c

  is the social science that analyzes the production, distribution,

and consumption of goods and services. Current economic models emerged from the broader field
of political economy in the late 19th century. A primary stimulus for the development of modern
economics was the desire to use an empirical approach more akin to the physical sciences. [2]

Economics aims to explain how economies work and how economic agents interact. Economic
analysis is applied throughout society, in business, finance and government, but also
in crime,[3] education,[4] the family, health, law, politics, religion,[5] social institutions,
war,[6] and science.[7] The expanding domain of economics in the social sciences has been described
as economic imperialism. [8]

Common distinctions are drawn between vari ous dimensions of economics. The primary textbook
distinction is between microeconomics, which examines the behavior of basic elements in the
economy, including individual market s and agents (such as consumers and firms, buyers and
sellers), and macroeconomics, which addresses issues affecting an entire economy, including
unemployment, inflation, economic growth, and monetary and fiscal policy. Other distinctions
include: between positive economics (describing "what is") and normative economics (advocating
"what ought to be"); between economic theory and applied economics; between mainstream
economics (more "orthodox" dealing with the "rationality -individualism-equilibrium nexus")
and heterodox economics (more "radical" dealing with the "institutions -history-social structure
nexus"[9]); and between rational and behavioral economics.

Production-possibility frontier and opportunity cost

In economics, a 



 


, sometimes called a 



 

 or 





 , is a graph that shows the different rates of production o f
two goods and/or services that an economy can produce „

„ during a specified period of
time with a 

„

  
„ „ „ , or factors of production. The PPF shows the
maximum amount of one commodity that can be obtained for any specified production level of the
other commodity (or composite of all other commodities), given the society's technology and the
amount of factors of production available.

Though they are normally drawn as concave (bulging out) from the origin, PPFs can also be
represented as linear (straight) or bulging in toward the origin, depending on a number of factors. A
PPF can be used to represent a number of economic concepts, such as scarcity of resources (i.e.,
the fundamental economic problem all societies face ), opportunity cost (or marginal rate of
transformation), productive efficiency, allocative efficiency, and economies of scale. In addition, an
outward shift of the PPF results from growth of the availability of inputs such as physical capital or
labor, or technological progress in our knowledge of how to transform inputs into outputs. Such a
shift allows economic growth of an economy already operating at full capacity (on the PPF), which
me
s   more of 2  outputs c
be produced during the specified period of timewithout
reducing the output of either good. Conversey the PPF will shift inward if the labor force shrinks
the supply of raw materials is depleted, of a natural disaster decreases the stock of physical capital.
However, most economic contractions reflect not that less can be produced, but that the economy
has started operating below the frontierͶtypically both labor and physical capital are
underemployed. The combination represented by the point on the PPF where an economy
operates shows the priorities or choices of the economy, such as the choice between producing
relatively morecapital goods and relatively fewer consumer goods, or vice versa.

[edit] ndicators

[edit]c 

An eample PPF with illustrative points marked

 
‰               
A PPF shows all possible combinations of two goods that can be produced simultaneously during a
given period of time,    2. Commonly, it takes the form of the curve on the right. For an
economy to increase the quantity of one good produced, production of the other good must be
sacrificed. Here, butter production must be sacrificed in order to produce more guns. PPFs
represent how much of the latter must be sacrificed for a given increase inproduction of the
former.[1]

Such a two-good world is a theoretical simplification, necessary for graphical analysis. If one good is
of primary interest, all others can be represented as a composite good.[2][3] In addition, the model
can be generalised to the -good case using mathematics.[4]
Assuming that the supply of the economys factors of production does not increase, making more
butter requires that resources be redirected from making "guns" to making "butter". Ifproduction
is efficient, the economy can choose between combinations (i.e. points on the PPF ] if guns are to
be prioritised, if more butter is needed,
if an intermediate mix is required, and so forth.[1]
Hence, all points  the curve are points of maximum productive efficiency (i.e., no more output
can be achieved from the given inputs all points inside the frontier (such as) are feasible but

productively  ; all points outside the curve (such as ) are infeasible with the given
resources and thus unattainable in the short run. [5] A point on the curve satisfies allocative
efficiency, also called Pareto efficiency, if, for given preferences and distribution of income, no
movement along the curve or redistribution of income there could raiseutility of someone without
lowering the utility of someone else.[6]

[edit]Ä





Increasing butter from A to B carries little opportunity cost, but for C to D the cost is great.

‰!  "#!$%&  "#!#' $ ( #

If there is no increase in productive resources, increasing production of a first good entails
decreasing production of a second, because resources must be transferred to the first and away
from the second. Points along the curve describe the trade-off between the goods. The sacrifice in
the production of the second good is called the  "#!#' $ ( # (because increasing production of
the first good entails losing the opportunity to produce some amount of the second). Opportunity
cost is measured in the number of units of the second good forgone for one or more units of the
first good.[1]
In the context of a PPF, opportunity cost is directly related to the shape of the curve (see below).
Unless a straight-line PPF is used, opportunity cost will vary depending on the start and end point.
In the diagram on the right, producing 10 more packets of butter, at a low level of butter
production, costs the opportunity of 5 guns (as with a movement from to ]). At point C, the
economy is already close to its maximum potiential butter output. To produce 10 more packets of
butter, 50 guns must be sacrificed (as with a movement from to
). The ratio of opportunity costs
. .
is determined by the )*+ ),- ,)/ ) ,* 

[edit]‰


0








Marginal rate of transformation increases when the transition is made from AA to BB.

The slope of the production-possibility frontier (PPF) at any given point is called the 


0







 (‰). It describes numerically the rate at which output of one good can be
transformed (by re-allocation of production resources) into output of the other. It is also called the
(marginal) "opportunity cost" of a commodity, that is, it is the opportunity cost of  in terms of  at
the margin. It measures how much of good Y is given up for one more unit of good X or vice versa.
Since the shape of a PPF is commonly drawn as concave from the origin to represent increasing
opportunity cost with increased output of a good. Thus, MRT increases in absolute size as one
moves from the top left of the PPF to the bottom right of the PPF.[7]

The marginal rate of transformation can be expressed in terms of either commodity. The marginal
opportunity costs of guns in terms of butter is simply the reciprocal of the marginal opportunity
cost of butter in terms of guns. If, for example, the (absolute) slope at point ]] in the diagram is
equal to 2, then, in order to produce one more packet of butter, the production of 2 guns must be
sacrificed. If at , the marginal opportunity cost of butter in terms of guns is equal to 0.25, then,
the sacrifice of one gun could produce four packets of butter, and the opportunity cost of guns in
terms of butter is 4.

[edit]Shape
 The production-possibility frontier can be constructed from the contract curve in anEdgeworth
production box diagram of factor intensity.[8] The example used above (which demonstrates
increasing opportunity costs, with a curve concave from the origin) is the most common form of
PPF.[9] It represents a disparity in the factorintensities and technologies of the two production
sectors. That is, as an economy specializes more and more into one product (e.g., moving from
point ] to point
), the opportunity cost of producing that product increases, because we are using
more and more resources that are less efficient in producing it. With increasing production of
butter, workers from the gun industry will move to it. At first, the least qualified (or most general)
gun workers will be transferred into making more butter, and moving these workers has little
impact on the opportunity cost of increasing butter production: the loss in gun production will be
small. But the cost of producing successive units of butter will increase as resources that are more
and more specialised in gun production are moved into the butter industry.[10]

If opportunity costs are constant, a straight-line (linear) PPF is produced.[11] This case reflects a
situation where resources are not specialised and can be substituted for each other with no added
cost.[10] Products requiring similar resources (bread and pastry, for instance) will have an almost
straight PPF, hence almost constant opportunity costs.[10] More specifically, with constant returns
to scale, there are two opportunities for a linear PPF: firstly, if there was only onefactor of
production to consider, or secondly, if the factor intensity ratios in the two sectors were constant at
all points on the production-possibilities curve. With varying returns to scale, however, it may not
be entirely linear in either case.[12]

With economies of scale, the PPF would appear bowed in ("inverted") toward the origin, with
opportunity costs falling as more is produced of each respective product. Here greater
specialization in producing successive units of a good drives down its opportunity cost (say
from mass production methods or specialization of labor).[13]

mon PPF: increasing opportunity cost straight line PPF: constant opportunity costn inverted PPF: decreasing opportunity cost
[edit]Position
An unbiased expansion in a PPF

The two main determinants of the position of the PPF at any given time are the state
of technology and management expertise (which are reflected in the available production
functions) and the available quantities and productivity of factors of production. Only points on or
within a PPF are actually possible to achieve in the short run. In the long run, if technology
improves or if the productivity or supply of factors of production increases, the economy1s capacity
to produce both goods increases, i.e., economic growth occurs. This increase is shown by a shift of
the production-possibility frontier to the right (outward). Conversely, a natural, military or
ecological disaster might move the PPF to the left (inward), reflecting a reduction in an economy1s
total productive capacity.[1] Thus all points on or within the curve are part of the production set,
i.e., combinations of goods that the economy could potentially produce.

If the two production goods depicted are capital investment (to increase future production
possibilities) or current consumption goods, the PPF can represent, how the higher investment this
year, the more the PPF would shift out in following years.[14] It can also represent how a
technological progress that more favors production possibilities of one good, say Guns, shifts the
PPF outwards more along the Gun axis, "biasing" production possibilities in that direction. Similarly,
if one good makes relatively more use of say capital and if capital grows faster than other factors,
growth possibilities might be biased in favor of the capital-intensive good.[15][16]

[edit]Other applications

In microeconomics, the PPF shows the options open to an individual,household, or firm in a two-
good world. By definition, each point on the curve is productively efficient, but, given the nature
of market demand, some points will be more profitable than others. Equilibrium for a firm will be
the combination of outputs on the PPF that is most profitable.[17]

From a macroeconomic perspective, the PPF illustrates the production possibilities available to a
nation or economy during a given period of time for broad categories of output. However, an
economy may achieve productive efficiency without necessarily being allocatively efficient. Market
failure (such as imperfect competition or externalities) and some institutions of social decision-
making (such as government and tradition) may lead to the wrong combination of goods being
produced (hence the wrong mix of resources being allocated between producing the two goods)
compared to what consumers would prefer, given what is feasible on the PPF.[18]

Supply and demand

From Wikipedia, the free encyclopedia
6 8
 2 342 545  544  7  4   5 2 3 

The price P of a product is determined by a balance between production at each price (supply S) and the desires of those
withpurchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase
in price (P) and quantity sold (Q) of the product.

  9   :  is an economic model of price determination in a market. It concludes that in

a competitive market, the unit price for a particular good will vary until it settles at a point where the
quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current
price), resulting in an economic equilibrium of price and quantity.

The four basic laws of supply and demand are [1]

1.? If demand increases and supply remains unchanged then higher equilibrium price and quantity.
2.? If demand decreases and supply remains the same then lower equilibrium price and quantity.
3.? If supply increases and demand remains unchanged then lower equilibrium price and higher
quantity.
4.? If supply decreases and demand remains the same then higher price and lower quantity.
i

;

 [hide]

? 1 The graphical representation of supply and demand

? 1.1 Supply schedule
? 1.2 Demand schedule
? 2 Microeconomics
? 2.1 Equilibrium
? 3 Changes in market equilibrium
? 3.1 Demand curve shifts
? 3.2 Supply curve shifts
? 4 Elasticity

? 4.1 Vertical supply curve (perfectly inelastic

upply)
? 5 Other markets
? 6 Empirical estimation
? 7 Macroeconomic uses of demand and supply
? 8 History

? 9 Criticism
? 10 See also
? 11 References
? 12 External links

[edit]The graphical representation of supply and demand

The supply-demand model is a partial equilibrium model representing the determination of the price of a
particular good and the quantity of that good which is traded. Although it is normal to regard the quantity
demanded and the quantity supplied as functions of the price of the good, the standard graphical
representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the
horizontal axis, the opposite of the standard convention for the representation of a mathematical function.

Determinants of supply and demand other than the price of the good in question, such as consumers'
income, input prices and so on, are not explicitly represented in the supply-demand diagram. Changes in the
values of these variables are represented by shifts in the supply and demand curves. By contrast, responses
to changes in the price of the good are represented as movements along unchanged supply and demand
curves.

[edit]    

The supply schedule, depicted graphically as the supply curve, represents the amount of some good that
producers are willing and able to sell at various prices, assuming ceteris paribus, that is, assuming all
determinants of supply other than the price of the good in question, such as technology and the prices of
factors of production, remain the same.

Under the assumption of perfect competition, supply is determined by marginal cost. Firms will produce
additional output as long as the cost of producing an extra unit of output is less than the price they will
receive.

By its very nature, conceptualizing a supply curve requires that the firm be a perfect competitorͶthat is,
that the firm has no influence over the market price. This is because each point on the supply curve is the
answer to the question "If this firm is „ 
 this potential price, how much output will it be able to sell?"
If a firm has market power, so its decision of how much output to provide to the market influences the
market price, then the firm is not "faced with" any price, and the question is meaningless.

Economists distinguish between the supply curve of an individual firm and the market supply curve. The
market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price.
Thus in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the
market supply curve.

Economists also distinguish the short-run market supply curve from the long-run market supply curve. In this
context, two things are assumed constant by definition of the short run: the availability of one or more fixed
inputs (typically physical capital), and the number of firms in the industry. In the long run, firms have a
chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at
any given price. Furthermore, in the long run potential competitors can enter or exit the industry in response
to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-
run counterparts.

[edit]V  
The demand schedule, depicted graphically as the demand curve, represents the amount of some good that
buyers are willing and able to purchase at various prices, assuming all determinants of demand other than
the price of the good in question, such as income, personal tastes, the price of substitute goods, and the
price of complementary goods, remain the same. Following the law of demand, the demand curve is almost
always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the
good.[2]

Just as the supply curves reflect marginal cost curves, demand curves are determined by marginal
utility curves.[3] Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal
utility of additional consumption is equal to the opportunity cost determined by the price, that is, the
marginal utility of alternative consumption choices. The demand schedule is defined as
the 

„ and 2

 of a consumer to purchase a given product in a given frame of time.

As described above, the demand curve is generally downward-sloping. There may be rare examples of goods
that have upward-sloping demand curves. Two different hypothetical types of goods with upward-sloping
demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods made more
fashionable by a higher price).

By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitorͶ
that is, that the purchaser has no influence over the market price. This is because each point on the demand
curve is the answer to the question "If this buyer is `<=  > this potential price, how much of the product
will it purchase ?" If a buyer has market power, so its decision of how much to buy influences the market
price, then the buyer is not "faced with" any price, and the question is meaningless.

As with supply curves, economists distinguish between the demand curve of an individual and the market
demand curve. The market demand curve is obtained by summing the quantities demanded by all
consumers at each potential price. Thus in the graph of the demand curve, individuals @ demand curves are
added horizontally to obtain the market demand curve.

[edit] Microeconomics

[edit]c  
 

Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity
supplied, represented by the intersection of the demand and supply curves.

[edit]Changes in market equilibrium

Practical uses of supply and demand analysis often center on the different variables that change equilibrium
price and quantity, represented as shifts in the respective curves.Comparative statics of such a shift traces
the effects from the initial equilibrium to the new equilibrium.

[edit]   

 

‰ A 
 A 

An outward (rightward) shift in demand increases both equilibrium price and quantity

When consumers increase the quantity demanded A , it is referred to as an  B .
Increased demand can be represented on the graph as the curve being shifted to the right. At eachprice
point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this
raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the
higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it
from a "change in demand," that is, a shift of the curve. In the example above, there has been an  C  in
demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come
from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market
expectations, and number of buyers. This would cause the entire demand curve to shift changing the
equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new
equilibrium price to emerge, resulted in    the supply curve from the point (Q1, P1) to the
point Q2, P2).

If the  C 

, then the opposite happens: a shift of the curve to the left. If the demand starts
at D2, and  

to D1, the equilibrium price will decrease, and the equilibrium quantity will also
decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that
the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the
change (shift) in demand.

The movement of the demand curve in response to a change in a non-price determinant of demand is
caused by a change in the x-intercept, the constant term of the demand equation.

[edit]  

 

‰   


An outward (rightward) shift in supply reduces the equilibrium price but increases the equilibrium quantity

When the suppliers D unit input costs change, or when technological progress occurs, the supply curve shifts.
For example, assume that someone invents a better way of growing wheat so that the cost of growing a
given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at
every price and this shifts the supply curve S1 outward, to S2Ͷan  

. This increase in supply
causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as
consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the
price and the quantity move in opposite directions.
If the quantity supplied „„„, the opposite happens. If the supply curve starts at S2, and shifts leftward
to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along
the demand curve to the new higher price and associated lower quantity demanded. The quantity
demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has
not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed.

The movement of the supply curve in response to a change in a non-price determinant of supply is caused by
a change in the y-intercept, the constant term of the supply equation. The supply curve shifts up and down
the y axis as non-price determinants of demand change.

[edit]Elasticity
G

 
„ E !

 F„  


Elasticity is a central concept in the theory of supply and demand. In this context, „

 refers to how
strongly the quantities supplied and demanded respond to various factors, including price and other
determinants. One way to define elasticity is the percentage change in one variable (the quantity supplied or
demanded) divided by the percentage change in the causative variable. For discrete changes this is known
as  „

, which calculates the elasticity over a range of values. In contrast, 
 „

 uses
differential calculus to determine the elasticity at a specific point. Elasticity is a measure of relative changes.

Often, it is useful to know how strongly the quantity demanded or supplied will change when the price
changes. This is known as the price elasticity of demand or the price elasticity of supply. If
a monopolist decides to increase the price of its product, how will this affect the amount of their good that
customers purchase? This knowledge helps the firm determine whether the increased unit price will offset
the decrease in sales volume. Likewise, if a government imposes a tax on a good, thereby increasing the
effective price, knowledge of the price elasticity will help us to predict the size of the resulting effect on the
quantity demanded.

Elasticity is calculated as the percentage change in quantity divided by the associated percentage change in
price. For example, if the price moves from $1.00 to $1.05, and as a result the quantity supplied goes from
100 pens to 102 pens, the quantity of pens increased by 2%, and the price increased by 5%, so the price
elasticity of supply is 2%/5% or 0.4.

Since the changes are in percentages, changing the unit of measurement or the currency will not affect the
elasticity. If the quantity demanded or supplied changes by a greater percentage than the price did, then
demand or supply is said to be elastic. If the quantity changes by a lesser percentage than the price did,
demand or supply is said to be inelastic. If supply is perfectly inelastic;that is, has zero elasticity, then there is
a vertical supply curve.

Short-run supply curves are not as elastic as long-run supply curves, because in the long run firms can
respond to market conditions by varying their holdings of physical capital, and because in the long run new
firms can enter or old firms can exit the market.
Elasticity in relation to variables other than price can also be considered. One of the most common to
consider is income. How strongly would the demand for a good change if income increased or decreased?
The relative percentage change is known as the income elasticity of demand.

Another elasticity sometimes considered is the cross elasticity of demand, which measures the
responsiveness of the quantity demanded of a good to a change in the price of another good. This is often
considered when looking at the relative changes in demand when studyingcomplements and substitute
goods. Complements are goods that are typically utilized together, where if one is consumed, usually the
other is also. Substitute goods are those where one can be substituted for the other, and if the price of one
good rises, one may purchase less of it and instead purchase its substitute.

Cross elasticity of demand is measured as the percentage change in demand for the first good divided by the
causative percentage change in the price of the other good. For an example with a complement good, if, in
H H
response to a 10 increase in the price of fuel, the quantity of new cars demanded decreased by 20 , the
cross elasticity of demand would be -2.0.

In a frictionless economy, the price and quantity in any market would be able to move to a new equilibrium
position instantly, without spending any time away from equilibrium. Any change in market conditions
would cause a jump from one equilibrium position to another at once. In real economic systems, markets
don't always behave in this way, and markets take some time before they reach a new equilibrium position.
This is due to asymmetric, or at least imperfect, information, where no one economic agent could ever be
expected to know every relevant condition in every market. Ultimately both producers and consumers must
rely on trial and error as well as prediction and calculation to find the true equilibrium of a market.

[edit] r


  

 


 

  

When demand D1 is in effect, the price will beP1 . When D2 is occurring, the price will beP2. The equilibrium quantity is alwaysQ, and
any shifts in demand will only affect price.

If the quantity supplied is fixed in the very short run no matter what the price, the supply curve is a vertical
line, and supply is called perfectly inelastic.
[edit]Other markets
The model of supply and demand also applies to various specialty markets.

The model is commonly applied to wages, in the market for labor. The typical roles of supplier and
demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The
demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The
equilibrium price for a certain type of labor is the wage rate.[4]

A number of economists (for example Pierangelo Garegnani[5], Robert L. Vienneau[6], and Arrigo Opocher &
Ian Steedman[7]), building on the work of Piero Sraffa, argue that that this model of the labor market, even
given all its assumptions, is logically incoherent. Michael Anyadike-Danes and Wyne Godley [8] argue, based
on simulation results, that little of the empirical work done with the textbook model constitutes a potentially
falsifying test, and, consequently, empirical evidence hardly exists for that model. Graham White [9] argues,
partially on the basis of Sraffianism, that the policy of increased labor market flexibility, including the
reduction of minimum wages, does not have an "intellectually coherent" argument in economic theory.

This criticism of the application of the model of supply and demand generalizes, particularly to all markets
for factors of production. It also has implications for monetary theory[10] not drawn out here.

In both classical and Keynesian economics, the money market is analyzed as a supply-and-demand system
with interest rates being the price. The money supply may be a vertical supply curve, if the central bank of a
country chooses to use monetary policy to fix its value regardless of the interest rate; in this case the money
supply is totally inelastic. On the other hand,[11] the money supply curve is a horizontal line if the central
bank is targeting a fixed interest rate and ignoring the value of the money supply; in this case the money
supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the
interest rate.[12]

[edit]Empirical estimation
Demand and supply relations in a market can be statistically estimated from price, quantity, and
other data with sufficient information in the model. This can be done with 
„ "„

 „ 
„

 in econometrics. Such methods allow solving for the model-relevant "structural coefficients,"
the estimated algebraic counterparts of the theory. TheI„„
„


  2„ is a common issue
in "structural estimation." Typically, data on exogenous variables (that is, variables other than price and
quantity, both of which areendogenous variables) are needed to perform such an estimation. An alternative
to "structural estimation" is reduced-form estimation, which regresses each of the endogenous variables on
the respective exogenous variables.

[edit]Macroeconomic uses of demand and supply

Demand and supply have also been generalized to explain macroeconomic variables in a market economy,
including the quantity of total output and the general price level. The Aggregate Demand-Aggregate Supply
model may be the most direct application of supply and demand to macroeconomics, but other
macroeconomic models also use supply and demand. Compared tomicroeconomic uses of demand and
supply, different (and more controversial) theoretical considerations apply to
such macroeconomic counterparts as aggregate demandand aggregate supply. Demand and supply are also
used in macroeconomic theory to relate money supply and money demand to interest rates, and to relate
labor supply and labor demand to wage rates.

Price elasticity of demand

PED is derived from the percentage change in quantity (%ȴQd) and percentage change in price (%ȴP).

(

 


J
   ((c or c) is a measure used in economics to show the responsiveness,
or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives
the percentage change in quantity demanded in response to a one percent change in price (holding constant
all the other determinants of demand, such as income). It was devised by Alfred Marshall.

Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can
lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods,
have a positive PED. In general, the demand for a good is said to be 
 (or 
) when the
PED is less than one (in absolute value): that is, changes in price have a relatively small effect on the quantity
of the good demanded. The demand for a good is said to be 
 (or 
) when its PED is
greater than one (in absolute value): that is, changes in price have a relatively large effect on the quantity of
a good demanded.
Revenue is maximised when price is set so that the PED is exactly one. The PED of a good can also be used to
predict the incidence (or "burden") of a tax on that good. Various research methods are used to determine
price elasticity, including test markets, analysis of historical sales data and conjoint analysis.

i



[hide]

? 1 Definition
? 1.1 Point-price elasticity
? 1.2 Arc elasticity
? 2 History
? 3 Determinants

? 4 Interpreting values of price elasticity

oefficients
? 5 Effect on total revenue
? 6 Effect on tax incidence

? 7 Selected price elasticities

? 8 See also
? 9 Notes
? 10 References
? 11 External links

[edit]Definition

PED is a measure of the sensitivity (or responsiveness) of the quantity of a good or service demanded to
changes in its price.[1] The formula for the coefficient of price elasticity of demand for a good is:[2][3][4]

The above formula usually yields a negative value, due to the inverse nature of the relationship between
price and quantity demanded, as described by the "law of demand".[3] For example, if the price increases by
5% and quantity demanded decreases by 5%, then the elasticity at the initial price and quantity = о5%/5% =
о1. The only classes of goods which have a PED of greater than 0 are Veblen and Giffen goods.[5] Because the
PED is negative for the vast majority of goods and services, however, economists often refer to price
elasticity of demand as a positive value (i.e., in absolute value terms).[4]

This measure of elasticity is sometimes referred to as the "
„ elasticity of demand for a good, i.e., the
elasticity of demand with respect to the good's own price, in order to distinguish it from the elasticity of
demand for that good with respect to the change in the price of some other good, i.e.,
a complementary or substitute good.[1] The latter type of elasticity measure is called a  -price elasticity
of demand.[6][7]
As the difference between the two prices or quantities increases, the accuracy of the PED given by the
formula above  

for a combination of two reasons. First, the PED for a good is not necessarily
constant; as explained below, PED can vary at different points along the demand curve, due to its
percentage nature.[8][9] Elasticity is not the same thing as the slope of the demand curve, which is dependent
on the units used for both price and quantity.[10][11] Second, percentage changes are not symmetric; instead,
the percentage changebetween any two values depends on which one is chosen as the starting value and
which as the ending value. For example, if quantity demanded increases `  10 units  15 units, the
percentage change is 50%, i.e., (15 о 10) ÷ 10 (converted to a percentage). But if quantity demanded
decreases `  15 units  10 units, the percentage change is о33.3%, i.e., (15 о 10) ÷ 15.[12][13]

Two alternative elasticity measures avoid or minimise these shortcomings of the basic elasticity
formula:  " 
 and  
.

[edit](



 



One way to avoid the accuracy problem described above is to minimise the difference between the starting
and ending prices and quantities. This is the approach taken in the definition of "  elasticity, which
uses differential calculus to calculate the elasticity for an infinitesimal change in price and quantity at any
given point on the demand curve: [14]

In other words, it is equal to the absolute value of the first derivative of quantity with respect to price
(dQd/dP) multiplied by the point's price (P) divided by its quantity (Qd).[15]

In terms of partial-differential calculus, point-price elasticity of demand can be defined as

follows:[16] let be the demand of goods as a function of parameters price and

wealth, and let be the demand for good . The elasticity of demand for good with
respect to price # is

However, the point-price elasticity can be computed only if the formula for the demand function, $ = `(),
is known so its derivative with respect to price, $ / , can be determined.

[edit]!

 



A second solution to the asymmetry problem of having a PED dependent on which of the two givenpoints
on a demand curve is chosen as the "original" point and which as the "new" one is to compute the
percentage change in P and Q relative to the   of the two prices and the   of the two
quantities, rather than just the change relative to one point or the other. Loosely speaking, this gives an
"average" elasticity for the section of the actual demand curveͶi.e., the   of the curveͶbetween the two
points. As a result, this measure is known as the  
, in this case with respect to the price of the
good. The arc elasticity is defined mathematically as:[13][17][18]

This method for computing the price elasticity is also known as the "midpoints formula", because the
average price and average quantity are the coordinates of the midpoint of the straight line between the two
given points.[12][18] However, because this formula implicitly assumes the section of the demand curve
between those points is linear, the greater the curvature of the actual demand curve is over that range, the
worse this approximation of its elasticity will be.[17][19]

Price elasticity of supply

From Wikipedia, the free encyclopedia
  2 `
  
 `

In economics, 

 


K
  K ((c) is an elasticity defined as a numerical measure of the
responsiveness of the supply of a given good to a change in the price of that good.[1]

i



[hide]

? 1 Calculation
? 2 Interpretation
? 3 Determinants
? 4 Graphical
epresentation
? 5 Selected Supply
lasticities
? 6 See also
? 7 Notes
? 8 References

[edit]Calculation

Price elasticity of supply is a measure of the sensitivity of the quantity of a good supplied in a market to
changes in the market price for that good,  
 2
.[2]
Per the law of supply, it is posited that at a given price and corresponding quantity supplied in a market, a
price increase will also increase the quantity supplied.[2][3] PES is a numerical measure (coefficient) of by how
much that supply is affected.[1] Mathematically:[2][4]

In other words, PES is the percentage change in quantity supplied one that would occur would expect after a
1% change in price.[2] For example, if, in response to a 10% rise in the price of a good, the quantity supplied
increases by 20%, the price elasticity of supply would be 20%/10% = 2.[5]

[edit]Interpretation

If the law of supply holds, an upward-sloping supply curve would result from this.[6] As a ratio of two
percentages, the price elasticity is not tied to any specific units.[2] However, the exact value can yield more
inferences about the good in question.

When the coefficient is less than one, the supply of that good can be described as
„
; when the
coefficient is greater than one, the supply can be described as „
.[2] An elasticity of zero indicates that
quantity supplied does not respond to a price change: it is "fixed" in supply. Such goods often have no labor
component or are not produced, limiting the short run prospects of expansion. If the coefficient is exactly
one, the good is said to be 
 „
.

The quantity of goods supplied can, in the short term, be different from the amount produced, as
manufacturers will have stocks which they can build up or run down.

[edit]Determinants

!  


  for example, availability may cap the amount of gold that can be produced in a
country regardless of price. Likewise, the price of Van Gogh paintings is unlikely to affect their supply.[7]



 




 Much depends on the complexity of the production process. Textile
production is relatively simple. The labor is largely unskilled and production facilities are little more than
buildings - no special structures are needed. Thus the PES for textiles is elastic. On the other hand, the PES
for specific types of motor vehicles is relatively inelastic. Auto manufacture is a multi-stage process that
requires specialized equipment, skilled labor, a large suppliers network and large R&D costs.[8]




 The more time a producer has to respond to price changes the more elastic the
supply.[7][8] Supply is normally more elastic in the long run than in the short run for produced goods, since it
is generally assumed that in the long run all factors of production can be utilised to increase supply, whereas
in the short run only labor can be increased, and even then, changes may be prohibitively costly.[2] For
example, a cotton farmer cannot immediately (i.e. in the short run) respond to an increase in the price of
soybeans because of the time it would take to procure the necessary land.
c   
 A producer who has unused capacity can (and will) quickly respond to price changes in his
market assuming that variable factors are readily available.[2]



 A producer who has a supply of goods or available storage capacity can quickly increase supply
to market.

Various research methods are used to calculate price elasticities in real life, including analysis of historic
sales data, both public and private, and use of present-day surveys of customers' preferences to build up test
markets capable of modelling such changes. Alternatively, conjoint analysis (a ranking of users' preferences
which can then be statistically analysed) may be used.[9]

[edit]Graphical representation
It is important to note that elasticity and slope are, in the most part, unrelated. Thus, when supply is
represented linearly, regardless of the slope of the supply line, the coefficient of elasticity of any linear
supply curve that passes through the origin is 1 (unit elastic);[10] the coefficient of elasticity of any linear
supply curve that cuts the y-axis is greater than 1 (elastic), and the coefficient of elasticity of any linear
supply curve that cuts the x-axis is less than 1 (inelastic).[

 „„„] Likewise, for any given supply curve, it is
likely that PES will vary along the curve.[2]

Gross domestic product

The 


 

( V) or 


 
 ( V) 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 thestandard 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]

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

i




[hide]

? 1 Determining GDP
? 1.1 Income Approach
? 1.2 Expenditure approach
? 1.2.1 Components of GDP by
xpenditure
? 1.2.2 Examples of GDP component
ariables
? 1.3 Income approach
? 2 GDP vs GNP
? 2.1 International standards
? 2.2 National measurement
? 2.3 Interest rates
? 3 Adjustments to GDP
? 4 Cross-border comparison
? 5 Standard of living and GDP
? 6 Limitations of GDP to judge the health of an economy
? 6.1 Alternatives to GDP
? 7 Lists of countries by their GDP
? 8 See also
? 9 Bibliography
? 10 References
? 11 External links
? 11.1 Global
? 11.2 Data
? 11.3 Articles and books

[edit] Determining GDP

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:

Ú
  
 


  
 
 
, or
±

 "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. "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:

â? 

 

 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.
â? If separated from endogenous private consumption, 


 

 can be treated
as exogenous,[

 „„„] so that different government spending levels can be considered within a
meaningful macroeconomic framework.
[edit]
!
 
This method measures GDP by adding the incomes that firms pay households for the factors of production
they hire- wages for labor, interest for capital, rent for land and profits for entrepreneurship.

The US "National Income and Expenditure Accounts" divide incomes into five categories:

1.? Wages, salaries, and supplementary labour income

2.? Corporate profits
3.? Interest and miscellaneous investment income
4.? Farmers͛ income
5.? Income from non-farm unincorporated businesses

These five income components sum to net domestic income at factor cost.

Two adjustments must be made to get GDP:

1.? Indirect taxes minus subsidies are added to get from factor cost to market prices.
2.? Depreciation (or capital consumption) is added to get from net domestic product to gross
domestic product.
[edit]c

 
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.

˜i
  
 

Components of U.S. GDP

(  is a sum of i
 


i,  
 
,

 
   and ±
c


‰.

=i++ + ‰

Here is a description of each GDP component:

â? i

 

 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.
â?  
 
 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 

. 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 orstocks is a swapping
of deeds, a transfer of claims on future production, not directly an expenditure on products.
â? 

 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.
â? m

 represents gross exports. GDP captures the amount a country produces, including
goods and services produced for other nations' consumption, therefore exports are added.
â? ‰

 represents gross imports. Imports are subtracted since imported goods will be
included in the terms , , or i, and must be deducted to avoid counting foreign supply as domestic.

A fully equivalent definition is that V! is the sum of  
 



ic, 
 
 



 i, and 


m‰.

! = ic + i+ 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 i, , and  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.[4] )

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]."[5]
L M N OP N LNQ Q R
˜„
c
  
   M
i, , , and ±m(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 ), 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 onsumption, 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 .

If the renovation involves the purchase of a chandelier from abroad, that spending would be counted
as i, , or  (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 i, , or , but would be counted as an export.

[edit]

 
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:

Ú
  „
 „ „„    „
     
%„
 „  %„ „ 2

„ 
 
 
 
V = i c +  + ‰ + "‰ - "‰

â? i




 (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.
â? 


   (GOS) is the surplus due to owners of incorporated businesses. Often
called profits, although only a subset of total costs are subtracted from gross outputto calculate GOS.
â? 

 (GMI) is the same measure as GOS, but for unincorporated businesses. This
often includes most small businesses.

The sum of i c,  and ‰ 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:

ð   
 „  ! „„  „
   „ 
 
 
„„&
 „  '„
 „ 
„
„„[6]

Yet another formula for GDP by the income method is:[

 „„„]
S
Ú
='+(+
+ +)
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 boundaryʹthat is, what parts of the myriad human activities are to be included in or excluded
from the measure of the economic production."[7]

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."[8] 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.[9] 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."[10]

Within the limits so far described, the boundary is further constricted by "functional considerations."[11] 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.[12] 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.[13] 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 „ included within the boundary are listed below. Since, by definition, they do not
have a market price, the compilers of GDP must
„ 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.

â? 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.[14]
â? 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.
â? 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.[15] 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.
â? Agricultural production for consumption by oneself or one's household is included.
â? 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.[16]
[edit]GDP vs GNP
GDP can be contrasted with 


 

( ±) or 


 
 ( ±). The difference is
that GDP defines its scope according to location, while GNP defines its scope according to ownership. In a
global context, world GDP and world GNP are therefore equivalent terms.
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 itsGDP 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.[17] The relationship between United States GDP and GNP is shown in table 1.7.5 of the  
   
[18] .

[edit]



 


The international standard for measuring GDP is contained in the book 
 `  
(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)[ 
][ ]
.

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.

his section requires expansion.

[edit] ±

  
 

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).

‰  

 
 
2` Ú

 

[edit]





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 moneyʹinflation 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,
 *++,  „ „ T 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 Ú
„  . Unlike
the Consumer price index, which measures inflation (or deflationʹrarely!) in the price of household
consumer goods, the GDP deflator measures changes in the prices all domestically produced goods and
services in an economyʹincluding investment goods and government services, as well as household
consumption goods.[19]

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  = [(Real GDP in year ) - (Real GDP in year  - 1)]/ (Real GDP in year  - 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.
„"

Ú
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 „
„ the current currency exchange rate, or the purchase power parity exchange rate.

â? i 
   
 is the exchange rate in the international currency market.
â?   

 
 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.

â? The „ „%„ „ „  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 „ „%„ „, 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.
â? The 
  „ 
 „  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 11th 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 
  „ 
 „  decreasing the disparity in GDP between high
and low income (GDP) countries, as compared to the „ „%„ „ „ . 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.[20]

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 activityͶ 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 „ 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.[21] Other criticisms of how the GDP is used include:

â? §



ʹGDP 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.
â? ±
#



ʹGDP 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.
â? 


ʹOfficial 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.
â? ±




ʹGDP 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).
â? GDP also ignores subsistence production.
â?   


 



ʹBy 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.
â? §

 ʹGDP 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 exampleͶit
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.
â? c
 
ʹGDP 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.
â?  
 



ʹGDP 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.
â? 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.
â? 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.
â? Transfer pricing on cross-border trades between associated companies may distort import and
export measures[ ].
â? 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 underestimateaggregate utility.

Simon Kuznets in his very first report to the US Congress in 1934 said:[22]

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

In 1962, Kuznets stated:[23]

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.

(

  

 



[57]
The prestigious Tidel Park in Chennai. India has Asia's largest outsourcingindustry and is the world's second most favorable
[58]
outsourcing destination after theUnited States.

[59][60]
India has one of the world's fastest growingautomobile industries Shown here is the Tata Motors' Nano, the world's
[61]
cheapest car.

Industry accounts for 28% of the GDP and employ 14% of the total workforce.[22] However, about one-
third of the industrial labour force is engaged in simple household manufacturing only.[62][#] In
absolute terms, India is 16th in the world in terms of nominal factory output.[63]

Economic reforms brought foreign competition, led to privatisation of certain public sector industries,
opened up sectors hitherto reserved for the public sector and led to an expansion in the production of
fast-moving consumer goods.[64] Post-liberalisation, the Indian private sector, which was usually run by
oligopolies of old family firms and required political connections to prosper was faced with foreign
competition, including the threat of cheaper Chinese imports. It has since handled the change by
squeezing costs, revamping management, focusing on designing new products and relying on low labour
costs and technology.[65]

Textile manufacturing is the second largest source for employment after agriculture and accounts for
26% of manufacturing output.[66] Ludhianaproduces 90% of woolens in India and is also Known as the
Manchester of India. Tirupur has gained universal recognition as the leading source of hosiery, knitted
garments, casual wear and sportswear.[67] Dharavi slum in Mumbai has gained fame for leather
products. Tata Motors' Nanoattempts to be the world's cheapest car.[61]

India is fifteenth in services output. It provides employment to 23% of work force, and it is growing fast,
growth rate 7.5% in 1991ʹ2000 up from 4.5% in 1951ʹ80. It has the largest share in the GDP, accounting
for 55% in 2007 up from 15% in 1950.[22]

Business services (information technology, information technology enabled services, business process
outsourcing) are among the fastest growing sectors contributing to one third of the total output of
services in 2000. The growth in the IT sector is attributed to increased specialization, and an availability
of a large pool of low cost, but highly skilled, educated and fluent English-speaking workers, on
the supply side, matched on the demand side by an increased demand from foreign consumers
interested in India's service exports, or those looking tooutsource their operations. The share of India's
IT industry to the country's GDP increased from 4.8 % in 2005-06 to 7% in 2008.[68][69] In 2009, seven
Indian firms were listed among the top 15 technology outsourcing companies in the world.[70] In March
2009, annual revenues from outsourcing operations in India amounted to US$60 billion and this is
expected to increase to US$225 billion by 2020.[71]

Organized retail such supermarkets accounts for 24% of the market as of 2008.[72] Regulations prevent
most foreign investment in retailing. Moreover, over thirty regulations such as "signboard licences" and
"anti-hoarding measures" may have to be complied before a store can open doors. There are taxes for
moving goods to states, from states, and even within states.[72]

Tourism in India is relatively undeveloped, but growing at double digits. Some hospitals woo medical
tourism.[73]

Economic liberalisation in India

From Wikipedia, the free encyclopedia

The 

   


 refers to ongoing economic reforms in India that started in 1991.
After Independence in 1947, India adhered to socialist policies. In the 1980s, Prime Minister Rajiv
Gandhi initiated some reforms. In 1991, after the International Monetary Fund (IMF) had bailed out the
bankrupt state, the government of P. V. Narasimha Rao and his finance minister Manmohan
Singh started breakthrough reforms.[1] The new neo-liberal policies included opening for international
trade and investment, deregulation, initiation ofprivatization, tax reforms, and inflation-controlling
measures. The overall direction of liberalisation has since remained the same, irrespective of the ruling
party, although no party has yet tried to take on powerful lobbies such as the trade unions and farmers,
or contentious issues such as reforming labor laws and reducing agricultural subsidies.[2] The main
objective of the government was to transform the economic system from socialist to capitalist so that to
achieve high economic growth and industrialize the nation for the well-being of Indian citizens.[3]Today
India is mainly characterized as a market economy.[4]

As of 2009, about 300 million peopleͶequivalent to the entire population of the United StatesͶ
have escaped extreme poverty.[5] The fruits of liberalisation reached their peak in 2007, when India
recorded its highest GDP growth rate of 9%.[6] With this, India became the second fastest growing major
economy in the world, next only to China.[7] An Organisation for Economic Co-operation and
Development (OECD) report states that the average growth rate 7.5% will double the average income in
a decade, and more reforms would speed up the pace.[8]

Indian government coalitions have been advised to continue liberalisation. India grows at slower pace
than China, which has been liberalising its economy since 1978.[9] McKinsey states that removing main
obstacles "would free India͛s economy to grow as fast as China͛s, at 10 percent a year".[10]

Narasimha Rao government (1991ʹ1996)

Present Prime Minister Manmohan Singhwas then Finance Minister in Cabinet of Prime MinisterP V Narasimha Rao

[edit]i

‰ *++*   



The assassination of prime minister Indira Gandhi in 1984, and later of her son Rajiv Gandhi in 1991,
crushed international investor confidence on the economy that was eventually pushed to the brink by
the early 1990s.

As of 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a
basket of currencies of major trading partners. India started having balance of payments problems since
1985, and by the end of 1990, it was in a serious economic crisis. The government was close to
default,[18] its central bank had refused new credit and foreign exchange reserves had reduced to the
point that Indiacould barely finance three weeks͛ worth of imports.