What Is the Money Supply? The U.S. money supply comprises currency—dollar bills and coins issued by the Federal Reserve System and the U.S. Treasury—and various kinds of deposits held by the public at commercial banks and other depository institutions such as thrifts and credit unions. On June 30, 2004, the money supply, measured as the sum of currency and checking account deposits, totaled $1,333 billion. Including some types of savings deposits, the money supply totaled $6,275 billion. An even broader measure totaled $9,275 billion. These measures correspond to three definitions of money that the Federal Reserve uses: M1, a narrow measure of money’s function as a medium of exchange; M2, a broader measure that also reflects money’s function as a store of value; and M3, a still broader measure that covers items that many regard as close substitutes for money. The definition of money has varied. For centuries, physical commodities, most commonly silver or gold, served as money. Later, when paper money and checkable deposits were introduced, they were convertible into commodity money. The abandonment of convertibility of money into a commodity since August 15, 1971, when President Richard M. Nixon discontinued converting U.S. dollars into gold at $35 per ounce, has made the monies of the United States and other countries into fiat money—money that national monetary authorities have the power to issue without legal constraints. Why Is the Money Supply Important? Because money is used in virtually all economic transactions, it has a powerful effect on economic activity. An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending. Business firms respond to increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labor and raises the demand for capital goods. In a buoyant economy, stock market prices rise and firms issue equity and debt. If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits. As the public begins to expect inflation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans. Opposite effects occur when the supply of money falls

Monetarism is a macroeconomic school of thought that emphasizes (1) long-run monetary neutrality, (2) short-run monetary nonneutrality, (3) the distinction between real and nominal interest rates, and (4) the role of monetary aggregates in policy analysis. It is particularly associated with the writings of Milton Friedman, Anna Schwartz, Karl Brunner, and Allan Meltzer, with early contributors outside the United States including David Laidler, Michael Parkin, and Alan Walters. Some journalists—especially in the United Kingdom—have used the term to refer to doctrinal support of free-market positions more generally, but that usage is inappropriate; many free-market advocates would not dream of describing themselves as monetarists. An economy possesses basic long-run monetary neutrality if an exogenous increase of Z percent in its stock of money would ultimately be followed, after all adjustments have taken place, by a Z percent increase in the general price level, with no effects on real variables (e.g., consumption, output, relative prices of individual commodities). While most economists believe that long-run neutrality is a feature of actual market economies, at least approximately, no other group of macroeconomists emphasizes this proposition as strongly as do monetarists. Also, some would object that, in practice, actual central banks almost never conduct policy so as to involve exogenous changes in the money supply. This objection is correct factually but irrelevant: the crucial matter is whether the supply and demand choices of households and businesses reflect concern only for the underlying quantities of goods and services that are consumed and produced. If they do, then the economy will have the property of longrun neutrality, and thus the above-described reaction to a hypothetical change in the money supply would occur.1 Other neutrality concepts, including the natural-rate hypothesis, are mentioned below. Short-run monetary nonneutrality obtains, in an economy with long-run monetary neutrality, if the price adjustments to a change in money take place only gradually, so that there are temporary effects on real output (GDP) and employment. Most economists consider this property realistic, but an important school of macroeconomists, the so-called real business cycle proponents, denies it. Continuing with our list, real interest rates are ordinary (“nominal”) interest rates adjusted to take account of expected inflation, as rational, optimizing people would do when they make trade-offs between present and future. As long ago as the very early 1800s, British banker and economist Henry Thornton recognized the distinction between real and nominal interest rates, and American economist Irving Fisher emphasized it in the early 1900s. However, the distinction was often neglected in macroeconomic analysis until monetarists began insisting on its importance during the 1950s. Many Keynesians did not disagree in principle, but in practice their models often did not recognize the distinction and/or they judged the “tightness” of monetary policy by the prevailing level of nominal interest rates. All monetarists emphasized the undesirability of combating inflation by nonmonetary means, such as wage and price controls or guidelines, because these would create market distortions. They stressed, in other words, that ongoing inflation is fundamentally monetary in nature, a viewpoint foreign to most Keynesians of the time. Finally, the original monetarists all emphasized the role of monetary aggregates—such as M1, M2, and the monetary base—in monetary policy analysis, but details differed between Friedman and Schwartz, on the one hand, and Brunner and Meltzer, on the other. Friedman’s striking and famous recommendation was that, irrespective of current macroeconomic conditions, the stock of money

When economists such as robert mundell were theorizing about optimal monetary unions in the middle of the twentieth century, most people regarded the exercise as largely hypothetical. But since many European countries established a monetary union at the end of the century, the theory of monetary unions has become much more relevant to many more people. Definitions and Background The ability to issue money usable for transactions is a power usually reserved by a country’s central government, and it is often seen as a part of a nation’s sovereignty. A monetary union, also known as a currency union or common currency area, entails multiple countries ceding control over the supply of money to a common authority. Adjusting the money supply is a common tool for managing overall economic activity in a country (see monetary policy), and changes in the money supply also affect the financing of government budgets. So giving up control of a national money supply introduces new limitations on a country’s economic policies. A monetary union in many ways resembles a fixed-exchange-rate regime, whereby countries retain distinct national currencies but agree to adjust the relative supply of these to maintain a desired rate of exchange. A monetary union is an extreme form of a fixed-exchange-rate regime, with at least two distinctions. First, because the countries switch to a new currency, the cost of abandoning the new system is much higher than for a typical fixed-exchange-rate regime, giving people more confidence that the system will last. Second, a monetary union eliminates the transactions costs people incur when they need to exchange currencies in carrying out international transactions. Fixed-exchange-rate regimes have been quite common throughout recent history. The United States participated in such a regime from the 1940s until 1973; numerous Europeans participated in one until the creation of the monetary union; and many small or poor countries (Belize, Bhutan, and Botswana, to name just a few) continue to fix their exchange rates to the currencies of major trading partners. The precedents for monetary unions prior to the current European Monetary Union are rare. From 1865 until World War I, all four members of the Latin Monetary Union—France, Belgium, Italy, and Switzerland—allowed coins to circulate throughout the union. Luxembourg shared a currency with its larger neighbor Belgium from 1992 until the formation of the broader European Monetary Union. In addition, many former colonies such as the franc zone in western Africa or other small poor countries (Ecuador and Panama) adopted the currency of a large, wealthier trading partner. But the formation of the European Monetary Union by a group of large and wealthy countries is an unprecedented experiment in international monetary arrangements. Optimal Currency Area Theory Forming a monetary union carries benefits and costs. One benefit is that merchants no longer need worry about unexpected movements in the exchange rate. Suppose a seller of computers in Germany must decide between buying from a supplier in the United States at a price set in dollars and a supplier in France with a price in euros, payment on delivery. Even if the U.S. supplier’s price is lower once it is converted from dollars to euros at the going exchange rate, there is a risk that the dollar’s value will rise before the time of payment, raising the cost of the computers in euros, and hence lowering the merchant’s profits. Even if the merchant expects that the import price probably will be lower, he may decide it is not worth risking a mistake. A monetary union, like any fixed-exchange-rate regime, eliminates this risk. One effect is to promote international trade among members of the monetary union. The same argument can be made for international investment. If a European investor is considering buying a computer manufacturing company in the United States, the value of profits converted from dollars to euros is uncertain. On the other hand, exchange-rate fluctuations

The earth’s natural resources are finite, which means that if we use them continuously, we will eventually exhaust them. This basic observation is undeniable. But another way of looking at the issue is far more relevant to assessing people’s well-being. Our exhaustible and unreproducible natural resources, if measured in terms of their prospective contribution to human welfare, can actually increase year after year, perhaps never coming anywhere near exhaustion. How can this be? The answer lies in the fact that the effective stocks of natural resources are continually expanded by the same technological developments that have fueled the extraordinary growth in living standards since the Industrial Revolution. Innovation has increased the productivity of natural resources (e.g., increasing the gasoline mileage of cars). Innovation also increases the recycling of resources and reduces waste in their extraction and processing. And innovation affects the prospective output of natural resources (e.g., the coal still underneath the ground). If a scientific breakthrough in a given year increases the prospective output of the unused stocks of a resource by an amount greater than the reduction (via resources actually used up) in that year, then, in terms of human economic welfare, the stock of that resource will be larger at the end of the year than at the beginning. Of course, the remaining physical amount of the resource must continually decline,

A monopoly is an enterprise that is the only seller of a good or service. In the absence of government intervention, a monopoly is free to set any price it chooses and will usually set the price that yields the largest possible profit. Just being a monopoly need not make an enterprise more profitable than other enterprises that face competition: the market may be so small that it barely supports one enterprise. But if the monopoly is in fact more profitable than competitive enterprises, economists expect that other entrepreneurs will enter the business to capture some of the higher returns. If enough rivals enter, their competition will drive prices down and eliminate monopoly power. Before and during the period of the classical economics (roughly 1776–1850), most people believed that this process of monopolies being eroded by new competitors was pervasive. The only monopolies that could persist, they thought, were those that got the government to exclude rivals. This belief was well expressed in an excellent article on monopoly in the Penny Cyclopedia (1839, vol. 15, p. 741): It seems then that the word monopoly was never used in English law, except when there was a royal grant authorizing some one or more persons only to deal in or sell a certain commodity or article. If a number of individuals were to unite for the purpose of producing any particular article or commodity, and if they should succeed in selling such article very extensively, and almost solely, such individuals in popular language would be said to have a monopoly. Now, as these individuals have no advantage

Natural gas is the commercial name for methane, a hydrocarbon produced by the same geological processes that produce oil. Relatively abundant in North America, its production and combustion have fewer adverse environmental effects than those of coal or oil. The 23.1 trillion cubic feet (TCF) of gas that Americans consumed in 2002 accounted for 30.3 percent of all their energy use (measured in British thermal units), up from 21.5 percent in 1952.1 Households consumed 23.3 percent of delivered gas, electric utilities used 27.0 percent as generator fuel, and the remainder went to commercial and industrial users. In 2002, 3.8 TCF were imported from Canada and a negligible amount was exported.2 The U.S. output was produced in 383,000 wells owned by hundreds of producers and was transported through 285,000 miles of interstate pipelines.3 Before high-pressure pipelines were developed in the 1920s, gas was either consumed in the vicinity of its production or flared off as hazardous. Today, producers and marketers use interstate pipelines for deliveries to distributors and large consumers. The Federal Energy Regulatory Commission (FERC) determines cost-based pipeline rates, but pipelines are free to discount these (which they often do) in order to attract business. The rates of most local distribution companies (LDCs) that deliver and sell gas to final users are under state regulation, and the remainder are operated by municipal governments. Thus, gas is a vertically unintegrated industry in which dependable product flows require coordination among producers, pipelines, and LDCs. Since the 1970s, the industry has relied more heavily on coordination by market forces and less heavily on regulation, although the latter still plays a large role. Somewhat unusually, regulators themselves took major initiatives to bring competition to the industry, rather than protecting the status quo or imposing heavier regulations. The industry’s evolution is a case study in the replacement of inefficient economic institutions by efficient ones and the replacement of localized markets by national and global ones. 1938–1985: Pervasive Regulation and Shortages The Natural Gas Act of 1938 instituted pipeline regulation by the Federal Power Commission, which was reconstituted as FERC in 1978. The government justified regulation by asserting that pipelines were “natural monopolies” with scale economies so pervasive that a single line (or a handful to guarantee reliability) was the most economical link between producing and consuming areas. At the same time, state-regulated LDCs were (and continue to be) monopoly franchises with cost-based rates and the ability to pass on gas costs dollar for dollar to end-users. Until the mid-1980s, pipelines purchased gas from producers and resold it, with no markup, to LDCs. In 1954, the Supreme Court ruled that federal regulation extended to the wellhead prices received by producers. Prices were to be determined using recorded costs. Regulators set the allowable costs of replacing exhausted wells at low levels that seriously discouraged exploration for new gas. Because oil prices remained unregulated through the 1960s (most gas is found in association with oil), gas shortages became serious only when new price controls on oil helped bring about the “energy crisis” of 1973–1975. Administrations of both political parties were unable or unwilling to acknowledge that the controls restricted the amount supplied and increased the amount demanded. Instead, they instituted direct controls on gas use, such as prohibiting construction of new gas-burning power plants, in the mistaken belief that falling reserves indicated the exhaustion of supply. In reality, reserves were falling because allowable prices were too low to make exploration profitable. Prior to 1978, intrastate markets were exempt from federal price controls, and they experienced no shortages. 1985–2000: A National Gas Market Emerges A complex series of events in the early 1980s led FERC to lift all price controls in 1985, a promarket policy that the Supreme Court subsequently ratified. The decontrol followed on 1984’s Order 436, which effectively ended the earlier role of pipelines as purchasers and resellers of gas to LDCs. Order 436 (followed by Order 636 in 1992) turned pipelines into “open access” transporters for gas owned by producers, LDCs, and others. FERC still set maximum

National income accounts (NIAs) are fundamental aggregate statistics in macroeconomic analysis. The ground-breaking development of national income and systems of NIAs was one of the most far-reaching innovations in applied

Paul Volcker, while chairman of the Board of Governors of the federal reserve system (1979–1987), was often called the second most powerful person in the United States. Volcker and company triggered the “double-dip” recessions of 1980 and 1981–1982, vanquishing the double-digit inflation of 1979–1980 and bringing the unemployment rate into double digits for the first time since 1940. Volcker then declared victory over inflation and piloted the economy through its long 1980s recovery, bringing unemployment below 5.5 percent, half a point lower than in the 1978–1979 boom. Volcker was powerful because he was making monetary policy. His predecessors were powerful too. At least five of the previous eight postwar recessions can be attributed to their anti-inflationary policies. Likewise, Alan Greenspan’s Federal Reserve bears the main responsibility for the 1990–1991 and 2001 recessions. Central banks are powerful everywhere, although few are as independent of their governments as the Fed is of Congress and the White House. Central bank actions are the most important government policies affecting economic activity from quarter to quarter or year to year. Monetary policy is the subject of a lively controversy between two schools of economics: monetarist and keynesian. Although they agree on goals, they disagree sharply on priorities, strategies, targets, and tactics. As I explain how monetary policy works, I shall discuss these disagreements. At the outset I disclose that I am a Keynesian. Common Goals Few monetarists or Keynesians would disagree with this dream scenario: • First, no business cycles. Instead, production—as measured by real (inflation-corrected) gross national product—would

Mercantilism is economic nationalism for the purpose of building a wealthy and powerful state. Adam Smith coined the term “mercantile system” to describe the system of political economy that sought to enrich the country by restraining imports and encouraging exports. This system dominated Western European economic thought and policies from the sixteenth to the late eighteenth centuries. The goal of these policies was, supposedly, to achieve a “favorable” balance of trade that would bring gold and silver into the country and also to maintain domestic employment. In contrast to the agricultural system of the physiocrats or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state. The most important economic rationale for mercantilism in the sixteenth century was the consolidation of the regional power centers of the feudal era by large, competitive nation-states. Other contributing factors were the establishment of colonies outside Europe; the growth of European commerce and industry relative to agriculture; the increase in the volume and breadth of trade; and the increase in the use of metallic monetary systems, particularly gold and silver, relative to barter transactions. During the mercantilist period, military conflict between nation-states was both more frequent and more extensive than at any other time in history. The armies and navies of the main protagonists were no longer temporary forces raised to address a specific threat or objective, but were full-time professional forces. Each government’s primary economic objective was to command a sufficient quantity of hard currency to support a military that would deter attacks by other countries and aid its own territorial expansion. Most of the mercantilist policies were the outgrowth of the relationship between the governments of the nation-states and their mercantile classes. In exchange for paying levies and taxes to support the armies of the nation-states, the mercantile classes induced governments to enact policies that would protect their business interests against foreign competition. These policies took many forms. Domestically, governments would provide capital to new industries, exempt new industries from guild rules and taxes, establish monopolies over local and colonial markets, and grant titles and pensions to successful producers. In trade policy the government assisted local industry by imposing tariffs, quotas, and prohibitions on imports of goods that competed with local manufacturers. Governments also prohibited the export of tools and capital equipment and the emigration of skilled labor that would allow foreign countries, and even the colonies of the home country, to compete in the production of manufactured goods. At the same time, diplomats encouraged foreign manufacturers to move to the diplomats’ own countries. Shipping was particularly important during the mercantile period. With the growth of colonies and the shipment of gold from the New World into Spain and Portugal, control of the oceans was considered vital to national power. Because ships could be used for merchant or military purposes, the governments of the era developed strong merchant marines. In France, Jean-Baptiste Colbert, the minister of finance under Louis XIV from 1661 to 1683, increased port duties on foreign vessels entering French ports and provided bounties to French shipbuilders. In England, the Navigation Act of 1651 prohibited foreign vessels from engaging in coastal trade in England and required that all goods imported from the continent of Europe be carried on either an English vessel or a vessel registered in the country of origin of the goods. Finally, all trade between England and its colonies had to be carried in either English or colonial vessels. The Staple Act of 1663 extended the Navigation Act by requiring that all colonial exports to Europe be landed through an English port before being re-exported to Europe. Navigation policies by France, England, and other powers were directed primarily against the Dutch, who dominated commercial marine activity in the sixteenth and seventeenth centuries. During the mercantilist era it was often suggested, if not actually believed, that the principal benefit of foreign trade was the importation of gold and silver. According to this view the benefits to one nation were matched by costs to the other nations that exported gold and silver, and there were no net gains from trade. For nations almost constantly on the verge of war, draining one another of valuable gold and silver was thought to be almost as desirable as the direct benefits of trade. Adam Smith refuted the idea that the wealth of a nation is measured by the size of the treasury in his famous treatise The Wealth of Nations, a book considered to be the foundation of modern economic theory. Smith made a number of important criticisms of mercantilist doctrine. First, he demonstrated that trade, when freely initiated, benefits both parties. Second, he argued that specialization in production allows for economies of scale, which improves efficiency and growth. Finally, Smith argued that the collusive relationship between government and industry was harmful to the general population. While the mercantilist policies were designed to benefit the government and the commercial class, the doctrines of laissez-faire, or free markets, which originated with Smith, interpreted economic welfare in a far wider sense of encompassing the entire population. While the publication of The Wealth of Nations is generally considered to mark the end of the mercantilist era, the laissez-faire doctrines of free-market economics also reflect a general disenchantment with the imperialist policies of nation-states. The Napoleonic Wars in Europe and the Revolutionary War in the United States heralded the end of the period of military confrontation in Europe and the mercantilist policies that supported it. Despite these policies and the wars with which they were associated, the mercantilist period was one of generally rapid growth, particularly in England. This is partly because the governments were not very effective at enforcing the policies they espoused. While the government could prohibit imports, for example, it lacked the resources to stop the smuggling that the prohibition would create. In addition, the variety of new products that were created during the industrial revolution made it difficult to enforce the industrial policies that were associated with mercantilist doctrine. By 1860 England had removed the last vestiges of the mercantile era. Industrial regulations, monopolies, and tariffs were abolished, and emigration and machinery exports were freed. In large part because of its free trade policies, England became the dominant economic power in Europe. England’s success as a manufacturing and financial power, coupled with the United States as an emerging agricultural powerhouse, led to the resumption of protectionist pressures in Europe and the arms race between Germany, France, and England that ultimately resulted in World War I. Protectionism remained important in the interwar period. World War I had destroyed the international monetary system based on the gold standard. After the war, manipulation of the exchange rate was added to governments’ lists of trade weapons. A country could simultaneously lower the international prices of its exports and increase the local currency price of its imports by devaluing its currency against the currencies of its trading partners. This “competitive devaluation” was practiced by many countries during the Great Depression of the 1930s and led to a sharp reduction in world trade. A number of factors led to the reemergence of mercantilist policies after World War II. The Great Depression created doubts about the efficacy and stability of free-market economies, and an emerging body of economic thought ranging from Keynesian countercyclical policies to Marxist centrally planned systems created a new role for governments in the control of economic affairs. In addition, the wartime partnership between government and industry in the United States created a relationship—the military-industrial complex, in Dwight D. Eisenhower’s words—that also encouraged activist government policies. In Europe, the shortage of dollars after the war induced governments to restrict imports and negotiate bilateral trading agreements to economize on scarce foreign exchange resources. These policies severely restricted the volume of intra-Europe trade and impeded the recovery process in Europe in the immediate postwar period. The economic strength of the United States, however, provided the stability that permitted the world to emerge from the postwar chaos into a new era of prosperity and growth. The Marshall Plan provided American resources that overcame the most acute dollar shortages. The Bretton Woods agreement established a new system of relatively stable exchange rates that encouraged the free flow of goods and capital. Finally, the signing of the GATT (General Agreement on Tariffs and Trade) in 1947 marked the official recognition of the need to establish an international order of multilateral free trade. The mercantilist era has passed. Modern economists accept Adam Smith’s insight that free trade leads to international specialization of labor and, usually, to greater economic well-being for all nations. But some mercantilist policies continue to exist. Indeed, the surge of protectionist sentiment that began with the oil crisis in the mid-1970s and expanded with the global recession of the early 1980s has led some economists to label the modern pro-export, anti-import attitude “neomercantilism.” Since the GATT went into effect in 1948, eight rounds of multilateral trade negotiations have resulted in a significant liberalization of trade in manufactured goods, the signing of the General Agreement on Trade in Services (GATS) in 1994, and the establishment of the World Trade Organization (WTO) to enforce the agreed-on rules of international trade. Yet numerous exceptions exist, giving rise to discriminatory antidumping actions, countervailing duties, and emergency safeguard measures when imports suddenly threaten to disrupt or “unfairly” compete with a domestic industry. Agricultural trade is still heavily protected by quotas, subsidies, and tariffs, and is a key topic on the agenda of the ninth (Doha) round of negotiations. And cabotage laws, such as the U.S. Jones Act, enacted in 1920 and successfully defended against liberalizing reform in the 1990s, are the modern counterpart of England’s Navigation Laws. The Jones Act requires all ships carrying cargo between U.S. ports to be U.S. built, owned, and documented. Modern mercantilist practices arise from the same source as the mercantilist policies of the sixteenth through eighteenth centuries. Groups with political power use that power to secure government intervention to protect their interests while claiming to seek benefits for the nation as a whole. In their recent interpretation of historical mercantilism, Robert B. Ekelund and Robert D. Tollison (1997) focused on the privilege-seeking activities of monarchs and merchants. The mercantile regulations protected the privileged positions of monopolists and cartels, which in turn provided revenue to the monarch or state. According to this interpretation, the reason England was so prosperous during the mercantilist era was that mercantilism was not well enforced. Parliament and the common-law judges competed with the monarchy and royal courts to share in the monopoly or cartel profits created by mercantilist restrictions on trade. This made it less worthwhile to seek, and to enforce, mercantilist restrictions. Greater monarchical power and uncertain property rights in France and Spain, by contrast, were accompanied by slower growth and even stagnation during this period. And the various cabotage laws can be understood as an efficient tool to police the trading cartels. By this view, the establishment of the WTO will have a liberalizing effect if it succeeds in raising the costs or reducing the benefits of those seeking mercantilist profits through trade restrictions. Of the false tenets of mercantilism that remain today, the most pernicious is the idea that imports reduce domestic employment. Labor unions have used this argument to justify protection from imports originating in low-wage countries, and there has been much political and media debate about the implications of offshoring of service sector jobs for national employment. Many opponents have claimed that offshoring of services puts U.S. jobs at risk. While it does threaten some U.S. jobs, it puts no jobs at risk in the aggregate, however, but simply causes a reallocation of jobs among industries. Another mercantilist view that persists today is that a current account deficit is bad. When a country runs a current account deficit, it is either borrowing from or selling assets to the rest of the world to finance expenditure on imports in excess of export revenue. However, even when this results in an increase of net foreign indebtedness, and associated future debtservicing requirements, it will promote economic wealth if the spending is for productive purposes that yield a greater return than is forgone on the assets exchanged to finance the spending. Many developing countries with high rates of return on capital have run current account deficits for extremely long periods while enjoying rapid growth and solvency. The United States was one of these for a large part of the nineteenth century, borrowing from English investors to build railroads (see international capital flows). Furthermore, persistent surpluses may primarily reflect a lack of viable investment opportunities at home or a growing demand for money in a rapidly developing country, and not a “mercantile” accumulation of international reserves at the expense of the trading partners. About the Author Laura LaHaye is an adjunct professor at the Illinois Institute of Technology. She was a visiting scholar from 2004 to 2005 at the University of Illinois in Chicago and an economics professor there from 1981 to 1990. In 1981, she was a research economist with the General Agreement on Tariffs and Trade. Further Reading   Allen, William R. “Mercantilism.” In John Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave: A Dictionary of Economics. Vol. 3. London: Macmillan, 1987. Pp. 445–448. Ekelund, Robert B. Jr., and Robert D. Tollison. Politicized Economies: Monarchy, Monopoly and Mercantilism. College Station: Texas A&M University Press, 1997. Heckscher, Eli. Mercantilism. 2 vols. London: Allen and Unwin, 1934. Magnusson, Lars. Mercantilism: The Shaping of an Economic Language. London: Routledge, 1994. Salvatore, Dominick, ed. The New Protectionist Threat to World Welfare. New York: North-Holland, 1987. Smith, Adam. The Wealth of Nations. Edwin Cannan edition. 1937. Available online at: http://www.econlib.org/library/Smith/smWN.html Viner, Jacob. Studies in the Theory of International Trade. New York: Harper and Brothers, 1937.   (0 COMMENTS)

Until the so-called Keynesian revolution of the late 1930s and 1940s, the two main parts of economic theory were typically labeled “monetary theory” and “price theory.” Today, the corresponding dichotomy is between “macroeconomics” and “microeconomics.” The motivating force for the change came from the macro side, with modern macroeconomics being far more explicit than old-fashioned monetary theory about fluctuations in income and employment (as well as the price level). In contrast, no revolution separates today’s microeconomics from old-fashioned price theory; one evolved from the other naturally and without significant controversy. The strength of microeconomics comes from the simplicity of its underlying structure and its close touch with the real world. In a nutshell, microeconomics has to do with supply and demand, and with the way they interact in various markets. Microeconomic analysis moves easily and painlessly from one topic to another and lies at the center of most of the recognized subfields of economics. Labor economics, for example, is built largely on the analysis of the supply and demand for labor of different types. The field of industrial organization deals with the different mechanisms (monopoly, cartels, different types of competitive behavior) by which goods and services are sold. International economics worries about the demand and supply of individual traded commodities, as well as of a country’s exports and imports taken as a whole, and the consequent demand for and supply of foreign exchange. Agricultural economics deals with the demand and supply of agricultural products and of farmland, farm labor, and the other factors of production involved in agriculture. Public finance (see public choice) looks at how the government enters the scene. Traditionally, its focus was on taxes, which automatically introduce “wedges” (differences between the price the buyer pays and the price the seller receives) and cause inefficiency. More recently, public finance has reached into the expenditure side as well, attempting to analyze (and sometimes actually to measure) the costs and benefits of various government outlays and programs. Applied welfare economics is the fruition of microeconomics. It deals with the costs and benefits of just about anything—government projects, taxes on commodities, taxes on factors of production (corporation income taxes, payroll taxes), agricultural programs (like price supports and acreage controls), tariffs on imports, foreign exchange controls, various forms of industrial organization (like monopoly and oligopoly), and various aspects of labor market behavior (like minimum wages, the monopoly power of labor unions, and so on). It is hard to imagine a basic course in microeconomics failing to include numerous cases and examples drawn from all of the fields listed above. This is because microeconomics is so basic. It represents the trunk of the tree from which all the listed subfields have branched. At the root of everything is supply and demand. It is not at all farfetched to think of these as basically human characteristics. If human beings are not going to be totally self-sufficient, they will end up producing certain things that they trade in order to fulfill their demands for other things. The specialization of production and the institutions of trade, commerce, and markets long antedated the science of economics. Indeed, one can fairly say that from the very outset the science of economics entailed the study of the market forms that arose quite naturally (and without any help from economists) out of human behavior. People specialize in what they think they can do best—or more existentially,