Economics

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(c) cash cow products – those that have a low growth rate and a high market share (so that they tend to generate a lot of cash). Cash cows are usually mature products in the later phases of the product life cycle.

Fig. 16 Boston matrix. The matrix identifies cash generators and cash users.

(d) dog products – those that have a low growth rate and a low market share and tend to generate little cash. Dog products generally have little potential for future development.

It is important for any firm to have a balanced portfolio of mature ‘cash cow’ products, newer ‘stars’, etc., and to use the cash generated by cash cows to help the development of ‘problem children’ if its product development policy is to ensure the firm’s long-term survival. See PRODUCT PERFORMANCE, DIVERSIFICATION, PRODUCT-MARKET MATRIX.

bounded rationality limits on the capabilities of people to deal with complexity, process information and pursue rational aims. Bounded rationality prevents parties to a CONTRACT from contemplating or enumerating every contingency that might arise during a TRANSACTION, so preventing them from writing complete contracts.

boycott 1 the withholding of supplies of GOODS from a distributor by a producer or producers in order to force that distributor to resell those goods only on terms specified by the producer. In the past, boycotts were often used as a means of enforcing RESALE PRICE MAINTENANCE.

2 the prohibition of certain imports or exports, or a complete ban on INTERNATIONAL TRADE with a particular country by other countries.

brand the name, term or symbol given to a product by a supplier in order to distinguish his offering from that of similar products supplied by competitors. Brand names are used as a focal point of PRODUCT DIFFERENTIATION between suppliers.

In most countries, brand names and trade marks are required to be registered with a central authority so as to ensure that they are uniquely applied to a single, specific product. This makes it easier for consumers to identify the product when making a purchase and also protects suppliers against unscrupulous imitators. See INTELLECTUAL PROPERTY RIGHTS, BRAND TRANSFERENCE.

brand loyalty the continuing willingness of consumers to purchase and repurchase the brand of a particular supplier in preference to competitive products. Suppliers cultivate brand loyalty by PRODUCT-DIFFERENTIATION strategies aimed at emphasizing real and imaginary differences between competing brands. See ADVERTISING.

brand proliferation an increase in the number of brands of a particular product, each additional brand being very similar to those already available. Brand proliferation occurs mainly in oligopolistic markets (see OLIGOPOLY) where competitive rivalry is centred on PRODUCT-DIFFERENTIATION strategies, and is especially deployed as a means of MARKET SEGMENTATION. In the THEORY OF MARKETS, excessive brand proliferation is generally considered to be against consumers’ interests because it tends to result in higher prices by increasing total ADVERTISING and sales promotional expenses.

brand switching the decision by consumers to substitute an alternative BRAND for the one they currently consume. Brand switching may be induced by ADVERTISING designed to overcome BRAND LOYALTY to existing brands.

brand transference the use of an existing BRAND name for new or modified products. Brand transference or extension seeks to capitalize on consumers’ BRAND LOYALTY towards the firm’s established brands to gain rapid consumer acceptance of a new product.

brand value the money value of an established BRAND name. The valuation of a brand reflects the BRAND LOYALTY of consumers towards it, built up by cumulative ADVERTISING. See TAKEOVER.

Fig. 17 Break-even. A supplier’s typical short-run costs and revenues. Fixed costs do not vary with output and so are shown as the horizontal line FC. Total cost comprises both fixed costs and total variable costs and is shown by line TC. Total revenue rises as output and sales are expanded and is depicted by line TR. At low levels of output like Q

total costs exceed total revenues and the supplier makes a loss equal to AB. At high levels of output like Q

revenues exceed costs and the supplier makes a profit equal to DE. At output Q

total revenues exactly match total costs (at C) and the supplier breaks even.

break-even the short-run rate of output and sales at which a supplier generates just enough revenue to cover his fixed and variable costs, earning neither a PROFIT nor a LOSS. If the selling price of a product exceeds its unit VARIABLE COST, then each unit of product sold will earn a CONTRIBUTION towards FIXED COSTS and profits. Once sufficient units are being sold so that their total contributions cover the supplier’s fixed costs, then the company breaks even. If less than the break-even sales volume is achieved, then total contributions will not meet fixed costs and the supplier will make a loss. If the sales volume achieved exceeds the break-even volume, total contributions will cover the fixed costs and leave a surplus that constitutes profit. See Fig. 17.

Bretton Woods System see INTERNATIONAL MONETARY FUND.

bridging loan a form of short-term LOAN used by a borrower as a continuing source of funds to ‘bridge’ the period until the borrower obtains a medium- or long-term loan to replace it. Bridging loans are used in particular in the housing market to finance the purchase of a new house while arranging long-term MORTGAGE finance and awaiting the proceeds from the sale of any existing property.

broad money see MONEY SUPPLY.

brownfield location a derelict industrial site or housing estate that has been demolished and redeveloped to accommodate new industrial premises, often as part of a regional industrial regeneration programme. Compare GREENFIELD LOCATION. See REGIONAL DEVELOPMENT AGENCY.

budget (firm) a firm’s planned revenues and expenditures for a given future period. Annual or monthly sales, production, cost and capital expenditure budgets provide a means for the firm to plan its future activities, and by collecting actual data about sales, product cost, etc., to compare with budget the firm can control these activities more effectively.

budget (government) a financial statement of the government’s planned revenues and expenditures for the fiscal year. The main sources of current revenues, as shown in Fig. 18 (a), are TAXATION, principally income and expenditure taxes, and NATIONAL INSURANCE CONTRIBUTIONS. The main current outgoings of GOVERNMENT EXPENDITURE are the provision of goods and services (principally wage payments to health, education, police and other public service employees), TRANSFER PAYMENTS (old-age pensions, interest payments on the NATIONAL DEBT, etc.) and social security benefits.

Fig. 18 Budget (government). (a) The UK budget for 2003/04. (b) UK budget deficits and surpluses, 1979–2004. Source: UK National Accounts, ONS (Blue Book), 2004.

The budget has two main uses: (a) it forms the basis of the government’s longer-term financial planning of its own economic and social commitments; (b) it is an instrument of FISCAL POLICY in regulating the level (and composition) of AGGREGATE DEMAND in the economy. A BUDGET SURPLUS (revenues greater than expenditures) reduces the level of aggregate demand. By contrast, a BUDGET DEFICIT (expenditure greater than revenues) increases aggregate demand. Fig. 18 (b) shows UK budget deficits (and surpluses) over the past two decades.

Recently (post 1997) the government has accepted that fiscal stability is an important element in the fight against INFLATION and UNEMPLOYMENT. To this end, fiscal ‘prudence’, specifically a current budget deficit within the European Union’s MAASTRICHT TREATY limits of no more than 3% of GDP (and an outstanding total debt limit of 60% of GDP), was endorsed as being a necessary adjunct to avoid excessive monetary creation of the kind that fuelled previous runaway inflation.

In fact, the government has gone further than this in adopting the so-called ‘golden rule’, which requires that the government should ‘aim for an overall budget surplus over the economic cycle’ (defined as 1998/99 to 2003/04, with some of the proceeds being used to pay off government debt to reduce outstanding debt eventually to 40% of GDP. Along the way it has introduced more rigorous standards for approving increases in public spending, in particular the ‘sustainable investment rule’, which stipulates that the government should borrow only to finance capital investment and not to pay for general spending. In addition, the government has announced it will ‘ring-fence’ increases in particular tax receipts to be used only for funding specific activities. For example, receipts from future increases in fuel taxes and tobacco taxes will be spent, respectively, only on road-building programmes and the National Health Service. See PUBLIC SECTOR BORROWING REQUIREMENT, PUBLIC SECTOR DEBT REPAYMENT, DEMAND MANAGEMENT, PUBLIC FINANCE.

budget (household) a household’s planned income and expenditure for a given time period. The household’s expenditure will depend upon its DISPOSABLE INCOME, and the THEORY OF CONSUMER BEHAVIOUR seeks to show how households, or consumers, allocate their income in spending on various goods and services. See CONSUMER EQUILIBRIUM.

budget deficit the excess of GOVERNMENT EXPENDITURE over government TAXATION and other receipts in any one fiscal year. See BUDGET (government). The operation of a budget deficit (deficit financing) is a tool of FISCAL POLICY to enable government to influence the level of AGGREGATE DEMAND and EMPLOYMENT in the economy. Such a policy was advocated by KEYNES in the 1930s to offset the DEPRESSION that occurred at that time. Opinion prior to this was that the government should operate a BALANCED BUDGET policy, allowing the economy to respond in its own way without government intervention. Keynes argued that government should intervene by deliberately imbalancing its budget in order to inject additional aggregate demand into a depressed economy and vice-versa.

Since the Second World War, most western governments have tended to operate a budget deficit to keep employment high and to promote long-term ECONOMIC GROWTH. This has been financed by increasing the PUBLIC SECTOR BORROWING REQUIREMENT (PSBR) through the issue of TREASURY BILLS and long-term bonds. This is acceptable as long as the economy is growing and the interest payments on such borrowings do not become disproportionate to the overall level of government expenditure. Government borrowing in excess of the amount required to promote long-term growth and effect counter-cyclical policies will ultimately result in INFLATION. Consequently, both the timing and magnitude of the expenditure over and above receipts is of crucial importance. In more recent times recognition that low inflation is necessary to secure low UNEMPLOYMENT has led to an acceptance of the need for ‘fiscal stability’. This has found expression, for example, within the European Union’s MAASTRICHT TREATY limits of a current budget deficit of no more than 3% of GDP and a total outstanding government debt limit of no more than 60% of GDP.

BUDGET SURPLUS is the opposite of the above whereby there is an excess of government receipts over expenditure. See AUTOMATIC (BUILT-IN) STABILIZERS, KEYNESIAN ECONOMICS, BUSINESS CYCLE, DEMAND MANAGEMENT.

budget lineorconsumption possibility line a line showing the alternative combinations of goods that can be purchased by a consumer with a given income facing given prices. See Fig. 19. See also CONSUMER EQUILIBRIUM, REVEALED PREFERENCE THEORY, PRICE EFFECT.

budget surplus a surplus of TAXATION receipts over GOVERNMENT EXPENDITURE. Budget surpluses are used as an instrument of FISCAL POLICY to reduce the level of AGGREGATE DEMAND in the economy. See BUDGET (government), BUDGET DEFICIT, PUBLIC SECTOR DEBT REPAYMENT.

buffer stock a stock of a COMMODITY (copper, wheat, etc.) that is held by a trade body or government as a means of regulating the price of that commodity. An ‘official’ price for the commodity is established, and if the open-market price falls below this because there is excess supply at the fixed price, then the authorities will buy the surplus and add it to the buffer stock in order to force the price back up. By contrast, if the open-market price rises above the fixed price because there is an excess demand at the fixed price, then the authorities will sell some of their buffer stock in order to bring the price down. Through this mechanism the price of the commodity can be stabilized over time, avoiding erratic, short-term fluctuations in price.

Thus this mechanism attempts to avoid erratic short-term fluctuations in price. If the official price is set at too high a level, however, this will encourage over-supply in the long term and expensively accumulating stocks; while if the official price is set at too low a level, this will discourage supply in the long term and lead to shortages. See INTERNATIONAL COMMODITY AGREEMENT, PRICE SUPPORT, COMMON AGRICULTURE POLICY.

Fig. 19 Budget line. If a consumer has an income of £10 and the price of good X is 50 pence and the price of good Y is £1, he can buy 20 units of X or 10 units of Y, or some combination of both, for example 10 units of X and 5 units of Y. The slope of the budget line measures the relative prices of the two goods.

Building Societies Act 1986 a UK Act that gave BUILDING SOCIETIES new powers to augment their traditional business MORTGAGES by providing a range of other financial services for their customers. These include money transmission facilities (via cheque books), arranging insurance cover, obtaining traveller’s cheques and foreign currencies, managing unit trust pension schemes, buying and selling stocks and shares, and the provision of estate agency facilities. The Act has thus served to increase competition in the provision of financial services as between building societies, the COMMERCIAL BANKS and other financial institutions.

The Act also permits building societies to increase their capital resources and growth potential by incorporating themselves as JOINT-STOCK COMPANIES (as have the Abbey National and the Halifax), issuing shares and securing a stock exchange listing.

building society a financial institution that offers a variety of savings accounts to attract deposits, mainly from the general public, and which specializes in the provision of long-term MORTGAGE loans used to purchase property. In recent years, many of the larger UK building societies have moved into the estate agency business. Additionally, they have entered into arrangements with other financial institutions that have enabled them to provide their depositors with limited banking facilities (the use of cheque books and credit cards, for instance) and other financial services, a development that has been given added impetus by the BUILDING SOCIETIES ACT 1986.

Most notably, major building societies, such as the Abbey National and Halifax, have taken advantage of changes introduced by the BUILDING SOCIETIES ACT 1986 and the FINANCIAL SERVICES ACT 1986 and have converted themselves into public JOINT-STOCK COMPANIES, setting themselves up as ‘financial supermarkets’ offering customers a banking service and a wide range of personal financial products, including insurance, personal pensions, unit trusts, individual savings accounts (ISAs), etc. This development has introduced a powerful new competitive impetus into the financial services industry, breaking down traditional ‘demarcation’ boundaries in respect of ‘who does what’, allowing former building societies to ‘cross-sell’ these services and products in competition with traditional providers such as the COMMERCIAL BANKS, INSURANCE COMPANIES, UNIT TRUSTS, etc.

Building society deposits constitute an important source of liquidity in the economy and count as ‘broad money’ in the specification of the MONEY SUPPLY. See FINANCIAL SYSTEM.

built-in stabilizers see AUTOMATIC (BUILT-IN) STABILIZERS.

bulk-buying the purchase of raw materials, components and finished products in large quantities, thereby enabling a BUYER to take advantage of DISCOUNTS off suppliers’ LIST PRICES. A supplier may offer a price discount to encourage the placement of large orders as a means of obtaining extra sales in order to exploit fully the ECONOMICS OF SCALE in production and distribution. In many cases, however, the initiative lies with buyers, with powerful retailing and wholesaling groups exacting favourable price concessions from suppliers by playing one supplier off against another. See CHAIN STORE, OLIGOPSONY, MONOPSONY.

bull a person who expects future prices in a STOCK EXCHANGE or COMMODITY MARKET to rise and who seeks to make money by buying shares or commodities. Compare BEAR. See SPOT MARKET, FUTURES MARKET, BULL MARKET.

bullion precious metals, such as GOLD, silver, platinum, etc., that are traded commercially in the form of bars and coins for investment purposes and are used to produce jewellery and as industrial base metals. Some items of bullion, gold in particular, are held by CENTRAL BANKS and are used as INTERNATIONAL RESERVES to finance balance of payments imbalances.

bullion market a MARKET engaged in the buying and selling of precious metals such as GOLD and silver and gold and silver coins such as ‘Krugerrands’ and ‘Sovereigns’. The London Bullion Market is a leading centre for such transactions.

bull market a situation where the prices of FINANCIAL SECURITIES (stocks, shares, etc.) or COMMODITIES (tin, wheat, etc.) are tending to rise as a result of persistent buying and only limited selling. Compare BEAR MARKET. See SPECULATOR.

Bundesbank the CENTRAL BANK of Germany.

burden of debt INTEREST charges on DEBT that arise as a result of BORROWING by individuals, firms and governments. In the case of governments, interest charges on the NATIONAL DEBT are paid for out of TAXATION and other receipts. The term ‘burden’ would seem to imply that government borrowing is a ‘bad’ thing insofar as it passes on financial obligations from present (overspending) generations to future generations. The fundamental point to emphasize, however, is that the interest paid on the national debt is a TRANSFER PAYMENT and does not represent a net reduction in the capacity of the economy to provide goods and services, provided that most of this debt is owed to domestic citizens.

INFLATION has the effect of eroding the real burden of debts, which are denominated in NOMINAL VALUES. See PUBLIC SECTOR BORROWING REQUIREMENT.

burden of dependency the non-economically active POPULATION of a country in relation to the employed and self-employed LABOUR FORCE. Dependants include very young, very old and disabled members of the community, their unpaid carers and the unemployed who must rely on the efforts of the labour force to provide them with goods and services. Countries with a proportionately large dependent population need to levy high taxes upon the labour force to finance the provision of TRANSFER PAYMENTS such as pensions, child benefit and unemployment benefit.

burden of taxation see TAX BURDEN.

business a supplier of goods and services. The term can also denote a FIRM. In economic theory, businesses perform two roles. On the one hand, they enter the market place as producers of goods and services bought by HOUSEHOLDS; on the other hand, they buy factor inputs from households in order to produce those goods and services. The term ‘businesses’ is used primarily in macro (national income) analysis, while the term ‘firms’ is used in micro (supply and demand) analysis. See also CIRCULAR FLOW OF NATIONAL INCOME MODEL.

business cycleortrade cycle fluctuations in the level of economic activity (ACTUAL GROSS NATIONAL PRODUCT), alternating between periods of depression and boom conditions.

The business cycle is characterized by four phases (see Fig. 20):

Fig. 20 Business cycle. Fluctuations in the level of economic activity.

(a) DEPRESSION, a period of rapidly falling AGGREGATE DEMAND accompanied by very low levels of output and heavy UNEMPLOYMENT, which eventually reaches the bottom of the trough;

(b) RECOVERY, an upturn in aggregate demand accompanied by rising output and a reduction in unemployment;

(c) BOOM, aggregate demand reaches and then exceeds sustainable output levels (POTENTIAL GROSS NATIONAL PRODUCT) as the peak of the cycle is reached. Full employment is reached and the emergence of excess demand causes the general price level to increase (see INFLATION);

(d) RECESSION, the boom comes to an end and is followed by recession. Aggregate demand falls, bringing with it, initially, modest falls in output and employment but then, as demand continues to contract, the onset of depression.

What causes the economy to fluctuate in this way? One prominent factor is the volatility of FIXED INVESTMENT and INVENTORY INVESTMENT expenditures (the investment cycle), which are themselves a function of businesses’ EXPECTATIONS about future demand. At the top of the cycle, income begins to level off and investment in new supply capacity finally ‘catches up’ with demand (see ACCELERATOR). This causes a reduction in INDUCED INVESTMENT and, via contracting MULTIPLIER effects, leads to a fall in national income, which reduces investment even further. At the bottom of the depression, investment may rise exogenously (because, for example, of the introduction of new technologies) or through the revival of REPLACEMENT INVESTMENT. In this case, the increase in investment spending will, via expansionary multiplier effects, lead to an increase in national income and a greater volume of induced investment. See also DEMAND MANAGEMENT, KONDRATIEF CYCLE, SECULAR STAGNATION.

Business Link a nationwide network of agencies that brings together the business support activities of many chambers of commerce, enterprise agencies, learning and skills councils and local authorities to provide a single local point of access for business information and advisory services to small and medium-sized businesses. The Business Link operates under the auspices of the SMALL BUSINESS SERVICE (SBS), an arm of the DEPARTMENT FOR TRADE AND INDUSTRY (DTI). See INDUSTRIAL POLICY.

business strategy the formulation of long-term plans and policies by a firm which interlock its various production and marketing activities in order to achieve its business objectives. See FIRM OBJECTIVES, COMPETITIVE STRATEGY, HORIZONTAL INTEGRATION, VERTICAL INTEGRATION, DIVERSIFICATION.

buyer a purchaser of a GOOD or SERVICE. A broad distinction can be made between purchasers of items such as raw materials, components, plant and equipment that are used to produce other products (referred to as ‘industrial buyers’) and purchasers of products for personal consumption (referred to as ‘consumers’).

In general, industrial buyers (in the main purchasing/procurement officers) are involved in the purchase of ‘functional’ inputs to the production process, usually in large quantities and often involving the outlay of thousands of pounds. Their particular concern is to obtain input supplies that are of an appropriate quality and possess the technical attributes necessary to ensure that the production process goes ahead smoothly and efficiently. In selling to industrial buyers, personal contacts, the provision of technical advice and back-up services are important.

Buyers of consumer goods, by contrast, typically buy a much wider range of products, mainly in small quantities. Purchases are made to satisfy some ‘physical’ or ‘psychological’ need of the consumer. Thus, it is important for suppliers to understand the basis of these needs and to produce and promote BRANDS that satisfy identifiable consumer demands. In this context, ADVERTISING and SALES PROMOTION are important tools for shaping consumers’ perceptions of a brand and establishing BRAND LOYALTY. See PRODUCT DIFFERENTIATION.

buyer concentration an element of MARKET STRUCTURE that refers to the number and size distribution of buyers in a market. In most markets, buyers are numerous, each purchasing only a tiny fraction of total supply. In some markets, however, most notably in INTERMEDIATE GOODS industries, a few large buyers purchase a significant proportion of total supply. Such situations are described as OLIGOPSONY, or, in the case of a single buyer, MONOPSONY.

Market theory predicts that MARKET PERFORMANCE will differ according to whether there are many buyers in the market, each accounting for only a minute fraction of total purchases, (PERFECT COMPETITION), or only a few buyers, each accounting for a substantial proportion of total purchases (oligopsony), or a single buyer (monopsony). See COUNTERVAILING POWER, MARKET CONCENTRATION, SELLER CONCENTRATION, BULK-BUYING.

buyer’s market a SHORT-RUN market situation in which there is EXCESS SUPPLY of goods or services at current prices, which forces prices down to the advantage of the buyer. Compare SELLER’S MARKET.

buy-in see MANAGEMENT BUY-IN.

buy-out see MANAGEMENT BUY-OUT.

by-product a product that is secondary to the main product emerging from a production process. For example, the refining of crude oil to produce petroleum generates a range of by-products like bitumen, naptha and creosote.

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Cadbury Committee Report see CORPORATE GOVERNANCE.

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

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

call option see OPTION.

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

Cambridge equation see QUANTITY THEORY OF MONEY.

CAP see COMMON AGRICULTURAL POLICY.

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

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

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

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

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

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

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

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

capital appreciation see APPRECIATION 2.

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

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

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

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

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

capital expenditure see INVESTMENT.

capital formation see CAPITAL ACCUMULATION.

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

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