Docstoc

Macro Economic Study

Document Sample
Macro Economic Study Powered By Docstoc
					sssssMacroeconomists study aggregated indicators such as GDP, unemployment rates,
and price indices to understand how the whole economy functions. Macroeconomists
develop models that explain the relationship between such factors as national income,
output, consumption, unemployment, inflation, savings, investment, international trade
and international finance. In contrast, microeconomics is primarily focused on the
actions of individual agents, such as firms and consumers, and how their behavior
determines prices and quantities in specific markets.




gross domestic
product (GDP

The gross domestic product (GDP) or gross domestic income (GDI) is a measure of a
country's overall economic output. It is the market value of all final goods and services
made within the borders of a country in a year. It is often positively correlated with the
standard of living,[1]; though its use as a stand-in for measuring the standard of living has
come under increasing criticism and many countries are actively exploring alternative
measures to GDP for that purpose.[2]

GDP can be determined in three ways, all of which should in principle give the same
result. They are the product (or output) approach, the income approach, and the
expenditure approach.

The most direct of the three is the product approach, which sums the outputs of every
class of enterprise to arrive at the total. The expenditure approach works on the principle
that all of the product must be bought by somebody, therefore the value of the total
product must be equal to people's total expenditures in buying things. The income
approach works on the principle that the incomes of the productive factors ("producers,"
colloquially) must be equal to the value of their product, and determines GDP by finding
the sum of all producers' incomes.[3]

Example: the expenditure method:

           GDP = private consumption + gross investment + government spending +
           (exports − imports), or




In the name "Gross Domestic Product":

"Gross" means that GDP measures production regardless of the various uses to which
that production can be put. Production can be used for immediate consumption, for
investment in new fixed assets or inventories, or for replacing depreciated fixed assets. If
depreciation of fixed assets is subtracted from GDP, the result is called the Net domestic
product; it is a measure of how much product is available for consumption or adding to
the nation's wealth. In the above formula for GDP by the expenditure method, if net
investment (which is gross investment minus depreciation) is substituted for gross
investment, then net domestic product is obtained.

"Domestic" means that GDP measures production that takes place within the country's
borders. In the expenditure-method equation given above, the exports-minus-imports
term is necessary in order to null out expenditures on things not produced in the country
(imports) and add in things produced but not sold in the country (exports).

Economists (since Keynes) have preferred to split the general consumption term into two
parts; private consumption, and public sector (or government) spending. Two advantages
of dividing total consumption this way in theoretical macroeconomics are:
          Private consumption is a central concern of welfare economics. The private
           investment and trade portions of the economy are ultimately directed (in
           mainstream economic models) to increases in long-term private consumption.
          If separated from endogenous private consumption, government
           consumption can be treated as exogenous,[citation needed] so that different
           government spending levels can be considered within a meaningful
           macroeconomic framework.

Gross domestic product comes under the heading of national accounts, which is a subject
in macroeconomics. Economic measurement is called econometrics.


Determining GDP

Production approach

Usually in this approach the producer units (corporated and unincorporated enterprises
which together form the business sector, "pure" households, governments and non-profit
institutions serving households) of an economy are classified into classes of industries:
agriculture, construction, manufacturing, etc. Their outputs are estimated largely on the
basis of surveys which businesses fill out, but also the services from dwellings owned by
households are counted towards production. To avoid "double-counting" in cases where
the output of a producer unit is not a final good or service, but serves as intermediate
input (intermediate consumption) into another producer unit, either only final goods and
services outputs must be counted, or a "value added" approach must be taken, where what
is counted is not the total value output of a producer unit, but its value added: the
difference between the value of its gross output and the value of its intermediate
consumption. Value added is obtained as a balancing item in the production account of
the national accounts.

           Gross Value Added (GVA) = Sum of gross value added by all producer units
           = Gross output - intermediate consumption of goods and services to produce
           the output.

For market producer sales is usually the largest part of output. But producer units may
also produce output for own final use (own final consumption or own gross fixed capital
formation) or add their output of goods to their inventories.

Depending on how gross value added has been calculated, it may be necessary to make
an adjustment to it before it can be considered equal to GDP. This is because GDP is the
market value of goods and services – the price paid by the customer – but the price
received by the producer may be different than this if the government taxes or subsidises
the product. For example, if there is a sales tax:

           Producer's price + sales tax = market price

If taxes and subsidies have not already been computed as part of GVA, we must compute
GDP as:[4]

           GDP = GVA + Taxes on products - Subsidies on products

[edit] Expenditure approach

In contemporary economies, most things produced are produced for sale, and sold.
Therefore, measuring the total expenditure of money used to buy things is a way of
measuring production. This is known as the expenditure method of calculating GDP.
Note that if you knit yourself a sweater, it is production but does not get counted as GDP
because it is never sold. Sweater-knitting is a small part of the economy, but if one counts
some major activities such as child-rearing (generally unpaid) as production, GDP ceases
to be an accurate indicator of production. Similarly, if there is a long term shift from non-
market provision of services (for example cooking, cleaning, child rearing, do-it yourself
repairs) to market provision of services, then this trend toward increased market
provision of services may mask a dramatic decrease in actual domestic production,
resulting in overly optimistic and inflated reported GDP. This is particularly a problem
for economies which have shifted from production economies to service economies.

[edit] Components of GDP by expenditure




Components of U.S. GDP

GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G)
and Net Exports (X - M).

           Y = C + I + G + (X − M)

Here is a description of each GDP component:


          C (consumption) is normally the largest GDP component in the economy,
           consisting of private (household final consumption expenditure) in the
           economy. These personal expenditures fall under one of the following
           categories: durable goods, non-durable goods, and services. Examples include
           food, rent, jewelry, gasoline, and medical expenses but does not include the
           purchase of new housing.
          I (investment) includes business investment in equipments for example and
           does not include exchanges of existing assets. Examples include construction
           of a new mine, purchase of software, or purchase of machinery and equipment
           for a factory. Spending by households (not government) on new houses is also
           included in Investment. In contrast to its colloquial meaning, 'Investment' in
           GDP does not mean purchases of financial products. Buying financial
           products is classed as 'saving', as opposed to investment. This avoids double-
           counting: if one buys shares in a company, and the company uses the money
           received to buy plant, equipment, etc., the amount will be counted toward
           GDP when the company spends the money on those things; to also count it
           when one gives it to the company would be to count two times an amount that
           only corresponds to one group of products. Buying bonds or stocks is a
           swapping of deeds, a transfer of claims on future production, not directly an
           expenditure on products.
          G (government spending) is the sum of government expenditures on final
           goods and services. It includes salaries of public servants, purchase of
           weapons for the military, and any investment expenditure by a government. It
           does not include any transfer payments, such as social security or
           unemployment benefits.
          X (exports) represents gross exports. GDP captures the amount a country
           produces, including goods and services produced for other nations'
           consumption, therefore exports are added.
          M (imports) represents gross imports. Imports are subtracted since imported
           goods will be included in the terms G, I, or C, and must be deducted to avoid
           counting foreign supply as domestic.

A fully equivalent definition is that GDP (Y) is the sum of final consumption
expenditure (FCE), gross capital formation (GCF), and net exports (X - M).

           Y = FCE + GCF+ (X − M)

FCE can then be further broken down by three sectors (households, governments and
non-profit institutions serving households) and GCF by five sectors (non-financial
corporations, financial corporations, households, governments and non-profit institutions
serving households). The advantage of this second definition is that expenditure is
systematically broken down, firstly, by type of final use (final consumption or capital
formation) and, secondly, by sectors making the expenditure, whereas the first definition
partly follows a mixed delimitation concept by type of final use and sector.

Note that C, G, and I are expenditures on final goods and services; expenditures on
intermediate goods and services do not count. (Intermediate goods and services are those
used by businesses to produce other goods and services within the accounting year.[5] )

According to the U.S. Bureau of Economic Analysis, which is responsible for calculating
the national accounts in the United States, :In general, the source data for the
expenditures components are considered more reliable than those for the income
components [see income method, below]."[6]

[edit] Examples of GDP component variables

C, I, G, and NX(net exports): If a person spends money to renovate a hotel to increase
occupancy rates, the spending represents private investment, but if he buys shares in a
consortium to execute the renovation, it is saving. The former is included when
measuring GDP (in I), the latter is not. However, when the consortium conducted its own
expenditure on renovation, that expenditure would be included in GDP.

If a hotel is a private home, spending for renovation would be measured as consumption,
but if a government agency converts the hotel into an office for civil servants, the
spending would be included in the public sector spending, or G.

If the renovation involves the purchase of a chandelier from abroad, that spending would
be counted as C, G, or I (depending on whether a private individual, the government, or a
business is doing the renovation), but then counted again as an import and subtracted
from the GDP so that GDP counts only goods produced within the country.

If a domestic producer is paid to make the chandelier for a foreign hotel, the payment
would not be counted as C, G, or I, but would be counted as an export.




GDP real growth rates for 2008

[edit] Income approach

Another way of measuring GDP is to measure total income. If GDP is calculated this way
it is sometimes called Gross Domestic Income (GDI), or GDP(I). GDI should provide the
same amount as the expenditure method described above. (By definition, GDI = GDP. In
practice, however, measurement errors will make the two figures slightly off when
reported by national statistical agencies.)

Total income can be subdivided according to various schemes, leading to various
formulae for GDP measured by the income approach. A common one is:

           GDP = compensation of employees + gross operating surplus + gross mixed
           income + taxes less subsidies on production and imports
           GDP = COE + GOS + GMI + TP & M - SP & M


          Compensation of employees (COE) measures the total remuneration to
           employees for work done. It includes wages and salaries, as well as employer
           contributions to social security and other such programs.
          Gross operating surplus (GOS) is the surplus due to owners of incorporated
           businesses. Often called profits, although only a subset of total costs are
           subtracted from gross output to calculate GOS.
          Gross mixed income (GMI) is the same measure as GOS, but for
           unincorporated businesses. This often includes most small businesses.

The sum of COE, GOS and GMI is called total factor income; it is the income of all of
the factors of production in society. It measures the value of GDP at factor (basic) prices.
The difference between basic prices and final prices (those used in the expenditure
calculation) is the total taxes and subsidies that the government has levied or paid on that
production. So adding taxes less subsidies on production and imports converts GDP at
factor cost to GDP(I).

Total factor income is also sometimes expressed as:

           Total factor income = Employee compensation + Corporate profits +
           Proprieter's income + Rental income + Net interest[7]

Yet another formula for GDP by the income method is:[citation needed]

           GDP = R + I + P + SA + W

where R : rents
I : interests
P : profits
SA : statistical adjustments (corporate income taxes, dividends, undistributed corporate
profits)
W : wages
Note the mnemonic, "ripsaw".

A "production boundary" that delimits what will be counted as GDP.

"One of the fundamental questions that must be addressed in preparing the national
economic accounts is how to define the production boundary – that is, what parts of the
myriad human activities are to be included in or excluded from the measure of the
economic production."[8]

All output for market is at least in theory included within the boundary. Market output is
defined as that which is sold for "economically significant" prices; economically
significant prices are "prices which have a significant influence on the amounts producers
are willing to supply and purchasers wish to buy."[9] An exception is that illegal goods
and services are often excluded even if they are sold at economically significant prices
(Australia and the United States exclude them).

This leaves non-market output. It is partly excluded and partly included. First, "natural
processes without human involvement or direction" are excluded.[10] Also, there must be a
person or institution that owns or is entitled to compensation for the product. An example
of what is included and excluded by these criteria is given by the United States' national
accounts agency: "the growth of trees in an uncultivated forest is not included in
production, but the harvesting of the trees from that forest is included."[11]

Within the limits so far described, the boundary is further constricted by "functional
considerations."[12] The Australian Bureau for Statistics explains this: "The national
accounts are primarily constructed to assist governments and others to make market-
based macroeconomic policy decisions, including analysis of markets and factors
affecting market performance, such as inflation and unemployment." Consequently,
production that is, according to them, "relatively independent and isolated from markets,"
or "difficult to value in an economically meaningful way" [i.e., difficult to put a price on]
is excluded.[13] Thus excluded are services provided by people to members of their own
families free of charge, such as child rearing, meal preparation, cleaning, transportation,
entertainment of family members, emotional support, care of the elderly.[14] Most other
production for own (or one's family's) use is also excluded, with two notable exceptions
which are given in the list later in this section.

Nonmarket outputs that are included within the boundary are listed below. Since, by
definition, they do not have a market price, the compilers of GDP must impute a value to
them, usually either the cost of the goods and services used to produce them, or the value
of a similar item that is sold on the market.


          Goods and services provided by governments and non-profit organisations
           free of charge or for economically insignificant prices are included. The value
           of these goods and services is estimated as equal to their cost of production.
           This ignores the consumer surplus generated by an efficient and effective
           government supplied infrastructure. For example, government-provided clean
           water confers substantial benefits above its cost. Ironically, lack of such
           infrastructure which would result in higher water prices (and probably higher
           hospital and medication expenditures) would be reflected as a higher GDP.
           This may also cause a bias that mistakenly favors inefficient privatizations
           since some of the consumer surplus from privatized entities' sale of goods and
           services are indeed reflected in GDP.[15]
          Goods and services produced for own-use by businesses are attempted to be
           included. An example of this kind of production would be a machine
           constructed by an engineering firm for use in its own plant.
          Renovations and upkeep by an individual to a home that she owns and
           occupies are included. The value of the upkeep is estimated as the rent that
           she could charge for the home if she did not occupy it herself. This is the
           largest item of production for own use by an individual (as opposed to a
           business) that the compilers include in GDP.[16] If the measure uses historical
           or book prices for real estate, this will grossly underestimate the value of the
           rent in real estate markets which have experienced significant price increases
           (or economies with general inflation). Furthermore, depreciation schedules for
           houses often accelerate the accounted depreciation relative to actual
           depreciation (a well built house can be lived in for several hundred years - a
           very long time after it has been fully depreciated). In summary, this is likely to
           grossly underestimate the value of existing housing stock on consumers'
           actual consumption or income.
          Agricultural production for consumption by oneself or one's household is
           included.
          Services (such as chequeing-account maintenance and services to borrowers)
           provided by banks and other financial institutions without charge or for a fee
           that does not reflect their full value have a value imputed to them by the
           compilers and are included. The financial institutions provide these services
           by giving the customer a less advantageous interest rate than they would if the
           services were absent; the value imputed to these services by the compilers is
           the difference between the interest rate of the account with the services and
           the interest rate of a similar account that does not have the services. According
           to the United States Bureau for Economic Analysis, this is one of the largest
           imputed items in the GDP.[17]

[edit] GDP vs GNI

GDP can be contrasted with gross national product (GNP) or gross national income
(GNI). The difference is that GDP defines its scope according to location, while GNP
defines its scope according to ownership. GDP is product produced within a country's
borders; GNP is product produced by enterprises owned by a country's citizens. The two
would be the same if all of the productive enterprises in a country were owned by its own
citizens, but foreign ownership makes GDP and GNP non-identical. Production within a
country's borders, but by an enterprise owned by somebody outside the country, counts as
part of its GDP but not its GNP; on the other hand, production by an enterprise located
outside the country, but owned by one of its citizens, counts as part of its GNP but not its
GDP.

To take the United States as an example, the U.S.'s GNP is the value of output produced
by American-owned firms, regardless of where the firms are located. Similarly, if a
country becomes increasingly in debt, and spends large amounts of income servicing this
debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a
country sells off its resources to entities outside their country this will also be reflected
over time in decreased GNI, but not decreased GDP. This would make the use of GDP
more attractive for politicians in countries with increasing national debt and decreasing
assets.

Gross national income (GNI) equals GDI plus income receipts from the rest of the world
minus income payments to the rest of the world.

In 1991, the United States switched from using GNP to using GDP as its primary
measure of production.[18] The relationship between United States GDP and GNP is
shown in table 1.7.5 of the National Income and Product Accounts[19] .

[edit] International standards

The international standard for measuring GDP is contained in the book System of
National Accounts (1993), which was prepared by representatives of the International
Monetary Fund, European Union, Organization for Economic Co-operation and
Development, United Nations and World Bank. The publication is normally referred to as
SNA93 to distinguish it from the previous edition published in 1968 (called SNA68)
[citation needed] [why?]
                         .

SNA93 provides a set of rules and procedures for the measurement of national accounts.
The standards are designed to be flexible, to allow for differences in local statistical
needs and conditions.


        This section requires expansion.


[edit] National measurement

Within each country GDP is normally measured by a national government statistical
agency, as private sector organizations normally do not have access to the information
required (especially information on expenditure and production by governments).

Main article: National agencies responsible for GDP measurement

[edit] Interest rates

Net interest expense is a transfer payment in all sectors except the financial sector. Net
interest expenses in the financial sector are seen as production and value added and are
added to GDP.

[edit] Adjustments to GDP

When comparing GDP figures from one year to another, it is desirable to compensate for
changes in the value of money – inflation or deflation. The raw GDP figure as given by
the equations above is called the nominal, or historical, or current, GDP. To make it more
meaningful for year-to-year comparisons, it may be multiplied by the ratio between the
value of money in the year the GDP was measured and the value of money in some base
year. For example, suppose a country's GDP in 1990 was $100 million and its GDP in
2000 was $300 million; but suppose that inflation had halved the value of its currency
over that period. To meaningfully compare its 2000 GDP to its 1990 GDP we could
multiply the 2000 GDP by one-half, to make it relative to 1990 as a base year. The result
would be that the 2000 GDP equals $300 million x one-half = $150 million, in 1990
monetary terms. We would see that the country's GDP had, realistically, increased 1.5
times over that period, not 3 times, as it might appear from the raw GDP data. The GDP
adjusted for changes in money-value in this way is called the real, or constant, GDP.

The factor used to convert GDP from current to constant values in this way is called the
GDP deflator. Unlike the Consumer price index, which measures inflation (or deflation
– rarely!) in the price of household consumer goods, the GDP deflator measures changes
in the prices all domestically produced goods and services in an economy – including
investment goods and government services, as well as household consumption goods.[20]

Constant-GDP figures allow us to calculate a GDP growth rate, which tells us how much
a country's production has increased (or decreased, if the growth rate is negative)
compared to the previous year.

           Real GDP growth rate for year n = [(Real GDP in year n) - (Real GDP in year
           n - 1)]/ (Real GDP in year n - 1)

Another thing that it may be desirable to compensate for is population growth. If a
country's GDP doubled over some period but its population tripled, the increase in GDP
may not be deemed such a great accomplishment: the average person in the country is
producing less than they were before. Per-capita GDP is the measure compensated for
population growth.

[edit] Cross-border comparison

The level of GDP in different countries may be compared by converting their value in
national currency according to either the current currency exchange rate, or the purchase
power parity exchange rate.


          Current currency exchange rate is the exchange rate in the international
           currency market.
          Purchasing power parity exchange rate is the exchange rate based on the
           purchasing power parity (PPP) of a currency relative to a selected standard
           (usually the United States dollar). This is a comparative (and theoretical)
           exchange rate, the only way to directly realize this rate is to sell an entire CPI
           basket in one country, convert the cash at the currency market rate & then
           rebuy that same basket of goods in the other country (with the converted
           cash). Going from country to country, the distribution of prices within the
           basket will vary; typically, non-tradable purchases will consume a greater
           proportion of the basket's total cost in the higher GDP country, per the
           Balassa-Samuelson effect.

The ranking of countries may differ significantly based on which method is used.


          The current exchange rate method converts the value of goods and services
           using global currency exchange rates. The method can offer better indications
           of a country's international purchasing power and relative economic strength.
           For instance, if 10% of GDP is being spent on buying hi-tech foreign arms,
           the number of weapons purchased is entirely governed by current exchange
           rates, since arms are a traded product bought on the international market.
           There is no meaningful 'local' price distinct from the international price for
           high technology goods.
          The purchasing power parity method accounts for the relative effective
           domestic purchasing power of the average producer or consumer within an
           economy. The method can provide a better indicator of the living standards of
           less developed countries, because it compensates for the weakness of local
           currencies in the international markets. For example, India ranks 12th by
           nominal GDP, but fourth by PPP. The PPP method of GDP conversion is
           more relevant to non-traded goods and services.
There is a clear pattern of the purchasing power parity method decreasing the disparity in
GDP between high and low income (GDP) countries, as compared to the current
exchange rate method. This finding is called the Penn effect.

For more information, see Measures of national income and output.

[edit] Standard of living and GDP

GDP per capita is not a measurement of the standard of living in an economy. However,
it is often used as such an indicator, on the rationale that all citizens would benefit from
their country's increased economic production. Similarly, GDP per capita is not a
measure of personal income. GDP may increase while real incomes for the majority
decline. For example, in the US from 1990 to 2006 the earnings (adjusted for inflation) of
individual workers, in private industry and services, increased by less than 0.5% per year
while GDP (adjusted for inflation) increased about 3.6% per year. [21]

The major advantage of GDP per capita as an indicator of standard of living is that it is
measured frequently, widely, and consistently. It is measured frequently in that most
countries provide information on GDP on a quarterly basis, allowing trends to be seen
quickly. It is measured widely in that some measure of GDP is available for almost every
country in the world, allowing inter-country comparisons. It is measured consistently in
that the technical definition of GDP is relatively consistent among countries.

The major disadvantage is that it is not a measure of standard of living. GDP is intended
to be a measure of total national economic activity— a separate concept.

The argument for using GDP as a standard-of-living proxy is not that it is a good
indicator of the absolute level of standard of living, but that living standards tend to move
with per-capita GDP, so that changes in living standards are readily detected through
changes in GDP.

[edit] Limitations of GDP to judge the health of an economy

GDP is widely used by economists to gauge the health of an economy, as its variations
are relatively quickly identified. However, its value as an indicator for the standard of
living is considered to be limited. Not only that, but if the aim of economic activity is to
produce ecologically sustainable increases in the overall human standard of living, GDP
is a perverse measurement; it treats loss of ecosystem services as a benefit instead of a
cost.[22] Other criticisms of how the GDP is used include:


          Wealth distribution – GDP does not take disparity in incomes between the
           rich and poor into account. See income inequality metrics for discussion of a
           variety of inequality-based economic measures.
          Non-market transactions – GDP excludes activities that are not provided
           through the market, such as household production and volunteer or unpaid
           services. As a result, GDP is understated. Unpaid work conducted on Free and
           Open Source Software (such as Linux) contribute nothing to GDP, but it was
           estimated that it would have cost more than a billion US dollars for a
           commercial company to develop. Also, if Free and Open Source Software
           became identical to its proprietary software counterparts, and the nation
           producing the propriety software stops buying proprietary software and
           switches to Free and Open Source Software, then the GDP of this nation
           would reduce, however there would be no reduction in economic production
           or standard of living. The work of New Zealand economist Marilyn Waring
           has highlighted that if a concerted attempt to factor in unpaid work were
           made, then it would in part undo the injustices of unpaid (and in some cases,
           slave) labour, and also provide the political transparency and accountability
           necessary for democracy. Shedding some doubt on this claim, however, is the
           theory that won economist Douglass North the Nobel Prize in 1993. North
           argued that the creation and strengthening of the patent system, by
           encouraging private invention and enterprise, became the fundamental catalyst
           behind the Industrial Revolution in England.
          Underground economy – Official GDP estimates may not take into account
           the underground economy, in which transactions contributing to production,
    such as illegal trade and tax-avoiding activities, are unreported, causing GDP
    to be underestimated.
   Non-monetary economy – GDP omits economies where no money comes
    into play at all, resulting in inaccurate or abnormally low GDP figures. For
    example, in countries with major business transactions occurring informally,
    portions of local economy are not easily registered. Bartering may be more
    prominent than the use of money, even extending to services (I helped you
    build your house ten years ago, so now you help me).
   GDP also ignores subsistence production.
   Quality improvements and inclusion of new products – By not adjusting
    for quality improvements and new products, GDP understates true economic
    growth. For instance, although computers today are less expensive and more
    powerful than computers from the past, GDP treats them as the same products
    by only accounting for the monetary value. The introduction of new products
    is also difficult to measure accurately and is not reflected in GDP despite the
    fact that it may increase the standard of living. For example, even the richest
    person from 1900 could not purchase standard products, such as antibiotics
    and cell phones, that an average consumer can buy today, since such modern
    conveniences did not exist back then.
   What is being produced – GDP counts work that produces no net change or
    that results from repairing harm. For example, rebuilding after a natural
    disaster or war may produce a considerable amount of economic activity and
    thus boost GDP. The economic value of health care is another classic
    example—it may raise GDP if many people are sick and they are receiving
    expensive treatment, but it is not a desirable situation. Alternative economic
    estimates, such as the standard of living or discretionary income per capita try
    to measure the human utility of economic activity. See uneconomic growth.
   Externalities – GDP ignores externalities or economic bads such as damage
    to the environment. By counting goods which increase utility but not
    deducting bads or accounting for the negative effects of higher production,
    such as more pollution, GDP is overstating economic welfare. The Genuine
    Progress Indicator is thus proposed by ecological economists and green
    economists as a substitute for GDP, supposing a consensus on relevant data to
    measure "progress". In countries highly dependent on resource extraction or
    with high ecological footprints the disparities between GDP and GPI can be
    very large, indicating ecological overshoot. Some environmental costs, such
    as cleaning up oil spills are included in GDP.
   Sustainability of growth – GDP is not a tool of economic projections, which
    would make it subjective, it is just a measurement of economic activity. That
    is why it does not measure what is considered the sustainability of growth. A
    country may achieve a temporarily high GDP by over-exploiting natural
    resources or by misallocating investment. For example, the large deposits of
    phosphates gave the people of Nauru one of the highest per capita incomes on
    earth, but since 1989 their standard of living has declined sharply as the
    supply has run out. Oil-rich states can sustain high GDPs without
    industrializing, but this high level would no longer be sustainable if the oil
    runs out. Economies experiencing an economic bubble, such as a housing
    bubble or stock bubble, or a low private-saving rate tend to appear to grow
    faster owing to higher consumption, mortgaging their futures for present
    growth. Economic growth at the expense of environmental degradation can
    end up costing dearly to clean up.
   One main problem in estimating GDP growth over time is that the purchasing
    power of money varies in different proportion for different goods, so when the
    GDP figure is deflated over time, GDP growth can vary greatly depending on
    the basket of goods used and the relative proportions used to deflate the GDP
    figure. For example, in the past 80 years the GDP per capita of the United
    States if measured by purchasing power of potatoes, did not grow
    significantly. But if it is measured by the purchasing power of eggs, it grew
    several times. For this reason, economists comparing multiple countries
    usually use a varied basket of goods.
   Cross-border comparisons of GDP can be inaccurate as they do not take into
    account local differences in the quality of goods, even when adjusted for
    purchasing power parity. This type of adjustment to an exchange rate is
    controversial because of the difficulties of finding comparable baskets of
    goods to compare purchasing power across countries. For instance, people in
    country A may consume the same number of locally produced apples as in
    country B, but apples in country A are of a more tasty variety. This difference
           in material well being will not show up in GDP statistics. This is especially
           true for goods that are not traded globally, such as housing.
          Transfer pricing on cross-border trades between associated companies may
           distort import and export measures[citation needed].
          As a measure of actual sale prices, GDP does not capture the economic
           surplus between the price paid and subjective value received, and can
           therefore underestimate aggregate utility.

Simon Kuznets in his very first report to the US Congress in 1934 said:[23]

...the welfare of a nation can, therefore, scarcely be inferred from a measure of national
income...

In 1962, Kuznets stated:[24]

Distinctions must be kept in mind between quantity and quality of growth, between costs
and returns, and between the short and long run. Goals for more growth should specify
more growth of what and for what.

[edit] Alternatives to GDP


          Human development index (HDI) - HDI uses GDP as a part of its calculation
           and then factors in indicators of life expectancy and education levels.
          Genuine progress indicator (GPI) or Index of Sustainable Economic Welfare
           (ISEW) - The GPI and the ISEW attempt to address many of the above
           criticisms by taking the same raw information supplied for GDP and then
           adjust for income distribution, add for the value of household and volunteer
           work, and subtract for crime and pollution.
          Gross national happiness (GNH) - GNH measures quality of life or social
           progress in more holistic and psychological terms than GDP.
          Gini coefficient - The Gini coefficient measures the disparity of income
           within a nation.
          Wealth estimates - The World Bank has developed a system for combining
           monetary wealth with intangible wealth (institutions and human capital) and
           environmental capital.[25]
          Private Product Remaining - Murray Newton Rothbard and other Austrian
           economists argue that because government spending is taken from productive
           sectors and produces goods that consumers do not want, it is a burden on the
           economy and thus should be deducted. In his book, America's Great
           Depression, Rothbard argues that even government surpluses from taxation
           should be deducted to create an estimate of PPR.

Some people have looked beyond standard of living at a broader sense of quality of life
or well-being:


          European Quality of Life Survey - The survey, first published in 2005,
           assessed quality of life across European countries through a series of
           questions on overall subjective life satisfaction, satisfaction with different
           aspects of life, and sets of questions used to calculate deficits of time, loving,
           being and having.[26]
          Gross national happiness - The Centre for Bhutanese Studies in Bhutan is
           working on a complex set of subjective and objective indicators to measure
           'national happiness' in various domains (living standards, health, education,
           eco-system diversity and resilience, cultural vitality and diversity, time use
           and balance, good governance, community vitality and psychological well-
           being). This set of indicators would be used to assess progress towards gross
           national happiness, which they have already identified as being the nation's
           priority, above GDP.
          Happy Planet Index - The happy planet index (HPI) is an index of human
           well-being and environmental impact, introduced by the New Economics
           Foundation (NEF) in 2006. It measures the environmental efficiency with
           which human well-being is achieved within a given country or group. Human
           well-being is defined in terms of subjective life satisfaction and life
           expectancy while environmental impact is defined by the Ecological
           Footprint.


Unemployment

Unemployment occurs when a person is able and willing to work but currently without
work.[1] The prevalence of unemployment is usually measured using the unemployment
rate, which is defined as the percentage of those in the labor force who are unemployed.
The unemployment rate is also used in economic studies and economic indices such as
the United States' Conference Board's Index of Leading Indicators as a measure of the
state of macroeconomics.

The causes of unemployment are disputed. Keynesian economics emphasizes
unemployment resulting from insufficient effective demand for goods and services in the
economy (cyclical unemployment). Others point to structural problems and inefficiencies
inherent in labour markets; structural unemployment involves mismatches between
demand and supply of laborers with the necessary skillset, sometimes induced by
technologies or globalisation. Classical or neoclassical economics tends to reject these
explanations, and focuses more on rigidities imposed on the labor market from the
outside, such as unionization, minimum wage laws, taxes, and other regulations that may
discourage the hiring of workers (classical unemployment). Yet others see unemployment
as largely due to voluntary choices by the unemployed and the time it takes to find a new
job (frictional unemployment). Behavioral economics highlights phenomena such as
sticky wages and efficiency wages which may lead to unemployment.

There is also disagreement on how exactly to measure unemployment. Different countries
experience different levels of unemployment; traditionally, the United States tends to
experience lower unemployment levels than countries in the European Union,[2] although
there is some variation there, with countries like the UK and Denmark outperforming
Italy and France and it also changes over time (e.g. the Great Depression) throughout
economic cycles.


Contents

[hide]


          1 Involuntary unemployment
          2 Solutions
                o 2.1 Demand side
                o 2.2 Supply side
          3 Types of unemployment
                o 3.1 Frictional unemployment
                o 3.2 Classical unemployment
                o 3.3 Cyclical or Keynesian unemployment
                o 3.4 Structural unemployment
                o 3.5 Hidden unemployment
                o 3.6 Full employment
          4 Costs of unemployment
                o 4.1 Individual
                o 4.2 Social
                o 4.3 Socio-political
          5 Historical and contemporary unemployment
          6 Measurement
                o 6.1 European Union (Eurostat)
                o 6.2 United States Bureau of Labor Statistics
                o 6.3 Limitations of the unemployment definition
          7 Aiding the unemployed
          8 Benefits
          9 See also
          10 References
          11 External links



[edit] Involuntary unemployment

In The General Theory, Keynes argued that neo-classical economic theory did not apply
during recessions because of oversaving and private investor timidity. In consequence,
people could be thrown out of work involuntarily and not be able to find acceptable new
employment.

This conflict between the neoclassical and Keynesian theories has had strong influence
on government policy. The tendency for government is to curtail and eliminate
unemployment through increases in benefits and government jobs, and to encourage the
job-seeker to both consider new careers and relocation to another city.

Involuntary unemployment does not exist in agrarian societies nor is it formally
recognized to exist in underdeveloped but urban societies, such as the mega-cities of
Africa and of India/Pakistan. In such societies, a suddenly unemployed person must meet
their survival needs either by getting a new job at any price, becoming an entrepreneur, or
joining the underground economy of the hustler.[3]

Involuntary unemployment is discussed from the narrative standpoint in stories by
Ehrenreich, the narrative sociology of Bourdieu, and novels of social suffering such as
John Steinbeck's The Grapes of Wrath.

[edit] Solutions

Societies try a number of different measures to get as many people as possible into work,
and various societies have experienced close to full employment for extended periods,
particularly during the Post-World War II economic expansion. The United Kingdom in
the 1950s and 60s averaged 1.6% unemployment,[4] while in Australia the 1945 White
Paper on Full Employment in Australia established a government policy of full
employment, which policy lasted until the 1970s.

Mainstream economics since the 1970s believes however that attempts to reduce the level
of unemployment below the natural rate of unemployment will fail, resulting only in less
output and more inflation.

[edit] Demand side




Government employment of the unemployed is one solution, as in the Works Progress
Administration.

A direct demand-side solution to unemployment is government-funded employment of
the able-bodied poor. This was notably implemented in Britain from the 17th century
until 1948 in the institution of the workhouse, which provided jobs for the unemployed
with harsh conditions and poor wages to dissuade their use. A modern alternative is a job
guarantee, where the government guarantees work at a living wage. Temporary measures
can include public works programs such as the Works Progress Administration.

Government-funded employment is not widely advocated as a solution to unemployment,
except in times of crisis; this is attributed to the public sector jobs' existence depending
directly on the tax receipts from private sector employment.

According to classical economic theory, markets reach equilibrium where supply equals
demand; everyone who wants to sell at the market price can. Those who do not want to
sell at this price do not; in the labour market this is classical unemployment. Increases in
the demand for labour will move the economy along the demand curve, increasing wages
and employment. The demand for labour in an economy is derived from the demand for
goods and services. As such, if the demand for goods and services in the economy
increases, the demand for labour will increase, increasing employment and wages.
Monetary policy and fiscal policy can both be used to increase short-term growth in the
economy, increasing the demand for labour and decreasing unemployment.

[edit] Supply side

However, the labour market is not efficient: it does not clear. Minimum wages and union
activity keep wages from falling, which means too many people want to sell their labour
at the going price but cannot. Advocates of supply-side policies believe those policies can
solve this by making the labour market more flexible. These include removing the
minimum wage and reducing the power of unions. Other supply side policies include
education to make workers more attractive to employers.

Supply side reforms also increase long-term growth. This increased supply of goods and
services requires more workers, increasing employment. It is argued that supply side
policies, which include cutting taxes on businesses and reducing regulation, create jobs
and reduce unemployment.

[edit] Types of unemployment

Economists distinguish between various types of unemployment, including cyclical
unemployment, frictional unemployment, structural unemployment and classical
unemployment.[5] Some additional types of unemployment that are occasionally
mentioned are seasonal unemployment, hardcore unemployment, and hidden
unemployment. Real-world unemployment may combine different types. The magnitude
of each of these is difficult to measure, partly because they overlap.

Though there have been several definitions of voluntary and involuntary unemployment
in the economics literature, a simple distinction is often applied. Voluntary
unemployment is attributed to the individual's decisions, whereas involuntary
unemployment exists because of the socio-economic environment (including the market
structure, government intervention, and the level of aggregate demand) in which
individuals operate. In these terms, much or most of frictional unemployment is
voluntary, since it reflects individual search behavior.

On the other hand, cyclical unemployment, structural unemployment, and classical
unemployment are largely involuntary in nature. However, the existence of structural
unemployment may reflect choices made by the unemployed in the past, while classical
(natural) unemployment may result from the legislative and economic choices made by
labor unions and/or political parties. So in practice, the distinction between voluntary and
involuntary unemployment is hard to draw. The clearest cases of involuntary
unemployment are those where there are fewer job vacancies than unemployed workers
even when wages are allowed to adjust, so that even if all vacancies were to be filled,
there would be unemployed workers. This is the case of cyclical unemployment, for
which macroeconomic forces lead to microeconomic unemployment.

[edit] Frictional unemployment
             The following text needs to be harmonized with text in Frictional
             unemployment.



Frictional unemployment is the time period between jobs when a worker moves from one
job to another. Frictional unemployment is an example of a productive part of the
economy, increasing both the worker's long term welfare and economic efficiency, and is
also a type of voluntary unemployment.

Frictional unemployment is always present in an economy, so the level of involuntary
unemployment is properly the unemployment rate minus the rate of frictional
unemployment, which means that increases or decreases in unemployment are normally
under-represented in the simple statistics.[6]

[edit] Classical unemployment

Classical or real-wage unemployment occurs when real wages for a job are set above the
market-clearing level, causing the number of job-seekers to exceed the number of
vacancies.

Libertarian economists like F.A. Hayek argued that unemployment increases the more the
government intervenes into the economy to try to improve the conditions of those with
jobs. For example, minimum wage laws raise the cost of labourers with few skills to
above the market equilibrium, resulting in people who wish to work at the going rate but
cannot as wage enforced is greater than their value as workers becoming unemployed. [7][8]
They believed that laws restricting layoffs made businesses less likely to hire in the first
place, as hiring becomes more risky, leaving many young people unemployed and unable
to find work.[8]

Some, such as Murray Rothbard,[9] suggest that even social taboos can prevent wages
from falling to the market clearing level.

Some economists theorize that this type of unemployment can be reduced by increasing
the flexibility of wages (e.g., abolishing minimum wages or employee protection), to
make the labor market more like a financial market.[citation needed]

[edit] Cyclical or Keynesian unemployment

Cyclical or Keynesian unemployment, also known as deficient-demand unemployment,
occurs when there is not enough aggregate demand in the economy. It gets its name
because it varies with the business cycle, though it can also be persistent, as during the
Great Depression of the 1930s. Cyclical unemployment is caused by a business cycle
recession, and wages not falling to meet the equilibrium level. Cyclical unemployment
rises during economic downturns and falls when the economy improves. Keynesians
argue that this type of unemployment exists due to inadequate effective aggregate
demand. Demand for most goods and services falls, less production is needed and
consequently fewer workers are needed, wages do not fall to meet the equilibrium level,
and mass unemployment results.

Some consider this type of unemployment one type of frictional unemployment in which
factors causing the friction are partially caused by some cyclical variables. For example,
a surprise decrease in the money supply may shock participants in society.

With cyclical unemployment, the number of unemployed workers exceeds the number of
job vacancies, so that if even all open jobs were filled, some workers would remain
unemployed. This kind of unemployment coincides with unused industrial capacity
(unemployed capital goods). Keynesian economists see it as possibly being solved by
government deficit spending or by expansionary monetary policy, which aims to increase
non-governmental spending by lowering interest rates.
In contrast, Austrian economists argue that government spending and policies are the root
cause of economic cycles and cyclical unemployment and should be reformed or
removed.

Classical economics rejects the conception of cyclical unemployment, seeing the
attainment of full employment of resources and potential output as the normal state of
affairs.[citation needed]

[edit] Structural unemployment



             The following text needs to be harmonized with text in Structural
             unemployment.



Structural unemployment occurs when a labor market is unable to provide jobs for
everyone who wants one because there is a mismatch between the skills of the
unemployed workers and the skills needed for the available jobs.[10]

Structural unemployment is hard to separate empirically from frictional unemployment,
except to say that it lasts longer. As with frictional unemployment, simple demand-side
stimulus will not work to easily abolish this type of unemployment.

Structural unemployment may also be encouraged to rise by persistent cyclical
unemployment: if an economy suffers from long-lasting low aggregate demand, it means
that many of the unemployed become disheartened, while their skills (including job-
searching skills) become "rusty" and obsolete. Problems with debt may lead to
homelessness and a fall into the vicious circle of poverty. This means that they may not
fit the job vacancies that are created when the economy recovers. Some economists see
this scenario as occurring under British Prime Minister Margaret Thatcher during the
1970s and 1980s. The implication is that sustained high demand may lower structural
unemployment. This theory of persistence in structural unemployment has been referred
to as an example of path dependence or "hysteresis".

Much technological unemployment (e.g. due to the replacement of workers by
machines) might be counted as structural unemployment. Alternatively, technological
unemployment might refer to the way in which steady increases in labor productivity
mean that fewer workers are needed to produce the same level of output every year. The
fact that aggregate demand can be raised to deal with this problem suggests that this
problem is instead one of cyclical unemployment. As indicated by Okun's Law, the
demand side must grow sufficiently quickly to absorb not only the growing labor force
but also the workers made redundant by increased labor productivity. Otherwise, we see a
jobless recovery such as those seen in the United States in both the early 1990s and the
early 2000s.

Seasonal unemployment may be seen as a kind of structural unemployment, since it is a
type of unemployment that is linked to certain kinds of jobs (construction work,
migratory farm work). The most-cited official unemployment measures erase this kind of
unemployment from the statistics using "seasonal adjustment" techniques.

[edit] Hidden unemployment

Hidden, or covered, unemployment is the unemployment of potential workers that is not
reflected in official unemployment statistics, due to the way the statistics are collected. In
many countries only those who have no work but are actively looking for work (and/or
qualifying for social security benefits) are counted as unemployed. Those who have given
up looking for work (and sometimes those who are on Government "retraining"
programmes) are not officially counted among the unemployed, even though they are not
employed. The same applies to those who have taken early retirement to avoid being laid
off, but would prefer to be working. The statistic also does not count the
"underemployed" - those with part time or seasonal jobs who would rather have full time
jobs. Because of hidden unemployment, official statistics often underestimate
unemployment rates.
[edit] Full employment

Main article: Full employment

In demand-based theory, it is possible to abolish cyclical unemployment by increasing
the aggregate demand for products and workers. However, eventually the economy hits
an "inflation barrier" imposed by the four other kinds of unemployment to the extent that
they exist.

Some demand theory economists see the inflation barrier as corresponding to the natural
rate of unemployment. The "natural" rate of unemployment is defined as the rate of
unemployment that exists when the labor market is in equilibrium and there is pressure
for neither rising inflation rates nor falling inflation rates. An alternative technical term
for this rate is the NAIRU or the Non-Accelerating Inflation Rate of Unemployment.

No matter what its name, demand theory holds that this means that if the unemployment
rate gets "too low," inflation will get worse and worse (accelerate) in the absence of wage
and price controls (incomes policies).

One of the major problems with the NAIRU theory is that no one knows exactly what the
NAIRU is (while it clearly changes over time). The margin of error can be quite high
relative to the actual unemployment rate, making it hard to use the NAIRU in policy-
making.

Another, normative, definition of full employment might be called the ideal
unemployment rate. It would exclude all types of unemployment that represent forms of
inefficiency. This type of "full employment" unemployment would correspond to only
frictional unemployment (excluding that part encouraging the McJobs management
strategy) and would thus be very low. However, it would be impossible to attain this full-
employment target using only demand-side Keynesian stimulus without getting below the
NAIRU and suffering from accelerating inflation (absent incomes policies). Training
programs aimed at fighting structural unemployment would help here.

To the extent that hidden unemployment exists, it implies that official unemployment
statistics provide a poor guide to what unemployment rate coincides with "full
employment".

[edit] Costs of unemployment

[edit] Individual




An 1837 political cartoon about unemployment in the United States.
Unemployed individuals are unable to earn money to meet financial obligations. Failure
to pay mortgage payments or to pay rent may lead to homelessness through foreclosure or
eviction.[11] Across the United States the growing ranks of people made homeless in the
foreclosure crisis are generating tent cities.[12] Unemployment increases susceptibility to
malnutrition, illness, mental stress, and loss of self-esteem, leading to depression.
According to a study published in Social Indicator Research, even those who tend to be
optimistic find it difficult to look on the bright side of things when unemployed. Using
interviews and data from German participants aged 16 to 94 – including individuals
coping with the stresses of real life and not just a volunteering student population – the
researchers determined that even optimists struggled with being unemployed.[13]

Dr. M. Brenner conducted a study in 1979 on the "Influence of the Social Environment
on Psychology." Brenner found that for every 10% increase in the number of unemployed
there is an increase of 1.2% in total mortality, a 1.7% increase in cardiovascular disease,
1.3% more cirrhosis cases, 1.7% more suicides, 4.0% more arrests, and 0.8% more
assaults reported to the police.[14] A more recent study by Christopher Ruhm[15] on the
effect of recessions on health found that several measures of health actually improve
during recessions. As for the impact of an economic downturn on crime, during the Great
Depression the crime rate did not decrease. Because unemployment insurance in the U.S.
typically does not replace 50% of the income one received on the job (and one cannot
receive it forever), the unemployed often end up tapping welfare programs such as Food
Stamps or accumulating debt.

Some hold that many of the low-income jobs are not really a better option than
unemployment with a welfare state (with its unemployment insurance benefits). But since
it is difficult or impossible to get unemployment insurance benefits without having
worked in the past, these jobs and unemployment are more complementary than they are
substitutes. (These jobs are often held short-term, either by students or by those trying to
gain experience; turnover in most low-paying jobs is high.)

Another cost for the unemployed is that the combination of unemployment, lack of
financial resources, and social responsibilities may push unemployed workers to take jobs
that do not fit their skills or allow them to use their talents. Unemployment can cause
underemployment, and fear of job loss can spur psychological anxiety.

[edit] Social

An economy with high unemployment is not using all of the resources, specifically
labour, available to it. Since it is operating below its production possibility frontier, it
could have higher output if all the workforce were usefully employed. However, there is
a trade-off between economic efficiency and unemployment: if the frictionally
unemployed accepted the first job they were offered, they would be likely to be operating
at below their skill level, reducing the economy's efficiency. [16]

During a long period of unemployment, workers can lose their skills, causing a loss of
human capital. Being unemployed can also reduce the life expectancy of workers by
about 7 years [17]

High unemployment can encourage xenophobia and protectionism as workers fear that
foreigners are stealing their jobs.[citation needed] Efforts to preserve existing jobs of domestic
and native workers include legal barriers against "outsiders" who want jobs, obstacles to
immigration, and/or tariffs and similar trade barriers against foreign competitors.

High unemployment can also cause social problems such as crime; if people don't have as
much disposable income as before, then it is very likely that crime levels within the
economy will increase.

[edit] Socio-political

High levels of unemployment can be causes of civil unrest, in some cases leading to
revolution, and particularly totalitarianism. The fall of the Weimar Republic in 1933 and
Adolf Hitler's rise to power, which culminated in World War II and the deaths of tens of
millions and the destruction of much of the physical capital of Europe, is attributed to the
poor economic conditions in Germany at the time, notably a high unemployment rate[18]
of above 20%; see Great Depression in Central Europe for details.
Note that the hyperinflation in the Weimar republic is not directly blamed for the Nazi
rise – the Inflation in the Weimar Republic occurred primarily in the period 1921–23,
which was contemporary with Hitler's Beer Hall Putsch of 1923, and is blamed for
damaging the credibility of democratic institutions, but the Nazi party only assumed
government in 1933, 10 years after the hyperinflation but in the midst of high
unemployment.

[edit] Historical and contemporary unemployment

In the 16th century in England, no distinction was made between vagrants and the
jobless; both were simply categorised as "sturdy beggars", to be punished and moved
on.[19] The closing of the monasteries in the 1530s increased poverty, as the church had
helped the poor. In addition, there was a significant rise in enclosure during the Tudor
period. Also the population was rising. Those unable to find work had a stark choice:
starve or break the law. In 1535, a bill was drawn up calling for the creation of a system
of public works to deal with the problem of unemployment, to be funded by a tax on
income and capital. A law passed a year later allowed vagabonds to be whipped and
hanged.[20] In 1547, a bill was passed that subjected vagrants to some of the more extreme
provisions of the criminal law, namely two years servitude and branding with a "V" as
the penalty for the first offence and death for the second. [21] During the reign of Henry
VIII, as many as 72,000 people are estimated to have been executed.[22]

In the 1576 Act each town was required to provide work for the unemployed. [23] The
Elizabethan Poor Law of 1601, one of the world's first government-sponsored welfare
programs, made a clear distinction between those who were unable to work and those
able-bodied people who refused employment.[24] Under the Poor Law systems of England
and Wales, Scotland and Ireland a workhouse was a place where people who were unable
to support themselves, could go to live and work.[25] In the early 1700s, there were
roughly 10 million people living in England, and an estimated two million were,
―vagrants, rogues, prostitutes, beggars or indigents.‖[26] In 18th century England, half the
population was at least occasionally dependent on charity for subsistence. [27] By 1776
some 1,912 parish and corporation workhouses had been established in England and
Wales, housing almost 100,000 paupers.




Unemployed men, marching for jobs during the Great Depression.

The decade of the 1930s saw the Great Depression in the United States and many other
countries. In 1929, the U.S. unemployment rate averaged 3%. [28] In 1933, 25% of all
American workers and 37% of all nonfarm workers were unemployed. [29] In Cleveland,
Ohio, the unemployment rate was 60%; in Toledo, Ohio, 80%.[30] Unemployment in
Canada reached 27% at the depth of the Depression in 1933.[31] In some towns and cities
in the north east of England, unemployment reached as high as 70%. In Germany the
unemployment rate reached nearly 25% in 1932.[32] One Soviet trading corporation in
New York averaged 350 applications a day from Americans seeking jobs in the Soviet
Union.[33] There were two million homeless people migrating across the United States.[30]
Over 3 million unemployed young men were taken out of the cities and placed into
2600+ work camps managed by the CCC.[34]
About 25 million people in the world's 30 richest countries will have lost their jobs
between the end of 2007 and the end of 2010 as the economic downturn pushes most
countries into recession.[35] In April 2010, the U.S. unemployment rate was 9.9%, but the
government’s broader U-6 unemployment rate was 17.1%.[36] There are six unemployed
people, on average, for each available job.[37] Men account for at least 7 of 10 workers
who lost jobs, according to Bureau of Labor Statistics data.[38] The youth unemployment
rate was 18.5% in July 2009, the highest July rate since 1948.[39] 34.5% of young African
American men were unemployed in October 2009.[40] Officially, Detroit’s unemployment
rate is 27%, but the Detroit News suggests that nearly half of this city’s working-age
population may be unemployed.[41] 3.8 million Americans lost their jobs in 2009.[37]

The official unemployment rate in the 16 EU countries that use the euro rose to 10% in
December 2009.[42] Latvia had the highest unemployment rate in EU at 22.3% for
November 2009.[43] Europe's young workers have been especially hard hit.[44] In
November 2009, the unemployment rate in the EU27 for those aged 15–24 was 18.3%.
For those under 25, the unemployment rate in Spain was 43.8%.[45]

A flood of inexpensive consumer goods from China has recently encountered criticism
from Europe, the United States and some African countries.[46] In South Africa, some
300,000 textile workers have lost their jobs due to the influx of Chinese goods. [47] The
increasing U.S. trade deficit with China has cost 2.4 million American jobs between 2001
and 2008, according to a study by the Economic Policy Institute (EPI).[48] A total of 3.2
million – one in six U.S. factory jobs – have disappeared between 2000 and 2007.[49]

[edit] Measurement

Though many people care about the number of unemployed, economists typically focus
on the unemployment rate. This corrects for the normal increase in the number of people
employed due to increases in population and increases in the labor force relative to the
population. The unemployment rate is expressed as a percentage, and is calculated as
follows:




As defined by the International Labour Organization, "unemployed workers" are those
who are currently not working but are willing and able to work for pay, currently
available to work, and have actively searched for work.[50] Individuals who are actively
seeking job placement must make the effort to: be in contact with an employer, have job
interviews, contact job placement agencies, send out resumes, submit applications,
respond to advertisements, or some other means of active job searching within the prior
four weeks. Simply looking at advertisements and not responding will not count as
actively seeking job placement. Since not all unemployment may be "open" and counted
by government agencies, official statistics on unemployment may not be accurate. [51]

The ILO describes 4 different methods to calculate the unemployment rate:[52]


          Labour Force Sample Surveys are the most preferred method of
           unemployment rate calculation since they give the most comprehensive results
           and enables calculation of unemployment by different group categories such
           as race and gender. This method is the most internationally comparable.
          Official Estimates are determined by a combination of information from one
           or more of the other three methods. The use of this method has been declining
           in favor of Labour Surveys.
          Social Insurance Statistics such as unemployment benefits, are computed base
           on the number of persons insured representing the total labour force and the
           number of persons who are insured that are collecting benefits. This method
           has been heavily criticized due to the expiration of benefits before the person
           finds work.
          Employment Office Statistics are the least effective being that they only
           include a monthly tally of unemployed persons who enter employment
           offices. This method also includes unemployed who are not unemployed per
           the ILO definition.
[edit] European Union (Eurostat)

Eurostat, the statistical office of the European Union, defines unemployed as those
persons age 15 to 74 who are not working, have looked for work in the last four weeks,
and ready to start work within two weeks, which conform to ILO standards. Both the
actual count and rate of unemployment are reported. Statistical data are available by
member state, for the European Union as a whole (EU27) as well as for the euro area
(EA16). Eurostat also includes a long-term unemployment rate. This is defined as part of
the unemployed who have been unemployed for an excess of 1 year.

The main source used is the European Union Labour Force Survey (EU-LFS). The EU-
LFS collects data on all member states each quarter. For monthly calculations, national
surveys or national registers from employment offices are used in conjunction with
quarterly EU-LFS data. The exact calculation for individual countries, resulting in
harmonised monthly data, depend on the availability of the data. [53]

[edit] United States Bureau of Labor Statistics




Unemployment rate in the US by county in 2008.[54]
  1.2–3% 3.1–          5.1–6% 6.1–          8.1–9% 9.1–               11.1–
4% 4.1–5%           7% 7.1–8%            10% 10.1–11%               13% 13.1–22.9%




Estimated U.S. Unemployment rate from 1800-1890. All data are estimates based on data
compiled by Lebergott.[55] See limitations section below regarding how to interpret
unemployment statistics in self-employed, agricultural economies. See image info for
complete data.
Estimated U.S. Unemployment rate from 1890-2010. 1890–1930 data are from Romer.[56]
1930–1940 data are from Coen.[57] 1940–2009 data are from Bureau of Labor
Statistics.[58] See also "Historical Comparability" under the Household Data section of the
Explanatory Notes at http://www.bls.gov/cps/eetech_methods.pdf. See image info for
complete data.

The Bureau of Labor Statistics measures employment and unemployment (of those over
15 years of age) using two different labor force surveys[59] conducted by the United States
Census Bureau (within the United States Department of Commerce) and/or the Bureau of
Labor Statistics (within the United States Department of Labor) that gather employment
statistics monthly. The Current Population Survey (CPS), or "Household Survey",
conducts a survey based on a sample of 60,000 households. This Survey measures the
unemployment rate based on the ILO definition.[60] The data are also used to calculate 5
alternate measures of unemployment as a percentage of the labor force based on different
definitions noted as U1 through U6:[61]


          U1: Percentage of labor force unemployed 15 weeks or longer.
          U2: Percentage of labor force who lost jobs or completed temporary work.
          U3: Official unemployment rate per ILO definition.
          U4: U3 + "discouraged workers", or those who have stopped looking for work
           because current economic conditions make them believe that no work is
           available for them.
          U5: U4 + other "marginally attached workers", or "loosely attached workers",
           or those who "would like" and are able to work, but have not looked for work
           recently.
          U6: U5 + Part time workers who want to work full time, but cannot due to
           economic reasons (underemployment).

Note: "Marginally attached workers" are added to the total labor force for
unemployment rate calculation for U4, U5, and U6. The BLS revised the CPS in 1994
and among the changes the measure representing the official unemployment rate was
renamed U3 instead of U5.[62]

It should also be noted that studies have found that the U.S. unemployment rate would be
at least 2% higher if prisoners and jail inmates were counted.[63][64]

The Current Employment Statistics survey (CES), or "Payroll Survey", conducts a survey
based on a sample of 160,000 businesses and government agencies that represent 400,000
individual employers.[65] This survey measures only nonagricultural, nonsupervisory
employment; thus, it does not calculate an unemployment rate, and it differs from the
ILO unemployment rate definition. These two sources have different classification
criteria, and usually produce differing results. Additional data are also available from the
government, such as the unemployment insurance weekly claims report available from
the Office of Workforce Security, within the U.S. Department of Labor Employment &
Training Administration.[66]

These statistics are for the U.S. economy as a whole, hiding variations among groups. For
January 2008 in the U.S. the unemployment rates were 4.4% for adult men, 4.2% for
adult women, 4.4% for Caucasians, 6.3% for Hispanics or Latinos (all races), 9.2% for
African Americans, 3.2% for Asian Americans, and 18.0% for teenagers. [65]

These percentages represent the usual rough ranking of these different groups'
unemployment rates. The absolute numbers change over time and with the business
cycle.[67]

The Bureau of Labor Statistics provides up-to-date numbers via a pdf linked here.[68] The
BLS also provides a readable concise current Employment Situation Summary, updated
monthly.[69]

[edit] Limitations of the unemployment definition

The unemployment rate may be different from the impact of the economy on people. The
unemployment figures indicate how many are not working for pay but seeking
employment for pay. It is only indirectly connected with the number of people who are
actually not working at all or working without pay. Therefore, critics believe that current
methods of measuring unemployment are inaccurate in terms of the impact of
unemployment on people as these methods do not take into account the 1.5% of the
available working population incarcerated in U.S. prisons (who may or may not be
working while incarcerated), those who have lost their jobs and have become discouraged
over time from actively looking for work, those who are self-employed or wish to
become self-employed, such as tradesmen or building contractors or IT consultants, those
who have retired before the official retirement age but would still like to work
(involuntary early retirees), those on disability pensions who, while not possessing full
health, still wish to work in occupations suitable for their medical conditions, those who
work for payment for as little as one hour per week but would like to work full-time.
These people are "involuntary part-time" workers, those who are underemployed, e.g., a
computer programmer who is working in a retail store until he can find a permanent job,
involuntary stay-at-home mothers who would prefer to work, and graduate and
Professional school students who were unable to find worthwhile jobs after they
graduated with their Bachelor's degrees.

Internationally, unemployment is sometimes muted due to the number of self-employed
individuals working in agriculture. Small independent farmers are often considered self-
employed; so, they cannot be unemployed. The impact of this is that in non-industrialized
economies such as the United States and Europe during the early 1800s, overall
unemployment was approximately 3% because so many individuals were self-employed
independent farmers; yet, unemployment outside of agriculture was as high as 80%. [70]
Many economies industrialize and experience increasing numbers of non-agricultural
workers. For example, the United States' non-agricultural laborforce increased from 20%
in 1800, to 50% in 1850, to 97% in 2000.[71] The shift away from self-employment
increases the percentage of the population who are included in unemployment rates.
When comparing unemployment rates between countries or time periods, it is best to
consider differences in their levels of industrialization and self-employment.

On the other hand, the measures of employment and unemployment may be "too high".
In some countries, the availability of unemployment benefits can inflate statistics since
they give an incentive to register as unemployed. People who do not really seek work
may choose to declare themselves unemployed so as to get benefits; people with
undeclared paid occupations may try to get unemployment benefits in addition to the
money they earn from their work. Conversely, the absence of any tangible benefit for
registering as unemployed discourages people from registering.

However, in countries such as the United States, Canada, Mexico, Australia, Japan and
the European Union, unemployment is measured using a sample survey (akin to a Gallup
poll). According to the BLS, a number of Eastern European nations have instituted labor
force surveys as well. The sample survey has its own problems because the total number
of workers in the economy is calculated based on a sample rather than a census.

It is possible to be neither employed nor unemployed by ILO definitions, i.e., to be
outside of the "labor force." These are people who have no job and are not looking for
one. Many of these are going to school or are retired. Family responsibilities keep others
out of the labor force. Still others have a physical or mental disability which prevents
them from participating in labor force activities. And of course some people simply elect
not to work, preferring to be dependent on others for sustenance.
Typically, employment and the labor force include only work done for monetary gain.
Hence, a homemaker is neither part of the labor force nor unemployed. Nor are full-time
students nor prisoners considered to be part of the labor force or unemployment. The
latter can be important. In 1999, economists Lawrence F. Katz and Alan B. Krueger
estimated that increased incarceration lowered measured unemployment in the United
States by 0.17% between 1985 and the late 1990s. In particular, as of 2005, roughly 0.7%
of the U.S. population is incarcerated (1.5% of the available working population).

Children, the elderly, and some individuals with disabilities are typically not counted as
part of the labor force in and are correspondingly not included in the unemployment
statistics. However, some elderly and many disabled individuals are active in the labor
market.

In the early stages of an economic boom, unemployment often rises. This is because
people join the labor market (give up studying, start a job hunt, etc.) because of the
improving job market, but until they have actually found a position they are counted as
unemployed. Similarly, during a recession, the increase in the unemployment rate is
moderated by people leaving the labor force or being otherwise discounted from the labor
force, such as with the self-employed.

For the fourth quarter of 2004, according to OECD, (source Employment Outlook 2005
ISBN 92-64-01045-9), normalized unemployment for men aged 25 to 54 was 4.6% in the
U.S. and 7.4% in France. At the same time and for the same population the employment
rate (number of workers divided by population) was 86.3% in the U.S. and 86.7% in
France.

This example shows that the unemployment rate is 60% higher in France than in the U.S.,
yet more people in this demographic are working in France than in the U.S., which is
counterintuitive if it is expected that the unemployment rate reflects the health of the
labor market.[72][73]

Due to these deficiencies, many labor market economists prefer to look at a range of
economic statistics such as labor market participation rate, the percentage of people aged
between 15 and 64 who are currently employed or searching for employment, the total
number of full-time jobs in an economy, the number of people seeking work as a raw
number and not a percentage, and the total number of person-hours worked in a month
compared to the total number of person-hours people would like to work. In particular the
NBER does not use the unemployment rate but prefer various employment rates to date
recessions.[74]

[edit] Aiding the unemployed

Many countries have aids for the unemployed as part of the social welfare. These
unemployment benefits include unemployment insurance, welfare, unemployment
compensation and subsidies to aid in retraining. The main goal of these programs is to
alleviate short-term hardships and, more importantly, to allow workers more time to
search for a job.

In the U.S. the unemployment insurance allowance one receives is based solely on
previous income (not time worked, family size, etc.) and usually compensates for one-
third of one's previous income. To qualify, one must reside in their respective state for at
least a year and, of course, work. The system was established by the Social Security Act
of 1935. While 90% of citizens are covered on paper, only 40% could actually receive
benefits.[citation needed] In cases of highly seasonal industries the system provides income to
workers during the off seasons, thus encouraging them to stay attached to the industry.
Unemployed man looking for a job in 1928
                      Families on relief 1935–41
                        Relief cases 1936–1941
                       Monthly average in 1,000
                Year                  1936 1937 1938 1939 1940 1941
Workers employed
                WPA                  1,995 2,227 1,932 2,911 1,971 1,638
            CCC and NYA              712   801    643    793   877    919
    Other federal work projects      554   663    452    488   468    681
Public assistance cases
     Social security programs        602   1,306 1,852 2,132 2,308 2,517
            General relief           2,946 1,484 1,611 1,647 1,570 1,206
       Total families helped         5,886 5,660 5,474 6,751 5,860 5,167
Unemployed workers (Bur Lab Stat) 9,030 7,700 10,390 9,480 8,120 5,560
   Coverage (cases/unemployed)    65% 74% 53% 71% 72% 93%


source: Donald S. Howard, WPA and Federal Relief Policy. 1943 p 34.


Year Unemployment (% labor force)
1933 24.9
1934 21.7
1935 20.1
1936 16.9
1937 14.3
1938 19.0
1939 17.2
1940 14.6
1941 9.9
1942 4.7
1943 1.9
1944 1.2
1945 1.9
source: Historical Statistics US (1976) series D-86

See also welfare and training.

[edit] Benefits

Main article: Full employment

Unemployment may have advantages as well as disadvantages for the overall economy.
Notably, it may help avert inflation, which is argued to have damaging effects, by
providing (in Marxian terms) a reserve army of labour, which keeps wages in check.

However the historical assumption that full local employment must lead directly to local
inflation has been attenuated, as recently expanded international trade has shown itself
able to continue to supply low-priced goods even as local employment rates rise closer to
full employment.[citation needed]

The inflation-fighting benefits to the entire economy arising from a presumed optimum
level of unemployment has been studied extensively. Before current levels of world trade
were developed, unemployment was demonstrated to reduce inflation, following the
Phillips curve, or to decelerate inflation, following the NAIRU/natural rate of
unemployment theory, since it is relatively easy to seek a new job without losing one's
current one. And when more jobs are available for fewer workers (lower unemployment),
it may allow workers to find the jobs that better fit their tastes, talents, and needs.

As in the Marxian theory of unemployment, special interests may also benefit: some
employers may expect that employees with no fear of losing their jobs will not work as
hard, or will demand increased wages and benefit. According to this theory,
unemployment may promote general labor productivity and profitability by increasing
employers' monopsony-like power (and profits).

Optimal unemployment has also been defended as an environmental tool to brake the
constantly accelerated growth of the GDP to maintain levels sustainable in the context of
resource constraints and environmental impacts. However the tool of denying jobs to
willing workers seems a blunt instrument for conserving resources and the
environment—it reduces the consumption of the unemployed across the board, and only
in the short-term. Full employment of the unemployed workforce, all focused toward the
goal of developing more environmentally efficient methods for production and
consumption might provide a more significant and lasting cumulative environmental
benefit and reduced resource consumption.[75] If so the future economy and workforce
would benefit from the resultant structural increases in the sustainable level of GDP
growth.

Some critics of the "culture of work" such as anarchist Bob Black see employment as
overemphasized culturally in modern countries. Such critics often propose quitting jobs
when possible, working less, reassessing the cost of living to this end, creation of jobs
which are "fun" as opposed to "work," and creating cultural norms where work is seen as
unhealthy. These people advocate an "anti-work" ethic for life


Price index

A price index (plural: ―price indices‖ or ―price indexes‖) is a normalized average
(typically a weighted average) of prices for a given class of goods or services in a given
region, during a given interval of time. It is a statistic designed to help to compare how
these prices, taken as a whole, differ between time periods or geographical locations.

Price indices have several potential uses. For particularly broad indices, the index can be
said to measure the economy's price level or a cost of living. More narrow price indices
can help producers with business plans and pricing. Sometimes, they can be useful in
helping to guide investment.

Some notable price indices include:
          Consumer price index
          Producer price index
          GDP deflator


Contents

[hide]


          1 History of early price indices
          2 Formal calculation
                o 2.1 Paasche and Laspeyres price indices
                o 2.2 Fisher index and Marshall-Edgeworth index
                o 2.3 Practical measurement considerations
                o 2.4 Normalizing index numbers
                             2.4.1 Relative ease of calculating the Laspeyres index
                             2.4.2 Calculating indices from expenditure data
                o 2.5 Chained vs non-chained calculations
          3 Index number theory
          4 Quality change
          5 See also
          6 Notes
          7 References
          8 External links
                o 8.1 Manuals
                o 8.2 Data


[edit] History of early price indices

No clear consensus has emerged on who created the first price index. The earliest
reported research in this area came from Welshman Rice Vaughan who examined price
level change in his 1675 book A Discourse of Coin and Coinage. Vaughan wanted to
separate the inflationary impact of the influx of precious metals brought by Spain from
the New World from the effect due to currency debasement. Vaughan compared labor
statutes from his own time to similar statutes dating back to Edward III. These statutes set
wages for certain tasks and provided a good record of the change in wage levels.
Vaughan reasoned that the market for basic labor did not fluctuate much with time and
that a basic laborers salary would probably buy the same amount of goods in different
time periods, so that a laborer's salary acted as a basket of goods. Vaughan's analysis
indicated that price levels in England had risen six to eightfold over the preceding
century.[1]

While Vaughan can be considered a forerunner of price index research, his analysis did
not actually involve calculating an index.[1] In 1707 Englishman William Fleetwood
created perhaps the first true price index. An Oxford student asked Fleetwood to help
show how prices had changed. The student stood to lose his fellowship since a fifteenth
century stipulation barred students with annual incomes over five pounds from receiving
a fellowship. Fleetwood, who already had an interest in price change, had collected a
large amount of price data going back hundreds of years. Fleetwood proposed an index
consisting of averaged price relatives and used his methods to show that the value of five
pounds had changed greatly over the course of 260 years. He argued on behalf of the
Oxford students and published his findings anonymously in a volume entitled Chronicon
Preciosum.[2]

[edit] Formal calculation

Further information: List of price index formulas

Given a set C of goods and services, the total market value of transactions in C in some
period t would be
where


                  represents the prevailing price of c in period t
                 represents the quantity of c sold in period t

If, across two periods t0 and tn, the same quantities of each good or service were sold, but
under different prices, then




and




would be a reasonable measure of the price of the set in one period relative to that in the
other, and would provide an index measuring relative prices overall, weighted by
quantities sold.

Of course, for any practical purpose, quantities purchased are rarely if ever identical
across any two periods. As such, this is not a very practical index formula.

One might be tempted to modify the formula slightly to




This new index, however, doesn't do anything to distinguish growth or reduction in
quantities sold from price changes. To see that this is so, consider what happens if all the
prices double between t0 and tn while quantities stay the same: P will double. Now
consider what happens if all the quantities double between t0 and tn while all the prices
stay the same: P will double. In either case the change in P is identical. As such, P is as
much a quantity index as it is a price index.

Various indices have been constructed in an attempt to compensate for this difficulty.

[edit] Paasche and Laspeyres price indices

The two most basic formulas used to calculate price indices are the Paasche index (after
the German economist Hermann Paasche [ˈpaːʃɛ]) and the Laspeyres index (after the
German economist Etienne Laspeyres [lasˈpejres]).


The Paasche index is computed as




while the Laspeyres index is computed as
where P is the change in price level, t0 is the base period (usually the first year), and tn the
period for which the index is computed.

Note that the only difference in the formulas is that the former uses period n quantities,
whereas the latter uses base period (period 0) quantities.

When applied to bundles of individual consumers, a Laspeyres index of 1 would state
that an agent in the current period can afford to buy the same bundle as he consumed in
the previous period, given that income has not changed; a Paasche index of 1 would state
that an agent could have consumed the same bundle in the base period as she is
consuming in the current period, given that income has not changed.

Hence, one may think of the Laspeyres index as one where the numeraire is the bundle of
goods using base year prices but current quantities. Similarly, the Paasche index can be
thought of as a price index taking the bundle of goods using current prices and current
quantities as the numeraire.

The Laspeyres index systematically overstates inflation, while the Paasche index
understates it, because the indices do not account for the fact that consumers typically
react to price changes by changing the quantities that they buy. For example, if prices go
up for good c then, ceteris paribus, quantities of that good should go down.

[edit] Fisher index and Marshall-Edgeworth index

A third index, the Marshall-Edgeworth index (named for economists Alfred Marshall
and Francis Ysidro Edgeworth), tries to overcome these problems of under- and
overstatement by using the arithmethic means of the quantities:




A fourth, the Fisher index (after the American economist Irving Fisher), is calculated as
the geometric mean of PP and PL:




Fisher's index is also known as the ―ideal‖ price index.

However, there is no guarantee with either the Marshall-Edgeworth index or the Fisher
index that the overstatement and understatement will thus exactly one cancel the other.

While these indices were introduced to provide overall measurement of relative prices,
there is ultimately no way of measuring the imperfections of any of these indices
(Paasche, Laspeyres, Fisher, or Marshall-Edgeworth) against reality.

[edit] Practical measurement considerations

[edit] Normalizing index numbers

Price indices are represented as index numbers, number values that indicate relative
change but not absolute values (i.e. one price index value can be compared to another or a
base, but the number alone has no meaning). Price indices generally select a base year
and make that index value equal to 100. You then express every other year as a
percentage of that base year. In our example above, let's take 2000 as our base year. The
value of our index will be 100. The price


          2000: original index value was $2.50; $2.50/$2.50 = 100%, so our new index
           value is 100
          2001: original index value was $2.60; $2.60/$2.50 = 104%, so our new index
           value is 104
          2002: original index value was $2.70; $2.70/$2.50 = 108%, so our new index
           value is 108
          2003: original index value was $2.80; $2.80/$2.50 = 112%, so our new index
           value is 112

When an index has been normalized in this manner, the meaning of the number 108, for
instance, is that the total cost for the basket of goods is 4% more in 2001, 8% more in
2002 and 12% more in 2003 than in the base year (in this case, year 2000).

[edit] Relative ease of calculating the Laspeyres index

As can be seen from the definitions above, if one already has price and quantity data (or,
alternatively, price and expenditure data) for the base period, then calculating the
Laspeyres index for a new period requires only new price data. In contrast, calculating
many other indices (e.g., the Paasche index) for a new period requires both new price
data and new quantity data (or, alternatively, both new price data and new expenditure
data) for each new period. Collecting only new price data is often easier than collecting
both new price data and new quantity data, so calculating the Laspeyres index for a new
period tends to require less time and effort than calculating these other indices for a new
period.[3]

[edit] Calculating indices from expenditure data

Sometimes, especially for aggregate data, expenditure data is more readily available than
quantity data.[4] For these cases, we can formulate the indices in terms of relative prices
and base year expenditures, rather than quantities.

Here is a reformulation for the Laspeyres index:



Let          be the total expenditure on good c in the base period, then (by definition) we



have                                   and therefore also                         . We can
substitute these values into our Laspeyres formula as follows:




A similar transformation can be made for any index.

[edit] Chained vs non-chained calculations

So far, in our discussion, we have always had our price indices relative to some fixed
base period. An alternative is to take the base period for each time period to be the
immediately preceding time period. This can be done with any of the above indices, but
here's an example with the Laspeyres index, where tn is the period for which we wish to
calculate the index and t0 is a reference period that anchors the value of the series:
Each term




answers the question "by what factor have prices increased between period tn − 1 and
period tn". When you multiply these all together, you get the answer to the question "by
what factor have prices increased since period t0.

Nonetheless, note that, when chain indices are in use, the numbers cannot be said to be
"in period t0" prices.

[edit] Index number theory

Price index formulas can be evaluated in terms of their mathematical properties per se.
Several different tests of such properties have been proposed in index number theory
literature. W.E. Diewert summarized past research in a list of nine such tests for a price

index                                               , where P0 and Pn are vectors giving prices

for a base period and a reference period while             and           give quantities for
these periods.[5]

        1.   Identity test:




             The identity test basically means that if prices remain the same and quantities
             remain in the same proportion to each other (each quantity of an item is
             multiplied by the same factor of either α, for the first period, or β, for the later
             period) then the index value will be one.

        2.   Proportionality test:




             If each price in the original period increases by a factor α then the index
             should increase by the factor α.

        3.   Invariance to changes in scale test:




             The price index should not change if the prices in both periods are increased
             by a factor and the quantities in both periods are increased by another factor.
             In other words, the magnitude of the values of quantities and prices should not
             affect the price index.

        4.   Commensurability test:

             The index should not be affected by the choice of units used to measure prices
             and quantities.

        5.   Symmetric treatment of time (or, in parity measures, symmetric treatment of
             place):
           Reversing the order of the time periods should produce a reciprocal index
           value. If the index is calculated from the most recent time period to the earlier
           time period, it should be the reciprocal of the index found going from the
           earlier period to the more recent.

     6.    Symmetric treatment of commodities:

           All commodities should have a symmetric effect on the index. Different
           permutations of the same set of vectors should not change the index.

     7.    Monotonicity test:



           A price index for lower later prices should be lower than a price index with
           higher later period prices.

     8.    Mean value test:

           The overall price relative implied by the price index should be between the
           smallest and largest price relatives for all commodities.

     9.    Circularity test:



           Given three ordered periods tm, tn, tr, the price index for periods tm and tn times
           the price index for periods tn and tr should be equivalent to the price index for
           periods tm and tr.

[edit] Quality change

Price indices often capture changes in price and quantities for goods and services, but
they often fail to account for improvements (or often deteriorations) in the quality of
goods and services. Statistical agencies generally use matched-model price indices, where
one model of a particular good is priced at the same store at regular time intervals. The
matched-model method becomes problematic when statistical agencies try to use this
method on goods and services with rapid turnover in quality features. For instance,
computers rapidly improve and a specific model may quickly become obsolete.
Statisticians constructing matched-model price indices must decide how to compare the
price of the obsolete item originally used in the index with the new and improved item
that replaces it. Statistical agencies use several different methods to make such price
comparisons.[6]

The problem discussed above can be represented as attempting to bridge the gap between
the price for the old item in time t, P(M)t, with the price of the new item in the later time
period, P(N)t + 1.[7]


          The overlap method uses prices collected for both items in both time periods, t
           and t+1. The price relative P(N)t + 1/P(N)t is used.
          The direct comparison method assumes that the difference in the price of the
           two items is not due to quality change, so the entire price difference is used in
           the index. P(N)t + 1/P(M)t is used as the price relative.
          The link-to-show-no-change assumes the opposite of the direct comparison
           method; it assumes that the entire difference between the two items is due to
           the change in quality. The price relative based on link-to-show-no-change is
           1.[8]
          The deletion method simply leaves the price relative for the changing item out
           of the price index. This is equivalent to using the average of other price
           relatives in the index as the price relative for the changing item. Similarly,
           class mean imputation uses the average price relative for items with similar
           characteristics (physical, geographic, economic, etc.) to M and N.[9]


           Measures of national income and output

A variety of measures of national income and output are used in economics to estimate
total economic activity in a country or region, including gross domestic product (GDP),
gross national product (GNP), and net national income (NNI). All are specially
concerned with counting the total amount of goods and services produced within some
"boundary". The boundary may be defined geographically, or by citizenship; and limits
on the type of activity also form part of the conceptual boundary; for instance, these
measures are for the most part limited to counting goods and services that are exchanged
for money: production not for sale but for barter, for one's own personal use, or for one's
family, is largely left out of these measures, although some attempts are made to include
some of those kinds of production by imputing monetary values to them. [1]


Contents

[hide]


          1 National accounts
          2 Market value
                o 2.1 The output approach
                o 2.2 The income approach
                o 2.3 The expenditure approach
          3 Names
          4 GDP and GNP
          5 National income and welfare
          6 See also
          7 Bibliography
          8 References
          9 External links



[edit] National accounts

Main article: National accounts

Arriving at a figure for the total production of goods and services in a large region like a
country entails a large amount of data-collection and calculation. Although some attempts
were made to estimate national incomes as long ago as the 17th century,[2] the systematic
keeping of national accounts, of which these figures are a part, only began in the 1930s,
in the United States and some European countries. The impetus for that major statistical
effort was the Great Depression and the rise of Keynesian economics, which prescribed a
greater role for the government in managing an economy, and made it necessary for
governments to obtain accurate information so that their interventions into the economy
could proceed as much as possible from a basis of fact.

[edit] Market value

Main article: Market value

In order to count a good or service it is necessary to assign some value to it. The value
that the measures of national income and output assign to a good or service is its market
value – the price it fetches when bought or sold. The actual usefulness of a product (its
use-value) is not measured – assuming the use-value to be any different from its market
value.
Three strategies have been used to obtain the market values of all the goods and services
produced: the product (or output) method, the expenditure method, and the income
method. The product method looks at the economy on an industry-by-industry basis. The
total output of the economy is the sum of the outputs of every industry. However, since
an output of one industry may be used by another industry and become part of the output
of that second industry, to avoid counting the item twice we use, not the value output by
each industry, but the value-added; that is, the difference between the value of what it
puts out and what it takes in. The total value produced by the economy is the sum of the
values-added by every industry.

The expenditure method is based on the idea that all products are bought by somebody or
some organisation. Therefore we sum up the total amount of money people and
organisations spend in buying things. This amount must equal the value of everything
produced. Usually expenditures by private individuals, expenditures by businesses, and
expenditures by government are calculated separately and then summed to give the total
expenditure. Also, a correction term must be introduced to account for imports and
exports outside the boundary.

The income method works by summing the incomes of all producers within the
boundary. Since what they are paid is just the market value of their product, their total
income must be the total value of the product. Wages, proprieter's incomes, and corporate
profits are the major subdivisions of income.

[edit] The output approach

The output approach focuses on finding the total output of a nation by directly finding the
total value of all goods and services a nation produces.

Because of the complication of the multiple stages in the production of a good or service,
only the final value of a good or service is included in total output. This avoids an issue
often called 'double counting', wherein the total value of a good is included several times
in national output, by counting it repeatedly in several stages of production. In the
example of meat production, the value of the good from the farm may be $10, then $30
from the butchers, and then $60 from the supermarket. The value that should be included
in final national output should be $60, not the sum of all those numbers, $100. The values
added at each stage of production over the previous stage are respectively $10, $20, and
$30. Their sum gives an alternative way of calculating the value of final output.

Formulae:

GDP(gross domestic product) at market price = value of output in an economy in a
particular year - intermediate consumption

NNP at factor cost = GDP at market price - depreciation + NFIA (net factor income from
abroad) - net indirect taxes[3]

[edit] The income approach

The income approach focuses on finding the total output of a nation by finding the total
income received by the factors of production owned by that nation.

The main types of income that are included in this approach are rent (the money paid to
owners of land), salaries and wages (the money paid to workers who are involved in the
production process, and those who provide the natural resources), interest (the money
paid for the use of man-made resources, such as machines used in production), and profit
(the money gained by the entrepreneur - the businessman who combines these resources
to produce a good or service).

Formulae:

NDP at factor cost = compensation of employee + operating surplus + mixed income of
self employee
National income = NDP at factor cost + NFIA (net factor income from abroad) -
Depreciation

[edit] The expenditure approach

The expenditure approach is basically an output accounting method. It focuses on finding
the total output of a nation by finding the total amount of money spent. This is
acceptable, because like income, the total value of all goods is equal to the total amount
of money spent on goods. The basic formula for domestic output combines all the
different areas in which money is spent within the region, and then combining them to
find the total output.

           GDP = C + I + G + (X - M)

Where:
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services

Note: (X - M) is often written as XN, which stands for "net exports"




[edit] Names

The names of the measures consist of one of the words "Gross" or "Net", followed by one
of the words "National" or "Domestic", followed by one of the words "Product",
"Income", or "Expenditure". All of these terms can be explained separately.

           "Gross" means total product, regardless of the use to which it is subsequently
           put.
           "Net" means "Gross" minus the amount that must be used to offset
           depreciation – ie., wear-and-tear or obsolescence of the nation's fixed capital
           assets. "Net" gives an indication of how much product is actually available for
           consumption or new investment.
           "Domestic" means the boundary is geographical: we are counting all goods
           and services produced within the country's borders, regardless of by whom.
           "National" means the boundary is defined by citizenship (nationality). We
           count all goods and services produced by the nationals of the country (or
           businesses owned by them) regardless of where that production physically
           takes place.
           The output of a French-owned cotton factory in Senegal counts as part of the
           Domestic figures for Senegal, but the National figures of France.
           "Product", "Income", and "Expenditure" refer to the three counting
           methodologies explained earlier: the product, income, and expenditure
           approaches. However the terms are used loosely.
           "Product" is the general term, often used when any of the three approaches
           was actually used. Sometimes the word "Product" is used and then some
           additional symbol or phrase to indicate the methodology; so, for instance, we
           get "Gross Domestic Product by income", "GDP (income)", "GDP(I)", and
           similar constructions.
           "Income" specifically means that the income approach was used.
           "Expenditure" specifically means that the expenditure approach was used.

Note that all three counting methods should in theory give the same final figure.
However, in practice minor differences are obtained from the three methods for several
reasons, including changes in inventory levels and errors in the statistics. One problem
for instance is that goods in inventory have been produced (therefore included in
Product), but not yet sold (therefore not yet included in Expenditure). Similar timing
issues can also cause a slight discrepancy between the value of goods produced (Product)
and the payments to the factors that produced the goods (Income), particularly if inputs
are purchased on credit, and also because wages are collected often after a period of
production.
[edit] GDP and GNP

Main articles: GDP and GNP

Gross domestic product (GDP) is defined as "the value of all final goods and services
produced in a country in 1 year".[4]

Gross National Product (GNP) is defined as "the market value of all goods and services
produced in one year by labour and property supplied by the residents of a country."[5]

As an example, the table below shows some GDP and GNP, and NNI data for the United
States:[6]


   National income and output (Billions of dollars)
                Period Ending                       2003
Gross national product                           11,063.3
 Net U.S. income receipts from rest of the world     55.2
   U.S. income receipts                              329.1
   U.S. income payments                             -273.9
Gross domestic product                            11,008.1
 Private consumption of fixed capital              1,135.9
 Government consumption of fixed capital             218.1
 Statistical discrepancy                              25.6
National Income                                    9,679.7


          NDP: Net domestic product is defined as "gross domestic product (GDP)
           minus depreciation of capital",[7] similar to NNP.
          GDP per capita: Gross domestic product per capita is the mean value of the
           output produced per person, which is also the mean income.

[edit] National income and welfare

GDP per capita (per person) is often used as a measure of a person's welfare. Countries
with higher GDP may be more likely to also score highly on other measures of welfare,
such as life expectancy. However, there are serious limitations to the usefulness of GDP
as a measure of welfare:


          Measures of GDP typically exclude unpaid economic activity, most
           importantly domestic work such as childcare. This leads to distortions; for
           example, a paid nanny's income contributes to GDP, but an unpaid parent's
           time spent caring for children will not, even though they are both carrying out
           the same economic activity.
          GDP takes no account of the inputs used to produce the output. For example,
           if everyone worked for twice the number of hours, then GDP might roughly
           double, but this does not necessarily mean that workers are better off as they
           would have less leisure time. Similarly, the impact of economic activity on the
           environment is not measured in calculating GDP.
          Comparison of GDP from one country to another may be distorted by
           movements in exchange rates. Measuring national income at purchasing
           power parity may overcome this problem at the risk of overvaluing basic
           goods and services, for example subsistence farming.
          GDP does not measure factors that affect quality of life, such as the quality of
           the environment (as distinct from the input value) and security from crime.
           This leads to distortions - for example, spending on cleaning up an oil spill is
           included in GDP, but the negative impact of the spill on well-being (e.g. loss
           of clean beaches) is not measured.
          GDP is the mean (average) wealth rather than median (middle-point) wealth.
           Countries with a skewed income distribution may have a relatively high per-
           capita GDP while the majority of its citizens have a relatively low level of
           income, due to concentration of wealth in the hands of a small fraction of the
           population. See Gini coefficient.


           Output (economics)

           From Wikipedia, the free encyclopedia
           Jump to: navigation, search

           Output in economics is the total value of all of the goods and services
           produced in an entity's economy. It is a concept used in macroeconomics, or
           the study of the economic transactions of broad groups such as countries.

           Net output, sometimes called netput is a quantity, in the context of production,
           that is positive if the quantity is output by the production process and negative
           if it is an input to the production process.
           Several different methods of measuring output are utilized.




Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an
economy over a period of time.[1] When the price level rises, each unit of currency buys
fewer goods and services; consequently, inflation is also an erosion in the purchasing
power of money – a loss of real value in the internal medium of exchange and unit of
account in the economy.[2][3] A chief measure of price inflation is the inflation rate, the
annualized percentage change in a general price index (normally the Consumer Price
Index) over time.[4]

Inflation's effects on an economy are manifold and can be simultaneously positive and
negative. Negative effects of inflation include a decrease in the real value of money and
other monetary items over time; uncertainty about future inflation may discourage
investment and saving, or may lead to reductions in investment of productive capital and
increase savings in non-producing assets. e.g. selling stocks and buying gold. This can
reduce overall economic productivity rates, as the capital required to retool companies
becomes more elusive or expensive. High inflation may lead to shortages of goods if
consumers begin hoarding out of concern that prices will increase in the future. Positive
effects include a mitigation of economic recessions,[5] and debt relief by reducing the real
level of debt.

High rates of inflation and hyperinflation can be caused by an excessive growth of the
money supply.[6] Views on which factors determine low to moderate rates of inflation are
more varied. Low or moderate inflation may be attributed to fluctuations in real demand
for goods and services, or changes in available supplies such as during scarcities, as well
as to growth in the money supply. However, the consensus view is that a long sustained
period of inflation is caused by money supply growing faster than the rate of economic
growth.[7][8]

Today, most mainstream economists favor a low steady rate of inflation.[5] Low (as
opposed to zero or negative) inflation may reduce the severity of economic recessions by
enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a
liquidity trap prevents monetary policy from stabilizing the economy.[9] The task of
keeping the rate of inflation low and stable is usually given to monetary authorities.
Generally, these monetary authorities are the central banks that control the size of the
money supply through the setting of interest rates, through open market operations, and
through the setting of banking reserve requirements.[10]


Contents

[hide]


          1 History
          2 Related definitions
          3 Measures
                o 3.1 Issues in measuring
          4 Effects
                o 4.1 General
                o 4.2 Negative
                o 4.3 Positive
          5 Causes
                o 5.1 Keynesian view
                o 5.2 Monetarist view
                o 5.3 Unemployment
                o 5.4 Rational expectations theory
                o 5.5 Austrian theory
                o 5.6 Real bills doctrine
                o 5.7 Anti-classical or backing theory
          6 Controlling inflation
                o 6.1 Monetary policy
                o 6.2 Fixed exchange rates
                o 6.3 Gold standard
                o 6.4 Wage and price controls
                o 6.5 Cost-of-living allowance
          7 See also
          8 Notes
          9 References
          10 Further reading
          11 External links



History




Inflation rates around the world in 2007

The term "inflation" originally referred to increases in the amount of money in
circulation. Today, the term monetary inflation is generally used to distinguish such an
occurrence from a general rise in prices, sometimes called price inflation.[11] The
occurrence of an increase of the quantity of money and the overall money supply (or
debasement of the means of exchange) has occurred in many different societies
throughout history, changing with different forms of money used. [12][13]

For instance, when gold was used as currency, the government could collect gold coins,
melt them down, mix them with other metals such as silver, copper or lead, and reissue
them at the same nominal value. By diluting the gold with other metals, the government
could issue more coins without also needing to increase the amount of gold used to make
them. When the cost of each coin is lowered in this way, the government profits from an
increase in seigniorage.[14] This practice would increase the money supply but at the same
time the relative value of each coin would be lowered. As the relative value of the coins
becomes less, consumers would need to give more coins in exchange for the same goods
and services as before. These goods and services would experience a price increase as the
value of each coin is reduced.[15]
From second half of the 15th century to the first half of the 17th, Western Europe
experienced a major inflationary cycle referred to as "price revolution",[16][17] with prices
on average rising perhaps sixfold over 150 years. It was thought that this was caused by
the increase in wealth of Habsburg Spain, with a large influx of gold and silver from the
New World.[18] The spent silver, suddenly spread throughout a previously cash starved
Europe, caused widespread inflation.[19][20] Demographic factors also contributed to
upward pressure on prices, with European population growth after depopulation caused
by the Black Death pandemic.

By the nineteenth century, economists categorized three separate factors that cause a rise
or fall in the price of goods: a change in the value or resource costs of the good, a change
in the price of money which then was usually a fluctuation in the commodity price of the
metallic content in the currency, and currency depreciation resulting from an increased
supply of currency relative to the quantity of redeemable metal backing the currency.
Following the proliferation of private bank note currency printed during the American
Civil War, the term "inflation" started to appear as a direct reference to the currency
depreciation that occurred as the quantity of redeemable bank notes outstripped the
quantity of metal available for their redemption. The term inflation then referred to the
devaluation of the currency, and not to a rise in the price of goods. [21]

This relationship between the over-supply of bank notes and a resulting depreciation in
their value was noted by earlier classical economists such as David Hume and David
Ricardo, who would go on to examine and debate to what effect a currency devaluation
(later termed monetary inflation) has on the price of goods (later termed price inflation,
and eventually just inflation).[22]

Related definitions

The term "inflation" usually refers to a measured rise in a broad price index that
represents the overall level of prices in goods and services in the economy. The
Consumer Price Index (CPI), the Personal Consumption Expenditures Price Index
(PCEPI) and the GDP deflator are some examples of broad price indices. The term
inflation may also be used to describe the rising level of prices in a narrow set of assets,
goods or services within the economy, such as commodities (which include food, fuel,
metals), financial assets (such as stocks, bonds and real estate), and services (such as
entertainment and health care). The Reuters-CRB Index (CCI), the Producer Price Index,
and Employment Cost Index (ECI) are examples of narrow price indices used to measure
price inflation in particular sectors of the economy. Asset price inflation is a rise in the
price of assets, as opposed to goods and services. Core inflation is a measure of price
fluctuations in a sub-set of the broad price index which excludes food and energy prices.
The Federal Reserve Board uses the core inflation rate to measure overall inflation,
eliminating food and energy prices to mitigate against short term price fluctuations that
could distort estimates of future long term inflation trends in the general economy. [23]

Other related economic concepts include: deflation – a fall in the general price level;
disinflation – a decrease in the rate of inflation; hyperinflation – an out-of-control
inflationary spiral; stagflation – a combination of inflation, slow economic growth and
high unemployment; and reflation – an attempt to raise the general level of prices to
counteract deflationary pressures.

Measures
Annual inflation rates in the United States from 1666 to 2004.

Inflation is usually estimated by calculating the inflation rate of a price index, usually the
Consumer Price Index.[24] The Consumer Price Index measures prices of a selection of
goods and services purchased by a "typical consumer".[25] The inflation rate is the
percentage rate of change of a price index over time.

For instance, in January 2007, the U.S. Consumer Price Index was 202.416, and in
January 2008 it was 211.080. The formula for calculating the annual percentage rate
inflation in the CPI over the course of 2007 is




The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the
general level of prices for typical U.S. consumers rose by approximately four percent in
2007.[26]

Other widely used price indices for calculating price inflation include the following:


          Producer price indices (PPIs) which measures average changes in prices
           received by domestic producers for their output. This differs from the CPI in
           that price subsidization, profits, and taxes may cause the amount received by
           the producer to differ from what the consumer paid. There is also typically a
           delay between an increase in the PPI and any eventual increase in the CPI.
           Producer price index measures the pressure being put on producers by the
           costs of their raw materials. This could be "passed on" to consumers, or it
           could be absorbed by profits, or offset by increasing productivity. In India and
           the United States, an earlier version of the PPI was called the Wholesale Price
           Index.
          Commodity price indices, which measure the price of a selection of
           commodities. In the present commodity price indices are weighted by the
           relative importance of the components to the "all in" cost of an employee.
          Core price indices: because food and oil prices can change quickly due to
           changes in supply and demand conditions in the food and oil markets, it can
           be difficult to detect the long run trend in price levels when those prices are
           included. Therefore most statistical agencies also report a measure of 'core
           inflation', which removes the most volatile components (such as food and oil)
           from a broad price index like the CPI. Because core inflation is less affected
           by short run supply and demand conditions in specific markets, central banks
           rely on it to better measure the inflationary impact of current monetary policy.

Other common measures of inflation are:


          GDP deflator is a measure of the price of all the goods and services included
           in Gross Domestic Product (GDP). The US Commerce Department publishes
           a deflator series for US GDP, defined as its nominal GDP measure divided by
           its real GDP measure.
          Regional inflation The Bureau of Labor Statistics breaks down CPI-U
           calculations down to different regions of the US.
          Historical inflation Before collecting consistent econometric data became
           standard for governments, and for the purpose of comparing absolute, rather
           than relative standards of living, various economists have calculated imputed
           inflation figures. Most inflation data before the early 20th century is imputed
           based on the known costs of goods, rather than compiled at the time. It is also
           used to adjust for the differences in real standard of living for the presence of
           technology.
          Asset price inflation is an undue increase in the prices of real or financial
           assets, such as stock (equity) and real estate. While there is no widely
           accepted index of this type, some central bankers have suggested that it would
           be better to aim at stabilizing a wider general price level inflation measure that
           includes some asset prices, instead of stabilizing CPI or core inflation only.
           The reason is that by raising interest rates when stock prices or real estate
           prices rise, and lowering them when these asset prices fall, central banks
           might be more successful in avoiding bubbles and crashes in asset
           prices.[dubious – discuss]

Issues in measuring

Measuring inflation in an economy requires objective means of differentiating changes in
nominal prices on a common set of goods and services, and distinguishing them from
those price shifts resulting from changes in value such as volume, quality, or
performance. For example, if the price of a 10 oz. can of corn changes from $0.90 to
$1.00 over the course of a year, with no change in quality, then this price difference
represents inflation. This single price change would not, however, represent general
inflation in an overall economy. To measure overall inflation, the price change of a large
"basket" of representative goods and services is measured. This is the purpose of a price
index, which is the combined price of a "basket" of many goods and services. The
combined price is the sum of the weighted average prices of items in the "basket". A
weighted price is calculated by multiplying the unit price of an item to the number of
those items the average consumer purchases. Weighted pricing is a necessary means to
measuring the impact of individual unit price changes on the economy's overall inflation.
The Consumer Price Index, for example, uses data collected by surveying households to
determine what proportion of the typical consumer's overall spending is spent on specific
goods and services, and weights the average prices of those items accordingly. Those
weighted average prices are combined to calculate the overall price. To better relate price
changes over time, indexes typically choose a "base year" price and assign it a value of
100. Index prices in subsequent years are then expressed in relation to the base year
price.[10]

Inflation measures are often modified over time, either for the relative weight of goods in
the basket, or in the way in which goods and services from the present are compared with
goods and services from the past. Over time adjustments are made to the type of goods
and services selected in order to reflect changes in the sorts of goods and services
purchased by 'typical consumers'. New products may be introduced, older products
disappear, the quality of existing products may change, and consumer preferences can
shift. Both the sorts of goods and services which are included in the "basket" and the
weighted price used in inflation measures will be changed over time in order to keep pace
with the changing marketplace.[citation needed]

Inflation numbers are often seasonally adjusted in order to differentiate expected cyclical
cost shifts. For example, home heating costs are expected to rise in colder months, and
seasonal adjustments are often used when measuring for inflation to compensate for
cyclical spikes in energy or fuel demand. Inflation numbers may be averaged or
otherwise subjected to statistical techniques in order to remove statistical noise and
volatility of individual prices.[citation needed]

When looking at inflation economic institutions may focus only on certain kinds of
prices, or special indices, such as the core inflation index which is used by central banks
to formulate monetary policy.[citation needed]

Most inflation indices are calculated from weighted averages of selected price changes.
This necessarily introduces distortion, and can lead to legitimate disputes about what the
true inflation rate is. This problem can be overcome by including all available price
changes in the calculation, and then choosing the median value.[27]

Effects

General

An increase in the general level of prices implies a decrease in the purchasing power of
the currency. That is, when the general level of prices rises, each monetary unit buys
fewer goods and services.[28] The effect of inflation is not distributed evenly in the
economy, and as a consequence there are hidden costs to some and benefits to others
from this decrease in the purchasing power of money. For example, with inflation,
lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose
purchasing power from their interest earnings, while their borrowers benefit. Individuals
or institutions with cash assets will experience a decline in the purchasing power of their
holdings. Increases in payments to workers and pensioners often lag behind inflation,
especially for those with fixed payments.[10]

Increases in the price level (inflation) erodes the real value of money (the functional
currency) and other items with an underlying monetary nature (e.g. loans and bonds).
However, inflation has no effect on the real value of non-monetary items, (e.g. goods and
commodities, gold, real estate).[29]

Negative

High or unpredictable inflation rates are regarded as harmful to an overall economy. They
add inefficiencies in the market, and make it difficult for companies to budget or plan
long-term. Inflation can act as a drag on productivity as companies are forced to shift
resources away from products and services in order to focus on profit and losses from
currency inflation.[10] Uncertainty about the future purchasing power of money
discourages investment and saving.[30] And inflation can impose hidden tax increases, as
inflated earnings push taxpayers into higher income tax rates unless the tax brackets are
indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal
incomes, such as some pensioners whose pensions are not indexed to the price level,
towards those with variable incomes whose earnings may better keep pace with the
inflation.[10] This redistribution of purchasing power will also occur between international
trading partners. Where fixed exchange rates are imposed, higher inflation in one
economy than another will cause the first economy's exports to become more expensive
and affect the balance of trade. There can also be negative impacts to trade from an
increased instability in currency exchange prices caused by unpredictable inflation.

Cost-push inflation
           High inflation can prompt employees to demand rapid wage increases, to keep
           up with consumer prices. Rising wages in turn can help fuel inflation. In the
           case of collective bargaining, wage growth will be set as a function of
           inflationary expectations, which will be higher when inflation is high. This
           can cause a wage spiral.[31] In a sense, inflation begets further inflationary
           expectations, which beget further inflation.
Hoarding
           People buy consumer durables as stores of wealth in the absence of viable
           alternatives as a means of getting rid of excess cash before it is devalued,
           creating shortages of the hoarded objects.
Hyperinflation
           If inflation gets totally out of control (in the upward direction), it can grossly
           interfere with the normal workings of the economy, hurting its ability to
           supply goods. Hyperinflation can lead to the abandonment of the use of the
           country's currency, leading to the inefficiencies of barter.
Allocative efficiency
           A change in the supply or demand for a good will normally cause its relative
           price to change, signalling to buyers and sellers that they should re-allocate
           resources in response to the new market conditions. But when prices are
           constantly changing due to inflation, price changes due to genuine relative
           price signals are difficult to distinguish from price changes due to general
           inflation, so agents are slow to respond to them. The result is a loss of
           allocative efficiency.
Shoe leather cost
           High inflation increases the opportunity cost of holding cash balances and can
           induce people to hold a greater portion of their assets in interest paying
           accounts. However, since cash is still needed in order to carry out transactions
           this means that more "trips to the bank" are necessary in order to make
           withdrawals, proverbially wearing out the "shoe leather" with each trip.
Menu costs
           With high inflation, firms must change their prices often in order to keep up
           with economy-wide changes. But often changing prices is itself a costly
           activity whether explicitly, as with the need to print new menus, or implicitly.
Business cycles
           According to the Austrian Business Cycle Theory, inflation sets off the
           business cycle. Austrian economists hold this to be the most damaging effect
            of inflation. According to Austrian theory, artificially low interest rates and
            the associated increase in the money supply lead to reckless, speculative
            borrowing, resulting in clusters of malinvestments, which eventually have to
            be liquidated as they become unsustainable.[32]

Positive

Labor-market adjustments
            Keynesians believe that nominal wages are slow to adjust downwards. This
            can lead to prolonged disequilibrium and high unemployment in the labor
            market. Since inflation would lower the real wage if nominal wages are kept
            constant, Keynesians argue that some inflation is good for the economy, as it
            would allow labor markets to reach equilibrium faster.
Debt relief
            Debtors who have debts with a fixed nominal rate of interest will see a
            reduction in the "real" interest rate as the inflation rate rises. The ―real‖
            interest on a loan is the nominal rate minus the inflation rate.[dubious – discuss]
            (R=n-i) For example if you take a loan where the stated interest rate is 6% and
            the inflation rate is at 3%, the real interest rate that you are paying for the loan
            is 3%. It would also hold true that if you had a loan at a fixed interest rate of
            6% and the inflation rate jumped to 20% you would have a real interest rate of
            -14%. Banks and other lenders adjust for this inflation risk either by including
            an inflation premium in the costs of lending the money by creating a higher
            initial stated interest rate or by setting the interest at a variable rate.
Room to maneuver
            The primary tools for controlling the money supply are the ability to set the
            discount rate, the rate at which banks can borrow from the central bank, and
            open market operations which are the central bank's interventions into the
            bonds market with the aim of affecting the nominal interest rate. If an
            economy finds itself in a recession with already low, or even zero, nominal
            interest rates, then the bank cannot cut these rates further (since negative
            nominal interest rates are impossible) in order to stimulate the economy - this
            situation is known as a liquidity trap. A moderate level of inflation tends to
            ensure that nominal interest rates stay sufficiently above zero so that if the
            need arises the bank can cut the nominal interest rate.
Tobin effect
            The Nobel prize winning economist James Tobin at one point argued that a
            moderate level of inflation can increase investment in an economy leading to
            faster growth or at least a higher steady state level of income. This is due to
            the fact that inflation lowers the real return on monetary assets relative to real
            assets, such as physical capital. To avoid this effect of inflation, investors
            would switch from holding their assets as money (or a similar, susceptible-to-
            inflation, form) to investing in real capital projects. See Tobin monetary
            model[33][Unclear: See Discussion]

Causes




The Bank of England, central bank of the United Kingdom, monitors causes and attempts
to control inflation.

Historically, a great deal of economic literature was concerned with the question of what
causes inflation and what effect it has. There were different schools of thought as to the
causes of inflation. Most can be divided into two broad areas: quality theories of inflation
and quantity theories of inflation. The quality theory of inflation rests on the expectation
of a seller accepting currency to be able to exchange that currency at a later time for
goods that are desirable as a buyer. The quantity theory of inflation rests on the quantity
equation of money, that relates the money supply, its velocity, and the nominal value of
exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for
money, and a quality theory of inflation for production. [citation needed]

Currently, the quantity theory of money is widely accepted as an accurate model of
inflation in the long run. Consequently, there is now broad agreement among economists
that in the long run, the inflation rate is essentially dependent on the growth rate of
money supply. However, in the short and medium term inflation may be affected by
supply and demand pressures in the economy, and influenced by the relative elasticity of
wages, prices and interest rates.[34] The question of whether the short-term effects last
long enough to be important is the central topic of debate between monetarist and
Keynesian economists. In monetarism prices and wages adjust quickly enough to make
other factors merely marginal behavior on a general trend-line. In the Keynesian view,
prices and wages adjust at different rates, and these differences have enough effects on
real output to be "long term" in the view of people in an economy.

Keynesian view

Keynesian economic theory proposes that changes in money supply do not directly affect
prices, and that visible inflation is the result of pressures in the economy expressing
themselves in prices. The supply of money is a major, but not the only, cause of inflation.

There are three major types of inflation, as part of what Robert J. Gordon calls the
"triangle model":[35]


          Demand-pull inflation is caused by increases in aggregate demand due to
           increased private and government spending, etc. Demand inflation is
           constructive to a faster rate of economic growth since the excess demand and
           favourable market conditions will stimulate investment and expansion.
          Cost-push inflation, also called "supply shock inflation," is caused by a drop
           in aggregate supply (potential output). This may be due to natural disasters, or
           increased prices of inputs. For example, a sudden decrease in the supply of oil,
           leading to increased oil prices, can cause cost-push inflation. Producers for
           whom oil is a part of their costs could then pass this on to consumers in the
           form of increased prices.
          Built-in inflation is induced by adaptive expectations, and is often linked to
           the "price/wage spiral". It involves workers trying to keep their wages up with
           prices (above the rate of inflation), and firms passing these higher labor costs
           on to their customers as higher prices, leading to a 'vicious circle'. Built-in
           inflation reflects events in the past, and so might be seen as hangover
           inflation.

Demand-pull theory states that the rate of inflation accelerates whenever aggregate
demand is increased beyond the ability of the economy to produce (its potential output).
Hence, any factor that increases aggregate demand can cause inflation. [36] However, in the
long run, aggregate demand can be held above productive capacity only by increasing the
quantity of money in circulation faster than the real growth rate of the economy. Another
(although much less common) cause can be a rapid decline in the demand for money, as
happened in Europe during the Black Death, or in the Japanese occupied territories just
before the defeat of Japan in 1945.

The effect of money on inflation is most obvious when governments finance spending in
a crisis, such as a civil war, by printing money excessively. This sometimes leads to
hyperinflation, a condition where prices can double in a month or less. Money supply is
also thought to play a major role in determining moderate levels of inflation, although
there are differences of opinion on how important it is. For example, Monetarist
economists believe that the link is very strong; Keynesian economists, by contrast,
typically emphasize the role of aggregate demand in the economy rather than the money
supply in determining inflation. That is, for Keynesians, the money supply is only one
determinant of aggregate demand.
Some Keynesian economists also disagree with the notion that central banks fully control
the money supply, arguing that central banks have little control, since the money supply
adapts to the demand for bank credit issued by commercial banks. This is known as the
theory of endogenous money, and has been advocated strongly by post-Keynesians as far
back as the 1960s. It has today become a central focus of Taylor rule advocates. This
position is not universally accepted – banks create money by making loans, but the
aggregate volume of these loans diminishes as real interest rates increase. Thus, central
banks can influence the money supply by making money cheaper or more expensive, thus
increasing or decreasing its production.

A fundamental concept in inflation analysis is the relationship between inflation and
unemployment, called the Phillips curve. This model suggests that there is a trade-off
between price stability and employment. Therefore, some level of inflation could be
considered desirable in order to minimize unemployment. The Phillips curve model
described the U.S. experience well in the 1960s but failed to describe the combination of
rising inflation and economic stagnation (sometimes referred to as stagflation)
experienced in the 1970s.

Thus, modern macroeconomics describes inflation using a Phillips curve that shifts (so
the trade-off between inflation and unemployment changes) because of such matters as
supply shocks and inflation becoming built into the normal workings of the economy.
The former refers to such events as the oil shocks of the 1970s, while the latter refers to
the price/wage spiral and inflationary expectations implying that the economy "normally"
suffers from inflation. Thus, the Phillips curve represents only the demand-pull
component of the triangle model.

Another concept of note is the potential output (sometimes called the "natural gross
domestic product"), a level of GDP, where the economy is at its optimal level of
production given institutional and natural constraints. (This level of output corresponds to
the Non-Accelerating Inflation Rate of Unemployment, NAIRU, or the "natural" rate of
unemployment or the full-employment unemployment rate.) If GDP exceeds its potential
(and unemployment is below the NAIRU), the theory says that inflation will accelerate
as suppliers increase their prices and built-in inflation worsens. If GDP falls below its
potential level (and unemployment is above the NAIRU), inflation will decelerate as
suppliers attempt to fill excess capacity, cutting prices and undermining built-in
inflation.[37]

However, one problem with this theory for policy-making purposes is that the exact level
of potential output (and of the NAIRU) is generally unknown and tends to change over
time. Inflation also seems to act in an asymmetric way, rising more quickly than it falls.
Worse, it can change because of policy: for example, high unemployment under British
Prime Minister Margaret Thatcher might have led to a rise in the NAIRU (and a fall in
potential) because many of the unemployed found themselves as structurally unemployed
(also see unemployment), unable to find jobs that fit their skills. A rise in structural
unemployment implies that a smaller percentage of the labor force can find jobs at the
NAIRU, where the economy avoids crossing the threshold into the realm of accelerating
inflation.

Monetarist view

For more details on this topic, see Monetarists.

Monetarists believe the most significant factor influencing inflation or deflation is how
fast the money supply grows or shrinks. They consider fiscal policy, or government
spending and taxation, as ineffective in controlling inflation.[38] According to the famous
monetarist economist Milton Friedman, "Inflation is always and everywhere a monetary
phenomenon."[39] Some monetarists, however, will qualify this by making an exception
for very short-term circumstances.

Monetarists assert that the empirical study of monetary history shows that inflation has
always been a monetary phenomenon. The quantity theory of money, simply stated, says
that any change the amount of money in a system will change the price level. This theory
begins with the equation of exchange:
where

           M is the nominal quantity of money.
           V is the velocity of money in final expenditures;
           P is the general price level;
           Q is an index of the real value of final expenditures;

In this formula, the general price level is related to the level of real economic activity (Q),
the quantity of money (M) and the velocity of money (V). The formula is an identity
because the velocity of money (V) is defined to be the ratio of final nominal expenditure (
           ) to the quantity of money (M).

Monetarists assume that the velocity of money is unaffected by monetary policy (at least
in the long run), and the real value of output is determined in the long run by the
productive capacity of the economy. Under these assumptions, the primary driver of the
change in the general price level is changes in the quantity of money. With exogenous
velocity (that is, velocity being determined externally and not being influenced by
monetary policy), the money supply determines the value of nominal output (which
equals final expenditure) in the short run. In practice, velocity is not exogenous in the
short run, and so the formula does not necessarily imply a stable short-run relationship
between the money supply and nominal output. However, in the long run, changes in
velocity are assumed to be determined by the evolution of the payments mechanism. If
velocity is relatively unaffected by monetary policy, the long-run rate of increase in
prices (the inflation rate) is equal to the long run growth rate of the money supply plus
the exogenous long-run rate of velocity growth minus the long run growth rate of real
output.[7]

Unemployment

A connection between inflation and unemployment has been drawn since the emergence
of large scale unemployment in the 19th century, and connections continue to be drawn
this today. In Marxian economics, the unemployed serve as a reserve army of labour,
which restrain wage inflation. In the 20th century, similar concepts in Keynesian
economics include the NAIRU (Non-Accelerating Inflation Rate of Unemployment) and
the Phillips curve.

Rational expectations theory

Main article: Rational expectations theory

Rational expectations theory holds that economic actors look rationally into the future
when trying to maximize their well-being, and do not respond solely to immediate
opportunity costs and pressures. In this view, while generally grounded in monetarism,
future expectations and strategies are important for inflation as well.

A core assertion of rational expectations theory is that actors will seek to "head off"
central-bank decisions by acting in ways that fulfill predictions of higher inflation. This
means that central banks must establish their credibility in fighting inflation, or economic
actors will make bets that the central bank will expand the money supply rapidly enough
to prevent recession, even at the expense of exacerbating inflation. Thus, if a central bank
has a reputation as being "soft" on inflation, when it announces a new policy of fighting
inflation with restrictive monetary growth economic agents will not believe that the
policy will persist; their inflationary expectations will remain high, and so will inflation.
On the other hand, if the central bank has a reputation of being "tough" on inflation, then
such a policy announcement will be believed and inflationary expectations will come
down rapidly, thus allowing inflation itself to come down rapidly with minimal economic
disruption.

Austrian theory

           For more details on this topic, see The Austrian view of inflation
The Austrian School asserts that inflation is an increase in the money supply, rising
prices are merely consequences and this semantic difference is important in defining
inflation.[40] Austrian economists believe there is no material difference between the
concepts of monetary inflation and general price inflation. Austrian economists measure
monetary inflation by calculating the growth of new units of money that are available for
immediate use in exchange, that have been created over time.[41][42][43] This interpretation
of inflation implies that inflation is always a distinct action taken by the central
government or its central bank, which permits or allows an increase in the money
supply.[44] In addition to state-induced monetary expansion, the Austrian School also
maintains that the effects of increasing the money supply are magnified by credit
expansion, as a result of the fractional-reserve banking system employed in most
economic and financial systems in the world.[45]

Austrians argue that the state uses inflation as one of the three means by which it can
fund its activities (inflation tax), the other two being taxation and borrowing.[46] Various
forms of military spending is often cited as a reason for resorting to inflation and
borrowing, as this can be a short term way of acquiring marketable resources and is often
favored by desperate, indebted governments.[47]

In other cases, Austrians argue that the government actually creates economic recessions
and depressions, by creating artificial booms that distort the structure of production. The
central bank may try to avoid or defer the widespread bankruptcies and insolvencies
which cause economic recessions or depressions by artificially trying to "stimulate" the
economy through "encouraging" money supply growth and further borrowing via
artificially low interest rates.[48] Accordingly, many Austrian economists support the
abolition of the central banks and the fractional-reserve banking system, and advocate
returning to a 100 percent gold standard, or less frequently, free banking.[49][50] They
argue this would constrain unsustainable and volatile fractional-reserve banking
practices, ensuring that money supply growth (and inflation) would never spiral out of
control.[51][52]

Real bills doctrine

Main article: Real bills doctrine

Within the context of a fixed specie basis for money, one important controversy was
between the quantity theory of money and the real bills doctrine (RBD). Within this
context, quantity theory applies to the level of fractional reserve accounting allowed
against specie, generally gold, held by a bank. Currency and banking schools of
economics argue the RBD, that banks should also be able to issue currency against bills
of trading, which is "real bills" that they buy from merchants. This theory was important
in the 19th century in debates between "Banking" and "Currency" schools of monetary
soundness, and in the formation of the Federal Reserve. In the wake of the collapse of the
international gold standard post 1913, and the move towards deficit financing of
government, RBD has remained a minor topic, primarily of interest in limited contexts,
such as currency boards. It is generally held in ill repute today, with Frederic Mishkin, a
governor of the Federal Reserve going so far as to say it had been "completely
discredited." Even so, it has theoretical support from a few economists, particularly those
that see restrictions on a particular class of credit as incompatible with libertarian
principles of laissez-faire, even though almost all libertarian economists are opposed to
the RBD.

The debate between currency, or quantity theory, and banking schools in Britain during
the 19th century prefigures current questions about the credibility of money in the
present. In the 19th century the banking school had greater influence in policy in the
United States and Great Britain, while the currency school had more influence "on the
continent", that is in non-British countries, particularly in the Latin Monetary Union and
the earlier Scandinavia monetary union.

Anti-classical or backing theory

Another issue associated with classical political economy is the anti-classical hypothesis
of money, or "backing theory". The backing theory argues that the value of money is
determined by the assets and liabilities of the issuing agency.[53] Unlike the Quantity
Theory of classical political economy, the backing theory argues that issuing authorities
can issue money without causing inflation so long as the money issuer has sufficient
assets to cover redemptions. There are very few backing theorists, making quantity theory
the dominant theory explaining inflation.[citation needed]

Controlling inflation

A variety of methods have been used in attempts to control inflation.

Monetary policy

Main article: Monetary policy


               Please help improve this article by expanding it. Further information
               might be found on the talk page. (September 2008)




The U.S. effective federal funds rate charted over fifty years.

Today the primary tool for controlling inflation is monetary policy. Most central banks
are tasked with keeping the federal funds lending rate at a low level, normally to a target
rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere
from about 2% to 6% per annum. A low positive inflation is usually targeted, as
deflationary conditions are seen as dangerous for the health of the economy.

There are a number of methods that have been suggested to control inflation. Central
banks such as the U.S. Federal Reserve can affect inflation to a significant extent through
setting interest rates and through other operations. High interest rates and slow growth of
the money supply are the traditional ways through which central banks fight or prevent
inflation, though they have different approaches. For instance, some follow a symmetrical
inflation target while others only control inflation when it rises above a target, whether
express or implied.

Monetarists emphasize keeping the growth rate of money steady, and using monetary
policy to control inflation (increasing interest rates, slowing the rise in the money
supply). Keynesians emphasize reducing aggregate demand during economic expansions
and increasing demand during recessions to keep inflation stable. Control of aggregate
demand can be achieved using both monetary policy and fiscal policy (increased taxation
or reduced government spending to reduce demand).

Fixed exchange rates

Main article: Fixed exchange rate

Under a fixed exchange rate currency regime, a country's currency is tied in value to
another single currency or to a basket of other currencies (or sometimes to another
measure of value, such as gold). A fixed exchange rate is usually used to stabilize the
value of a currency, vis-a-vis the currency it is pegged to. It can also be used as a means
to control inflation. However, as the value of the reference currency rises and falls, so
does the currency pegged to it. This essentially means that the inflation rate in the fixed
exchange rate country is determined by the inflation rate of the country the currency is
pegged to. In addition, a fixed exchange rate prevents a government from using domestic
monetary policy in order to achieve macroeconomic stability.
Under the Bretton Woods agreement, most countries around the world had currencies that
were fixed to the US dollar. This limited inflation in those countries, but also exposed
them to the danger of speculative attacks. After the Bretton Woods agreement broke
down in the early 1970s, countries gradually turned to floating exchange rates. However,
in the later part of the 20th century, some countries reverted to a fixed exchange rate as
part of an attempt to control inflation. This policy of using a fixed exchange rate to
control inflation was used in many countries in South America in the later part of the 20th
century (e.g. Argentina (1991-2002), Bolivia, Brazil, and Chile).

Gold standard

Main article: Gold standard




Under a gold standard, paper notes are convertible into pre-set, fixed quantities of gold.

The gold standard is a monetary system in which a region's common media of exchange
are paper notes that are normally freely convertible into pre-set, fixed quantities of gold.
The standard specifies how the gold backing would be implemented, including the
amount of specie per currency unit. The currency itself has no innate value, but is
accepted by traders because it can be redeemed for the equivalent specie. A U.S. silver
certificate, for example, could be redeemed for an actual piece of silver.

The gold standard was partially abandoned via the international adoption of the Bretton
Woods System. Under this system all other major currencies were tied at fixed rates to
the dollar, which itself was tied to gold at the rate of $35 per ounce. The Bretton Woods
system broke down in 1971, causing most countries to switch to fiat money – money
backed only by the laws of the country. Austrian economists strongly favor a return to a
100 percent gold standard.

Under a gold standard, the long term rate of inflation (or deflation) would be determined
by the growth rate of the supply of gold relative to total output. [54] Critics argue that this
will cause arbitrary fluctuations in the inflation rate, and that monetary policy would
essentially be determined by gold mining,[55][56] which some believe contributed to the
Great Depression.[56][57][58]

Wage and price controls

Main article: Incomes policies

Another method attempted in the past have been wage and price controls ("incomes
policies"). Wage and price controls have been successful in wartime environments in
combination with rationing. However, their use in other contexts is far more mixed.
Notable failures of their use include the 1972 imposition of wage and price controls by
Richard Nixon. More successful examples include the Prices and Incomes Accord in
Australia and the Wassenaar Agreement in the Netherlands.

In general wage and price controls are regarded as a temporary and exceptional measure,
only effective when coupled with policies designed to reduce the underlying causes of
inflation during the wage and price control regime, for example, winning the war being
fought. They often have perverse effects, due to the distorted signals they send to the
market. Artificially low prices often cause rationing and shortages and discourage future
investment, resulting in yet further shortages. The usual economic analysis is that any
product or service that is under-priced is overconsumed. For example, if the official price
of bread is too low, there will be too little bread at official prices, and too little
investment in bread making by the market to satisfy future needs, thereby exacerbating
the problem in the long term.

Temporary controls may complement a recession as a way to fight inflation: the controls
make the recession more efficient as a way to fight inflation (reducing the need to
increase unemployment), while the recession prevents the kinds of distortions that
controls cause when demand is high. However, in general the advice of economists is not
to impose price controls but to liberalize prices by assuming that the economy will adjust
and abandon unprofitable economic activity. The lower activity will place fewer demands
on whatever commodities were driving inflation, whether labor or resources, and
inflation will fall with total economic output. This often produces a severe recession, as
productive capacity is reallocated and is thus often very unpopular with the people whose
livelihoods are destroyed (see creative destruction).

Cost-of-living allowance

For more details on this topic, see Cost of living.

The real purchasing-power of fixed payments is eroded by inflation unless they are
inflation-adjusted to keep their real values constant. In many countries, employment
contracts, pension benefits, and government entitlements (such as social security) are tied
to a cost-of-living index, typically to the consumer price index.[59] A cost-of-living
allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries
are typically adjusted annually in low inflation economies. During hyperinflation they are
adjusted more often.[59] They may also be tied to a cost-of-living index that varies by
geographic location if the employee moves.

Annual escalation clauses in employment contracts can specify retroactive or future
percentage increases in worker pay which are not tied to any index. These negotiated
increases in pay are colloquially referred to as cost-of-living adjustments or cost-of-living
increases because of their similarity to increases tied to externally determined indexes.
Many economists and compensation analysts consider the idea of predetermined future
"cost of living increases" to be misleading for two reasons: (1) For most recent periods in
the industrialized world, average wages have increased faster than most calculated cost-
of-living indexes, reflecting the influence of rising productivity and worker bargaining
power rather than simply living costs, and (2) most cost-of-living indexes are not
forward-looking, but instead compare current or historical data.




International trade

International trade is exchange of capital, goods, and services across international
borders or territories.[1]. In most countries, it represents a significant share of gross
domestic product (GDP). While international trade has been present throughout much of
history (see Silk Road, Amber Road), its economic, social, and political importance has
been on the rise in recent centuries.

Industrialization, advanced transportation, globalization, multinational corporations, and
outsourcing are all having a major impact on the international trade system. Increasing
international trade is crucial to the continuance of globalization. Without international
trade, nations would be limited to the goods and services produced within their own
borders.
International trade is in principle not different from domestic trade as the motivation and
the behavior of parties involved in a trade do not change fundamentally regardless of
whether trade is across a border or not. The main difference is that international trade is
typically more costly than domestic trade. The reason is that a border typically imposes
additional costs such as tariffs, time costs due to border delays and costs associated with
country differences such as language, the legal system or culture.

Another difference between domestic and international trade is that factors of production
such as capital and labour are typically more mobile within a country than across
countries. Thus international trade is mostly restricted to trade in goods and services, and
only to a lesser extent to trade in capital, labor or other factors of production. Then trade
in goods and services can serve as a substitute for trade in factors of production. Instead
of importing a factor of production, a country can import goods that make intensive use
of the factor of production and are thus embodying the respective factor. An example is
the import of labor-intensive goods by the United States from China. Instead of importing
Chinese labor the United States is importing goods from China that were produced with
Chinese labor.

International trade is also a branch of economics, which, together with international
finance, forms the larger branch of international economics.




International trade uses a variety of currencies, the most important of which are held as
foreign reserves by governments and central banks. Here the percentage of global
cummulative reserves held for each currency between 1995 and 2005 are shown: the US
dollar is the most sought-after currency, with the Euro in strong demand as well.
Contents

[hide]


          1 Models
                 o     1.1 Ricardian model
                 o     1.2 Heckscher-Ohlin model
                             1.2.1 Reality and Applicability of the Heckscher-Ohlin
                                  Model
                o 1.3 Specific factors model
                o 1.4 New Trade Theory
                o 1.5 Gravity model
                o 1.6 Ricardian theory of international trade (modern development)
                             1.6.1 Contemporary theories
                             1.6.2 Neo-Ricardian trade theory
                             1.6.3 Traded intermediate goods
                             1.6.4 Ricardo-Sraffa trade theory
          2 Top trading nations
          3 Regulation of international trade
          4 Risk in international trade
          5 Gallery
          6 See also
          7 Footnotes
          8 References
          9 External links
                o 9.1 Data
                                 9.1.1 Official statistics
                                 9.1.2 Other data sources
                 o     9.2 Other external links



[edit] Models

Several different models have been proposed to predict patterns of trade and to analyze
the effects of trade policies such as tariffs.

[edit] Ricardian model

Further information: Ricardian economics




The Panama Canal is important for international sea trade between the Atlantic Ocean
and the Pacific Ocean.

The Ricardian model focuses on comparative advantage and is perhaps the most
important concept in international trade theory. In a Ricardian model, countries specialize
in producing what they produce best. Unlike other models, the Ricardian framework
predicts that countries will fully specialize instead of producing a broad array of goods.
dfnlsrgjnvl;srgh Also, the Ricardian model does not directly consider factor endowments,
such as the relative amounts of labor and capital within a country. The main merit of
Ricardian model is that it assumes technology differences between countries. [citation needed]
Technology gap is easily included in the Ricardian and Ricardo-Sraffa model (See the
Ricardian theory (modern deveopment)).

The Ricardian model makes the following assumptions:

     1.    Labor is the only primary input to production (labor is considered to be the
           ultimate source of value).
     2.    Constant Marginal Product of Labor (MPL) (Labor productivity is constant,
           constant returns to scale, and simple technology.)
     3.    Limited amount of labor in the economy
     4.    Labor is perfectly mobile among sectors but not internationally.
     5.    Perfect competition (price-takers).

The Ricardian model measures in the short-run, therefore technology differs
internationally. This supports the fact that countries follow their comparative advantage
and allows for specialization.

For the modern development of Ricardian model, see the subsection below: Ricardian
theory of international trade.

[edit] Heckscher-Ohlin model
Main article: Heckscher-Ohlin model

In the early 1900s an international trade theory called factor proportions theory emerged
by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the
Heckscher-Ohlin theory. The Heckscher-Ohlin theory stresses that countries should
produce and export goods that require resources (factors) that are abundant and import
goods that require resources in short supply. This theory differs from the theories of
comparative advantage and absolute advantage since these theory focuses on the
productivity of the production process for a particular good. On the contrary, the
Heckscher-Ohlin theory states that a country should specialize production and export
using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier
theories stated, the goods it produces most efficiently.

The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of
basic comparative advantage. Despite its greater complexity it did not prove much more
accurate in its predictions. However from a theoretical point of view it did provide an
elegant solution by incorporating the neoclassical price mechanism into international
trade theory.

The theory argues that the pattern of international trade is determined by differences in
factor endowments. It predicts that countries will export those goods that make intensive
use of locally abundant factors and will import goods that make intensive use of factors
that are locally scarce. Empirical problems with the H-O model, known as the Leontief
paradox, were exposed in empirical tests by Wassily Leontief who found that the United
States tended to export labor intensive goods despite having a capital abundance.

The H-O model makes the following core assumptions:

     1.    Labor and capital flow freely between sectors
     2.    The production of shoes is labor intensive and the production of computers is
           capital intensive
     3.    The amount of labor and capital in two countries differ (difference in
           endowments)
     4.    Free trade
     5.    Technology is the same across countries (long-term)
     6.    Tastes are the same.

The problem with the H-O theory is that it excludes the trade of capital goods (including
materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to
each country. In a modern economy, capital goods are traded internationally. Gains from
trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001).

[edit] Reality and Applicability of the Heckscher-Ohlin Model

The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists,
because it makes fewer simplifying assumptions.[citation needed] In 1953, Wassily Leontief
published a study, where he tested the validity of the Heckscher-Ohlin theory[2]. The
study showed that the U.S was more abundant in capital compared to other countries,
therefore the U.S would export capital- intensive goods and import labour-intensive
goods. Leontief found out that the U.S's export was less capital intensive than import.

After the appearance of Leontief's paradox, many researchers tried to save the Heckscher-
Ohlin theory, either by new methods of measurement, or either by new interpretations.
Leamer[3] emphasized that Leontief did not interpret HO theory properly and claimed that
with a right interpretation paradox did not occur. Brecher and Choudri [4] found that, if
Leamer was right, the American workers consumption per head should be lower than the
workers world average consumption.

Many other trials followed but most of them failed.[5][6] Many of famous textbook writers,
including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about
the validity of H-O model.[7][8]. After examining the long history of empirical research,
Bowen, Hollander and Viane concluded: "Recent tests of the factor abundance theory [H-
O theory and its developed form into many-commodity and many-factor case] that
directly examine the H-O-V equations also indicate the rejection of the theory."[8]:321
Heckscher-Ohlin theory is not well adapted to the analyze South-North trade problems.
The assumptions of HO are less realistic with respect to N-S than N-N (or S-S) trade.
Income differences between North and South is the one that third world cares most. The
factor price equalization [a consequence of HO theory] has not shown much sign of
realization. HO model assumes identical production functions between countries. This is
highly unrealistic. Technological gap between developed and developing countries is the
main concern of the poor countries[9].

[edit] Specific factors model


                This section does not cite any references or sources.
                Please help improve this article by adding citations to reliable sources.
                Unsourced material may be challenged and removed. (October 2009)




Current members of the World Trade Organisation.




Global Competitiveness Index (2008-2009): competitiveness is an important determinant
for the well-being of states in an international trade environment.

In this model, labor mobility between industries is possible while capital is immobile
between industries in the short-run. Thus, this model can be interpreted as a 'short run'
version of the Heckscher-Ohlin model. The specific factors name refers to the given that
in the short-run, specific factors of production such as physical capital are not easily
transferable between industries. The theory suggests that if there is an increase in the
price of a good, the owners of the factor of production specific to that good will profit in
real terms.

Additionally, owners of opposing specific factors of production (i.e. labor and capital) are
likely to have opposing agendas when lobbying for controls over immigration of labor.
Conversely, both owners of capital and labor profit in real terms from an increase in the
capital endowment. This model is ideal for particular industries. This model is ideal for
understanding income distribution but awkward for discussing the pattern of trade.

[edit] New Trade Theory

Main article: New Trade Theory

New Trade theory tries to explain several facts about trade, which the two main models
above have difficulty with. These include the fact that most trade is between countries
with similar factor endowment and productivity levels, and the large amount of
multinational production(i.e.foreign direct investment) which exists. In one example of
this framework, the economy exhibits monopolistic competition and increasing returns to
scale. There are three basic theories that global marketer has to comprehend: 1.
Comparative Advantage Theory 2. Trade or product trade cycle theory 3. Business
orientation theory

[edit] Gravity model
Main article: Gravity model of trade

The Gravity model of trade presents a more empirical analysis of trading patterns rather
than the more theoretical models discussed above. The gravity model, in its basic form,
predicts trade based on the distance between countries and the interaction of the
countries' economic sizes. The model mimics the Newtonian law of gravity which also
considers distance and physical size between two objects. The model has been proven to
be empirically strong through econometric analysis. Other factors such as income level,
diplomatic relationships between countries, and trade policies are also included in
expanded versions of the model.




[edit] Ricardian theory of international trade (modern development)

The Ricardian theory of comparative advantage became a basic constituent of
neoclassical trade theory. Any undergraduate course in trade theory includes expansions
of Ricardo's example of four numbers in for form of a two commodity, two country
model.

This model was expanded to many-country and many-commodity cases. Major general
results were obtained by the beginning of 1960's by McKenzie[10] and Jones[11], including
his famous formula. It is a theorem about the possible trade pattern for N-country N-
commoditty cases. Let aij be the labor input coefficent for a country i and for the industry
j (or for the production of good j). If a trade pattern i country specialises in i industry,
then the product

   a11 a22 ... aNN

is strictly smaller than any permutation products of the form

   a1σ(1) a2σ(2) ... aNσ(N)

for any perumutation σ    except the identity permuation which transforms i onto i.




[edit] Contemporary theories

Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch,
Fischer, and Samuelson[12] This formulation is employed for example by Matsuyama [13]
and others. These theoris uses the special property which is applicable only for two
coutry case.

[edit] Neo-Ricardian trade theory

Inspired by Piero Sraffa, a new strand of trade theory emerged and was named neo-
Ricardian trade theory. The main contributors include Ian Steedman (1941-) and Stanley
Metcalfe (1946-). They have criticized neoclassical international trade theory, namely the
Heckscher-Ohlin model on the basis that the notion of capital as primary factor has no
method of measuring it before the determination of profit rate (thus trapped in a logical
vicious circle)[14]. This was a second round of the Cambridge capital controversy, this
time in the field of international trade.[15]

The merit of neo-Ricardian trade theory is that input goods are explicitly included to the
analytical framework. This is in accordance with Sraffa's idea that any commodity is a
product made by means of commodities. The limit of their theory is that the analysis is
limited to small country cases.

[edit] Traded intermediate goods
Ricardian trade theory ordinarily assumes that the labor is the unique input. This is a
great deficiency as trade theory, for the intermediate goods occupy the major part of the
world international trade. Yeats[16] found that 30% of world trade in manufacturing is
intermediate inputs. Bardhan and Jafee[17] found that intermediate inputs occupy 37 to
38% in the imports to the US for years 1992 and 1997, whereas the percentage of
intrafirm trade grew from 43% in 1992 to 52% in 1997.

McKenzie[18] and Jones[19] emphasized the necessity to expand the Ricardian theory to the
cases of traded inputs. In a famous comment McKenzie (1954, p. 179) pointed that "A
moment's consideration will convince one that Lancashire would be unlikely to produce
cotton cloth if the cotton had to be grown in England."[20] Paul Samuelson[21] coined a
term Sraffa bonus to name the gains from trade of inputs.

[edit] Ricardo-Sraffa trade theory

John Chipman observed in his survey that McKenzie stumbled upon the questions of
intermediate products and discovered that "introduction of trade in intermediate product
necessitates a fundamental alteration in classical analysis."[22] It took may years until
recently Y. Shiozawa[23] succeded to remove this deficiency. The Ricardian trade theory
was now constructed in a form to include intermediate input trade for the most general
case of many countries and many goods. This new theory is called Ricardo-Sraffa trade
theory.

It is emphasized that the Ricardian trade theory now provides a general theory which
includes trade of intermediates such as fuel, machine tools, machinery parts and
processed materials. The traded intermediate goods are then used as inputs of productions
in the importing country. Capital goods are nothing other than inputs to the productions.
Thus, in the Ricardo-Sraffa trade theory, capital goods moves freely from country to
country. Labor is the unique factor of production that remains immobile in the country of
its origin.

In a blog post of April 28, 2007, Gregory Mankiw compared Ricardian theory and
Heckscher-Ohlin theory and stood by the Ricardian side[24]. Mankiw argued that
Ricardian theory is more realistic than the Heckscher-Ohlin theory as the latter assumes
that capital does not move from country to country. Mankiw's argument contains a
logical slip, for the traditional Ricardian trade theory does not admit any inputs.
Shiozawa's result saves Mankiw from his slip[25].

The neoclassical Heckscher-Ohlin-Samuelson theory only assumes production factors
and finished goods. It contains no concept of intermediate goods. Therefore, it is the
Ricardo-Sraffa trade theory that provides theoretical bases for the topics such as
outsourcing, fragmentation and intra-firm trade.

[edit] Top trading nations

Main articles: List of countries by exports and List of countries by imports

Rank                    Country                  Exports + Imports             Date of
                                                                         information
-               European Union (Extra-EU27) $3,197,000,000,000           2009 [26]
1               United States                    $2,439,700,000,000      2009 est.
2               People's Republic of China       $2,208,000,000,000      2009 est.
3               Germany                          $2,052,000,000,000      2009 est.
4               Japan                            $1,006,900,000,000      2009 est.

5               France                           $989,000,000,000        2009 est.
6               United Kingdom                   $824,900,000,000        2009 est.
7               Netherlands                      $756,500,000,000        2009 est.
8               Italy                            $727,700,000,000        2009 est.
-               Hong Kong                        $672,600,000,000        2009 est.
9                South Korea                       $668,500,000,000         2009 est.

10               Belgium                           $611,100,000,000         2009 est.
11               Canada                            $603,700,000,000         2009 est.
12               Spain                             $508,900,000,000         2009 est.

13               Russia                            $492,400,000,000         2009 est.
14               Mexico                            $458,200,000,000         2009 est.
15               Singapore                         $454,800,000,000         2009 est.

16               India                             $387,300,000,000         2009 est.

17               Taiwan                            $371,400,000,000         2009 est.

18              Switzerland                        $367,300,000,000         2009 est.

19               Australia                         $322,400,000,000         2009 est.
20               United Arab Emirates              $315,000,000,000         2009 est.


Source : Exports. Imports. The World Factbook.

[edit] Regulation of international trade

Traditionally trade was regulated through bilateral treaties between two nations. For
centuries under the belief in mercantilism most nations had high tariffs and many
restrictions on international trade. In the 19th century, especially in the United Kingdom,
a belief in free trade became paramount.[citation needed] This belief became the dominant
thinking among western nations since then. In the years since the Second World War,
controversial multilateral treaties like the General Agreement on Tariffs and Trade
(GATT) and World Trade Organization have attempted to promote free trade while
creating a globally regulated trade structure. These trade agreements have often resulted
in discontent and protest with claims of unfair trade that is not beneficial to developing
countries.

Free trade is usually most strongly supported by the most economically powerful nations,
though they often engage in selective protectionism for those industries which are
strategically important such as the protective tariffs applied to agriculture by the United
States and Europe.[citation needed] The Netherlands and the United Kingdom were both strong
advocates of free trade when they were economically dominant, today the United States,
the United Kingdom, Australia and Japan are its greatest proponents. However, many
other countries (such as India, China and Russia) are increasingly becoming advocates of
free trade as they become more economically powerful themselves. As tariff levels fall
there is also an increasing willingness to negotiate non tariff measures, including foreign
direct investment, procurement and trade facilitation.[citation needed] The latter looks at the
transaction cost associated with meeting trade and customs procedures.

Traditionally agricultural interests are usually in favour of free trade while manufacturing
sectors often support protectionism. [citation needed]This has changed somewhat in recent
years, however. In fact, agricultural lobbies, particularly in the United States, Europe and
Japan, are chiefly responsible for particular rules in the major international trade treaties
which allow for more protectionist measures in agriculture than for most other goods and
services.

During recessions there is often strong domestic pressure to increase tariffs to protect
domestic industries. This occurred around the world during the Great Depression. Many
economists have attempted to portray tariffs as the underlining reason behind the collapse
in world trade that many believe seriously deepened the depression.

The regulation of international trade is done through the World Trade Organization at the
global level, and through several other regional arrangements such as MERCOSUR in
South America, the North American Free Trade Agreement (NAFTA) between the
United States, Canada and Mexico, and the European Union between 27 independent
states. The 2005 Buenos Aires talks on the planned establishment of the Free Trade Area
of the Americas (FTAA) failed largely because of opposition from the populations of
Latin American nations. Similar agreements such as the Multilateral Agreement on
Investment (MAI) have also failed in recent years.

[edit] Risk in international trade

Companies doing business across international borders face many of the same risks as
would normally be evident in strictly domestic transactions. For example,


          Buyer insolvency (purchaser cannot pay);
          Non-acceptance (buyer rejects goods as different from the agreed upon
           specifications);
          Credit risk (allowing the buyer to take possession of goods prior to payment);
          Regulatory risk (e.g., a change in rules that prevents the transaction);
          Intervention (governmental action to prevent a transaction being completed);
          Political risk (change in leadership interfering with transactions or prices); and
          War and other uncontrollable events.

In addition, international trade also faces the risk of unfavorable exchange rate
movements (and, the potential benefit of favorable movements).[27]

[edit] Gallery




Dual-currency cash
machines in Jersey: as                        Globalisation:
international trade
                       A 1672 painting by Peugeot in Jakarta,        A camel caravan, still
increases, the need to
                       Gérard de Lairesse: Indonesia.                used today for
handle multiple                               International trade
                       allegory of the                               international trade,
currencies is
                       freedom of trade (see coincides with the      especially in Sahara.
becoming more                                 expansion of
                       also: free market).
powerful.
                       International trade is multinational
                       commonly associated corporations.
                       with freedom of trade.




                      Triangle trade: Slaves
                      being sold from
                      Africa to North        Some people do not
A modern camel
caravan carrying      America, sugar from see international trade
                                             favourably: here a
goods across villages South America to
                      New England, and       person protests
and international
borders.              Rum and other goods against the WTO in
                      from North America Jakarta.
                      back to Africa.


International finance
International finance is the branch of economics that studies the dynamics of exchange
rates, foreign investment, and how these affect international trade. It also studies
international projects, international investments and capital flows, and trade deficits. It
includes the study of futures, options and currency swaps. International finance is a
branch of international economics.

Important theories in international finance include the Mundell-Fleming model, the
optimum currency area (OCA) theory, as well as the purchasing power parity (PPP)
theory. Whereas international trade theory makes use of mostly microeconomic methods
and theories, international finance theory makes use of predominantly macroeconomic
methods and concepts

Exchange rate


In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or
FX rate) between two currencies specifies how much one currency is worth in terms of
the other. It is the value of a foreign nation’s currency in terms of the home nation’s
currency.[1] For example an exchange rate of 91 Japanese yen (JPY, ¥) to the United
States dollar (USD, $) means that JPY 91 is worth the same as USD 1. The foreign
exchange market is one of the largest markets in the world. By some estimates, about 3.2
trillion USD worth of currency changes hands every day.

The spot exchange rate refers to the current exchange rate. The forward exchange rate
refers to an exchange rate that is quoted and traded today but for delivery and payment on
a specific future date.


Contents

[hide]


          1 Quotations
          2 Free or pegged
          3 Bilateral vs. effective exchange rate
          4 Uncovered interest rate parity
          5 Balance of payments model
          6 Asset market model
          7 Fluctuations in exchange rates
          8 See also
          9 References
          10 External links



[edit] Quotations

An exchange system quotation is given by stating the number of units of "quote
currency" (price currency, payment currency) that can be exchanged for one unit of "base
currency" (unit currency, transaction currency). For example, in a quotation that says the
EUR/USD exchange rate is 1.2290 (1.2290 USD per EUR, also known as EUR/USD; see
foreign exchange market), the quote currency is USD and the base currency is EUR.

There is a market convention that determines which is the base currency and which is the
term currency. In most parts of the world, the order is: EUR – GBP – AUD – NZD –
USD – others. Thus if you are doing a conversion from EUR into AUD, EUR is the base
currency, AUD is the term currency and the exchange rate tells you how many Australian
dollars you would pay or receive for 1 euro. Cyprus and Malta which were quoted as the
base to the USD and others were recently removed from this list when they joined the
euro. In some areas of Europe and in the non-professional market in the UK, EUR and
GBP are reversed so that GBP is quoted as the base currency to the euro. In order to
determine which is the base currency where both currencies are not listed (i.e. both are
"other"), market convention is to use the base currency which gives an exchange rate
greater than 1.000. This avoids rounding issues and exchange rates being quoted to more
than 4 decimal places. There are some exceptions to this rule e.g. the Japanese often
quote their currency as the base to other currencies.

Quotes using a country's home currency as the price currency (e.g., EUR 0.735342 =
USD 1.00 in the euro zone) are known as direct quotation or price quotation (from that
country's perspective)[2] and are used by most countries.

Quotes using a country's home currency as the unit currency (e.g., EUR 1.00 = USD
1.35991 in the euro zone) are known as indirect quotation or quantity quotation and are
used in British newspapers and are also common in Australia, New Zealand and the
eurozone.


          direct quotation: 1 foreign currency unit = x home currency units
          indirect quotation: 1 home currency unit = x foreign currency units

Note that, using direct quotation, if the home currency is strengthening (i.e., appreciating,
or becoming more valuable) then the exchange rate number decreases. Conversely if the
foreign currency is strengthening, the exchange rate number increases and the home
currency is depreciating.

Market convention from the early 1980s to 2006 was that most currency pairs were
quoted to 4 decimal places for spot transactions and up to 6 decimal places for forward
outrights or swaps. (The fourth decimal place is usually referred to as a "pip"). An
exception to this was exchange rates with a value of less than 1.000 which were usually
quoted to 5 or 6 decimal places. Although there is no fixed rule, exchange rates with a
value greater than around 20 were usually quoted to 3 decimal places and currencies with
a value greater than 80 were quoted to 2 decimal places. Currencies over 5000 were
usually quoted with no decimal places (e.g. the former Turkish Lira). e.g. (GBPOMR :
0.765432 - EURUSD : 1.5877 - GBPBEF : 58.234 - EURJPY : 165.29). In other words,
quotes are given with 5 digits. Where rates are below 1, quotes frequently include 5
decimal places.

In 2005 Barclays Capital broke with convention by offering spot exchange rates with 5 or
6 decimal places on their electronic dealing platform.[3] The contraction of spreads (the
difference between the bid and offer rates) arguably necessitated finer pricing and gave
the banks the ability to try and win transaction on multibank trading platforms where all
banks may otherwise have been quoting the same price. A number of other banks have
now followed this.

While official quotations are given with the full number, for example 1.4320, many
investors and analysts drop the integer for convenience and use only the fractional part,
such as 4320. These are used frequently where a move in price is being described, for
example 4320 to 4290 as opposed to 1.4320 to 1.4290.[4]

[edit] Free or pegged

Main article: Exchange rate regime

If a currency is free-floating, its exchange rate is allowed to vary against that of other
currencies and is determined by the market forces of supply and demand. Exchange rates
for such currencies are likely to change almost constantly as quoted on financial markets,
mainly by banks, around the world. A movable or adjustable peg system is a system of
fixed exchange rates, but with a provision for the devaluation of a currency. For example,
between 1994 and 2005, the Chinese yuan renminbi (RMB) was pegged to the United
States dollar at RMB 8.2768 to $1. China was not the only country to do this; from the
end of World War II until 1967, Western European countries all maintained fixed
exchange rates with the US dollar based on the Bretton Woods system. [1]

The RER{Real Exchange Rate}is based on the GDP deflator measurement of the price
level in the domestic and foreign countries (P,Pf), which is arbitrarily set equal to 1 in a
given base year. Therefore, the level of the RER is arbitrarily set, depending on which
year is chosen as the base year for the GDP deflator of two countries. The changes of the
RER are instead informative on the evolution over time of the relative price of a unit of
GDP in the foreign country in terms of GDP units of the domestic country. If all goods
were freely tradable, and foreign and domestic residents purchased identical baskets of
goods, purchasing power parity (PPP) would hold for the GDP deflators of the two
countries, and the RER would be constant and equal to one.

[edit] Bilateral vs. effective exchange rate

Bilateral exchange rate involves a currency pair, while effective exchange rate is
weighted average of a basket of foreign currencies, and it can be viewed as an overall
measure of the country's external competitiveness. A nominal effective exchange rate
(NEER) is weighted with the inverse of the asymptotic trade weights. A real effective
exchange rate (REER) adjust NEER by appropriate foreign price level and deflates by the
home country price level. Compared to NEER, a GDP weighted effective exchange rate
might be more appropriate considering the global investment phenomenon.

[edit] Uncovered interest rate parity

See also: Interest rate parity#Uncovered interest rate parity

Uncovered interest rate parity (UIRP) states that an appreciation or depreciation of one
currency against another currency might be neutralized by a change in the interest rate
differential. If US interest rates increase while Japanese interest rates remain unchanged
then the US dollar should depreciate against the Japanese yen by an amount that prevents
arbitrage (in reality the opposite (appreciation) quite frequently happens, as explained
below). The future exchange rate is reflected into the forward exchange rate stated today.
In our example, the forward exchange rate of the dollar is said to be at a discount because
it buys fewer Japanese yen in the forward rate than it does in the spot rate. The yen is said
to be at a premium.

UIRP showed no proof of working after 1990s. Contrary to the theory, currencies with
high interest rates characteristically appreciated rather than depreciated on the reward of
the containment of inflation and a higher-yielding currency.

[edit] Balance of payments model

This model holds that a foreign exchange rate must be at its equilibrium level - the rate
which produces a stable current account balance. A nation with a trade deficit will
experience reduction in its foreign exchange reserves which ultimately lowers
(depreciates) the value of its currency. The cheaper currency renders the nation's goods
(exports) more affordable in the global market place while making imports more
expensive. After an intermediate period, imports are forced down and exports rise, thus
stabilizing the trade balance and the currency towards equilibrium.

Like PPP, the balance of payments model focuses largely on trade-able goods and
services, ignoring the increasing role of global capital flows. In other words, money is not
only chasing goods and services, but to a larger extent, financial assets such as stocks and
bonds. Their flows go into the capital account item of the balance of payments, thus,
balancing the deficit in the current account. The increase in capital flows has given rise to
the asset market model.

[edit] Asset market model

See also: Capital asset pricing model and Net Capital Outflow

The blowing up in trading of financial assets (stocks and bonds) has reshaped the way
analysts and traders look at currencies. Economic variables such as economic growth,
inflation and productivity are no longer the only drivers of currency movements. The
proportion of foreign exchange transactions stemming from cross border-trading of
financial assets has dwarfed the extent of currency transactions generated from trading in
goods and services.

The asset market approach views currencies as asset prices traded in an efficient financial
market. Consequently, currencies are increasingly demonstrating a strong correlation
with other markets, particularly equities.
Like the stock exchange, money can be made or lost on the foreign exchange market by
investors and speculators buying and selling at the right times. Currencies can be traded
at spot and foreign exchange options markets. The spot market represents current
exchange rates, whereas options are derivatives of exchange rates

[edit] Fluctuations in exchange rates




Exchange rates display

A market based exchange rate will change whenever the values of either of the two
component currencies change. A currency will tend to become more valuable whenever
demand for it is greater than the available supply. It will become less valuable whenever
demand is less than available supply (this does not mean people no longer want money, it
just means they prefer holding their wealth in some other form, possibly another
currency).

Increased demand for a currency is due to either an increased transaction demand for
money, or an increased speculative demand for money. The transaction demand for
money is highly correlated to the country's level of business activity, gross domestic
product (GDP), and employment levels. The more people there are unemployed, the less
the public as a whole will spend on goods and services. Central banks typically have little
difficulty adjusting the available money supply to accommodate changes in the demand
for money due to business transactions.

The speculative demand for money is much harder for a central bank to accommodate but
they try to do this by adjusting interest rates. An investor may choose to buy a currency if
the return (that is the interest rate) is high enough. The higher a country's interest rates,
the greater the demand for that currency. It has been argued that currency speculation can
undermine real economic growth, in particular since large currency speculators may
deliberately create downward pressure on a currency by shorting in order to force that
central bank to sell their currency to keep it stable (once this happens, the speculator can
buy the currency back from the bank at a lower

Foreign direct investment


Foreign direct investment (FDI) refers to long term participation by country A into
country B. It usually involves participation in management, joint-venture, transfer of
technology and expertise. There are two types of FDI: inward foreign direct investment
and outward foreign direct investment, resulting in a net FDI inflow (positive or
negative).


Contents

[hide]
          1 History
          2 Types
          3 Methods
          4 Debates about the benefits of FDI for low-income countries
          5 Foreign direct investment in the United States
          6 Foreign direct investment in China
          7 See also
          8 References
          9 External links



[edit] History

Foreign direct investment (FDI) is a measure of foreign ownership of productive assets,
such as factories, mines and land. Increasing foreign investment can be used as one
measure of growing economic globalization. Figure below shows net inflows of foreign
direct investment. The largest flows of foreign investment occur between the
industrialized countries (North America, Western Europe and Japan). But flows to non-
industrialized countries are increasing sharply.

US International Direct Investment Flows:[1]


Period FDI Outflow FDI Inflows               Net
1960-69 $ 42.18 bn      $ 5.13 bn       + $ 37.04 bn
1970-79 $ 122.72 bn     $ 40.79 bn      + $ 81.93 bn
1980-89 $ 206.27 bn     $ 329.23 bn     - $ 122.96 bn
1990-99 $ 950.47 bn     $ 907.34 bn     + $ 43.13 bn
2000-07 $ 1,629.05 bn $ 1,421.31 bn + $ 207.74 bn
Total $ 2,950.69 bn $ 2,703.81 bn + $ 246.88 bn


[edit] Types

A foreign direct investor may be classified in any sector of the economy and could be any
one of the following:[citation needed]


          an individual;
          a group of related individuals;
          an incorporated or unincorporated entity;
          a public company or private company;
          a group of related enterprises;
          a government body;
          an estate (law), trust or other societal organisation; or
          any combination of the above.

[edit] Methods

The foreign direct investor may acquire 10% or more of the voting power of an enterprise
in an economy through any of the following methods:


          by incorporating a wholly owned subsidiary or company
          by acquiring shares in an associated enterprise
          through a merger or an acquisition of an unrelated enterprise
          participating in an equity joint venture with another investor or enterprise
Foreign direct investment incentives may take the following forms:[citation needed]


          low corporate tax and income tax rates
          tax holidays
          other types of tax concessions
          preferential tariffs
          special economic zones
          EPZ - Export Processing Zones
          Bonded Warehouses
          Maquiladoras
          investment financial subsidies
          soft loan or loan guarantees
          free land or land subsidies
          relocation & expatriation subsidies
          job training & employment subsidies
          infrastructure subsidies
          R&D support
          derogation from regulations (usually for very large projects)

[edit] Debates about the benefits of FDI for low-income countries

Some countries have put restrictions on FDI in certain sectors. India, with its restriction
on FDI in the retail sector is an example.[2] In a country like India, the ―walmartization‖
of the country could have significant negative effects on the overall economy by reducing
the number of people employed in the retail sector (currently the second largest
employment sector nationally) and depressing the income of people involved in the
agriculture sector (currently the largest employment sector nationally).[3]

[edit] Foreign direct investment in the United States

"Invest in America" is an initiative of the Commerce department and aimed to promote
the arrival of foreigners investors to the country.[4]

The ―Invest in America‖ policy is focused on:


          Facilitating investor queries.
          Carrying out maneuvers to aid foreign investors.
          Provide support both at local and state levels.
          Address concerns related to the business environment by helping as an
           ombudsman in Washington Dc for the international venture community.
          Offering policy guidelines and helping getting access to the legal system.

The United States is the world’s largest recipient of FDI. More than $325.3 billion in FDI
flowed into the United States in 2008, which is a 37 percent increase from 2007. The $2.1
trillion stock of FDI in the United States at the end of 2008 is the equivalent of
approximately 16 percent of U.S. gross domestic product (GDP).55

Benefits of FDI in America: In the last 6 years, over 4000 new projects and 630,000 new
jobs have been created by foreign companies, resulting in close to $314 billion in
investment.[citation needed] Unarguably, US affiliates of foreign companies have a history of
paying higher wages than US corporations.[citation needed] Foreign companies have in the past
supported an annual US payroll of $364 billion with an average annual compensation of
$68,000 per employee.[citation needed]

Increased US exports through the use of multinational distribution networks. FDI has
resulted in 30% of jobs for Americans in the manufacturing sector, which accounts for
12% of all manufacturing jobs in the US.[5]
Affiliates of foreign corporations spent more than $34 billions on research and
development in 2006 and continue to support many national projects. Inward FDI has led
to higher productivity through increased capital, which in turn has led to high living
standards.[6]

[edit] Foreign direct investment in China

FDI in China has been one of the major successes of the past 3 decades. [citation needed]
Starting from a baseline of less than $19 billion just 20 years ago, FDI in China has
grown to over $300 billion in the first 10 years. China has continued its massive growth
and is the leader among all developing nations in terms of FDI. [citation needed] Even though
there was a slight dip in FDI in 2009 as a result of the global slowdown, 2010 has again
seen investments increase. [citation needed] The Chinese continue to steam roll with
expectations of an economic growth of a 10% this year.[7]

International trade


International trade is exchange of capital, goods, and services across international
borders or territories.[1]. In most countries, it represents a significant share of gross
domestic product (GDP). While international trade has been present throughout much of
history (see Silk Road, Amber Road), its economic, social, and political importance has
been on the rise in recent centuries.

Industrialization, advanced transportation, globalization, multinational corporations, and
outsourcing are all having a major impact on the international trade system. Increasing
international trade is crucial to the continuance of globalization. Without international
trade, nations would be limited to the goods and services produced within their own
borders.

International trade is in principle not different from domestic trade as the motivation and
the behavior of parties involved in a trade do not change fundamentally regardless of
whether trade is across a border or not. The main difference is that international trade is
typically more costly than domestic trade. The reason is that a border typically imposes
additional costs such as tariffs, time costs due to border delays and costs associated with
country differences such as language, the legal system or culture.

Another difference between domestic and international trade is that factors of production
such as capital and labour are typically more mobile within a country than across
countries. Thus international trade is mostly restricted to trade in goods and services, and
only to a lesser extent to trade in capital, labor or other factors of production. Then trade
in goods and services can serve as a substitute for trade in factors of production. Instead
of importing a factor of production, a country can import goods that make intensive use
of the factor of production and are thus embodying the respective factor. An example is
the import of labor-intensive goods by the United States from China. Instead of importing
Chinese labor the United States is importing goods from China that were produced with
Chinese labor.

International trade is also a branch of economics, which, together with international
finance, forms the larger branch of international economics.
International trade uses a variety of currencies, the most important of which are held as
foreign reserves by governments and central banks. Here the percentage of global
cummulative reserves held for each currency between 1995 and 2005 are shown: the US
dollar is the most sought-after currency, with the Euro in strong demand as well.
Contents

[hide]


          1 Models
                o      1.1 Ricardian model
                o      1.2 Heckscher-Ohlin model
                             1.2.1 Reality and Applicability of the Heckscher-Ohlin
                                  Model
                o 1.3 Specific factors model
                o 1.4 New Trade Theory
                o 1.5 Gravity model
                o 1.6 Ricardian theory of international trade (modern development)
                             1.6.1 Contemporary theories
                             1.6.2 Neo-Ricardian trade theory
                             1.6.3 Traded intermediate goods
                             1.6.4 Ricardo-Sraffa trade theory
          2 Top trading nations
          3 Regulation of international trade
          4 Risk in international trade
          5 Gallery
          6 See also
          7 Footnotes
          8 References
          9 External links
                o 9.1 Data
                             9.1.1 Official statistics
                             9.1.2 Other data sources
                o 9.2 Other external links


[edit] Models

Several different models have been proposed to predict patterns of trade and to analyze
the effects of trade policies such as tariffs.

[edit] Ricardian model

Further information: Ricardian economics




The Panama Canal is important for international sea trade between the Atlantic Ocean
and the Pacific Ocean.
The Ricardian model focuses on comparative advantage and is perhaps the most
important concept in international trade theory. In a Ricardian model, countries specialize
in producing what they produce best. Unlike other models, the Ricardian framework
predicts that countries will fully specialize instead of producing a broad array of goods.
dfnlsrgjnvl;srgh Also, the Ricardian model does not directly consider factor endowments,
such as the relative amounts of labor and capital within a country. The main merit of
Ricardian model is that it assumes technology differences between countries. [citation needed]
Technology gap is easily included in the Ricardian and Ricardo-Sraffa model (See the
Ricardian theory (modern deveopment)).

The Ricardian model makes the following assumptions:

     1.    Labor is the only primary input to production (labor is considered to be the
           ultimate source of value).
     2.    Constant Marginal Product of Labor (MPL) (Labor productivity is constant,
           constant returns to scale, and simple technology.)
     3.    Limited amount of labor in the economy
     4.    Labor is perfectly mobile among sectors but not internationally.
     5.    Perfect competition (price-takers).

The Ricardian model measures in the short-run, therefore technology differs
internationally. This supports the fact that countries follow their comparative advantage
and allows for specialization.

For the modern development of Ricardian model, see the subsection below: Ricardian
theory of international trade.

[edit] Heckscher-Ohlin model

Main article: Heckscher-Ohlin model

In the early 1900s an international trade theory called factor proportions theory emerged
by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the
Heckscher-Ohlin theory. The Heckscher-Ohlin theory stresses that countries should
produce and export goods that require resources (factors) that are abundant and import
goods that require resources in short supply. This theory differs from the theories of
comparative advantage and absolute advantage since these theory focuses on the
productivity of the production process for a particular good. On the contrary, the
Heckscher-Ohlin theory states that a country should specialize production and export
using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier
theories stated, the goods it produces most efficiently.

The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of
basic comparative advantage. Despite its greater complexity it did not prove much more
accurate in its predictions. However from a theoretical point of view it did provide an
elegant solution by incorporating the neoclassical price mechanism into international
trade theory.

The theory argues that the pattern of international trade is determined by differences in
factor endowments. It predicts that countries will export those goods that make intensive
use of locally abundant factors and will import goods that make intensive use of factors
that are locally scarce. Empirical problems with the H-O model, known as the Leontief
paradox, were exposed in empirical tests by Wassily Leontief who found that the United
States tended to export labor intensive goods despite having a capital abundance.

The H-O model makes the following core assumptions:

     1.    Labor and capital flow freely between sectors
     2.    The production of shoes is labor intensive and the production of computers is
           capital intensive
     3.    The amount of labor and capital in two countries differ (difference in
           endowments)
     4.    Free trade
     5.    Technology is the same across countries (long-term)
     6.    Tastes are the same.

The problem with the H-O theory is that it excludes the trade of capital goods (including
materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to
each country. In a modern economy, capital goods are traded internationally. Gains from
trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001).

[edit] Reality and Applicability of the Heckscher-Ohlin Model

The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists,
because it makes fewer simplifying assumptions.[citation needed] In 1953, Wassily Leontief
published a study, where he tested the validity of the Heckscher-Ohlin theory[2]. The
study showed that the U.S was more abundant in capital compared to other countries,
therefore the U.S would export capital- intensive goods and import labour-intensive
goods. Leontief found out that the U.S's export was less capital intensive than import.

After the appearance of Leontief's paradox, many researchers tried to save the Heckscher-
Ohlin theory, either by new methods of measurement, or either by new interpretations.
Leamer[3] emphasized that Leontief did not interpret HO theory properly and claimed that
with a right interpretation paradox did not occur. Brecher and Choudri [4] found that, if
Leamer was right, the American workers consumption per head should be lower than the
workers world average consumption.

Many other trials followed but most of them failed.[5][6] Many of famous textbook writers,
including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about
the validity of H-O model.[7][8]. After examining the long history of empirical research,
Bowen, Hollander and Viane concluded: "Recent tests of the factor abundance theory [H-
O theory and its developed form into many-commodity and many-factor case] that
directly examine the H-O-V equations also indicate the rejection of the theory."[8]:321

Heckscher-Ohlin theory is not well adapted to the analyze South-North trade problems.
The assumptions of HO are less realistic with respect to N-S than N-N (or S-S) trade.
Income differences between North and South is the one that third world cares most. The
factor price equalization [a consequence of HO theory] has not shown much sign of
realization. HO model assumes identical production functions between countries. This is
highly unrealistic. Technological gap between developed and developing countries is the
main concern of the poor countries[9].

[edit] Specific factors model


                This section does not cite any references or sources.
                Please help improve this article by adding citations to reliable sources.
                Unsourced material may be challenged and removed. (October 2009)




Current members of the World Trade Organisation.
Global Competitiveness Index (2008-2009): competitiveness is an important determinant
for the well-being of states in an international trade environment.

In this model, labor mobility between industries is possible while capital is immobile
between industries in the short-run. Thus, this model can be interpreted as a 'short run'
version of the Heckscher-Ohlin model. The specific factors name refers to the given that
in the short-run, specific factors of production such as physical capital are not easily
transferable between industries. The theory suggests that if there is an increase in the
price of a good, the owners of the factor of production specific to that good will profit in
real terms.

Additionally, owners of opposing specific factors of production (i.e. labor and capital) are
likely to have opposing agendas when lobbying for controls over immigration of labor.
Conversely, both owners of capital and labor profit in real terms from an increase in the
capital endowment. This model is ideal for particular industries. This model is ideal for
understanding income distribution but awkward for discussing the pattern of trade.

[edit] New Trade Theory

Main article: New Trade Theory

New Trade theory tries to explain several facts about trade, which the two main models
above have difficulty with. These include the fact that most trade is between countries
with similar factor endowment and productivity levels, and the large amount of
multinational production(i.e.foreign direct investment) which exists. In one example of
this framework, the economy exhibits monopolistic competition and increasing returns to
scale. There are three basic theories that global marketer has to comprehend: 1.
Comparative Advantage Theory 2. Trade or product trade cycle theory 3. Business
orientation theory

[edit] Gravity model

Main article: Gravity model of trade

The Gravity model of trade presents a more empirical analysis of trading patterns rather
than the more theoretical models discussed above. The gravity model, in its basic form,
predicts trade based on the distance between countries and the interaction of the
countries' economic sizes. The model mimics the Newtonian law of gravity which also
considers distance and physical size between two objects. The model has been proven to
be empirically strong through econometric analysis. Other factors such as income level,
diplomatic relationships between countries, and trade policies are also included in
expanded versions of the model.




[edit] Ricardian theory of international trade (modern development)

The Ricardian theory of comparative advantage became a basic constituent of
neoclassical trade theory. Any undergraduate course in trade theory includes expansions
of Ricardo's example of four numbers in for form of a two commodity, two country
model.

This model was expanded to many-country and many-commodity cases. Major general
results were obtained by the beginning of 1960's by McKenzie[10] and Jones[11], including
his famous formula. It is a theorem about the possible trade pattern for N-country N-
commoditty cases. Let aij be the labor input coefficent for a country i and for the industry
j (or for the production of good j). If a trade pattern i country specialises in i industry,
then the product

   a11 a22 ... aNN

is strictly smaller than any permutation products of the form
   a1σ(1) a2σ(2) ... aNσ(N)

for any perumutation σ    except the identity permuation which transforms i onto i.




[edit] Contemporary theories

Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch,
Fischer, and Samuelson[12] This formulation is employed for example by Matsuyama [13]
and others. These theoris uses the special property which is applicable only for two
coutry case.

[edit] Neo-Ricardian trade theory

Inspired by Piero Sraffa, a new strand of trade theory emerged and was named neo-
Ricardian trade theory. The main contributors include Ian Steedman (1941-) and Stanley
Metcalfe (1946-). They have criticized neoclassical international trade theory, namely the
Heckscher-Ohlin model on the basis that the notion of capital as primary factor has no
method of measuring it before the determination of profit rate (thus trapped in a logical
vicious circle)[14]. This was a second round of the Cambridge capital controversy, this
time in the field of international trade.[15]

The merit of neo-Ricardian trade theory is that input goods are explicitly included to the
analytical framework. This is in accordance with Sraffa's idea that any commodity is a
product made by means of commodities. The limit of their theory is that the analysis is
limited to small country cases.

[edit] Traded intermediate goods

Ricardian trade theory ordinarily assumes that the labor is the unique input. This is a
great deficiency as trade theory, for the intermediate goods occupy the major part of the
world international trade. Yeats[16] found that 30% of world trade in manufacturing is
intermediate inputs. Bardhan and Jafee[17] found that intermediate inputs occupy 37 to
38% in the imports to the US for years 1992 and 1997, whereas the percentage of
intrafirm trade grew from 43% in 1992 to 52% in 1997.

McKenzie[18] and Jones[19] emphasized the necessity to expand the Ricardian theory to the
cases of traded inputs. In a famous comment McKenzie (1954, p. 179) pointed that "A
moment's consideration will convince one that Lancashire would be unlikely to produce
cotton cloth if the cotton had to be grown in England."[20] Paul Samuelson[21] coined a
term Sraffa bonus to name the gains from trade of inputs.

[edit] Ricardo-Sraffa trade theory

John Chipman observed in his survey that McKenzie stumbled upon the questions of
intermediate products and discovered that "introduction of trade in intermediate product
necessitates a fundamental alteration in classical analysis."[22] It took may years until
recently Y. Shiozawa[23] succeded to remove this deficiency. The Ricardian trade theory
was now constructed in a form to include intermediate input trade for the most general
case of many countries and many goods. This new theory is called Ricardo-Sraffa trade
theory.

It is emphasized that the Ricardian trade theory now provides a general theory which
includes trade of intermediates such as fuel, machine tools, machinery parts and
processed materials. The traded intermediate goods are then used as inputs of productions
in the importing country. Capital goods are nothing other than inputs to the productions.
Thus, in the Ricardo-Sraffa trade theory, capital goods moves freely from country to
country. Labor is the unique factor of production that remains immobile in the country of
its origin.

In a blog post of April 28, 2007, Gregory Mankiw compared Ricardian theory and
Heckscher-Ohlin theory and stood by the Ricardian side[24]. Mankiw argued that
Ricardian theory is more realistic than the Heckscher-Ohlin theory as the latter assumes
that capital does not move from country to country. Mankiw's argument contains a
logical slip, for the traditional Ricardian trade theory does not admit any inputs.
Shiozawa's result saves Mankiw from his slip[25].

The neoclassical Heckscher-Ohlin-Samuelson theory only assumes production factors
and finished goods. It contains no concept of intermediate goods. Therefore, it is the
Ricardo-Sraffa trade theory that provides theoretical bases for the topics such as
outsourcing, fragmentation and intra-firm trade.

[edit] Top trading nations

Main articles: List of countries by exports and List of countries by imports

Rank                    Country                  Exports + Imports             Date of
                                                                         information
-               European Union (Extra-EU27) $3,197,000,000,000           2009 [26]
1               United States                    $2,439,700,000,000      2009 est.
2               People's Republic of China       $2,208,000,000,000      2009 est.
3               Germany                          $2,052,000,000,000      2009 est.
4               Japan                            $1,006,900,000,000      2009 est.
5               France                           $989,000,000,000        2009 est.
6               United Kingdom                   $824,900,000,000        2009 est.
7               Netherlands                      $756,500,000,000        2009 est.

8               Italy                            $727,700,000,000        2009 est.
-               Hong Kong                        $672,600,000,000        2009 est.

9               South Korea                      $668,500,000,000        2009 est.
10              Belgium                          $611,100,000,000        2009 est.
11              Canada                           $603,700,000,000        2009 est.
12              Spain                            $508,900,000,000        2009 est.

13              Russia                           $492,400,000,000        2009 est.
14              Mexico                           $458,200,000,000        2009 est.
15              Singapore                        $454,800,000,000        2009 est.
16              India                            $387,300,000,000        2009 est.

17              Taiwan                           $371,400,000,000        2009 est.

18              Switzerland                      $367,300,000,000        2009 est.

19              Australia                        $322,400,000,000        2009 est.
20              United Arab Emirates             $315,000,000,000        2009 est.


Source : Exports. Imports. The World Factbook.

[edit] Regulation of international trade

Traditionally trade was regulated through bilateral treaties between two nations. For
centuries under the belief in mercantilism most nations had high tariffs and many
restrictions on international trade. In the 19th century, especially in the United Kingdom,
a belief in free trade became paramount.[citation needed] This belief became the dominant
thinking among western nations since then. In the years since the Second World War,
controversial multilateral treaties like the General Agreement on Tariffs and Trade
(GATT) and World Trade Organization have attempted to promote free trade while
creating a globally regulated trade structure. These trade agreements have often resulted
in discontent and protest with claims of unfair trade that is not beneficial to developing
countries.

Free trade is usually most strongly supported by the most economically powerful nations,
though they often engage in selective protectionism for those industries which are
strategically important such as the protective tariffs applied to agriculture by the United
States and Europe.[citation needed] The Netherlands and the United Kingdom were both strong
advocates of free trade when they were economically dominant, today the United States,
the United Kingdom, Australia and Japan are its greatest proponents. However, many
other countries (such as India, China and Russia) are increasingly becoming advocates of
free trade as they become more economically powerful themselves. As tariff levels fall
there is also an increasing willingness to negotiate non tariff measures, including foreign
direct investment, procurement and trade facilitation.[citation needed] The latter looks at the
transaction cost associated with meeting trade and customs procedures.

Traditionally agricultural interests are usually in favour of free trade while manufacturing
sectors often support protectionism. [citation needed]This has changed somewhat in recent
years, however. In fact, agricultural lobbies, particularly in the United States, Europe and
Japan, are chiefly responsible for particular rules in the major international trade treaties
which allow for more protectionist measures in agriculture than for most other goods and
services.

During recessions there is often strong domestic pressure to increase tariffs to protect
domestic industries. This occurred around the world during the Great Depression. Many
economists have attempted to portray tariffs as the underlining reason behind the collapse
in world trade that many believe seriously deepened the depression.

The regulation of international trade is done through the World Trade Organization at the
global level, and through several other regional arrangements such as MERCOSUR in
South America, the North American Free Trade Agreement (NAFTA) between the
United States, Canada and Mexico, and the European Union between 27 independent
states. The 2005 Buenos Aires talks on the planned establishment of the Free Trade Area
of the Americas (FTAA) failed largely because of opposition from the populations of
Latin American nations. Similar agreements such as the Multilateral Agreement on
Investment (MAI) have also failed in recent years.

[edit] Risk in international trade

Companies doing business across international borders face many of the same risks as
would normally be evident in strictly domestic transactions. For example,


          Buyer insolvency (purchaser cannot pay);
          Non-acceptance (buyer rejects goods as different from the agreed upon
           specifications);
          Credit risk (allowing the buyer to take possession of goods prior to payment);
          Regulatory risk (e.g., a change in rules that prevents the transaction);
          Intervention (governmental action to prevent a transaction being completed);
          Political risk (change in leadership interfering with transactions or prices); and
          War and other uncontrollable events.

In addition, international trade also faces the risk of unfavorable exchange rate
movements (and, the potential benefit of favorable movements).[27]

[edit] Gallery
Dual-currency cash
machines in Jersey: as                        Globalisation:
international trade
                       A 1672 painting by Peugeot in Jakarta,       A camel caravan, still
increases, the need to
                       Gérard de Lairesse: Indonesia.               used today for
handle multiple                               International trade
                       allegory of the                              international trade,
currencies is
                       freedom of trade (see coincides with the     especially in Sahara.
becoming more                                 expansion of
                       also: free market).
powerful.
                       International trade is multinational
                       commonly associated corporations.
                       with freedom of trade.




                      Triangle trade: Slaves
                      being sold from
                      Africa to North        Some people do not
A modern camel
caravan carrying      America, sugar from see international trade
                                             favourably: here a
goods across villages South America to
                      New England, and       person protests
and international
borders.              Rum and other goods against the WTO in
                      from North America Jakarta.
                      back to Africa.