claim is that r has usually exceeded g and the twentieth century was an exception produced by war and taxation, not by any equilibrating mechanism.

In practice

• Two wars, a depression and confiscatory top rates compressed wealth for fifty years, and the compression ended when they did.
• A family holding property through three generations of 4% returns and 1.5% growth ends with a larger share of national wealth without anyone working harder.

Attributed to

Thomas Piketty

Standing

Piketty's central inequality; his second fundamental law is the separate beta = s/g relation.

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In the long run the capital-to-income ratio converges on the savings rate divided by the growth rate.

Distinct from the r > g inequality: this is the accounting relationship beta = s/g. A country saving 10% and growing 2% converges on a capital stock five times national income.

In practice

• A household putting aside the same share of a shrinking income accumulates more relative to what it earns each year, and feels no richer.
• A slowing economy with unchanged saving accumulates a larger stock of wealth relative to income, which is arithmetic rather than policy.

Attributed to

Thomas Piketty

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Where benefits withdraw as earnings rise, the effective marginal tax on additional work can approach or exceed 100%.

Effective marginal rates above 80% are documented in several benefit systems, and above 100% in some combinations. The trap is arithmetic rather than motivational.

In practice

• A claimant who takes ten extra hours' work loses housing benefit, tax credits and free school meals, and is worse off.
• A household earning £1 above a threshold loses a benefit worth £900, which is a marginal rate no tax system would defend if stated openly.

Attributed to

Welfare economics

Also called

Welfare cliff; benefits cliff

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Market relations were established not by voluntary exchange but by enclosure, dispossession, and force, and the origin shapes what follows.

Marx's 1867 account of the English enclosures, which he offered against the idyllic story of accumulation through thrift. The historical record on enclosure largely supports the coercion he described.

In practice

• A common where villagers grazed animals for four centuries becomes one man's field by Act of Parliament, and the villagers become his labourers.
• A market that emerged from a privatisation nobody could contest carries that origin in who owns what, whatever the subsequent trading.

Attributed to

Karl Marx

Also called

Original accumulation

Further reading

Wikipedia

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Agents may not act in the best interest of principals they represent.

Ross's 1973 formulation, and the reason for boards, audits, stock compensation and fiduciary duty. Every one of those instruments is a partial and costly response to the same structural gap.

In practice

• A fund manager paid on assets under management grows assets; the investors wanted returns.
• A letting agent paid per tenancy recommends more tenancies than the landlord would choose, and no one has behaved improperly.

Attributed to

Stephen Ross; Jensen & Meckling

Further reading

Wikipedia

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In a rich market economy, private goods tend to be abundant while public goods are starved, because private goods are marketed and sold while public goods must be paid for through taxes.

Galbraith described it in The Affluent Society (1958) with the picture of a family driving an air-conditioned car along badly paved, litter-strewn roads to picnic beside a polluted stream. The imbalance, he argued, followed from private wants being cultivated by salesmanship while public services had no advertising budget.

In practice

• A town with a new car in every driveway argues for years over a levy to repair its library roof.
• A family spends freely on a new television and resents the local tax that pays for the park it uses every weekend.

Attributed to

J. K. Galbraith

Also called

Social balance

Possible explanations

One explanation is visibility: private purchases bring direct, personal benefit, while public goods are shared and taken for granted. Another is Galbraith's own, that advertising inflates private wants. A third is political, since taxes are felt as losses while services are diffuse.

In its favour

Describes a persistent pattern in public finance debates and anticipated later work on the political weakness of diffuse benefits.

Against it

Critics point out that public spending has grown greatly since 1958, and argue that shortfalls may reflect inefficient public provision rather than underfunding. The right balance between public and private is a value judgement.

Standing

Disputed across the political spectrum as a question of values as well as evidence. Compare the dependence effect and the tragedy of the commons.

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People value gains and losses differently, leading to inconsistent decision-making.

Kahneman and Tversky's 1979 paper, the most cited in economics. Its two departures from expected utility are the value function's kink at the reference point and the overweighting of small probabilities.

In practice

• A firm will pay far more to avoid recognising a £2m write-down than it would to gain £2m.
• A person will take a certain small gain over a gamble, and gamble to avoid a certain small loss of the same size.

Attributed to

Kahneman & Tversky

Further reading

Wikipedia

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It's rational to remain ignorant when the cost of education exceeds expected benefit.

Downs's 1957 argument. One vote almost never decides an election, so the cost of becoming informed exceeds the expected benefit — which makes ignorance rational and democratic competence a collective problem.

In practice

• A voter who would need four evenings to compare two manifestos spends those evenings otherwise, and votes anyway.
• A shareholder with 0.001% of a company rationally does not read the annual report, and the aggregate of that rationality is an unmonitored board.

Attributed to

Anthony Downs

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Consumption depends on income relative to a reference group rather than on absolute income, and falls stickily when income drops.

Duesenberry's 1949 hypothesis. Its distinctive prediction is the ratchet: consumption resists falling when income falls, because the reference point is one's own past standard rather than current means.

In practice

• A family whose income doubles adjusts its spending within a year and calls the new level normal by the second.
• A household that loses a fifth of its income cuts spending by far less in the first year, drawing on savings to protect a standard set by its own past.

Attributed to

James Duesenberry

Also called

Ratchet effect in consumption

Further reading

Wikipedia

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Persistent unemployment disciplines wages, so slack in the labour market serves employers whether or not anyone intends it.

Marx's 1867 concept. The mechanism survives in modern labour economics as the reservation-wage effect, without requiring the rest of the theoretical apparatus.

In practice

• A warehouse that can fill any vacancy within a week has no reason to improve the shift pattern, and does not.
• A labour market with high unemployment sees wage growth stall without any employer coordinating, which is the observable part of the claim.

Attributed to

Karl Marx

Also called

Industrial reserve army

Further reading

Wikipedia

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Preferences are revealed through actions, not stated preferences.

Samuelson's 1938 approach was an attempt to make economics independent of unobservable mental states. Its limit is that choice under constraint reveals ranking, not intensity, and not welfare.

In practice

• A regulator inferring how much households value a rail service from ticket sales learns what they bought, and not what they would have paid.
• A customer who buys the cheaper option has revealed a ranking, and nothing about how much they wanted the other.

Attributed to

Paul Samuelson

Further reading

Wikipedia

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Deficit-financed spending may not stimulate, if households save against the future taxes it implies.

Barro's 1974 revival of Ricardo, who proposed and rejected it. Empirical support is weak — households do not appear to offset deficits fully — but the direction of the effect is measurable.

In practice

• A government borrows to fund a rebate, and households save a fifth of it against the taxes they expect, rather than all of it or none.
• The direction is measurable and the magnitude is not one-for-one, which is why the strong version is a theoretical benchmark rather than a forecast.

Attributed to

Ricardo; Barro

Possible explanations

The explanation is foresight: a household that understands a deficit as deferred taxation saves to meet the future bill, offsetting the stimulus.

In its favour

The direction is measurable, since some private saving does rise with public deficits, and the argument disciplined loose claims about deficit-financed spending.

Against it

It requires foresight, bequest motives and access to credit that are rarely all present, and studies find only partial offset, with households that cannot borrow spending most of what they receive.

Standing

Requires assumptions about foresight, bequests and credit access that are rarely met, and studies find only partial offset.

Further reading

Wikipedia

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Rent accrues to the owner of the more productive land as a residual, so gains from improvement flow to scarcity rather than effort.

Ricardo's 1817 argument. Its political consequence, drawn by Henry George, is that improvements in productivity flow to landowners rather than to labour or capital, which is the case for land value taxation.

In practice

• A farmer on good land pays more rent and ends with the same income as one on poor land, and the difference goes to the landlord.
• A town that gets a new station finds the gain capitalised into house prices within two years, and the commuters are no better off.

Attributed to

David Ricardo

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Poverty is expensive: the inability to pay once for durable goods forces repeated payment for inferior ones.

Pratchett's 1993 formulation in Men at Arms: ten-dollar boots last ten years, five-dollar boots last a season, and the poor man spends more on boots while having wet feet. Now cited in poverty economics.

In practice

• A household that cannot find £400 for a washing machine rents one at £8 a week, and has paid £1,200 by the third year.
• A household without a deposit pays weekly rent above the mortgage it cannot get, and the payments build nothing.

Attributed to

Terry Pratchett

Also called

Boots theory of socioeconomic unfairness

Standing

A novelist's formulation now cited in poverty-economics discussion.

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Production generates incomes and purchasing power, so a general excess supply of all goods cannot be explained simply by a shortage of aggregate purchasing power.

Say's 1803 law of markets. The familiar shorthand, supply creates its own demand, is a later formulation that historians dispute as a statement of Say. The standing question is whether the law holds in the short run: Keynes's law was formulated against it, and the 1930s were the decisive test for most economists.

In practice

• A factory that starts producing pays wages, and those wages buy the output of the factory next door, which is the mechanism in its uncontested form.
• Every household in a town holds back spending in the same quarter and the shops empty, and the argument is about whether that persists or corrects itself.

Attributed to

Jean-Baptiste Say

Also called

Supply creates its own demand

Standing

'Supply creates its own demand' is a later shorthand whose adequacy as a statement of Say is disputed by historians.

Further reading

Wikipedia

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Costly and hard-to-fake actions convey private information; the cost is what makes the signal credible.

Spence's 1973 model. A degree can be worth paying for even if it teaches nothing, provided it is cheaper to obtain for the able than the unable, which is the uncomfortable half of the theory.

In practice

• A graduate scheme that requires a 2:1 in any subject whatever is not asking about the subject.
• An employer that requires a qualification unrelated to the work is not being irrational; it is buying a filter, and the candidate is paying for it.

Attributed to

Michael Spence

Standing

In education, the sheepskin effect is the evidence most often offered for it.

Further reading

Wikipedia

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An organisation confident of rescue does not economise, so the expectation of bailout is itself the distortion.

Kornai's 1979 term from socialist enterprises, and it applies directly to too-big-to-fail banking. The expectation of rescue is the distortion, so it operates before any rescue occurs.

In practice

• A university that has never let a department run out of money finds every department planning on the assumption that it never will.
• A division that has been bailed out twice by head office budgets less carefully than one that has not, and no one has promised anything.

Attributed to

János Kornai

Further reading

Wikipedia

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Capital accumulation alone yields diminishing returns; sustained per-capita growth requires technological progress.

Solow's 1956 model, which won the 1987 Nobel. Its awkward finding is that the growth it set out to explain is left as a residual — technological progress enters as an unexplained input.

In practice

• Two countries with the same saving rate and the same population growth converge on the same income per head, and whichever pulls ahead did so for reasons the model books as a residual.
• A firm that doubles its equipment without changing its methods gets less than double the output, which is the diminishing-returns half everyone accepts.

Attributed to

Solow & Swan

Also called

Neoclassical growth model

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Cutting taxes will force governments to cut spending, because they cannot spend revenue they do not collect.

The phrase came into use in the 1980s for a strategy endorsed by economists from Milton Friedman to Robert Barro: shrink government by cutting the revenue that feeds it. William Niskanen, a former Reagan adviser, found in 2006 that lower federal revenue went with higher, not lower, spending, and Romer and Romer found no support for the hypothesis in 2009.

In practice

• A state cuts income tax to impose budget discipline and closes the gap by borrowing.
• A household that cuts its income by working fewer hours keeps spending and runs up the credit card.

Attributed to

American fiscal conservatism

Possible explanations

One explanation, the hypothesis's own, is that tight budgets force hard choices. The explanation offered for the contrary evidence, by Niskanen and by Buchanan and Wagner, is fiscal illusion: tax cuts without spending cuts make government seem cheaper to voters, who then ask for more of it.

In its favour

Theoretically plausible, and its defenders note that the studies against it rest on a handful of major tax cuts in a single country's history.

Against it

The best-known empirical tests, by Niskanen and by Romer and Romer, found no restraining effect and some evidence of the opposite.

Standing

The weight of evidence runs against it, though defenders dispute the tests. Compare Bowen's revenue theory of cost and Buchanan's constitutional economics.

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Firms in one industry cluster into groups pursuing similar strategies, and barriers between groups are often higher than barriers into the industry.

The concept explains why industry-level analysis misleads: rivalry is concentrated within groups, and the difficulty for a firm is usually not entering the industry but moving between positions in it. The barriers are the accumulated commitments of the current position, which is why firms tend to compete hardest with those most like them.

In practice

• A budget airline and a flag carrier share an industry and barely compete, while two budget airlines fight over a route.
• A firm trying to move upmarket finds its cost base, brand and staff all built for where it was.

Attributed to

Michael Hunt; developed by Michael Porter

Also called

Mobility barriers

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When some people decide that others should be helped at a third party's expense, the third party who pays is the one nobody considers.

William Graham Sumner put it in an 1883 lecture: when A and B decide what C shall do for D, C is the forgotten man, the ordinary taxpayer who is never consulted and whose loss is invisible. Franklin Roosevelt borrowed the phrase in 1932 for the opposite figure, the man at the bottom of the economic pyramid, so both sides have claimed it.

In practice

• A council votes a subsidy for a stadium, the club and the fans celebrate, and the residents whose taxes pay for it are not in the room.
• Two colleagues agree between themselves that a third will cover the extra shift.

Attributed to

William Graham Sumner

Also called

The forgotten man

Possible explanations

One explanation is visibility: beneficiaries are concentrated and identifiable, while payers are dispersed. Another is political: those who propose a transfer and those who receive it are present when it is decided, and the payer is not.

In its favour

Anticipates the public choice analysis of concentrated benefits and diffuse costs, and names a real asymmetry in how policy debates are framed.

Against it

Critics note that the forgotten man can be anyone depending on the framing, as Roosevelt's reuse shows, and that taxpayers also benefit from many transfers. It identifies a cost without weighing it against the benefit.

Standing

Compare concentrated benefits, diffuse costs, and Bastiat's broken window.

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Where changing supplier is costly, customers stay with an incumbent whose offer is worse, so the incumbent can price above a rival's without losing them.

Klemperer's analysis shows the market splitting into two phases: competition to acquire customers, which can be fierce and unprofitable, and harvesting afterwards. Switching costs include learning, data, contracts, and the risk of the transition itself, and they are frequently created deliberately by the design of the product.

In practice

• A firm quotes a rival 20% cheaper and stays put, because migration would take a year of someone's time.
• A bank keeps customers who would leave if the account number moved with them.

Attributed to

Paul Klemperer

Also called

Lock-in through switching costs

Standing

Compare path dependence and lock-in, which describe the same mechanism at the level of standards rather than firms.

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Rising capital intensity is claimed to depress the rate of profit over time, driving crises.

Long contested inside and outside Marxian economics, and the empirical record does not clearly support it. Countervailing tendencies Marx himself listed make the prediction hard to test at all.

In practice

• A haulage firm replaces loaders with automated handling, and its margin per delivery falls while its total profit rises.
• The same firm's margin recovers when fuel cheapens and a rival closes, which are two of the countervailing tendencies and leave the trend unreadable.

Attributed to

Karl Marx

Possible explanations

The proposed explanation is composition: as firms substitute machinery for labour, and labour is held to be the source of surplus, the ratio of profit to total capital falls even as output rises.

In its favour

It gave an internal account of crisis rather than treating downturns as external shocks, and Marx himself listed the countervailing tendencies, which is unusually explicit.

Against it

The empirical record does not clearly support a long-run fall, the countervailing tendencies make the prediction hard to test at all, and the argument depends on the labour theory of value, which most economists reject.

Standing

Long contested inside and outside Marxian economics; the empirical record does not clearly support it.

Further reading

Wikipedia

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Developed economies exhausted the easy gains of free land, cheap mass education, and low-hanging technology, so measured growth slowed.

Cowen's 2011 argument, and he has since argued the stagnation is ending. It replaces the "inequality trade-off" sometimes attributed to him, which is not a claim he named.

In practice

• A household in 1950 gained indoor plumbing, a car and a telephone within one generation; the household of 1990 gained a better telephone.
• The national accounts record a free mapping application at nothing and the paper atlas it replaced at the price of the atlas.

Attributed to

Tyler Cowen

Possible explanations

The proposed explanation is exhaustion of one-off gains: free land, the move from farm to factory, and the extension of schooling to most of the population each raised output once and cannot be repeated.

In its favour

Measured productivity growth did slow across developed economies from the 1970s, and the low-hanging-fruit account fits the timing.

Against it

Critics argue that measurement misses the value of free digital goods, that the slowdown has several competing explanations, and Cowen himself has since argued the stagnation is ending.

Standing

Contested, and Cowen has since argued the stagnation is ending. Replaces the "inequality trade-off" sometimes attributed to him, which is not a claim he named.

Further reading

Wikipedia

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Bad economic outcomes make people more receptive to bad economic ideas, which produce worse outcomes, so a country can be caught in a self-reinforcing decline.

Caplan's mechanism runs through voter opinion: growth makes electorates more tolerant of markets and openness, stagnation makes them more receptive to protection and inflation, and those policies deepen the stagnation. The trap is that the moment good ideas are most needed is the moment they are least saleable.

In practice

• A firm in decline becomes less willing to fund the change that would arrest it, and calls the refusal prudence.
• A department whose budget was cut for underperformance now performs worse, which justifies the next cut.

Attributed to

Bryan Caplan

Also called

Bad ideas and bad outcomes as a cycle

Possible explanations

The explanation runs through voter opinion: growth makes electorates more tolerant of markets and openness, while stagnation makes them more receptive to protection and inflationary policy, which then produces more stagnation.

In its favour

It was proposed with supporting cross-country survey evidence linking economic conditions to expressed economic beliefs, and the feedback it describes is specific.

Against it

The direction of causation is the pivot and it is contested, since bad policy produces bad outcomes as readily as bad outcomes produce bad policy, and countries have escaped the supposed trap often enough to question its grip.

Standing

Proposed with supporting cross-country survey evidence and contested on the direction of causation, which is the pivot of the argument.

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In an unmanaged or weakly governed common-pool resource, where users capture private gains while sharing depletion costs, individually rational extraction can produce overuse.

Hardin's 1968 essay, and Ostrom showed managed commons frequently avoid it. Hardin's own case was unmanaged open access, which is the condition Ostrom's design principles remove.

In practice

• A fishery with no licences and no quota is emptied by boats that would each have preferred a stock that lasted.
• A shared team inbox that belongs to everyone is answered by nobody; the same inbox with a named rota is answered.

Attributed to

Garrett Hardin; earlier William Forster Lloyd

Possible explanations

The mechanism is the split between private gain and shared cost: each user takes the whole benefit of one more unit and bears only a fraction of the depletion.

In its favour

It describes open-access resources well, including ocean fisheries and groundwater, where extraction has repeatedly exceeded renewal.

Against it

Ostrom's field studies found communities managing shared resources sustainably for centuries under their own rules, so the tragedy follows from absent governance rather than from common ownership. Hardin's essay also drew population-control conclusions his evidence did not support.

Standing

Ostrom showed managed commons frequently avoid it.

Further reading

Wikipedia

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Satisfaction comes partly from the perceived quality of the deal rather than from the good itself.

Thaler's 1983 concept. It is why struck-through reference prices work, and why a fairly-priced item can disappoint next to an identical item marked as discounted.

In practice

• A shopper buys a coat reduced from £300 to £120 and would not have bought the same coat priced at £120.
• A season ticket bought in the January sale feels like a win every month; the identical fare paid weekly feels like an imposition.

Attributed to

Richard Thaler

Standing

Why reference prices and struck-through prices work.

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Social losses from rent-seeking can exceed the rents themselves.

Tullock's 1967 insight. If a monopoly worth a billion is up for award, competitors will rationally spend up to a billion competing for it, and that spending produces nothing.

In practice

• A franchise worth £40m draws four bidders who each spend £3m on advisers, and £12m is consumed before anything is built.
• A grant round worth £2m attracts £600,000 of bid-writing effort across forty applicants, and thirty-nine of those bids produce nothing.

Attributed to

Gordon Tullock

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Managerial coordination can replace market mechanisms in large organizations.

Chandler's 1977 argument, written as the deliberate counterpart to Smith's invisible hand. Where throughput is high and coordination is time-critical, managers displaced markets — the railroads being his case.

In practice

• A railway moving perishable freight across four regions on one timetable employs schedulers rather than buying each leg on a spot market.
• A retailer that once bought haulage by the load now runs a planning department, because the market could not be asked a question fast enough.

Attributed to

Alfred D. Chandler Jr.

Also called

Managerial capitalism

Further reading

Wikipedia

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A resource yields sustained advantage only if it is valuable, rare, hard to imitate and the organisation is arranged to exploit it.

Barney's 1991 framework is the standard test in the resource-based view, and its practical value is as a checklist that eliminates most claimed advantages. Almost everything a firm calls a strength fails on rarity or on imitability. The theoretical objection is that the criteria are often applied after observing the performance they are meant to explain.

In practice

• A firm listing its culture as an inimitable advantage has not asked whether a competitor could hire the same people.
• A capability that is valuable and widely held is a cost of entry, not an advantage.

Attributed to

Jay Barney

Also called

VRIN; the resource-based view

Standing

Criticised as close to tautological: a resource is identified as valuable and inimitable partly because the firm holding it does well.

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Firms exist and integrate when markets are costlier than hierarchy.

Williamson's 1975 answer to Coase's question of why firms exist. Asset specificity, uncertainty and frequency determine whether a transaction is cheaper inside a hierarchy or in the market.

In practice

• A car maker buys the supplier that presses its body panels, and buys screws from whoever is cheapest that quarter.
• A firm that outsources a function requiring constant renegotiation has moved the cost rather than removed it.

Attributed to

Oliver Williamson

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Where the seller knows more than the buyer, the burden of inspection falls on the buyer unless institutions shift it.

The default rule of English commerce for centuries, and the pre-modern statement of what Akerlof formalised in 1970. Consumer protection law is the record of institutions deciding to shift the burden.

In practice

• A buyer of a leasehold flat who does not read the service charge history discovers a £30,000 roof bill that was in the papers all along.
• An employer hiring on a glowing reference from a friend of the candidate learns what the reference did not say.

Attributed to

English common law

Also called

Let the buyer beware

Standing

The pre-modern statement of the problem Akerlof formalised in 1970.

Further reading

Wikipedia

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A policy is efficient if winners could compensate losers.

The standard justification for cost-benefit analysis, and its standard weakness: compensation need only be possible, not actual. Whether that is a defensible test is the live dispute.

In practice

• A road scheme where the time savings exceed the property losses is efficient by this test, and the households whose homes go are not in fact compensated.
• A trade agreement that raises national income and destroys one region's employment passes the test and fails the region.

Attributed to

Kaldor & Hicks

Further reading

Wikipedia

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The bet size that maximises long-run growth is proportional to edge divided by odds; betting more reduces growth.

Kelly's 1956 formula from information theory, adopted by blackjack teams and hedge funds. Its practical lesson is asymmetric: betting above the Kelly fraction reduces long-run growth and eventually guarantees ruin.

In practice

• A trader with a genuine 2% edge who stakes a quarter of capital per trade goes broke faster than one with no edge who stakes 1%.
• A firm with a real advantage in one market that commits its whole balance sheet to it does not survive the first bad year.

Attributed to

J. L. Kelly Jr.

Also called

Kelly bet; Kelly sizing

Further reading

Wikipedia

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The true cost of any choice is the best alternative it displaces.

Wieser's term. Its practical difficulty is that the displaced alternative is counterfactual and therefore invisible, which is why organisations systematically undercount it.

In practice

• A team that takes a low-value project has not lost money on it; it has lost the high-value project it could not staff.
• A council that spends four months on a consultation has spent four months not doing the thing it consulted about.

Attributed to

Friedrich von Wieser

Further reading

Wikipedia

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A state where no one can be made better off without making someone else worse off.

Pareto efficiency is a low bar deliberately: a distribution where one person holds everything can be Pareto efficient. It says nothing about fairness, which is why Kaldor-Hicks and Rawls exist.

In practice

• A landlord and tenant who have agreed a rent they both prefer to no tenancy have reached a Pareto-efficient outcome, whatever either thinks of the figure.
• A reallocation that makes ninety-nine people better off and one worse off fails the test, and may still be worth doing.

Attributed to

Vilfredo Pareto

Further reading

Wikipedia

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Many outcomes are highly concentrated in a minority of causes; 80/20 is a rule of thumb rather than a universal constant.

Named for Pareto by Juran in the 1940s, from Pareto's finding that 20% of Italians held 80% of the land. The ratio is a memorable label for a rough family of concentrated distributions rather than a constant.

In practice

• A support team finds a fifth of its ticket types produce four-fifths of its volume.
• A retailer's stock report shows a small fraction of lines carrying most of the margin; the concentration recurs widely, and the exact ratio does not.

Attributed to

Named for Vilfredo Pareto by Joseph Juran

Also called

80/20 rule; the vital few

Possible explanations

One explanation is multiplicative growth, in which success feeds on success and outcomes become concentrated. Another is preferential attachment in networks, which produces the same shape from a different mechanism.

In its favour

Concentration is genuinely common, in sales, faults, citations and wealth, and the rule directs attention to the few causes that carry most of the effect.

Against it

The 80/20 ratio is not a constant and matches exactly only by coincidence, and it is often applied to headcount or pay where the underlying distribution has never been measured.

Standing

A memorable rule of thumb for concentrated distributions, not a universal constant.

Further reading

Wikipedia

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Achieving N policy targets generally requires at least N instruments.

Tinbergen's 1952 rule. A central bank with one instrument cannot target both inflation and employment independently, which is why dual mandates require either more instruments or an accepted trade-off.

In practice

• A council with one budget cannot cut the precept and expand a service at once, whatever the manifesto promised.
• A manager with one lever — headcount — cannot simultaneously hit a cost target and a delivery date, and will be judged on both.

Attributed to

Jan Tinbergen

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A place that becomes popular ceases to offer what made it popular, so its success destroys the thing being sought.

The apparent contradiction dissolves once the two groups are separated: the people who valued it when it was quiet no longer go, and the crowd consists of people who came for its reputation. It is a congestion externality stated as a joke, and it describes restaurants, beaches, neighbourhoods and investment strategies equally well.

In practice

• A fund that publishes its edge finds the edge gone, and the inflow is what removed it.
• A quiet beach recommended in a newspaper is not the beach that was recommended.

Attributed to

Attributed to Yogi Berra

Also called

Nobody goes there anymore, it's too crowded

Standing

The attribution to Berra is traditional and poorly documented, as with most remarks assigned to him.

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Export-led growth can leave a country worse off, when the extra supply drives its own terms of trade down far enough to swamp the gain.

Bhagwati's 1958 result. A country that dominates world supply of a commodity can expand output, crash the price, and end up with less purchasing power than before.

In practice

• A region that dominates world cobalt supply doubles output, watches the price fall by two-thirds, and earns less than before.
• A freelance market where every writer doubles their output finds rates halve and the same total money is shared among more work.

Attributed to

Jagdish Bhagwati

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A reward offered for reducing a problem creates a supply of the problem.

The term was popularised by Horst Siebert using a colonial-India cobra-bounty story whose historicity is uncertain. The well-documented analogue is the 1902 Hanoi rat-tail bounty, which encouraged rat farming and the gaming of the bounty system.

In practice

• A support team rewarded for tickets closed begins closing tickets and reopening them under new numbers.
• A council paying per fly-tipping incident cleared finds contractors declining to report the small ones until they become large ones.

Attributed to

Horst Siebert

Also called

Perverse incentive

Possible explanations

The explanation is that a bounty pays for the measured quantity rather than the outcome, so whoever can produce the measured quantity cheaply will do so, which is the same structure as Goodhart's law.

In its favour

The mechanism is well documented, notably in the 1902 Hanoi rat-tail bounty that produced rat farming, and it recurs wherever a target can be met by supplying the problem.

Against it

The colonial-India cobra story that gives the effect its name is poorly documented, so the founding case may not have happened as told.

Standing

The colonial-India cobra story is poorly documented; the 1902 Hanoi rat-tail bounty is the better-evidenced case.

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Road journey speed is set by the speed of the parallel public transport, so expanding roads without transit yields no gain.

Named jointly for Downs and Thomson. Adding road capacity draws riders off transit, transit frequency falls, and the equilibrium journey time returns to where it was.

In practice

• A city widens its ring road, bus ridership falls, services are cut, and journey times return to where they started.
• A commuter route where the train is slow finds that road improvements are absorbed within two years.

Attributed to

Anthony Downs & J. M. Thomson

Also called

Lewis–Mogridge position

Further reading

Wikipedia

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Richer people within a country report more happiness, yet rising national income does not raise average happiness over time.

Easterlin's 1974 finding. The within-country gradient is not disputed; the long-run time series is, with Stevenson and Wolfers arguing the paradox dissolves in better data.

In practice

• A team receiving a large pay rise reports high satisfaction for about four months, and then reports what it reported before.
• A country's average reported wellbeing is flat across thirty years of doubled GDP, while within any given year the richer report higher.

Attributed to

Richard Easterlin

Possible explanations

One explanation is adaptation, since people adjust to a new income and return to their previous level of satisfaction. Another is relative position, in which what matters is income compared with others rather than its absolute level.

In its favour

The within-country gradient and the adaptation effect are both well documented, and several long national series do show flat average happiness alongside decades of growth.

Against it

Stevenson and Wolfers find a positive long-run relationship in wider and better data, and bounded survey scales may hide growth at the top, so the paradox may be an artefact of measurement.

Standing

Long-run data are contested; the within-country gradient is not.

Further reading

Wikipedia

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Shares have returned far more than safe bonds over the long run, by more than any plausible degree of risk aversion explains.

Mehra and Prescott stated it in 1985: reproducing the historical gap inside a standard model requires a level of risk aversion that would imply implausible behaviour everywhere else. The candidate explanations are rare disaster risk, loss aversion combined with short evaluation horizons, borrowing constraints, and survivorship in the record itself, since the American market that produced the numbers is the one that did not collapse.

In practice

• A pension fund holds bonds because its committee reviews results yearly, and the yearly odds look worse than the thirty-year odds it is actually running.
• A saver who checks a portfolio daily sells during a fall that would have been invisible on an annual statement.

Attributed to

Rajnish Mehra & Edward Prescott

Standing

Still open. Each proposed resolution explains part of the gap, and the premium has narrowed in recent decades and in other countries' data. Compare survivorship bias and loss aversion.

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For an inferior staple that dominates a poor household's budget, a price rise can increase the quantity bought, because the income effect swamps the substitution effect.

Named by Marshall for Giffen in 1895. Clean cases are rare and contested; the best evidence comes from Jensen and Miller's work on rice in Hunan and noodles in Gansu.

In practice

• A subsidised staple's price rises and poor households buy more of it, because the meat they could previously afford is now out of reach.
• A commuter facing higher fares gives up the occasional taxi and takes more buses, so the fare rise raises bus journeys.

Attributed to

Named by Alfred Marshall for Robert Giffen

Also called

Giffen good

Possible explanations

The explanation is that for a staple dominating a poor household's budget, a price rise makes the household so much poorer that it substitutes away from costlier foods and buys more of the staple, with the income effect outweighing substitution.

In its favour

Jensen and Miller's work on rice in Hunan and noodles in Gansu provides the cleanest evidence, produced by a field experiment designed to test it.

Against it

Clean cases are rare and contested, the conditions required are narrow, and the historical examples usually cited, including Irish potatoes, do not survive scrutiny.

Standing

Clean real-world cases are rare and contested; the best evidence comes from rice and noodle staples in Hunan and Gansu.

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If prices reflected all information, nobody would be paid to gather it, so prices could not reflect it.

Grossman and Stiglitz's 1980 result. Markets must be slightly inefficient to pay for the analysis that makes them efficient, so perfect efficiency is self-undermining rather than an ideal limit.

In practice

• An asset manager charging fees for research that the price already reflects is either adding nothing or the price does not reflect it.
• A market where everyone indexes has no one setting prices, which is what makes indexing work.

Attributed to

Grossman & Stiglitz

Further reading

Wikipedia

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Technological progress that increases efficiency may increase total consumption of a resource.

Jevons observed in 1865 that Watt's more efficient engine increased coal consumption rather than reducing it, because efficiency made coal-powered production worth doing in more places.

In practice

• A firm that halves the energy cost of its process runs it around the clock and uses more energy than before.
• A household that fits efficient lighting leaves more lights on, and the bill falls by less than the specification implied.

Attributed to

William Stanley Jevons

Also called

Rebound effect

Further reading

Wikipedia

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The United States, the most capital-rich economy of its day, exported goods that were more labour-intensive than the goods it imported.

Leontief tested the Heckscher-Ohlin theory of trade against American input-output data for 1947 and found the opposite of what it predicted. The explanations offered since are that American labour was more productive per worker, that human capital belongs inside the measure of capital, and that technology differs across countries in ways the theory assumed away. It is the standard example of a clean theory meeting its own data.

In practice

• A country convinced that it competes on machinery discovers that its exports are carried by the skills of the people running the machines.
• A firm sure its advantage is its equipment finds that the equipment is for sale to everyone and the crew is not.

Attributed to

Wassily Leontief

Standing

A measured anomaly rather than a paradox in the logical sense. Later work using human capital and multiple factors reduces it without erasing it.

Further reading

Wikipedia

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Capital does not flow from rich countries to poor ones on anything like the scale that differences in capital per worker imply it should.

Lucas asked in 1990 why capital was not rushing from the United States to India, where the return on each additional machine should have been far higher. The candidate answers are human capital and infrastructure, which make workers less productive than the raw ratio suggests, and institutional risk, expropriation, weak contract enforcement and capital controls, which make the returns unavailable even where they exist. The question organised two decades of development economics.

In practice

• A fund finds a country where returns look unbeatable and cannot get its money out again, which is why they looked unbeatable.
• An employer puzzled that cheaper labour abroad has not undercut him learns what the wage does not include.

Attributed to

Robert Lucas

Also called

Why doesn't capital flow from rich to poor countries

Standing

Unresolved in the sense that no single factor accounts for the gap, though institutional explanations now carry most of the weight.

Further reading

Wikipedia

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Nothing is really free: every benefit is paid for by someone, somewhere, in money, time or forgone alternatives.

The phrase recalls the free lunch that American saloons offered drinkers in the nineteenth century, paid for through the price of the drinks. Robert Heinlein popularised the acronym TANSTAAFL in The Moon Is a Harsh Mistress (1966), and Milton Friedman used the phrase as the title of a 1975 book.

In practice

• A free app pays for itself by selling its users' attention to advertisers.
• A free gift with purchase is priced into the purchase.

Attributed to

American saloon lore; popularised by Robert Heinlein and Milton Friedman

Also called

TANSTAAFL; there ain't no such thing as a free lunch

Possible explanations

One explanation is opportunity cost: resources used for one thing cannot be used for another. Another is that apparent gifts shift costs onto less visible payers.

In its favour

Expresses the principle of opportunity cost, accepted by every school of economics.

Against it

Some goods cost almost nothing to share once they exist, such as knowledge and open-source software, and gains from trade and innovation can leave everyone better off. The phrase can be used to dismiss genuinely positive-sum arrangements.

Standing

Compare opportunity cost and Sumner's forgotten man.

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Socialist governments eventually run out of other people's money.

Margaret Thatcher said in a 1976 television interview that socialist governments traditionally make a financial mess and always run out of other people's money. The line has been quoted ever since, often shortened to a claim about the trouble with socialism.

In practice

• A government that funds rising pensions by borrowing finds lenders unwilling to lend at any tolerable rate.
• A shared flat that pays every bill from one member's account finds that member moving out.

Attributed to

Margaret Thatcher

Also called

The problem with socialism

Possible explanations

One explanation is fiscal: spending financed from a narrow tax base or by borrowing cannot grow indefinitely. Another is incentive: high taxation may reduce the activity it taxes.

In its favour

Consistent with fiscal crises in heavily state-directed economies, such as Venezuela's in the 2010s.

Against it

Many high-spending social democracies have remained solvent for decades, and fiscal crises have occurred under governments of every political colour. The quip does not distinguish socialism from the welfare state.

Standing

Compare the Laffer curve and starve the beast.

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Computers appeared everywhere except in the productivity statistics.

Solow's line of 1987 named a real puzzle: American productivity growth stayed weak through two decades of heavy computer investment. The explanations that survived were mismeasurement of output, long lags while firms reorganised themselves around the technology, and gains captured by some firms at the expense of others. Measured productivity growth accelerated in the late 1990s, which is generally treated as the paradox closing.

In practice

• A firm buys a system that saves each clerk an hour a day, and total output does not move, because the hour goes to work that was already waiting.
• A department automates its reporting and hires two people to manage the reports.

Attributed to

Robert Solow

Also called

Solow's paradox; the computer productivity paradox

Standing

Historically resolved for computers. Whether the same lag explains the figures for today's technologies is an open question rather than a settled one. Compare Jevons's paradox and the irony of automation.

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If something cannot go on forever, it will stop.

Stein's law is a warning about extrapolation, formulated about US trade deficits. Unsustainable trends end whether or not anyone can say when, which makes "this cannot continue" a weak prediction.

In practice

• A firm's costs have risen faster than its revenue for six years, and the trend ends whether or not anyone in the building can say in which quarter.
• Its weakness is that it forecasts nothing: "this cannot continue" is compatible with continuing for another thirty years.

Attributed to

Herbert Stein

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When too many parties hold veto rights over a resource, it is underused rather than depleted.

Heller's 1998 term. Post-Soviet Moscow storefronts sat empty because too many agencies held veto rights, and patent thickets in biotechnology produce the same underuse.

In practice

• A row of shops stands empty for years because four different bodies each hold a consent, and not one of them is refusing.
• A project needing sign-off from six departments is not delivered slowly; it is not delivered, and every department can say it approved.

Attributed to

Michael Heller

Further reading

Wikipedia

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The issuer of the global reserve currency must run deficits to supply it, which erodes confidence in it.

Triffin's 1960 warning about the dollar, which anticipated the collapse of Bretton Woods in 1971. The dilemma persists: reserve supply requires deficits, and deficits erode the confidence reserves depend on.

In practice

• A country whose currency everyone wants to hold must send more of it abroad than it takes back, and the deficit it is criticised for is the mechanism supplying the reserves.
• A firm whose vouchers circulate as local money must keep issuing them for the system to work, and every issue is a claim on stock it has not sold.

Attributed to

Robert Triffin

Also called

Triffin paradox

Further reading

Wikipedia

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