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Economic Terms

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Capital goods

Goods that are used in the production of other goods and services e.g. machinery, computers, vehicles. They will create more value than consumer good and contribute to economic growth.

Capital Markets

Provides medium to long-term finance to firms and governments via long-term debt or equity. These instruments are illiquid as these instruments typically last for more than a year.

Below is a table to illustrate the methods in which different economic agents can obtain finance.

Capital Output Ratio

Measures the amount of capital that is needed to produce one unit of output and therefore is a measure of a country's capital productivity. This is one of two factors that the Harrod Domar Model states can affect economic growth substantially in developing and emerging economies.

Below is an illustration of how important the capital-output ratio is for development in emerging economies. If the capital-output ratio falls this is a positive note for a country's growth rate as it means less capital is needed to produce each extra unit of output. Therefore with the same capital input, output for a country should be boosted and generating a higher level of national income and output. However, if the ratio increases this reduces capital productivity per unit and leads to a lower level of output being produced and economic growth will slow.



Capital productivity

The quantity of output produced by each unit of capital.

Below is a table to show how capital productivity can vary with just one unit of labour operating them.

Capital spending

Money spent on infrastructure projects by the Government e.g. new schools and the high speed rail project (HS2). Funding is usually provided by borrowing money via the issue of Gilts so that the cost of capital projects can be spread to reflect the long term nature of the benefits the project is excepted to deliver.

Capital widening

Is when the capital levels increase at the same rate as labour input i.e. total capital increases but capital per worker remains constant.

Capital-output ratio

The amount of capital required to produce a given amount of goods. Assumed to be fixed within the model explaining the accelerator effect.

Capital-to-Loans Ratio

Is the amount of capital a bank needs to hold to back against a loan. The higher this ratio the smaler the maximum value of loans a bank can make and therefore the smaller the credit multiplier.


Factors of production are privately rather than state owned.


These are price fixing agreements where individual firms are given production quotas for the given market.

Below is a diagram showing how a cartel gets formed in an industry and how it affects each of the individual firms involved. If each of the firms involved charge a price of P at their given quota they will make a high level of supernormal profits (shown by the red box) whilst more importantly maximising industry profits (MR=MC). The idea is that if firms stick to this production quota, profits across the industry will be maximised.

But the issue with a cartel is that firms have an incentive to 'cheat' - by producing more than their subscribed quota to ensure they can increase their level of abnormal profits. The diagram below shows how a cheating firm can charge at a lesser price and produce above their quantity to increase individual profits (shaded orange box).


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