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Vocabulary and Catechism The words microeconomics and macroeconomics, by the way, didn’t exist until Ragnar Frisch coined them in the 1920s. We use terms retrospectively to describe old arguments in language familiar now. That segues into the next steps in the foundations. What should be the basic vocabulary and catechism, meaning basic logic, in terms understood today? Consideration of purpose always comes first. The purpose of economics is prediction. We happen to know that one of the most powerful predictors of economic behavior is maximization of risk-adjusted return. This was Robert Turgot’s insight of 1766, although he left the risk variable unsaid. (His real first name was somehow Anne, so we'll go with the second). He wrote that return equilibrates across markets as investors leave low-return businesses to crowd into higher-return ones. The shift bids up capital denominators in the higher-return businesses, and conversely, until return converges. It was David Ricardo, in 1817 who added that the convergence is more exactly for businesses judged equal in risk. The evidence is everywhere we look. I call this the maximand rule: all behavior maximizes perceived risk-adjusted rate of return. I'll show its proof below. That means all behavior in all markets, and markets are where any choice among alternatives is made. Return means ratio of (net) output to capital generating it. Then the vocabulary wanted might as well include capital and output. But what is capital? Economics is choices, and the measure is price or value. Price can’t be measured exactly outside literal markets, which is why economists follow those markets, but is measured in principle by what we give up in exchange. The price of any capital, even human capital, is given by the present value rule as time- discounted cash flow. Then cash flow and its positive and negative components belong to the basic vocabulary, while the present value and maximand rules both belong in the catechism. Output is total return, so the total return truism belongs in the catechism too. Chapter 3: Foundations 1/11/16 8 HOUSE_OVERSIGHT_010979