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1. News 2. Top News 3. Top Story Email Story Economics for Everyone – Economics and concept of curves First Name Enter your Email-ID Enter your Friend's Email-ID Submit Cancel Economics for Everyone – Economics and concept of curves Prof. M. Guruprasad, AICAR Business School | Mumbai | July 02, 2015 12:17 IST Economics and Economists have a way explaining the rationale of their decisions through some interesting curves and Graphs. Let us see some of the important concept of curves. A + a- 0 Open FREE Demat Account and get access to indepth research on 500 stocks Name Mobile City
Submit T&C apply. × Terms & Conditions By clicking on submit button, you authorize IIFL & its representatives & agents to provide information about various products, offers and services provided by IIFL through any mode including telephone calls, SMS, letters etc. . you confirm that laws in relation to unsolicited communication referred in National Do Not Call Registry as laid down by Telecom Regulatory Authority of India will not be applicable for such information/ communication. Economics and Economists offers theoretical and practical solutions for numerous economic and policy decisions and they have a way explaining the rationale of their decisions through some interesting curves and Graphs. Infact, Economics is full of curves. Let us see some of the important concept of curves. 1. Demand Curve 2. Supply Curve 3. Indifference Curve 4. Cost curve and Production Functions 5. Production–possibility Curve 6. Offer curve 7. Laffer curve 8. Contract curves 9. Engel Curve 10. J curve 11. Kuznets curve 12. Lorentz curve 13. Philips curve 14. Rahn curve 15. Wage Curve 16. Yield curve 17. Kinked Demand Curve 18. Beveridge curve 19. Great Gaspy curve 20. IS-LM model. 1.Demand Curve
An example of a demand curve shifting. The shift from D1 to D2 means an increase in demand with consequences for the other variables In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule. The demand curve for all consumers together follows from the demand curve of every individual consumer: the individual demands at each price are added together. Demand curves are used to estimate behaviors in competitive markets, and are often combined with supply curves to estimate the equilibrium price (the price at which sellers together are willing to sell the same amount as buyers together are willing to buy, also known as market clearing price) and the equilibrium quantity (the amount of that good or service that will be produced and bought without surplus/excess supply or shortage/excess demand) of that market. In a monopolistic market, the demand curve facing the monopolist is simply the market demand curve. Meaning of Demand Demand in economics means desire to buy backed by adequate purchasing power. Mere desire or wish cannot buy goods. The demand for goods therefore denotes that someone is able and willing to buy the goods. Law of Demand The relation of price to sales is known in economics as the ‘Law of Demand’. The Law of Demand states that “higher the price, lower the demand and vice versa, other things remaining the same”. 2.Supply Curve
Supply curve, in economics, graphic representation of the relationship between product price and quantity of product that a seller is willing and able to supply. Product price is measured on the vertical axis of the graph and quantity of product supplied on the horizontal axis. In most cases, the supply curve is drawn as a slope rising upward from left to right, since product price and quantity supplied are directly related (i.e., as the price of a commodity increases in the market, the amount supplied increases). This relationship is dependent on certain ceteris paribus (other things equal) conditions remaining constant. Such conditions include the number of sellers in the market, the state of technology, the level of production costs, the seller’s price expectations, and the prices of related products. A change in any of these conditions will cause a shift in the supply curve. A shifting of the curve to the left corresponds to a decrease in the quantity of product supplied, whereas a shift to the right reflects an increase. AD–AS model Aggregate supply/demand graph The AD–AS or aggregate demand–aggregate supply model is a macroeconomic model that explains price level and output through the relationship of aggregate demand and aggregate supply. It is based on the theory of John Maynard Keynes presented in his work The General Theory of Employment, Interest, and Money. It is one of the primary simplified representations in the modern field of macroeconomics, and is used by a broad array of economists, from libertarian, Monetarist, supporters of laissez-faire, such as Milton Friedman, to Post-Keynesian supporters of economic interventionism, such as Joan Robinson. The conventional "aggregate supply and demand" model is, in actuality, a Keynesian visualization that has come to be a widely accepted image of the theory. The Classical supply and demand model, which is largely based on Say's law—that supply creates its own demand— depicts the aggregate supply curve as being vertical at all times. 3.Indifference Curve
An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility. Graphically, the indifference curve is drawn as a downward sloping convex to the origin. The graph shows a combination of two goods that the consumer consumes.
The above diagram shows the U indifference curve showing bundles of goods A and B. To the consumer, bundle A and B are the same as both of them give him the equal satisfaction. In other words, point A gives as much utility as point B to the individual. The consumer will be satisfied at any point along the curve assuming that other things are constant. 4.Cost curve and Production Functions
In economics, a cost curve is a graph of the costs of production as a function of total quantity produced. In a free market economy, productively efficient firms use these curves to find the optimal point of production (minimizing cost), and profit maximizing firms can use them to decide output quantities to achieve those aims. There are various types of cost curves, all related to each other, including total and average cost curves, and marginal ("for each additional unit") cost curves, which are equal to the differential of the total cost curves. Some are applicable to the short run, others to the long run.
The shape of cost curves help us to understand the efficient operations (cost and production efficiency) of a firm or business enterprise which is also known as Economics of Scale. Economies of scale refer to the phenomenon where the average costs per unit of output decrease with the increase in the scale or magnitude of the output being produced by a firm. Economies of scope exist when it is cheaper to produce two products together (joint production) than to produce them separately. Economies of scope is a term that refers to the reduction of per-unit costs through the production of a wider variety of related goods or services. Whereas economies of scale for a firm primarily refers to reductions in the average cost (cost per unit) associated with increasing the scale of production for a single product type, economies of scope refers to lowering the average cost for a firm in producing two or more products. CONCEPT OF RETURNS TO SCALE PRODUCTION FUNTION WITH MORE THAN TWO VARIABLES (ALL VARIABLE) INPUTS A closely related question in production economics is how a proportionate increase in all the inputs factors will affect total production. This is the question of returns to scale and one can think of three possible situations: 1. If the proportional increase in all inputs is equal to the proportional increase in output, returns to scale are constant. For instance, if a simultaneous doubling of all inputs results in a doubling of production then returns to scale are constant.
2. If the proportional increase in output is larger than that of the inputs, then we have increasing returns to scale.
3. If the output increases less than proportionally with input increases, we have decreasing returns to scale. The most typical situation is for a production function to have first increasing then decreasing returns to scale as shown in the figure, The increasing returns to scale are attributable to specialized labour can be used and efficient, large scale machinery can be employed in the production process. However, beyond some scale of production not only are further gains from specialization limited, but also co-ordination problems may begin to increase costs more than offset additional benefits of specialization, decreasing returns to scale begin.
Returns to scale describes what happens to the output rate when each input rate is increased by the same proportion. If output increases by a large percentage that the increase in each input then are increasing returns to scale; if it increases by smaller percentage there are diminishing returns to scale; if it increases by same proportion there are diminishing returns to scale if it increases by the same proportion there are constant returns to scale. Importance of Returns to scale concept. The returns to scale concept is important in the theory of production. If an industry is characterized by increasing returns to scale there will be a tendency for expanding the size of the firm, and thus the industry will be dominated by large firms. Increasing returns to scale are another important source of market power. Firms experiencing increasing returns to scale are also experiencing decreasing average total costs. Firms in such industries become more profitable with size. Therefore over time the industry is dominated by a few large firms. The opposite will be true in industries characterized by constant returns to scale firms of all sizes would survive equally well. Though production function may seem to be abstract and unrealistic, in fact, they are both logical and useful. 5.Production–possibility Curve (Frontier)
In economics, a production–possibility Curve or Frontier (PPF), sometimes called a production-possibility boundary or product transformation curve, is a graph representing production tradeoffs of an economy given fixed resources. In its microeconomic applications the graph shows the various combinations of amounts of two commodities that an economy can produce (e.g., number of guns vs kilos of butter) using a fixed amount of each of the factors of production. At the macroeconomic level it can be used to depict other rivalrous trade-offs like savings versus consumption. Graphically bounding the production set for fixed input quantities, the PPF curve shows the maximum possible production level of one commodity for any given production level of the other, given the existing state of technology. By doing so, it defines productive efficiency in the context of that production set: a point on the frontier indicates efficient use of the available inputs, while a point beneath the curve indicates inefficiency. A period of time is specified as well as the production technologies and amounts of inputs available. The commodities compared can either be goods or services. PPFs are normally drawn as bulging upwards ("concave") from the origin but can also be represented as bulging downward or linear (straight), depending on a number of factors. A PPF can be used to illustrate a number of economic concepts, such as scarcity of resources (i.e., the fundamental economic problem all societies face), opportunity cost (or marginal rate of transformation), productive efficiency, allocative efficiency, and economies of scale. In addition, an outward shift of the PPF results from growth of the availability of inputs such as physical capital or labour, or technological progress in our knowledge of how to transform inputs into outputs. Such a shift allows economic growth of an economy already operating at its full productivity (on the PPF), which means that more of both outputs can be produced during the specified period of time without sacrificing the output of either good. Conversely, the PPF will shift inward if the labor force shrinks, the supply of raw materials is depleted, or a natural disaster decreases the stock of physical capital. However, most economic contractions reflect not that less can be produced, but that the economy has started operating below the frontier—typically both labor and physical capital are underemployed. The combination represented by the point on the PPF where an economy operates shows the priorities or choices of the economy, such as the choice of producing more capital goods and fewer consumer goods or vice versa.
6.Offer curve
Offer Curve of Country “K”. In economics and particularly in international trade, an offer curve shows the quantity of one type of product that an agent will export ("offer") for each quantity of another type of product that it imports. The offer curve was first derived by English economists Edgeworth and Marshall to help explain international trade. The offer curve is derived from the country's PPF. We describe a Country named K which enjoys both goods Y and X. It is slightly better at producing good X, but wants to consume both goods. It wants to consume at point C or higher (above the PPF). Country K starts in Autarky at point C. At point C, country K can produce (and consume) Y units for X units. As trade begins with another country, and country K begins to specialize in producing good X. When it produces at point B, it can trade with the other country and consume at point S. We now look at our Offer curve and draw a ray at this level. When full specialization occurs, K then produces at point A, trades and then consumes at point T. 7.Laffer curve
Legend has it that in November 1974 Arthur Laffer, a young economist, drew a curve on a napkin in a Washington bar, linking average tax rates to total tax revenue. Initially, higher tax rates would increase revenue, but at some point further increases in tax rates would cause revenue to fall, for instance by discouraging people from working. The curve became the basis of supply-side economics. Some economists said that it proved that most governments could raise more revenue by cutting tax rates, an argument that was often cited in the 1980s by the taxcutting governments of Ronald Reagan and Margaret Thatcher. The Laffer curve is typically represented as a graph which starts at 0% tax with zero revenue, rises to a maximum rate of revenue at an intermediate rate of taxation, and then falls again to zero revenue at a 100% tax rate. However, the shape of the curve is uncertain and disputed.
In economics, the Laffer curve is one possible representation of the relationship between rates of taxation and the hypothetical resulting levels of government revenue. The Laffer curve claims to illustrate the concept of taxable income elasticity—i.e., taxable income will change in response to changes in the rate of taxation. It postulates that no tax revenue will be raised at the extreme tax rates of 0% and 100% and that there must be at least one rate where tax revenue would be a non-zero maximum. One potential result of the Laffer curve is that increasing tax rates beyond a certain point will be counter-productive for raising further tax revenue. 8.Contract Curve
In microeconomics, the contract curve is the set of points representing final allocations of two goods between two people that could occur as a result of mutually beneficial trading between those people given their initial allocations of the goods. All the points on this locus are Pareto efficient allocations, meaning that from any one of these points there is no reallocation that could make one of the people more satisfied with his or her allocation without making the other person less satisfied. The contract curve is the subset of the Pareto efficient points that could be reached by trading from the people's initial holdings of the two goods. It is drawn in the Edgeworth box diagram, in which each person's allocation is measured vertically for one good and horizontally for the other good from that person's origin (point of zero allocation of both goods); one person's origin is the lower left corner of the Edgeworth box, and the other person's origin is the upper right corner of the box. The people's initial endowments (starting allocations of the two goods) are represented by a point in the diagram; the two people will trade goods with each other until no further mutually beneficial trades are possible. The set of points that it is conceptually possible for them to stop at are the points on the contract curve. As with all points that are Pareto efficient, each point on the contract curve is a point of tangency between an indifference curve of one person and an indifference curve of the other person. Thus, on the contract curve the marginal rate of substitution is the same for both people.
Blue contract curve showing points of tangency of indifference curves in an Edgeworth box 9.Engel Curve
Engel Curve An Engel Curve is a function relating the quantity purchased of a commodity to the level of money income. In other words, the income-demand curve showing the relationship between money income and demand is known Engle curve. An Engel curve describes how household expenditure on a particular good or service varies with household income. There are two varieties of Engel Curves. Budget share Engel Curves describe how the proportion of household income spent on a good varies with income. Alternatively, Engel curves can also describe how real expenditure varies with household income. They are named after the German statistician Ernst Engel (1821–1896) who was the first to investigate this relationship between goods expenditure and income systematically in 1857. The best-known single result from the article is Engel's law which states that the poorer a family is, the larger the budget share it spends on nourishment. Some success has been achieved in understanding how social status concerns have influenced household expenditure on highly visible goods. Ernst Engel argued that households possessed a hierarchy of wants that determined the shape of Engel curves. As household income rises some motivations become more prominent in household expenditure as the more basic wants that dominate consumption patterns at low-income levels, such as hunger, eventually become satiated at higher income levels. The following figures shows different Engel curves for Necessities: In figure (a), the Engel curve is showing the relationship between income and demand in case of necessities. Here consumers will purchase a certain amount even at very low levels of income but they will not increase their income rises. As such, the Engel curve here is mainly flat. (a)
Luxury: Figure (b) gives an Engel curve showing relationship between income and demand in case of luxury goods. Here, little or nothing will be spent at very low levels of income is reached as at Y0, demand for such goods will increase rapidly. (b)
Inferior Goods: Figure (c) gives an Engel curve relevant for income-demand relationship of inferior goods. In case of inferior goods, consumers choose to purchase less of such commodities as they have higher incomes. (C)
10.J curve
The term J curve is used in several different fields to refer to a variety of unrelated J-shaped diagrams where a curve initially falls, but then rises to higher than the starting point. Balance of trade model
In economics, the 'J curve' refers to the trend of a country’s trade balance following a devaluation or depreciation under a certain set of assumptions. A devalued currency means imports are more expensive, and on the assumption that the volume of imports and exports change little immediately, this causes a depreciation of the current account (a bigger deficit or smaller surplus). After some time, though, the volume of exports may start to rise because of their lower more competitive prices to foreign buyers, and domestic consumers may buy fewer of the costlier imports. Eventually, if this happens, the trade balance may improve on what it was before the devaluation. If there is a currency revaluation or appreciation the same reasoning leads to an inverted J-curve. Immediately following the depreciation or devaluation of the currency, the volume of imports and exports may remain largely unchanged due in part to pre-existing trade contracts that have to be honoured. Moreover, in the short run, demand for the more expensive imports (and demand for exports, which are cheaper to foreign buyers using foreign currencies) remain price inelastic. This is due to time lags in the consumer's search for acceptable, cheaper alternatives (which might not exist). Over the longer term depreciation in the exchange rate can have the desired effect of improving the current account balance. Domestic consumers might switch their expenditure to domestic products and away from expensive imported goods and services, assuming equivalent domestic alternatives exist. Equally, many foreign consumers may switch to purchasing the products being exported into their country, which are now cheaper in the foreign currency, instead of their own domestically produced goods and services. Empirical investigations of the J-curve have sometimes focused on the effect of exchange rate changes on the trade ratio, i.e. exports divided by imports, rather than the trade balance, exports minus imports. Unlike the trade balance, the trade ratio can be logged regardless of whether a trade deficit or trade surplus exists. 11.Kuznets curve
In economics, a Kuznets curve graphs the hypothesis that as an economy develops, market forces first increase and then decrease economic inequality. The hypothesis was first advanced by economist Simon Kuznets in the 1950s and '60s.
Hypothetical Kuznets curve. Empirically observed curves aren't smooth or symmetrical—see reference for examples of "real" curves. One explanation of such a progression suggests that early in development investment opportunities for those who have money multiply, while an influx of cheap rural labor to the cities holds down wages. Whereas in mature economies, human capital accrual, or an estimate of cost that has been incurred but not yet paid, takes the place of physical capital accrual as the main source of growth; and inequality slows growth by lowering education levels because poorer, disadvantaged people lack finance for their education in imperfect credit-markets. The Kuznets curve implies that as a nation undergoes industrialization – and especially the mechanization of agriculture – the center of the nation’s economy will shift to the cities. As internal migration by farmers looking for better-paying jobs in urban hubs causes a significant rural-urban inequality gap (the owners of firms would be profiting, while laborers from those industries would see their incomes rise at a much slower rate and agricultural workers would possibly see their incomes decrease), rural populations decrease as urban populations increase. Inequality is then expected to decrease when a certain level of average income is reached and the processes of industrialization – democratization and the rise of the welfare state – allow for the trickle-down of the benefits from rapid growth, and increase the per-capita income. Kuznets believed that inequality would follow an inverted “U” shape as it rises and then falls again with the increase of income per-capita. Kuznets curve diagrams show an inverted U curve, although variables along the axes are often mixed and matched, with inequality or the Gini coefficient on the Y axis and economic development, time or per-capita incomes on the X axis. 12.Lorenz curve
Lorentz curves are used to illustrate the distribution of resources in a community/society/nation. The Lorenz curve is a graphical representation of the cumulative distribution function of a probability distribution; it is a graph showing the proportion of the distribution assumed by the bottom y% of the values. It is often used to represent income distribution, where it shows for the bottom x% of households, what percentage y% of the total income they have. The percentage of households is plotted on the x-axis, the percentage of income on the y-axis. It can also be used to show distribution of assets. In such use, many economists consider it to be a measure of social inequality. It was developed by Max O. Lorenz in 1905 for representing income distribution.
Explanation Points on the Lorenz curve represent statements like "the bottom 20% of all households have 10% of the total income." A perfectly equal income distribution would be one in which every person has the same income. In this case, the bottom N% of society would always have N% of the income. This can be depicted by the straight line y = x; called the "line of perfect equality." By contrast, a perfectly unequal distribution would be one in which one person has all the income and everyone else has none. In that case, the curve would be at y = 0% for all x < 100%, and y = 100% when x = 100%. This curve is called the "line of perfect inequality." Gini Index the measure of INEQUALITY Gini index is a measure of inequality in the income distribution in an economy. The index measures the extent to which the distribution of income (or, in some cases, consumption expenditure) among individuals or households within an economy deviates from a perfectly equal distribution. The Gini index is helpful for tracking inequity over time, or comparing distributions of resources among countries. The Gini coefficient is the area between the line of perfect equality and the observed Lorenz curve, as a percentage of the area between the line of perfect equality and the line of perfect inequality. The higher the coefficient, the more unequal the distribution is. 13.Phillips curve
The Phillips curve shows a historical inverse relationship between rates of unemployment and corresponding rates of inflation that result in an economy. Stated simply, decreased unemployment, (i.e., increased levels of employment) in an economy will correlate with higher rates of inflation. Well known economist Milton Friedman asserted that the Phillips Curve was only applicable in the short-run and that in the long-run, inflationary policies will not decrease unemployment. Friedman then correctly predicted that, in the upcoming years after 1968, both inflation and unemployment would increase. The long-run Phillips Curve is now seen as a vertical line at the natural rate of unemployment, where the rate of inflation has no effect on unemployment. Accordingly, the Phillips curve is now seen as too simplistic, with the unemployment rate supplanted by more accurate predictors of inflation based on velocity of money supply measures such as the MZM ("money zero maturity") velocity, which is affected by unemployment in the short but not the long term.
Rate of Change of Wages against Unemployment, United Kingdom 1913–1948 from Phillips (1958) William Phillips, a New Zealand born economist, wrote a paper in 1958 titled The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957, which was published in the quarterly journal Economica. In the paper Phillips describes how he observed an inverse relationship between money wage changes and unemployment in the British economy over the period examined. Similar patterns were found in other countries and in 1960 Paul Samuelson and Robert Solow took Phillips' work and made explicit the link between inflation and unemployment: when inflation was high, unemployment was low, and vice versa. In the 1920s an American economist Irving Fisher noted this kind of Phillips curve relationship. However, Phillips' original curve described the behavior of money wages. In the years following Phillips' 1958 paper, many economists in the advanced industrial countries believed that his results showed that there was a permanently stable relationship between inflation and unemployment. One implication of this for government policy was that governments could control unemployment and inflation with a Keynesian policy. They could tolerate a reasonably high rate of inflation as this would lead to lower unemployment – there would be a trade-off between inflation and unemployment. For example, monetary policy and/or fiscal policy (i.e., deficit spending) could be used to stimulate the economy, raising gross domestic product and lowering the unemployment rate. Moving along the Phillips curve, this would lead to a higher inflation rate, the cost of enjoying lower unemployment rates. Economist James Forder argues that this view is historically false and that neither economists nor governments took that view and that the 'Phillips curve myth' was an invention of the 1970s. Since 1974 seven Nobel Prizes have been given for work critical of the Phillips curve. Some of this criticism is based on the United States' experience during the 1970s, which had periods of high unemployment and high inflation at the same time. 14.Rahn curve
The U-shaped Rahn curve is an economic theory, proposed in 1996 by American economist Richard Rahn, which indicates that there is a level of government spending which maximises economic growth. The theory is used by classical liberals to argue for a decrease in overall government spending and taxation. The curve suggests the optimal level of government spending is 15–25% of GDP. 15.Wage curve
The wage curve is the negative relationship between the levels of unemployment and wages that arises when these variables are expressed in local terms. According to David Blanch flower and Andrew Oswald (1994, p. 5), the wage curve summarizes the fact that "A worker who is employed in an area of high unemployment earns less than an identical individual who works in a region with low joblessness."In short - the lower unemployment is and the fewer the laborers there are available, the higher the wages. The contrary is true when the unemployment is high. This is the essence of the wage curve. It is utilised to explain why within a country, some regions suffer worse unemployment than others. 16.Yield curve
The curve has a typical upward sloping shape. In finance, the yield curve is a curve showing several yields or interest rates across different contract lengths (2 month, 2 year, 20 year, etc...) for a similar debt contract. The curve shows the relation between the (level of) interest rate (or cost of borrowing) and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S. Treasury securities for various maturities are closely watched by many traders, and are commonly plotted on a graph such as the one on the right which is informally called "the yield curve". More formal mathematical descriptions of this relation are often called the term structure of interest rates. The shape of the yield curve indicates the cumulative priorities of all lenders relative to a particular borrower (such as the US Treasury or the Treasury of Japan). Usually, lenders are concerned about a potential default (or rising rates of inflation), so they offer higher interest rates on long-term loans than they offer on shorter-term loans. Occasionally, when lenders are seeking long-term debt contracts more aggressively than short-term debt contracts, the yield curve "inverts", with interest rates (yields) being lower for the longer periods of repayment so that lenders can attract long-term borrowing. The yield of a debt instrument is the overall rate of return available on the investment. In general the percentage per year that can be earned is dependent on the length of time that the money is invested. For example, a bank may offer a "savings rate" higher than the normal checking account rate if the customer is prepared to leave money untouched for five years. Investing for a period of time t gives a yield Y (t). This function Y is called the yield curve, and it is often, but not always, an increasing function of t. Yield curves are used by fixed income analysts, who analyze bonds and related securities, to understand conditions in financial markets and to seek trading opportunities. Economists use the curves to understand economic conditions. The yield curve function Y is actually only known with certainty for a few specific maturity dates, while the other maturities are calculated by interpolation Yield curves are usually upward sloping asymptotically: the longer the maturity, the higher the yield, with diminishing marginal increases (that is, as one moves to the right, the curve flattens out). There are two common explanations for upward sloping yield curves. First, it may be that the market is anticipating a rise in the risk-free rate. If investors hold off investing now, they may receive a better rate in the future. Therefore, under the arbitrage pricing theory, investors who are willing to lock their money in now need to be compensated for the anticipated rise in rates—thus the higher interest rate on long-term investments. Another explanation is that longer maturities entail greater risks for the investor (i.e. the lender). A risk premium is needed by the market, since at longer durations there is more uncertainty and a greater chance of catastrophic events that impact the investment. This explanation depends on the notion that the economy faces more uncertainties in the distant future than in the near term. This effect is referred to as the liquidity spread. If the market expects more volatility in the future, even if interest rates are anticipated to decline, the increase in the risk premium can influence the spread and cause an increasing yield. The opposite position (short-term interest rates higher than long-term) can also occur. For instance, in November 2004, the yield curve for UK Government bonds was partially inverted. The yield for the 10-year bond stood at 4.68%, but was only 4.45% for the 30-year bond. The market's anticipation of falling interest rates causes such incidents. Negative liquidity premiums can also exist if long-term investors dominate the market, but the prevailing view is that a positive liquidity premium dominates, so only the anticipation of falling interest rates will cause an inverted yield curve. Strongly inverted yield curves have historically preceded economic depressions. The shape of the yield curve is influenced by supply and demand: for instance, if there is a large demand for long bonds, for instance from pension funds to match their fixed liabilities to pensioners, and not enough bonds in existence to meet this demand, then the yields on long bonds can be expected to be low, irrespective of market participants' views about future events. The yield curve may also be flat or hump-shaped, due to anticipated interest rates being steady, or short-term volatility outweighing long-term volatility. Inverted yield curve An inverted yield curve occurs when long-term yields fall below short-term yields. Under unusual circumstances, long-term investors will settle for lower yields now if they think the economy will slow or even decline in the future. Campbell R. Harvey's 1986 dissertation showed that an inverted yield curve accurately forecasts U.S. recessions. An inverted curve has indicated a worsening economic situation in the future 7 times since 1970. The New York Federal Reserve regards it as a valuable forecasting tool in predicting recessions two to six quarters ahead. In addition to potentially signaling an economic decline, inverted yield curves also imply that the market believes inflation will remain low. This is because, even if there is a recession, a low bond yield will still be offset by low inflation. However, technical factors, such as a flight to quality or global economic or currency situations, may cause an increase in demand for bonds on the long end of the yield curve, causing long-term rates to fall. Yield Curve and the Business cycle The slope of the yield curve is one of the most powerful predictors of future economic growth, inflation, and recessions. One measure of the yield curve slope (i.e. the difference between 10-year Treasury bond rate and the 3-month Treasury bond rate) is included in the Financial Stress Index published by the St. Louis Fed. A different measure of the slope (i.e. the difference between 10-year Treasury bond rates and the federal funds rate) is incorporated into the Index of Leading Economic Indicators published by The Conference Board. An inverted yield curve is often a harbinger of recession. A positively sloped yield curve is often a harbinger of inflationary growth. Work by Dr. Arturo Estrella & Dr. Tobias Adrian has established the predictive power of an inverted yield curve to signal a recession. Their models show that when the difference between short-term interest rates (he uses 3-month T-bills) and long-term interest rates (10-year Treasury bonds) at the end of a federal reserve tightening cycle is negative or less than 93 basis points positive that a rise in unemployment usually occurs. The New York Fed publishes a monthly recession probability prediction derived from the yield curve and based on Dr. Estrella's work. All the recessions in the US since 1970 (up through 2015) have been preceded by an inverted yield curve (10-year vs 3-month). Over the same time frame, every occurrence of an inverted yield curve has been followed by recession as declared by the NBER business cycle dating committee. Theory of Yield Curve There are three main economic theories attempting to explain how yields vary with maturity. Two of the theories are extreme positions, while the third attempts to find a middle ground between the former two. Market expectations (pure expectations) hypothesis Liquidity premium theory Market segmentation theory Preferred habitat theory Historical development of yield curve theory On 15 August 1971, U.S. President Richard Nixon announced that the U.S. dollar would no longer be based on the gold standard, thereby ending the Bretton Woods system and initiating the era of floating exchange rates. Floating exchange rates made life more complicated for bond traders, including those at Salomon Brothers in New York. By the middle of the 1970s, encouraged by the head of bond research at Salomon, Marty Liebowitz, traders began thinking about bond yields in new ways. Rather than think of each maturity (a ten-year bond, a five-year, etc.) as a separate marketplace, they began drawing a curve through all their yields. The bit nearest the present time became known as the short end—yields of bonds further out became, naturally, the long end. Academics had to play catch up with practitioners in this matter. One important theoretic development came from a Czech mathematician, Oldrich Vasicek, who argued in a 1977 paper that bond prices all along the curve are driven by the short end (under risk neutral equivalent martingale measure) and accordingly by short-term interest rates. The mathematical model for Vasicek's work was given by an Ornstein–Uhlenbeck process, but has since been discredited because the model predicts a positive probability that the short rate becomes negative and is inflexible in creating yield curves of different shapes. Vasicek's model has been followed by many different models including the Hull–White model (which allows for time varying parameters in the Ornstein–Uhlenbeck process), the Cox–Ingersoll–Ross model, which is a modified Bessel process, and the Heath–Jarrow–Morton framework. There are also many modifications to each of these models. Another modern approach is the LIBOR market model, introduced by Brace, Gatarek and Musiela in 1997 and advanced by others later. In 1996 a group of derivatives traders led by Olivier Doria (then head of swaps at Deutsche Bank) and Michele Faissola, contributed to an extension of the swap yield curves in all the major European currencies. Until then the market would give prices until 15 years maturities. The team extended the maturity of European yield curves up to 50 years (for the lira, French franc, Deutsche mark, Danish krone and many other currencies including the ecu). This innovation was a major contribution towards the issuance of long dated zero coupon bonds and the creation of long dated mortgages. 17.Kinked Demand Curve
The Kinked-Demand curve theory is an economic theory regarding oligopoly and monopolistic competition. When it was created, the idea fundamentally challenged classical economic tenets such as efficient markets and rapidly changing prices, ideas that underlie basic supply and demand models. Kinked demand was an initial attempt to explain sticky prices.
"Kinked" demand curves and traditional demand curves are similar in that they are both downward-sloping. They are distinguished by a hypothesized concave bend with a discontinuity at the bend - the "kink." Therefore, the first derivative at that point is undefined and leads to a jump discontinuity in the marginal revenue curve. Classical economic theory assumes that a profit-maximizing producer with some market power (either due to oligopoly or monopolistic competition) will set marginal costs equal to marginal revenue. This idea can be envisioned graphically by the intersection of an upward-sloping marginal cost curve and a downward-sloping marginal revenue curve (because the more one sells, the lower the price must be, so the less a producer earns per unit). In classical theory, any change in the marginal cost structure (how much it costs to make each additional unit) or the marginal revenue structure (how much people will pay for each additional unit) will be immediately reflected in a new price and/or quantity sold of the item. This result does not occur if a "kink" exists. Because of this jump discontinuity in the marginal revenue curve, marginal costs could change without necessarily changing the price or quantity. 18.Beveridge curve
A Beveridge curve, or UV-curve, is a graphical representation of the relationship between unemployment and the job vacancy rate (the number of unfilled jobs expressed as a proportion of the labor force). It typically has vacancies on the vertical axis and unemployment on the horizontal. The curve is named after William Beveridge and it is hyperbolic shaped and slopes downwards as a higher rate of unemployment normally occurs with a lower rate of vacancies. If it moves outwards over time, then a given level of vacancies would be associated with higher and higher levels of unemployment, which would imply decreasing efficiency in the labour market. Inefficient labour markets are due to mismatches between available jobs and the unemployed and an immobile labour force. The position on the curve can indicate the current state of the economy in the business cycle. For example, the recessionary periods are indicated by high unemployment and low vacancies, corresponding to a position on the lower side of the 45 degree line, and likewise high vacancies and low unemployment indicate the expansionary periods, above the 45 degree line. 19.Great Gatsby curve
The Great Gatsby curve is a chart plotting the (positive) relationship between inequality and intergenerational social immobility in several countries around the world. The curve was introduced in a 2012 speech by chairman of the Council of Economic Advisers Alan Krueger, and the President’s Economic Report to Congress, using data from labor economist Miles Corak. The name was coined by former Council of Economic Advisers (CEA) staff economist Judd Cramer, for which he was given a bottle of wine as a reward. The curve plots "intergenerational income elasticity"—i.e. the likelihood that someone will inherit their parents' relative position of income level—and inequality in the United States and twelve other developed countries, though some versions of the curve include developing countries. Countries with low levels of inequality such as Denmark, Norway and Finland (all located in European Scandinavia) had some of the greatest mobility, while the two countries with the high level of inequality—Chile and Brazil—had some of the lowest mobility. The name of the curve refers, somewhat ironically, to Jay Gatsby (born Gatz), the character in F. Scott Fitzgerald's novel The Great Gatsby. Jay shows a high degree of mobility, rising from being a bootlegger, to leading the Long Island north shore social set. Krueger predicted that "the persistence in the advantages and disadvantages of income passed from parents to the children" will "rise by about a quarter for the next generation as a result of the rise in inequality that the U.S. has seen in the last 25 years. Source: From Wikipedia, the free encyclopedia 20.IS–LM model
The IS–LM model, or Hicks–Hansen model, is a macroeconomic tool that demonstrates the relationship between interest rates and real output, in the goods and services market and the money market (also known as the assets market). The intersection of the "investment–saving" (IS) and "liquidity preference–money supply" (LM) curves is the "general equilibrium" where there is simultaneous equilibrium in both markets. Two equivalent interpretations are possible: first, the IS–LM model explains changes in national income when the price level is fixed in the short-run; second, the IS–LM model shows why the aggregate demand curve shifts. Hence, this tool is sometimes used not only to analyse the fluctuations of the economy but also to find appropriate stabilisation policies.
The model was developed by John Hicks in 1937, and later extended by Alvin Hansen, as a mathematical representation of Keynesian macroeconomic theory. Between the 1940s and mid1970s, it was the leading framework of macroeconomic analysis. SOURCE: Wikipedia - Prof. M. Guruprasad, AICAR Business School Tags Economics for Everyone Economics Economics and concept of curves Prof. M. Guruprasad AICAR Business School concept of curves Advertisements Save upto Rs.2.67 lakh with Pradhan Mantri Awas Yojana ...Know more Now Save Rs.3150 on your Demat Account ...Click here Now get IIFL Personal Loan in just 8* hours...APPLY NOW! Get the most detailed result analysis on the web - Real Fast! Actionable & Award-Winning Research on 500 Listed Indian Companies. Quick Jump Top News Business News FLAME News Sports General Corporate News Economy Budget Politics IPO International Sectors Agriculture Automobiles & Ancillaries Aviation Banking & Financials Breweries Cap Goods, Eng & Infra Cement Consumer Goods Diversified E-Commerce Fertilizers FMCG Gems & Jewellery Hotels & Tourism IT Logistics Media & Entertainment Metals, Mining & Minerals
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