Gold Standard

During the current recession, different theories were put forward to suggest the decline of the US economy. Some researchers attributed abandoning of gold standard as one of the factors for economic instability. Since then, a lot of people want to know what is the gold standard. Although the gold standard is no longer in use today, the influence it had on the world economy cannot be neglected. The gold standard is a system in which the monetary unit of a country is expressed as a fixed weight of gold. Gold standard was an agreement by several countries that they would value their currencies in such a way that it could buy the exact amount of gold. For example, if a country had X units of gold reserves, then it could mint only a specific amount of currency equivalent to that amount of gold. The Gold Standard Act was passed in 1900 and it established gold as monetary standard all over the world. Richard Nixon ended the convertibility of currency into gold some 40 years ago, and today the incident is known as 'Nixon Shock' or 'Nixon Gold Standard'. A lot of thinkers, to this date, are critical of Nixon's decision and question Nixon's legal right to end the gold standard. Today most of the economies work on the floating exchange system.

Gold Standard Types

Gold was always looked upon as a precious metal and people were well aware of its properties. It was used as a standard by various countries, but with time, some changes were made to the way it was used. Let us take a look at the types of gold standards.

• Gold Specie Standard: This monetary system is one of the oldest in the world. It was based on the actual gold coins of different denominations. In US, it was adopted in 1873, with the American Gold Eagle as its unit. The various denominations in which the gold coins were available were $50, $25, $10 and $5. You can read more on history of American money.
• Gold Exchange Standard: In this type of monetary system the currency used was not made up of gold but it had a value equivalent to that of gold. It was widely used in the late ninetieth century and was in use till the beginning of twentieth century. In this system, coins made of silver and other metals were used for circulation but the government guaranteed an exchange rate that was equivalent to value of gold coins.
• Gold Bullion Standard: This was the last gold standard that was used before the gold standard was completely abandoned. In this system, the government started selling gold bullion at a fixed price. International trade caused a lot of gold bullion to be shipped out of countries like Britain, France, etc. and the gold bullion standard was abandoned as well.

The Gold Standard Act

The Gold Standard Act was approved on March 14, 1900 in US, when gold was declared to be the standard for all the national currency. It had taken around 25 years for the US government to choose between the value of silver or gold. It also set a standard for gold as 1 oz of troy gold was equivalent to $20.67. (one troy is equal to 31.1034768 grams) The gold standard act was dissolved in 1934 with the adoption of the Gold Reserve Act, which stopped the use of gold as a standard for currencies.

Today, most of the economies work on floating money or fiat money. Adopting the gold standard again is very difficult as gold is found only in selected parts of the world and no country has the gold reserves for the amount of currencies they generate. An unstable US dollar is a concern for many countries and many economists are of the opinion that there should be a monetary system in which a precious metal, gold/silver etc., is linked to the currency of the country. In the end, we hope that this article may help in understand what is gold standard and the important part it played in shaping the world economy.

What is Comparative Advantage

Before we proceed to uncover what is comparative advantage, let's take a brief tour of the foundation of international trade. International trade - all of this import and export affair - is founded upon the economic principles of scarcity and choice. To elaborate, it is not possible for every individual to be self sufficient and produce all those things he needs, wants or desires in his life himself. Neither does he have access to all available resources nor is he equally talented in each and every skill necessary for making the objects that are suitable for the satisfaction of his wants. This is where the entire concept of specialization, exchange and trade takes root. Now, magnifying this phenomenon to a macroeconomic scale, the situation is same in case of individual nations as well. Not all countries are equally equipped to produce a particular commodity and each has to depend on others for fulfilling the requirements of those commodities which it is ill disposed to produce on its own. This is where the theories of absolute followed by comparative advantage in economics make a grand entrance.

What is Comparative Advantage in Economics?

The theory of comparative advantage stems from its predecessor, the theory of absolute advantage. Propounded by Adam Smith in the year 1776 in his legendary economic treatise An Inquiry into the Nature and Causes of the Wealth of Nations (most popularly known as Wealth of Nations), the theory of absolute advantage argues that each nation can benefit by entering into trade with other nations as not all countries are equally endowed for the production of all economic utilities. He argued that gold reserves alone do not suffice to measure the wealth of a nation and taking the economic utilities available to its citizens is a better way to judge how rich a country is. For this purpose, a country would benefit most if it imports those goods for the production of which it is not well disposed (in terms of resources or opportunity cost) and it should export all those commodities which it has the ability to produce in surplus.

For instance, if Country A can produce 500 units of a commodity in a day using 300 units of labor and Country B can produce produce 1000 units of the same commodity in a day using 300 units of labor, then the latter is identified as having an absolute advantage over the former and A would be better off importing the commodity from B, assuming each unit of the factors of production cost the same in both countries.

Although profitable, this method may not be mutually beneficial for both countries entering into a commercial relation with each other. The theory of comparative advantage builds up from hereon. Propounded by David Ricardo in the year 1817 in his famous work On the Principles of Political Economics and Taxation, this theory argues that both parties of an international trade can reap mutual benefits and that it is not necessary for such a relation to be a one-way affair (one country only importing and the other only exporting). There are certain assumptions that are necessary for better explaining this theory. These assumptions are:

• Suppose there are two countries.
• Each country produces two commodities, such that all of the country's resources are allocated towards the production of just these two commodities.
• One of the countries produces both commodities more than the other
• The cost of the factors of production are the same in both countries
• .....and of course, Ceteris Paribus

The purpose of assuming two commodities for each country is to measure the opportunity cost of each commodity in terms of the other. Now, building on these assumptions, let's understand what is comparative advantage all about from the following comparative advantage example.

Utopia devotes all its resources towards the production of 200 tonnes of cloth or 200 tonnes of wine. Narnia devotes all its resources towards the production of 300 tonnes of cloth or 500 tonnes of wine. The opportunity cost of Utopia in producing 200 tonnes of cloth is 200 tonnes of wine and vice versa. However, the opportunity cost of Narnia in producing 300 tonnes of cloth is 500 tonnes of wine and its opportunity cost in producing 500 tonnes of wine is 300 tonnes of cloth, making it a 3:5 ratio. Therefore, in order to produce 1 tonne of cloth, Narnia must give up on the opportunity to produce 0.6 tonnes of wine and for producing 1 tonne of wine, Narnia must give up on the opportunity of producing 1.7 tonnes of cloth.

Here, if we see in terms of just the numbers, Narnia seems to have an absolute advantage over Utopia in producing both commodities. Hence, no mutual benefits are to be derived from a trade between the two. However, judging by opportunity cost, Narnia would benefit if it goes for cloth production and Utopia would benefit from producing wine (Utopia's opportunity cost for producing wine is lower than Narnia's in terms of cloth) and then export each of their surplus produce to the other.

I hope that helped you understand what is comparative advantage. The key differentiating factor between Smith's and Ricardo's theories is the absence and presence of the concept of opportunity cost, respectively, from the entire national product equation. While absolute advantage paves the way for economic dominance by the country wielding the exporting power over the importing country, the theory of comparative advantage extends a solution by which both countries can mutually exist and be interdependent on each other for a symbiotic economic relationship.

Perfectly Inelastic Supply

In the world of economics, the forces of demand and supply play a large role in determining the way certain goods and services are priced. These forces of demand and supply act in conjunction with each other, and a change in one of the factors inadvertently affects the other one. This is where the concept of elasticity arises from, and here we will help you learn about perfectly inelastic supply.

What is Perfectly Inelastic Supply

The elasticity of supply is defined as its ability to change when the surrounding market forces change. Thus, if other forces lead to a drastic change in supply, then it is deemed more elastic, but if the supply is relatively unaffected it is known as inelastic supply. This means that no matter how significantly demand or price factors change, the amount of supply will continue to be the same.

When one studies demand and supply curves on a graph and the law of supply and demand, the demand curve goes from left to right and the supply curve goes from right to left. The X-axis denotes the quantity of a good or a service and the Y-axis denotes the price. The point at which the demand curve and the supply curve meet is known as the Point of Equilibrium, and this denotes the amount of good that can be bought for the corresponding price.

When we speak of perfectly inelastic supply, the perfectly inelastic supply curve is a straight line which is parallel to the Y-axis. This means that no matter what the price and no matter what the demand at any given moment in time, the amount of the good or service that is supplied will be exactly the same. Hence, the supply is completely inelastic and unresponsive to any changes in other factors.

Perfectly Inelastic Supply Example

Once you understand the perfectly inelastic supply definition clearly, you can understand the concept even better with the aid of an example of demand and supply analysis. If the quantity that is supplied does not change at all, then this means that the producers or sellers of the good have no choice but to produce or sell it at any price possible. This occurs in the case of goods that have a large number of substitutes available in the market. Hence, the seller is forced to sell, even if he has to undergo a loss by doing so.

The best example is to imagine a situation where a very famous deceased painter has created three masterpieces and these need to be sold. Now, since the painter is dead, there are no forces of demand or price that can change the supplied quantity. No matter how much money a buyer is willing to pay, the supply for the paintings will be fixed at 3. This is a suitable example of perfectly inelastic supply.

Another example of perfectly inelastic supply is to consider a scenario where a farmer has to sell 100 tomatoes. These tomatoes need to be sold by the end of the day or else they will become rotten and the farmer will just have to throw them away. Thus, as the day goes by, the farmer will get more and more desperate to sell the tomatoes irrespective of what price they sell for. Hence the supply at the end of the day is the same, no matter what the price and the demand will be. The same scenario can also be applied to a florist who has to sell his flowers before they wilt. You can also read about perfectly inelastic demand.

The field of economics is not a simple one, and the concept of demand and supply curves is much more complicated than this. There are a number of other factors that affect the elasticity of supply as well, and this is something that will require careful study and research. As for now, this information on perfectly inelastic supply should suffice.

Economic Value Added – Advantages and Disadvantages

The economic value added is a strict utility, incorporating the traditional definition of capital costs contributed by the shareholders in the income statement. Think of a statement in which shareholders receive “interest” as well as creditors, as if charged for the capital in the business.

The economic value added, can also be seen as a set of administrative tools that take into account the gain that should be in the company to recover its investment.

As expected, the economic value added has some advantages that should be highlighted, among which we mention the fact recognize the importance of using capital (operating assets) and their associated costs for (cost of capital).

Another important advantage presented by the economic value added, is that it shows clearly the relationship between the operating margin and intense use of capital, so that can be used to identify opportunities for improvement and appropriate investment levels to achieve them.

Of course, the model presented by the economic value added are also some disadvantages, such as failure to consider the future prospects of the company, besides requiring a lot of adjustments to financial information company.

Moreover, taking into account the above, the economic value added requires a tradeoff between accuracy and simplicity of calculation, since very complicated adjustments resulted in a lack of credibility in the results.

So Mr. employer, now has many more tools to make the decision on starting the process of calculating the economic value added, taking into account all the advantages but also all the inconveniences that can be generated.

The Practitioner’s Guide to a Measurement and Management Framework: Craig Savarese

The shareholder value creation philosophy is a central element in many companies’ financial management practices. A widely adopted approach to measuring financial performance and managing for value creation is economic profit (economic value added). A deceptively simple concept, companies often are not prepared for the challenges and issues they need to consider when measuring economic profit, nor for how to incorporate it into financial management practices. This book addresses these challenges by: developing a framework for linking economic profit to shareholder value; explaining the issues relevant to developing a company-specific economic profit measure; and demonstrating how to incorporate economic profit into financial management practices. The book is about practical application - designed as a user’s guide - so that you can apply shareholder value principles and understand the implications for your business. It shows how economic profit links to shareholder value, and dispels commonly cited myths about adopting a shareholder value framework to drive a company’s financial management practices. It is aimed at financial managers and accounting professionals, managers, consultants and equity analysts who want to understand the application of shareholder value.