What is meant by financial sector stability?

Financial stability is considered to be a state in which the financial system i. e. the key financial markets and financial institutional system (banking) is resistant to economic shocks such as a global recession.

A stable financial system is capable of efficiently allocating resources, managing risks and arranging payments. When in financial stability, the system will absorb external and internal shocks using self-corrective mechanisms.

Financial stability is considered paramount for economic growth as most transactions in the modern economy are made through the financial system.

Financial instability leads to banks becoming unwilling to fund profitable projects and reluctant to distribute credit. This could lead to bank runs, hyperinflation or a stock market crash of the bank. Financial stability can also have a severe adverse impact on consumer and business confidence.

The recent banking crisis and 'credit crunch' that accompanied the 2008 global recession stimulated the creation of the Financial Policy  Committee (FPC) in the UK. The role of the FPC is to identify, monitor and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system.

What is Quantitative Easing?

Using money that has been electronically created, the Monetary Policy Committee purchases assets (usually government debt) from the private sector in order to inject money directly into the economy. This increases the demand, and therefore the price of government bonds and so encourages investors to instead purchase other assets such as corporate bonds and shares. This then encourages the issuance of new bonds to stimulate spending thus increasing aggregate demand within the economy. 

Since the policy was introduced in the UK in 2009, £375bn has been injected into the economy through quantitative easing. 

Market Failure (AS/A2 Macroeconomics)

Market failure refers to a situation in which a market fails to operate efficiently, hence the title ‘Market Failure’. There are two kinds of efficiency; allocative efficiency, which occurs when the market provides the desired quantity of the products in high demand, it is illustrated by when Price=Marginal cost, as shown on the diagram for perfect competition. Productive efficiency is the second type and this requires production to be at the lowest cost and is shown by production to be at the lowest point of the average cost curve. The result of market failure is a loss in economic and social welfare.

There are a number of examples of market failure that can be taken from AS principles, such as externalities. Products with negative externalities have a negative effect on a third party and cause the social cost to be higher than the private cost, in other words the price is lower than the cost of the implications consumption has. Negative externality markets demonstrate market failure as the wrong number of goods are supplied causing a loss in social welfare.

A situation where information failure is present is a second example of a failing market. When consumers are not fully aware of the benefits of merit goods they have a lower level of demand than what they would if there was perfect information and they were fully aware of the benefits they will receive through use or consumption of the good. The consequence of this is the loss in social welfare that consumers could potentially achieve if they had full information.

An example can also be taken from the A2 market typologies, this would be a market experiencing the dominance of a monopoly. This is because theory suggests that monopolies under produce, therefore purposely creating scarcity, to ensure high prices and as a result not providing allocative efficiency.  Also monopolies fail to achieve productive efficiency as they do not operate at the lowest point of the average cost curve. This is due to the lack of competition, monopolies don’t have to compete on price so will maximise profits with high profit margins through high prices rather than encouraging productivity to drive down costs.

The market of perfect competition is a market that provides both allocative and productive efficiency.  This is because there are so many buyers and sellers that competition is so intense that any firm operating above the most productive output will go out of business as there is only room for businesses making normal profits under perfect competition. Allocative efficiency is also seen to be achieved as price is equal to marginal cost, however, perfect competition is criticised for being idealistic as it is almost impossible to re-create in the real world. Therefore, for a market to be judged to be operating efficiently it can be compared with the characteristics of perfect competition as that is the most efficient market.

REER and NEER (A2 Macroeconomics)

REER and NEER

NEER

This refers to the nominal effective exchange rate, it is a measure of the percentage change in a currency’s value. It is known as the nominal exchange because it only calculates the numerical exchange value, it ignores the purchasing power of the currency (which is a theory that explains why people in India for example can live off the average wage of £3,850 a year, after exchanging Rupees to £’s). The nominal effective exchange rate of a currency is determined by the government under a fixed exchange policy and by the supply and demand of the currency for a floating exchange rate system. 

Extract 4 from the pre-release material for OCR Econ 4 includes a graph which illustrates a 50% fall in Iceland’s NEER, this is a steep depreciation. This means that the Icelandic Krona could only purchase half of the amount British pounds in 2011 that it could in 2007. This was caused by the drastic fall in demand for the Krona when the Icelandic banks collapsed during the world recession of 2008.

REER

The real effective exchange rate takes purchasing power into account and measures the change in prices that country’s demand for their exports. If a country’s real effective exchange rate falls it means that the price of their exports has fallen. 

In the same extract, it is highlighted that Latvia’s NEER was unchanged but experienced a 20% decrease of its REER, this was a result of the vigorous austerity policy Latvia implemented. Latvia carried out an internal devaluation by keeping wages low, the objective of this was to improve the international competitiveness of Latvia’s exports to soften the effect of the recession. 

The Law of Diminishing Returns (A2 Microeconomics)

This refers to the cost of production to firms in the short run, where short run is considered to be the period of time when at least one factor of production is fixed. 

The law of diminishing returns relies on the assumption that capital is a fixed factor. It states that as a firm increases the amount of inputs of a variable factor (such as labour), it will gradually derive less additional output per unit of labour for each further increase. This is a result of the fixed factor of production, which limits the capacity of cost efficient production. For example if a manufacturing firms owns 100 sewing machines, as the number of machine operators employed by the firm passes 100 and employees are required to share machines the output per worker will begin to fall.

As it becomes more expensive to produce each additional unit of output, marginal cost (MC) and average variable cost (AVC) will start to rise. 

Eventually, the rise in AVC will exceed the fall in average fixed cost (AFC) which generally occurs as fixed costs can be spread to a larger amount of units of output. When this happens, average total cost (AC) will also start to rise.

Source http://www.bized.co.uk/

Here, where MC is below AC, AC must be falling. This is because an additional unit of output that is cheaper than the average unit cost will pull down the average cost of production. Once the MC curve meets the AC curve, average costs begin to rise as they are exceeded by the marginal cost of output. If an additional unit of output is more expensive to produce that the average cost, the new average cost including this additional unit will be greater. 

This relationship results in the MC curve cutting the AC curve at its lowest point. This is where costs of production are at a minimum. Profit maximising firms will aim to produce at this point.

The Resource Curse (A2 Macroeconomics)

The Resource Curse

Over the past couple of decades we have seen the BRIC (Brazil, Russia, India and China) countries grow rapidly through various different methods. We already know that to achieve growth; there must be an increase in aggregate demand, which means there must be an improvement in at least one of the elements of aggregate demand.  However undeveloped countries will already have low consumerism due to limited disposable income, investment is minimal because they’re not attractive economies to trade in, consequently the government receive little in taxation revenue so do not have the finance to spur growth through fiscal policy. This leaves countries in the position where they must improve the balance of X-M, they can either increase exports which is known as an export led growth, or they can reduce imports by producing a high variety of goods to sell domestically. 

China is a great example of an economy exploiting export led growth as they specialised in cheap consumer goods to export to the Western economies. India is an example of an import based growth as they produced all the goods they needed and placed protectionist policies on foreign goods, this forces up the sales of domestic goods.

How does a country decide on their method?

One factor and often the deciding factor is the country’s access to resources, for example as mentioned in the ECON 4 extract many Sub Saharan African countries have found that they’re rich in natural resources such as oil and gas. This would encourage an economy to opt for an export led growth of primary commodity goods.

Finding masses of oil would therefore sound ideal for an undeveloped country as it will encourage firms to invest into the country, high sales for firms selling the commodities will increase aggregate demand. Therefore, the government will collect more in taxes so will have finance available to spend on education and health care which illustrates a multiplier effect on aggregate demand and will also improve the standard of life for the people.

So then why have the sub Saharan countries grown at a rate of 5% (much higher than EU economies) but according to the Human Development Index still have a standard of living that is significantly below the world average?

There are number of interconnected reasons for this, the most important and probably obvious one in my opinion is the high levels of corruption. Companies trading with foreign oil companies rarely trade as simplistically as business to business, the executives of the foreign firms often demand payments into private accounts to ensure the deal. This links to the second reason which is the inequality created as a result, the powerful few receive high payments from corporate deals the revenue of exports are kept in the hands of the elite rather than distributed to the many through higher wages. This is worsened as the process of extracting natural resources no longer requires heavy amounts of labour as modernisation and improvements in technology have caused the industry to become capital intensive. This may be more efficient for firms but will limit the effect on unemployment.

These reasons identify why the general population of resource rich countries do not benefit, but demand inflation can actually cause people to become worse off than they were before. As aggregate demand rises from the rise in exports it will shift up the supply curve and cause price level to rise, which is shown by an increase in the rate of inflation. This will make all the normal goods people buy more expensive, which will leave people with less money and therefore worse off than before the natural resources were found. This illustrates how although growth is required to fund development. Development is not always enjoyed from an increase in growth.

Balanced Budget Fiscal Expansion (A2 Macroeconomics)

Balanced budget fiscal expansion is defined as: a policy to increase GDP through changing government spending and taxation levels, whilst leaving the overall fiscal budget position the same.

This method of fiscal expansion could be used in two ways. The first is that if you increase spending and taxes equally, through the multiplier effect, the expansionary government spending should have a bigger positive impact on economic growth than the negative impact of higher taxes. An example of this would be to temporarily increase income tax in order to finance capital investment.

The second is through a reallocation of government funding. In this case, cuts in spending on items such as public sector wages could be used to finance higher spending on items such a as infrastructure. Again, the multiplier effect should result in the benefits of increased spending on infrastructure being greater than the costs of cutting public sector wages. Another example of this would be to reduce spending on pensions and increase spending on capital investment.

Spending on pensions may be reduced by increasing the retirement age. As well as allowing more money to be spent on funding capital investment such as infrastructure projects, people will also be working longer causing the labour force to increase. This will therefore stimulate an increase in both aggregate demand and the economy's productive potential without increasing the government's budget deficit. 

The idea of a balanced budget fiscal expansion relies on the positive multiplier effect being greater than one. Generally, unless the economy is at or close to full capacity this is likely to be the case as a result of its reduction in unemployment.

For those currently studying at A2 through OCR, balanced budget fiscal expansion is mentioned in Extract 1 of the case study for The Global Economy module. The IMF recommended that the UK pursue a balanced budget fiscal expansion to increase growth. This form of fiscal expansion, if successful, would stimulate an increase in aggregate demand without compromising the government's Deficit Reduction Plan.

Should Latvia have joined the Euro?

Latvia is a reasonably new country as it only gained independence from Russia in 1991. With a population of 2 million, it has one of the smallest in the EU since joining the union in 2004. For Latvia to move to the next level of economic integration it had to meet the five regulations of the Maastricht Criteria which included restrictions on levels of inflation, debt and the ability to fix their currency to the Euro for two years. These are in place to ensure that economies sharing currency (in this case the euro) are similar and sync business cycles.

Probably the most obvious, but also potentially the most important benefit of joining the Euro for Latvia was that it will remove financial transaction costs of international trade. Although restrictions on trade such as tariff, quotas or regulations are already exempt to Latvia as they’re a member of the European Union, by joining the Euro the cost of exchanging currencies will be removed for Latvian firms. This will reduce Latvian firms costs as they will no longer have to ‘hedge’ their prices incase exchange rates change between the time an order is made and when it is paid for which can often be months down the line. This is especially beneficial for Latvia as it as an extremely open economy since they adopted a policy of internal devaluation, implementing austerity and a fiscal tightening, consequently making their exports cheaper which has since lead to a reliance on international trade for Latvia.

A second benefit to Latvian firms and also their people is that by joining the euro it guarantees that any debts to European countries will not increase due to fluctuating exchange rates. This may actually have a double positive effect for Latvia as this guarantee will ease the stress of debts for Latvians and could lead to an increase in domestic consumerism which would be more than welcomed by yet another economy recovering in an unbalanced manner from the deep recession of 2008.

However as with all economic decisions there are drawbacks or at least potential drawbacks! In the case of joining a single currency it places restriction on an economy, Latvia will no longer have control over their monetary policies, these will be controlled by European Central Bank in Frankfurt. It is unlikely that monetary policies will be consciously made in the interests of Latvia as they contribute little to the EU in comparison to economies such as Germany and France. An additional restriction is Latvia’s ability to undertake Keynesian policies of high government spending and low taxation. This is because even after joining the Eurozone Latvia must conform to the criteria concerning levels of Government debt.

Furthermore although joining the Euro does bring financial transaction benefits, it will intensify the competition on domestic Latvian firms from other countries within the Eurozone. Having a separate currency adds protection to domestic firms as Latvian consumers buying imports would have to pay for the transaction costs included in the price of goods, however now that these will be removed they will become more attractive. The extent of this effect will depend upon the elasticity of demand for the goods that Latvians import from within the EU, however they are likely to be elastic luxuries unavailable in Latvia, such as expensive German cars. This will reduce consumerism in Latvia on domestic goods, resulting in a fall in demand leading to a drop in investment from Latvian firms. This is a prime example of the negative multiplier effect within an economy. The significance of this is that Latvia’s reliance on exports will be greater.

Was it a good move?

We must remember that Latvia had no choice but to join the Euro at some point because they didn’t join the European Union until after the Euro was incorporated, however they could have delayed the transition like Poland who have done so for over 10 years and are still yet to show any interest in following suit. It is difficult to say whether it will be a success and we will not be able to judge this for some time, but although many of the effects of joining a single currency are economic, these may not have been the primary motive for Latvia. Only 25% of Latvia’s international trade is with other EU members which reduce the significance of the trade benefits already mentioned; however by furthering their integration with the union they will receive protection against any potential political confrontation with currently boisterous Russia. 

Submitted By Jack Murray

Is 'free' trade hindering the development of poor countries?

Trade is considered by many to be the engine of growth in a nation, acting as a spur for development. Neo-liberalists believe that free trade will lift people out of poverty, a view that is supported by the rapid development of the Newly Industrialised Countries (NICs), with the growth of China and India being particularly strong examples.

However, the view that free trade will lead the development of a nation is a highly controversial one. Strong arguments exist, stating that trade is often unfair to developing countries as stronger economies, firms and organisations control markets by following protectionist strategies such as tariffs and subsidisation and by controlling commodity prices.   

An example of this occurring is in the cocoa industry in Ghana where foreign commodity traders such as buyers for MNCs like Nestle and Cadbury trade in future markets (i.e. they buy supplies now to ensure delivery in 3 to 6 months). A downward pressure is put on cocoa prices due to competition from other exporting nations. Due to this, commodity prices are volatile which results in irregular income for workers and uncertain tax returns for governments of developing nations. 

The prices of commodities are also volatile as a result of their price inelastic demand and supply. A price inelastic demand is caused by most commodities being necessities rather than luxury goods and due to their lack of substitute goods. Commodities also have a price inelastic supply due to their relatively long period of time taken to excavate and the limit to their potential supply. This means that a small change in quantity demanded or supplied can radically affect their price and so make predicting revenue generated from their export difficult. 

In Ghana, as with many other developing nations, much of the nations income therefore depends on the actions of powerful MNCs from the developed world. Such as relationship is described as neo-colonial meaning that countries remain under control of overseas countries indirectly - despite them supposedly being independent. 

Further injustice: how 'free' is free trade?

This seems like a ridiculous question but, unfortunately, as developing countries are pressured into completely liberalising their markets the same is not being done to wealthier and more powerful nations.

In the EU free trade occurs internally. Externally, however, traders are faced with high import tariffs. Most of the processing and packaging of cocoa is completed in Europe as a result of the occurrence of tariff escalation. EU tariff imports are much higher for processed cocoa than for raw cocoa beans and as a result Ghana is forced to export the raw beans and lose out on the value added by processing them, meaning that workers have little opportunity to earn higher incomes. Through this process strong economies are able to maintain poorer countries in a state of under development and prevent large scale industrialisation. Instead high income countries purchase cheap commodities from the developing world and add value to them before exporting them back as high value, manufactured goods. Developing nations can become stuck in the primary sector, a constraint on development. This is known as the resource curse and is considered to be a curse because resources are exhaustible and currently depletion rates are unsustainable.

This supports A.G Frank's Dependency Theory which splits the world into an economically developed core and and underdeveloped periphery. The theory states that developed countries keep developing countries in a state of under development by exploiting its raw materials and selling it costly manufactured goods, technology and credit. Developing countries are exporting low value goods and importing high value goods. This results in a poor terms of trade. As the periphery remains underdeveloped, its most skilled workers move to the developed core creating a brain drain, further exacerbating the problem. 

The role of the World Trade Organisation (WTO)

The purpose of the WTO is to promote global free trade. Despite pressurising developing nations into completely liberalising trade, the WTO has not been successful in removing the EU Common Agricultural Policy (CAP) which discriminates against farmers in developing countries by undermining their natural price advantage and flooding their economies with heavily subsided imports. Critics of the WTO describe it as an organisation that favours the wealthy nations that were responsible for its creation by pressuring poorer nations into unfair trade agreements. 


Referring back to the example of Ghana, in 1995 Ghana joined the WTO in an attempt to increase its global trade. Instead the nation was faced with the joining condition that farms in Ghana should no longer be subsidised by the government (which until then had occurred to encourage farmers to continue supplying food for the country's growing cities). As a result, local farmers lost out to cheaper competition from EU imported goods that had been subsidised in their country of production. 


It cannot be denied that free trade between nations generates wealth, but is the benefit really being felt in the worlds poorer nations or is the liberalisation of markets in fact acting as a constraint to development?

Exchange Rates: Fixed vs Floating (A2 Macroeconomics)

The exchange rate is the price at which one currency is exchanged for another on the foreign exchange (FOREX) market. Two of the main types of exchange rate used by Governments are a free floating exchange rate and fixed exchange rate.

The Free Floating Exchange Rate

A free floating exchange rate is a system whereby the price of one currency expressed in terms of another is determined by the forces of demand and supply.

Advantages:

• A floating exchange rate means that a government can have a larger focus on achieving other macroeconomic objectives. For example, there is no need to set interest rates to achieve an exchange rate target so interest rates can be used to achieve price stability or encourage investment.
• Automatic adjustment should ensure a Balance of Payments equilibrium is achieved. For example, if a country has a balance of payments deficit then the currency should depreciate. This is because a deficit means that imports will be greater than exports. As a result, the supply of the nations currency will exceed its demand on the FOREX market which will cause the value of the currency to depreciate. This will make exports cheaper (and so raise demand) and imports more expensive (reducing demand), eliminating the B of P deficit. 
• It may be easier to adjust to external economic shocks such as a global recession. A global recession would reduce the demand for exports, causing reduced demand for currency on the FOREX markets and lead to a depreciation in the value of the currency, lowering the price of exports and making them more attractive.

Disadvantages:

• A changing value of a currency may result in consumer uncertainty. Exporters may be unsure of how much money they will receive when they sell abroad and importers may not know exactly how much it is going to cost to import a foreign good.
• The freedom to set domestic policy does not guarantee that price stability will be prioritised over other objectives. Automatic adjustment mechanisms may lead to governments pursuing short-term economic growth at the expense of higher inflation.
• The floating exchange rate can be inflationary by allowing import prices to rise as the exchange rate depreciates. This particularly an issue for countries who depend on imports for the provision of certain goods such as exotic foods.

The Fixed Exchange Rate

In a fixed exchange rate system, the government intervenes in the currency market so that the exchange rate stays close to an exchange rate target. 

Advantages:  

• A fixed exchange rate provides certainty for traders, investors and consumers by allowing the price of imports and exports to remain more stable. Some economists argue that this will result in higher levels of trade and investment.
• Fixed exchange rates can impose financial discipline on domestic firms to keep their costs under control in order to remain competitive in international markets. This helps the government maintain low inflation, which in the long run should reduce interest rates and stimulate trade and investment.
• A fixed exchange rate reduces the costs of international trade to firms by removing the need of hedging (limiting the risk that losses are made in changes in the price of currencies by buying currencies in future markets).

Disadvantages: 

• It may be difficult to work out the initial fixing of the rate of exchange. If it is fixed at a rate too high, exports will remain relatively expensive and imports cheap. This will result in a long term loss in international competitiveness by domestic firms and a poor position in the current account of the balance of payments. 
• In order to fix the exchange rate, the government will need to maintain a high level of foreign currency reserves in order to intervene on the FOREX market. This incurs an opportunity cost. In addition, whilst maintaining the exchange at a fixed rate, other macroeconomic policy objectives may be sacrificed. For example, governments may alter interest rates in order to influence the rate of exchange, conflicting with with the objective of maintaining price stability. 
• A fixing of the exchange rate could result in retaliation by other nations. Retaliation may take the form of protectionist measures such as trade barriers against imports from domestic firms. This will increase the price of exports, thus rendering the fixed rate ineffective in increasing trade.

Economic Growth: China vs. the UK (Eco4 and Buss4)

The logical place to begin this would be to ensure we’re aware of what growth actually is and how it comes about. Growth is illustrated by an increase in Gross Domestic Product, these figures are released on a quarterly basis but are likely to be re-examined and corrected as initial figures are often inaccurate. An increase in GDP is an example of short run economic growth as it shows a change in the output of an economy. This is caused by either an increase in Aggregate Demand or short run Aggregate Supply, therefore in theory an increase in any of the elements of Aggregate Demand will bring an economy growth. Okay so now that we’ve got the basic economic explanation sorted lets apply this to relevant reading for both Eco4 and Buss4.

To ordinary followers of the news the phrase ‘economic growth’ will be covered in positivity, however economists will be intrigued to understand what has caused this growth to then forecast the implications of the economic growth. In the UK growth brings scares of rising inflation, so how on earth have the Chinese managed to grow at an average rate of 9.5% over the past 10 years and only feel inflation levels of 3%? This is due to the nature of China’s growth, the Chinese have escaped the fear of inflation by ensuring that Aggregate Supply is increasing at a rate that matches that of aggregate demand. This can be achieved by increasing the quality of capital, China have tackled this by encouraging foreign investment through financial incentives such as tax allowances for foreign firms and improving infrastructure  with thousands of miles of new motorway and over 30 new airports subsequently making China a more efficient and therefore profitable country for a firm to operate in. This approach is shown by a shift to the right of the short run aggregate supply curve and therefore maintaining the current levels of inflation.

However this rapid rate of growth is finally appearing to begin to catch up on China, this is highlighted by the wage inflation that the economy is now experiencing. At first this seems strange considering the first attraction of expansion for Western firms to China was the appealingly low wage costs. However due to the one child policy the supply to the labour force has been restricted, which has left the economy nearing full capacity, this is shown by a movement of the aggregate demand curve up the vertical curve on the Keynesian aggregate supply curve.

Bringing things closer to home, as well documented in the news the UK economy is experiencing new found growth and climbing out of the deep recession of 2008. This is where the UK converse with China as our growth has been primarily powered by consumer spending and a recovery of the housing market. How does this happen though, why during a recession would we begin to start spending more money? Us as consumers have clearly taken the conscious decision to spend more and save less in other words increase our marginal propensity to spend. This decision derives from consumer confidence, we have been encouraged to feel more confident by policies introduced by Mark Carney. Such as forward guidance that gives us assurance that interest rates will not swiftly increase after loans are taken out and funding for lending which has made it easier to obtain house mortgages. Increasing the demand for houses has boosted the house markets recovery and caused prices to rise, consequently providing more confidence to consumers as we feel wealthier when we see our house increase in value. 

But there must be a catch, if recovering an economy was this simple then why would we ever worry? The consumer spending is worsening the Balance of Payments deficit because the level of imports is outweighing exports. The implications of this is that the government are forced to sell their bonds at a higher rate of interest thus making the economy more expensive to run. Secondly the issue with becoming reliant upon an improving housing market is that people will take out risky re-mortgages and cheaper loans due to the base rate of 0.5% is that if and when the housing market begins to decline then people may fall into negative equity on their property and this will cause consumer spending to come to a standstill as it is the ultimate killer of consumer confidence.  Ring any bells from 2008?

We are forever reminded of balanced diets and balanced lifestyles are the life to lead, well economies are the same, for them to operate healthily they must be balanced. Which is why China are not trying to encourage consumer spending, the current culture of China is to save almost a third of their income whereas UK consumers save as little as 5.7% of theirs. China have switched to this approach as it is seen as more sustainable method of growth. They’re promoting this policy by increasing their national minimum wage to leave people with more disposable income as consumption = disposable income X average propensity to consume. China have understood and accepted that growth will slow down with under this approach and have just released forecasted growth figures of 7.5%, but it may be in exchange for an economy that will continue to grow for years to come. Similarly the UK are also attempting this economy balancing act as Osbourne admits that an economic recovery based on debt fueled consumerism will not lead to a sustainable future. The plan is to boost and support investment end exporting business, as the UK are in the position where they can benefit from successful economies overseas and tap into their consumer market.  It poses the question of whether the UK and China could benefit assist each other with China’s newly proposed consumer market and the UK’s desire for exporting, the answer is quite possibly as Jaguar Land Rover demonstrate with their UK manufactured luxury cars receiving high demand from China. 

Submitted by Jack Murray

Economic Systems (AS Revision)

An economic system is the way in which production is organised in a country or group of countries. This includes what goods and services are produced, how theses goods and services are produced and who these goods and services should be received by. The three main economic systems that will be covered in this post are market economies, command economies and mixed economies.

The Market Economy

A market economy is defined as "an economic system whereby resources are allocated through the market forces of supply and demand". In a market economy the consumer is sovereign; the demand by consumers controls the output of produces and therefore the allocation of resources. This takes place through the price mechanism where firms respond to consumer choice through the free movement of price in response to demand and supply. The government will have little involvement in this process, with their main roles involving legislation and the protection of property rights. The USA may be considered the closest to a free market, however governments still play roles in providing some public services.

In a market economy the level of consumer choice will be dependent upon their income. The higher the income of the consumer, the greater their choice. This could lead to social inequality by excluding those on low incomes from various goods and services. However, a free market economy may be seen as beneficial to the consumer a competition between producers will be high. This will encourage allocative and productive efficiency in order to be price competitive as well as encouraging research and development by firms to compete on non-price factors such as quality. 

Command/ Centrally Planned Economies

A command economy is "an economic system where government, through a planning process, allocates resources in society". Examples of command economies include North Korea and Cuba. It is the governments that own the majority of resources and it is their role to allocate these resources. Both wages and prices of essential items are controlled by the state. Governments of command economy's set targets for production in long term plans that often aim for a high rate of growth in output.

Arguments against command economies include a lack of consumer choice. Not only are consumers exposed to a lack of variety of goods and services, but as workers they are also allocated jobs by the state.With equal choice and opportunity, workers have little incentive to improve. The lack of competition between producers removes the incentive to achieve economic efficiency, and also likely to result in a lower quality of goods and services that are provided.

The Mixed Economy

A mixed economy is defined as "an economic system in which resources are allocated though a mixture of the free market and direct public sector involvement". The UK is an example of a mixed economy, where a Private Sector and Public Sector exists. The private sector allocates resources through the market forces of supply and demand, but with government intervention in markets that would fail if left to the free market. The government allocates resources in the Public Sector, which includes services such as education, healthcare and the emergency services. 

If governments intervene effectively and to the correct extent, a mixed economy may considered to be the best of both worlds. However in some cases, government intervention in markets is unable to correct the existing the market failure and may even make the situation worse resulting in government failure.

Measuring Inflation - What you need to know at AS (Revision)

Inflation is defined as "a general increase in prices, and fall in the purchasing value of money overtime". 

How inflation works can be shown through a trip to the supermarket. I head to Sainsbury's and purchase a trolley full of a range of goods for £100. I then return to the supermarket a year later and purchase the same items, this time coming to a total of £105. I have experienced the effects of a 5% inflation rate. If I am to purchase these goods I will have to spend an extra £5 to what I did last year or I will need to remove an item from my trolley (shoplifting is against the law, no kleptomaniacs please). Inflation thus leads to higher prices and lower purchasing power. It tends to be a monetary phenomenon caused by a country printing more money than is justified by the country's wealth.

There are two main methods used to measure inflation in the UK. One being the Consumer Price Index (CPI) and the other being the Retail Price Index (RPI). The consumer price index (CPI) is a weighted index. The results from a Family Expenditure Survey are used to find out what people spend their money on. It measures a monthly change in the prices of over 600 different goods and services. These products have weights attached to them. The weight reflects the proportion spent on the different items. For example, if 15% of  consumer expenditure is on food then this will be given a weight of 15/100. 

The expenditure weights are held constant for a year. They are then reviewed and changed depending on a change in the households spending patterns. Then, throughout the year government employees visit a range of outlets throughout the country gathering price quotations for the 600 different goods and services. This is completed each month. Ultimately, the weights are multiplied by the new price index for each category in order to find a change in the total price level. 

The RPI uses the same basket of goods and services that the CPI uses but also includes housing costs (house prices and mortgage and council tax payments) that are excluded from the CPI. The RPI also uses the arithmetic mean between the old and new price whilst CPI uses the geometric mean. The end result of this is that the RPI always gives a larger figure for inflation than CPI. 

So what ones better? 

• CPI is regarded to be more accurate. It's maths is truer and reflects to the inflation that a lot more people experience.
• The RPI does not meet international standards. It doesn't match what other countries do.
• The CPI excludes all housing costs including mortgages, interest payments and council tax. It also excludes the road fund licence and TV licence.
• Both do not respond to changes in quality. Although the price of a good or service may rise, this may be accompanied by an improvement in quality. In this respect, both measures may over-estimate inflation. 
• Both do not take into account the prices of second hand goods. 

All in all, it is difficult to measure inflation within an economy. There are many factors that cannot be taken into account but may have a large effect on the rise or fall in levels of inflation. This therefore makes it hard to put a definitive value on the exact rate of inflation at a given time.

YOUR IDEAS:

At this point in time, the UK inflation rate is 1.9%. This is lower than the Bank of England's target of 2%. Is this good or bad for our economy? Tell us your thoughts!

Is mercantilism really a thing of the past?

So far while completing A level Economics, although I have learnt a relatively large amount that relates to mercantilism (monopolistic market structures and profit maximising firms), I have only come across the term through further reading. 

Put simply, mercantilism is the belief in the benefits of profitable trading. It involves maximising net inflow of foreign exchange (traditionally in the forms of gold and silver) by restraining imports and encouraging exports. It serves the interests of producers whose actions are protected and encouraged by the national government. Core to the support of of mercantilism is another new term - Bullionism. Bullionism is an economic theory that defines wealth by the amount of precious metals owned.

Mercantilism was most popular in the 16th to 18th centuries (know as the mercantile era). Mercantile firms would be protected against foreign and domestic competition through policies set by national government. Such policies included the provision of capital, the establishment of monopolies and the implement of tariffs and/or quotas to competing imported goods.


An example of extremity of mercantilism policy can be seen the Hudson's Bay Company, who traded beaver fur. In 1670 King Charles II granted the company a charter which gave Hudson's Bay Company a monopoly status in England and sole trade of the Hudson Straight territory. The charter also made the three founders of the company "the true and absolute lords and proprietors" of the Hudson's Bay area- an area which roughly took up 40% of Canada. The firm were the unofficial government of the area and had the power to pass laws, fight wars and issued its own currency. It has territorial control of the area for 200 years before being sold to the Dominion of Canada. The power given to the trading monopolies during the mercantile era, in my opinion, makes the power of modern day large MNCs seem slightly less threatening.

The end of the mercantile era is seen to be at around the time of the publishing of Adam Smith's The Wealth of Nations, which is considered to be at the base of the modern economic theory. The book argued that such a relationship between government and markets was a harm to the general population. Instead, Smith promoted policy based around free markets and the liberalisation of trade. He argued that mercantilism reduces competition and so acts as a drag on economic development.  By the middle of the 19th century, this opinion had caught on a Britain had embraced the idea of free trade.

More recently, mercantilism is seen as nothing more than a part of economic history. However, arguments for the mercantilism continuing to take place exist, particularly when looking at the case of China.

After China opened its doors to free trade in 2001, Chinese economic policy focused on encouraging FDI by MNCs through the promise of cheap labour a special export zones which contained lower tax rates. However, in 2006 China chose to move attraction of investment from foreign firms to investment into Chinese firms. It is the methods that China has taken to achieve this that are now being considered to be neo mercantilism. Policies have included actions to spur exports while reduce imports such as currency manipulation, high tariffs and tax incentives for exports. There are also arguments that China is now discriminating against foreign firms through policies such as land grants and tax incentives to Chinese firms, cash subsidies and controls on foreign purchases designed to force technology transfer into China.

The question is, is this really a new era of mercantilism in China or is the country simply showing justified levels of support to its growing domestic firms?


Suggested further reading: Enough is Enough: Confronting Chinese Innovation Mercantilism

Whats that? WhatsApp. Is it worth the $19bn takeover?

The majority of phone users from my generation will have at least heard of this App. It's a "cross-platform mobile messaging app which allows you to exchange messages without having to pay for SMS." The advantages it has over iMessage or BBM (now available on iPhone and Android) is that WhatsApp Messenger is available for iPhone, BlackBerry, Android, Windows Phone and Nokia. In addition to basic messaging WhatsApp users can create groups, send each other unlimited images, video and audio media messages. It now has around 500 million users world wide and of which 70% use the service everyday. 

Before we go into the details as to why Facebook believed Whatsapp was worth the $19bn they paid, lets put in perspective how much that is. Three days ago  the worlds most wanted man was arrested in Mexico, Joaquin Guzman. He has been listed on Forbes 100 richest men in the world (ranked 41^st in 2009) and said to be worth $1bn. WhatsApp has now been sold for 19 times the value of him. When you're to think of it this way, considering the company had made only $20 million in sales last year, it's laughable. Is there a bigger picture? 

Mark Zuckerburg spoke on behalf of Facebook at a press conference in Barcelona yesterday and believes that WhatsApp is a "rare platform that has the potential to reach out to 1 billion mobile users". The real majesty of web dynamics and most obvious is the colossal global reach at nearly zero marginal costs. Whatsapp has around 50 employees. It has no marketing costs. No Washington lobbyists. No stores. No global campus. No sponsorship of the local symphony. With the introduction of voice calling becoming available in the next few months, at what is said to be free, potential add-ons to this feature are endless. Adaptations of the iPhone's FaceTime or extra emoticons at low prices will help create the revenue the company is needing and make the sum of $19bn seem a lot more reasonable. What most new users don't realise, like myself, is only the first year of WhatsApp is free. After 12 months your account will expire and you will be asked to pay prior to your subscription end date.

But what has Facebook really got to lose? Zuckerburg bought WhatsApp because it gives him a hook into hundreds of millions of customers, who may get shoved over to Facebook, and its ad platform, in ways even he's not dreamed of yet. As of yet Whatsapp is ad-free but who's to say they won't start displaying them on this platform? It's now in Facebooks hands to do what they like. There's been so little precedent for business at this scale that all we can do is wait to see what comes of it and if the takeover really was worth the price they've paid. 

Fiscal Multipliers (A2 Macroeconomics)

If you are currently studying A2 Economics through OCR you are likely to already be fairly familiar with the pre-release stimulus material. Within each section of this material a variety of key terminology that you will not necessarily study in depth in class are used. In the introduction of the stimulus material, fiscal multipliers are mentioned:

"Later in 2012 the IMF published research which suggested that fiscal multipliers in a number of countries were much higher than previously thought and estimated these to be in the range of 0.9 and 1.7"

A fiscal multiplier measures the final change in national income (real GDP) that results from a deliberate change in either government spending and/or taxation. For example, if a government spends £1 million on a project that causes GDP to increase by £1.5 million then the fiscal multiplier for this project was 1.5. Several factors affect the size of the fiscal multiplier. Some of these include:

• The nature of the fiscal policy. In terms of fiscal stimulus, Keynesian economists believe that the size of the fiscal multiplier effect is higher for government spending than for tax cuts.
• The Availability of credit. As demand rises, it will be necessary for credit to be easily available to those firms that require it in order to fund production increases and capital investment. 
• Monetary Policy. For example, government spending through borrowing that leads to higher interest rates may result in a smaller fiscal multiplier as firms may feel less inclined to borrow and consumers may increase their marginal propensity to save (MPS).
• Levels of international trade. The more open an economy is, the greater the extent to which higher government spending or tax cuts will feed into rising demand for imported goods and services, lowering the impact on domestic GDP.  
• Confidence. Consumers MPS might be higher if there is uncertainty about job prospects, future income and inflation. 

It is possible for the fiscal multiplier to be less than one, as seen in the extract from the introduction to the pre-release material. This is the case if the change in government spending or tax rates is greater relative to the change in national income. This could occur if initial injections into the economy are saved rather than consumed. It may also occur if spending was received by foreign MNCs rather than by domestic firms. 

A Day for the Bookies

Earlier this week figures showed that 1.7 million square ft of retail space had been sold off last year to bookmakers. In total, 106 new betting shops have opened up around the country as retail space had been re-allocated to such companies. 

Is this necessarily a bad thing? During the recession betting-shops were not as hard hit as general retail outlets and in some cases, gambling increased. The use of high-stake roulette machines have raised by around 5% from 2008. According to the LGA (Local Government Association) the number of betting shops in some parts of London have doubled in the past decade.

The LGA have called for councils to increase the difficulty of Bookmakers to purchase such retail space as they believe it is having a negative impact among local communities. A spokesman from LGA said in an interview with the BBC last week "Councils aren't anti-bookies but need powers to tackle the damage that can be caused to High Streets and town centres". He believes that they have became "far too concentrated" in certain towns and cities around the UK and added "Licensing laws must be updated to allow councils to consider the impact a new betting shop would have on their local economy and existing businesses. This would protect the power of local communities and democratically-elected councillors to shape their area.".

However, in a submission to a particular government consultation it highlights social and economic benefits from betting shops which include the following:

• The Centre for Economic and Business Research (Cebr)’s study reveals that betting shops contribute £3.2 billion to UK GDP, support 100,000 jobs and pay £1 billion in taxes.
• For every £1 of Gross Value Add (GVA) generated by betting shops, an additional £0.61 of GVA is generated in the wider economy through indirect and induced impacts.
• Bookmakers have already invested about £2 billion in local economies through the opening new and refitted betting shops.
• Betting shops employ 14,000 young people aged 18-24 (25%), an age group with 20% unemployment currently.

Nevertheless, yesterday Ladbrokes confirmed they are to be closing down 40-50 shops around the country as it looks to optimise its retail estate in “secondary locations”. They believe this is likely to be a common move amongst other high street bookmakers in the UK as the industry looks to reduce the number of retail outlets it has opened in the past few years. 

The question local councils need to be asking is if they are to tighten their laws the approval of betting shops to use retail space, what will be the opportunity cost? Clearly the data above proves that despite the stereotypical view on bookmakers, there are clear advantages to both the local and national economy. Dead-weight loss would arise if these areas of potential shop space were unused. This may therefore generate a negative multiplier throughout the economy as employment decreases and ultimately cause a fall in Real GDP. 

Should we pay more to use roads? (A2 Transport Economics)

Roads are an example of a quasi-public good. This means that they have many but not all of the characteristics of a public good. They are semi non-rivalrous (additional consumers will eventually cause congestion) and semi non-excludable (legally, only those holding licences can drive on roads).  The use of roads result in negative externalities (the bad spillover effects resulting from a transaction between a producer and consumer on a third party, usually society). The negative externalities that result from the use of cars on roads includes congestion, air pollution, noise pollution and car accidents.

Road pricing is an indirect tax that charges drivers for the use of roads. It is a market based policy that aims to directly reduce the demand for road use and so correct the resulting negative externalities. Ideally, the size of the tax should equal the (estimated) monetary value of the negative externalities of road use. For this to occur, the tax should be representative of where its being paid, when the road is being used and how polluting the vehicle being used is. For existing examples of road pricing in the UK this is not the case. The London Congestion Charge is a fee of £10 for the majority of vehicles operating within the Congestion Charge Zone in central London, despite the length of time in the zone, the time of day or how highly polluting the car being taxed is. 

Currently in the UK cars are required to pay Vehicle Excise Duty (VED), an annual indirect tax on car use. However as car ownership increases and roads become more congested, is this enough?

The arguments for the use of further road pricing include that it will be successful in achieving its main aim: reducing the negative externalities of road use. By internalising external costs, road pricing would cause a contraction in the demand for road use and thus reduce congestion. For those willing to pay the tax, journey times would decrease. Levels of noise and air pollution that result from congestion would also be reduced. Revenue generated from road pricing could also be used to fund investment into substitute forms of public transport such as the rail and bus networks. This will be particularly beneficial if hypothecation (a situation where revenue from a tax is directly allocated to spending within the area taxed, in this case transport) occurs.

If it was that simple road pricing would be an obvious solution to the negative externalities produced by road use, however, arguments against road pricing also exist. The first of these is that for firms that use roads as a means of transporting freight, a tax on road use will increase the cost of production of these firms and result in lower profit margins or higher prices (that could cause cost-push inflationary pressure). This will led to a reduced ability to be price competitive against rival firms who operate in areas where road use is free. The effectiveness of the tax may also be questionable due to the price inelastic nature of the demand for road use. In order to address this, vast amounts of government spending would be necessary to improve public transport, a possible substitute to car use (the initial implementation costs are also likely to be high).

Another argument against road pricing is the social exclusion that it is likely to incur. Road pricing is a regressive tax, meaning that low-income individuals will be harder hit by the tax than high-income individuals, as the tax will be the same level for both groups. This makes roads more excludable and they therefore become a more private good.

It is potential costs (particular the social costs) that generally lead to road pricing to be an unpopular option within the UK population. It is for this reason that it seems that, despite its potential benefits, any implementation of further road pricing is unlikely to be drastic or widespread. It is too politically unpopular for any government to publicly back the idea. It seems that here in the UK people would rather queue to use roads than pay for it and while owning a car continues to become increasingly fashionable, these queues are only going to get longer. 

Is Economic Growth always desirable? (AS Revision)

Economic growth is defined as the increase in the productive potential of an economy. Short-run growth is an increase in the use of available resources within an economy. This is best shown on a PPC (Productive Potential Curve). The shift from A-B represents short-run economic growth. This would result in greater levels of consumption, employment and investment. Short-term growth is also defined as the annual % change in real national output. 

PPC curve showing Short-Run economic Growth

From short run growth many benefits arise. An increase in the Real GDP will result in higher levels of income thus resulting in a boost in average living standards. The positive multiplier will ultimately lead to improved confidence throughout the economy for both households and businesses. As stated above this leads to higher levels of investment which will in turn generate long-run economic growth. Tax revenue  will also increase which means projects that may necessarily not have been able to be carried out beforehand could now proceed due to larger sums of funding available. More so, if a country (for example the UK) had a large budget deficit then in times of prosperity, governments can aim to pay this off. 

PPC curve showing Long-Run economic Growth

Long-term economic growth is the increase in an economy's maximum possible output. This can illustrated from the diagram with the shift of B-C. Before, the economy's maximum productivity was at B but due to long-run economic growth and the advantages it brings, the productive potential shifts outwards, forming a new curve. This can be because of a number of reasons. 

The increased confidence in firms and investors will lead to R&D (Research and Development) taking place. If this is successful among firms then the introduction of new technology can consequently increase the productive capacity of an economy. Newer and more efficient capital equipment may lead to a rise in production levels, thus a rise in the supply of both public and private goods.

Despite all these benefits of economic growth, costs still exist. The environmental impact it can have on a country may eventually result in long-term disadvantages to future generations. Using up non-renewable energy sources will increase pollution levels whilst damaging the landscape from the extraction of these goods. Sustained economic growth would be more advantageous as it avoids the negative externalities that arise from market failure (this being the damage from pollution and loss to future generations). Furthermore, quality of life may be reduced due to the increase in working hours and stress put on employers to maintain such high levels of output. In terms of GNH (Gross National Happiness), economic growth that is not sustainable is not in anyway beneficial to an economy. This would mean as an economic indicator, countries achieving long-term economic growth that is unsustainable would be one of the lowest on this measure. Income inequality may also increase and widen the gap between the rich and the poor. This again is the opposite to sustained economic growth which has the desire to reduce the economic, social, environmental and political costs that result from economic growth. 

To conclude, economic growth, even if not sustainable gives firms the money to help improve the environment and develop research for newer, cleaner fuels and technology. Fundamentally resulting in sustained economic growth.