MACRO ECONOMICS

1.

Microeconomics and macroeconomics—the two major divisions of

economics—have different objectives to be pursued.
The key microeconomic goals are the efficient use of resources that are
employed and the efficient distribution of output.
These two goals of microeconomics are encapsulated as ‘efficiency’ and
‘equity’.But macroeconomic goals are quite different because the overall
response of the economy must not match with the individual units. As
macroeconomics looks at the whole, its objectives are aggregative in
character. In other words, because of different level of aggregation, these
two branches of economics focuses on different economic objectives.
1. Macroeconomic Policy Objectives:
The macroeconomic policy objectives are the following:
(i) Full employment,
(ii) Price stability,
(iii) Economic growth,
(iv) Balance of payments equilibrium and exchange rate stability, and
(v) Social objectives.
(i) Full employment:
Performance of any government is judged in terms of goals of achieving full
employment and price stability. These two may be called the key indicators
of health of an economy. In other words, modern governments aim at
reducing both unemployment and inflation rates.

Unemployment refers to involuntary idleness of mainly labour force and

other productive resources. Unemployment (of labour) is closely related to
the economy’s aggregate output. Higher the unemployment rate, greater
the divergence between actual aggregate output (or GNP/CDP) and
potential output. So, one of the objectives of macroeconomic policy is to
ensure full employment.
The objective of full employment became uppermost amongst the
policymakers in the era of Great Depression when unemployment rate in all
the countries except the then socialist country, the USSR, rose to a great
height. It may be noted here that a free enterprise capitalist economy
always exhibits full employment.
But, Keynes said that the goal of full employment may be a desirable one
but impossible to achieve. Full employment, thus, does not mean that
nobody is unemployed. Even if 4 or 5 p.c. of the total population remain
unemployed, the country is said to be fully employed. Full employment,
though theoretically conceivable, is difficult to attain in a market-driven
economy. In view of this, full employment objective is often translated into
‘high employment’ objective. This goal is desirable indeed, but ‘how high’
should it be? One author has given an answer in the following way; “The
goal for high employment should therefore be not to seek an unemploy-
ment level of zero, but rather a level of above zero consistent with full
employment at which the demand for labour equals the supply of labour.
This level is called the natural rate of unemployment.”
(ii) Price stability:
No longer the attainment of full employment is considered as a
macroeconomic goal. The emphasis has shifted to price stability. By price
stability we must not mean an unchanging price level over time. Not
necessarily, price increase is unwelcome, particularly if it is restricted
within a reasonable limit. In other words, price fluctuations of a larger
degree are always unwelcome.
However, it is difficult again to define the permissible or reasonable rate of
inflation. But sustained increase in price level as well as a falling price level
produce destabilising effects on the economy. Therefore, one of the
objectives of macroeconomic policy is to ensure (relative) price level
stability. This goal prevents not only economic fluctuations but also helps in
the attainment of a steady growth of an economy.
(iii) Economic growth:
Economic growth in a market economy is never steady. These economies
experience ups and downs in their performance. This objective became
uppermost in the period following the World War II (1939-45). Economists
call such ups and downs in the economic performance as trade cycle/
business cycle. In the short run such fluctuations may exhibit depressions
or prosperity (boom).
One of the important benchmarks to measure the performance of an
economy is the rate of increase in output over a period of time. There are
three major’ sources of economic growth, viz. (i) the growth of the labour
force, (ii) capital formation, and (iii) technological progress. A country
seeks to achieve higher economic growth over a long period so that the
standards of living or the quality of life of people, on an average, improve. It
may be noted here that while talking about higher economic growth, we
take into account general, social and environmental factors so that the
needs of people of both present generations and future generations can be
met.
However, promotion of higher economic growth is often hampered by short
run fluctuations in aggregate output. In other words, one finds a conflict
between the objectives of economic growth and economic stability (in
prices). In view of this conflict, it is said that macroeconomic policy should
promote economic growth with reasonable price stability.
(iv) Balance of payments equilibrium and exchange rate
stability:
From a macroeconomic point of view, one can show that an international
transaction differs from domestic transaction in terms of (foreign) currency
exchange. Over a period of time, all countries aim at balanced flow of
goods, services and assets into and out of the country. Whenever this
happens, total international monetary reserves are viewed as stable.

If a country’s exports exceed imports, it then experiences a balance of

payments surplus or accumulation of reserves, like gold and foreign
currency. When the country loses reserves, it experiences balance of
payments deficit (or imports exceed exports). However, depletion of
reserves reflects the unhealthy performance of an economy and thus creates
various problems. That is why every country aims at building substantial
volume of foreign exchange reserves.
Anyway, the accumulation of foreign exchange reserves is largely
conditioned by the exchange rate the rate at which one currency is
exchanged for another currency to carry out international transactions. The
foreign exchange rate should be stable as far as possible. This is what one
may call it external stability in price.
External instability in prices hampers the smooth flow of goods and
services between nations. It also erodes the confidence of currency.
However, maintenance of external stability is no longer considered as the
macroeconomic policy objective as well as macroeconomic policy
instrument.
It is, however, because of growing interconnectedness and interdependence
between different nations in the globalised world, the task of fulfilling this
macroeconomic policy objective has become more problematic.
(v) Social objectives:

The list of objectives that we have referred here is by no means an

exhaustive one; one can add more in the list. Even then we have
incorporated the major ones.
Macroeconomic policy is also used to attain some social ends or social
welfare. This means that income distribution needs to be more fair and
equitable. In a capitalist market-based society some people get more than
others. In order to ensure social justice, policymakers use macroeconomic
policy instruments.
We can add another social objective in our list. This is the goal of economic
freedom. This is characterised by the right of taking economic decisions by
any individual (rich or poor, high caste or low caste).
2. Macroeconomic Policy Instruments:
As our macroeconomic goals are not typically confined to “full
employment”, “price stability”, “rapid growth”, “BOP equilibrium and
stability in foreign exchange rate”, so our macroeconomic policy
instruments include monetary policy, fiscal policy, income policy in a
narrow sense. But, in a broder sense, these instruments should include
policies relating to labour, tariff, agriculture, anti-monopoly and other
relevant ones that influence the macroeconomic goals of a country.
Confining our attention in a restricted way we intend to consider two types
of policy instruments the two “giants of the industry” monetary (credit)
policy and fiscal (budgetary) policy. These two policies are employed
toward altering aggregate demand so as to bring about a change in
aggregate output (GNP/GDP) and prices, wages and interest rates, etc.,
throughout the economy.

2.

The business cycle is the irregular and nonrepeating upand-down

movement of business activity. The average recession lasts a bit more
than one year, and GDP falls 6 percent from peak to trough. The average
expansion lasts almost four years, and GDP rises 22 percent from trough
to peak.

♦ Some cycles (e.g., tennis matches) require impulses to start each cycle.

♦ Some cycles (e.g., sunrise and sunset) reflect the design of the system.

♦ Some cycles (e.g., rocking horses) combine impulses and design.

Investment and capital accumulation play key roles in the business cycle.
Recessions occur when investment decreases; expansions occur when
investment increases. Business cycles can be classified as aggregate
demand theories and real business cycle theory.

︎ Aggregate Demand Theories of the Business Cycle

The Keynesian theory of the business cycle regards volatile expectations

as the main source of economic fluctuations.

♦ The Keynesian impulse is changes in firms’ expectations about future

sales and profits. This change affects investment.

♦ The Keynesian mechanism has two aspects. First, a change in

investment has a multiplier effect on aggregate demand. Second, the
short-run aggregate supply curve is horizontal, so, as illustrated in Figure
14.1, shifts in the AD curve have a large effect on GDP.

♦ The response of money wages is asymmetric; wages do not fall in

response to decreases in aggregate demand but they do rise in response
to increases in aggregate demand. Hence the economy can remain stuck
in a recession.

The monetarist theory of the business cycle regards fluctuations in the

money stock as the main source of economic fluctuation.

♦ The impulse in the monetarist theory is changes in the growth rate of

the quantity of money.

♦ The monetarist mechanism is changes in the growth rate of the quantity

of money that shift the AD curve. The economy moves along an
upwardsloping SAS curve, as is illustrated in Figure 14.2, for a decline in
the monetary growth rate. Aggregate demand decreases from AD0 to AD1.

♦ Eventually, money wages respond to the change in the price level so

that the SAS curve shifts and the economy returns to potential GDP.

A rational expectation is a forecast based on all available information.

Rational expectations theories of business cycles focus on the rationally
expected money wage rate. The two rational expectations theories are the
new classical theory and new Keynesian theory.

♦ The impulse in the new classical theory is unanticipated changes in

aggregate demand.

♦ The major impulse in the new Keynesian theory is unanticipated

changes in aggregate demand, but anticipated changes also play a role.

♦ The rational expectations mechanism is an unexpected shift in the AD

curve that moves the economy along its SAS curve as real wage rates
change. The recession ends when aggregate demand increases back to
expected aggregate demand.

The new classical theory asserts that only unexpected changes in

aggregate demand affect real wage rates and GDP.

The new Keynesian theory asserts that labor contracts allow money wages
to change only slowly. A change in aggregate demand that was
unanticipated when the labor contract was signed will affect real wages
and GDP even if, when the event actually occurs, it has come to be
anticipated.

Real Business Cycle Theory

The real business cycle theory (RBC) regards random fluctuations in

productivity as the main source of economic fluctuations.

♦ The impulse in RBC theory is technological changes that affect the

growth rate of productivity.

♦ The RBC mechanism is a change in productivity that affects investment

demand and labor demand. During a recession, both decrease. The
decrease in investment demand lowers the real interest rate, so the
intertemporal substitution effect decreases the supply of labor. As
illustrated in Figure 14.3, the LAS curve shifts leftward and employment
decreases. The AD curve shifts leftward because of the decrease in
investment. GDP decreases and the price level falls.

3.

The Wholesale Price Index (WPI) is the price of a representative basket of

wholesale goods. Some countries (like the Philippines) use WPI changes
as a central measure of inflation. But now India has adopted new CPI to
measure inflation. However, United States now report a producer price
index instead.
It also influences stock and fixed price markets. The WPI is published by
the Economic Adviser in the Ministry of Commerce and Industry.The
Wholesale Price Index focuses on the price of goods traded between
corporations, rather than the goods bought by consumers, which is
measured by the Consumer Price Index. The purpose of the WPI is to
monitor price movements that reflect supply and demand in industry,
manufacturing and construction. This helps in analyzing both
macroeconomic and microeconomic conditions.The wholesale price index
(WPI) is based on the wholesale price of a few relevant commodities of
over 240 commodities available. The commodities chosen for the
calculation are based on their importance in the region and the point of time
the WPI is employed. For example in India about 435 items were used for
calculating the WPI in base year 1993-94 while the advanced base year
2011-12 uses 697 items.[1]. Currently the base year has been revised from
2004-05 to 2011-12 by the Office of Economic Advisor(OEA), Department
for promotion of industry and internal trade Ministry of Commerce and
Industry to align it with the base year of other macro economic indicators
like the Gross Domestic Product (GDP)and Index of Industrial Production
(IIP).[2]
Under primary article group of the new WPI there are 117 items against
earlier 98, while fuel and power category remains static at 16. In the new
series, there are 564 items of manufactured products compared to 318
items earlier.
The indicator tracks the price movement of each commodity individually.
Based on this individual movement, the WPI is determined through the
averaging principle. The following methods are used to compute the WPI:
The Laspeyres Formula is the weighted arithmetic mean based on the fixed
value-based weights for the base period.
The Ten-Day Price Index is a procedure under which, “sample prices” with
high intra-month fluctuations are selected and surveyed every ten days by
phone. Utilizing the data retrieved by this procedure, and with the
assumption that other non-surveyed “sample prices” remain unchanged, a
“ten-day price index” is compiled and released.
Monthly price indexes are compiled by calculating the simple arithmetic
mean of three ten-day “sample prices” in the month.
Wholesale price indexes (WPIs) report monthly to show the average price
changes of goods. They then compare the total costs of the goods being
considered in one year with the total costs of goods in the base year. The
total prices for the base year are equal to 100 on the scale. Prices from
another year are compared to that total and expressed as a percentage of
change.

To illustrate, imagine 2013 is the base year. If the total price of the goods
under consideration in 2013 was $4,300, and the total for 2018 is $5,000,
the WPI for 2018 with a base year of 2013 is 116 [5000- 4300 = 700/6
years], indicating an increase of 16 percent.
A WPI typically takes into account commodity prices, but the products
included vary from country to country, and they are subject to change as
needed to better reflect the current economy. Some small countries only
compare the prices of 100 to 200 products, while large industrial countries
like the United Kingdom and the United States tend to include thousands of
products in their WPIs.

The United States includes commodities at various stages of production,

and as a result, many items are counted more than once. For example, the
index includes cotton prices for raw cotton, cotton yarn, cotton gray goods
and cotton clothing. In addition, the United States also includes crude
materials, consumer goods, fruit, grains and apples, and it creates indexes
for nearly 100 subgroups.
The Wholesale Price Index Versus the Producer Price Index
The United States first began measuring its economy with a wholesale
price index in 1902. But in 1978, it changed the name of the measured
index to PPI. Based on data collected by the Bureau of Labor Statistics, the
PPI relies on the same calculation formula as the WPI, but it includes the
prices of services as well as physical goods and eliminates the component
of indirect taxes from prices.

The PPI also actually consists of three indexes, covering different stages of
production – industry-based, commodity-based and commodity-based final
demand-intermediate demand. The use of all three helps minimize the bias
toward double-counting that is inherent in the WPI, which doesn't always
segregate intermediate and final products.

4.
1)

The Wholesale Price Index Versus the Producer Price Index

The United States first began measuring its economy with a wholesale
price index in 1902. But in 1978, it changed the name of the measured
index to PPI. Based on data collected by the Bureau of Labor Statistics, the
PPI relies on the same calculation formula as the WPI, but it includes the
prices of services as well as physical goods and eliminates the component
of indirect taxes from prices.

The PPI also actually consists of three indexes, covering different stages of
production – industry-based, commodity-based and commodity-based final
demand-intermediate demand. The use of all three helps minimize the bias
toward double-counting that is inherent in the WPI, which doesn't always
segregate intermediate and final products.

Understanding Marginal Propensity To Consume (MPC)

The marginal propensity to consume is equal to ΔC / ΔY, where ΔC is the
change in consumption, and ΔY is the change in income. If consumption
increases by 80 cents for each additional dollar of income, then MPC is
equal to 0.8 / 1 = 0.8.

Suppose you receive a $500 bonus on top of your normal annual earnings.
You suddenly have $500 more in income than you did before. If you decide
to spend $400 of this marginal increase in income on a new suit and save
the remaining $100, your marginal propensity to consume will be 0.8 ($400
divided by $500).

The other side of marginal propensity to consume is marginal propensity to

save, which shows how much a change in income affects levels of saving.
Marginal propensity to consume + marginal propensity to save = 1. In the
suit example, your marginal propensity to save will be 0.2 ($100 divided by
$500).

If you decide to save the entire $500, your marginal propensity to consume
will be 0 ($0 divided by 500), and your marginal propensity to save will be 1
($500 divided by 500).

MPC and Economic Policy

Given data on household income and household spending, economists can
calculate households’ MPC by income level. This calculation is important
because MPC is not constant; it varies by income level. Typically, the
higher the income, the lower the MPC because as income increases more
of a persons wants and needs become satisfied; as a result, they save
more instead. At low-income levels, MPC tends to be much higher as most
or all of the person's income must be devoted to subsistence consumption.

According to Keynesian theory, an increase in investment or government

spending increases consumers’ income, and they will then spend more. If
we know what their marginal propensity to consume is, then we can
calculate how much an increase in production will affect spending. This
additional spending will generate additional production, creating a
continuous cycle via a process known as the Keynesian multiplier. The
larger the proportion of the additional income that gets devoted to spending
rather than saving, the greater the greater the effect. The higher the MPC,
the higher the multiplier—the more the increase in consumption from the
increase in investment; so, if economist can estimate the MPC, then they
can use it to estimate the total impact of a prospective increase in incomes.
2)

A central bank is a financial institution given privileged control over the

production and distribution of money and credit for a nation or a group of
nations. In modern economies, the central bank is usually responsible for
the formulation of monetary policy and the regulation of member banks.

Central banks are inherently non-market-based or even anticompetitive

institutions. Although some are nationalized, many central banks are not
government agencies, and so are often touted as being politically
independent. However, even if a central bank is not legally owned by the
government, its privileges are established and protected by law.

The critical feature of a central bank—distinguishing it from other banks—is

its legal monopoly status, which gives it the privilege to issue bank notes
and cash. Private commercial banks are only permitted to issue demand
liabilities, such as checking deposits.

How a Central Bank Works

Although their responsibilities range widely, depending on their country,
central banks' duties (and the justification for their existence) usually fall
into three areas. 

First, central banks control and manipulate the national money supply:
issuing currency and setting interest rates on loans and bonds. Typically,
central banks raise interest rates to slow growth and avoid inflation; they
lower them to spur growth, industrial activity, and consumer spending. In
this way, they manage monetary policy to guide the country's economy and
achieve economic goals, such as full employment.

Second, they regulate member banks through capital requirements,

reserve requirements (which dictate how much banks can lend to
customers, and how much cash they must keep on hand), and deposit
guarantees, among other tools. They also provide loans and services for a
nation’s banks and its government and manage foreign exchange reserves.

Finally, a central bank also acts as an emergency lender to distressed

commercial banks and other institutions, and sometimes even a
government. By purchasing government debt obligations, for example, the
central bank provides a politically attractive alternative to taxation when a
government needs to increase revenue.
Central Banks and the Economy
Along with the measures mentioned above, central banks have other
actions at their disposal. In the U.S., for example, the central bank is the
Federal Reserve System, aka the Fed. The Federal Reserve Board, the
governing body of the Fed, can affect the national money supply by
changing reserve requirements. When the requirement minimums fall,
banks can lend more money, and the economy’s money supply climbs. In
contrast, raising reserve requirements decreases the money supply.

When the Fed lowers the discount rate that banks pay on short-term loans,
it also increases liquidity. Lower rates increase the money supply, which in
turn boosts economic activity. But decreasing interest rates can fuel
inflation, so the Fed must be careful.

And the Fed can conduct open market operations to change the federal
funds rate. The Fed buys government securities from securities dealers,
supplying them with cash, thereby increasing the money supply. The Fed
sells securities to move the cash into its pockets and out of the system.

History of Central Banks

The first prototypes for modern central banks were the Bank of England
and the Swedish Riksbank, which date back to the 17th century. The Bank
of England was the first to acknowledge the role of lender of last resort.
Other early central banks, notably Napoleon’s Bank of France and
Germany's Reichsbank, were established to finance expensive government
military operations.
It was principally because European central banks made it easier for
federal governments to grow, wage war, and enrich special interests that
many of United States' founding fathers—most passionately Thomas
Jefferson—opposed establishing such an entity in their new country.
Despite these objections, the young country did have both official national
banks and numerous state-chartered banks for the first decades of its
existence, until a “free-banking period” was established between 1837 and
1863.
The National Banking Act of 1863 created a network of national banks and
a single U.S. currency, with New York as the central reserve city. The
United States subsequently experienced a series of bank panics in 1873,
1884, 1893, and 1907. In response, in 1913 the U.S. Congress established
the Federal Reserve System and 12 regional Federal Reserve Banks
throughout the country to stabilize financial activity and banking operations.
The new Fed helped finance World War I and World War II by issuing
Treasury bonds.

Central Banks and Deflation

Over the past quarter-century, concerns about deflation have spiked after
big financial crises. Japan has offered a sobering example. After its equities
and real estate bubbles burst in 1989-90, causing the Nikkei index to lose
one-third of its value within a year, deflation became entrenched. The
Japanese economy, which had been one of the fastest-growing in the world
from the 1960s to the 1980s, slowed dramatically. The '90s became known
as Japan's Lost Decade. In 2013, Japan's nominal GDP was still about
6% below its level in the mid-1990s.

The Great Recession of 2008-09 sparked fears of a similar period of

prolonged deflation in the United States and elsewhere because of the
catastrophic collapse in prices of a wide range of assets. The global
financial system was also thrown into turmoil by the insolvency of a number
of major banks and financial institutions throughout the United States and
Europe, exemplified by the collapse of Lehman Brothers in September
2008.

The Federal Reserve's Approach

In response, in December 2008, the Federal Open Market Committee
(FOMC), the Federal Reserve's monetary policy body, turned to two main
types of unconventional monetary policy tools: (1) forward policy guidance
and (2) large-scale asset purchases, aka quantitative easing (QE).

The former involved cutting the target federal funds rate essentially to zero
and keeping it there at least through mid-2013. But it's the other tool,
quantitative easing, that has hogged the headlines and become
synonymous with the Fed's easy-money policies. QE essentially involves a
central bank creating new money and using it to buy securities from the
nation's banks so as to pump liquidity into the economy and drive down
long-term interest rates. In this case, it allowed the Fed to purchase riskier
assets, including mortgage-backed securities and other non-government
debt.

This ripples through to other interest rates across the economy and the
broad decline in interest rates stimulate demand for loans from consumers
and businesses. Banks are able to meet this higher demand for loans
because of the funds they have received from the central bank in exchange
for their securities holdings.

Other Deflation-Fighting Measures

In January 2015, the European Central Bank (ECB) embarked on its own
version of QE, by pledging to buy at least 1.1 trillion euros' worth of bonds,
at a monthly pace of 60 billion euros, through to September 2016. The ECB
launched its QE program six years after the Federal Reserve did so, in a
bid to support the fragile recovery in Europe and ward off deflation, after its
unprecedented move to cut the benchmark lending rate below 0% in
late-2014 met with only limited success.

While the ECB was the first major central bank to experiment with negative
interest rates, a number of central banks in Europe, including those of
Sweden, Denmark, and Switzerland, have pushed their benchmark interest
rates below the zero bound.

Results of Deflation-Fighting Efforts

The measures taken by central banks seem to be winning the battle
against deflation, but it is too early to tell if they have won the war.
Meanwhile, the concerted moves to fend off deflation globally have had
some strange consequences: 

• QE could lead to a covert currency war: QE programs have led to

major currencies plunging across the board against the U.S. dollar.
With most nations having exhausted almost all their options to
stimulate growth, currency depreciation may be the only tool
remaining to boost economic growth, which could lead to a covert
currency war.
• European bond yields have turned negative: More than a quarter of
debt issued by European governments, or an estimated $1.5 trillion,
currently has negative yields. This may be a result of the ECB's bond-
buying program, but it could also be signaling a sharp economic
slowdown in the future.
• Central bank balance sheets are bloating: Large-scale asset
purchases by the Federal Reserve, Bank of Japan, and the ECB are
swelling balance sheets to record levels. Shrinking these central bank
balance sheets may have negative consequences down the road.

In Japan and Europe, the central bank purchases included more than
various non-government debt securities. These two banks actively engaged
in direct purchases of corporate stock in order to prop up equity markets,
making the BoJ the largest equity holder of a number companies including
Kikkoman, the largest soy-sauce producer in the country, indirectly via
large positions in exchange traded funds (ETFs).

5.

Macroeconomics is a branch of economics that studies how an overall

economy—the market systems that operate on a large scale—behaves.
Macroeconomics studies economy-wide phenomena such as inflation,
price levels, rate of economic growth, national income, gross domestic
product (GDP), and changes in unemployment.
Some of the key questions addressed by macroeconomics include: What
causes unemployment? What causes inflation? What creates or stimulates
economic growth? Macroeconomics attempts to measure how well an
economy is performing, to understand what forces drive it, and to project
how performance can improve.

Macroeconomics deals with the performance, structure, and behavior of the

entire economy, in contrast to microeconomics, which is more focused on
the choices made by individual actors in the economy ((like people,
households, industries, etc.).

Understanding Macroeconomics
There are two sides to the study of economics: macroeconomics and
microeconomics. As the term implies, macroeconomics looks at the overall,
big-picture scenario of the economy. Put simply, it focuses on the way the
economy performs as a whole and then analyzes how different sectors of
the economy relate to one another to understand how the aggregate
functions. This includes looking at variables like unemployment, GDP, and
inflation. Macroeconomists develop models explaining relationships
between these factors. Such macroeconomic models, and the forecasts
they produce, are used by government entities to aid in the construction
and evaluation of economic, monetary and fiscal policy; by businesses to
set strategy in domestic and global markets; and by investors to predict and
plan for movements in various asset classes.

Given the enormous scale of government budgets and the impact of

economic policy on consumers and businesses, macroeconomics clearly
concerns itself with significant issues. Properly applied, economic theories
can offer illuminating insights on how economies function and the long-term
consequences of particular policies and decisions. Macroeconomic theory
can also help individual businesses and investors make better decisions
through a more thorough understanding of what motivates ot, andarties and
how to best maximize utility and scarce resources.

Limits of Macroeconomics
It is also important to understand the limitations of economic theory.
Theories are often created in a vacuum and lack certain real-world details
like taxation, regulation and transaction costs. The real world is also
decidedly complicated and their matters of social preference and
conscience that do not lend themselves to mathematical analysis.

Even with the limits of economic theory, it is important and worthwhile to

follow the major macroeconomic indicators like GDP, inflation and
unemployment. The performance of companies, and by extension their
stocks, is significantly influenced by the economic conditions in which the
companies operate and the study of macroeconomic statistics can help an
investor make better decisions and spot turning points.

Likewise, it can be invaluable to understand which theories are in favor and

influencing a particular government administration. The underlying
economic principles of a government will say much about how that
government will approach taxation, regulation, government spending, and
similar policies. By better understanding economics and the ramifications of
economic decisions, investors can get at least a glimpse of the probable
future and act accordingly with confidence.Areas of Macroeconomic
Research
Macroeconomics is a rather broad field, but two specific areas of research
are representative of this discipline. The first area is the factors that
determine long-term economic growth, or increases in the national income.
The other involves the causes and consequences of short-term fluctuations
in national income and employment, also known as the business cycle.

Economic Growth

Economic growth refers to an increase in aggregate production in an

economy. Macroeconomists try to understand the factors that either
promote or retard economic growth in order to support economic policies
that will support development, progress, and rising living standards.

Adam Smith's classic 18th-century work, An Inquiry into the Nature and
Causes of the Wealth of Nations, which advocated free trade, laissez-faire
economic policy, and expanding the division of labor, was arguably the first,
and cetainly one of the seminal works in this body of research. By the 20th
century, macroeconomists began to study growth with more formal
mathematical models. Growth is commonly modeled as a function of
physical capital, human capital, labor force, and technology.

Business Cycles

Superimposed over long term macroeconomic growth trends, the levels

and rates-of-change of major macroeconomic variables such as
employment and national output go through occasional fluctuations up or
down, expansions and recessions, in a phenomenon known as the
business cycle. The 2008 financial crisis is a clear recent example, and the
Great Depression of the 1930s was actually the impetus for the
development of most modern macroeconomic theory.

History of Macroeconomics
While the term "macroeconomics" is not all that old (going back to Ragnar
Frisch in 1933), many of the core concepts in macroeconomics have been
the focus of study for much longer. Topics like unemployment, prices,
growth, and trade have concerned economists almost from the very
beginning of the discipline, though their study has become much more
focused and specialized through the 1990s and 2000s. elements of earlier
work from the likes of Adam Smith and John Stuart Mill clearly addressed
issues that would now be recognized as the domain of macroeconomics.

Macroeconomics, as it is in its modern form, is often defined as starting

with John Maynard Keynes and the publication of his book The General
Theory of Employment, Interest and Money in 1936. Keynes offered an
explanation for the fallout from the Great Depression, when goods
remained unsold and workers unemployed. Keynes's theory attempted to
explain why markets may not clear.

Prior to the popularization of Keynes' theories, economists did not generally

differentiate between micro- and macroeconomics. The same
microeconomic laws of supply and demand that operate in individual goods
markets were understood to interact between individuals markets to bring
the economy into a general equilibrium, as described by Leon Walras. The
link between goods markets and large-scale financial variables such as
price levels and interest rates was explained through the unique role that
money plays in the economy as a medium of exchange by economists
such as Knut Wicksell, Irving Fisher, and Ludwig von Mises.

Throughout the 20th century, Keynesian economics, as Keynes' theories

became known, diverged into several other schools of thought.

Macroeconomic Schools of Thought

The field of macroeconomics is organized into many different schools of
thought, with differing views on how the markets and their participants
operate.

Classical

Classical economists hold that prices, wages, and rates are flexible and
markets always clear, building on Adam Smith's original theories.
Keynesian 

Keynesian economics was largely founded on the basis of the works of
John Maynard Keynes. Keynesians focus on aggregate demand as the
principal factor in issues like unemployment and the business cycle.
Keynesian economists believe that the business cycle can be managed by
active government intervention through fiscal policy (spending more in
recessions to stimulate demand) and monetary policy (stimulating demand
with lower rates). Keynesian economists also believe that there are certain
rigidities in the system, particularly sticky prices and prices, that prevent the
proper clearing of supply and demand.
Monetarist
The Monetarist school is largely credited to the works of Milton Friedman.
Monetarist economists believe that the role of government is to control
inflation by controlling the money supply. Monetarists believe that markets
are typically clear and that participants have rational expectations.
Monetarists reject the Keynesian notion that governments can "manage"
demand and that attempts to do so are destabilizing and likely to lead to
inflation.
New Keynesian
The New Keynesian school attempts to add microeconomic foundations to
traditional Keynesian economic theories. While New Keynesians do accept
that households and firms operate on the basis of rational expectations,
they still maintain that there are a variety of market failures, including sticky
prices and wages. Because of this "stickiness", the government can
improve macroeconomic conditions through fiscal and monetary policy.
Neoclassical

Neoclassical economics assumes that people have rational expectations
and strive to maximize their utility. This school presumes that people act
independently on the basis of all the information they can attain. The idea
of marginalism and maximizing marginal utility is attributed to the
neoclassical school, as well as the notion that economic agents act on the
basis of rational expectations. Since neoclassical economists believe the
market is always in equilibrium, macroeconomics focuses on the growth of
supply factors and the influence of money supply on price levels.
New Classical
The New Classical school is built largely on the Neoclassical school. The
New Classical school emphasizes the importance of microeconomics and
models based on that behavior. New Classical economists assume that all
agents try to maximize their utility and have rational expectations. They
also believe that the market clears at all times. New Classical economists
believe that unemployment is largely voluntary and that discretionary fiscal
policy is destabilizing, while inflation can be controlled with monetary policy.
Austrian
The Austrian School is an older school of economics that is seeing some
resurgence in popularity. Austrian school economists believe that human
behavior is too idiosyncratic to model accurately with mathematics and that
minimal government intervention is best. The Austrian school has
contributed useful theories and explanations on the business cycle,
implications of capital intensity, and the importance of time and opportunity
costs in determining consumption and value.

Macroeconomics vs. Microeconomics

Macroeconomics differs from microeconomics, which focuses on smaller
factors that affect choices made by individuals and companies. Factors
studied in both microeconomics and macroeconomics typically have an
influence on one another. For example, the unemployment level in the
economy as a whole has an effect on the supply of workers from which a
company can hire.

A key distinction between micro and macroeconomics is that

macroeconomic aggregates can sometimes behave in ways that are very
different or even the opposite of the way that analogous microeconomic
variables do. For example, Keynes proposed the so-called Paradox of
Thrift, which argues that while for an individual, saving money may be the
key building wealth, when everyone tries to increase their savings at once it
can contribute to a slowdown in the economy and less wealth in the
aggregate.

Meanwhile, microeconomics looks at economic tendencies, or what can

happen when individuals make certain choices. Individuals are typically
classified into subgroups, such as buyers, sellers, and business owners.
These actors interact with each other according to the laws of supply and
demand for resources, using money and interest rates as pricing
mechanisms for coordination.

6.
1)

The recent Asian financial crisis has raised a series of questions about the
efficacy and sustainability of the so-called East Asian model of economic
development. Many have questioned whether the model could be
considered valid for other developing countries to follow in pursuit of
economic development. In fact, some have suggested that the Asian crisis
not only signifies “the end of the Asian mir- acle,” but also signals the failure
of the East Asian model.
The debate on the validity of the model is not that simple, however. For
instance, South Korea and Taiwan are known to have followed the model
for their successful economic development efforts. This model of state-
directed capitalism seemed to combine the dynamic aspects of a market-
oriented economy with the advantages of centralized government planning
and direction. The model has beencredited for transforming East Asian
countries into an export powerhouse and for producing spectacular
economic growth. While South Korea, along with other Southeast Asian
countries, was hard hit by the crisis of 1997 to 1998, Taiwan has not only
avoided the Asian financial contagion, but has also continued to grow at a
respectable rate. Is the model itself in crisis or are there other explanations
for the varying outcomes of the East Asian model as followed by South
Korea, Taiwan, and other Southeast Asian countries? The common
economic success as well as the common financial crisis in recent years
has led many to presume the existence of a single model of economic
development for the economies in East Asia. This is implicit in most of
discussions concerning the underlying reasons for the economic rise and
fall of East Asia.
The main purpose of this paper is to examine the debate on the East Asian
model of economic development in light of the different approaches
undertaken by different groups of countries (economies) in Northeast Asia
and Southeast Asia. The paper is organized as follows. We first review, in
Section II, some of the common elements that are believed to be
responsible for the Asian financial cri- sis, which has opened the debate on
the East Asian model for development. Section III examines the old
paradigms for development—one emphasizing mar- kets and the other
government planning—before discussing the common elements
responsible for the rise of the East Asian economies. In Section IV we
argue that there is no such thing as a single East Asian model of economic
development. Even South Korea and Taiwan, two prime examples of the
stylized East Asian model of development, have employed different
developmental strategies, result- ing in different outcomes. Section V
examines some of the similarities as well as differences in development
strategies across the economies in Northeast Asia and those in Southeast
Asia. The similarities and differences will be noted in terms of the role of
government and industrial policy, attitudes, and policies towards FDI and
technology transfer, and policies for export-led growth. Section VI
concludes the paper with a discussion of the applicability of East Asia’s
development experiences to other developing countries.

The East Asian model (sometimes known as state-sponsored

capitalism)[1] is an economic system where the government invests in
certain sectors of the economy in order to stimulate the growth of new (or
specific) industries in the private sector. It generally refers to the model of
development pursued in East Asian economies such as Hong Kong,
Macau, Japan, South Korea and Taiwan.[2] It has also been used to classify
the contemporary economic system in Mainland China since the Deng
Xiaoping's economic reforms during the late 1970s.[3]
Key aspects of the East Asian model include state control of finance, direct
support for state-owned enterprises in strategic sectors of the economy or
the creation of privately owned national champions, high dependence on
the export market for growth and a high rate of savings. It is similar to
dirigisme.
This economic system differs from a centrally planned economy, where the
national government would mobilize its own resources to create the needed
industries which would themselves end up being state-owned and
operated. East Asian model of capitalism refers to the high rate of savings
and investments, high educational standards, assiduity and export-oriented
policy.

The East Asian Meltdown: Some Common Elements

The reversal of foreign capital, combined with the flight of domestic funds,
caused massive depreciation of the Asian 5’s currencies: the Indonesian
rupiah by 75 percent, the Malaysian ringgit and the Philippines peso by 40
percent, and the Thai baht and Korean won by almost 50 percent. These
crashes in currency were soon followed by dramatic falls in the stock
market in these countries as well as in Hong Kong and Singapore,
eventually leading these “miracle economies” into the “Asian meltdown.”
Government officials, business executives, and academi- cians pondered
what went wrong in East and Southeast Asia. The miracle economies in the
region were contracting much faster than anyone had anticipat- ed.
Hundreds and thousands of business firms went bankrupt, including some
big chaebols in Korea. Unemployment soared in a country where lifetime
employ- ment was a norm. How could this happen to the miracle
economies? Does this mean the end of the East Asian miracle?
The seeds of the 1997 to 1998 Asian financial crisis were sown during the
previous decades when East and Southeast Asian countries were
experiencing unprecedented economic growth, which has transformed their
economies. Although there have been and remain important differences
between individual countries, the Asian 5 shared a number of common
elements, all contributing directly or indirectly to the crisis. They include a
credit-fueled investment boom, a weak and unsound banking sector and
financial system, a pegged exchange rate regime, current account deficits,
and loss in investor confidence.
Credit-Fueled Investment Boom
During the 1990s, GDP growth in the region exceeded 5 percent per
annum and often was closer to 10 percent. Such strong economic growth,
and the expectation that the growth would continue, led to an enormous
increase in investment. The investment shares in GDP in most Asian
countries increased substantially between 1988 and 1996. Between 1990
and 1996, for instance, gross domestic investment grew by over 16 percent
per year in Indonesia, 16 percent in Malaysia, 15.3 per- cent in Thailand,
and 7.2 percent in Korea, while investment grew only by 4.1 per- cent in the
U.S. and by .8 percent in all other high-income countries (World Bank1997,
table 11). Much of this unprecedented growth in investment in these Asian
countries was financed by bank credit, and was concentrated either in
areas with highly volatile returns, such as stocks and real estate, or in
areas where substan- tial capacity already existed, thus leading to over-
expansion and excess capacity.
Inefficient Bank-Centered Financial Systems
One of the elements shared by the Asian 5 has been the weakness of their
bank- centered financial systems. The banks in these countries simply
failed to develop appropriate procedures for evaluating risks when
extending loans. There was little incentive to develop such procedures
because the bank managers were sub- ject to direction by the government
authorities, and they expected the government to support their borrowers.
The government-directed, discretionary policy of cred- it allocation for rapid
economic growth may have achieved its goal, but the finan- cial institutions,
including commercial banks, became simply a “silent partner” in the
process of economic development. Financial repression, characteristic of
the East Asian model for development, has been responsible for the
unsound, weak, and inefficient financial systems in these countries. The
surveillance of bank operations was lacking, and prudent regulation of the
banking system was lax, resulting in inadequate bank capital relative to the
risky bank loans. In addition, banks did not have adequate capacity for
project evaluation in lending practices, especially in the aftermath of
increased financial liberalization in these countries. As a result, when
economic conditions abruptly worsened, the quality of the bank assets
deteriorated quickly, producing non-performing loans.

2)

In the United States, antitrust law is a collection of federal and state

government laws that regulates the conduct and organization of business
corporations, generally to promote competition for the benefit of
consumers. (The concept is called competition law in other English-
speaking countries.) The main statutes are the Sherman Act of 1890, the
Clayton Act of 1914 and the Federal Trade Commission Act of 1914. These
Acts serve three major functions. First, Section 1 of the Sherman Act
prohibits price-fixing and the operation of cartels, and prohibits other
collusive practices that unreasonably restrain trade. Second, Section 7 of
the Clayton Act restricts the mergers and acquisitions of organizations that
would likely substantially lessen competition. Third, Section 2 of the
Sherman Act prohibits the abuse of monopoly power.[2]
The Federal Trade Commission, the U.S. Department of Justice, state
governments and private parties who are sufficiently affected may all bring
actions in the courts to enforce the antitrust laws. The scope of antitrust
laws, and the degree to which they should interfere in an enterprise's
freedom to conduct business, or to protect smaller businesses,
communities and consumers, are strongly debated. One view, mostly
closely associated with the "Chicago School of economics" suggests that
antitrust laws should focus solely on the benefits to consumers and overall
efficiency, while a broad range of legal and economic theory sees the role
of antitrust laws as also controlling economic power in the public interest.
Cartels and collusion[edit]
Preventing collusion and cartels that act in restraint of trade is an essential
task of antitrust law. It reflects the view that each business has a duty to act
independently on the market, and so earn its profits solely by providing
better priced and quality products than its competitors. The Sherman Act §1
prohibits "[e]very contract, combination in the form of trust or otherwise, or
conspiracy, in restraint of trade or commerce."[14] This targets two or more
distinct enterprises acting together in a way that harms third parties. It does
not capture the decisions of a single enterprise, or a single economic entity,
even though the form of an entity may be two or more separate legal
persons or companies. In Copperweld Corp. v. Independence Tube Corp.[15]
it was held an agreement between a parent company and a wholly owned
subsidiary could not be subject to antitrust law, because the decision took
place within a single economic entity.[16] This reflects the view that if the
enterprise (as an economic entity) has not acquired a monopoly position, or
has significant market power, then no harm is done. The same rationale
has been extended to joint ventures, where corporate shareholders make a
decision through a new company they form. In Texaco Inc. v. Dagher[17] the
Supreme Court held unanimously that a price set by a joint venture
between Texaco and Shell Oil did not count as making an unlawful
agreement. Thus the law draws a "basic distinction between concerted and
independent action".[18] Multi-firm conduct tends to be seen as more likely
than single-firm conduct to have an unambiguously negative effect and "is
judged more sternly".[19] Generally the law identifies four main categories of
agreement. First, some agreements such as price fixing or sharing markets
are automatically unlawful, or illegal per se. Second, because the law does
not seek to prohibit every kind of agreement that hinders freedom of
contract, it developed a "rule of reason" where a practice might restrict
trade in a way that is seen as positive or beneficial for consumers or
society. Third, significant problems of proof and identification of wrongdoing
arise where businesses make no overt contact, or simply share information,
but appear to act in concert. Tacit collusion, particularly in concentrated
markets with a small number of competitors or oligopolists, have led to
significant controversy over whether or not antitrust authorities should
intervene. Fourth, vertical agreements between a business and a supplier
or purchaser "up" or "downstream" raise concerns about the exercise of
market power, however they are generally subject to a more relaxed
standard under the "rule of reason".
Restrictive practices[edit]
Some practices are deemed by the courts to be so obviously detrimental
that they are categorized as being automatically unlawful, or illegal per se.
The simplest and central case of this is price fixing. This involves an
agreement by businesses to set the price or consideration of a good or
service which they buy or sell from others at a specific level. If the
agreement is durable, the general term for these businesses is a cartel. It is
irrelevant whether or not the businesses succeed in increasing their profits,
or whether together they reach the level of having market power as might a
monopoly. Such collusion is illegal per se.
• United States v. Trenton Potteries Co., 273 U.S. 392 (1927) per se
illegality of price fixing
• Appalachian Coals, Inc. v. United States, 288 U.S. 344 (1933)
• United States v. Socony-Vacuum Oil Co., 310 U.S. 150 (1940)
Bid rigging is a form of price fixing and market allocation that involves an
agreement in which one party of a group of bidders will be designated to
win the bid. Geographic market allocation is an agreement between
competitors not to compete within each other's geographic territories.
• Addyston Pipe and Steel Co. v. United States[20] pipe manufacturers
had agreed among themselves to designate one lowest bidder for
government contracts. This was held to be an unlawful restraint of
trade contrary to the Sherman Act. However, following the reasoning
of Justice Taft in the Court of Appeals, the Supreme Court held that
implicit in the Sherman Act §1 there was a rule of reason, so that not
every agreement which restrained the freedom of contract of the
parties would count as an anti-competitive violation.
• Hartford Fire Insurance Co. v. California, 113 S.Ct. 2891 (1993) 5 to
4, a group of reinsurance companies acting in London were
successfully sued by California for conspiring to make U.S. insurance
companies abandon policies beneficial to consumers, but costly to
reinsure. The Sherman Act was held to have extraterritorial
application, to agreements outside U.S. territory.
Group boycotts of competitors, customers or distributors
• Fashion Originators' Guild of America v. FTC, 312 U.S. 457 (1941)
the FOGA, a combination of clothes designers, agreed not to sell
their clothes to shops which stocked replicas of their designs, and
employed their own inspectors. Held to violate the Sherman Act §1
• Klor's, Inc. v. Broadway-Hale Stores, Inc., 359 U.S. 207 (1959) a
group boycott is per se unlawful, even if it may be connected with a
private dispute, and will have little effect upon the markets
• American Medical Association v. United States, 317 U.S. 519 (1943)
• Molinas v. National Basketball Association, 190 F. Supp. 241
(S.D.N.Y. 1961)
• Associated Press v. United States, 326 U.S. 1 (1945) 6 to 3, a
prohibition on members selling "spontaneous news" violated the
Sherman Act, as well as making membership difficult, and freedom of
speech among newspapers was no defense, nor was the absence of
a total monopoly
• Northwest Wholesale Stationers v. Pacific Stationery, 472 U.S. 284
(1985) it was not per se unlawful for the Northwest Wholesale
Stationers, a purchasing co-operative where Pacific Stationery had
been a member, to expel Pacific Stationery without any procedure or
hearing or reason. Whether there were competitive effects would
have to be adjudged under the rule of reason.
 • NYNEX Corp. v. Discon, Inc., 525 U.S. 128 (1998) the per se group
boycott prohibition does not apply to a buyer's decision to purchase
goods from one seller or another

7.

The relationship between inflation and unemployment has traditionally been

an inverse correlation. However, this relationship is more complicated than
it appears at first glance and has broken down on a number of occasions
over the past 45 years. Since inflation and (un)employment are two of the
most closely monitored economic indicators, we'll delve into
their relationship and how they affect the economy.

Labor Supply and Demand

If we use wage inflation, or the rate of change in wages, as a proxy for
inflation in the economy, when unemployment is high, the number of people
looking for work significantly exceeds the number of jobs available. In other
words, the supply of labor is greater than the demand for it.

With so many workers available, there's little need for employers to "bid" for
the services of employees by paying them higher wages. In times of high
unemployment, wages typically remain stagnant, and wage inflation (or
rising wages) is non-existent.

In times of low unemployment, the demand for labor (by employers)

exceeds the supply. In such a tight labor market, employers typically
need to pay higher wages to attract employees, ultimately leading to rising
wage inflation.

Over the years, economists have studied the relationship between

unemployment and wage inflation as well as the overall inflation rate.

The Phillips Curve

A.W. Phillips was one of the first economists to present compelling
evidence of the inverse relationship between unemployment and wage
inflation. Phillips studied the relationship between unemployment and the
rate of change of wages in the United Kingdom over a period of almost a
full century (1861-1957), and he discovered that the latter could be
explained by (a) the level of unemployment and (b) the rate of change of
unemployment.

Phillips hypothesized that when demand for labor is high and there are few
unemployed workers, employers can be expected to bid wages up quite
rapidly. However, when demand for labor is low, and unemployment is high,
workers are reluctant to accept lower wages than the prevailing rate, and
as a result, wage rates fall very slowly.

A second factor that affects wage rate changes is the rate of change of
unemployment. If business is booming, employers will bid more vigorously
for workers, which means that demand for labor is increasing at a fast pace
(i.e., percentage unemployment is decreasing rapidly), than they would if
the demand for labor were either not increasing (e.g., percentage
unemployment is unchanging) or only increasing at a slow pace.

Since wages and salaries are a major input cost for companies, rising
wages should lead to higher prices for products and services in an
economy, ultimately pushing the overall inflation rate higher. As a
result, Phillips graphed the relationship between general price inflation and
unemployment, rather than wage inflation. The graph is known today as the
Phillips Curve.

Phillips Curve Implications

Low inflation and full employment are the cornerstones of monetary policy
for the modern central bank. For instance, the U.S. Federal Reserve's
monetary policy objectives are maximum employment, stable prices, and
moderate long-term interest rates.

The tradeoff between inflation and unemployment led economists to use

the Phillips Curve to fine-tune monetary or fiscal policy. Since a Phillips
Curve for a specific economy would show an explicit level of inflation for a
specific rate of unemployment and vice versa, it should be possible to aim
for a balance between desired levels of inflation and unemployment.

The Consumer Price Index or CPI is the rate of inflation or rising prices in

the U.S. economy.

Figure 1 shows the CPI and unemployment rates in the 1960s.

If unemployment was 6% – and through monetary and fiscal stimulus, the

rate was lowered to 5% – the impact on inflation would be negligible. In
other words, with a 1% fall in unemployment, prices would not rise by
much.

If instead, unemployment fell to 4% from 6%, we can see on the left axis

that the corresponding inflation rate would rise to 3% from 1%.

Figure 1: U.S. inflation (CPI) and unemployment rates in the 1960s

Source: U.S. Bureau of Labor Statistics

Monetarist Rebuttal
The 1960s provided compelling proof of the validity of the Phillips Curve,
such that a lower unemployment rate could be maintained indefinitely as
long as a higher inflation rate could be tolerated. However, in the late
1960s, a group of economists who were staunch monetarists, led by Milton
Friedman and Edmund Phelps, argued that the Phillips Curve does not
apply over the long term. They contended that over the long run, the
economy tends to revert to the natural rate of unemployment as it adjusts
to any rate of inflation.

The natural rate is the long-term unemployment rate that is observed once
the effect of short-term cyclical factors has dissipated and wages have
adjusted to a level where supply and demand in the labor market are
balanced. If workers expect prices to rise, they will demand higher wages
so that their real (inflation-adjusted) wages are constant.

In a scenario wherein monetary or fiscal policies are adopted to lower

unemployment below the natural rate, the resultant increase in demand will
encourage firms and producers to raise prices even faster.

As inflation accelerates, workers may supply labor in the short term

because of higher wages – leading to a decline in the unemployment rate.
However, over the long-term, when workers are fully aware of the loss of
their purchasing power in an inflationary environment, their willingness to
supply labor diminishes and the unemployment rate rises to the natural
rate. However, wage inflation and general price inflation continue to rise.

Therefore, over the long-term, higher inflation would not benefit the
economy through a lower rate of unemployment. By the same token, a
lower rate of inflation should not inflict a cost on the economy through a
higher rate of unemployment. Since inflation has no impact on the
unemployment rate in the long term, the long-run Phillips curve morphs into
a vertical line at the natural rate of unemployment.

Friedman's and Phelps' findings gave rise to the distinction between the
short-run and long-run Phillips curves. The short-run Phillips curve includes
expected inflation as a determinant of the current rate of inflation and
hence is known by the formidable moniker "expectations-augmented
Phillips Curve."

(*Note: The natural rate of unemployment is not a static number but

changes over time due to the influence of a number of factors. These
include the impact of technology, changes in minimum wages, and the
degree of unionization. In the U.S., the natural rate of unemployment was
at 5.3% in 1949; it rose steadily until it peaked at 6.3% in 1978-79, and
then declined afterward. It is expected to be at 4.8% for a decade starting
from 2016.)

Relationship Breakdown
The 1970s

The monetarists' viewpoint did not gain much traction initially as it was
made when the popularity of the Phillips Curve was at its peak. However,
unlike the data from the 1960s, which definitively supported the Phillips
Curve premise, the 1970s provided significant confirmation of Friedman's
and Phelps' theory. In fact, the data at many points over the next three
decades do not provide clear evidence of the inverse relationship between
unemployment and inflation.

The 1970s were a period of both high inflation and high unemployment in
the U.S. due to two massive oil supply shocks. The first oil shock was from
the 1973 embargo by Middle East energy producers that caused crude oil
prices to quadruple in about a year. The second oil shock occurred when
the Shah of Iran was overthrown in a revolution and the loss of output from
Iran caused crude oil prices to double between 1979 and 1980. This
development led to both high unemployment and high inflation. 

The 1990s

The boom years of the 1990s were a time of low inflation and low
unemployment. Economists attribute a number of reasons for this positive
confluence of circumstances. These include:

• The global competition that kept a lid on price increases by U.S.

producers
• Reduced expectations of future inflation as tight monetary policies
had led to declining inflation for more than a decade
• Productivity improvements due to the large-scale adoption of
technology
 • Demographic changes in the labor force, with more aging baby
boomers and fewer teens

8.

International trade is the exchange of capital, goods, and services across

international borders or territories.[1]
In most countries, such trade represents a significant share of gross
domestic product (GDP). While international trade has existed throughout
history (for example Uttarapatha, Silk Road, Amber Road, scramble for
Africa, Atlantic slave trade, salt roads), its economic, social, and political
importance has been on the rise in recent centuries.
Carrying out trade at an international level is a complex process when
compared to domestic trade. When trade takes place between two or more
nations factors like currency, government policies, economy, judicial
system, laws, and markets influence trade.
To smoothen and justify the process of trade between countries of different
economic standing, some international economic organisations were
formed, such as the World Trade Organization. These organisations work
towards the facilitation and growth of international trade. Statistical services
of intergovernmental and supranational organisations and national
statistical agencies publish official statistics on international trade.

Characteristics of global trade[edit]

A product that is transferred or sold from a party in one country to a party in
another country is an export from the originating country, and an import to
the country receiving that product. Imports and exports are accounted for in
a country's current account in the balance of payments.[2]
Trading globally gives consumers and countries the opportunity to be
exposed to new markets and products. Almost every kind of product can be
found in the international market: food, clothes, spare parts, oil, jewellery,
wine, stocks, currencies, and water. Services are also traded: tourism,
banking, consulting, and transportation

Advanced technology (including transportation), globalisation,

industrialisation, outsourcing and multinational corporations have major
impact on the international trade system.
Increasing international trade is crucial to the continuance of globalisation.
Nations would be limited to the goods and services produced within their
own borders without international trade.
Differences from domestic trade[edit]
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.
However, in practical terms, carrying out trade at an international level is
typically a more complex process than domestic trade. The main difference
is that international trade is typically more costly than domestic trade. This
is due to the fact 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 (non-tariff
barriers).
Another difference between domestic and international trade is that factors
of production such as capital and labor are often 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, labour, or other factors of production. 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 that factor of production and thus embody it. An example of
this is the import of labor-intensive goods by the United States from China.
Instead of importing Chinese labor, the United States imports goods that
were produced with Chinese labor. One report in 2010 suggested that
international trade was increased when a country hosted a network of
immigrants, but the trade effect was weakened when the immigrants
became assimilated into their new country.[3]

International trade gives rise to a world economy, in which supply and

demand, and therefore prices, both affect and are affected by global
events. Political change in Asia, for example, could result in an increase in
the cost of labor, thereby increasing the manufacturing costs for an
American sneaker company based in Malaysia, which would then result in
an increase in the price charged at your local mall. A decrease in the cost
of labor, on the other hand, would likely result in you having to pay less for
your new shoes.
A product that is sold to the global market is called an export, and a product
that is bought from the global market is an import. Imports and exports are
accounted for in a country's current account in the balance of payments.

Comparative Advantage: Increased Efficiency of Trading Globally

Global trade allows wealthy countries to use their resources—whether
labor, technology or capital—more efficiently. Because countries are
endowed with different assets and natural resources (land, labor, capital,
and technology), some countries may produce the same good more
efficiently and therefore sell it more cheaply than other countries. If a
country cannot efficiently produce an item, it can obtain the it by trading
with another country that can. This is known as specialization in
international trade.

Let's take a simple example. Country A and Country B both produce cotton
sweaters and wine. Country A produces ten sweaters and six bottles of
wine a year while Country B produces six sweaters and ten bottles of wine
a year. Both can produce a total of 16 units. Country A, however, takes
three hours to produce the ten sweaters and two hours to produce the six
bottles of wine (total of five hours). Country B, on the other hand, takes one
hour to produce ten sweaters and three hours to produce six bottles of wine
(a total of four hours).

But these two countries realize that they could produce more by focusing
on those products with which they have a comparative advantage. Country
A then begins to produce only wine, and Country B produces only cotton
sweaters. Each country can now create a specialized output of 20 units per
year and trade equal proportions of both products. As such, each country
now has access to 20 units of both products.

We can see then that for both countries, the opportunity cost of producing
both products is greater than the cost of specializing. More specifically, for
each country, the opportunity cost of producing 16 units of both sweaters
and wine is 20 units of both products (after trading). Specialization reduces
their opportunity cost and therefore maximizes their efficiency in acquiring
the goods they need. With the greater supply, the price of each product
would decrease, thus giving an advantage to the end consumer as well.

Note that, in the example above, Country B could produce both wine and
cotton more efficiently than Country A (less time). This is called an absolute
advantage, and Country B may have it because of a higher level of
technology.

According to the international trade theory, even if a country has an

absolute advantage over another, it can still benefit from specialization.
Origins of Comparative Advantage
The law of comparative advantage is popularly attributed to English political
economist David Ricardo. It's discussed in his book “On the Principles of
Political Economy and Taxation” published in 1817, although it has been
suggested that Ricardo's mentor, James Mill, likely originated the analysis.

David Ricardo famously showed how England and Portugal both benefit by
specializing and trading according to their comparative advantages. In this
case, Portugal was able to make wine at a low cost, while England was
able to cheaply manufacture cloth. Ricardo predicted that each country
would eventually recognize these facts and stop attempting to make the
product that was more costly to generate.

Indeed, as time went on, England stopped producing wine, and Portugal
stopped manufacturing cloth. Both countries saw that it was to their
advantage to stop their efforts at producing these items at home and,
instead, to trade with each other.