Saturday, January 31, 2009

Similarities Between Feng Shui Masters & Economists

One of my curious students had questioned me earlier with this posting, wondering if his Economics teacher has gone nuts during this festive season. Well, before any writing I would like to stress that this short article has nothing to do with belittling those feng shui master out there, just my random opinion

Here it goes:

(1) There is no consensus. If you put 2 different feng shui masters together, probably you will get 3 different answers! That’s how it goes. For instance, one may say that those born in the Rooster year will have a good year ahead & wealth is abundance. Another may agree partially & claim that second half of 2009 will be a financially challenging one! For economists, one may say that we will likely see recovery by the second half of the year. Another argued that since the negative multiplier effect has not ended, probably we will see the worst of all time by the end of year! So who do you believe?

(2) Both talks about fortune. There is no qualm that feng shui masters are excellent when it comes to fortune telling. Whether one will believe it or not, it’s entirely a different story. In fact I have even seen, Joey Yap our famous local fortune teller appeared on The Exchange, TV3 last year. Using his feng shui knowledge, he attempted to predict the direction of global stock market. The same goes for economists or financial analysts. They seem to be very good with their quantitative skills & using sophisticated software to analyse figures. During stock market boom, these people would love to give advice on which stocks to buy, hold or sell. In fact many had debated somewhere early 2007 that the stock market rally will likely continue up to 2009 given the strong credit boom, house prices that ‘seems to be rising forever’ & exponentially rising consumption across America & UK. But that has happened today?

(3) There are quantitative & qualitative analysts. Believe it or not, many feng shui masters have some sort of ‘formula’ to predict an event. Layman like me will never understand the mechanics behind it! Likewise, there are even some feng shui masters that do not rely on complicated formula to judge an event. Having one’s ba zi (date & time of birth) is sufficed for them to tell the journey of your life. The same goes for economists. We have both versions. Those sophisticated economists more often than not, use statistical tools like data mining, SAS, E-Views & SPSS to analyse an event. I’m sort of qualitative analyst. I judge an event based on present & past history, before coming out with my set of conclusions

Video Lesson By Phil Holden: Automatic Stabiliser

Thursday, January 29, 2009

How Can Simple Theory Like Total Revenue (TR) Explain About Businesses?

Every single economic theories & tools that we learn, can actually be used to analyse real life situations. Think about this. In textbook, we were taught:

Total Revenue = Price x Quantity or
TR = P x Q

Then you may start wondering, to what extent is this simple formula applicable in explaining businesses?

(1) Plan strategy to achieve targeted revenue. It is mostly desirable to achieve high sales revenue by increasing both P & Q. However, not all businesses are able to do so given that P & Q are often inversely related (law of demand). Furthermore, most businesses out there are facing stiff price competition domestically & internationally. Since there is great difficulty to adjust price upward, it makes sense for companies to concentrate on non-pricing strategy such as advertisement on unique feature of products, free trial, after sales service, loyalty card etc to magnify Q. These strategy works perfectly well for Tesco & Walmart. Despite selling cheap goods, they still chunk high revenue due to high inventory turnover

Source of diagram: BBC

(2) Explain phenomenon. I came across an interesting article on McDonald’s revenue. It was reported that although sales had increased about 7.6% in Europe & 10% respectively in Middle East, Asia & Africa, total revenue generated somehow fell from $5.75 billion (2007) to $5.57 billion (2008). How could that be? Isn’t it increase in sales means increase in revenue, as given by the mathematical formula?

The reason is simple. In 2008 itself, dollar has strengthened against many other major currencies such as Euro, sterling, renminbi etc. Although the total revenue say, in UK had increased it was somehow offset by the rising strength of dollar. It means every conversion of £1, we get lesser dollar.

Consider the example (refer the exchange rate above):

2007, before significant strengthening, £1, 000, 000 = £ 1, 000, 000 x 2.1 = $2, 100, 000

After strengthening, £1, 200, 000 = £1, 200, 000 x 1.55 = $1, 860, 000

Although sales had increased 20% to 1.2 million, still total revenue had fallen when overseas earnings are transferred back into dollars
(3) Revenue maximisation. The theory was put forward by William Baumol (1959). According to him, conflict of interests actually exists between the managers (people who run the companies) & shareholders (people who own the companies). For managers, they may be looking towards revenue maximisation as their primary goal since their salaries, perks & benefits such as luxury vacation are closely related to total sales revenue rather than bottom line profits. Revenue maximisation does not necessarily translate to profit maximisation as the latter needs to incorporate costs. Interestingly, shareholders desire profit maximisation as their dividend payments from owning the shares depends on how much profits posted by the company

'Challenge' The Chancellor Competition: Any A-Levels Students Up To The Call?

Monday, January 26, 2009

Video Lesson by Richard Pettinger: How The Recession Would Have Been Different If UK Adopts Euro?

The Prospect Of Euro-Pound In 2009

It is rather interesting to watch how Euro has strengthened so much & yet so fast against the sterling. Referring to the graph above, I wouldn’t be surprised if both move towards parity at £1 = €1.

Reasons for weakening pound against Euro:

(1) Economy is in bad shape.
Recession in UK is far worse than many of those in Eurozone. The official data reported that output in the 4th quarter shrank by 1.5%, the sharpest contraction in 30 years. Economists fear that the worse is yet to come as we have not seen the last of de-multiplier effect feeding into the whole economic system. Over the time there will be more firms going under administration, increase in the number of unemployed, falling asset prices as banks are tidying their balance sheet & ballooning UK’s national debt. Many aggressive stances had been taken but its effect is yet to be seen owing to the lag effects. At the meantime, investors are fleeing pound denominated assets & convert to Euro, the next safest economy after US

(2) Cut in interest rates. MPC has been aggressively cutting interest rates since September 2007, where base rates stood at 5.75%. Now it is standing at only 1.5%. Rate cut generally encourage investors to switch to other currencies which have higher rate of return such as Euro. Although ECB has slashed interest rates several rounds, each cut was relatively small. As a result, Euro’s interest rate is always higher than in UK

(3) Euro as world reserve currency. Investors view the whole Eurozone as relatively a stable pact. Besides it has great economic diversity & the size of their GDP is even larger than US. For investors from Middle East, Euro is politically more attractive as it has less affluent in issues surrounding their area & around the world. As these investors ‘wanted to believe’ that Euro will one day replace the dollar as world trading currency, they slowly withdraw their pound assets & demand for euro currency causing it to appreciate

(4) Current account deficit. UK trade a lot with other European countries (like France, Germany & Italy) & its current account has almost been permanently in deficit. This is due to large deficits in the trade of goods, as UK people have high marginal propensity to import (high tendency to consume imported goods). Although there is an increase in the trade of services over the year, somehow it is still insufficient to offset the large deficit. To finance this, UK partly relies on the inflow of foreign capital or hot money, especially from Europe. But since the deficit is widening, it creates imbalances (outflow greater than inflow). As such pound devaluate

(5) Large national debt. UK’s debt has been increasing steeply in the recent as a result of heavy pump priming to revive the economy & not to mention bailing out those banks in trouble. Therefore it makes sense for the government to raise borrowing since their tax collection has also fallen. However, some investors began to view this as not manageable. They will not be keen to hold government bonds & securities. This leads to lower demand for pound causing it to fall

I hold my view that in 2009 pound & Euro will be on parity, considering other factors e.g. both in recession & interest rates about the same 1.5% (UK) vs. 2% (EU). However, the initial direction of pound also depends on how agressive it cut interest rates compared to ECB. When base rates are on par for both say 1%, then this view may hold

The Economics Of US Debt-Part 1

Source of diagram:

This chart should be able to give readers some hindsight regarding the position of US National Debt. Although not seen (before 1950), we knew that the debt is ballooning during World War II due to increase government spending. US took a painful 3 decades to reduce it. However the debt increased exponentially once again when Ronald Reagan (1981-1989) & George H.W. Bush (1989-1992) swore in office. During their administration, the government incur huge military spending & cut in taxes.

Clinton’s administration was a remarkable one. Vibrant economic growth, low unemployment, low payment of unemployment benefits & high tax receipts largely explained for the success of bringing down the debt

Why national debt has increased in US under George W. Bush? (reasons for tax cut & reasons for increase spending)

(1) Massive tax cut. To increase public support, in 2001 Bush had announced the most controversial & yet largest tax cut in US history of $1.35 trillion. According to his rhetoric, unspent government funds should be returned to taxpayers. I personally view this as not a wise idea. Yes, in fact the burden of national debt has been reduced during Clinton’s era, but not to forget that actually it is still increasing BUT at a slower rate. To make things worse, unemployment actually rose from 4.2% in 2001 to 6.3% in 2003. This put a further constraint onto government expenditure

(2) Massive spending. 8 months after his presidency, he declared a war & invasion into Afghanistan. In 2003 US spearheaded an invasion into Iraq. President Bush also aggressively spent into the economy to promote policies on healthcare, education, social security reform & many others. As such US government need to increase borrowing to finance all its public investment

(3) Political mileage. It is very politically unpopular if a candidate/ re-election announce steps to balance the budget. In other word, narrowing the fiscal deficit by cutting public expenditure & increase taxes at the same time. As such, there is a strong incentive to continuously ‘increase the national debt’

(4) Doom & gloom. Marked December 2007, US had entered into one of the worst ever recession since World War II. Currently, the de-multiplier effect has fed into the whole economy, causing large scale unemployment, lower consumption, declining company profits & period of free fall in asset prices. This had inevitably narrow down the base of tax revenue when lesser people pay income tax, lower corporation tax as some companies make lesser profits & some went under administration, lower VAT due to lower consumption & drop in stamp duties due to falling house prices. On the other hand, government has to increase payment to unemployed people, incur higher borrowing to bailout AIG, Freddie Mac & Fannie Mae. All these contribute to ballooning debt

(5) Ageing population. US & UK are currently facing exactly the same problem & that is increasing number of retiring population. As baby boomer generations start to retire, this will reduce the size of labour force & increase the dependency ratio. Hence there will be lower income tax receipt & yet government is committed to more pension payments. Although the US government can always increase the retirement age, but its effectiveness is muted as the problem will be evaded just momentarily.

Sunday, January 25, 2009

Video Lesson by Phil Holden: Is Monopoly Bad?

This is a popular question in the legacy Unit 2: Market Failure & Unit 4: Industrial Economics

Saturday, January 24, 2009

Video Lesson by Phil Holden: How A Monopolist Can Further Increase Its Supernormal Profit?

This video shows another way of illustrating price discrimination. In my lecture, I don't use this version as it's not that student-friendly. The diagram which I draw will have the MR & AR of both different market being put as if they are under a 'mirror-reflection'. Then I will draw an MC curve cutting through both. Using MC = MR1 = MR2, show that prices charged in 2 different markets (elastic & inelastic demand) are not the same

It is worth to take note the conditions for price discrimination:

(a) The firm must have some price making ability. That means, at least it must be in a monopolistic market & better if in monopoly

(b) The firm must be able to segregate the market into 2. The market with higher willingness to pay (PED less than 1) will be charged higher price, while another market with lower willingness to pay (PED greater than 1) will be charged lower price. This in fact is one of the main condition to increase its supernormal profit

(c) Must be able to prevent resell of product from one market to another. Otherwise price discrimination is a failure when a buyer can buy in the market with lower price & go to another market & sell it there with higher price. This is a practice of arbitrage

(d) The sum of supernormal profit for both new market must be larger than the original supernormal profit (before price discrimination) & costs of separating the market. If not price discrimination is futile

Women generally put more care onto their hair than men. Therefore they wouldn't mind to pay extra to get their hair nicely done. As such we say, women's demand is inelastic while men's elastic

Tuesday, January 20, 2009

Statistical Data: Malaysia vs. UK

I often receive comments & requests from friends and some students to blog more on Malaysian economy, which I normally incline to do so.

Here’s the reason:

(1) Teaching A-Levels. Currently I’m specialising in A-Levels Economics. Therefore I ought to provide my students with more information from abroad especially in UK, US & major Western European economies. Also I will begin to blog a lot on Development Economics since I will be teaching Unit 5B next term. As such my focus will be mostly on African regions & in comparisons to China & India. I will also provide some useful information for students from other group which will be taking up 5A: Labour Economics.

(2) Statistical data in Malaysia is not easily available. Even if they do provide, very often it’s in a book form & you’ll have to pay to get access to those information. Secondly, the information available in Malaysia’s Statistic Department is too little to contain value of research. You’ll understand if you click on the 4 links below. Remember to see how they present those information by clicking on each indicators (UK)- please click on 'More' (UK)

vs. (Malaysia) (Malaysia)-where everything needs to be paid

(3) News ‘not economic’ enough. As I have mentioned, the Westerners are very ‘economic society’. They tend to explain businesses, investment & economies by the way that even people like doctor, lawyer, students or butcher can understand. Each and every economic event is explained thoroughly e.g. chain effects etc. In other word, having public’s understanding in mind when writing. This makes it so interesting. Furthermore, they often use simple (but explained) economic terms from textbooks to ‘educate’ the society especially students letting them know that what they learn in textbook is applicable in the real world. Click on the link below: (UK)-in response to recent rate cut

vs. (Malaysia)-where I think only economists or businessmen can understand

All in all, there is still much for us to learn from the more developed economies. Being a developing countries, it is crucially important to have all these information available to the public especially professors & other academicians. Having an easy access to information, will definitely encourage R&D activities from the supply side arguments. This may increase the productive capacity of Malaysian economy

Strategies For Development 2: Should Developing Countries Continue To Focus On Agriculture Sector?

The greed to industrialise while is to utmost important, need to be treated with caution. I personally do not think that all developing countries are adaptable to such stance. Countries with fairly educated workforce & where food supply is not a major concern can strive for such strategy such as the Asian Tigers

But what about countries especially those from Sub Saharan African regions where majority of its people have never even received primary education? Can they take complicated management instructions & operate machineries? Furthermore, clean water supply is even restricted in many town areas, so how to base factories there? Besides, famine is everywhere & how can we ask them to ignore basic necessity such as farming?

Arguments to focus on primary sector to thrive development:

(1) Food supply. Robert Malthus’ argument is strongly applicable here. According to him, population is growing at geometric progression while food is arithmetic progression. Very soon, there will not be enough food for everyone. This claim is strongly criticise by Western economists due to the fact that high technology & modern farming can actually aggravate the production rate of food. However, this is not the case in primary-thrived African economies, where the capital goods are obsolete & peasants often show resistance to technology

(2) Exploits comparative advantage. Comparative advantage advocates that if a country can actually produce a good at a lower opportunity cost than other countries, then they should specialise in the production of it. In other word, large proportion of exports should consist of primary products. Poor developing countries have abundance of lands & cheap labour. As such they could produce wheat, crops etc at competitive price

(3) Engine for ‘growth’. In theory, exporting agriculture produce can enable developing countries to earn some income which can be source of economic growth. The industrial expansion which takes place in Northern Hemisphere will create additional demand for primaries from the South. That is because, as industrialisation swept over, there will be lesser lands available for farming. In many cases, agriculture is insignificant of total output. Like UK, farming is only 1% of its economy (manufacturing 26% & services sector 73%)

It is difficult to promote development via farming

(1) Low price elasticity of demand (PED lesser than 1). Recall what I have taught in Unit 1. If the demand curve is very inelastic, any increase in supply will result in a huge fall in price, eventually pushing the total revenue to a very low level (TR = P x Q). Here the price effect is greater than quantity effect. Primary products have low PED as they are often necessities & have few or no close substitutes

Source of diagram:
(2) Low income elasticity of demand (YED lesser than 1). As world incomes grow, smaller proportion of income will be spent on primaries. Since food is necessity, consumers especially in rich countries already consume virtually all they require. A rise in incomes therefore tends to be spent on luxury goods & services and only a meagre increase on basic foodstuffs. Poor countries especially from African regions which specialise in primaries will face deteriorating terms of trade. It means for e.g. more cocoa need to be exported in order to import the same amount of other consumer goods

(3) Agricultural protection in advanced economies. EU government is to be largely blamed for this. In order to be self-sufficient & to protect some local farmers, they erect various policies that prevent the poor farmers from exporting their way out. For instance, they imposed quotas on food import, creating minimum guaranteed price (MGP) to ensure high local price for farmers & dump all those surpluses into world market thus destroying market price for the poor farming countries

(4) Biasness in modernisation programs. Government in developing countries should be held responsible too. Thrive to develop industrial base has often meant that most funding will be spent onto developing urban areas. They ‘forgot’ that it is the majority of the poor who live in rural areas. Those places remain undeveloped. Villagers are left without electricity & clean water supply. Transportation such as roads to connect these people to town is left untouched. As such the standard of living of those peasants will remain low

(5) Low marginal revenue product of labour (low MRPL). According to the theory of labour markets, MRP is the demand curve for peasants by landlords. MRP itself is determined by the productivity of peasants & the price of agriculture produce. In reality, productivity is often low as workers on farms tend to be not educated, strong resistance to modern farming & operate with obsolete & worn off machineries. Prices of output tend to be low on the other hand. When these 2 are multiplied (MPL x Poutput), we can see mathematically that very few farmers will actually be hired & wages paid are very low. Based on this argument unemployment remains at large in rural. Ask yourself, from logical point of view how many person can work on a small farm? (which is fragmented)

Monday, January 19, 2009

Strategies For Development 1: Inward Or Outward Industrialisation?

“Outward-looking development policies encourage not only free trade but also the free movement of capital, workers, enterprises & student……the multinational enterprise & an open system of telecommunications”

“By contrast inward-looking policies stress the need for LDCs to develop their own style of development & to control their own destiny”

By Dr. Paul Streeten (professor emeritus at Boston University)

ISI (Import Substitution Industrialisation)/ Inward-looking strategies

During 1950s & 1960s, developing country experienced a sharp decline in world markets of their primary products & growing balance of payment deficit on their current accounts. It was thought that unavailability of manufacturing sector was always the cause. Thereby many countries such as Brasil, Mexico & Argentina etc increasingly embrace the idea of creating a local industrial base

Its main intention is to:

(1) Create employment. Local firms lose out to multinational corporations in many ways from management skills to professional workforce, amount of investment into operations & scale of productions. In order to help local industries to strive, import barriers such as tariffs & quotas were erected, making it more costly for consumers to purchase imported goods than locally made ones. By ‘supporting’ home-made substitute goods, producers will over time reap supernormal profit. They will be able to grow further thus creating more job opportunities. At same time, this is hopefully can eradicate poverty

(2) Improve BOP deficit. Balance of payment records the financial transaction between one country & the rest of the world. BOP normally runs into deficit due to the deficit in current account. It could be imports are growing, exports are falling or both. By operating behind government’s protection, it is hoped that local producers will be able to produce locally. These products can be exported, thus boosting exports. Meanwhile, as consumers substitute away from foreign goods, imports will fall. BOP deficit will be narrowed

(3) To build strong base for EP (export promotion). Barriers will stay as they are until local firms are able to compete in terms of size & have acquired the know-how techniques to be productively efficient. Good examples will be the East Asian economies such as Taiwan, Hong Kong, South Korea & Singapore which once operate behind protection. Now they are able to produce at competitive costs to the whole world. This is the strongest argument use by economists to defend the need of ISI

Is ISI really that good?

(1) Productively inefficient. In theory, local firms will eventually be more cost efficient once the industry reached maturity. However, that’s not the case in reality. These firms realised that they have their own ‘captive’ markets & yet being insulated from competition. So what’s the need to improve? As a result, they will never strive to be cost-efficient. Also in many cases, the products are of ill-quality & yet expensive. Consumer surplus falls

(2) Never removed. As mentioned, local producers will tend to slack ‘forever’ knowing that once they become more-able, protections will be removed & there is no guarantee that they are able to compete internationally & earn as much profit as now. So they tend to remain as they are. Furthermore, removal of protections is very politically unpopular & may cause resentment. Ruling government may lose its mandate (think of Proton, our so called pride for more than 20 years!)

(3) Capital-intensive. Even if there were improvements made in terms of cost efficiency, very often it is done at the expense of another. As infant industry grows, they may begin to capitalise & substituting manpower with machineries, giving rise to large scale unemployment

(4) BOP deficit. We must acknowledge that poor developing countries do not have the sufficient means to grow by themselves. To develop a strong local industrial base, other than human capital they also need capital goods such as specialise machineries which must be imported from abroad. Again, this represents an outflow in current account. Hence, improvement of BOP deficit is largely questionable here

How does an import tariff works?

Tariff is a tax imposed onto imported goods

Before tariff. The price at which the good can be imported from world markets is given by PW. So in the absence of tariff domestic demand is given by DF of which SF is supplied within the domestic economy & the remainder SFDF is imported

After tariff. When government introduces tariff, the domestic price rises to PW+T, where T is the amount of tariff. It has 2 effects. First, reducing demand for good from DF to DT. Secondly, is to encourage producers to expand their output from SF to ST. As a result, imports fall substantially to DTST. However, not all the effects of tariff are favourable. For instance higher price has reduced consumer surplus. There is also deadweight loss represented by the 2 triangles at the side. For government, the tax revenue can be channelled onto local industries

Outward looking

Export promotion requires a more dynamic & outward-looking approach, as domestic producers need to be able to compete with established producers in world markets. China & India are 2 rising stars in export-led growth


(1) Create employment. Many of these factories are located in urban areas & they are labour-intensive. It provides great employment opportunity to not only people in town but also to rural migrants. As a result, we will witness lesser urban slums which are disgust to sights. Also it reduces the level of absolute poverty

(2) Influence AD. We have learned this in Unit 3. An export-oriented economy will expect an increase in its exports over imports, thus creating net exports. This shall move the AD curve rightward resulting in an increase in real GDP. Through the multiplier effect, national income & employment will further increase

(3) Financing capital goods. An increase in exports over imports can improve its terms of trade. Terms of trade means ratio of export prices to import prices. In other word, the country need to export lesser to finance the same amount of imported goods e.g. machineries. Also there will be lesser danger that the economy will run into foreign exchange & foreign debt problems

(4) Exploit EOS. Since local manufacturers are producing on a large scale to world market, it is able to significantly exploit EOS. It could be any of the combination of purchasing EOS, marketing EOS, managerial EOS, technical EOS etc. This will give the particular developing countries an added advantage on top of its cheap labour. As such it will be able to compete easily at international scale given its cost competitiveness. China is a good example. It has successfully create a chaos in British, US & other Western European’s manufacturing industry

(5) Learn from rivals. By competing with multinational companies, local firms will be able to improve its competitiveness. There will be more efforts put into R&D. Marketing team will be more aggressive. Also they can learn the unique features of rivals’ product & perhaps make a large improvement over their existing ones to enlarge market share


(1) Dependent culture. Export-led growth is not without its problems too. Its level of success depends a lot on the pace of economic growth in rich Western countries. If say, US is hit by a recession, then third world countries could be the worst affected. Level of exports will slump. Unemployment will escalate & the demultiplier effect will feed into the whole system

(2) Rich countries erect protectionism. It is unlikely that Western manufacturing sectors are able to compete with low cost Asian economies. What’s more in manufacturing sector which is labour intensive. More often than not, labours form a large portion of total costs. That is also one of the major arguments as to why major Western economies are shifting their comparative advantage to services sector, except Germany. Others which still have manufacturing industry as their core economic activity began to erect unfair protectionism

(3) Environmental degradation. Developing countries are often accused by Western economies as the major contributors to global warming, especially China. This is true. Rich Western economies have already reached the desired level of income. As such living in a cleaner environment is now their priority. Meanwhile, for poor but booming countries they have to sacrifice environment at the expense of economic growth & development. Besides, industrialists in developing economies are not that well educated. As such their level of environmental awareness is very low

(4) Fall in export prices. This is assuming if all developing countries are trying to export their way out simultaneously. Due to flooding of manufactured goods into the world market, its prices will be forced to plunge, putting exporters in disadvantage

I'm very pro free-market & for that I fully support export-led growth. I actually do not believe that excessive governement protection will eventually turn 'an ugly frog into a handsome prince'. Furthermore, it's just too costly for persistent intervention

Inferior Goods For UK In 2009

This topic is much central to the concept of YED (income elasticity of demand). Again, it is defined as responsiveness of quantity demanded due to the change in income

Generally we have 3 situations:

(1) Luxury goods (YED greater than 1). This means, a slight increase in income will cause a greater than proportionate increase in the quantity demanded for that product or services. Of course it works the other way too. When there is a slight fall in income, it will lead to a larger than proportionate fall in the quantity demanded for it

(2) Inferior goods (YED is negative). This means, as our income falls our quantity demanded for that particular item will increase & vice versa

(3) Normal goods (YED between 0 & 1). An increase in income, will only generate a smaller than proportionate increase in its consumption (vice versa)

As for this case study which I found from BBC (I realise UK people are really an ‘economic society’), I am interested only in the argument of luxury & inferior goods. The timing is just right. UK is already in recession technically & unemployment has escalated to an unseen level since 1997. It will be interesting to find out how does the consumption pattern have changed in the recent months. Also, it will be relatively easy to identify which items are inferior & which are luxuries in such period

Source of diagram: BBC

Baked beans (inferior good)

What items have soared in demand?

(1) Baked beans. According to data, its year-on-year sales (e.g. Nov 07 to Nov 08) have surged with an increasing rate, reaching a double-digit growth in November (21.7%) & December (22.6%)

Croissants (luxury goods)

Bagels (luxury goods)

(2) Standard white sliced bread (classic inferior good). I wouldn’t be surprised with rising demand on this item. This is because, it complements with baked beans. People normally served them together (look at picture). Its demand soared to 55% in August. An increase in demand for one, will lead to an increase demand for another. This also shows that at the moment, Britons do not favour premium bread like seeded loaves, croissants & bagels

(3) Olive oil. Well this is a conflicting one. It used to be known as luxury good. People consume more of it during the period of stable economy. Somehow, the consumption pattern has shown increasing trend in period of difficulty. Does the preference of Britons changed so much that now it becomes a staple food? There could be other reasons here. It could be the British consumers are more convinced of olive oil’s benefit to health, which ensure them to continuously spend money on it rather than cutting back

Which items plunged in demand?

(1) Organic food. In period of falling income, demand for organic food has shown a slide too. Relationship between income & demand is positive suggesting it as form of luxury good. Somehow, certain consumers claim that it is shameful to assume organic food as luxury rather than necessity accruing to the benefits it provided

(2) Sparkling wine. The sales of sparkling wine falls 2.3% while champagne falls 10%. So, generally both are regarded as luxury good due to its relation with income. But in this case, these luxury goods are substitute to one another. I would classify champagne as ‘more luxury’ (e.g. YED = 3.2) while sparkling wine as ‘less luxury’ (e.g. YED = 1.3)

How does simple knowledge of YED becomes a powerful tool to business?

(1) Discount retailers & large supermarket like Tesco. They can plan ahead to stock more of these goods in their outlet. It is also a way to increase their profit even in the period of doom & gloom. Besides they can push for the sales of ‘own brand’ such as Tesco brand bread, Tesco brand shampoo etc. Also it enables them to conduct pricing strategy given that some inferior goods could be substitute to another e.g. baked beans & white sliced bread

(2) Manufacturers. There is no other time like now to boost the production of can food. They may witness a windfall profit while other food companies are on the declining side

What To Be Expected For Unit 4 Examination?

As a teacher, I feel rather bad seeing my students struggling next week Monday, a day which they shouldn’t. That is actually the biggest day for the Chinese as we will be celebrating CNY, a festival equivalent to Christmas

But nevertheless, that’s the hard fact. It’s also the last paper for all Edexcel examinations in January sittings

This posting is actually in response to request by my students, wanting to know what will likely appear in Unit 4 both Part A (MCQ) & Part B (Essay)

But bear in mind, Unit 4 is rather hard to predict accurately due to the following reasons:

(a) It is such a huge Unit & there are just too many things that they can ask

(b) Questions in Unit 4 have high tendency to combine topics with topics unlike the previous Units

Having said so, doesn’t mean that there are no popular questions. There are some which has high tendency to repeat themselves. I will now go to Part A.

Types of questions tested (% means chances of coming out)

(1) Calculations on MC, MR, AC, AR & AVC (100%)

(2) Theory of curves. Students must know that the MC will ALWAYS cut the AC at its minimum. As MC is below AC, AC will decrease. On the other hand if MC is above AC, AC will rise (80%)

(3) Identifying the market structure for perfectly competitive market. Students will be given options A to E such as steel company, pharmaceutical, coal mines, national newspaper & wheat. So in this case if a student has chose wheat, then he is right (40%)

(4) A perfectly competitive market is productively inefficient in SR (P ≠ AC) but productively efficient in LR (P = AC). It is both allocatively efficient in SR & LR (80%)

(5) As long as P > AVC, even though the perfectly competitive firm is making losses in the short run, it will still continue to produce (50%)

(6) Changes to output & price when a monopoly firm switches its objective from e.g. profit maximisation to sales maximisation. In this case, a student must be able to identify that price has went down but quantity of output produced increases (90%)

(7) Changes to output & price when there is a change to either AC & MC or AR & MR. In this case, students must draw the diagram in order to have a better view (80%)

(8) Assumptions of price discrimination. Students must be able to tell that if willingness to pay is low (PED greater than 1), producers musnt't charge a high price & vice versa. Also situations will be given & students are asked to assess which of those, price discrimination is highly unlikely e.g. car sold in European market, rail travel, bus travel, theme park & milk on the shelves (50%)

(9) Concepts of productive & allocative efficient are also tested for monopoly related questions. Make sure you know that a monopolist is neither productive nor allocative efficiency in BOTH short run & long run (95%)

(10) Concepts of rising concentration ratio & how can this lead to establishment of collusive practices, predatory pricing, limit pricing to drive new competitors away, & how its mergers will likely attract the attention of Competition Commission & Office of Fair Trading (OFT). Also it must be acknowledged that in the oligopoly market, barriers of entry & exit are rather high. Expect around 2 questions from here (100%)

(11) Calculations of market share & making conclusion that the reference market is oligopoly (80%)

(12) Role of OFT & Competition Commission is to protect public interest, ensure existence of choice & maintaining a certain level of competition within an industry (100%)

(13) Price control by industry regulators such as RPI-X & RPI+K (100%)

Part B

(1) Calculation of concentration ratio & identifying the market structure. Sometimes students will be asked to explain the changing concentration ratio (80%)

(2) Is the reference market contestable? Argue by giving sound reasons for both side (100%)

(3) Why firms in oligopoly market collude? Answer this by showing kinked demand curve or Game Theory diagram. May carry around 8m to 12m (70%)

(4) Diagrams of monopoly. They may ask things like what happen to profit, price & quantity if there are changes to AC & MC or AR & MR (70%)

(5) How does a monopolist maximise profit using price discrimination? Draw a diagram, give assumptions & explain how it works (80%)

(6) Naming 2 types of inefficiencies a firm faced. Mention about productively inefficient & allocatively inefficient. Draw a diagram & then give examples from Extracts. Very popular in recent years (90%)

(7) How does Competition Commission & OFT function to protect consumers’ interest? (80%)

Sunday, January 18, 2009

How Are Wages Determined In Imperfect Labour Market?

Ever wonder how wages will be determined in the presence of both monopsonist employer & strong labour union? What will happen to wages & level of employment?

Saturday, January 17, 2009

Interesting Latest UK Macroeconomics Statistics

(1) Real GDP. UK economy is slowing down markedly from its peak of 3.3% at Q3 of 2007. In Q2 of 2008, it registered 0% growth & Q3 is -0.6% growth for the first time. Recession is defined as 2 successive quarters of negative economic growth. Therefore, we can only officially declare UK economy in a recession state based on the Q4 data. But from inference, one can tell that Q4 economic growth will fall very sharply & thereby any chances of economic recovery in 2009 is remote

(2) Unemployment. The number of people out of job has increased dramatically up to 6% in October from 5.8%. This is the highest level seen after 1997 & it’s very worrying due to the potential contraction in consumption spending (de-multiplier effect). Number of people claiming Jobseekers Allowance also showed highest rise since March 1991. Unemployment often has lag changes in the economy. That’s one of my strongest arguments against any proponents that second half of 2009 will see any recovery

(3) Inflation. CPI had earlier rose significantly to 5.2% due to escalating world oil price. It peaked at 11th July at $147 dollar per barrel. First half of the year, inflation has captured the attention of economists. But with sharp contraction in economic activity due to credit crisis in the second half of 2008, had fuelled the fear of deflation which could spark tragedy of Great Depression in 1929 & in Japan in 1990s

(4) BOP. Surprising the BOP deficit widened during that period which contradicts any economic theory that in period of slowdown demand for imports will fall thereby reducing the deficit. The possible explanation for this is although demand has fallen, the export of UK services had fallen too at a larger rate

(5) Retail Sales. Retail sales increased momentarily in July largely due to summer holiday before went down. It increased slightly again, somewhere in November due to preparation for Christmas

(6) Investment. Business spending has suffered a free fall. It will not be surprising to see investment expenditure falls below 0% in the release of Q4 data. Although interest rates had gone down from its peak of 5.75% in September 2007, poor business confidence & unavailability of credit largely explained for this trend

(7) Government spending. Government borrowing has increased markedly & is expected to hit 40% UK’s GDP this year. However this is expected in the period of recession. Government has the responsibility to increase public investment & at same time reduce direct tax thereby widening

(8) Interest rates. The Bank of England has taken a drastic measure in the recent by cutting interest rates to 1.5%, the lowest level ever in the 315 years since it was founded in 1694.This show how desperate are policymakers in preventing the threat of deflation which may lead us to another Great Depression. This is also a far cry if we compare the interest rates to the period of 1979-80 when Margaret Thatcher came into power. That time, she was determined to combat inflation of 27%. As such, interest rates were raised to an extraordinary level. Also, during the late 1980s Lawson Boom, interest rates were raised to unprecedented level to tackle another inflationary threat & as part of effort to maintain the exchange rate of £2.95 to 1 DM

(9) House prices. Most of the UK people tend to store their wealth in property market. But due to the credit crunch issue, increasing number of homeowners finds great difficulty in securing loan from banks. This leads to fall in demand for housing which is followed by decrease in house prices. Collapsed in wealth leads to lower consumer confidence hurts UK economy which is mainly consumption-led

Wednesday, January 14, 2009

What Are The Major Obstacles In Development?

Farming community in Africa

Countries can be generally classified into 3 types:

First World: G7 countries like US, UK, France, Germany, Italy, Canada & Japan. This also include many other rich Western European countries

Second World: former communist block with countries from Eastern European such as Bulgaria, Belarus, Czech Republic, Hungary etc

Third World: poor but developing countries which mainly come from Asia, Latin America & Sub Saharan African countries. Asian countries are like Bangladesh, Pakistan, South Asia & Central Asia. Latin America is like Bahamas, Panama, Peru, Paraguay, Uruguay, Venezuela, Argentina, Brasil etc. From SSA are like war-torn Sierra Leone, Burundi, Botswana, Zimbabwe etc.

There is even the term Fourth World countries (countries with low income) due to the vast divide even within Asian countries itself. Countries like Malaysia & Singapore are in middle income while Myanmar for instance as low income. Then we also have NIC (Newly Industrialised Countries) such as Taiwan, South Korea, Hong Kong & Singapore which has strong Western industrial base

If one observes, most of the rich countries belong to the northern hemisphere while those poor countries are mainly from southern hemisphere. Hence economists come out with the term ‘North-South Divide’ to describe the growing income inequality

Constraints of development in Third World countries can be divided into 4 categories:

(a) Natural resources
(b) Human capital
(c) Poor infrastructure
(d) Institutional factors

(1) Inadequate natural resources. As learnt in Unit 1 & Unit 3, a country’s economic growth will be limited if it is running out of resources including fertile land. This can be shown using the PPF or even the AS curve. All these resources are said to be able to increase the productive capacity of the economy. Developing countries are too populous. As such serious shortage of land is a common phenomenon which leads to many damaging effects. First, with lesser lands, there will be significant fall in cultivation activities which are the main source of income for poor countries. This is being made worse with low level of technology acquisition which could have helped them to produce in mass. Also farmers couldn’t reap the benefits of EOS since lands are often being fragmented either through force by government to ensure fairness in society or pass on from one generation to another. Second problem is acute food shortage. All these will hinder economic growth & lead to problems like starvation

Evaluation: Natural resources could be one of the most dominant factors in pursuing growth & development. However, there are some countries which have no resources such as Singapore & many others from Western which have been successful in pursuing their objectives. This is because they shift their PPF outward by ensuring the high standard of their human capital. Countries like Russia (earlier), Ukraine & Argentina are endowed with such resources but have poor growth

(2) Untapped resources. No doubt many poor countries (Sub Saharan African) are blessed with natural resources. However most of them are untapped. The reason is because lack of R&D which may lead to low discovery of mineral deposits. Also they do not possess the necessary technology to mine. Rich countries which often have the expertise will not want to set up a firm in a country where its political system has collapsed & the governments are corrupt.

(3) Inefficiently managed resources. Many poor countries do not achieve both productive & allocative efficiency. Productive inefficiency exists due to absence of competition, contracts & projects are awarded to family members or political patronage, government adopting a close economy policy etc. Allocative inefficiency persists as factors of production like labor & capital are used to produce too much of something & too few of something else. As such someone else can still be made better off without making someone else worse off. For e.g. Indian government was being criticised for encouraging the production of oilseeds & sugar cane where it has no comparative advantage. It should concentrate on rice, wheat & cotton

(4) Lack of human capital. Poor countries have low allocation of budget onto education & health sector. This is due to 3 factors. Firstly, falling export revenue of agriculture produce due to various import restrictions from developed countries e.g. CAP (Common Agriculture Policy). Secondly, large proportion of national income was devoted to service debts to IMF & World Bank. Thirdly, these financial institutions imposed various austerity measures as a condition for rescheduling of loans.

Low spending on education means many will not know how to read, write, perform basic arithmetic, operate electronic equipments & to take complex instructions. Lesser availability of healthcare means lower life expectancy, more days taken off as leave resulting in lower output & loss of workforce at productive age etc

Evaluation: At the meantime, healthcare sector should get more attention in funding than education. There is no point having educated workforce but with poor health & low life expectancy

(5) Rapid population growth. According to Thomas Malthus, the food is growing at an arithmetic progression while population at geometric progression. There will be a period where we may run out of land to produce food sufficiently to sustain the rising world population. His argument seems to be true in some poor areas like in Africa where changes in weather caused difficulty in carrying out agriculture activity & yet population growth is a time bomb

Evaluation: He had actually underestimated 2 things, the role played by technology to increase the productivity in farming. In developed countries food growth rate is actually faster than population growth rate. Second, highly populated countries have imposed measures to restrict population growth rate like China

(6) High dependency ratio. This ratio is set to rise as number of children is growing & yet number of working adults is declining. There will be more children being taken care of for every adult & could be a burden to an already poor family

Evaluation: From the formula of dependency ratio, it is stated that one category of people being considered as dependence is those between 0-15 years old. But in many poor agriculture-based countries, those young ones are being forced out of school to help on the farms. As such, they may help to reduce the burden of family

(7) Lack of savings. We have learned in Unit 1. To achieve higher growth in future, a country must invest more on capital goods by sacrificing current consumption. Unfortunately, the living standard in many developing countries is very near to subsistence level. Wages are more often than not, sufficient for consumption & other basic needs. There will be very less savings, which is crucial for acquisition of capital goods in future

Evaluation: The government can play a role in encouraging savings via expansionary fiscal policy which lead to creation of new jobs. The state government can also reduce wastage by identifying state-owned firms which will never be profitable. Also monetary tools such as increase in interest rates can be enforced to encourage savings

(8) Lack of infrastructures. Due to the burden of debt & austerity measures imposed onto many developing countries, infrastructure development is far left behind. Nothing much has been done to improve the telecommunication & transportation which are key services that will attract foreign investment. Roads, bridges, harbours & railways are in bad condition & may affect the timely delivery of goods. Also in most places in SSA, safe & clean water supply is still an unresolved issue. It is therefore very common to hear outbreak of diseases such as cholera with the most recent one in Zimbabwe

Evaluation: The IMF & World Bank are not to be fully blamed for all the economic mess in developing countries. While it is true that austerity measures had played some role in putting poor countries in tighter condition, the recipients of aid must shoulder the blame too. It is not uncommon to hear that some corrupt country leaders had siphoned those monies into their own account, use it for political agenda etc. Also it depends on their prudence on using the fund provided

My Essay Appeared In Jan 09 Unit 3 Q1 Edexcel Exam

Click this link:

This was in the December's posting. Hopefully those who have read it benefited from it!

Sunday, January 11, 2009

Consumer Surplus & Malaysian Students' Culture Against Academics Textbooks

Source: economicshelp, by Richard Pettinger

Consumer surplus: Defined as the difference between the price a consumer is willing to pay & what he actually pays

For example I’m willing to offer up to RM 200 for a good Economics textbook. But this book called ‘Economics: A Complete Course for IGCSE’ written by Dan Moynihan was sold at MPH for at RM 119. As such my consumer surplus is RM200 – RM119 = RM 81

Generally consumer surplus measures the welfare or benefits we derive from the consumption of goods & services. The larger the portion, the greater the benefits or welfare or satisfaction

What determines the size of our consumer surplus?

(1) Power of firms. Normally, firms with monopoly market structure, will abuse their dominant position by charging exorbitantly. Assuming that the willingness to pay remain the same, increase in price of a good will reduce the size of the triangle or the gap between willingness to pay & price actually paid. Monopoly here could mean that the firm is the sole producer or perhaps owning market share greater than 25%. Companies in oligopoly market structure can also do the same if they behave collusively & act as if there is only ‘single pricing’ in the market

(2) Elasticity of demand. The more inelastic our demand for a good, the greater the benefits we derive out of it (PED <1). To me, my demand for Economics book are most of the time inelastic due to the nature of my profession & my understanding of the subject. That’s why I’m willing to pay for a high price to ‘work’ with a good book

(3) Size of shift in demand curve. The larger the increase in demand curve (shifts right), the greater will be the increase in consumer surplus. If the demand curve falls, it works the other way. The size of surplus will be different if we consider factor 2 & 3 simultaneously

(4) Size of shift in supply curve. The larger the rightward shift in supply curve, the greater will be the gap generated between willingness to pay & market price, thus increasing the benefits or welfare. It is true if we consider opposite direction. Elasticity of supply curve will influence the producer surplus but not consumer surplus


Students normally have very high PED (PED > 1) for academic textbooks. In other word, their willingness to pay is very low. That’s why publishers normally provide discounts for students up to 20%. But I argue that this is very much insufficient to encourage the take up rate given that their PED is crucially high e.g. could be PED = 6

Reasons for low consumer surplus among students (could be 0 or negative):

(1) Lack of interest & appreciation of the context in the subject

(2) Will dispose it anyway after a semester or two

(3) Existence of perfect substitutes e.g. photocopied versions

Students’ consumer surplus could be zero if their demand is perfectly elastic. Here their willingness to pay & the actual price they paid is the same. In some cases, could be negative. For instance they value the book at RM 20, but since they were forced by lecturers to buy original version at RM100, then this is large negative consumer surplus of RM 80

Saturday, January 10, 2009

Supply Side Measure Announced To Help Recent Graduates

“Ministers are worried graduates could swell the ranks of the unemployed…..”

“Four top firms, including Barclays and Microsoft, will take on some of this year's 300,000 graduates”

“……the internships secured under the national scheme would last for three months”

Source of quotes: --BBC, 10th January 09--

What policy is this?

The 3 months internships for fresh graduates are best classified as supply side measures since the intention is to increase productive capacity of the economy by increasing participants’ skills & increasing their employability

How likely is this in reducing unemployment?


(1) In short run. Assuming if there is no government intervention, probably majority of these graduates will remain as they were, struggling to look for a stable job by competing with those more experienced workers who probably demand for wages not much higher than them. Since government officials have held talk with large companies like Barclays & Microsoft, at least they are temporarily guaranteed a place to render their labour rather be part of the unemployment statistic

(2) In long run. Assuming these graduates are competent, probably they will be offered permanent positions. Furthermore which companies that doesn’t want to keep good people at reasonably low wage? One could also argue that by having experience working in household brand companies such as Microsoft, will boost their resume when they applied for another job


(1) De-multiplier effect is just too strong. As explained in much earlier posting, unemployment effect can snowball & months after months we will see quotes like “unemployment in December at 11 years high” & probably “18 years high” a month later. 300, 000 workers absorbed into labour market is not sufficient to offset the snowballing effect. Often this is being used as a tool by politicians to temporarily masked the real unemployment situation in UK

(2) Worsening frictional unemployment. In reality, it is very unlikely that many of the 300, 000 graduates will be retained. Business activities are slowing down markedly. There is no point maintaining redundant workers. Firms are now desperate to cut costs to offset the falling sales revenue, so that they can still make out of it. Workers retrenched after 3 months will then look around for their second job. However, given the current economic tsunami, they will likely take longer period to successfully engage one. This is said to worsen the frictional unemployment

(3) Not marketable enough. What can an average graduates learn in 3 months? Furthermore slower business transactions also mean lesser things to do & lesser skills to learn. This definitely will not be a plus point for them to easily secure another new job if their labour service is unwanted

Refer original article at:

Slower Posting

Dear fellow readers & students,

The semester for new intakes, A55 had commenced recently. On the other hand, those senior students of mine, A52 will be back in February & I'm in the midst of updating & preparing new sets of lecture notes. Also, nearly forget that Chinese New Years are about 2 weeks away

Due to these reasons, I'll be EXTRA busy both in college & outside, and as such there will be lesser posting in the month of January


Lawrence Low

Thursday, January 8, 2009

How Effective Is Quantitative Easing In Both US & UK?

Quantitative easing. When Central Bank buys securities, government debts, mortgage-backed securities etc to increase the money supply in banking system so that they can resume lending as usual

Why quantitative easing?

(1) Credit crunch. This is not a common sight in the advance money markets in US, UK & many other parts of the Western economies, not until recently. It is a phenomenon where borrowers which can be made up of consumers or firms find great difficulty in securing loans. Banks have been more frugal in lending due to the ballooning number of defaults from homeowners & bankruptcies from firms. Despite moves by central banks like the Fed or even Bank of England cutting short term interest rates to 0% & 1.5% respectively, banks are still highly stubborn in passing on the rate cut

The prime reason is to recapitalise by maintaining an attractive interest rate to attract depositors. Some notoriously increase the credit card charge. All as an excuse to replenish their balance sheet

There is also a momentarily period where the 3 month LIBOR (London Interbank Offered Rate) increase. This is the rate where banks charged when they lend to each other in the wholesale money markets. In fact this could be a better indicator of lending rather than the base rates. In normal circumstance, fall in key interest rates will be followed by a fall in 3-month LIBOR (look at diagram). But since credit crunch, banks are more reluctant to lend to each other, causing a shortage of funds & this raise interest rates. As such fall in key rates which was supposed to boost lending had been offset by the increase in LIBOR. I argue that the problem of tightening credit is self-perpetuated by the ‘short-sightedness’ of those banks

(2) End of traditional tool. Here we refer specifically to monetary policy. It is a policy to influence the movement of AD or spending into the economy by manipulating the level of interest rates. In the period of rising inflation, interest rates can be raised indefinitely to curb spending. However in the current period of rapid deflation, interest rates can’t be reduced to below 0%
In US, interest rate is already at 0%, while in UK is now at 1.5% Although UK still has some room for further cut in rates, it’ll soon be running out of ammo. Perhaps in the next 2 meetings. At the moment, consumer confidence is really weak. I don’t see any possibility for both these large economies to turn around soon, not even when the rates are 0%. This has created a situation called liquidity trap. Japan should be a good proxy. Interest rates were at historical low level of 0% for years, & yet it fails to inflate the economy

Will quantitative easing (QE) works?

In theory, this should work. Quantitative easing is often suggested as a secondary tool to counter liquidity trap. Bank of Japan had attempted this in 2001 to prevent deflationary scare. Buying up securities & government bonds will increase the money supply or reserves in commercial banks so that they can resume lending as usual. Arguably this should be a better tool than the traditional rate cut, since the main problem is banks’ liquidity rather than costs of borrowing itself

These unemployment data is good enough to turn-off the mood for spending

(1) Consumer confidence. As imply by the term lending & borrowing, it shows that for spending to take place in economy, banks must be willing to lend & people or firms must be willing to take financing. However, daily news of job losses, unemployment at record level both in UK & US or even famous firms which went under administration are good enough to create a stigma among borrowers. Who dares to take up large credit commitment when they aren’t sure if they can still hold on to their jobs? Which firms will expand their operations in such period? Therefore, collapse in C & I may undermine the effectiveness of quantitative easing

(2) Could be overdose. There is even a possibility that if QE does work through, US & UK economy will be ‘over-cured’. If there is even a slightest mistake e.g. miscalculations, wrong timing, pumping in too much liquidity etc, money supply will increase dramatically & this may create a spiraling inflation. It could be an ugly one-hyperinflation which we witness during the period France Revolution, Weimar Republic & the current one in Zimbabwe. With QE stance, it shows that monetary committees place higher priority on economic growth rather than the threat of inflation. In hyperinflation, many things may happen e.g. paying salary twice a day, daily menu costs rather than annual, more empty shelves etc

(3) Lack of experience. US & UK had underwent through series of economic slowdown both big & small ones e.g. Great Depression 1929, October 1987 crash, Enron accounting scandal, September 11th terrorist attack etc. To great extent, many of these problems have similarities in nature, but what we are facing now is a new type of contagious ‘disease’ which fast spread to whole economic system. Banks have never been so short in cash, government had never announced such large fiscal stimulus, unexpected collapse of Freddie Mac & Fannie Mae and Lehman Brothers, AIG which nearly went under etc. Quantitative easing is rather new to policymakers in Western economies. Furthermore, learning from Japan experience, they should know that this have a chance of not working out

(4) Still need fiscal policy. Even if it does work, it may take ages before people & firms realised that prices of assets have finally rock bottomed. By then, unemployment could have surpassed the level we last seen in Great Depression & much damage has been done. Therefore, QE & fiscal spending could necessary be complement to jump start the economy. Large scale public spending into economy has effect on both AD & AS. Obama has announced his plan to transform public buildings to be more energy-efficient, increase broadband access, repair roads & bridges etc. All these are meant to absorb retrenched people into employment which may induce spending at later stage

(5) Velocity of circulations. Money supply actually depends on both the amount of money printed (monetary base) & also its velocity of circulation. In other word how fast it changes hand. The prime concern at the moment of writing is velocity of circulation which is falling faster than the rate Fed increase the monetary base. Thus this may reduce the level of success of QE. The speed where money changes hand goes down dramatically due to escalating unemployment, falling consumption (C), declining & investment (I)

Wednesday, January 7, 2009

What Happens To Firms If There Is An Increase In Prices Of Raw Materials?

I noticed one of the most popular questions being asked in Part B of Unit 1 (legacy) is “What is the impact onto the consumers of the commodity when there is an increase in price?”

I generally put commodity here since it can be anything: oil, copper, aluminium, steel, palladium, uranium etc

When the question mentions about consumers of the commodity it meant the producers because they are the one who use it in their manufacturing process. Some students confused with the word ‘consumers’ & thought that it is referring to a typical consumers on the street & thus easily lose 6m for this type of question. Consumers like us are called end consumers

So what happen to firms?

(1) Passing on the costs. Since commodities are part of the production cost, therefore any increase will normally be passed on to end consumers. Also one could argue that they may not pass on the cost. This is true especially if their products have many substitutes. Any price increase will cause consumers to switch away to rival goods. Another is depending on the cost of commodity as a % of total costs. If it’s insignificant, firms may not consider passing on the cost

(2) Firms will make losses. Due to stiff competition firms may not be able to pass on much of the cost to consumers. As such they may have to absorb part of the losses. Depending on severe & how long will this last, the firms may go bankrupt in the long run. Those firms that still survive may not have much incentive to conduct R&D

(3) Produce substitute goods. There was one question on the production of tequila using blue agave in 2005. Since blue agave, the main ingredient in tequila manufacturing have gone up in price, producers decide to switch over to other form of alcoholic drinks such as wine etc

(4) Cut costs elsewhere. Firms may start to look elsewhere to cut costs. They may start to shrink employment, use lesser quantity & lower quality of raw materials which are normally substitutes, relocate, combine production under one roof etc. It has lots of implications. Cut employment may lead to problems like structural unemployment. Lesser quantity of raw materials may affect the quality of end products e.g. taste of tequila drinks, safety of the cars etc

Saturday, January 3, 2009

What Is The Wisdom Of Minimum Wage?

National Minimum Wage Act 1998 was a flagship policy of the Labour government which officially came into effect on 1st April 99. The main reason as to why it was introduced is due to steadily declining membership in unions, particularly services sector. Weakening unions generally mean weakening bargaining power for employees

The minimum wage as at 1st October 08:

(a) £5.73 per hour for adult workers (this has risen since 1999 from the initial £3.60 an hour)

(b) £4.77 per hour for 18-to-21-year-olds

(c) £3.53 per hour for under-18s who have finished compulsory education

(d) None for those who have not yet finished compulsory education (the age when a person finishes compulsory education is either 15 or 16)

Diagram of minimum wage. We refers to wages in equilibrium market & Qe is quantity of labour in equilibrium. Wtu is the minimum wage

Reasons for minimum wage:

(1) Protecting those low paid. People with lowest pay scale will always be the worst affected during the period of inflation. This is because the total price they paid for goods & services now as a % of their income has increased. Think about this. Say a basket of common goods was available in 2005 for £100 & now it costs £150. Say Mr. A earns £1500 & Mr. B earns £6000. Do the math & you’ll find that it is 10% of Mr. A’s income while only a meager 2.5% of Mr. B’s income

(2) Productivity argument. Minimum wage has the supply-side effect. Since people received higher income, they will be more motivated to work & as such this may lead to an increase in their productivity. It will be good for employers too since more output will be produced & this will lead to reduction of costs for every unit of output

(3) Stimulate consumption. Since people have higher income, it makes economic sense that they will increase their spending. It will have a great effect onto UK economy since its economic growth is consumption-led. To strengthen the argument, minimum wage applies only to low paid people & these are the people who have high marginal propensity to consume (mpc). In other word, tendency to spend more for every increase in £1 of disposable income. Unlike the rich, they have low mpc. Even if there is any increase in disposable income, they are unlikely to spend much since they have own many things

(4) Increase incentive to look for jobs. Introduction or any increase in minimum wage will create an incentive for jobless people to seek employment. This is because the opportunity cost of being unemployed has increased. In other word, the gap between wages & unemployment benefit has widened

Reasons against:

(1) Fall in demand for labours.
Firms are the buyers here. With minimum wage legislation, they find that hiring workers are now more expensive & as such will have the tendency to retrench workers. As such this has the effect of creating unemployment. Some firms do not reduce the amount of workers they have but rather make them work lesser hours a day to be cost competitive

(2) Hurting labour-intensive businesses. Textile factories, hotels & other industries which use up a large proportion of low-paid workers are the worst affected. With minimum wage, it simple means increase in production costs. However one could also argue that industries such as hotel have seasonal employment. Many of the jobs created are part time basis. For e.g. employment will increase during peak period such as summer holiday. Therefore, the increase in operating costs is viewed as temporarily

(3) Passing on the costs. One of the most common thing firms will do is passing on the increase in production costs to end consumers in the form of higher price. Slashing employment may not be the best solution as it may affect the smoothness in the day-to-day operation. Also one could argue that firms may not necessarily pass on the costs to customers. They may attempt to reduce their costs elsewhere like using lower quality materials in production or reduce its quantity of usage. Also they may start to look for new suppliers

(4) Does not increase productivity. Increase in productivity is sometimes true. In certain situation, workers may not even bother to increase their productivity since they know that whether they work hard or not, they still get the minimum wage just like those who work hard

(5) Disincentive to further education.
Minimum wage could be a great disincentive for young people to pursue higher education, especially those who are under 18 but have finished compulsory education & to those between 18-21 years old. Depending on how high is the increase, the greater per hour pay, the greater will be the disincentive. In the long run, UK may have lesser number of educated workforce although the figure could be insignificant

In theory, minimum wage would increase unemployment. However, empirical evidence from both the States & UK suggest that moderate increase in minimum wage will not have an undesirable effect onto the economy. Thereby it will be interesting to find out, how much will minimum wage need to increase to begin having any effect onto employment

How A Restaurant Can Increase Its Profit?

This posting is dedicated to my friend, Mr. Tong a restaurant manager. Well, I’m no great consultant. Neither am I, someone experienced in food business, but I can always give sound argument & opinion on how to increase business efficiency

The restaurant is operating in a monopolistic environment, since it fulfills all the condition:

(a) There are many customers & restaurants in the same area

(b) It produces goods (in this case chicken rice & hor fun) which are identical to many other restaurants BUT is differentiated with branding (the restaurant is well known for recipes from Ipoh)

(c) It has some price making ability

(d) It operates in an environment of low entry barriers & exit barriers. New restaurants can therefore come in easily & leave as they wish due to low set up costs. RM 150,000 to RM 400, 000 is considered low enough compared to setting up a multinational firm. He even told me that several restaurants have went bankrupt

(e) In long run it (may) achieves normal-profit (AC = AR), since any short run supernormal profit (AR > AC) will be competed away by new restaurants operating in the same area. Probably true, since the growth rate of restaurants greater than growth rate of customers in that area. In other word, profits being ‘shared’ out

Since all firms exist to make profit, thereby the restaurant operates where MC = MR. This intersection is called profit-maximisation. In other word, profit of the restaurant is maximised when MR (marginal revenue) is equal to MC (marginal cost). Producing there means profit is at its peak & can no longer go any higher

Equally, one can also look at the TR (total revenue) & TC (total cost) diagram above. We can see that profit is maximised when the gap between TR & TC is the BIGGEST

One should never think that profit is the same as total revenue. This is because

Profit = TR – TC
Profit = (price x quantity) – TC
Profit = (PxQ) – TC

From our conversation, he mentioned that since the restaurant (2nd branch) is relatively new in the area of about 5 months & the margin is thin due to stiff competition & high operating costs, he needs to think how to reduce costs & increase volume of food sold

Here’s what I think:

To increase the profit, there are generally 3 broad ways, either increase TR or minimise TC or if both can be done simultaneously, that would be great

(1) To increase total revenue (TR = P x Q):

(a) Manipulate P. Flirting with P could be a little difficult. Increasing the price may lead to fall in quantity of food sold in near term. In other word, losing the customers. The more sensible, but indirect way of price increase would be to reduce the amount of chicken, rice, hor fun, putting more ice in the drinks etc while maintaining the same price. However, he outlawed that option since the restaurant’s policy is ‘generosity’.

(b) Manipulating Q. He repeatedly used the word VOLUME & this is tied with quantity of food & drinks sold. From economic point of view, this refers a necessarily increase in demand. To increase demand the following can be done:

(b)(i) Advertising. Earlier, Kar Heong has launched an advertisement in the form of booklet. According to him, it was effective in pulling a larger crowd to the restaurant. It costs them about RM4, 000. Since that’s the case, I would recommend the restaurant owner to advertise more often, e.g. every few months. Never belittle the power of advertisement. The short term advertising expenditure should not be seen as a great barrier towards greater sales in future

(b)(ii) Credit card facilities. At the meantime the restaurant is accepting cash payment. Later it will have credit facilities as well. This is important since modern urban consumers are increasingly not carrying cash with them when they go out

(b)(iii) Good customer relationship. Always ‘attack’ parents that bring kids along with them e.g. giving them candies or sweets. I saw you did it that day, congratulations! I remembered a businessman told me that if you can make the kids like you, for some reason you have already won the heart of their parents. This will ensure them to come more often. Also I recommend, greeting the names of those regular customers. People like when their names being called. It is actually a kind of respect. I got this from Dale Carnegie in his book “How To Win Friends & Influence People”. To me, I always look at customers as the ambassador of the product we sold

(b)(iv) Loyalty cards. Although there is, I feel that the 10% discount given for the tenth visit is not strong enough to create an incentive for customers to ‘hit that target’. Perhaps a 30%-40% would do. Anyway, I do understand that at the meantime the profit margin is thin. Perhaps, putting 2-3 marks for every visit is good a beginning. At least people will think, to reach the hilltop, I just have to climb 4 stairs rather than 10 stairs. This may create those incentives

(b)(v) Promotion at the entrance. There are many passer-bys & of course many will take notice of this. If it’s appealing enough, people may want to step in. The previous ice-cream promotion wasn’t a bad one, just that it’s not sufficient, although I understand that it’s not cost-effective due to last minute of getting a provider for that. I would recommend the restaurant owner, to reconsider the ice-cream option. Perhaps over the time, something else could be dished out as dessert, e.g. pudding. Higher initial expenditure is common in any business, but this is necessarily to create those demand

(b)(vi) Introducing new menus. I would recommend the types of drinks to be diversified e.g. cappuccino, mocha, cokes with ice-cream top, ice-blended drinks etc. First, it is not that difficult to learn how to produce these drinks. Secondly, they give very high MR (marginal revenue). People don’t mind paying. I have seen simple drink like those being sold at RM 5.50-RM 6.00 & how much is the cost? Or perhaps could introduce dessert to be added in the menu

(b)(vii) Customers’ suggestion form. As mentioned earlier, businesses must strive to understand consumers’ need. Those who are successful at doing so will win their heart & loyalty. Customers don’t pay for the sake of paying it. They are willing to pay because they like it. Having a suggestion form on the table, shows how much the business owner is concern towards customers’ need. This is also part of the effort to achieve greater allocative efficiency (P = MC). I understand that it is difficult to fulfill everyone’s need, but having that form on the table at least will also create an impression that you care for their need

(2) Reducing cost

(a) Energy efficiency. A small space shouldn’t be occupied with so many air conditioners. It’s time to shift one & move it to the right, so that the cool air circulation is more balanced. Closed, perhaps one air conditioner after peak period such as lunch. I don’t see the need of fans too

(b) Reduce water shortage. Make more frequent trips to the back to ensure that the kitchen helper do not waste water by turning on the tap all the time

(c) Reduce wages cost in future. Since the commitment has been made, it is sort of difficult to turn & reverse the decision. However, for future maybe the owner can consider reducing the payroll. In fact I feel that the current pay is extremely high for a Myanmar worker. Furthermore, they have been provided with food & accommodation or even transportation. Busy during the peak period is not a good excuse to ‘overhire’ workers. Many restaurants operate the same way too

(d) Not necessarily for specialisation. Normally, division of labour each specialising in a specific task applies more to big large organisations. This is because the volume of production is very high & also it enables them to actually achieve economies of scale (EOS) from doing so. For small scale business, such action is not feasible as it only increase the production costs. Say, 3 workers preparing the meals are paid RM 1200 each (RM 3600). I would rather reduce them to 2 & the task of the third worker is shared between those 2. Now I will just have to pay them say, RM 1400 each (RM 800 cost saving). The restaurant at the meantime is said as being productive inefficiency (MC ≠ AC, not producing at the minimum of LRAC)

I didn't mention about reducing the cost of raw materials due to difficulty to get a supplier for good meatballs, vegetables, chicken etc at reasonable price