Business Economics - Research Paper Example

Business Economics Limitations of National Income Accounts in How They Represent Our Standard of Living The World Bank (2004, Glossary) defines standard of living as “the level of well-being as measured by the level of income or the quantity of various goods and services consumed.” It is also referred to as the “quality of life” of a people. National income accounting is an aggregate measure of the outcome of economic activities. The most commonly used measure is the gross domestic product (GDP) which represents the aggregate production of goods and services at market value.

There are some serious limitations in how it represents our standard of living. The underground economy or black market is not reflected. GDP only covers formally reported income and production. It does not cover activities like prostitution and drugs as both of these are illegal activities. However, individuals use income from these sources as a means of improving their standard of living. “GDP does not account for income distribution effects that may be important to economic well-being” Suranovic (2010).

GDP per capita might have increased but income is not equally distributed. Additionally, Economic activity as represented by GDP may rise while the standard of living may have fallen. For example, situations may occur that negatively impact people and therefore cause them to increase spending. Examples of these are natural disasters such as hurricanes and earthquakes. Further, work done at home is not included in production. For example, if you go out to eat in a restaurant the cost of that meal is included but if the housewife prepares that same meal at home it is not included.

According to the Director of the Bureau of Economic Analysis - Steve Landefeld (2010, GDP: Statement) “It was not designed to be, nor should be regarded as, a comprehensive measure of society's well-being. Nonetheless, it has also proven useful as a gauge of an economy's capacity to improve living standards.” The Importance of Frictional Unemployment to an Economy Rittenberg and Tregarthen (2009) states that: “Unemployment that occurs because it takes time for employers and workers to find each other is called frictional unemployment”frictional unemploymentUnemployment that occurs because it takes time for employers and workers to find each other.. Frictional unemployment is the temporary displacement of workers for various reasons.

Persons, who change jobs, are laid off or who have recently graduated from College will go through a period of temporary unemployment. A minimum level of unemployment will occur in even the most efficient economy. This is described as the natural rate of unemployment. Frictional unemployment is important in any economy because full employment will result in inflationary pressures on the economy. If full employment exists it means that when a firm wants to employ workers it would have to offer them higher wages to lure them away from their current jobs.

In order for firms from which those workers were attracted to get new workers they will have to offer higher wages to lure other workers away from their current jobs. This process of increasing wages will result in higher prices for the goods and services in the economy as the demand for goods and services increases. Thus Suranovic (2010) states: “As prices for final products begin to rise, workers may begin to demand higher wages to keep up with the rising cost of living. These wage increases will in turn lead firms to raise the prices of their outputs, leading to another round of increases in wages and prices.

This process is known as wage spiral.” Additionally, Frictional unemployment is important because it allows employers to find persons who are best suited for jobs and also allows workers to move to jobs that are suited to their skills, knowledge and qualifications. Without this necessary event persons would remain in jobs for a long time thus stifling both their growth and that of the firm to which they are employed. With new employees there is increased possibility of new skills, ideas and innovation.

Differences between Fixed and Flexible Exchange Rates Fixed exchange rate is also referred to as pegged exchange rate. Countries using this type of exchange rate regime match the value of their currency to another countries currency or a basket of foreign currencies. As the referenced currency to which a country’s currency is pegged devalues (decrease in value) the country’s currency devalues as well and as the referenced currency revalues (increase in value) it revalues with it. The referenced currency is normally the currency of a major trading partner or partners.

This allows for stable prices between the country and its major trading partner or partners. Rittenberg & Tregarthen (2009) states that: “Fixed exchange rate systems offer the advantage of predictable currency values—when they are working. But for fixed exchange rates to work, the countries participating in them must maintain domestic economic conditions that will keep equilibrium currency values close to the fixed rates.” Flexible exchange rate is also referred to as floating exchange rate.

Countries using this regime can adopt a managed float or a free float. Under a managed float the exchange rate is allowed to float but government intervenes when necessary to prevent large swings. With a free float the value of the currency changes in response to the market forces of demand and supply. These movements are normally based on the foreign currency reserves of the country, its international trade balance, inflation rate, interest rate and the strength of the country’s economy. A flexible exchange rate system usually allow for improvements in the balance of trade as the prices of goods produced in that country become cheaper when the currency devalues.

“An exchange rate change, however, affects not only the domestic currency values of your future foreign currency receipts and payments but also affects their foreign currency values by affecting the volume and value of future trade flows” (Kenen, 2000). References Kenen, P. B. (2000). Fixed versus Floating Exchange Rates. Cato Journal. 20 (1) 109-113. Landefeld, S. (2010, April). GDP: Incomplete. Retrieved from: http://www.economist.com/debate/days/view/501 Rittenberg, L. and Tregarthen, T. (2009). Principles of Economics.

Retrieved from: http://www.flatworldknowledge.com/pub/1.0/principles-economics/31872#web-31916 Suranovic, S. (2010). International Economics: Theory and Policy. http://www.flatworldknowledge.com/pub/1.0/international-economics-theory/203710#web The World Bank. (2004). Beyond Economic Growth student Book: Glossary. Retrieved from: http://www.worldbank.org/depweb/english/beyond/global/glossary.html