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tynamite's avatar First, a little bit of background.

Say you have a little country of your own, off on an island someplace. You and a few hundred friends, let's say it is. You have a government — monarchy, republic, whatever; doesn't matter. That government has a treasury, but the treasury has no money in it. Which is fine … so long as you don't actually want your government to do anything. If you just want to be able to say you have a government, knock yourself out; nobody can stop you. But as soon as you want that government to do stuff — like hiring police officers, or raising an army — you need money in your treasury.

The way this works is simple: Your treasury issues bonds. A bond is sort of like a very ritualized type of loan. You sell bonds with the promise to, after a set amount of time, buy them back for more than what you sold them for. So say you could sell a bond for $100, with the promise to buy it back in a year for $110. The difference between how much you promise to buy the bond back for and how much it sells for, expressed as a percentage, is called the interest, and the date on which you promise to buy it back is called the maturity.

Who buys bonds? Who cares? Literally anybody with money can buy these bonds. Maybe those are private citizens in your country, maybe it's your central bank (that's how you create money in your economy in the first place), or maybe it's private citizens or other concerns in other countries. Point is, you offer the bonds for sale, and people agree to buy them. Thus do you get money in your treasury.

Of course, people will only agree to buy your treasury's bonds if they think there's a good chance your treasury will buy them back when it promises to. If there's reason to doubt your treasury's willingness or ability to buy the bonds back, the people who have the money to buy them will demand a higher rate of interest to justify the higher risk.

If there's a lot of reason to doubt your treasury's willingness or ability to pay, potential bond buyers might demand an impossibly high interest rate, making it effectively impossible for you to sell bonds, which in turn means it's effectively impossible for you to fund your government's activities.

When one of those government activities you can no longer fund is redeeming previously issued bonds, you've got yourself a sovereign debt crisis. And when a debt crisis gets really bad, you've got yourself a sovereign default situation.

So your question is what happens in a sovereign default situation? Well, most of the time the answer is that doesn't come up, because people, on the whole, aren't complete idiots. You can see a sovereign default situation coming from a mile away. When confidence in your bonds drops, and the demand price rises as a result, it's clear that you're going to have a problem in the future if you don't take measures to prevent it. So people, as a rule, tend to have plenty of chances to see these things coming and avert them.

But sometimes that doesn't happen. (In the case of Greece, it didn't play out that way because there was a big disconnect between the perceived value of Greek sovereign bonds and their actual value, due to what we could charitably call reporting irregularities. When that disconnect was resolved, the market value of Greek sovereign bonds dropped like a rock practically overnight.) In those cases — where a sovereign default situation occurs anyway — one of two things can happen.

Most of the time, you end up with what's called a controlled default. This includes two parts: a restructuring of the sovereign debt, and a guarantor.

In the broadest terms, sovereign debt restructuring just means rearranging things to reduce the debt burden on the treasury in question. That might mean getting holders of bonds to agree to new terms of repayment, or it might mean somebody buying up a bunch of bonds on the open market and then destroying them, whatever. It's usually very complicated, but the general principle is that the country's sovereign debt obligation is changed to reduce the scope of the problem and increase the chance that the holders of those bonds will get at least some return on their investment.

A guarantor, on the other hand, is some body that injects capital into the treasury to cover bond repayments. In the modern era, that's usually the International Monetary Fund, or IMF. The IMF functions much like an insurance underwriter: Countries pay into the fund as they can, and in return receive the right to draw on the fund if needed. In a sovereign default situation, the IMF will extend loans to the troubled treasury — usually loans with lots of very short strings attached — to guarantee the treasury retains the ability to redeem its outstanding bonds as it recovers from its debt crisis. Having a guarantor is good, because it raises market confidence in your ability and willingness to buy back new bonds, meaning you can get money flowing through your treasury again, which is how you climb out of a debt crisis.

But remember I said that only happens — the thing with the restructuring and the guarantor — most of the time. It's also entirely possible for a government to just say "screw it, we ain't payin'." When that happens — and it's worth remembering that in the modern era it's exceedingly rare — the people who hold those bonds just take it in the shorts. The bonds become absolutely, literally worthless; you're better off burning them to heat your house than you are holding on to them in the hope of future repayment.

Of course, the failure of a government to buy back its bonds doesn't just render those bonds worthless. It renders all future bonds issued by the same treasury worthless. Because once a government exercises its power — and it is a power; nobody can stop it from happening — to nullify its bonds, what's to stop it from using that power again the next time a series of bonds matures? Nothing, is the answer. So once a government has demonstrated its willingness to say "screw you" to investors, faith in that government is ruined forever. Meaning that government can no longer fund its operations, meaning it can no longer do anything, meaning it no longer has any reason to exist, as far as its people are concerned. That's how you end up with things like the fall of the Weimar Republic … which is precisely why today we have this vast infrastructure in place to keep things from getting to that point.

Why can't this sovereign nation just create lets say 1 million "money" and hire police/workers/etc who then start buying stuff from bakers/butchers etc who then pay taxes and get the society running, why do they need to sell bonds for dollars?

Ah, great question. The answer is that selling bonds is how you create money in the first place.

Here's how initial money creation works in a modern economy: You start by establishing two institutions. First you need a treasury, and second you need a central bank.

The treasury has exactly two powers: It can sell bonds for money, and it can spend money. That's it. That's all the treasury has the power to do.

The central bank, on the other hand, also has exactly two powers: It can buy government bonds, and it can sell government bonds. But there's a catch. When the central bank buys government bonds, it creates the money to do so out of thin air. And when the central bank sells government bonds, the money it takes in return for them vanishes from existence.

The central bank, then, is a money source and a money sink. It has an infinite supply of money, in the sense that it can create money out of nothing, but it's also a monetary black hole into which money flows and then disappears.

So in the initial condition, the treasury has the power to issue bonds, but it has no actual money. The central bank has, in a sense, infinite money, but all it can do with that money is buy government bonds. So what do you do? Duh. You have the treasury issue a series of bonds and sell them to the central bank; the central bank wishes the necessary money into existence and then gives it to the treasury in exchange for the bonds. The treasury then goes and spends that money on stuff — like paying police officers for example — and that's how money gets out into the economy.

But the central bank is not the sole source of money in the economy. There are also commercial banks, also called lending institutions. They create money too. Here's how:

Remember that police officer the government hired, and how he gets paid out of the treasury? Well, he doesn't want to just carry a big sack of currency around with him all the time, so he finds a bank and opens an account. He deposits his money into his account — say it's $100. The bank is allowed, by law, to lend out $90 of that $100 in loans to the community. Somebody else — Alice, we'll call her — goes to the bank and asks to borrow $90 to start a business. Alice has no money, because remember, the economy just started like five minutes ago. But she does have a business plan, and the bank manager likes it, so he agrees to lend her the money.

Alice takes her newly-borrowed $90 and uses it to buy something from Bob, something she needs to start her business. I dunno, maybe she's starting a gardening business and needs to buy a rake, whatever, doesn't matter. Point is, Bob has something Alice needs but no money; Alice has the $90 she borrowed from the bank that came out of the government-employed police officer's deposit account that holds the $100 he got paid by the treasury which came out of the money the treasury got from the central bank by the sale of bonds which were paid for by money the central bank literally wished into existence.

Pant, pant.

Okay, so anyway, Alice gives her $90 to Bob, who gives her the rake. Alice goes off and starts her gardening business. Bob, meanwhile, now has $90 that he didn't have before. He doesn't want to carry that around, so he goes to the local bank and opens an account of his own — that same bank that holds Alice's loan and the cop's deposit account. Bob deposits his $90 into his new account and calls it a good day.

We just made $90 out of nothing. Our cop deposited $100, the bank lent out $90 of that, that $90 was used to buy something, the person who sold that thing deposited that $90 in the bank, and now there's a total of $190 on deposit at the bank, even though all we did was move some money around.

When we say that wealth is created by the movement of capital, we aren't kidding around.

Of course, it's not really right to say that we created that $90 out of nothing. That $90 on deposit at the bank is actually backed by Alice's promise to pay back the loan she got. And Alice's promise is, in turn, backed by both her ability and her willingness to earn money in the future by working. So what that $90 in Bob's deposit account really represents is Alice's future labor.

So every dollar in the economy is backed by a dollar of debt. Bob's bank account balance is backed by Alice's debt to the local bank, the cop's paycheck is backed by the treasury's debt to the central bank. For every dollar that exists in the world, you can — if you had access to all the information, which you don't, because it's none of your business where other people get their money — trace it back to some debt somewhere. There's a one-to-one correspondence between dollars in circulation and dollars of debt.

Why do we do it this way? Well, we could dive in to all the various ifs and buts of the thing, but the bottom line is we do it this way because it works. Seriously. It's that simple. No other economic system that's ever been tried has proven to work as consistently, as reliably, and as scalably as the treasury/central bank/fractional reserve lending system we're talking about here. And that counts for a lot, y'know?

Still not clear on the extra 90 dollars. The bank loaned out the police officers money which was subsequently deposited by Bob. What if Bob and the police officer both wanted to take out their money (90 and 100). This would exceed what the bank has correct?

No, but that's a good question.

There are two topics here that are closely related but distinct: solvency and liquidity.

A bank has to be liquid. That is to say, it must have enough cash on hand (or very quick access to cash, as in minutes or hours at most) to cover withdrawals. Have you ever gone to an ATM and found that you can't make a withdrawal because that ATM is out of money? If you were to imagine that that ATM represents the whole entire bank, that's a liquidity problem. The bank literally doesn't have the cash on hand to give you what you ask for.

But solvency is a different matter. To be solvent, in simplistic terms, means a bank's assets must equal or exceed its liabilities. Your demand deposit account is a liability, as far as the bank's concerned. But in the example above, Alice's loan is an asset. An asset is something that isn't money, but is worth money and can be (in principle) converted to money. Our cop's deposit account and Bob's account are the liabilities in our little story; they're equal to $190 total. The bank only has $100 in cash on hand … but it holds Alice's loan, which is an asset worth $90. So the sum of the bank's assets and the bank's liabilities are equal, meaning the bank is solvent. (In real life, Alice's loan would be worth more than $90. Why? Because the bank manager who signed off on the loan would damn well have made sure it was!)

So what would happen in our little story if both Bob and the cop showed up looking to withdraw all their funds? Well, clearly one of them would get there first. Let's say that's Bob. He withdraws $90. No problem; the banker takes $90 out of the shoebox (or whatever) and hands it over, thank you sir, have a nice day.

But then the cop asks for his $100 … and the bank can't give it to him, because there's only $10 left in the shoebox. What happens? The bank managers says, "It'll take just a few minutes, sir, please have a seat, would you like a cup of coffee?" and then gets on the phone.

Who does the bank manager call? Well, if this bank is just one branch of an institution, he calls his boss. "Can you send over a truck full of cash? We're short," he says. Then at another branch somewhere across town, some guys with tasers throw sacks of cash into a truck and drive it over. In minutes, the cop has his cash.

But what if this were the only branch of this bank? The bank manager would call the central bank and ask for an overnight loan against assets. The conceit would be that this is a temporary liquidity shortfall, and it'll solve itself the next day when people come in and make deposits. So the banker can borrow a reasonable amount of currency — careful here: currency, not money — from the central bank against its illiquid asset reserve, that being Alice's $90 loan. Of course, in this case the bank is cutting it very close to the bone, since this is just an example and we haven't talked about things like cash flow or interest or anything like that. But suffice to say, the bank manager gets his overnight loan.

Where does that currency come from? From another bank. The central bank, remember, only has the power to buy and sell government bonds; it doesn't extend loans to banks in our little example story. So what happens is the central banker calls up another bank across town that's cash-flush and asks to borrow some currency, offering such-and-such interest for it. The bank puts the money in a truck and drives it over to our bank, and the cop takes his withdrawal, having been inconvenienced by having to wait, but not terribly so.

The next day, when other depositors come in and make their deposits, the bank ends up cash-flush again, and puts the currency it borrowed in a truck and drives it back over to wherever it came from.

Now, in the real world, it's more complicated than that. There are other mechanisms in place to provide liquidity to solvent banks, and they're quite detailed. But that's the general principle. A bank doesn't have to be liquid every single day; it just has to be solvent. A bank that can't consistently maintain liquidity has a relatively minor customer-service problem — people have to wait longer than they'd like for their withdrawals to be taken care of — but a bank that can't maintain solvency has a very big business problem.

Source: https://www.reddit.com/r/explainlikeimfive/comments/lhffb/what_happens_when_a_country_defaults_on_its_debt/
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tynamite's avatar It's hard to explain this to a five-year-old, because there are some fairly abstract concepts involved, but here goes...

All actual "money" is debt. All of it, including monetary gold, etc. (Don't argue with me yet, I'll get to that.)

Imagine a pretend world with no money, some kind of primitive villiage or something. Now let's invent paper money. You can't just print a bunch of paper that says people have to give you stuff, because nobody would honor it. But you could print IOUs. Let's walk through this...

  • Let's say you're an apple-farmer and I'm a hunter. You want some meat but haven't harvested your crops yet. You say to me, "hey, go hunt me some meat and I'll give you 1/10th of my apple harvest in the fall". Fair enough, I give you meat, you owe me apples. There's probably a lot of this kind of stuff going on, in addition to normal barter. In time, standard "prices" start to emerge: a deer haunch is worth a bushel of apples, or whatever.
  • Now, let's say a week later, I realize that my kid needs a new pair of shoes more than I need a bushel of apples. I come back to you and say, "Hey remember that bushel of apples you owe me? Could you write a marker, redeemable for one bushel of apples, that I can give to the shoemaker in trade for a pair of shoes?" You say okay, and we have invented a transferable note, something a lot like money.
  • In time, our little villiage starts to figure out that a note redeemable for a bushel of apples can be swapped for all kinds of things. The fisherman who doesn't even like apples will accept apple-certificates in trade for fish, because he knows he can trade them to boat-builder who loves apples. In time, you can even start to hire farm-workers without giving them anything except a note promising a cut of the future harvest.

Now, you are issuing debt: a promise to provide apples. The "money" is a transferable IOU-- your workers get a promise to provide value equal to a day of farm-work, or whatever, and it's transferrable, so they can use it to buy whatever they want. The worker gets fish from the fisherman, not in exchange for doing any work or giving him anything he can use, but in exchange for an IOU that the fisherman can redeem anywhere.

So far so good. But there are a couple of forks in the road here, on the way to a realistic monetary system, that we'll address separately:

  • What happens if your apple orchard is destroyed in a wildfire? Suddenly all the notes that everyone has been trading are basically wiped out. It didn't "go" anywhere, it's just gone, it doesn't exist. Real value was genuinely destroyed. There is no thermodynamic law of the conservation of monetary value-- just as you and I created it by creating transferable debt, it can also be genuinely destroyed. (We'll get back to this in a minute, it gets interesting).
  • The second issue is that, in all probability, the whole town is not just trading apple-certificates. I could also issue promises to catch deer, the fisherman could issue promises of fish, and so on. This could get pretty messy, especially if you got the notion to issue more apple-certificates than you can grow: you could buy all kinds of stuff with self-issued debt that you could never repay, and the town wouldn't find out until harvest-time comes. Once again, value has been "destroyed" people worked and made stuff and gave you stuff in exchange for something that doesn't exist, and will never exist. All that stuff they made is gone, you consumed it, and there is nothing to show for it.

The above two concerns are likely to become manifest in our village sooner or later, and probably sooner. This leads to the question of credit, which is, at its most basic, a measure of credibility. Every time you issue an apple-certificate, you are borrowing, with a promise to repay from future apple-harvests.

After the first couple of town scandals, people will start taking a closer look at the credibility of the issuer. Let's say the town potato-farmer comes up with a scheme where his potato-certificates are actually issued by some credible third-party, say the town priest or whatever, who starts every growing season with a book of numbered certificates equal to the typical crop-yield and no more, and keeps half of the certificate on file, issuing the other half. Now there is an audit trail and a very credible system that is likely to earn the potato-grower a lot of credit, compared to other farmers in town. That means that the potato-grower can probably issue more notes at a better exchange rate than some murkier system. Similarly, the town drunk probably won't get much value for his certificates promising a ship of gold.

Now we have something like a credit market emerging, and the potato-farmer is issuing something closer to what we might call a modern "bond"..

  • So some time goes by and people start catching onto this system of credit-worthiness, and farmers and fishermen and so on start to realize that they can get better value for their IOUs by demonstrating credibility. People with shakier reputations or dubious prospects may not be able to "issue money", or might only be able to do so at very high "interest". E.g., a new farmer with no track-record might have to promise me twice as many potatoes in exchange for a deer haunch, due to the risk that I might never see any potatoes at all.
  • This obviously gets very messy fast, as different apple- and potato-certificates have different values depending on whether they were issued by Bob or Jane, and everyone has to keep track of and evaluate whose future apples are worth what.
  • Some enterprising person, maybe the merchant who runs the trading-post, comes up with the idea to just issue one note for all the farms in town. He calls a meeting with all the farmers, and proposes to have the town priest keep a book of certificates and so on, and the farmers will get notes just like everyone else in exchange for the crops they contribute to the pool, and the merchant will keep a cut of the crops with which to hire some accountants and farm-surveyors to estimate the total crop yields across town and so on.
  • Everyone agrees (or at least, enough farmers agree to kind of force the other ones to get on-board if they want to participate meaningfully in the town economy), and we now have something like a central bank issuing something like fiat currency: that is, currency whose value is "decided" by some central authority, as opposed to the kind of straight-up exchange certificates that can be traded for an actual apple from the issuer, for example.
  • Now we have something that looks a lot like a modern monetary system. The town can set up audit committees or whatever, but the idea is that there is some central authority basically tasked with issuing money, and regulating the supply of that money according to the estimated size of ongoing and future economic activity (future crop yields).
  • If they issue too much money, we get inflation, where more apple-certificates are issued than apples grown, and each apple-note ends up being worth only three-quarters of an apple come harvest-time. If they issue too little currency, economic activity is needlessly restricted: the farmers are not able to hire enough workers to maximize crop yields and so on, the hunter starts hunting less because his deer meat is going bad since nobody has money to buy it, and so on.

At this point, you may be asking, "Why the hell go through all this complexity just to trade apples for deer and shoes? Isn't this more trouble than it's worth?"

shoes? Isn't this more trouble than it's worth?"

The answer is because this is a vastly more efficient system than pure barter. I, as a hunter, no longer need to trade a physical deer haunch for a bushel of apples to carry over to the shoemaker in order to get shoes. You, as an apple-farmer, can hire workers before the crop is harvested, and therefore can grow more, and your workers can eat year-round instead of just getting a huge pile of apples at harvest-time to try and trade for for whatever they will need for the rest of the year.

So back to money...

The thing to remember is that all throughout, from the initial trade to this central-banking system, all of this money is debt. It is IOUs, except instead of being an IOU that says "Kancho_Ninja will give one bushel of apples to the bearer of this bond in October", it says "Anyone in town will give you anything worth one bushel of apples in trade."

The money is not an actual thing that you can eat or wear or build a house with, it's an IOU that is redeemable anywhere, for anything, from anyone. It is a promise to pay equivalent value at some time in the future, except the holder of the money can call on anybody at all to fulfill that promise-- they don't have to go back to the original promiser.

This is where it starts getting interesting, and where we can start to answer your question...

(for the sake of simplicity, let's stop calling these notes "apple certificates", and pretend that the village has decided to call them "Loddars").

  • So now you're still growing apples, but instead of trading them for deer-haunches and shoes, you trade them for Loddars. So far, so good.
  • Once again, you want some meat, except harvest time hasn't come yet so you don't have any Loddars to buy meat with. You call me up (cellphones have been invented in this newly-efficient economy), "Hey otherwiseyep, any chance you could kill me a deer and I'll give you ten Loddars for it at harvest-time?"
  • I say, "Jeez, I'd love to, but I really need all the cash I can get for every deer right now: my kid is out-growing shoes like crazy. Tell you what: if you can write me a promise to pay twelve Loddars in October, I can give that to the shoe-maker." You groan about the "interest rate" but agree.

Did a lightbulb just go off? You and I have once again created Money. Twelve loddars now exist in the town economy that have not been printed by the central bank. Counting all the money trading hands in the village, there are now (a) all the loddars that have ever been printed, plus (b) twelve more that you have promised to produce.

This is important to understand: I just spent money on shoes, which you spent on deer meat, that has never been printed. It's obviously not any of the banknotes that have already been issued, but it's definitely real money, because I traded it for new shoes, and you traded it for a dead deer.

  • Once you and I and others start to catch on that this is possible, that we can spend money that we don't have and that hasn't even been printed yet, it is entirely possible for a situation to arise where the total amount of money changing hand in the village vastly exceeds the number of loddars that have actually been printed. And this can happen without fraud or inflation or anything like that, and can be perfectly legitimate.
  • Now, what happens if another wildfire hits your orchard? Those twelve loddars are destroyed, they are gone, the shoe-maker is twelve loddars poorer, without spending it and without anyone else getting twelve loddars richer.

The money that bought your deer and my shoes has simply vanished from the economy, as though it never existed, despite the fact that it bought stuff with genuine economic utility and value.

Sidebar on gold and gold-backed currency and stuff like that:

Because I said I would get to it...

The above pretend history of the pretend village is not how modern money actually came to be. In reality, things are much less sequential and happen much more contemporaneously without the "eureka!" moments. The above was a parable to illustrate how money works to a 5-year-old, not an actual history of how money emerged.

Until fairly recent times, paper money was not really very useful or practical for most purposes, especially if you wanted to spend money in a different village than where it was printed.

If we go back in time a period before ATMs, wire-transfers, widespread literacy, etc, then a piece of paper written in Timbuktu is not likely to get you very far in Kathmandu. You could take your apples and deer-haunches and shoes around with you to trade, but the earliest naturally-emerging currencies tend to be hard things that were rare and easily-identifiable (jewels, colored shells, etc), and they frequently coincided with the personal decorations of the rich, in a self-reinforcing feedback loop (people with a surplus of time and food could decorate themselves with pretty things, which became valuable as status symbols, which made them more valuable as decorations, which made them more valuable as barter objects, which made them more prestigious shows of wealth, etc).

Gold emerged as a sort of inevitable global currency, before people even thought of it as currency. It is rare, portable, easy to identify, can easily be made into jewelry, and can be easily quantified (unlike, say, jewels or seashells, which are harder to treat as a "substance"). Once word got around that rich people like it, it became easy to barter with anyone, anywhere, for anything.

In the early stages, it was not really the same thing as "money", it was just an easy thing to barter. But it had money-like characteristics:

  • If someone walked into your apple-orchard offering to trade a yellow rock for apples, you might look at them a little funny. What use does an apple-grower have for a yellow rock?
  • But if you know that rich people in town covet this soft yellow metal as something they can make jewelry out of, then you might be happy to trade apples for it.
  • Once everyone knows that rich people will trade for this stuff, it becomes something like actual currency: neither the hunter, the shoemaker, nor the fisherman in town has much use for it, but because they know they can redeem it for the stuff they do want and need, it becomes a sort of transferable IOU that can be redeemed anywhere, i.e., money.

The early history of paper money did not evolve the way I described in the earlier posts (although it could have, and would have got to the same place). Instead, the early history of paper money was certificates issued by storage-vaults of precious metals (i.e., early "banks"). Instead of carrying around yellow and silver rocks, you could deposit them somewhere and get a piece of paper entitling the holder to withdraw a certain quantity of gold or silver or whatever.

Pre-1934 dollars, like virtually all paper currency until fairly recently, could be redeemed for physical gold or silver at a Federal Reserve Bank, and dollars were only printed if the treasury had enough physical gold and silver to "pay off" the bearer with precious metals.

For a whole lot of reasons that are topics for another discussion, decisions were made that eventually led to the abandonment of the "gold standard" and now the dollar, like most modern currencies, is pure fiat paper: it's only "worth" whatever everyone agrees it is worth, and can only be "redeemed" by trading it to someone else for whatever they will give you for it. There are long, loud, and ongoing feuds over whether that was a good idea, and I'm not going to get into that here.

Source: https://www.reddit.com/r/finance/comments/utf5u/where_has_all_the_money_in_the_world_gone/
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tynamite's avatar

Imperfections and Distortions Defined

Market imperfections and distortions, generally, mean any deviation from the assumptions of perfect competition. Many of the assumptions in a perfectly competitive model are implicit rather than explicit. That is, they are not always stated.

Below is a description of many different types of imperfections and distortions.

Monopoly, Duopoly and Oligopoly

Perhaps the most straightforward deviation from perfect competition occurs when there are a relatively small number of firms operating in an industry. At the extreme, one firm produces for the entire market in which case the firm is referred to as a monopoly. A monopoly has the ability to affect both its output and the price that prevails on the market. A duopoly consists of two firms operating in a market. An oligopoly represents more than two firms in a market but less than the many, many firms assumed in a perfectly competitive market. The key distinction between an oligopoly and perfect competition is that oligopoly firms have some degree of influence over the price that prevails in the market. In other words each oligopoly firm is large enough, relative to the size of the market, that changes in its output cause a change in the equilibrium price in the market.

Another key feature of these imperfectly competitive markets is that the firms within them make positive economic profits. The profits, however, are not sufficient to encourage entry of new firms into the market. In other words free entry in response to profit is not allowed. The typical method of justifying this is by assuming that there are relatively high fixed costs. High fixed costs, in turn, implies increasing returns to scale. Thus most monopoly and oligopoly models assume some form of imperfect competition.

Large Countries in International Trade

Surprisingly, "large" importing countries and "large" exporting countries have a market imperfection present. This imperfection is more easily understood if we use the synonymous terms for "largeness," monopsony and monopoly power. Large importing countries are said to have "monopsony power in trade", while large exporting countries are said to have "monopoly power in trade." Let's first consider monopoly power.

When a large exporting country implements a trade policy it will affect the world market price for the good. That is the fundamental implication of largeness. For example, if a country imposes an export tax, the world market price will rise because the exporter will supply less. It was shown in Section 90-23 that an export tax set optimally will cause an increase in national welfare due to the presence of a positive terms of trade effect. This effect is analagous to that of a monopolist operating in it's own market. A monopolist can raise its profit (i.e., its firm's welfare) by restricting supply to the market and raising the price it charges its consumers. In much the same way a large exporting country can restrict its supply to international markets with an export tax, force the international price up, and create benefits for itself with the terms of trade gain. The term monopoly "power" is used because the country is not a pure monopoly in international markets. There may be other countries exporting the product as well. Nonetheless, because its exports are a sufficiently large share of the world market, the country can use its trade policy in a way that mimics the effects caused by a pure monopoly, albeit to a lesser degree. Hence the country is not a monopolist in the world market but has "monopoly power" instead.

Similarly, when a country is a large importer of a good we say that it has "monopsony power." A monoposonist represents a case in which there is a single buyer in a market where there are many sellers.A monopsonist raises his own welfare or utility by restricting his demand for the product and thereby forcing the sellers to lower their price to him. By buying fewer units at a lower price the monopsonist becomes better-off. In much the same way, when a large importing country places a tariff on imports, the country's demand for that product on world markets falls, which in turn lowers the world market price. It was shown in Section 90-8 that an import tariff set optimally will raise national welfare due to the positive terms of trade effect. The effects in these two situations are analogous. We say that the country has monopsony "power" because the country may not be the only importer of the product in international markets, yet because of its large size it has "power" like a pure monopsonist.


Externalities represent economic actions which have effects external to the market in which the action is taken. Externalities can arise out of production processes (production externalities) or out of consumption activities (consumption externalities). The external effects can be beneficial to others (positive externalities) or detrimental to others (negative externalities). Typically because the external effects occur to someone other than the producer or consumer, they do not take the effects into account when they make their production or consumption decision. We shall consider each type in turn.

Positive Production Externalities

Positive production externalities occur when production has a beneficial effect in other markets in the economy. Most examples of positive production externalities incorporate some type of learning effect.

For example, manufacturing production is sometimes considered to have positive spillover effects, especially for countries that are not highly industrialized. By working in a factory, the production workers and managers all learn what it takes to operate the factory successfully. These skills develop and grow over time, a process sometimes referred to as learning-by-doing. The skills acquired by the workers, however, are likely to spill over to others in the rest of the economy. Why? Because workers will talk about their experiences with other family members and friends. Factory managers may teach others their skills at local vocational schools. Some workers will leave to take jobs at other factories, carrying with them the skills that they acquired at the first factory. In essence, learning spillovers are analogous to infectious diseases. Workers who acquire skills in one factory, in turn, will "infect" other workers that the come into contact with and will spread the skill disease through the economy.

A similar story is told concerning research and development (R&D). When a firm does R&D, its researchers learn valuable things about production which in turn are transmitted through the rest of the economy and have positive impacts on other products or production processes.

Negative Production Externalities

Negative production externalities occur when production has a detrimental effect in other markets in the economy. The negative effects could be felt by other firms or by consumers. The most common example of negative production externalities involve pollution or other environmental effects.

Thus when a factory emits smoke into the air, the pollution will reduce the well being of all of the individuals who must breathe the polluted air. The polluted air will also likely require more frequent cleaning by businesses and households, raising the cost incurred by them.

Water pollution would have similar effects. A polluted river cannot be used for recreational swimming or at least reduces swimmers' pleasures as the pollution rises. The pollution can also eliminate species or flora and fauna and change the entire ecosystem.

Positive Consumption Externalities

Positive consumption externalities occur when consumption has a beneficial effect in other markets in the economy. Most examples of positive consumption externalities involve some type of aesthetic effect.

Thus when a homeowner landscapes their property and plants beautiful gardens, it benefits not only themselves but neighbors and passers-by as well. In fact, an aesthetically pleasant neighborhood where yards are neatly kept and homes are well-maintained would generally raise the property values of all houses in the neighborhood.

One could also argue that a healthy lifestyle has positive external effects on others by reducing societal costs. A more healthy person would reduce the likelihood of expensive medical treatment and lower the cost of insurance premiums or the liability of the government in state-funded healthcare programs.

Negative Consumption Externalities

Negative production externalities occur when consumption has a detrimental effect in other markets in the economy. Most examples of negative consumption externalities involve some type of dangerous behavior.

Thus a mountain climber in a national park runs the risk of ending up in a precarious situation. Sometimes climbers become stranded due to storms or avalanches. This usually leads to expensive rescue efforts, the cost of which is generally borne by the government and hence the taxpayers.

A drunk driver places other drivers at increased risk. In the worst outcome the drunk driver causes the death of another. A smoker may also put others at risk if second-hand smoke causes negative health effects. At the least though, cigarette smoke does bother non-smokers when smoking occurs in public enclosed areas.

Public Goods

Public goods have two defining characteristics: non-rivalry and non-excludability. Non-rivalry means that the consumption or use of a good by one consumer does not diminish the usefulness of the good to another. Non-excludability means that once the good is provided it is exceedingly costly to exclude non-paying customers from using it. The main problem posed by public goods is the difficulty of a free market to get people to pay for them.

The classic example of a public good is a lighthouse perched on a rocky shoreline. The lighthouse sends a beacon of light outward for miles warning every passing ship of the danger nearby. Since two ships passing are equally warned of the risk, the lighthouse is non-rival. Since it would be impossible to provide the lighthouse services only to those passing ships that paid for the service, the lighthouse is non-excludable.

The other classic example of a public good is national security or national defense. The armed services provide security benefits to everyone who lives within the borders of a country. Also, once provided it is difficult to exclude non-payers.

Information has public good characteristics as well. Indeed this is one reason for the slow start of electronic information services on the world wide web. Once information is placed onto a web site it can be accessed and used by millions of consumers almost simultaneously. Thus it is non-rivalrous. Also, it can be difficult to exclude non-paying customers from accessing the services.

Non-Clearing Markets

A standard assumption in general equilibrium models is that markets always clear. That is, supply equals demand at the equilibrium. In actuality, however, markets do not always clear. When this arises, for whatever reason, the market is distorted.

The most obvious case of a non-clearing market occurs when there is unemployment in the labor market. Unemployment could arise if there is price stickiness in the downward direction. If firms are reluctant to lower their wages in the face of restricted demand, then unemployment would arise. Alternatively, unemployment may arise because of costly adjustment when some industries expand while others contract. As described in the immobile factor model, many factors would not immediately find alternative employment after being laid off from a contracting industry. In the interim, the factors must search for alternative opportunities, may need to relocate to another geographical location, or may need to be retrained. During this phase the factors remain unemployed.

Imperfect Information

One key assumption often made in perfectly competitive models is that agents have perfect information. If some of the participants in the economy do not have full and complete information in order to make decisions then the market is distorted.

For example, suppose entrepreneurs did not know that firms in an industry were making positive economic profits. Without this information, new firms would not open to force economic profit to zero in the industry. As such, imperfect information can create a distortion in the market.

Policy-Imposed Distortions

Another type of distortion occurs when government policies are set in markets which are perfectly competitive and exhibit no other distortions or imperfections. These were labeled policy-imposed distortions by Bhagwati.

Thus suppose the government of a small country sets a trade policy, such as a tariff on imports. In this case the equilibrium that arises with the tariff in place represents a distorted equilibrium.

International Trade Theory and Policy - Chapter 100-1: Last Updated on 10/28/01
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tynamite's avatar That it's a threat that must be destroyed.

facebook.com gets more traffic than google.com

News websites and blogs get more traffic from facebook.com than google.com . All Perez Hilton has to do is make a wall post or upload an image on his Facebook page or post a link to his page wall and BOOM, loads of website traffic.

Information on Facebook cannot be indexed by Google making Facebook a walled garden.

Google wants you to use their search engine to get information so they can control and dictate the internet. Facebook wants you to use your friends to get decisions so each person will get a different result for "What restaurants are good in birmingham" as a wall post than to use "Birmingham restaurants" in Google.

More games are played from Facebook applications than are played on online flash websites? Why? Because rather than game developers rely on paying for advertising and backlinks and pagerank; they can instead spread the game virally by asking their gamers to like their application page and put stuff on their profile wall.

FarmVille, the most popular Facebook game has more members than Twitter. Bye bye searching Google for games.

Facebook has the potential to launch an advertising system to rival Google AdSence.

Online advertising sucks. With Google AdSence you pay money for clicks and you have no control over where your adverts go and which websites you want to reject advertising on. You also have to put up with Google's automatic targeting and trust they can target your adverts correctly on websites.

Why use them? Because you can target people locally such as "rent a fridge in birmingham" or "birmingham plumbers"

What AdWords is good at doing is pleasing advertisers by connecting them to customers who know what they want. It is NOT good at getting advertisers trying to promote new services. When Nestle or Loreal have a new product to sell, don't use Google AdWords, instead use tv, outdoor or print adverts as they're more effective.

Facebook advertising on the other hand, can please advertisers by giving them sales to customers who do not know what they're looking for. When was the last time you saw an advert you liked on a Google advert for something you never heard of? Compare that to Facebook.

Also Facebook has people's likes, interactions, demographics and interests. Something Google does not have. If Google had this, their adverts would be alot more effective and less of a waste of money. Facebook adverts are 3 cents cost per click and are more effective as they are engaging.

When people are on their mobile phones, they logon to Facebook instead of Google. That's why they created Android, to get mobile advertising revenue.
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tynamite's avatar When Orkut was in beta, when it first came out, it had the best user interface and that was before Facebook came out. Now they decided to intregate Google Talk, Google Buzz, Google Wave, Picasa and all their other stuff in it and put their Google bar at the top of every page and ruined it.

Why did they do it? Because nobody used it anyway so they're having fun with it.
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tynamite's avatar Answer 1 4th July 2010
Because when this RPX or whatever they use now has a box that comes up with images of Google, Yahoo, Windows Live, AOL, Livejournal, Blogger and other websites the person has signed up with; the person on the website has no idea that by having a Blogger account, they already have an OpenID.

So because they have no idea, they then go through all the effort of creating a new OpenID with MyOpenID and using it's horrendous interface.

Answer 2 22nd March 2011
OpenID is supposed to consolidate people's online identities by making them authenticate themselves to websites only using one account. It's also designed to increase security.

Increase security? Increase security? Then how come on the login page of a third party OpenID provider to the actual website you want to login to, there's some warning about the risk of giving your details to dodgy third parties?
I signed up to a third party OpenID provider, and I'm being warned when I login with my OpenID that I should be careful who I give my details to.

Doesn't that sound ridiculous to you?

Maybe the true risk is signing up to OpenID in the first place, because once it becomes widespread, you hand over your persona to a site, they know your personal details, and possibly your password from a low security OpenID provider.
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tynamite's avatar


I know people that spend hours browsing photos on Facebook like zombies. They would have fewer and less interesting photos to browse if everyone's photos were not public.

They will often look up women in advance to see if they are attractive and what social events they attend and the people they hang out with.
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tynamite's avatar


I think its a valid stance on privacy. People do not seem to care. Less privacy is often better.

I think when you look at the Facebook usage metrics and data, the best thing for Facebook is going to be to eliminate privacy.
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What's an assertion, and what should I type in?

Compesh is a question and answer (and debate) website, so before you make a debate, you better learn what an assertion is. I suppose you already know what a question is, and that you've typed it in the box. ;)

An assertion, is basically a statement you can make, that is either true or false.

Richer people have better health.

The question for that would be, Do richer people have better health?

And don't forget to make your assertion, match your question.

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