Beijing Olympics: Costs & Benefits (Unit 2)

Readers’ Question: Can you post something on upcoming Olympic?

Beijing National Stadium

Major sporting events such as Olympics, World Cup & even Euro often bring along opportunity for economic regeneration. But of course not without critics.

Benefits:

1. Increase in economic growth. Over the past 7 years, the Chinese government had spent $33 billion onto sport venues, roads, airport terminals, improving subway lines, parking accommodations etc. It is reported that infrastructure boom also happens 1000 miles away at the East of Beijing. This is closely associated with the multiplier effect. Increase in government spending over various projects will cause AD to shift right & this lead to higher economic growth

2. Efficiency & productive capacity. The Chinese government has spent heavily on infrastructures like new highways, subway lines, sail port etc. The most significant one will be the Beijing Capital International Airport which has a floor area larger than all 5 terminal buildings at London Heathrow Airport. More roads help to reduce congestion. The airport will encourage more international trade. Overall, productive capacity of economy will be increased & AS curve shifts right

3. Fall in unemployment. As government spending into the economy increases, more contractors & project managers will be engaged to run the project within the stipulated time frame. In return this means more job creations & ultimately this will lead to fall in local unemployment. It has many knock on effects such as lower crime rate, more tax revenue for the government etc

4. Wealth effect. Development all over Beijing & in cities nearby had caused the prices of property to surge to record high level. For example, Qingdao which will be hosting sailing & windsurfing is now experiencing the biggest increase in its property prices compared to other major China cities. This in return means growing wealth which can be a boost to existing consumption power

5. Projecting the positive image. The Chinese government can use this opportunity to advertise the modern China to the rest of the world. Bear in mind that there will be more than 30,000 journalists during the event (asia.investorplace) & the broadcast may reach to a number of 4 billion viewers. If it is done effectively, it will leave a long lasting impact towards the Chinese economy in aspects like increase in numbers of foreign investors, tourists & greater trade

6. Influx of foreign visitors. Number of tourists will increase significantly by July & August. Hotels will be fully booked, local shops & stores will gain record high profits etc. Normally, major sporting events can lead to a long term growth in visitor numbers. Barcelona saw higher visitor numbers after the Barcelona Olympic

Costs

1. Expenditure is actually much larger than estimated. The costs of hosting such major events have surged in recent years. It includes not only the initial money pumped but also the heightened security. Furthermore there are just too many costs that increase out of hand e.g. raw materials, oil, & land

2. Negative externalities. The construction of infrastructures all over the place in these few years may have led to problems like serious congestion, worse air pollution especially in Beijing & noise pollution especially on those who live in proximity of the site

3. Higher tax. Since the government had spent so much, it may think of raising various taxes in the near future (In China there are 26 types of taxes, Wikipedia)

4. Will the infrastructure be used in the future? The investment onto so many infrastructures like Beijing National Stadium, Beijing National Indoor Stadium, National Aquatics Centre, Green Convention Centre etc could be a huge waste if the Chinese government fails to recoup the spending & if it can’t be turned into other uses in the future

Evaluations

1. Beijing Olympic expenditure leaves minimal impact onto economy. From the $33 billion spent over the span of 7 years, roughly the Chinese government spends $5 billion each year. However the China’s total annual construction spending is larger than $300 billion which means that the additional spending due to Olympic contributes only to 2% of total construction spending. Hence it is very arguable whether this will leave significant impact onto the local economy

2. Tourists arrival in Beijing may not be that high. There are many that visit China for the purpose of leisure. As such they may choose to avoid crowded places like Beijing, Qingdao etc where sports event will be held. Therefore the estimated private benefits & external benefits may not be that high as anticipated

3. The venues will still be use after Olympics. Tenders for building sports venues encouraged winners to put these structures to commercial use after the games. Other venues went up in universities and other educational institutions which will make use of them after the competitions are over. These arrangements reduce the future cost to the government of maintaining these facilities

Video Lesson: Income Elasticity of Demand

Video Lesson: Cross Elasticity of Demand

BNM Maintain OPR At 3.5%: Right or Wrong?

Does Bank Negara Malaysia (BNM) made the right decision by maintaining base rate at 3.5%?

Yes, (should not increase)

1. Prevent economy slowdown & higher unemployment. Higher interest rates would deter both capital investment & consumer spending. Fall in these two would possibly send Malaysian economy into recession given that we are already slowing down. Besides, in the environment of high interest rates, employers may opt to cut jobs on the basis of cost management

2. Demand pull vs. cost push inflation. Interest rates are normally raised to combat demand pull inflation resulting from excessive spending into the economy by households & private sectors. However, we are facing cost push inflation due to high oil prices & fundamentally it is not right to raise base rates. If we insist, inflation may be lowered at the expense of economy running into a recession

3. Cushion the impact of global economy slowdown. If the present situation prevails, borrowings can be increased to finance productive growth domestically. In current capacity, it’s difficult to export ourselves out given that slowing economy is inevitable in US & Western Europe

4. Unavoidable trade off. While it is true that spiraling inflation rate erode savings from fixed deposits, but this is the social cost the nation has to pay to battle tough times

5. Healthy fundamentals. Interest rates need not be adjusted downwards too given that our current account was in surplus to the tune of 16% of GNP last year (The Edge, 28th July 08). Others like Malaysia’s total debt to GDP is only 40% & federal government deficit is 3.2% which is far from the 5% which indicates that the economy is in trouble

No, (should increase)

1. Stronger ringgit is a must. By raising the interest rates, it will help Malaysia a lot since this will lead to appreciation of ringgit, which means relatively cheaper imports. Bear in mind that many food & general items in shops are imported. What’s more now they are even pricier due to global stagflation (imported inflation)

2. Inflation is hurting growth not now, but future. If interest rate is not raised, it may temporarily boost economic growth when there is increase spending into the economy by both households & firms. With the ambitious government expenditure under 9th Malaysia Plan (9MP), spending has increased from RM30 billion to RM 230 billion. Hence it’s just a matter of time before inflation is ballooning. That’s not all. There is already table talk to increase wages & introduce minimum wages in Malaysia. The combination of these may send inflation level to another record high

3. Enforce efficiencies. While it is true that increase in base rates may deter firms from expanding their business, it must be looked positively from another angle. Higher costs of doing business, may force those firms to be more cost efficient. As such, this means shifting aggregate supply to the right resulting in economic growth & yet lowers inflation

4. Ringgit will depreciate. If Malaysia interest rate is lower than global rates, investors will flee ringgit assets & place their money in higher yielding assets elsewhere, which will pressure ringgit to depreciate. In the period of imported inflation & stagflation, depreciating currency is the last thing we want

Hyperinflation in Germany Explained (Unit 3)

It was much cheaper to light the fire with paper money than with newspaper



What is hyperinflation?

Inflation itself is defined as sustained increase in general price level. Hyperinflation as whole means continuous increase in price level which is out of control

How it started in Germany?

Germany began to suffer serious inflation during World War I. The German government did not finance the war by taxing its people more heavily. Instead it paid its bills by printing more banknotes. Soon there was too much money chasing too few goods. An inflationary spiral had started here.

Things got worse at the end of the war. A huge amount in reparations was demanded from Germany (Germany lost the war to Allies). The sum to be paid was fixed at £6,600,000 in 1921. Many foreigners thought that Germany would be unable to pay. They began to lose confidence in Germany's currency. Foreign banks and businesses expected increasingly large amounts of German money in exchange for their own currency (excessive supply of money leads to depreciation)

It became very expensive for Germany to buy food and raw materials from other countries. This led to a further increase in prices in Germany (imported inflation). In late 1922 they tried to support the Mark by purchasing it in the foreign exchange markets. However, since they continued printing new currency at a feverish rate, the attempt failed

Late in 1922 Germany failed to pay an instalment of reparations on time. France replied in January 1923. The French troops occupied Germany's main industrial region, the Ruhr. The French were determined to make Germany pay every penny it owed. They wanted to keep Germany weak as weak Germany meant that France was safe from the threat of attack.

The German government ordered a policy of passive resistance in the Ruhr. Workers were told to do nothing. What this meant in practice was a strike. The cost of the government's policy was frightening. All the workers on strike had to be given financial support. The government paid its way by printing more and more banknotes. As a result, there were too much money in the circulation, leading to spiral increase in demand for goods which was not met by the increase in production. Hyperinflation raged.

Good consequences:

1. Booming businesses & fall in unemployment. People rushed in to buy goods to get rid of their fast-depreciating money. Businessmen hastened to buy goods, build new factories and buy stocks of raw materials like coals & steels. These two leads to fall in unemployment from a temporary increase in production

2. Debt burden eliminated. Those who had access to credit borrowed heavily for business purposes, and inflation wiped out their debt. In other word, the 1,000,000 Mark those businessmen borrowed is worthless in nearest future when they repay it.

Bad consequences:

1. Waste & inefficiency. Bewildering fluctuations in costs prices & wages made it impossible to allocate resources and production rationally. Furthermore much of the new capital plant invested is unneeded

2. Fall in productivity. Workers knew that their paper wages are rising rapidly & will continue to rise in the light of hyperinflation. This certainty caused them to be more reluctant to work harder. As such there is a fall in productivity

3. Fall in the value of savings. Savings in bank accounts were wiped off with the spiraling inflation. Retirees & pensioners were the one suffer the most that time

4. Waste of time & energy. Government & economists wasted too much time on speculating the value of the currency. Paper work increased multiple folds

5. Increasing income gap. The rich became richer, while the poor became poorer. The very rich were land owners & could produce food on their own estates. By doing so, they could at least mitigate the effect of spiraling food price inflation. The poor suffered the most as not only their hard earned savings disappeared overnight but also nothing e.g. land to back them up

6. High unemployment. Towards the last stage of inflation, economy began to collapse. Retailers could not get goods & increasing number of shelves became empty. Now unemployment began to soar

Reasons for current account deficit in UK (Unit 3/ 6)

Reasons for current account deficit in UK

Price uncompetitiveness

1. Inflation rate. Countries with high inflation rate generally have more pricey goods as firms need to factor in increase in costs of production such as wages, oil price, raw materials, capital goods, rental etc. This can erode its international competitiveness, as the demand for the exported goods will likely fall. This has adverse effect onto the Balance of Payments, particularly the current account. However, this may not be that applicable to UK, since it generally has low & stable inflation even within the EU

2. Exchange rate. Pound has risen sharply against many other major currencies ever since 1996. As a result, UK exports have become less price-competitive, while its imports have become more price-competitive. This is true especially for manufactured goods. Assuming the sum of elasticity of demand for both exports & imports is greater than 1, the appreciation of pound will worsen the existing trade deficit

3. Costs of labour. In UK, unit labour costs have also risen relative to its major competitors like France & Germany, partly due to sluggish productivity growth. Besides, workers there often demand for higher pay which is not compensated by an equal increase in productivity

4. Loss of comparative advantage. UK used to be famous for its visible exports & was previously known as ‘workshop of the world’. However, UK loss its comparative advantage with respect to production costs to NICs like China. The latter has risen & dominates the global export market due to factors like EOS, weak Yuan & cheap labour

Non-price uncompetitiveness

5. Income elasticity of demand. YED for imported goods in UK is reckoned to be between 1.6 to 2.0 (very elastic) while the YED for exports is lower at between 1.0 to 1.5. This means that when world incomes rise, UK imports will grow quicker than exports. This also helps to explain, why the UK’s current account has been in persistent deficit

6. Other non-price factors include unattractive design, relatively poor quality control, difficulty to obtain spare parts, poor after sales service especially outside Europe & low spending onto fixed capital

Should Malaysians pay more for oil price?

Should we pay more for oil?

Yes,

1. Scarce resource. Oil just like coal, steel & other form of minerals are finite resources. There is no other way better than the price mechanism to allocate them. Furthermore oil crisis is not faced by Malaysian alone, but worldwide. Some countries face more severe oil price hike but their economy are still able to grow

2. Increase in efficiency. Facing higher costs of production resulting from oil price e.g. transporting goods, people demanding for higher wages etc will inevitably force firms to be more efficient in their operation even when there is less or no competition

3. Reduce congestion. Paying 41% more for petrol will force households to travel prudently & cut unnecessary journey. This will help to ease the congestion & thus contribute to lower accident statistics

4. Reduction in pollution. As Malaysian & the rest of the world travel lesser, it will contribute greatly to the environment in terms of reduction of carbon emission. Also there will be greater usage of public transport, thus significantly slash the number of cars on the road. Process of global warming will be slowed down

5. To avoid sudden increase in future. It is much better that we pay high price now, than to pay higher price in the future. Suppose that in these 5 years we maintain the RM1.92 per liter system with heavy subsidy from the government, there is a possibility we have to pay RM12 per liter after 5 years if the oil price is extremely high & the government suddenly have to remove the subsidy. By then Malaysians will not be able to cope with a sudden 600% increase in oil price

6. Opportunity costs. Continuous subsidy by Malaysian government means there will be many next best alternatives forgone. Penang’s second bridge, number of schools, improvement in public transport & etc are just few of them.

However (evaluation),

1. Malaysia as net exporter of oil. Just like many oil producing countries such as Qatar, Nigeria, Venezuela, Iran & etc their oil price is cheap, so why can’t we? The country produce 625, 000 barrel of oil with 400, 000 for local consumption & the remaining for export

2. Low per capita income. In forums & debates many people often refer to Norway, Switzerland, the States & many other developed countries as having oil price much higher than us & yet they can cope. But the politicians forget that their per capita income some is as much as 10 times ours. Hence the comparison is meaningless

3. Using public transport is no way out for Malaysians. With poor public transport network & availability, people will be late for work, business appointment cancelled recklessly etc. As a result, people will drive once again & the road will become congested. Furthermore people prefer to travel in their own space which is more comfortable

4. Various macroeconomic problems. As oil price increase, people will be forced to change their lifestyle such as eat lesser outside, do lesser shopping, travel lesser etc. This means lower consumption which is harmful to economic growth. Bear in mind growth is often associated with increase spending onto goods & services in the economy. Unemployment will also increase as firms observed that there is a fall in profitability

In person, I would agree with the Government's unpopular decision to increase the oil price in accordance with the workings of price mechanism

Do We Have To Worry About Current Account Deficit? (Unit 3/ 6)

Student’s Question: Current account deficit may not necessarily bad right?

It may & it may not

Current account consists of 4 main components:
(i) Trade in goods (manufactured goods, capital goods, durable & non-durable goods etc)
(ii) Trade in services (financial, banking, tourism, education etc)
(iii) Income & profits (Britons working abroad sending money back to England etc)
(iv) Current transfers (Aid or subsidies given by EU government, bilateral aid etc)

In UK, the current account under the Balance of Payments (BOP) has been under persistent deficit for 19 years. The large deficit in current account is mainly driven by trade deficit in goods & it seems that the growing surplus in trade in services is still insufficient to offset it

However, the deficit accounts only about 2.5% of UK’s GDP. For US which has the world’s largest trade deficit, it accounts for nearly 6% of its GDP

Financial/ Capital account records:
(i) Short term money flows (speculative/ hot-money)
(ii) Long term investment e.g. Japanese pension fund may wants to broaden its international portfolio to UK, Malaysian firms setting up companies in Malaysia, so send money from Malaysia to UK to finance its building & operation, etc)

General arguments
Reasons to worry for current account deficit:
1. May lead to depreciation of home currency. When a country borrows from international organisation such as IMF to finance the deficit, it may raise market concern that the Central Bank may not have sufficient foreign exchange reserves say, dollar to meet the obligations. The expectation of dollar shortage leads to the expectation of depreciation of home currency. This will fuel the concern that the external debt burden would increase & thereby intensifies the demand for dollar by speculators. This eventually leads to depreciation of home currency (self-fulfilling, due to market EXPECTATION)

2. Burden of debt repayment. Borrowing to finance the deficit is not sustainable in long term. Excessive borrowings & failure to repay on schedule had put many countries into greater debt due to high interest payments. Countries such as Russia, Brasil, African countries & many other developing countries faced similar situation

3. Fall in the standards of living. As home currency faces rapid depreciation, it means fall in the purchasing power & imported goods are now more expensive. This will ultimately lead to fall in the standard of living as people get to consume lesser goods of better quality

4. Sign of structural weakness in economy. For UK, the deficit in current account is largely fuelled by the weak export in goods which has strong relation with the sluggish manufacturing sector in UK. 3 reasons accounted for this. UK’s goods are not price competitive due to low productivity in the manufacturing sector which raises the costs. Second, pound has been appreciating against many major currencies since 1996, which means relatively more expensive to buy from UK. Finally UK has lost its comparative advantage in manufacturing sector to China

5. Foreigners have increasing claim on UK assets. To finance the deficit, other than borrowing UK can also attract inflow of foreign investments (causing a surplus in capital/ financial account). However this means increasing foreign ownership of domestic assets. Shall there is an economic crisis, UK will be in a very vulnerable position when foreigners withdraw their investments, causing a rapid depreciation of sterling especially against Yen

6. Capital flows may dry up 1 day. Country like US has been able to finance its deficit by attracting capital flows from Asian countries, particularly Japan and China (similar to Point 5). Both countries are willing to buy dollar assets because they don't want their currency's to appreciate and therefore reduce their competitiveness when trading with US. How long will this continue is uncertain

Reasons not to worry about current account deficit:
1. The deficit has not triggered any crisis thus far. UK has sustained current account deficits of much larger proportions in the past and this has not provoked a major crisis of confidence in the international financial markets. UK has one of the most open capital markets in the world. Thus far the country has proved to be a favoured venue for overseas investment & financing a trade deficit in goods and services has not triggered a sharp collapse in the value of sterling

2. Great knock-on effects from foreign investment. Increase in the number of foreign firms setting up operations in UK has many advantages. These include the increase in job opportunities, technology transfer & better management practices. For e.g. Japanese firms may bring over their management practices which greatly benefit the Britons as it helps increase their productivity

3. Economy is growing faster than the others. Increase in import relative to export may mean that the country is growing relatively faster compared to its trading partner. Higher economic growth means people have higher tendency to consume imported goods. Also increase in import could be due to greater imports of raw materials to fuel the awakening manufacturing sector. However since other countries are growing at slower pace, this explains why the demand for exported goods is rather low

Balance of Payments: Current Account (Unit 3)

Which Earns More? Kim Gary or Mixed Rice

Student's Question: I entered into an argument with my friend recently regarding which business model is more profit making? Kim Gary or mixed rice? Maybe you can help me clear the clout

I would love to. Before I address this question, few assumptions must be made:

(a) Both are operating in an outlet of equal size
(b) Both are operating at a hotspot, say Kim Gary in a famous shopping mall while mixed rice is operating nearby housing areas & office
(c) Both start operating from 9am-10pm
(d) It’s not a comparison of chain of restaurants, but 1 vs. 1

Why mixed rice is more profitable?

1. Pricing. There are certain dishes with elastic & inelastic demand (this however differs from one seller to another). Dishes with elastic demand e.g. vegetables will be priced lower while those with inelastic demand e.g. meat will be priced higher. These are done to maximise revenue (Unit 1). The ability to exploit this form of pricing is greatly enhanced due to the presence of imperfect information (Unit 2). Unlike Kim Gary, prices of food are stated at the menu. Therefore there is no way they can manipulate the prices as they wish

2. Necessity & luxury. Mixed rice is a ‘necessity’ while Kim Gary is viewed as more of a ‘luxury’. In times of difficulty, or when the economy is slowing down like now, people tend to eat lesser at such an expensive outlet. As such its business is subject to business cycle

3. Higher frequency of customers. Although mixed rice is far cheaper than Kim Gary, but its turnover is very high. People tend to leave once they finish their lunch or dinner. And not to forget, many people at the same time can pack & bring it home or back to their office. Unlike Kim Gary, people frequent the outlet for leisure & as such they will be there much longer, which means lower turnover of food & drinks served

4. High ability to pass on the increase in the costs of food. Certain places had started to increase the price of mixed rice by RM1 (including rice & dishes). This is because the demand for mixed rice is inelastic. However, if Kim Gary attempt to do so it will lose large portion of its customers given that it’s operating in a competitive environment say, MidValley

5. Lower operating costs. Mixed rice does not need to incur high costs of operation such as expensive rental of premise, paying high salary to its chef, wages to waiters & waitresses, more expensive electricity & water bill etc. In mixed rice business, most of the time the cook itself is the owner

In a nutshell Kim Gary earns a lot, but incur higher costs of production whereas mixed rice earns a lot but incur lower costs of production. I would vote for mixed rice.

FAQ On Costings (Unit 4)

Theory of costing

Popular FAQ by students:
1. Why the average fixed costs (AFC) curve looks like a hyperbola?

AFC = (TFC/ Q). It looks like a hyperbola because fixed cost is spread over a larger range of output e.g. 50/5, 50/8, 50/10 etc (yellow line)

2. Why marginal cost (MC) curve looks like a ‘Nike’ sign?

We have to relate this one to the theory of marginal productivity of labour. By hiring an optimal number of labours, works can be done efficiently. As productivity increase, MC will initially fall. However, if more & more labours are being hired, overall productivity will be affected & this means increase in the costs of production. This explains why at a later part the MC will increase (green line)

Think about this. What will happen if you put 10 employees in a small office with maximum capacity of 5 employees?

3. What does the gap between AC & AVC means?

The gap means AFC since AFC = AC—AVC

4. Why is the gap between AC & AVC getting smaller towards the end?

Again the gap means AFC. Smaller gap towards the end means falling value of AFC as fixed cost is largely spread over a greater range of output

Can Starbucks Outperform Rivals Through Market Research?

Student’s Question: Do you think Starbucks would have out-competed other firms with a stronger market research into "what people want" in terms of beverage?

Yes,

Consumer’s market is dynamic rather than static. People are constantly looking out for something new especially after experiencing various types of coffee drinks. Then they will make comparisons & coming out with something ‘ideal’ e.g. the tastes that they want like what is the level of bitterness, strength of the aroma etc. Firms that produce the ‘ideal’ coffee will capture the larger market share

By engaging the service of consumer research house like AC Nielsen to unseal customers’ insight, Starbucks can outperform their rivals.

However,

If Starbucks can do so, why not their rivals? McDonalds, Coffee Bean, Dunkin’ Donuts etc are large enough that they can too spend large proportion of their retained profits onto reinvestment. In economics normally the term reinvestment we meant firms spending money to enrich its business e.g. improve its product, improve customer service, R&D to discover more cost efficient method of production etc

Why Starbucks Decide To Close 600 Outlets In US?

Why Starbucks may decide to close up to 600 stores in US?

1. Diseconomies of scale. DEOS is defined as an increase in costs of production due to overexpansion by firms. It has the total number 15011 outlets worldwide as at November 2007 (Wikipedia). In the 1990s, it opened up a new outlet every workday & this pace continue until 2000s. When the US economy slowed down around that time, they expanded outside US with an average of 7 new outlets a day. Its aggressive expansion locally & internationally has led to various management inefficiencies. Problems such as difficulty to monitor such a huge number of outlets & workers, coordinating the marketing effort & communication failure are responsible for its increase in costs of production

2. Rise in other costs. Rising costs of milk has been cited as one of the primary reason for deteriorating profits. Furthermore at such a time where consumers demand is low, it is not wise to pass on the costs. Other factors are like increasing operational costs due to increase in rental rate & workers are demanding for higher pay rise

3. Sharp fall in consumer demand. Increase in the cost of living stemmed from fuel price hike recently has inevitably forced people to adopt different lifestyle. People are substituting Starbucks coffee to other form of drinks like tea or even ‘non-branded’ coffee. This is due to falling purchasing power which makes Starbucks coffee relatively more expensive compared to any other form of drinks

4. Emergence of strong substitute. Starbucks is not the only outlet that sells coffee. There are others like Coffee Bean, McDonald, Burger King, Dunkin’ Donuts etc. In the earlier survey, US consumers claimed that McDonald’s coffee tastes better & yet cheaper compared to Starbucks.

5. Discovery of other potential market outside US. Starbucks management is ‘relocating’ those underperforming outlets in US to Europe countries such as UK, German & France. It’s CEO, Howard Schultz plans to launch another 150 outlets in these countries with 120 itself in German (The China Post)

How To Study Unit 3 Effectively?

How to do well in Unit 3?

Student’s question: Unit 3 seems to be interesting. Any suggestions on how to make the learning more effective?

Right question at the right time. If you were to ask me how to make learning more fun & yet effective at the same time, stick to these 2 rules:

Rule no. 1: Learn Economics through case studies
Rule no. 2: Never forget rule no. 1

But even if we read case studies, there are few principles for students to uphold

Step 1: Make sure you understand all essential macroeconomic terms or definitions

There are several Macroeconomic jargons that you can often see in newspaper, magazine, internet etc. So, before you read those case studies, please make sure you got them all at your finger tips. They are like:

(a) real GDP
(b) real GDP per capita
(c) economy slowing down
(d) recession
(e) inflation
(f) unemployment
(g) import & export
(h) Balance of Payments
(i) Interest rate
(j) National debt etc

Step 2: Choose reading materials that you are comfortable with

I strongly do not suggest ‘beginners’ to read up The Economist, Forbes, Fortune 500 etc. No doubt they are very informative, but more often than not they are long winded. Furthermore, they are not cheap. As an example, The Economist costs RM 18 & it is published weekly. Choose sources that are more students friendly like the following:

http://news.bbc.co.uk/ (highly recommended)
http://www.telegraph.co.uk/
http://www.guardian.co.uk/

Step 3: Relate with what you have learned in the class

Read the articles analytically. Try to relate them with relevant concepts you learned in class. For example:

“In the light of creeping inflation, Bank of England decides to increase interest rates”
Ask yourself these questions as you go along:
(i) What is inflation anyway?
(ii) What will happen to an average people on the street when there is inflation?
(iii) How by raising interest rate can curb inflation?
(iv) What are the factors that Bank of England needs to consider before raising interest rate?
(v) Will it be successful? Or is it a short run effort?

Step 4: Discuss with your teacher on the articles you read

Your teacher can help you to brainstorm & arrived at various possibilities of answers to above questions. By doing this more often, in no time you will find that your reasoning & evaluation skills will improve tremendously

How Good Is GDP To Measure Standard of Living? (Unit 3)

GDP is basically used to measure the economic well being of population in a country through the concept of standard of living. From GDP, economists derive real GDP per person (per capita).

The nominal GDP (GDP at current prices) figure must be adjusted to net off the effect of inflation rate which artificially push up the value of GDP. Hence economists arrive at real GDP

Per capita means real GDP divided by total number of population

Limitations of GDP when measuring standards of living:

1. Fails to take into account income disparity. There are 2 ways to look at this. First, some countries although having extremely high GDP but this doesn’t mean each individual in that country is rich. It could be those few very rich individuals that inflate this figure. Second, among states or region. GDP of China ranks second in the world, but the income gap between the northern China & southern China is widening

2. GDP figures ignore the impact of negative externalities which may reduce standard of living. Sometimes high GDP figures are achieved at the expense of environmental degradation e.g. more pollution & congestion. As such, our standard of living may not be that high as being anticipated

3. Ignores the factor of leisure time which also contributes to higher standard of living. Sometimes high GDP figures are achieved by sacrificing our leisure time. There is no point we achieved high GDP or high income but at the end of day, having no time for ourselves. British workers have the longest working hour in Europe, so even if GDP in UK is higher compared to the rest of Europe, can we conclude an average Britons are better off?

4. Doesn’t take into account black economy (some does e.g. Nigeria, Columbia, Thailand). Illegal activities which are not openly traded such as piracy, prostitution, weaponry, illegal drugs & smuggling will not be taken into account. If all this were to be considered, GDP figures in many countries could be much higher than reported. E.g. Thailand & Nigeria have the world’s largest black economies, both accounting for more than 70% of their GDP. If they were to take it out, then their GDP figures will be very low

5. Doesn’t take into account non-monetary activities. Goods that are not traded in the market e.g. production for self consumption, voluntary work & DIY work will not be counted in GDP. If we were to do so, just like in (4), the value of GDP could be much higher

UK Housing Market Price Crash Explained (Unit 3)

'Houses running & jumping off the cliff' shows that the prices of house in UK has declined in a rapid manner

Reasons for UK housing market price crash:

1. Nature of houses having inelastic demand & supply. Price elasticity of demand for houses is low due to its nature as necessities (PED <1), while price elasticity of supply for houses is low (PES<1) due to the considerably long time period taken to complete any single housing projects. As such when there is a fall in demand like now, prices of house will suffer a huge fall

2. People adopting the ‘wait & see’ attitude. Many home buyers, existing or first-timers are anticipating that the prices of house are set to fall further. In the meantime, demand & thus prices will continue to rock bottom before they pick up again in the future

3. Difficulty to obtain loan. The subprime mortgage crisis has been a nightmare to bankers. Billions of losses had been uncovered. High number of defaulters has caused them to be more prudent in lending out the money e.g. tightening the screening criteria & eligibility to acquire loan

4. Rising mortgage cost. Even if there were loans available, they are now made more costly for borrowers to incorporate unforeseen credit risk especially fixed rate mortgages. As such there is lower willingness for people to buy houses

5. Falling consumer confidence towards UK economy. Traditionally most Britons store their wealth in property market. As such, when there is a fall in housing prices, their wealth are severely affected. This makes them more reluctant to acquire more houses. Second, rising energy prices & food prices mean lesser disposable income for a working individual. Third, fear over job security. Recently BBC reported that number of unemployment had rose by 38, 000 to 1.64 million (BBC news, 11th June 2008). What’s more, when financing a house is a long term commitment

However,

1. This means increased in affordability. First-time buyers are normally being priced out as prices of house increase at a rate faster than inflation & their income. Now, with more mortgages becoming affordable, inequality in property ownership between the younger & older generation will be narrowed. But one can always argue that this claim is only true if the fall in prices is significant

2. Greater mobility of labour. High prices of house almost everywhere in UK have contributed to geographical immobilities & difficulties to attract sufficient quantities of labour e.g. teachers & nurses in some parts of UK. This is because in some areas, prices of house are so expensive & yet these workers earn only a decent wages. Now with cheaper accommodation, perhaps the shortages of labour in some areas could be eliminated

Introduction to Unit 3: Managing the Economy (AS)

Subprime Mortgage Crisis Explained (Unit 3)

Student’s question: The sub prime mortgage crisis has been around for a year but I still do not understand what is it actually? So why economy is slowing down?

It’s rather complicated, but I’ll try my best to make it comprehensive.

1. The sub-prime mortgage crisis originated from US. The term sub-prime lending itself means loans given out that do not meet certain official guidelines e.g. given to borrowers with poor credit history or low income

2. As such we say it is risky for both the borrowers & lenders. Default rate could be high due to the combination of high interest rates & poor credit background

3. But what is the rationale of issuing these mortgages knowing that it has high default rate? Those US mortgage lenders hoped that with the booming housing market that time, the mortgages will remain affordable

4. Furthermore mortgage brokers are paid handsomely for selling these mortgages & as such there will be great incentive to sell even more regardless of one’s credit ability

5. Mortgage companies then bundled these debts into consolidation packages called mortgage-backed securities (MBS) and sold the debt onto other finance companies (3rd party). In exchange for purchasing MBS & assuming credit risk, third-party investors receive a claim on the mortgage assets and related cash flows, which become collateral in the event of default

6. These mortgages have low interest rate for the introductory period of 1-2 years. Subsequently interest rate will be much higher. However due to series of inflation that hit US economy, Fed Reserve had to increase interest rates to curb further inflation. Now many homeowners begin to face ballooning mortgage payments every month

7. This lead a rise in mortgage defaults & is indicating that the US housing market boom has come to an end

8. The number of defaults caused many medium sized US mortgage companies & banks to go bankrupt. Banks had to write off large losses and this made them reluctant to make any further lending

9. Now in US it has become very difficult to borrow money & raise funds. Cost of interbank lending has also increased. The slowdown in borrowing has a knock on effects towards the US economy at large.

10. Now it seems that the economy is running into a greater slowdown or perhaps even recession given that the price of oil is out of control once again

11. We in Malaysia & the rest of the world is affected as US is the main importer of goods & services around the world. As their economy slows down, their people generally have lower appetite on imported stuffs & hence revenue for many industries from exporting countries will fall. This translates into global economy slowdown

Remember the popular phrase: “When US sneeze, all of us get the cold”

Positive Effects of Global Warming (Unit 2)

Student’s question: Global warming is an issue that is discussed more and more intensely nowadays... what are the negative impacts & what are the positive?

Ok, thanks again for asking. This is a very interesting question to address seemingly that most of the people out there will say that only those who are insane would say global warming has its good side.

Positive effects of global warming:

1. There will be a sudden increase in the awareness of environmental conservation. Once people have achieved a higher standard of living & earn higher income, they will be automatically looking into living in a cleaner & healthier environment. This explains why the environmental activists in the West place more concern over this issue compared to the East. Subject of Environmental Economics may become a more popular subject taken up in most universities

2. Possibly, more usable land for farming & housing. Large stocks of land in the northern hemisphere (cold area), just south of Canadian & US border could be suitable for habitation. By that time, land scarcity will be less severe & prices of house will become more affordable once the ice retreats. Problems of expensive food price & global food shortages could be overcome with more land turn into agriculture


3. A slower increase in the price of crude oil. Research shown that global warming has shortened the lifespan of winters. As such demand for home heating oil will reduce greatly & this may bear a temporary slowdown in the price of oil

4. Greater economic activity. Shorter period of winters mean people will spend lesser time staying indoors & more time outside. Hence there will be a higher level of economic activity when people pump money into the economy like shopping, dining outside, watching movies, recreation. This explains why GDP is normally higher in Summer

5. Lesser number of accidents. With most streets free from ice & snow, driving will be a lot safer. There is no need to incur additional expenditure of shovelling the snow. Also, the air, road & rail transportation could benefit greatly & perhaps generate more profit as they need not caught up in any weather related delays


For negative effects, please look at my previous postings,
http://econsguide.blogspot.com/2008/06/economics-of-global-warming.html

Economics of Pirated Goods

“The five luxury European brands namely Burberry, Gucci, Prada, Chanel & Louis Vuitton jointly filed a lawsuit against the Chinese Silk Market for facilitating the sales of counterfeit handbags which look like the original ones”

---Beijing Times---

“French name-brand Lacoste has brought to court the owner of Beijing's Silk Market Plaza and some of its tenants for selling fake T-shirts with its labels, claiming its trademark was infringed upon”

---GOV.cn, Chinese Government’s Official Web Portal---

China is well known as the “land of paradise” for counterfeit goods & at least 70% of worldwide pirated goods originate from there.

The reason for the presence of pirated goods can be analysed from 2 angles.

Why people demand?

1. Cheap & it works as good as the original ones. Most of these goods illegally use big names such as Nike, Gucci, Prada & Rolex (just to name a few). Some even produce exactly the similar design & pattern but with a fake brand name. However its price is sometimes less than 10% of the original ones & it can still be bargained

2. To project image but having tight budget. There are many people out there who want to wear & use branded goods. However branded goods often come with a hefty price. Using counterfeit goods which look similar or even bearing the branded name itself can project a ‘luxurious’ image to an individual

3. Ease of availability

4. Weak or no law enforcement against people who buy counterfeit goods. As such people will continue to support these goods given that there is low risk of discovery or prosecution

Why producer supply?

1. Weak legal enforcement. 2 reasons accounted for this. The existing penalty or fine is minimal. Producers do not mind paying for those fine if they were caught as it resembles an insignificant portion of their profits. Second, enforcements which are seasonal & not continuous

2. Low reinvestment & moderate technology requirements. E.g. Nike may need to incur millions to advertise its new product, conduct research in finding out how to maximise users’ comfort, pay wages to employee etc. Meanwhile producers of fake Nike shoes make lots of profit & save all these costs simply by using its brand illegally (leveraging). The only cost that matter the most is raw material

3. High per unit profitability. Producers of counterfeit goods enjoy very low costs on 2 bases. First not having to reinvest their profit into the business & second significant EOS especially technical. This explains why they are able to sell their goods at such a low price compared to original ones

Economic implication

1. Innovation & growth. Innovators protect their ideas through patents, trademarks & copyrights. Without proper & adequate protection for intellectual property right, the incentive to develop new ideas & products would be reduced. In other words, possible fall in the production of goods & services that can hamper economic growth. By then, consumers will have lesser choice to pick from

2. Negative externalities. Growing volume of seized goods raises environmental issues since their destruction creates a great amount of non-biodegradable waste. Also use of counterfeit fertilizers caused serious damage to the environment

3. Increasing unemployment in the economy. Many firms have reported millions if not billions of losses as a result from increasing piracy activities. To remain profitable, the normal action being taken is to shed employment since that is the easiest way to reduce operation costs

4. FDI (Foreign Direct Investment). An intellectual property right is one of many factors considered by firms who are investing abroad. According to research done by OECD, FDI from Germany, Japan & US was relatively higher in economies with lower rate of counterfeiting

5. Losses from royalties. Royalties are usage-based payments made by the licensee to the licensor from the ongoing usage use of an intellectual property rights

6. Costs of combating piracy. E.g. costs of inspection, large scale campaigns to persuade consumers to buy original goods etc & yet the results are by no mean guaranteed.

In a nutshell, there is no definite way we can break the law of demand here. Most people will still stick to cheap pirated good which is almost a perfect substitute most of the time. So long there is a demand, there will be a supply.