Economics

consumer price index (CPI) a weighted average of the PRICES of a general ‘basket’ of goods and services bought by consumers. Each item in the index is weighted according to its relative importance in total consumers’ expenditure (see Fig. 31). Starting from a selected BASE YEAR (index value = 100), price changes are then reflected in changes in the index value over time. Thus, in the case of the UK’s CPI, the current base year is 1996 = 100; in February 2005 the index value stood at 112.2, indicating that consumer prices, on average, had risen 12% between the two dates.

Since December 2003 the CPI has been used by the UK government as a measure of the rate of INFLATION in the economy for the purposes of applying macroeconomic policy in general and monetary policy in particular (see MONETARY POLICY COMMITTEE). Previously, the RETAIL PRICE INDEX (RPI) was used for this purpose, but the CPI measure was adopted to harmonize the way the UK measured its inflation rate with that of other countries in the EUROPEAN UNION.

consumer protection measures taken by the government and independent bodies such as the Consumers’ Association in the UK to protect consumers against unscrupulous trade practices such as false descriptions of goods, incorrect weights and measures, misleading prices and defective goods. See TRADE DESCRIPTIONS ACT 1968, WEIGHTS AND MEASURES ACT 1963, CONSUMER CREDIT ACT 1974, PRICE MARKETING (BARGAIN OFFERS) ORDER 1979, OFFICE OF FAIR TRADING, COMPETITION POLICY, CONSUMERISM.

Fig. 31 Consumer price Index. Source: Office of National Statistics.

consumer rationalityoreconomic rationality the assumption, in demand theory, that CONSUMERS attempt to obtain the greatest possible satisfaction from the money resources they have available when making purchases. Because economic theory tends to sum household demands in constructing market DEMAND CURVES, it is not important if a few households do not conform to rational behaviour as long as the majority of consumers or households act rationally. See ECONOMIC MAN.

consumer sovereignty the power of CONSUMERS to determine what is produced since they are the ultimate purchasers of goods and services. In general terms, if consumers demand more of a good then more of it will be supplied. This implies that PRODUCERS are ‘passive agents’ in the PRICE SYSTEM, simply responding to what consumers want. In certain kinds of market, however, notably, OLIGOPOLY and MONOPOLY, producers are so powerful vis-à-vis consumers that it is they who effectively determine the range of choice open to the consumer. See REVISED SEQUENCE.

consumers’ surplus the extra satisfaction or UTILITY gained by consumers from paying an actual price for a good that is lower than that which they would have been prepared to pay. See Fig. 32 (a). The consumers’ surplus is maximized only in PERFECT COMPETITION, where price is determined by the free play of market demand and supply forces and all consumers pay the same price. Where market price is not determined by demand and supply forces in competitive market conditions but is instead determined administratively by a profit-maximizing MONOPOLIST, then the resulting restriction in market output and the increase in market price cause a loss of consumer surplus, indicated by the shaded area PP

XE in Fig. 32 (b). If a DISCRIMINATING MONOPOLIST were able to charge a separate price to each consumer that reflected the maximum amount that the consumer was prepared to pay, then the monopolist would be able to appropriate all the consumer surplus in the form of sales revenue.

Business strategists can use the concept of the consumers’ surplus to increase the firm’s profit (see VALUE-CREATED MODEL). To illustrate: you are a Manchester United football fan; tickets for a home game are currently priced at £50 but you would be willing to pay £75. Hence, you have ‘received’ as a consumer ‘perceived benefit’ or ‘surplus’ of £25 over and above the price actually charged. Manchester United, however, instead of charging a single price of £50 could segment its market by charging different prices for admission to different parts of the ground (see PRICE DISCRIMINATION, MARKET SEGMENTATION) in order to ‘capture’ more of the consumers’ surplus for itself. Thus, it could continue to charge the ‘basic’ price of £50 for admission to certain parts of the ground, £75 for seating in the main stand and £120 for an ‘executive box’ seat. Compare PRODUCERS’ SURPLUS. See DIMINISHING MARGINAL UTILITY, DEADWEIGHT LOSS.

Fig. 32 Consumers’ surplus. (a) At the EQUILIBRIUM PRICE OP, utility from the marginal unit of the good is just equal to its price; all previous units yield an amount of utility that is greater than the amount paid by the consumer, insofar as consumers would have been prepared to pay more for these intramarginal units than the market price. The total consumer surplus is represented by the shaded area PEP

(b)The loss of consumers’ surplus because of monopoly.

consumption the satisfaction obtained by CONSUMERS from the use of goods and services. Certain CONSUMER DURABLE products, like washing machines, are consumed over a longish period of time, while other products, like cakes, are consumed immediately after purchase. The DEMAND CURVE for a particular product reflects consumers’ satisfactions from consuming it. See WANTS, DEMAND.

consumption expenditure the proportion of NATIONAL INCOME or DISPOSABLE INCOME spent by HOUSEHOLDS on final goods and services. Consumption expenditure is the largest component of AGGREGATE DEMAND and spending in the CIRCULAR FLOW OF NATIONAL INCOME. It is one of the most stable components of aggregate demand, showing little fluctuation from period to period.

In 2003, consumption expenditure accounted for 52% of gross final expenditure (GFE) on domestically produced output (GFE minus imports = GROSS DOMESTIC PRODUCT). See Fig. 132 (b), NATIONAL INCOME ACCOUNTS. See CONSUMPTION SCHEDULE, VEBLEN EFFECT.

consumption function a statement of the general relationship between the dependent variable, CONSUMPTION EXPENDITURE, and the various independent variables that determine consumption, such as current DISPOSABLE INCOME and income from previous periods and WEALTH. See CONSUMPTION SCHEDULE, LIFE-CYCLE HYPOTHESIS, PERMANENT-INCOME HYPOTHESIS, WEALTH EFFECT.

consumption possibility line see BUDGET LINE.

consumption schedule a schedule depicting the relationship between CONSUMPTION EXPENDITURE and the level of NATIONAL INCOME or DISPOSABLE INCOME, also called consumption function. At low levels of disposable income, households consume more than their current income (see DISSAVING), drawing on past savings, borrowing or selling assets in order to maintain consumption at some desired minimum level (AUTONOMOUS CONSUMPTION). At higher levels of disposable income, they consume a part of their current income and save the rest (see SAVING). See Fig. 33. See INDUCED CONSUMPTION.

Fig. 33 Consumption schedule. A simple consumption schedule that takes the linear form C = a + bY, where C is consumption and a is the minimum level of consumption expenditure at zero-disposable income (autonomous consumption). Thereafter consumption expenditure increases as income rises (induced consumption), and b is the proportion of each extra £ (pound) of disposable income that is spent. The 45-degree line OE shows what consumption expenditure would have been had it exactly matched disposable income. The difference between OE and the consumption schedule indicates the extent of dissavings or SAVINGS at various income levels. The slope of the consumption schedule is equal to the MARGINAL PROPENSITY TO CONSUME. See SAVINGS SCHEDULE, LIEE-CYCIE HYPOTHESIS, PERMANENT-INCOME HYPOTHESIS.

contestable market a MARKET where new entrants face costs similar to those of established firms and where, on leaving, firms are able to recoup their capital costs, less depreciation. Consequently, it is not possible for established firms to earn ABOVE NORMAL PROFIT as this will be eroded by the entry of new firms, or, alternatively, the mere threat of such new entry may be sufficient to ensure that established firms set prices that yield them only a NORMAL PROFIT return. Perfectly competitive markets (see PERFECT COMPETITION) are all contestable, but even some oligopolistic markets (see OLIGOPOLY) may be contestable if entry and exit are easily affected.

In recent times many markets have been opened up by a number of developments, including increasing international competition as trade barriers have been reduced, the introduction of FLEXIBLE MANUFACTURING SYSTEMS and E-COMMERCE trading on the INTERNET. See WORKABLE COMPETITION, CONDITION OF ENTRY, BARRIERS TO ENTRY, BARRIERS TO EXIT.

contingency theory the proposition that the best organization structure for a particular firm depends upon the specific circumstances that it faces and that there is no uniformly best organization structure for all firms in all circumstances. The appropriate organizational structure for a firm in particular circumstances seeks to balance ECONOMIES OF SCALE and ECONOMIES OF SCOPE in production and distribution; TRANSACTION COSTS; AGENCY COSTS; and information flows.

contract a legally enforceable agreement between two or more people or firms generally relating to a TRANSACTION for the purchase or sale of goods and services. Contracts may take a standardized form, with the same conditions of exchange being applied to every one of a large number of contracts, for example, airline ticket contracts. Alternatively, contracts may be lengthy and complicated because they are carefully tailored to a specific transaction such as the contract to build an office block for a client.

A complete contract stipulates each party’s responsibilities and rights for every contingency that could conceivably arise during the transaction. Such a complete contract would bind the parties to particular courses of action as the transaction unfolds, with neither party having any freedom to exploit weaknesses in the other’s position. It is difficult to develop complete contracts since parties to the contract must be able to specify every possible contingency and the required responses by the contracting parties, to stipulate what constitutes satisfactory performance, to measure performance, to make the contract enforceable and to have access to complete information about circumstances surrounding the contract.

In practice, most contracts are incomplete contracts in which the precise terms of the contract relating to product specifications, supply or delivery terms cannot be fully specified. In such situations, one or other parties to the agreement may be tempted to take advantage of the open-endedness or ambiguity of the contract at the expense of the other party. See ADVERSE SELECTION, MORAL HAZARD, ASYMMETRY OF INFORMATION, ASSET SPECIFICITY.

contract curve see EDGEWORTH BOX.

contractor a person or firm that enters into a CONTRACT enforceable in law with another person or firm to supply goods or services. For example, a house builder may employ contractors to undertake the plumbing work involved in the construction of houses rather than do this work itself. The plumbing contractor would provide, for the contract price, all piping, wire, tanks, etc., needed, plus the specialist workers to install them. In turn, the plumber may enter into an agreement with a subcontractor to install the time clocks and electrical controls for the central heating system.

contribution the difference between a product’s SALES REVENUE and its VARIABLE COSTS. If total contributions are just large enough to cover FIXED COSTS then the producer BREAKS EVEN; if contributions are less than fixed costs, the producer makes a LOSS; while if contributions exceed fixed costs then the producer makes a PROFIT. See LOSS MINIMIZATION, MARGINAL COST PRICING.

control loss see AGENCY COST.

conventional sequence see REVISED SEQUENCE.

convertibility the extent to which one foreign currency or INTERNATIONAL RESERVE ASSET can be exchanged for some other foreign currency or international reserve asset.

International trade and investment opportunities are maximized when the currencies used to finance them are fully convertible, i.e. free of FOREIGN EXCHANGE CONTROL restrictions.

convertible loans long-term LOANS to a JOINT-STOCK COMPANY that may be converted at the option of the lender into ORDINARY SHARES at a predetermined share price.

conveyance a document that transfers the legal ownership of land and buildings from one person/business to another person/business. See MORTGAGE.

cooperation 1 the process whereby FIRMS seek to coordinate their pricing and output policies rather than compete with one another in order to achieve JOINT-PROFIT MAXIMIZATION. See MUTUAL INTERDEPENDENCE, OLIGOPOLY.

2 the process whereby individuals coordinate their work in TEAMS.

cooperative a form of business FIRM that is owned and run by a group of individuals for their mutual benefit. Examples of cooperatives include:

(a) worker or producer cooperatives: businesses that are owned and managed by their employees, who share in the net profit of the business.

(b) wholesale cooperatives: businesses whose membership comprises a multitude of small independent retailers. The prime objective of such a group is to use its combined BULK-BUYING power to obtain discounts and concessions from manufacturers, similar to those achieved by larger SUPERMARKET chains.

(c) retail cooperatives: businesses that are run in the interest of customers, who hold membership rights entitling them to receive an annual dividend or refund in proportion to their spending at the cooperative’s shops. See WHOLESALER, RETAILER, DISTRIBUTION CHANNEL.

coordination the process whereby the specialized (see SPECIALIZATION) activities of different participants in an economy are synchronized. Coordination of TRANSACTIONS may take place through MARKETS or within ORGANIZATIONS. Within organizations, coordination is necessary to try to ensure that decisions within subunits of the organization are consistent with each other and with the objectives of the organization as a whole. See INTERNAL MARKETS.

copyright the ownership of the rights to a publication of a book, manual, newspaper, etc., giving legal entitlement and powers of redress against theft and unauthorized publication or copying. See INTELLECTUAL PROPERTY RIGHT.

Copyright, Designs and Patents Act 1988 a UK Act that provides for the establishment and protection of the legal ownership rights of persons and businesses in respect of various classes of ‘intellectual property’, in particular COPYRIGHTS, DESIGN RIGHTS and PATENTS.

The Act is administered in part by the PATENTS OFFICE, with cases of unauthorized copying, patent infringements, etc., being handled by the courts.

core business the particular products supplied by a firm that constitute the heart of its business. These are generally products in which the firm has a competitive advantage. Over time the firm may begin to supply other products that may be associated with its core business but are more peripheral to the firm and its operations. See DIVERSIFICATION.

core competence a key resource, process or system possessed by a firm that allows it to gain a COMPETITIVE ADVANTAGE over rivals.

core product a basic product such as a motor car. See TOTAL PRODUCT.

cornervb. to buy or attempt to buy up all the supplies of a particular product on the MARKET, thereby creating a temporary MONOPOLY situation with the aim of exploiting the market.

corporate bond see BOND.

corporate control the ability to exercise control over a public JOINT-STOCK COMPANY. In countries where shares in a large company are freely traded, if the incumbent directors and senior managers fail to achieve good profit and dividend performance, the price of the company’s shares will fall, making it possible for managers of another company to buy a majority of shares in the underperforming company and to gain control of it. This market for corporate control can exercise a restraining effect upon incumbent managers of a firm who are aware that they can lose their jobs if their company underperforms to the extent of provoking a takeover bid by other managers who feel that they can run the company more profitably. See CORPORATE GOVERNANCE, TAKEOVER, PRINCIPAL-AGENT THEORY, DIVORCE OF OWNERSHIP FROM CONTROL.

corporate governance