- Rescheduled paper of MA (Final) External / Regular JULY 14TH, 2011

IQRA STUDY CENTRE - Introduction to Correlation and Regression

IQRA STUDY CENTRE - Introduction to Correlation and Regression

Hypergeometric Distribution

Hypergeometric Experiments
A hypergeometric experiment is a statistical experiment that has the following properties:

A sample of size n is randomly selected without replacement from a population of N items.
In the population, k items can be classified as successes, and N - k items can be classified as failures.
Consider the following statistical experiment. You have an urn of 10 marbles - 5 red and 5 green. You randomly select 2 marbles without replacement and count the number of red marbles you have selected. This would be a hypergeometric experiment.

Note that it would not be a binomial experiment. A binomial experiment requires that the probability of success be constant on every trial. With the above experiment, the probability of a success changes on every trial. In the beginning, the probability of selecting a red marble is 5/10. If you select a red marble on the first trial, the probability of selecting a red marble on the second trial is 4/9. And if you select a green marble on the first trial, the probability of selecting a red marble on the second trial is 5/9.

Note further that if you selected the marbles with replacement, the probability of success would not change. It would be 5/10 on every trial. Then, this would be a binomial experiment.

Notation
The following notation is helpful, when we talk about hypergeometric distributions and hypergeometric probability.

N: The number of items in the population.
k: The number of items in the population that are classified as successes.
n: The number of items in the sample.
x: The number of items in the sample that are classified as successes.
kCx: The number of combinations of k things, taken x at a time.
h(x; N, n, k): hypergeometric probability - the probability that an n-trial hypergeometric experiment results in exactly x successes, when the population consists of N items, k of which are classified as successes.
Hypergeometric Distribution
A hypergeometric random variable is the number of successes that result from a hypergeometric experiment. The probability distribution of a hypergeometric random variable is called a hypergeometric distribution.

Given x, N, n, and k, we can compute the hypergeometric probability based on the following formula:

Hypergeometric Formula. Suppose a population consists of N items, k of which are successes. And a random sample drawn from that population consists of n items, x of which are successes. Then the hypergeometric probability is:
h(x; N, n, k) = [ kCx ] [ N-kCn-x ] / [ NCn ]

The hypergeometric distribution has the following properties:

The mean of the distribution is equal to n * k / N .
The variance is n * k * ( N - k ) * ( N - n ) / [ N2 * ( N - 1 ) ] .
Example 1

Suppose we randomly select 5 cards without replacement from an ordinary deck of playing cards. What is the probability of getting exactly 2 red cards (i.e., hearts or diamonds)?

Solution: This is a hypergeometric experiment in which we know the following:

N = 52; since there are 52 cards in a deck.
k = 26; since there are 26 red cards in a deck.
n = 5; since we randomly select 5 cards from the deck.
x = 2; since 2 of the cards we select are red.
We plug these values into the hypergeometric formula as follows:

h(x; N, n, k) = [ kCx ] [ N-kCn-x ] / [ NCn ]
h(2; 52, 5, 26) = [ 26C2 ] [ 26C3 ] / [ 52C5 ]
h(2; 52, 5, 26) = [ 325 ] [ 2600 ] / [ 2,598,960 ] = 0.32513
Thus, the probability of randomly selecting 2 red cards is 0.32513.

Binomial Distribution

To understand binomial distributions and binomial probability, it helps to understand binomial experiments and some associated notation; so we cover those topics first.

Binomial Experiment
A binomial experiment (also known as a Bernoulli trial) is a statistical experiment that has the following properties:

The experiment consists of n repeated trials.
Each trial can result in just two possible outcomes. We call one of these outcomes a success and the other, a failure.
The probability of success, denoted by P, is the same on every trial.
The trials are independent; that is, the outcome on one trial does not affect the outcome on other trials.
Consider the following statistical experiment. You flip a coin 2 times and count the number of times the coin lands on heads. This is a binomial experiment because:

The experiment consists of repeated trials. We flip a coin 2 times.
Each trial can result in just two possible outcomes - heads or tails.
The probability of success is constant - 0.5 on every trial.
The trials are independent; that is, getting heads on one trial does not affect whether we get heads on other trials.
Notation
The following notation is helpful, when we talk about binomial probability.

x: The number of successes that result from the binomial experiment.
n: The number of trials in the binomial experiment.
P: The probability of success on an individual trial.
Q: The probability of failure on an individual trial. (This is equal to 1 - P.)
b(x; n, P): Binomial probability - the probability that an n-trial binomial experiment results in exactly x successes, when the probability of success on an individual trial is P.
nCr: The number of combinations of n things, taken r at a time.
Binomial Distribution
A binomial random variable is the number of successes x in n repeated trials of a binomial experiment. The probability distribution of a binomial random variable is called a binomial distribution (also known as a Bernoulli distribution).

Suppose we flip a coin two times and count the number of heads (successes). The binomial random variable is the number of heads, which can take on values of 0, 1, or 2. The binomial distribution is presented below.

Number of heads Probability
0 0.25
1 0.50
2 0.25
The binomial distribution has the following properties:

The mean of the distribution (μx) is equal to n * P .
The variance (σ2x) is n * P * ( 1 - P ).
The standard deviation (σx) is sqrt[ n * P * ( 1 - P ) ].
Binomial Probability
The binomial probability refers to the probability that a binomial experiment results in exactly x successes. For example, in the above table, we see that the binomial probability of getting exactly one head in two coin flips is 0.50.

Given x, n, and P, we can compute the binomial probability based on the following formula:

Binomial Formula. Suppose a binomial experiment consists of n trials and results in x successes. If the probability of success on an individual trial is P, then the binomial probability is:
b(x; n, P) = nCx * Px * (1 - P)n - x


Example 1

Suppose a die is tossed 5 times. What is the probability of getting exactly 2 fours?

Solution: This is a binomial experiment in which the number of trials is equal to 5, the number of successes is equal to 2, and the probability of success on a single trial is 1/6 or about 0.167. Therefore, the binomial probability is:

b(2; 5, 0.167) = 5C2 * (0.167)2 * (0.833)3
b(2; 5, 0.167) = 0.161

Example 1

What is the probability of obtaining 45 or fewer heads in 100 tosses of a coin?

Solution: To solve this problem, we compute 46 individual probabilities, using the binomial formula. The sum of all these probabilities is the answer we seek. Thus,

b(x < 45; 100, 0.5) = b(x = 0; 100, 0.5) + b(x = 1; 100, 0.5) + . . . + b(x = 45; 100, 0.5)
b(x < 45; 100, 0.5) = 0.184


Example 2

The probability that a student is accepted to a prestigeous college is 0.3. If 5 students from the same school apply, what is the probability that at most 2 are accepted?

Solution: To solve this problem, we compute 3 individual probabilities, using the binomial formula. The sum of all these probabilities is the answer we seek. Thus,

b(x < 2; 5, 0.3) = b(x = 0; 5, 0.3) + b(x = 1; 5, 0.3) + b(x = 2; 5, 0.3)
b(x < 2; 5, 0.3) = 0.1681 + 0.3601 + 0.3087
b(x < 2; 5, 0.3) = 0.8369


Example 3

What is the probability that the world series will last 4 games? 5 games? 6 games? 7 games? Assume that the teams are evenly matched.

Solution: This is a very tricky application of the binomial distribution. If you can follow the logic of this solution, you have a good understanding of the material covered in the tutorial, to this point.

In the world series, there are two baseball teams. The series ends when the winning team wins 4 games. Therefore, we define a success as a win by the team that ultimately becomes the world series champion.

For the purpose of this analysis, we assume that the teams are evenly matched. Therefore, the probability that a particular team wins a particular game is 0.5.

Let's look first at the simplest case. What is the probability that the series lasts only 4 games. This can occur if one team wins the first 4 games. The probability of the National League team winning 4 games in a row is:

b(4; 4, 0.5) = 4C4 * (0.5)4 * (0.5)0 = 0.0625

Similarly, when we compute the probability of the American League team winning 4 games in a row, we find that it is also 0.0625. Therefore, probability that the series ends in four games would be 0.0625 + 0.0625 = 0.125; since the series would end if either the American or National League team won 4 games in a row.

Now let's tackle the question of finding probability that the world series ends in 5 games. The trick in finding this solution is to recognize that the series can only end in 5 games, if one team has won 3 out of the first 4 games. So let's first find the probability that the American League team wins exactly 3 of the first 4 games.

b(3; 4, 0.5) = 4C3 * (0.5)3 * (0.5)1 = 0.25

Okay, here comes some more tricky stuff, so listen up. Given that the American League team has won 3 of the first 4 games, the American League team has a 50/50 chance of winning the fifth game to end the series. Therefore, the probability of the American League team winning the series in 5 games is 0.25 * 0.50 = 0.125. Since the National League team could also win the series in 5 games, the probability that the series ends in 5 games would be 0.125 + 0.125 = 0.25.

The rest of the problem would be solved in the same way. You should find that the probability of the series ending in 6 games is 0.3125; and the probability of the series ending in 7 games is also 0.3125.

KARACHI UNIVERSITY HAS POSTPONED ALL PAPERS TODAY

KARACHI UNIVERSITY HAS POSTPONED ALL PAPERS TODAY,NEW DATES WILL BE ANNOUNCED LATER.

ATTENTION COMMERCE STUDENTS

Dunya Classifieds

IQRA STUDY CENTRE - A Comparative Analysis of Capitalist and Islamic Economic Systems

IQRA STUDY CENTRE - A Comparative Analysis of Capitalist and Islamic Economic Systems

The Delphi technique

What is it?
The Delphi technique has been described as ‘a method for structuring a 
group communication process so that the process is effective in allowing a 
group of individuals, as a whole, to deal with a complex problem’ 

Where does it come from?
It has its origins in the Cold War in the 1950s when the Rand Corporation, 
funded by the US Air Force, was trying to find a way to establish reliable 
consensus of opinion among a group of experts about how Soviet military 
planners might target the US industrial system in an attack and how many 
atomic bombs would be needed to have a specified level of impact on US 
military capability. This was the original ‘Project Delphi’.

What is it used for?
Fifty years later, it is widely used for more peaceful purposes, but with the
same underlying rationale: to establish as objectively as possible a
consensus on a complex problem, in circumstances where accurate
information does not exist or is impossible to obtain economically, or inputs to
conventional decision making for example by a committee meeting face to 
face are so subjective that they risk drowning out individuals’ critical 
judgements.

It is a family of techniques, rather than a single clearly­understood procedure, 
but the typical features of a Delphi procedure are an expert panel; a series of 
rounds in which information is collected from panellists, analysed and fed 
back to them as the basis for subsequent rounds; an opportunity for
individuals to revise their judgments on the basis of this feedback; and some 
degree of anonymity for their individual contributions.

The ELTons is certainly a complex problem requiring structured decisionmaking!
The format we have used for the last seven years has a panel of six
or seven judges, working at a distance, with all communication by email
through a moderator. There are two separate stages, shortlisting and judging,
each consisting of an initial round that elicits panellists’ comments on the
entries or the products, followed by one, two or three rounds in which
panellists nominate their preferred entries. The number of rounds depends on
how quickly a consensus emerges.
Panellists send their responses to the moderator, who collates them and
circulates them anonymously after each round, as the basis for the next
round. The panellists have at each stage a full record of what comments and
nominations other panellists have made, but they do not know who made
which comment or voted for which entry. Nor do they know the final result;
like the rest of the audience at the awards party, the judges themselves do
not know the outcome until the envelope is opened!

HENRI FAYOL’S 14 Principles of Management

Management Principles developed by Henri Fayol:

DIVISION OF WORK:
Work should be divided among individuals and groups to ensure that effort and attention are focused on special portions of the task. Fayol presented work specialization as the best way to use the human resources of the organization.
AUTHORITY:
The concepts of Authority and responsibility are closely related. Authority was defined by Fayol as the right to give orders and the power to exact obedience. Responsibility involves being accountable, and is therefore naturally associated with authority. Whoever assumes authority also assumes responsibility.

DISCIPLINE:
A successful organization requires the common effort of workers. Penalties should be applied judiciously to encourage this common effort.

UNITY OF COMMAND:
Workers should receive orders from only one manager.
UNITY OF DIRECTION:
The entire organization should be moving towards a common objective in a common direction.
SUBORDINATION OF INDIVIDUAL INTERESTS TO THE GENERAL INTERESTS:
The interests of one person should not take priority over the interests of the organization as a whole.
REMUNERATION:
Many variables, such as cost of living, supply of qualified personnel, general business conditions, and success of the business, should be considered in determining a worker’s rate of pay.
CENTRALIZATION:
Fayol defined centralization as lowering the importance of the subordinate role. Decentralization is increasing the importance. The degree to which centralization or decentralization should be adopted depends on the specific organization in which the manager is working.
SCALAR CHAIN:
Managers in hierarchies are part of a chain like authority scale. Each manager, from the first line supervisor to the president, possess certain amounts of authority. The President possesses the most authority; the first line supervisor the least. Lower level managers should always keep upper level managers informed of their work activities. The existence of a scalar chain and adherence to it are necessary if the organization is to be successful.
ORDER:
For the sake of efficiency and coordination, all materials and people related to a specific kind of work should be treated as equally as possible.

EQUITY:
All employees should be treated as equally as possible.
STABILITY OF TENURE OF PERSONNEL:
Retaining productive employees should always be a high priority of management. Recruitment and Selection Costs, as well as increased product-reject rates are usually associated with hiring new workers.
INITIATIVE:
Management should take steps to encourage worker initiative, which is defined as new or additional work activity undertaken through self direction.

ESPIRIT DE CORPS:
Management should encourage harmony and general good feelings among employees.

Product life cycle management

Product life cycle management (or PLCM) is the succession of strategies used by business management as a product goes through its life cycle. The conditions in which a product is sold (advertising, saturation) changes over time and must be managed as it moves through its succession of stages.
Product life cycle (PLC) Like human beings, products also have a life-cycle. From birth to death, human beings pass through various stages e.g. birth, growth, maturity, decline and death. A similar life-cycle is seen in the case of products. The product life cycle goes through multiple phases, involves many professional disciplines, and requires many skills, tools and processes. Product life cycle (PLC) has to do with the life of a product in the market with respect to business/commercial costs and sales measures. To say that a product has a life cycle is to assert three things:
Products have a limited life,
Product sales pass through distinct stages, each posing different challenges, opportunities, and problems to the seller,
Products require different marketing, financing, manufacturing, purchasing, and human resource strategies in each life cycle stage.
The four main stages of a product's life cycle and the accompanying characteristics are:
Stage Characteristics
1. Market introduction stage
costs are very high
slow sales volumes to start
little or no competition
demand has to be created
customers have to be prompted to try the product
makes no money at this stage
2. Growth stage
costs reduced due to economies of scale
sales volume increases significantly
profitability begins to rise
public awareness increases
competition begins to increase with a few new players in establishing market
increased competition leads to price decreases
3. Maturity stage
costs are lowered as a result of production volumes increasing and experience curve effects
sales volume peaks and market saturation is reached
increase in competitors entering the market
prices tend to drop due to the proliferation of competing products
brand differentiation and feature diversification is emphasized to maintain or increase market share
Industrial profits go down
4. Saturation and decline stage
costs become counter-optimal
sales volume decline or stabilize
prices, profitability diminish
profit becomes more a challenge of production/distribution efficiency than increased sales

W.W. Rostow, The Stages of Economic Growth

It is possible to identify all societies, in their economic dimensions, as lying within one of five categories: the traditional society, the preconditions for take-off, the take-off, the drive to maturity, and the age of high mass-consumption.

THE TRADITIONAL SOCIETY

First, the traditional society. A traditional society is one whose structure is developed within limited production functions, based on pre-Newtonian science and technology, and on pre-Newtonian attitudes towards the physical world. Newton is here used as a symbol for that watershed in history when men came widely to believe that the external world was subject to a few knowable laws, and was systematically capable of productive manipulation.

The conception of the traditional society is, however, in no sense static; and it would not exclude increases in output. Acreage could be expanded; some ad hoc technical innovations, often highly productive innovations, could be introduced in trade, industry and agriculture; productivity could rise with, for example, the improvement of irrigation works or the discovery and diffusion of a new crop. But the central fact about the traditional society was that a ceiling existed on the level of attainable output per head. This ceiling resulted from the fact that the potentialities which flow from modern science and technology were either not available or not regularly and systematically applied.

Both in the longer past and in recent times the story of traditional societies was thus a story of endless change. The area and volume of trade within them and between them fluctuated, for example, with the degree of political and social turbulence, the efficiency of central rule, the upkeep of the roads. Population--and, within limits, the level of life--rose and fell not only with the sequence of the harvests, but with the incidence of war and of plague. Varying degrees of manufacture developed; but, as in agriculture, the level of productivity was limited by the inaccessibility of modern science, its applications, and its frame of mind.

Generally speaking, these societies, because of the limitation on productivity, had to devote a very high proportion of their resources to agriculture; and flowing from the agricultural system there was an hierarchical social structure, with relatively narrow scope--but some scope--for vertical mobility. Family and clan connexions played a large role in social organization. The value system of these societies was generally geared to what might be called a long-run fatalism; that is, the assumption that the range of possibilities open to one's grandchildren would be just about what it had been for one's grandparents. But this long-run fatalism by no means excluded the short-run option that, within a considerable range, it was possible and legitimate for the individual to strive to improve his lot, within his lifetime. In Chinese villages, for example, there was an endless struggle to acquire or to avoid losing land, yielding a situation where land rarely remained within the same family for a century.

Although central political rule--in one form or another--often existed in traditional societies, transcending the relatively self-sufficient regions, the centre of gravity of political power generally lay in the regions, in the hands of those who owned or controlled the land. The landowner maintained fluctuating but usually profound influence over such central political power as existed, backed by its entourage of civil servants and soldiers, imbued with attitudes and controlled by interests transcending the regions.

In terms of history then, with the phrase 'traditional society' we are grouping the whole pre-Newtonian world : the dynasties in China; the civilization of the Middle East and the Mediterranean; the world of medieval Europe. And to them we add the post-Newtonian societies which, for a time, remained untouched or unmoved by man's new capability for regularly manipulating his environment to his economic advantage.

To place these infinitely various, changing societies in a single category, on the ground that they all shared a ceiling on the productivity of their economic techniques, is to say very little indeed. But we are, after all, merely clearing the way in order to get at the subject of this book; that is, the post-traditional societies, in which each of the major characteristics of the traditional society was altered in such ways as to permit regular growth: its politics, social structure, and (to a degree) its values, as well as its economy.

THE PRECONDITIONS FOR TAKE-OFF

The second stage of growth embraces societies in the process of transition; that is, the period when the preconditions for take-off are developed; for it takes time to transform a traditional society in the ways necessary for it to exploit the fruits of modern science, to fend off diminishing returns, and thus to enjoy the blessings and choices opened up by the march of compound interest.

The preconditions for take-off were initially developed, in a clearly marked way, in Western Europe of the late seventeenth and early eighteenth centuries as the insights of modern science began to be translated into new production functions in both agriculture and industry, in a setting given dynamism by the lateral expansion of world markets and the international competition for them. But all that lies behind the break-up of the Middle Ages is relevant to the creation of the preconditions for take-off in Western Europe. Among the Western European states, Britain, favoured by geography, natural resources, trading possibilities, social and political structure, was the first to develop fully the preconditions for take-off.

The more general case in modern history, however, saw the stage of preconditions arise not endogenously but from some external intrusion by more advanced societies. These invasions-literal or figurative-shocked the traditional society and began or hastened its undoing; but they also set in motion ideas and sentiments which initiated the process by which a modern alternative to the traditional society was constructed out of the old culture.

The idea spreads not merely that economic progress is possible, hut that economic progress is a necessary condition for some other purpose, judged to be good: be it national dignity, private profit, the general welfare, or a better life for the children. Education, for some at least, broadens and changes to suit the needs of modern economic activity. New types of enterprising men come forward--in the private economy, in government, or both--willing to mobilize savings and to take risks in pursuit of profit or modernization. Banks and other institutions for mobilizing capital appear. Investment increases, notably in transport, communications, and in raw materials in which other nations may have an economic interest. The scope of commerce, internal and external, widens. And, here and there, modern manufacturing enterprise appears, using the new methods. But all this activity proceeds at a limited pace within an economy and a society still mainly characterized by traditional low-productivity methods, by the old social structure and values, and by the regionally based political institutions that developed in conjunction with them.

In many recent cases, for example, the traditional society persisted side by side with modern economic activities, conducted for limited economic purposes by a colonial or quasi-colonial power.

Although the period of transition--between the traditional society and the take-off--saw major changes in both the economy itself and in the balance of social values, a decisive feature was often political. Politically, the building of an effective centralized national state--on the basis of coalitions touched with a new nationalism, in opposition to the traditional landed regional interests, the colonial power, or both, was a decisive aspect of the preconditions period; and it was, almost universally, a necessary condition for take-off.

There is a great deal more that needs to be said about the preconditions period, but we shall leave it for chapter 3, where the anatomy of the transition from a traditional to a modern society is examined.

THE TAKE-OFF

We come now to the great watershed in the life of modern societies: the third stage in this sequence, the take-off. The take-off is the interval when the old blocks and resistances to steady growth are finally overcome. The forces making for economic progress, which yielded limited bursts and enclaves of modern activity, expand and come to dominate the society. Growth becomes its normal condition. Compound interest becomes built, as it were, into its habits and institutional structure.

In Britain and the well-endowed parts of the world populated substantially from Britain (the United States, Canada etc.) the proximate stimulus for take-off was mainly (but not wholly) technological. In the more general case, the take-off awaited not only the build-up of social overhead capital and a surge of technological development in industry and agriculture, but also the emergence to political power of a group prepared to regard the modernization of the economy as serious, high-order political business.

During the take-off, the rate of effective investment and savings may rise from, say, 5 % of the national income to 10% or more; although where heavy social overhead capital investment was required to create the technical preconditions for take-off the investment rate in the preconditions period could be higher than 5%, as, for example, in Canada before the 1890's and Argentina before 1914. In such cases capital imports usually formed a high proportion of total investment in the preconditions period and sometimes even during the take-off itself, as in Russia and Canada during their pre-1914 railway booms.

During the take-off new industries expand rapidly, yielding profits a large proportion of which are reinvested in new plant; and these new industries, in turn, stimulate, through their rapidly expanding requirement for factory workers, the services to support them, and for other manufactured goods, a further expansion in urban areas and in other modern industrial plants. The whole process of expansion in the modern sector yields an increase of income in the hands of those who not only save at high rates but place their savings at the disposal of those engaged in modern sector activities. The new class of entrepreneurs expands; and it directs the enlarging flows of investment in the private sector. The economy exploits hitherto unused natural resources and methods of production.

New techniques spread in agriculture as well as industry, as agriculture is commercialized, and increasing numbers of farmers are prepared to accept the new methods and the deep changes they bring to ways of life. The revolutionary changes in agricultural productivity are an essential condition for successful take-off; for modernization of a society increases radically its bill for agricultural products. In a decade or two both the basic structure of the economy and the social and political structure of the society are transformed in such a way that a steady rate of growth can be, thereafter, regularly sustained.

As indicated in chapter 4, one can approximately allocate the take-off of Britain to the two decades after 1783; France and the United States to the several decades preceding 1860; Germany, the third quarter of the nineteenth century; Japan, the fourth quarter of the nineteenth century; Russia and Canada the quarter-century or so preceding 1914; while during the 1950's India and China have, in quite different ways, launched their respective take-offs.

THE DRIVE TO MATURITY

After take-off there follows a long interval of sustained if fluctuating progress, as the now regularly growing economy drives to extend modern technology over the whole front of its economic activity. Some 10-20% of the national income is steadily invested, permitting output regularly to outstrip the increase in population. The make-up of the economy changes unceasingly as technique improves, new industries accelerate, older industries level off. The economy finds its place in the international economy: goods formerly imported are produced at home; new import requirements develop, and new export commodities to match them. The society makes such terms as it will with the requirements of modern efficient production, balancing off the new against the older values and institutions, or revising the latter in such ways as to support rather than to retard the growth process.

Some sixty years after take-off begins (say, forty years after the end of take-off) what may be called maturity is generally attained. The economy, focused during the take-off around a relatively narrow complex of industry and technology, has extended its range into more refined and technologically often more complex processes; for example, there may be a shift in focus from the coal, iron, and heavy engineering industries of the railway phase to machine-tools, chemicals, and electrical equipment. This, for example, was the transition through which Germany, Britain, France, and the United States had passed by the end of the nineteenth century or shortly thereafter. But there are other sectoral patterns which have been followed in the sequence from take-off to maturity, which are considered in chapter 5.


Formally, we can define maturity as the stage in which an economy demonstrates the capacity to move beyond the original industries which powered its take-off and to absorb and to apply efficiently over a very wide range of its resources--if not the whole range--the most advanced fruits of (then) modern technology. This is the stage in which an economy demonstrates that it has the technological and entrepreneurial skills to produce not everything, but anything that it chooses to produce. It may lack (like contemporary Sweden and Switzerland, for example) the raw materials or other supply conditions required to produce a given type of output economically; but its dependence is a matter of economic choice or political priority rather than a technological or institutional necessity.

Historically, it would appear that something like sixty years was required to move a society from the beginning of take-off to maturity. Analytically the explanation for some such interval may lie in the powerful arithmetic of compound interest applied to the capital stock, combined with the broader consequences for a society's ability to absorb modern technology of three successive generations living under a regime where growth is the normal condition. But, clearly, no dogmatism is justified about the exact length of the interval from take-off to maturity.

THE AGE OF HIGH MASS-CONSUMPTION

We come now to the age of high mass-consumption, where, in time, the leading sectors shift towards durable consumers' goods and services: a phase from which Americans are beginning to emerge; whose not unequivocal joys Western Europe and Japan are beginning energetically to probe; and with which Soviet society is engaged in an uneasy flirtation.

As societies achieved maturity in the twentieth century two things happened: real income per head rose to a point where a large number of persons gained a command over consumption which transcended basic food, shelter, and clothing; and the structure of the working force changed in ways which increased not only the proportion of urban to total population, but also the proportion of the population working in offices or in skilled factory jobs-aware of and anxious to acquire the consumption fruits of a mature economy.

In addition to these economic changes, the society ceased to accept the further extension of modern technology as an overriding objective. It is in this post-maturity stage, for example, that, through the political process, Western societies have chosen to allocate increased resources to social welfare and security. The emergence of the welfare state is one manifestation of a society's moving beyond technical maturity; but it is also at this stage that resources tend increasingly to be directed to the production of consumers' durables and to the diffusion of services on a mass basis, if consumers' sovereignty reigns. The sewing-machine, the bicycle, and then the various electric-powered household gadgets were gradually diffused. Historically, however, the decisive element has been the cheap mass automobile with its quite revolutionary effects--social as well as economic--on the life and expectations of society.

For the United States, the turning point was, perhaps, Henry Ford's moving assembly line of 1913-14; but it was in the 1920's, and again in the post-war decade, 1946-56, that this stage of growth was pressed to, virtually, its logical conclusion. In the 1950's Western Europe and Japan appear to have fully entered this phase, accounting substantially for a momentum in their economies quite unexpected in the immediate post-war years. The Soviet Union is technically ready for this stage, and, by every sign, its citizens hunger for it; but Communist leaders face difficult political and social problems of adjustment if this stage is launched.

BEYOND CONSUMPTION

Beyond, it is impossible to predict, except perhaps to observe that Americans, at least, have behaved in the past decade as if diminishing relative marginal utility sets in, after a point, for durable consumers' goods; and they have chosen, at the margin, larger families- behaviour in the pattern of Buddenbrooks dynamics.*


Americans have behaved as if, having been born into a system that provided economic security and high mass-consumption, they placed a lower valuation on acquiring additional increments of real income in the conventional form as opposed to the advantages and values of an enlarged family. But even in this adventure in generalization it is a shade too soon to create--on the basis of one case--a new stage-of-growth, based on babies, in succession to the age of consumers' durables: as economists might say, the income-elasticity of demand for babies may well vary from society to society. But it is true that the implications of the baby boom along with the not wholly unrelated deficit in social overhead capital are likely to dominate the American economy over the next decade rather than the further diffusion of consi' mers' durables.

Here then, in an impressionistic rather than an analytic way, are the stages-of-growth which can be distinguished once a traditional society begins its modernization: the transitional period when the preconditions for take-off are created generally in response to the intrusion of a foreign power, converging with certain domestic forces making for modernization; the take-off itself; the sweep into maturity generally taking up the life of about two further generations; and then, finally, if the rise of income has matched the spread of technological virtuosity (which, as we shall see, it need not immediately do) the diversion of the fully mature economy to the provision of durable consumers' goods and services (as well as the welfare state) for its increasingly urban-and then suburban-population. Beyond lies the question of whether or not secular spiritual stagnation will arise, and, if it does, how man might fend it off:

NEW DATES FOR MA ECONOMICS PAPERS OF 8TH & 9TH JULY

MA ECONOMICS MONETARY ECONOMICS PAPER III,9TH JULY HAS BEEN POSTPONED

MA ECONOMICS MONETARY ECONOMICS PAPER III,9TH JULY HAS BEEN POSTPONED.

Islamic Economic System - TRCB

Islamic Economic System - TRCB

Open Market Operation

Generally speaking, Open Market Operation (OMO) is a transaction on the open financial market, involving fiscal instruments such as governments` securities, or commercial papers, commenced by a central banking authority, with the purpose of regulating the money supply and credit conditions. In terms of their duration, there may be distinguished two types of OMO – PEMO (permanent OMO) and REPO (temporary OMO, or repurchase agreement OMO). Most central banks focus their monetary-regulating policies and monitoring on REPO transactions. As transactions, both REPO and PEMO serve to drain or add the available to the banking system reserves. However, PEMO means an outright buying or selling of government securities, while a distinguished feature of REPO is that they are generally short-term, often overnight, and the securities are subject to buy-back.

OMO, as related to the commercial banks, serves a liquidity-providing function. The central banking authority may provide money reserve to the commercial banks by buying securities and unleashing money in the banking system, or it may sell securities. By selling, the central bank (or a group of reserve banks as is the case with the US FED) may lower the interest. The institution does so by means of lowering the interest rates on the government securities and by increasing their offering and, consequently, price, on the open market. Often, OMO is a direct instrument of monetary policy, because the instrument influences the money supply directly. Forex swaps and other types of foreign exchange operations are also open market operations.

For the European Union, the European Central Bank (ECB) is an independent monetary institution, which is responsible for the monetary policy of the Union and the Euro zone. OMOs of the ECB, as part of the European System of Central Banks, are governed and regulated by CHAPTER IV. Article 18 of the Statute of the European System of Central Banks and of the European Central Bank declares that while attaining the aims of the ESCB and implementing its tasks, the ECB, together with the central banking institutions may: — function in the financial markets through the purchase and sale outright or via repurchase agreements, conducted in different currencies and precious metals. In the functioning of the ECB and the national banks in Europe, OMO serves not only as the aforementioned liquidity generator and a steering wheel for short-term interest rates, but also as a way to proclaim the ECB position on the monetary situation in the Euro area. Between mid - 2009 and mid - 2010 the central banks from the Eurosystem plan to conduct OMO purchases in covered bonds with a targeted nominal of EUR60.000.000.000.

According to Reuters, it is the open market operations that helped the Fed to hold interest rates down by backing the WWII borrowing extravaganza of the US government, while refinancing effectively the debt at low cost. Reuters also adds that the Fed of Bernanke is acting in a similar manner through its Treasury bills purchase program.

FED’s Federal Open Market Committee (FOMC) is responsible for conducting OMO policy in the US. FOMC has 12 members. Seven of the members come from the Board of Governors of the Federal Reserve System and thus constitute a majority. They are appointed by the President of the US and approved by the Senate before starting their 14 years of service in the Board. The other 5 representatives in the Committee are Presidents of the Reserve Bank: one of them is the President of the district FRB of New York. This district reserve bank is the largest and most prominent of the twelve reserve banks.

Functions of Central Bank

Central bank is an important organization for any country. It performs traditional and developmental role to accomplish macro-economic objectives. This includes currency issuance, regulation of liquidity, supervision of banks and secondary markets, exchange rate management, balance of payment, establishment and development of financial institutions.
Central bank is the center of banking system of any country and has sole authority to control and regulate the supply of money. Central bank controls the supply of money by keeping the welfare of people in mind as primary object. Functions of central bank are discussed in detail below.

Monopoly over Issuing Currency

The primary function of central banks is to issue money in the country. Central bank issue currency notes by following certain regulations enforced by the state. There are different requirements which central bank need to fulfill for this purpose, one important prerequisite is keeping reserve against issued money. Some important advantages for this sole authority are:
- Credit creation by commercial banks can be checked and controlled by central bank.
- Central Bank has the confidence of people as it has the government backing and recognition.
- As the sole authority of issuing currency there is uniformity in the country’s currency.
- Government can use this sole authority for the best interest of people.

Government Agent and Advisor

It acts as the government bank and agent, to collect and pay transactions on behalf of the government. Central bank has a detail record of all monetary issues and present in good position to advise government for monetary, banking and financial issues.

Bankers Bank

It is the bank for all commercial banks and monitor and control all commercial banks by its regulations. Commercial banks keep reserves with central bank as a requirement. Central bank also helps commercial banks in their daily business life by providing loans, security to cash reserves and gives them advice on financial and economic issues.

Clearing House

Another important function central bank does for commercial banks is acting as a clearing house for settle all the bill and checks drawn one another.

Lender of the Last Resort

Central bank helps commercial banks when they face any crisis, central bank come to rescue by advancing loans and bailout packages.

Credit Control

Credit Control becomes an emerging vital function of Central Banks. Although monitoring and controlling credit been always a function of central banks but as the technology grew and use of plastic and e-transaction is becoming more common there are many sensitive monetary issues arises. Central Banks take quantitative and qualitative methods for credit control such as bank rate, open market operation and moral situations etc.

Financial Agent

Central bank works as government agent for foreign exchange and gold transactions.

MA EXAMS POSTPONE TODAY IN KARACHI UNIVERSITY

Comparative advantage

In economics, the law of comparative advantage says that two countries (or other kinds of parties, such as individuals or firms) can both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods. Even if one country is more efficient in the production of all goods (absolute advantage), it can still gain by trading with a less-efficient country, as long as they have different relative efficiencies.[
For example, if, using machinery, a worker in one country can produce both shoes and shirts at 6 per hour, and a worker in a country with less machinery can produce either 2 shoes or 4 shirts in an hour, each country can gain from trade because their internal trade-offs between shoes and shirts are different. The less-efficient country has a comparative advantage in shirts, so it finds it more efficient to produce shirts and trade them to the more-efficient country for shoes. Without trade, its cost per shoe was 2 shirts; by trading, its cost per shoe can reduce to as low as 1 shirt depending on how much trade occurs (since the more-efficient country has a 1:1 trade-off). The more-efficient country has a comparative advantage in shoes, so it can gain in efficiency by moving some workers from shirt-production to shoe-production and trading some shoes for shirts. Without trade, its cost to make a shirt was 1 shoe; by trading, its cost per shirt can go as low as 1/2 shoe depending on how much trade occurs.
The net benefits to each country are called the gains from trade.

Origins of the theory

Comparative advantage was first described by David Ricardo who explained it in his 1817 book On the Principles of Political Economy and Taxation in an example involving England and Portugal.[4] In Portugal it is possible to produce both wine and cloth with less labor than it would take to produce the same quantities in England. However the relative costs of producing those two goods are different in the two countries. In England it is very hard to produce wine, and only moderately difficult to produce cloth. In Portugal both are easy to produce. Therefore while it is cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine, and trade that for English cloth. Conversely England benefits from this trade because its cost for producing cloth has not changed but it can now get wine at a lower price, closer to the cost of cloth. The conclusion drawn is that each country can gain by specializing in the good where it has comparative advantage, and trading that good for the other.

Example 1

Two men live alone on an isolated island. To survive they must undertake a few basic economic activities like water carrying, fishing, cooking and shelter construction and maintenance. The first man is young, strong, and educated. He is also faster, better, and more productive at everything. He has an absolute advantage in all activities. The second man is old, weak, and uneducated. He has an absolute disadvantage in all economic activities. In some activities the difference between the two is great; in others it is small.
Despite the fact that the younger man has absolute advantage in all activities, it is not in the interest of either of them to work in isolation since they both can benefit from specialization and exchange. If the two men divide the work according to comparative advantage then the young man will specialize in tasks at which he is most productive, while the older man will concentrate on tasks where his productivity is only a little less than that of the young man. Such an arrangement will increase total production for a given amount of labor supplied by both men and it will benefit both of them.

Example 2

Suppose there are two countries of equal size, Northland and Southland, that both produce and consume two goods, food and clothes. The productive capacities and efficiencies of the countries are such that if both countries devoted all their resources to food production, output would be as follows:
Northland: 100 tonnes
Southland: 400 tonnes
If all the resources of the countries were allocated to the production of clothes, output would be:
Northland: 100 tonnes
Southland: 200 tonnes
Assuming each has constant opportunity costs of production between the two products and both economies have full employment at all times. All factors of production are mobile within the countries between clothes and food industries, but are immobile between the countries. The price mechanism must be working to provide perfect competition.
Southland has an absolute advantage over Northland in the production of food and clothes. There seems to be no mutual benefit in trade between the economies, as Southland is more efficient at producing both products. The opportunity costs shows otherwise. Northland's opportunity cost of producing one tonne of food is one tonne of clothes and vice versa. Southland's opportunity cost of one tonne of food is 0.5 tonne of clothes, and its opportunity cost of one tonne of clothes is 2 tonnes of food. Southland has a comparative advantage in food production, because of its lower opportunity cost of production with respect to Northland, while Northland has a comparative advantage in clothes production, because of its lower opportunity cost of production with respect to Southland.
To show these different opportunity costs lead to mutual benefit if the countries specialize production and trade, consider the countries produce and consume only domestically. The volumes are:
Production and consumption before trade
Country Food Clothes
Northland 50 50
Southland 200 100
TOTAL 250 150
This example includes no formulation of the preferences of consumers in the two economies which would allow the determination of the international exchange rate of clothes and food. Given the production capabilities of each country, in order for trade to be worthwhile Northland requires a price of at least one tonne of food in exchange for one tonne of clothes; and Southland requires at least one tonne of clothes for two tonnes of food. The exchange price will be somewhere between the two. The remainder of the example works with an international trading price of one tonne of food for 2/3 tonne of clothes.
If both specialize in the goods in which they have comparative advantage, their outputs will be:
Production after trade
Country Food Clothes
Northland 0 100
Southland 300 50
TOTAL 300 150
World production of food increased. clothes production remained the same. Using the exchange rate of one tonne of food for 2/3 tonne of clothes, Northland and Southland are able to trade to yield the following level of consumption:
Consumption after trade
Country Food Clothes
Northland 75 50
Southland 225 100
World total 300 150
Northland traded 50 tonnes of clothes for 75 tonnes of food. Both benefited, and now consume at points outside their production possibility frontiers.
Assumptions in Example 2:
Two countries, two goods - the theory is no different for larger numbers of countries and goods, but the principles are clearer and the argument easier to follow in this simpler case.
Equal size economies - again, this is a simplification to produce a clearer example.
Full employment - if one or other of the economies has less than full employment of factors of production, then this excess capacity must usually be used up before the comparative advantage reasoning can be applied.
Constant opportunity costs - a more realistic treatment of opportunity costs the reasoning is broadly the same, but specialization of production can only be taken to the point at which the opportunity costs in the two countries become equal. This does not invalidate the principles of comparative advantage, but it does limit the magnitude of the benefit.
Perfect mobility of factors of production within countries - this is necessary to allow production to be switched without cost. In real economies this cost will be incurred: capital will be tied up in plant (sewing machines are not sowing machines) and labour will need to be retrained and relocated. This is why it is sometimes argued that 'nascent industries' should be protected from fully liberalised international trade during the period in which a high cost of entry into the market (capital equipment, training) is being paid for.
Immobility of factors of production between countries - why are there different rates of productivity? The modern version of comparative advantage (developed in the early twentieth century by the Swedish economists Eli Heckscher and Bertil Ohlin) attributes these differences to differences in nations' factor endowments. A nation will have comparative advantage in producing the good that uses intensively the factor it produces abundantly. For example: suppose the US has a relative abundance of capital and India has a relative abundance of labor. Suppose further that cars are capital intensive to produce, while cloth is labor intensive. Then the US will have a comparative advantage in making cars, and India will have a comparative advantage in making cloth. If there is international factor mobility this can change nations' relative factor abundance. The principle of comparative advantage still applies, but who has the advantage in what can change.
Negligible transport cost - Cost is not a cause of concern when countries decided to trade. It is ignored and not factored in.
Before specialization, half of each country's available resources are used to produce each good.
Perfect competition - this is a standard assumption that allows perfectly efficient allocation of productive resources in an idealized free market.

Example 3

The economist Paul Samuelson provided another well known example in his Economics. Suppose that in a particular city the best lawyer happens also to be the best secretary, that is he would be the most productive lawyer and he would also be the best secretary in town. However, if this lawyer focused on the task of being a lawyer and, instead of pursuing both occupations at once, employed a secretary, both the output of the lawyer and the secretary would increase, as it is more difficult to be a lawyer than a secretary.
[edit]Effect of trade costs

Trade costs, particularly transportation, reduce and may eliminate the benefits from trade, including comparative advantage. Paul Krugman gives the following example.[5]
Using Ricardo's classic example:
Unit labor costs
Cloth Wine
Britain 100 110
Portugal 90 80
In the absence of transportation costs, it is efficient for Britain to produce cloth, and Portugal to produce wine, as, assuming that these trade at equal price (1 unit of cloth for 1 unit of wine) Britain can then obtain wine at a cost of 100 labor units by producing cloth and trading, rather than 110 units by producing the wine itself, and Portugal can obtain cloth at a cost of 80 units by trade rather than 90 by production.
However, in the presence of trade costs of 15 units of labor to import a good (alternatively a mix of export labor costs and import labor costs, such as 5 units to export and 10 units to import), it then costs Britain 115 units of labor to obtain wine by trade – 100 units for producing the cloth, 15 units for importing the wine, which is more expensive than producing the wine locally, and likewise for Portugal. Thus, if trade costs exceed the production advantage, it is not advantageous to trade.
Krugman proceeds to argue more speculatively that changes in the cost of trade (particularly transportation) relative to the cost of production may be a factor in changes in global patterns of trade: if trade costs decrease, such as on the advent of steam-powered shipping, trade should be expected to increase, as more comparative advantages in production can be realized. Conversely, if trade costs increase, or if production costs decrease faster than trade costs (such as via electrification of factories), then trade should be expected to decrease, as trade costs become a more significant barrier.

Effects on the economy

Conditions that maximize comparative advantage do not automatically resolve trade deficits. In fact, many real world examples where comparative advantage is attainable may require a trade deficit. For example, the amount of goods produced can be maximized, yet it may involve a net transfer of wealth from one country to the other, often because economic agents have widely different rates of saving.
As the markets change over time, the ratio of goods produced by one country versus another variously changes while maintaining the benefits of comparative advantage. This can cause national currencies to accumulate into bank deposits in foreign countries where a separate currency is used.
Macroeconomic monetary policy is often adapted to address the depletion of a nation's currency from domestic hands by the issuance of more money, leading to a wide range of historical successes and failures.
[edit]Considerations

Development economics

The theory of comparative advantage, and the corollary that nations should specialize, is criticized on pragmatic grounds within the import substitution industrialization theory of development economics, on empirical grounds by the Singer–Prebisch thesis which states that terms of trade between primary producers and manufactured goods deteriorate over time, and on theoretical grounds of infant industry and Keynesian economics. In older economic terms, comparative advantage has been opposed by mercantilism and economic nationalism. These argue instead that while a country may initially be comparatively disadvantaged in a given industry (such as Japanese cars in the 1950s), countries should shelter and invest in industries until they become globally competitive. Further, they argue that comparative advantage, as stated, is a static theory – it does not account for the possibility of advantage changing through investment or economic development, and thus does not provide guidance for long-term economic development.
Much has been written since Ricardo as commerce has evolved and cross-border trade has become more complicated. Today trade policy tends to focus more on "competitive advantage" as opposed to "comparative advantage". One of the most indepth research undertakings on "competitive advantage" was conducted in the 1980s as part of the Reagan administration's Project Socrates to establish the foundation for a technology-based competitive strategy development system that could be used for guiding international trade policy.

Free mobility of capital in a globalized world

Ricardo explicitly bases his argument on an assumed immobility of capital:
" ... if capital freely flowed towards those countries where it could be most profitably employed, there could be no difference in the rate of profit, and no other difference in the real or labour price of commodities, than the additional quantity of labour required to convey them to the various markets where they were to be sold."
He explains why, from his point of view, (anno 1817) this is a reasonable assumption: "Experience, however, shows, that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and entrust himself with all his habits fixed, to a strange government and new laws, checks the emigration of capital."
Some scholars, notably Herman Daly, an American ecological economist and professor at the School of Public Policy of the University of Maryland, have voiced concern over the applicability of Ricardo's theory of comparative advantage in light of a perceived increase in the mobility of capital: "International trade (governed by comparative advantage) becomes, with the introduction of free capital mobility, interregional trade (governed by Absolute advantage)."
Adam Smith developed the principle of absolute advantage. The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile.[8][9] Limitations to the theory may exist if there is a single kind of utility. Yet the human need for food and shelter already indicates that multiple utilities are present in human desire. The moment the model expands from one good to multiple goods, the absolute may turn to a comparative advantage. The opportunity cost of a forgone tax base may outweigh perceived gains, especially where the presence of artificial currency pegs and manipulations distort trade. Global labor arbitrage, where one country exploits the cheap labor of another, would be a case of absolute advantage that is not mutually beneficial.
Economist Ha-Joon Chang criticized the comparative advantage principle, contending that it may have helped developed countries maintain relatively advanced technology and industry compared to developing countries. In his book Kicking Away the Ladder, Chang argued that all major developed countries, including the United States and United Kingdom, used interventionist, protectionist economic policies in order to get rich and then tried to forbid other countries from doing the same. For example, according to the comparative advantage principle, developing countries with a comparative advantage in agriculture should continue to specialize in agriculture and import high-technology widgits from developed countries with a comparative advantage in high technology. In the long run, developing countries would lag behind developed countries, and polarization of wealth would set in. Chang asserts that premature free trade has been one of the fundamental obstacles to the alleviation of poverty in the developing world. Recently, Asian countries such as South Korea, Japan and China have utilized protectionist economic policies in their economic development

Customs Unions

A customs union is an association of two or more countries to encourage trade. The countries making such an arrangement agree to eliminate tariffs and other restrictive regulations on trade among them. It is a discriminating trade arrangement since the liberalisation only includes the countries that are members of the customs union and they formulate and administer a common foreign trade policy in regard to tariffs and other trade restrictions against third countries.

The best-known customs unions have included the Zollverein, Benelux and the EEC, now called the EU. The Zollverein was formed by German states in the 1830's. These states became the German nation in 1871. Belgium, the Netherlands and Luxembourg established Benelux in the 1940's. Belgium, France, Italy, Luxembourg, the Netherlands and West Germany set up the EU in 1957.

Customs union theory builds on relatively strict assumptions such as perfect competition in commodity and factor markets and hence it is often referred to as orthodox customs union theory. It also only deals with the static welfare effects of a customs union. It has both positive and negative welfare effects, compared to a situation in which every member state practices protectionism. Therefore no conclusion can be drawn in advance as to the net welfare result of a customs union. It must be mentioned that some alternative theories have appeared which try to give an economic explanation of protectionism including customs unions but these shall not be discussed here.

In this essay I will start by looking at a small country in a small customs union. I will assess its effects on trade creation, trade diversion and trade expansion. This will be followed by the incidence of positive and negative effects of a customs union. I will then proceed to look at a large customs union in the world economy and link it to the terms of trade. Long term restructuring effects will be discussed, then the effects of 1992, and finally I will assess customs unions in relation to the EU and GATT.

A Small Country in a Small Customs Union

As already mentioned, the term `orthodox customs union theory' is due to the relatively strict assumptions of this theory, i.e. perfect competition in the commodity market and factor markets, perfect factor mobility within individual countries but not among the countries, foreign trade equilibrium and full employment. The opportunity cost in production is reflected in the relative commodity prices in each country and transport costs are not included since tariffs are assumed to be the only kind of international trade barrier.

Here I will look at a partial equilibrium model for a good X. It is a situation in which the small home country (H) forms a customs union with a small partner country (P). dH and sH indicate the home country's demand and supply of good X. sP and sW indicate the perfectly elastic supply by the partner country and the world.











Initially H imposes a non-discriminating specific tariff (T) on its imports, implying that the import supply curve is sW + T. Country H now consumes quantity O(1), where quantity O(2) is supplied by the home producers and quantity (2)(1) imported from the world producers. The creation of the customs union between country H and P will mean that the supply curve of country H will be sP. The price in the home market then decreases to pP. From this it can be seen that domestic production decreases from O(2) to O(4) while domestic consumption increases from O(1) to O(3). The imports of country H now also increase to (4)(3) and are no longer bought from the world producer but from the partner country at a price of pP.

Effects on Trade

To discover whether this new situation of a customs union has led to trade creation, trade diversion, trade expansion or a combination of the three, it is necessary to define them. Trade creation will occur when there is a shift from a higher cost to a lower cost producer, i.e. in country H demand will shift from the expensive protected domestic product to the cheaper product from the partner country, implying a shift from a less efficient to a more efficient producer. This is the case in the diagram and is shown by the area (4)(2). Trade diversion will occur when imports from the efficient or cheap world producer are replaced with imports from a less efficient and higher cost partner country. That country's product can be sold more cheaply in the home country than the world's products because the customs union imposes a protective tariff on the imports from the world, while leaving the imports of the partner country tariff free. This is also the case in our diagram and can be seen by the change from (2)(1) to (4)(3). Finally, trade expansion will occur if the lower market price in country H stimulates total domestic demand which will be satisfied by foreign trade. In our diagram the increase in total consumption can be seen by the area (1)(3).

Welfare Effects

The total welfare effects to H are also illustrated in this diagram. The increase in consumer surplus is equal to the areas (1)+(2)+(3)+(4). The decrease in producer surplus is area (1). The tariff revenue equal to areas (3)+(5) disappears. Areas (1) and (3) are internal redistribution from domestic producers and the government to the consumers. Hence the trade creation effect of the customs union is the sum of (2) and (4), and the trade diversion effect is equal to area (5). The question of whether the customs union leads to a welfare gain or loss cannot be answered unless we have further information about the relative sizes of the areas (2), (4) and (5). It can be said with accuracy that the larger the price elasticity and the difference between pH and pP, the larger the gain in welfare resulting from the trade creation effect and the larger the difference between pP and pW, the larger will be the size of the trade diversion effect of a customs union.

Determinants of gains from Customs Unions

Various factors exist which influence the occurrence of negative and positive effects of a customs union. I will mention five of the most important, the first being the production structure. Two countries can be complementary or competitive. If either country is a potential competitor of the other, specialisation in the products which either country can make best and cheapest is probable, and the advantages of a customs union are likely to be relatively important. The opposite is true if the production structures are complementary. The second factor is the size of the union. The more and the larger the countries participating in the customs union, the larger is its share in the total world trade and the smaller the risk of trade diversion. The third factor has to do with the level of the tariffs. If the initial tariffs of the trade partners are higher, the inefficiencies will probably be worse and the welfare effects of the abolition of the tariffs will be greater. Also the introduction of high tariffs against the world producers will reduce the positive effects. The fourth factor is transportation and transaction costs. For increased trade we will need efficient transport systems, the lack of which will replace tariffs as an obstacle for further specialisation. Clerical procedures at the frontier and linguistic differences in Europe also tend to make transaction costs higher. Finally, the advantages of forming a customs union are greater if member countries can respond more flexibly to new prospects.

A large Customs Union in the World Economy and Terms of Trade

Assuming the customs union is large there are two considerable implications for the total welfare of the customs union. The larger the customs union, the larger the possibility that the most efficient producers of various goods will be inside the customs union and hence, the smaller the potential for trade diverting effects. Secondly, when the large customs union fixes it's common external tariff rate then the possibility of it affecting its external terms of trade is increased and thus it can obtain an additional welfare gain.

So far I have assumed that the terms of trade relative to world producers will not be affected by the creation of a customs union but for a large customs union like the EU this assumption is not appropriate. For a large customs union a general tariff imposed on imports can lead to gains in the terms of trade which exceed the negative welfare effects resulting from a decrease in imports to the benefit of the domestic production. This is the rationale for the optimal tariff rates. I will illustrate this in a diagram.











In the initial situation the member states practice free trade on their own. Initial equilibrium is where the demand curve for imports of the potential customs union cuts the world export supply curve; imports being O(1) and price being pWo. With the formation of the customs union the optimal volume of imports from the world producers will be O(2) where the marginal cost of imports (sW) equal the marginal import utility measured along the demand curve for imports dCU. The optimal tariff rate for the union is therefore tCU. The creation of this customs union leads to an increase in the home market price to pCU and a decrease in the world price of good X from pWo to pW1.

There is a reduction in the import consumer surplus inside the customs union (area (1)+(2)) and the export producer surplus of the world is reduced by area (3)+(4). The total tariff revenue (1)+(3) accrues to the customs union. In this case the customs union has a trade diverting effect and there is a global efficiency and welfare loss of areas (2)+(4). Since the tariff rate tCU is optimal the customs union achieves a net welfare gain since efficiency loss (2) is less than the welfare gain resulting from the improvement in the terms of trade on the quantity of imports O(2), i.e. area (3).

Long Term Restructuring Effects

Restructuring or dynamic effects occur with the creation of a customs union because firms, workers and governments react to new situations and adapt the structure of production and the economy. Firms faced with increased competition will try to lower their costs to stay in the market and increased technical efficiency due to increased competition can have a welfare effect, exceeding many times the limited static effect. An establishment which can produce larger quantities cheaper than smaller ones and is constrained in its outlets by a market of limited size, would profit from the extension of the market, for example, by a customs union. The justification for the creation of a customs union on the point of economies of scale depends on the net effect for the entire customs union and their division between the partners.

Advantages of a customs union internal to the company depend on the size of the company, its growth rate and its learning curve. The larger the company the more efficient is its production and the stronger is its negotiating position. They are also more able to build up stable market positions in export countries. The growth rate of companies tends to have a positive effect on efficiency. Fast-growing firms have the most up to date machinery etc. but they tend to be less flexible in their response to entirely new markets. The learning curve indicates that companies learn to produce more efficiently by the production of greater numbers. Expansion permits producers to offer products of higher quality that are better adapted to specific consumer needs and demand will increase. Also, when a customs union puts a company in a better position, the positive influence is not confined to that company but extends to all related suppliers and buyers. That effect will be greater the better the various parts of the economy are equipped to respond to the impulse.

As barriers such as tariffs, quotas etc. are eliminated, domestic producers have to reduce their price to the level of the partner country. Excess profits will disappear and inefficiencies like overstaffing will have to be reduced. Consumers gain from these price reductions as they obtain more goods at lower prices and producers offset the loss by price reductions.

High Stakes for Europe: The 1992 Challenge

In the integrated Community market post-1992 a dramatically new environment awaits consumers and producers alike. The removal of a whole range of non-tariff barriers, i.e. government protection in procurement markets and a plethora of differing product standards leads to an immediate downward impact on costs. More substantial gains will be generated by completion of the EU internal market. There will be a new and pervasive competitive climate and firms can exploit new opportunities and make better use of available resources.

There are four major consequences which are expected from the combined impact of the removal of barriers and the subsequent boost to competition:

* a significant reduction in costs through the reorganisation of business and economies of scale

* improved efficiency within companies due to the downward pressure on costs due to more competitive markets

* new patterns of competition since real comparative advantages will play a determining role in market success

* increased innovation because new business products will be generated by the dynamics of the internal market.

These effects will be spread over differing time spans but the overall effect will be an increase in the competitiveness of business and the general economic welfare of the consumer.

The consumer will no longer be confronted with enormous price differences depending on their country of residence, as is the case in today's Community. Due to the reduction in costs, the level of this price will be on the downward journey. The consumer will also be faced with a wider choice as a result of market integration and increased competition leading to differentiating products as well as economies of scale.

1992 has led to the end of firms relying on the national soft option. Those who are able to scale up their performance to the demands of increased competition, will have an outlook for sales and profits which is dynamic but for others profits will be clearly squeezed by Europe's competitive renewal.

Strengthening European competitivity leads to the reconquest of the European market, but failure to do so will not mean that the challenges of the European market will not be mastered. They will, but not by the Europeans.

EU, GATT and Customs Unions

The basis of the EU according to Article IX of the Treaty of Rome is a customs union. Articles XII to XXIX give a detailed description of phasing out the internal tariff rates and establishing common external tariffs. In July 1968 a customs union for industrial goods had been realised. The idea of the customs union was to establish a totally free internal commodity market in the EU. This goal has still not been fully realised due to the use of non-tariff trade barriers such as technical trade barriers, government subsidies, etc. which became increasingly important in the 1970s.

Customs unions are discriminating trade arrangements and hence violate the rules of GATT. Under GATT's `principle of most favoured nation' member countries have to give each other the same favourable treatment that they give to any other country. Customs unions between a limited number of countries is a clear violation of the principle, but Article XXIV of the GATT treaty gives the right to form regional customs unions if certain conditions are satisfied because the overall aim of GATT is to promote international trade. When GATT was created in 1947, it was the widespread belief that customs unions were a step closer to free trade and it was not until later that it became clear that customs unions could in fact be a form of protectionism.

Conclusion

The creation of a customs union has some positive and some negative welfare effects. It can only be well founded in economic terms if the former exceeds the latter. The welfare effects of the customs union as a whole are uncertain. Only if it is possible for a customs union to affect the external terms of trade through the optimal tariff is it possible for the union to achieve a gain in net welfare.

In relation to the short term effects which affect consumers, producers and governments, customs unions tend to have more positive effects as production structures are more competitive, initial tariffs are higher and also, as customs unions are larger transaction costs are lower. Competition and economies of scale are long term effects and are better reasons for creating customs unions.

Home Trade and International/Foreign Trade:

Definition of Home Trade:

"Trade by a company within the country in which it is based, is known as home trade or domestic trade".

In the home trade, people try to specialize in the production of those commodities in which they have a comparative advantage.
.
Definition of International/Foreign Trade:
"The business of buying and selling commodities beyond national borders, is known as international/foreign trade".

Difference Between Home Trade and International Trade:

International trade like the home trade, it is said, is the result of division of labor and specialization. In the home trade, people try to specialize in the production of those commodities in which they have a comparative advantage. This is also what exactly happen in the international trade. In internal trade, people try to buy commodities from those markets which are the cheapest ones. So is also the case in international trade. Both in internal and external trade, exchange of goods takes place between persons with the only difference that in international trade people live in two different independent countries. The fact is that difference between home trade and international trade is only a matter of degree rather than of kind.

Those economist who differ with the above view state that there are some important points of difference between home trade and international trade and so, they say the international trade should be treated separately from home trade. The important points of difference between home trade and international trade are:

(i) Mobility of Labor and Capital: One very important difference between home trade and international trade is that labor and capital are not so mobile between different countries as they are in their own countries. Labor generally does not like to migrate from country because of differences in language, family ties, patriotism, customs, monetary systems, religious, social conditions, etc., etc. In recent years, the tightening of immigration laws has further affected the mobility of labor.

Capital is comparatively more mobile than labor because it is not subject to personal preferences. It can be invested abroad if the rate of return is much higher than what it can obtain in its own country. Even in case of capital, most people prefer to invest the savings at home due to a greater sense of security. The result of this greater immobility of labor and to a smaller extent of capital is that the rates of remuneration of the factors of production differ in different countries. These, countries become non-competing groups and so there arises basis for international trade and thus a need is felt for a separate theory to explain its course.

(ii) Barriers to Foreign Trade: Another reason for formulating a separate theory of international trade is that within a country there are no restrictions placed on the movements of goods from one place to another and if some restrictions are placed they are not of the same degree as that on the goods imported from abroad. Foreign trade is subject to various kinds of restrictions like tariff duties, exchange control, quota restrictions, etc., etc. It creates problems which are different from those of home trade. Hence, there is some necessity for have a separate theory of international trade.

(iii) Currency Differences: Every country has got its own separate currency system. When goods are exchanged between different countries, there arises a problem of exchanging currency of one country with the currency of another country. This problem of foreign exchange is absent in all internal transactions. Hence, there is a need for a separate theory of international trade.

Proportional Versus Progressive Taxation:

Proportional Versus Progressive Taxation:

Systems of Taxation:

While discussing the 'ability to pay theory', we gave a passing reference to two important systems of taxation, proportional and progressive. Let us discuss both these systems of taxation in detail.

(1) Proportional Principle of Tax:

Definition and Explanation of Proportional Principle of Tax:

The proportional system of taxation was advocated by classical economists. Under this system, the individuals are required to pay tax in proportion to their income, i.e., the rate of tax remains same as the base changes.

If for instance, the rate of tax is 5%, a man. with an income of $1,200 will pay $60 and another person with an income of $5,000 will pay $250 to the state.

The main advantages claimed for proportional system of taxation are that it is the must equitable method of raising revenue open to the state. When the individuals pay taxes to the government, their relative position remains the same after and before the tax. Moreover, this system is very simple. In the words of Say:

"The merit of proportional taxation is that it is very simply".

Meculoch was firm supporter of the principle of proportional taxation, He writes:

"When you abandon the plain principle (of proportional) you are at sea without radar and compass and there is no amount of injustice you may not commit".

The greatest drawback of the proportional system is that it does not entail equal sacrifice J.S. Mill and other supporters of this principle were not aware of this fact that when income increases, the marginal utility of money decreases.

For instance, the marginal' utility of $10 to a man earning $4000 p.m. is much greater than to a man earning $10000 p.m. So. if rich and poor are taxed at the same rate, it will be most unjust and unequitable. The best way to attain justice in taxation is that persons with higher incomes should be taxed at higher rates and those with lower incomes at lower rates. This equality of sacrifices can be attained if we adopt principle of progressive taxation. This we discuss now in detail.

(2) Progressive Principle of Tax:

Definition and Explanation of Progressive Principle of Tax:

Taxation is said to be progressive when the rate of tax increases as the tax base increase.

For instance, the monthly income of a person is $9000 and he is asked to pay 2% of his income to the government. Suppose further that hrs monthly income rises from $9000 to $15000.per month. The government instead of taking 2% of his income in a tax asks him to pay 6% in the form of tax.

Arguments in Favour of Progressive Taxation:

(i) The most powerful argument advanced for progressive taxation is that it leads to equality of sacrifice, whereas proportional taxation does not. As the income of a person increases, the marginal utility of income gradually decreases. So, if a man with higher income is taxed at a higher rate, it would not be unfair, but will be quite in conformity with the principle of justice.

(ii) Progressive taxation is also justified on the ground that it yields more revenue to the state than proportional taxation.

(iii) The merit of progressive taxation lies in the fact that it greatly helps in reducing the inequality in income by higher taxation oh the rich classes.

(iv) Progressive taxation is advocated on the ground that -it entails less expenses on collection. The tax is economical because when the rate of tax increases with the increase in income, the money spent on administration and collection does not increase or if it at all increase, it does not increase in the same ratio.

(v) Another merit claimed for the system of progressive taxation is that it conforms to the canon of elasticity. The state can easily increase its revenue by raising the tax rate.

(vi) J.M. Keynes is of the opinion that if we want to achieve full employment in the country, then progressive taxation is an imperative necessity. Progressive taxation helps the state in reducing inequalities of income by transferring wealth from the rich to the poor. When the inequality in the distribution of wealth is reduced, the propensity of the nation to consume increases. The rise in. aggregate demand for goods and services stimulates investment and provides greater opportunities for employment.

Arguments Against Progressive Taxation:

The principle of progressive taxation which is the most popular and plausible theory of justice in taxation has not escaped criticism. The main objections leveled against this principle are as under:

(i) In order to secure justice in taxation, it is very difficult to formulate a rational scheme of progression. The finance minister settles the degree of progression arbitrarily. As the rates of taxes are fixed on purely personal valuation, therefore, they may not lead to equal sacrifice. In the words of J.S. Mill:

"A graduated income tax is an entirely unjust mode of taxation and in fact of a graduated robbery".

(ii) Another objection leveled against this theory is that if the rate of progression is very high, it will discourage saving, impede the accumulation of capital and thus hamper the economic development of the country.

(iii) It is also pointed out that a very steep progression encourages evasion of I taxes. When people come to know that with the rise in their incomes, they will be taxed at steep rates, they may try to conceal their incomes by showing false statements. The state is, thus, deprived of much of its revenue.

(iv) If we carefully study the objections leveled against the principle of progressive taxation, we will soon come to the conclusion that they are not very convincing. Take the first objection. It is true the rates are fixed arbitrarily by the finance minister, but the members of the assembly are there to see that the rates of progression do not exceed the limits of justice. Moreover, the objection is not on the principle itself. It is only the degree of progression which has been brought under criticism. The second and third objection-like the first are again on the degree of progression.

We agree here with the criticism that if the people are taxed at very steep rates, it will discourage saving and encourage evasion of the tax. But if the degree of progression does not exceed the limits of reason and expediency, then progressive taxation is justified in every respect, because it conforms to the canon of equality, elasticity productivity and economy.

Theories of Taxation:

Theories of Taxation:

The economists have put forward many theories or principles of taxation at different times to guide the state as to how justice or equity in taxation can be achieved. The main theories or principles in brief, are:

(i) Benefit Theory:

According to this theory, the state should levy taxes on individuals according to the benefit conferred on them. The more benefits a person derives from the activities of the state, the more he should pay to the government. This principle has been subjected to severe criticism on the following grounds:

Firstly, If the state maintains a certain connection between the benefits conferred and the benefits derived. It will be against the basic principle of the tax. A tax, as we know, is compulsory contribution made to the public authorities to meet the expenses of the government and the provisions of general benefit. There is no direct quid pro quo in the case of a tax.

Secondly, most of the expenditure incurred by the slate is for the general benefit of its citizens, It is not possible to estimate the benefit enjoyed by a particular individual every year.
Thirdly, if we apply this principle in practice, then the poor will have to pay the heaviest taxes, because they benefit more from the services of the state. If we get more from the poor by way of taxes, it is against the principle of justice?

(ii) The Cost of Service Theory:

Some economists were of the opinion that if the state charges actual cost of the service rendered from the people, it will satisfy the idea of equity or justice in taxation. The cost of service principle can no doubt be applied to some extent in those cases where the services are rendered out of prices and are a bit easy to determine, e.g., postal, railway services, supply of electricity, etc., etc. But most of the expenditure incurred by the state cannot be fixed for each individual because it cannot be exactly determined. For instance, how can we measure the cost of service of the police, armed forces, judiciary, etc., to different individuals? Dalton has also rejected this theory on the ground that there s no quid pro qua in a tax.

(iii) Ability to Pay Theory:

The most popular and commonly accepted principle of equity or justice in taxation is that citizens of a country should pay taxes to the government in accordance with their ability to pay. It appears very reasonable and just that taxes should be levied on the basis of the taxable capacity of an individual. For instance, if the taxable capacity of a person A is greater than the person B, the former should be asked to pay more taxes than the latter.

It seems that if the taxes are levied on this principle as stated above, then justice can be achieved. But our difficulties do not end here. The fact is that when we put this theory in practice, our difficulties actually begin. The trouble arises with the definition of ability to pay. The economists are not unanimous as to what should be the exact measure of a person's ability or faculty to pay. The main view points advanced in this connection are as follows:

(a) Ownership of Property: Some economists are of the opinion that ownership of the property is a very good basis of measuring one's ability to pay. This idea is out rightly rejected on the ground that if a persons earns a large income but does not spend on buying any property, he will then escape taxation. On the other hand, another person earning income buys property, he will be subjected to taxation. Is this not absurd and unjustifiable that a person, earning large income is exempted from taxes and another person with small income is taxed?

(b) Tax on the Basis of Expenditure: It is also asserted by some economists that the ability or faculty to pay tax should be judged by the expenditure which a person incurs. The greater the expenditure, the higher should be the tax and vice versa. The viewpoint is unsound and unfair in every respect. A person having a large family to support has to spend more than a person having a small family. If we make expenditure. as the test of one's ability to pay, the former person who is already burdened with many dependents will have to' pay more taxes than the latter who has a small family. So this is unjustifiable.

(c) Income as the Basics: Most of the economists are of the opinion that income should be the basis of measuring a man's ability to pay. It appears very just and fair that if the income of a person is greater than that of another, the former should be asked to pay more towards the support of the government than the latter. That is why in the modern tax system of the countries of the world, income has been accepted as the best test for measuring the ability to pay of a person.

Proportionate Principle:

In order to satisfy the idea of justice in taxation, J. S. Mill and some other classical economists have suggested the principle of proportionate in taxation. These economists were of the opinion that if taxes are levied in proportion to the incomes of the individuals, it will extract equal sacrifice. The modern economists, however, differ with this view. They assert that when income increases, the marginal utility of income decreases. The equality of sacrifice can only be achieved if the persons with high incomes are taxed at higher rates and those with low income at lower rates. They favour progressive system of taxation, in all modern tax systems.