Handy Definitions for Unit 2: Managing the Economy

Here they are:

(1) Aggregate demand (AD): Total spending onto goods and services in an economy. The components of AD are consumption (C), investment (I), government spending (G) and net exports (X-M)

(2) Aggregate supply (AS): Total goods and services produced within an economy

(3) Balance of payments: An account that summarizes the financial transactions between one country and the rests of the world

(4) Current account: A record of country’s trade of exports, imports, investment income and current transfers with rest of the world

(5) Budget surplus: Situation where tax revenue exceeds public expenditure

(6) Fiscal surplus: A deflationary fiscal policy, where government spending is less than tax receipts

(7) Budget deficit: Situation where public expenditure exceeds tax revenue

(8) Fiscal deficit: An inflationary fiscal policy, where government spending is greater than tax revenue

(9) Claimant count: A measure of unemployment based on the number of people who register themselves as unemployed and claim for Jobseeker’s Allowance

(10) ILO measure of unemployment: Defines unemployment as people who are jobless, have been looking for job since the past four weeks and able to take up the job two weeks from the date of interview

(11) Demand management policies: Policies to influence the movement of AD such as fiscal and monetary policy

(12) Economic growth: Rise in real GDP/ rise in potential GDP

(13) GDP: The value of all goods and services produced within an economy

(14) Real GDP: Value of all goods and services produced within an economy adjusted for inflation

(15) Real GDP growth: An increase in the value of all goods and services produced within an economy adjusted for inflation

(16) Hot money: Defined as short term, speculative flows of money between countries

(17) HDI (Human Development Index): A measurement of economic development comprised of three components which are health, education and GDP per capita

(18) Inflation: Sustained increase in price level

(19) Injection: An inflow of money into the circular flow of income. Components of injections are investment, government spending and exports

(20) Withdrawal/ leakages: An outflow of money from the circular flow of income. Components of leakages are savings, tax and imports

(21) Investment: Change in capital stock such as the purchase of plants and machineries

(22) Monetary policy: Is the manipulation of interest rates to influence the movement of AD and overall level of economic activity

(23) Multiplier: An initial increase in injection which will lead to a larger secondary increase in AD

(24) Productivity: Output per worker/ unit of input

(25) Supply side policies: Policies to influence the movement of AS by increasing the productive capacity of an economy

(26) Employment rate: Percentage of people who are willing and able to work who are in employment

(27) Unemployment rate: Percentage of people who are willing and able to work but not in employment

Video Lesson: UK Budget 2010

Part 1: Budget 2010 in UK



Part 2: Budget 2010 in UK

Handy Definitions For Unit 1: Markets: How They Work and Why They Fail?

(1) Production possibility frontier (PPF). A curve that shows the combination of two goods that can be produced in an economy shall all resources are fully & efficiently used

(2) Opportunity cost. The next best alternative forgone

(3) Specialisation. Process of breaking up a task into a number of repetitive operations each done by different workers

(4) Free market economy. An economy where resources are all privately owned & price mechanism will act to allocate resources

(5) Command economy. An economy where all resources are publicly owned & state government will intervene to allocate resources

(6) Mixed economy. An economy where resources are owned & allocated by both private sector & government

(7) Positive statement. Statement that can be proven true or false by referring to facts

(8) Normative statement. Value judgement & cannot be proven true or false

(9) Substitutes. Goods that can be used in place of another

(10) Complements. Goods that are jointly used with another

(11) Consumer surplus. The difference between what the consumers are willing to pay & what they are actually paying

(12) Producer surplus. The difference between the actual price a producer receives for its good & the lower price it is willing to accept

(13) Price elasticity of demand (PED). Measures the responsiveness of demand for a good to a change in its price

(14) Cross elasticity of demand (XED). Measures the responsiveness of demand for a good (say Good X) to a change in the price of another good (say Good Y)

(15) Income elasticity of demand (YED). Measures the responsiveness of demand for a good to a change in income

(16) Price elasticity of supply (PES). Measures the responsiveness of supply for a good to a change in its own price

(17) Taxes. Fee charged onto a particular good or service to discourage its production or consumption

(18) Subsidies. Grants given by the government to encourage the production or consumption of a particular good or service

(19) Incidence of tax. Means upon who the tax fall onto

(20) Minimum guaranteed price. Price floor set by government onto agriculture produce in order to protect farmers’ income

(21) National minimum wage. Price floor on wages set by government, below which is illegal for employers to hire workers

(22) Economies of scale. Fall in long run average cost curve associate with an increase in output

(23) Private cost. Costs directly incurred by an individual consumer or producer when they engage in an economic activity

(24) External cost. Costs incurred by a third party not directly involved in an economic activity

(25) Private benefits. Benefits directly gained by an individual consumer or producer when they engage in economic activity

(26) External benefit. Benefits gained by a third party not directly involved in an economic activity

(27) Public goods. Must have two characteristics, non-rivalry & non-excludability. Non-rivalry means consumption of a good by an individual will not reduce the amount available for others to consume. Non-excludability means once the good is provided, no one can be excluded from benefiting it

(28) Free rider. Someone who receives the benefits that others have paid for without making any contribution themselves

(29) Government failure. When the government intervention into an economic activity leads to net loss in economic welfare

(30) Market failure. When price mechanism fails to allocate resources efficiently

Will Greece Government Be Able To Raise Sufficient Money To Finance Itself Out?

The recent Greece’s economic woes have certainly made its way into the heart of media. Economists, policymakers and politicians from all over the world are aroused once more. All are eager to see how the whole Eurozone economies come as one during stormy days and whether the single currency plan is viable or not in long term

How Greece end up with such mess?

Put in simple. Greece has been living beyond its mean in the past decade. To sustain such lifestyle, the government engaged in heavy borrowing and went on something of spending spree. As a result, public spending soared and public sector wages practically doubled that time. Unfortunately, this was not matched by the increase in tax revenue due to the widespread of tax evasion. However, stern action was not taken as the Greece government thought that the economic boom is likely to last ‘forever’ and they will always have their ways to finance themselves out

Hence when the global financial crisis hit out of nowhere, Greece was too ill-prepared to cope. The reported budget deficit was 12.9% last year, somewhat 4 times above the permissible level under the Growth and Stability Pact. Meanwhile the forecasted national debt is expected to exceed 130% in year 2011, again overshooting the stipulated level of 60%

Will Greece be able to get the funding needed?

Yes

(1) Initiative to fix its balance sheet. Whatever is the argument, it seems that this round the Greece government is really committed to bring the deficit under control. It has enacted an unpopular but necessary measure of fiscal austerity. There will be freeze on public sector wages. Retirement age on the other hand is increased to reduce the burden of pension payments and lastly the fuel taxes raised. If all these are successful to hammer the deficit, ideally market participants would be less ‘disturbed’ and once more willing to buy the bonds issued

(2) Higher interest rates. Usually, private sectors will be very glad to snap up government-issued bonds. This is because it is perceived as safe, upon the assumption that governments usually don’t default. Furthermore, investors are guaranteed a steady stream of income periodically, depending on the promised interest rate. However, this is not the case for Greece. Its government had overspent in the past and signs of defaulting are imminent. Even rating agency like Fitch downgraded its credit rating to BBB+, the lowest among 16 euro nations. Given that the risk of lending has increased, the only way to get the finances needed is to increase interest rates offered. That is a must to compensate the risk that bond buyers are assuming

(3) Joint-bail out programme. The plan was worked out in Brussels, and yes Greece is guaranteed a safety net of up to 22 billion euros if it fails to obtain the credit needed. But of course, the move has irritated some of its European partners like Germany. Chancellor Angela Merkel has strongly urged that Athens itself can solve the problem and any form of bail-out shouldn’t be allowed under the single currency rules

I personally feel that she should be more rationale and flexible. Such rigidity will only force Greece to fall out from the common currency area where once again it could allow its currency to fall in value and therefore gain some competitive ground. If that were to happen, we know that Portugal, Ireland and Spain (PIGS) will soon be tempted to do the same. The financial exodus would cause huge ruptures in the financial markets as investors are fearful that other nations might follow suit, thereby leading to the breaking up of monetary union

May not be able to get sufficient funding:

Fall in income. This is the most fundamental economics argument. Slash in public spending followed by rise in taxes will only worsen the current economic pain. This is because fall in economic growth will lead to falling average income. Households will have lesser to spend and firms facing deteriorating profits will be more reluctant to invest, thus igniting the vicious cycle over and over again through the negative multiplier effect. Putting elderly people to two more years of work will never help either, due to poorer health condition and also declining productivity. Not to forget, lower take-home pay will further erode the level of savings in Greece’s banks, which are also the biggest fans of government bonds

(2) Shaky investors’ confidence. When it comes to financial market, all I can say is sentiment. Consider Japan with its national debt of 190% of GDP and Singapore 118% of GDP. Despite close to or much higher than the level of Greece for some time, there is not much fuss about it, all because these two countries have high income per capita and of course better reputation in debt repayment. On the other hand, Greece just like Argentina has varying degrees of debt default. Therefore they are having such tough time convincing the investors that it will not happen again

Well, maybe investors are right this time. Debts too high for such size of economy, unemployment of 10%, fiscal and monetary constraint all sum to one word-default. The evidence is there and it is just some of us choose to ignore. Greece’s two-year government bonds are persistently on a heavy sold off. As the supply of bond in market increases, its price will fall. But investors are promised a fixed amount of return, which means that the effective interest rate attached onto it must increase. Because of this, Greece government has to pay 6%, double what Germany has to pay. This indicates how risky investors think it is to hold Greece debt. Most of the money fled to other safe haven

Does Globalisation Benefit Developing Countries More Than The Developed Ones?

Until now, there is no single generally accepted definition of globalisation. Put 10 different economists together and you will get 11 different definitions. However, most acknowledge that it is the process of freer movement of human, goods, capital and information due to increase in economic integration. Down the road, we have seen that level of international trade increases dramatically over the past decade, especially creation of new trade ties between the rich and poor countries

Some economists argue that such process actually benefits rich and developed nations more than the poor ones. On the other hand, some argue that the benefits accrued by third world countries have been underestimated

Why developing countries benefit more?

(1) Lift many out of poverty. It is not difficult to see why. When a transnational company (TNC) decides to relocate in low-cost economies, many new jobs will be created. It can be in production line, technical areas and also management. People who are once unemployed will now have an opportunity to improve their livelihood while those who already have working experience may be able to climb to a higher corporate platform, thus earn better pay. Consider China. It has the largest poverty reduction in history, from 250 million in 1978 to about 34 millions in 1999. Indian government, has successfully cut poverty rate by half despite late in opening up their economy

(2) Backbone of growth. With globalisation, goods can easily penetrate the borders of other countries, thanks to the prominent role played by WTO. With its establishment (previously was GATT), global tariffs on average has been reduced from 40% to just 4%. Low-cost Asian economies have the most to benefit from this. This is because of the comparative advantage in manufacturing sector. Unskilled labours are in abundance and yet level of productivity is comparable. Besides natural resources are easily obtainable which further reduces the production costs. As such local economies can pursue export-led growth, a buzzword synonymous with China. Such strategy allows economic diversification, rather than just having a typical primary sector. The impact onto local economy can be magnified through multiplier effect. Perhaps this explains, why China can register double-digit growth in the past few years

(3) Exposure to competition. Firms which were once operating behind walls of barriers will now be forced to be more competitive. Failure to do so, will force them to exit the industry very soon. Local firms will now be more careful with the allocation of scarce resources to ensure there is no wastage. They will employ the most efficient techniques of production. Innovation and R&D activities will increase to ensure the rolling-out of new products, to satisfy consumer needs. Workers must continuously improve their productivity to ensure that they are still relevant. All these when combine, will have a powerful supply-side effect that will ensure the success of local economy in long run

(4) Cheaper price and more choice of goods. That’s simple. Say, a country produces barley. When barley is also sourced from outside that means supply of barley in the economy will increase, causing its price to fall. That’s something to be cheered by most consumers who are best categorized as low to middle income earners. Consumer surplus will increase too since the gap between what they are willing to pay and what they are actually paying increases. On top of that, standard of living will also increase when there are more choice of goods

Why rich countries benefit more?

(1) Widening income inequality. Fragmentation of production process is driven by the goal of cost-minimising. In many parts of Asia, labours are cheap, productivity is considerably high, raw materials are easily obtainable and cost of shipping has fallen. Goods are produced with the lowest cost possible and in most circumstance, cost saving will not be passed on to foreign buyers when the goods are shipped back to home country. Entrepreneurs are reaping higher supernormal profits, while management will reward themselves with fat bonuses leaving nothing for those grass-root workers. Even if there is, the reward might be insignificant. This partly explains for the widening income inequality between the developed and developing nations. While I agree that very few people will make a huge fortune out of this, they are normally the firm owner which runs business that supply raw materials to foreign firms

(2) Low reinvestment onto local economy. In theory, foreign firms will reinvest part of their profits into the local economy hence giving the economic growth a boost. In reality, most of the post-tax profits will be repatriated towards home country, hence very little left to generate value for local economy. Local suppliers of raw materials and capital goods may not benefit from this. In some worst case scenarios, local firms will relocate to another place when the period of tax concession is over. All I can say is no reinvestment and no tax proceeds for government

(3) Source of environmental hazard. There is no way we can claim that standard of living in developing nations has increased when those countries become the house to so many factories which over-operate. Water and air pollution are inevitable. Noise pollution is out of control when houses are located near to factories or construction sites. Congestion is becoming more prominent when an area is designated for factories. It is worth to note that 1st world countries have ‘shifted their problems’ to the 3rd world. Air is cleaner over the other side. Their factories use clean technology unlike those in Asia. What’s more when the environmental law is weak

(4) Exploitation of labour. Perhaps proponents of globalisation have exaggerated their stand. Claiming that the standard of living in developing countries has increased based on real GDP per capita may not be that accurate. While it is true that unskilled workers have received an increase in their paycheck, it is nothing close to an increase in their workload. In short, an increase of wages by 10% leads to an increase of 50% in works. One does not need to be a genius to see how factory workers are exploited in China. They are paid peanuts and yet overworked. Women suffer the most in terms of discrimination in workplace. Labour union is weak and the existing law is just too fragile to uphold justice for them. Also some workers may be put to work under unsafe conditions. For instance, child labour in mines

(5) Put more into poverty. While it is true that many jobs are created when foreign factories and firms are opened, there are even more unseen job losses. Some claim that every one new job created, up to three will be lost. Think about this. How many local firms that really have the competitive edge to race against giant conglomerates? Nearly none. In short, industrial liberalization rewards the competitive firms and penalizes those uncompetitive ones which are made up of majority. Job creation is insufficient to offset the amount of job losses. If globalisation brings so much benefit, then how come 80% of the global populations earn only 20% of global income?

(6) Domination of local economy. Poor countries often become the subject of biasness. The WTO although in theory is said to be an independent organization, is not more than a puppet to rich and powerful nation like US. Poor countries are often urged to open up their economy to the import of agriculture goods from 1st world. On the other hand, it does not take any serious action when US and EU have such thick tariffs protecting their agriculture and dairy industry against agricultural produce from the 3rd world. Also through influential organization like IMF and World Bank, powerful countries have become the shadow that meddles with the fate of HIPCs (Highly Indebted Poor Countries). Many ill-suited policies are fed onto 3rd world which creates more harm than good. The intention is to keep them begging for more financial aid and hence being locked into more pricey agreement which they cannot commit

What Expedite Globalisation?

(1) Advancement of transportation system. Transport efficiency whether through the sea or air is as a result of continuous innovations. Ships and cargo planes have not only become larger but also faster. Goods that are ordered from another country can reach in another country in a matter of weeks. On top of that, the cost of doing so is cheap too. One of the reasons is emergence of many firms which create price competition. Secondly is due to the principles of dimension, where increase in cost is slower than the rate of increase in capacity. This will definitely encourage more goods to be delivered, since cost per unit of delivery is lower now

(2) Fast-evolving communication technology. There is no longer the need for someone to travel to another country just to have a look and place an order for the goods. One can easily view the goods online and communicate with the overseas supplier through channels like e-mail, phone calls or even through messages. Channels to promote these are like Facebook, Yahoo, online forums and especially e-bay

(3) Emergence of MNCs. MNCs (Multinational Companies) refer to firms that have operation in more than one country. There are many reasons why MNCs would like to expand their operation worldwide. Some of them are like saturated market in home country, to increase supernormal profits, to take advantage of weaker environmental law and especially abundance of cheap labour. For whatever reasons, their decision to relocate overseas has big impact. For instance, I will not be able to enjoy Krispy Kreme, Burger King, Starbucks and many more if these foreign firms do not relocate to Malaysia. By operating in other countries, goods and services which used to be available only in US, can now be enjoyed by people worldwide

(4) Establishment of trading blocs. Also known as trade pacts. Countries which belong to the same pact will give trade preferential to one another such as reduction of tariffs while at the same time imposes trade barriers to non-members. Most commonly cited examples are like EMU, NAFTA and MERCOSUR. This is said to expedite globalisation since member countries will trade with one another at greater intensity. Main reason is because of cheaper cost. For instance Germany may find cost of importing lamb from France is now lower than from New Zealand. However some may argue that the globalisation process is not expedited. It merely diverts one to another

(5) WTO. The role of WTO is instrumental in promoting the spirit of free trade. Here WTO will oversee the rules of international trade and policing countries that engage in such activity. As a result, the average world tariffs have fallen from 40% to just 4%, ever since the Second World War. This means it will be easier for foreign goods to penetrate local economy hence facilitate globalisation. WTO is also said to be very strict in accepting new member countries. Applicants must be able to prove that the remaining protectionist measures are not excessive or likely to be scrapped off in near future. That explains why Russia and Iran still fail to gain admission

Why An Increase In Supply Will Lead To A Drop In Price?

This is a question being asked by my student recently. Simple. Let's use a little bit of economics and business sense here. Imagine that if there is only one seller in an area or there are just very few available around. This means, it is rather difficult to get hold of that particular item or service. As such it gives the producer some room to adjust the price upward since they are in control of the situation

On the other hand, if a good or service is so widely available that consumers can get hold of it just anywhere, then the producers will not be in advantageous position to manipulate the price upward. This is because, an increase in price will cause the consumers to substitute away from that firm and move towards its competitors. A reduction in price makes more sense in order to get rid of those stocks which may be sitting on the shelves too long. Furthermore there will be new stocks coming in from time to time. If those old stocks are unsold, then there is no place to keep these new ones

Economic Reasons For Price Increase

In what circumstance will a producer increase prices?

(1) Demand inelastic. A business person will be more likely to increase the price of their good or service in case if they realise that the price elasticity of demand (PED) is less than 1. This means a large increase in price will lead to a less than proportionate fall in quantity demanded as can be seen from the steep demand curve. In layman, it means a big increase in price that will not affect the quantity demanded by much. This normally happens to the sellers of necessities or addictive goods. It could also be due to presence of strong brand loyalty that keeps these consumers coming back all the time that they wouldn’t even be bothered by a price increase

(2) Lack of competition. The location of the outlet can also give it a competitive edge. If it is a pioneer in an area, very likely that it will continue its dominance in that area despite the presence of rivals. This is because it has made itself established there. It can also be a situation where there is no competition at all since rival firms may not be able to secure a strategic place to position itself due to overcrowding of outlets

(3) Rising demand. The most fundamental reason of all. When there is an increase in demand which cannot be met by supply, producers will be in power to increase prices. It can also be due to both demand and supply increasing but demand is escalating at a higher rate

(4) Desire to increase revenue. This is closely related to the elasticity of demand for a good. If the demand is inelastic, it will be wise for businesses to increase prices since it will contribute to an increase in total revenue and therefore profits

(5) Increase in production costs. The most common practice in business. When there is an increase in the production costs such as rental, raw materials in use, wages and number of workers, utilities, logistics etc, sellers will most likely pass it on to consumers in the form of higher price. Having said so, it also depends on the level of competitiveness. If the competition is already stiff, it is wiser for the business to cut costs elsewhere or absorb it, or else a price increase is suicidal

(6) To reduce the demand. Sometimes a business is just too small for such a large number of clients or customers. The person itself may no longer be in such a capacity to attend to so many people. As such one of the ways is to increase the price of the good or service to reduce the number of customers. Businesses with such nature are like small hair saloon, clinic and private tuition

Mastering The Art of Evaluation

As EAL Economics candidates are aware, Unit 1 (Market) and Unit 3 (Business Economics) examination will be held on the 13th and 29th of this month. Therefore this post is dedicated to those students who, at this stage still find great difficulty to produce convincing evaluation

To be honest, this skill is not that hard to master, so long as the following techniques at the bottom are strongly adhered to:

(1)Contradiction. I often tell my students that this approach is something like “debating with yourself” You’re about to disagree with almost the entire texts that you have provided in earlier explanation BUT with solid reason. Let me give you an example

Example 1:
Explanation: An increase in the costs of production resulting from higher rubber prices will be passed on to end consumers in the form of higher price

Evaluation: However, considering that the automotive industry is so price competitive, passing on the rise in production costs to car buyers may not be such a wise business decision. This is because cost of rubber is insignificant as a proportion of total costs. It would be better for the car manufacturer to focus on cost efficiency to preserve profitability

Example 2:
Explanation: The government may consider an increase in tax onto cigarettes. By making cigarettes more expensive, people will be deterred from consuming it. This will, perhaps over time reduce the number of cases of smoking-related diseases

Evaluation: Clearly, government failure is inevitable in this case. Higher tax will cause tobacconists and retailers to smuggle in cheap cigarettes. By then, government will suffer from lower tax revenue. Also instead of bringing down number of smokers, the government actually increases it since smokers substitute towards cheap cigarettes

(2) Short run vs. long run implication. Using this technique, candidates will have to analyse and compare the outcome between two time periods. Sometimes the outcome has to be brainstormed while some other time, evidence from the extract can be used to support

Example 1
Explanation: By building more new roads and enlarging the existing one, congestion in certain areas in UK can be lessened. Journeys will be smoother and speedier. Working people will be able to reach workplace earlier and more jobs can be done by the end of day. As for logistic firms, smoother and speedier journey can help to reduce operation costs due to less petrol wastage having caught in heavy jam

Evaluation: However, the positive impact can only be felt in the short run. As road users begin to feel that there is more road space, they will be encouraged to travel more and possibly own more cars. As such in long run heavy congestion will arise once again and cycle may repeat itself. The problem is said to be remain unresolved but deferred to some near future

Example 2
Explanation: To achieve higher level of productivity, UK government can continue to increase public investment onto crucial sectors like education and healthcare. With more educated workforce, complex instructions can be understood and easily executed. Meanwhile, healthier workforce means that lesser absenteeism and at end of day more works could have been done

Evaluation: Expansionary policy is more of a short run solution to increase level of productivity among Britons. Considering the ailing government finances due to giant scale of banks bailout, such spending will just push the UK government and its people into deeper debt in future. Maybe the present administration can look into areas such as further deregulation or lowering of income tax to increase the working incentive. Furthermore the desirable impact could be felt much faster since it does not take years to ‘build’, like the hospitals and schools

(3) Magnitude. I consider this as the easiest technique to be mastered by candidates. It is often use when there is an element of quantitative. It is best to start the sentence with “It depends on…..”

Example 1
Explanation: Increase in the price of cigarettes due to tax will most likely work to reduce the level of cigarette consumption

Evaluation: However, it depends on how large is the hike in tax and thereby the price of cigarette. If it is insignificant, we may not get the desirable impact

Example 2
Explanation: Increase in the demand of rice will cause the price of rice to increase

Evaluation: However it depends on how large is the increase in demand. Also, one has to consider the price elasticity of supply for rice. If it is highly inelastic, the price of rice will likely to sky-rocket

(4) Criticise the data. Best to use when the question provides lots of statistics. Candidates will have to look at the weakness of the data provided. It could be statistics provided are contradicting one another. It could also be a situation where only certain information is provided which makes it difficult to arrive at conclusion

Example 1
Explanation: From Figure 1, it can be observed that there are 7 flights (created by myself) that share the same ticket price. Hence we can claim that price fixing is present

Evaluation: Again from Figure 1, there are 4 other flights on similar destinations that do not share the same ticket price. Thereby, it could be misleading to claim that price fixing is clearly presence. Besides, the data provided is only for the trips in August 2009 between British Airways and Company X. It would have been much better if ticket prices for similar destinations between more airline firms operating in UK are shown

Costa Coffee's Acquisition of Coffee Heaven

Just few days ago, Costa Ltd, the wholly-owned subsidiary of Whitbread had made a significant breakthrough into the Central and Eastern European (CEEC) market via the acquisition of Coffee Heaven. Costa sealed the deal with an attractive amount of £36 million, which is small compared to Whitbread’s annual capital spending of more than £ 300 million. But there are more to be gained by Costa:

Benefits:
(1) Greater supernormal profits. The acquisition of Coffee Heaven (CH) allows Costa to enlarge the scale of its operation into other parts of Europe. As in this case, CH owns chains of coffee shops in Poland, Czech Republic, Bulgaria, Hungary and Latvia. There are 90 outlets in total. No doubt CH is making losses in recent years. But if the management team of Costa were to be able to turn the fortune around, the economic benefits would be great. A larger supernormal profit is expected in near future.

(2) Faster way to grow. Basically a firm can choose to expand via both internal and external. Internal growth is normally slow. This is because a company may need years or even decades to build a reputation for the good or service it is selling. Once it successfully develops a brand loyalty, through spread of words and marketing campaign it will then enlarge its market pie. However, by acquisition of another brand, the company is almost certain to increase its market share in no time

(3) Easy to penetrate a market. To some extent, the coffee market in CEEC could have low contestability. This means certain high barriers are there. For instance, Costa may need to advertise aggressively to break the customers’ loyalty and also to promote itself since it is not a household brand there. Also Costa needs to consider the pricing policy of its rivals. They might use limit pricing to deter Costa from entering the market. This is a policy of reducing the price of a cup of coffee to a level where new firms may find it unprofitable to enter into the market. Through the acquisition of CH, Costa can immediately win the trust of consumers. Also it can leverage on the expertise of CH when it comes to exquisite taste of Polish people

(4) Saturated market in UK. Costa has more than 1000 stores in UK alone and this could be a sign that coffee market in UK has entered into a saturation stage. It is difficult for them to further grow their market share, unless there is a significant turn in tide for instance, collapse of rival firms, new brand of coffee drinks that take the market by storm or lowering down of business tax

(5) Rising income. At the moment of writing, there are tentative signs that CEEC economies are heading for the better. For instance, Poland showed a surprising economic growth in the second quarter of 2009 and wage growth is picking up again. Meanwhile Czech Republic’s real GDP is bouncing back in 3rd quarter, lifted by the performance of export. Most important of all, the number of middle income earners is rising substantially over the years. As such this will fuel the demand for high street coffee shops (better classified as luxury good with YED greater than 1). In other word, there is still plenty of room to expand

(6) Economies of scale. It is associated with the fall in long run average costs due to rise number coffee drinks sold. Costa will be purchasing more coffee beans, sugar and related equipments in a bigger scale. This will place them in a better position to negotiate for discounts. Also it is now much easier for them to borrow larger sum of money to expand their operations (if they want to). Banks will normally charge lower interest rates due to solid financial position and better ability to repay. Coffee house with no significant reputation will find it difficult to raise cash. Banks will demand higher rates for the risk they assume

List of Most Important Definitions For Unit 3: Business Economics and Economic Efficiency

Useful definitions for Edexcel candidates sitting for Economics Unit 3 in January 2010,

(1) Horizontal integration: When two firms in the same industry and at the same stage of production process merge

(2) Vertical integration: When two firms in the same industry but at different stage of production process merge

(3) Conglomerate integration: When two firms in a totally unconnected industry merge

(4) Fixed costs: Costs that do not vary with amount of output produced

(5) Variable costs: Costs that vary with amount of output produced

(6) Average costs (AC): Total costs per unit of output

(7) Marginal costs (MC): An additional cost incurred due to extra one unit of output produced

(8) Average fixed costs (AFC): Total fixed costs per unit of output

(9) Average variable costs (AVC): Total variable costs per unit of output

(10) Marginal revenue (MR): An additional revenue due to extra one unit of output sold

(11) Perfect competition: A market with huge number of sellers, where there is perfect information, firms being price taker, goods produced are identical and there is freedom of entry and exit

(12) Monopoly: A market with only one producer/ Legally a market is considered as monopoly when there is a firm that conquers more than 25% market share

(13) Oligopoly: A market with few large firms which are highly interdependent

(14) Monopolistic competition: A market with many sellers (not as many as in perfect market) and goods produced are identical but differentiated through branding

(15) Revenue maximisation: When firms choose to produce at an output where MR = 0

(16) Sales maximisation: When firms choose to produce at an output where AC = AR

(17) Profit maximisation: When firms choose to produce at an output where MC = MR

(18) Productive efficiency: When firms choose to produce output where long run average costs curve is minimised

(19) Allocative efficiency: A situation where there is optimal allocation of goods & services & it happens where P = MC/ AR = MC

(20) Price discrimination: A practice of selling the same good but to different market at different price

(21) Concentration ratio: The percentage of total sales contributed by the top 3 to 5 firms in the industry

(22) Contestable market: A market with low barriers to entry & where costs of exit is low

(23) Sunk costs: Costs that are irrecoverable upon exiting the industry

(24) Predatory pricing: Practice of selling a good at loss making level in order to drive out competitors

(25) Limit pricing: Practice of selling a good at just below the predicted AC curve of potential entrants to make the entrance into the industry not profitable

(26) Restrictive practices: Tactics used by producers to limit amount of competition in the market

(27) Collusion: Collective agreements between producers which restricts competition

(28) Tacit collusion: When firms collude without having any formal agreement been reached or even without any explicit communication between the firms having taking place

(29) Price leadership: When one firm, the price leader sets its own price & other firms in the market se their prices in relationship to the price leader

(30) X-inefficiency: Inefficiency that occurs when a firm fails to minimise its costs of production

(31) Competition Commission: An independent body/ tribunal set up to oversee UK competition policy & enforce the monopolies, mergers & restrictive practice act

(32) Office of Fair Trading (OFT): Established to promote fair competition & deals with violations under monopoly. Mergers & restrictive practices legislation

(33) RPI-X: RPI is retail price index, a measurement of inflation while X is expected fall in costs due to gain in efficiency

(34) RPI+K: RPI is retail price index, a measurement of inflation while K is capital investment requirement

List of Most Important Definitions For Unit 1: Markets-How They Work and Why They Fail?

This will be a brief but useful guide for all Edexcel candidates sitting for Economics paper Unit 1 this January

(1) Production possibility frontier (PPF). A curve that shows the combination of two goods that can be produced in an economy shall all resources are fully & efficiently employed

(2) Opportunity cost. The value of next best alternative forgone

(3) Specialisation. Where a production process is broken into many stages each done by a small group of people or an individual

(4) Free market economy. An economy where resources are all privately owned & price mechanism will act to allocate scarce resources

(5) Command economy. An economy where all resources are publicly owned & state government will intervene to allocate scarce resources

(6) Mixed economy. An economy where resources are owned & allocated by both private sector & government

(7) Positive statement. Statement that can be testified true or false by referring to facts

(8) Normative statement. A form of value judgement & cannot be proven true or false

(9) Substitutes. Goods that can be used in place of another

(10) Complements. Goods that are jointly used with another

(11) Consumer surplus. The difference between what the consumers are willing to pay & what they are actually paying

(12) Producer surplus. The difference between the actual price a producer receives for its good & the lower price it is willing to accept

(13) Price elasticity of demand (PED). Measures the responsiveness of demand for a good to a change in price

(14) Cross elasticity of demand (XED). Measures the responsiveness of demand for a good (say Good X) to a change in the price of another good (say Good Y)

(15) Income elasticity of demand (YED). Measures the responsiveness of demand for a good to a change in income

(16) Price elasticity of supply (PES). Measures the responsiveness of supply of a good to a change in price

(17) Indirect tax. Levied by the government onto a particular good or service to discourage its production or consumption/ to raise its production costs

(18) Subsidies. Grants given by the government to encourage the production or consumption of a particular good or service/ to lower the production costs

(19) Incidence of tax. Means upon who the tax fall onto

(20) Minimum guaranteed price. Price floor set by government onto agriculture produce in order to stabilise prices and farmers’ income

(21) National minimum wage. Price floor on wages set by government, below which is illegal for employers to hire workers

(22) Private costs. Costs directly incurred by an individual consumer or producer when they engaged in an economic activity

(23) External costs. Costs incurred by a third party which is not part of an economic transaction/ divergence between social cost and private cost

(24) Private benefits. Benefits directly gained by an individual consumer or producer when they engaged in an economic activity

(25) External benefit. Benefits gained by a third party which is not part of an economic transaction/ divergence between social benefits and private benefits

(26) Public goods. Must have two characteristics, non-rivalry & non-excludability. Non-rivalry means consumption of a good by an individual will not reduce the amount available for others to consume. Non-excludability means once the good is provided, no one can be excluded from benefiting it

(27) Free rider. Someone who receives the benefits that others have paid for without making any contribution themselves

(28) Government failure. When the government intervention into an economic activity leads to net loss in economic welfare

(29) Market failure. When price mechanism fails to allocate resources efficiently

(30) Property rights. Legal entitlement to use & sell a property, plus a legal rights that others have or do not have over the property

(31) Price mechanism. The interaction between demand and supply to resolve the issue of scarcity and infinite wants

(32) Asymmetric information. Where one party, (usually the sellers) is better informed than the other (buyers)

Does Current Recession Improve Contestability Of Market?

Contestable market is defined as a market structure where barriers of entry and exit are low

Does the current recession increase contestability of a market?

Yes

(1) Smaller number of firms. The current Great Recession has sent many businesses big or small under administration. As such theoretically we can say that with lesser number of firms in the industry, the level of competition will become less intense. That is because there will be lesser number of firms fighting for each other’s pie.

(2) Rival firms less likely to advertise. Firms may feel that advertising and marketing campaign during recession is just a waste of money as people are reluctant to spend. It is wiser to hoard these cash for unpredictable circumstance such as unexpected drop in sales or losses. Somehow this may also have the implication of deteriorating brand loyalty towards the company. As such it is to the best interest of new entrants as they do not have to advertise aggressively to break existing customers’ loyalty. Also this means lower sunk costs

(3) Cut in investment expenditure. Falling consumer spending will have a major setback towards the level of investment. First, drop in sales will most probably translate to falling profits or losses. As such firms will have lesser cash for reinvestment. Secondly, they may lack of the incentive to invest since there might be just few who are interested with the new products launched. Again this reduces the barriers of entry as rival firms do not have to spend aggressively on R&D to compete with products from larger firms

No

(1) Depends on nature of industry. Not all industries suffer a blow out during recession. In fact some even strengthened such as those which produce inferior or cheap goods. This is because inferior goods have negative income elasticity of demand. This means, a fall in income will lead to a rise in demand for those goods. New hypermarkets will find it increasingly difficult to challenge stores like Tesco, ASDA, Sainsbury and Morrison which are notoriously well known for their cheap household goods

(2) Warehouse sales. To avoid further losses, most firms will be rushing to dump their stocks into the market at an unbelievably low price. This can be seen as a form of limit pricing which prevents new companies from coming in. There is little economic incentive to do so since new firms usually have higher average costs and low price means thinner margin or even losses

(3) Strengthening of existing position. Recession could be a good news for big firms. Smaller rivals which do not have substantial supernormal profits generated during good days will not be able to withstand the onslaught of recession. As such they will be driven out of the industry. Their customers will turn away towards other bigger firms that are still standing. The rise in the concentration ratio may indicate challenge for new firms

(4) Patents protection. A patent provides protection for the invention to the owner of a patent. The protection is granted for a limited time period, generally between 15 to 20 years. However this is more than sufficient to allow the incumbent firm to monopolise the entire market share and thereby creates a powerful brand loyalty. Newcomers will have to put this under serious consideration in case their ideas may be clashed with existing ones.

The Food Crisis of India

Spiralling food price inflation associated with food crisis has became an ongoing struggle especially for the poor in India. This is nothing new. In fact it has its roots back in 1991 when neoliberal economic reforms took place. The problem somehow took a turn heading towards the worst in the recent. Various political parties and labour unions have called for a nationwide protest against the government’s failure to arrest the price rise

Food price inflation at wholesale level rose to 17.5% in the third week of November, up from the previous week of 15.6%, measured annually.

Why is this so?

(1) Malthusian theory. India is the world’s second most populous nation and the growth rate in number of people could have surpassed the growth rate of food. Most of the lands have been explored and cleared to accommodate the ever rising population, leaving not much for agriculture purposes. As such, in theory we say that the interaction between falling food supply and rising demand causes the food price to escalate

Evaluation
Despite the surging population, it is untrue to claim that food supply has fallen in India. In fact India is the world’s second largest producer of wheat and rice. Besides the Indian government does keep large reserves of rice and curbing rice exports should meant that food is abundance

(2) Weather uncertainty. The second half of 2009 spells the worst period for rice farmers. First food crops were hit by drought and three months after that devastated by flood. All these took place when crops are almost ready to be harvested. With such bad timing, it is of no surprise that food supplies are cut short significantly in the recent months, driving the price to all time high

Evaluation
There might be a possibility that areas hit by flood will suffer from more severe problem in the near future, such as fall in output per acre. This is because the structure of the soil could have been damaged by the flood. Land is no longer that fertile

(3) Government failure. Happens when government intervention to correct a market failure, not only fails to solve the problem, but instead making it worse. In this case, it is said that the action taken by the government is by imposing a curb on export to ensure self-sufficiency. Inability of domestic farmers to benefit from the high global price, will actually reduce their incentive to increase output. As such farming output will fall. The outcome will be much felt in near future. Another form of government failure is by being ignorant. For some weird reason, Indian government refused to flood the market with its large stocks of food and grain. In fact, food prices can go lower even if it is only 10 million tonnes of food released into market

Evaluation
It is rather difficult to tell whether government failure is present or not. On the other hand, one can also argue that if it is not because of government’s intervention, millions of domestic consumers will suffer from high rice price. This is a situation best we try to avoid since rice is a necessity and considering that big bulk of people are poor

(4) Existence of black market. Black marketeer is defined as people who buy and sell certain goods in a way that violate against law such as price control and rationing. It always happens when there are shortages. These profiteers will buy rice in a large quantity and hoard it, causing an artificial shortage of rice supply. Then it will be sold off to consumers with a much higher than market price. Also, cheap rice may be smuggled into India from countries like Myanmar, Indonesia and especially China where rice production is subsidised.

(5) Traditional farming. Farmers in India are generally naïve and do not know how to employ the best production technique. They may perhaps still unaware of the existence of Genetically Modified (GM) crops which can help to raise output or might not use modern farming equipments. The combination of these factors highly likely to account for the fall in supply

Revision Tips for Edexcel Economics Unit 1: Markets-How They Work and Why They Fail? (Data response)

In Section B (data response) of Unit 1, students will have to choose one out of two options. Each carries 48 marks which comprises questions from both Markets and How They Work? as well as Markets and Why They Fail?.

9 effective strategies:

(1) Read questions not extracts. This is what I always advise my students to do. Some candidates choose an extract just because they think that they are already familiar with it while some choose by ‘love at first sight’. Bear in mind that easy or familiar extracts may not necessarily imply easy questions

Instead, read through ALL the questions first. Try to get a ‘feel’ which question is easier to be answered. As a matter of fact most of the questions can actually be answered without referring to the extracts provided if candidates are really well-prepared. Extracts or texts are merely provided so that students can use evidence or figures to consolidate their explanation. Most of the time, both data response questions are equally balanced. Marks are equally spread out and the level of difficulty for both is about the same. In some cases, it is very obvious that one of the extracts is much tougher than the other. This is where candidates will have to exercise their prudence in determining which question to be answered

(2) Never ‘fall in love’ with a particular question. This is the simplest and yet the most effective strategies of all time. If candidates are stuck with a particular question, then it’s time to move on. Unfortunately, most students choose to ignore it. They spend about 15 minutes for a 6 marks question. The thumb rule is 1 minute to earn 1 mark. So if the question carries 6 marks, candidates should not allocate anything more than 8 minutes in my opinion. Pay more attention to questions that carry larger weightage e.g. 10 marks or 12 marks. Time mismanagement is one of the major reasons as to why candidates are unable to complete the whole paper on time

(3) Read analytically. Students must cultivate the habit of analytical-reading. Each and every sentence must be economically interpreted. For instance:

“House prices fell by 13.4% between October 2007 and September 2008, the fastest rate for more than 50 years, according to Halifax Bank, Britain’s biggest mortgage lender”

(a) Fastest rate for more than 50 years imply that we have never seen such a drastic decline in value of property in the past 50 years

(b) Between October 2007 and 2008 is where the subprime mortgage crisis had begun. Candidates must be able to relate it to major events like large losses suffered by major financial institutions in US and UK

(c) Drastic fall in value of property is bad for British economy. It is a sign of falling wealth, cut in consumption and possible a recession

“The government intends to permit the building of more than 1.1 million homes in the South-East by 2016, despite strong opposition from local councils and environment groups”

(a) 1.1 million homes is definitely an ambitious goal. But is it achievable?

(b) The construction of these homes brings along both positive and negative externalities. It creates jobs for the unemployed, improving local businesses due to higher number of traffic and enabling young workers to climb on the property ladder with more affordable homes. On the other side, it creates congestion and air pollution, noise pollution from construction works and degrading the quality of air in South-East

(c) Strong opposition may cause the current government to lose more votes when it is already unpopular with Britons

(4) Revise on common questions. Trust me. To some extent, questions are predictable for all the Units depending on the nature of the extracts. Let’s consider the following:

Housing market
(a) DD-SS diagram for houses
(b) Elasticity of supply for houses both short run and long run
(c) Are rented and owner-occupied accommodation good examples of substitutes?
(d) Calculation of increase/ decrease in house prices
(e) Comparison of house prices between regions
(f) Labour market immobility which is the main causes for shortage of key workers like teachers and nurses in City
(g) Construction of homes so will involve issues like external costs

Commodities
(a) DD-SS diagram for a particular commodity
(b) Cross elasticity of demand between two commodities
(c) Elasticity of supply both short run and long run
(d) Impact of the rising price of commodity towards consumers such as manufacturing and even construction industry
(e) Buffer stock scheme to stabilise the price and evaluation of its effectiveness

Education
(a) Define and give examples of private and external benefits
(b) Cost and benefit diagram
(c) Impact of rising tuition fee

Students might not be well aware of this, because similar questions reappear with different phrasing.

(5) KISS principle. Keep every sentence short and simple. Express your thoughts, opinions and economic principles involved systematically. In other word explain things stage by stage. Remember that clarity of expression is taken into consideration whenever you come across questions with asterisk (*). So do this to communicate your answer effectively to the examiner

(6) Link words. Please use lots of this. It helps us to connect ideas and sentences, so that examiner can understand the flow of our ideas. To sequences ideas we use firstly, secondly and finally, the former and the latter and the following. To give examples we use for instance, such as and namely. To add information we use furthermore, moreover, in addition to, besides, apart from etc. To explain result, we normally put as a consequence, therefore, leading to, this means that etc. To evaluate, we normally start with words like however, nevertheless, despite of, in theory and in practice etc

(7) Identify evaluation words. There are six of them. These words are justify, evaluate, discuss, assess, to what extent and examine. Instructions such as explain, outline and analyse require no evaluation.

(8) How many evaluations needed? If candidates bump into an evaluation question of 6 marks or 8 marks, normally one evaluation (2 marks) will be required. If 10 marks give two evaluations with total of 4 marks and 12 marks question will required three evaluations of 2 marks each

(9) Identify key words. Almost every question will carry key words such as price elasticity of demand (PED), price elasticity of supply (PES), cross elasticity of demand (XED), income elasticity of demand (YED), labour mobility, market failure, government failure, PPF etc. If this happens, please provide the definition. Normally it carries 1 mark

Revision Tips for Edexcel Economics Unit 1: Markets-How They Work and Why They Fail? (Section A-MCQ)

First of all, a grand apology to all the readers of my Economics blog. I am not really active in this term as you can see from the history of postings due to an extraordinary busy schedule in my college. Nevertheless I’m still committed and will make a major come back next month when the term break starts.

This post is written to assist all those who will be sitting for the Edexcel A-Levels Economics examination in January 2010. There are two papers offered, Unit 1 and Unit 3. Both are microeconomics. Unfortunately Unit 2 and Unit 4 are available only once a year and that is in June, at least for the meantime (heard that Unit 2 will be available for both January and June sitting 2011 onwards)

For this first posting, I will talk about Unit 1: Markets-How They Work and Why They Fail?

How different is it from the past?

Under the legacy syllabus, these two are called Unit 1: Markets and How They Work? (MAHTW) and Unit 2: Markets and Why They Fail? (MAWTF) However under the new specification, both have been combined to ultimately form the new Unit 1. In Section A, we have eight MCQs. With high possibilities, six of the questions will come from MAHTW and the other two from MAWTF. Unlike in the past, all the eight questions came from MAHTW

Meanwhile, there is a big revamp to Section B. In the past, it used to be 20m but now 48m. To be fair to candidates, the usual 1 hour paper is now becoming 1.5 hour paper. With more things to write, do not imply that candidates are at great disadvantage. In fact I prefer such new format because it makes those questions even more predictable since limited issues can be tested (I will explain this later)

Strategies to do well in Section A :

(1) The 4 principles

(a) If you are given a diagram, please do something to the diagram. For instance, you can draw additional curve on top of the existing one and this is very common with questions related to PPF (inward and outward shift) and consumer as well as producer surplus (new lines will change the area of surplus). Secondly, you can also shade the area (producer and consumer surplus area, incidence of tax and gain of subsidy). Last but not least, you are sometimes rewarded for indicating or labelling the area of tax and subsidy

(b) If you think you can support your answer with diagram, please do so. One of my favourite strategies of all time. Very applicable to questions from price mechanism, consumer and producer surplus, incidence of tax, distribution of subsidy, PED, XED, PES and YED

(c) If you are given table/ figures, perform analysis. Even mentioning “the table shows that for every additional 10 units of X produced, the number of Unit Y foregone will increase” can earn you 1m. Other questions that highly likely to involve calculations are PED, XED, YED and PES

(d) If you think that you can support your answer with own figures, please provide. For instance, the question may mention “YED of foreign holiday is 1.2”. So to convince the examiner that you understand how does the 1.2 come about, you can insert your own figures. This is what I will write:

YED foreign holiday

= (% of change in quantity demanded for foreign holiday) /. (% of change in income)
= (60% / 50%)
=1.2

This strategy can also be employed onto questions that come from PPF (own figures to show rising opportunity cost), consume and producer surplus (own figures to show how consumer surplus increase or fall)

(2) Eliminating the incorrect option. Sometimes a candidate may fall into a situation of not knowing how to explain the correct option chosen. However, those ‘streetwise’ students are still able to secure full 4m by providing solid explanation of why the other options are wrong. For instance the correct answer is B. rising opportunity cost (based on PPF). The candidate did not explain on why the opportunity cost is rising. Instead, he mentioned “option A is wrong since PPF is showing combination of output instead of shift in demand”

(3) Adopt a proper answering style. EAL Economics marking scheme is highly flexible. Students will be awarded full 4m as long as they get to the heart of the issue, provide relevant and understandable explanation. Usually I advise my students to carefully choose the correct option (1m), provide definition for the concept tested (1m) and explain why that option is chosen with the aid of diagram given/ own diagram/ figures given/ own figures (2m)

(4) Telling yourself that maximum is 5 minutes per question. The paper is 80m (32m Section A and 48m Section B) and time allocated is 90 minutes. So on average, students have 1 minute to earn 1 mark. Section A has 8 questions with 4 marks each. So the duration is about 32-40 minutes

(5) Do not write outside the space provided. Papers are scanned before examined. If you write outside or beyond the area provided, the scanner may not be able to capture the full image of candidates’ work and thereby causing them to lose marks just like that

What popular questions to expect from each topic?

(1) PPF
(a) Reason for PPF shifting inward or outward
(b) Reason for rising opportunity cost given a PPF diagram
(c) Changes in present and future standard of living if an economy chooses to have more capital goods in the present

(2) Positive and normative statement
(a) From the two statements, students have to identity which is positive and which is normative. From experience, one must be positive and another normative. Never in the situation where both are positive or both normative

(3) Price mechanism
One of the main functions tested is rationing. Candidates often have to draw diagram to illustrate. Also must mention that scarce goods are allocated to those who are able to pay

(4) Consumer surplus (CS) and producer surplus (PS)
(a) Identifying new area of consumer surplus or/ and producer surplus due to change in demand or supply
(b) Identifying additional/ reduction in the area of consumer surplus or producer surplus due to change in demand or supply

(5) PED
(a) Calculation of PED
(b) Identifying changes in revenue before and after price increase

(6) XED
(a) Identifying which pair of goods is substitute. Must mention that both have positive XED and increase in price of one will lead to an increase in demand for another
(b) Identifying which pair of goods is complement. Must mention that both have negative XED and increase in price of one will lead to a fall in demand for another

(7) YED
(a) Calculation of YED
(b) Identifying types of goods-necessity, luxury or inferior

(8) PES
Identifying the nature of goods such as banana, pea and houses which have high PES in long run (elastic) and low PES in short run (inelastic)

(9) Taxation
(a) Candidates are given diagram and asked to identify incidence of tax on consumers and producers. Also sometimes asked to identify the area which represents total tax revenue for government
(b) Identifying specific tax per unit of good is given by the vertical distance between old and new supply curve

(10) Subsidy
(a) Candidates are given diagram of subsidy and asked to identify total subsidy payout by government
(b) Acknowledging that subsidy per unit is given by the vertical distance between new and old supply curve

(11) New equilibrium
Candidates will be given information on both demand and supply, and then asked to determine the new equilibrium due to the interaction of these two

(12) Public good (most likely, based on three sets of papers in hand)
(a) Identifying which of the given option is public good
(b) Reason of not being provided in free market-free rider problem

(13) Asymmetric information (most likely, based on three sets of papers in hand)
Identifying which of the given option is reflecting imperfect knowledge, why and what will happen

(14) Positive or negative externalities (most likely, based on three sets of papers in hand)
Given a diagram, students must be able to identify whether this is the case of underconsumption or overconsumption of a good or service. Also must indicate area of welfare loss

Go and have a practice now!! Adhere to the 4 Principles as you go along your past year examination papers. You will realise that there are just too many ways to earn yourself the full 4 marks

I will blog about Section B later

Video Lesson: Origins of the Global Financial Crisis Simplified

Why Asymmetric Information Exist?

In a standard textbook theory, a competitive market assumes that economic agents like buyers have perfect knowledge of the goods and services sold. This means a buyer knows about the quality of product being sold, its cost structure and information of the product is freely available. As such purchasing decision is made

In reality, all these don’t exist. There is always the case of information deficit which leads to market failure. Sellers always have an upper hand over buyers. They just know too many things that buyers don’t. As such they can take advantage of the situation

Consider the following:

(1) Car mechanic. Whenever you send your car to the workshop, there is a tendency that he will tell you that your car has all sorts of problem. There could be several parts that need to be changed. He could be so convincing that you give in just like that. After all, who wants to take the risk of car breaking down in the middle of night or road

(2) E-bay transactions. A seller overseas may prescribe their item as ‘NEW’ or even ‘ORIGINAL’ or ‘NO MISSING PARTS’. For the same item, they may not even display using the picture of their own. Instead they use the picture of the item from some other sellers. Are they trying to hide something? No buyers know for sure. In such circumstance, it leads to market failure as transaction is prevented especially for very pricey items as buyers do not want to take the risk

In short asymmetric information can be caused by the followings:

(1) Addiction. Hardcore smokers and drug addicts maybe so addicted that they didn’t even realise the possible health problems they may be facing in near future. By the time they are aware, it could be too late already

(2) Misleading information. Companies that sell junk food often use persuasive advertisement to lure kids into consuming unhealthy stuffs. It may come along with free toys, interesting animation and of course making those kids in the advertisement look so cool when eating it. As such the demand for junk food can increase and the consumption will be more than optimal

(3) Uncertainties of costs and benefits. There is quite a number of young people I met who choose to drop out from school and start working at young age. That is because they see the short term monetary reward from working. However, they may not realise the potential private benefits accrued to them in the long run. Statistics have proven that on average employees with basic degree stand a better chance of earning much higher income than those who just possess O-:Level and A-Level. Another will be savings for retirement. Many young people choose to enjoy while young and start saving at later age. The problem is, they are unaware of the danger of getting into debts due to excessive spending. Also they are unaware of the point where they need to kick start savings

To What Extent E-Bay Resembles A Perfect Market?

In market structure, students are often told that perfect competition don’t really exist in the real world. It is not more than an idealistic business model with many unrealistic assumptions. My students often question me the purpose of learning this topic. Rather than telling them that it is syllabus requirement, I emphasized that economists developed the model so that we can later relax the theoretical assumptions and head towards more realistic ones

In short, it exists to facilitate comparison. However, sometimes I find myself in contradiction. Although not exact, there are indeed certain businesses out there that really meet some of the assumptions.

Consider E-bay.

Is one of the best examples of perfect market. There are just too many internet shoppers who are looking for certain item. None of them have dominant buying power to influence how it is priced. At the same time, there could be tenths or hundreds of sellers selling the same item. The number of items they have is insignificant as a proportion of market. They too cannot influence how it is priced

Also the barrier of entry and exit is either very low or none. To my knowledge, an e-bay seller will have to pay certain amount of money when they display or sell online, but the amount is ignorable. As such anyone can start their business online. Also if sales are no good, the seller can just exit the market or close an account with e-bay

Third, sellers are selling homogenous goods. There are certain same items which are sold by many e-bayers

Evaluations:

However, asymmetric information exists. It is said that buyers have complete knowledge on the price and quality of product. In reality, this is not the case. Sellers who are desperate to push for sales may provide fake information regarding the items on sale. Now, I will talk from my experience as an e-bayer myself. I do collect rare items such as Transformers robot from 1980s series. However, disappointingly I do get items which are not as prescribed by the seller. It stated the item is brand new when in fact it has turned yellowish due to lack of care or exposure to heat. The problem is payment has been made, and in ultra rare occasion will the seller refund you partially or fully

On the other hand, it is said that sellers know the best production techniques. In this case, source an item at the lowest cost possible. This may not be the case, as certain sellers order things in bulk while some not. Those who purchase inventories in bulk will be entitled to purchasing EOS and also likely to enjoy free shipping cost. As such it will be reflected in lower price. In a nutshell, even for the same item with same condition prices are highly unlikely the same

Lastly, sellers can influence the market price, depending on what they are selling. Those who sell rare items where very few have in the market, can somehow collude with other sellers and set high price. Don’t be surprised if I tell you that there are some Transformers 6 inch figurines which can fetch up to US$ 2000. In this case, oligopoly is said to have emerged. They collude in a way by sending price ‘signal’. If a seller places $2000, other e-bayers who have the same figure may take that as a signal and begin to price somewhere to that price. The first seller is said to be price leader

If you find this hard to believe, check this link:

http://cgi.ebay.com.my/ws/eBayISAPI.dll?ViewItem&item=330369160004&_trkparms=tab%3DWatching

Why Minimum Wage Is A Must?

A minimum wage is the lowest hourly wage an employer is obliged to pay to workers, below which is illegal for them to hire anyone. In UK, the national minimum wage (NMW) has come through a long way since first introduced in 1999 by the Labour. Since implemented, its advantages are as equally divided as its disadvantages

Supporters in general claim that this system can help the socially most disadvantage group, i.e. those with lowest paid. On the other hand, opponents claim that if it is high enough to be effective, unemployment will increase. In the end it will be a lose-lose situation for both parties

The latest statistics for minimum wage:

22 years and above--> an increase of 7p to £5.80
18-21 years --> an increase of 6p to £4.83
16-17 years --> an increase of 4p to £3.57

Let’s examine the situation

Advantages:

(1) Poverty reduction. A mandatory annual increase in minimum pay is highly applauded by the most vulnerable group of the society. With increasing income, they are able to purchase more necessities especially food and on clothing. Although may not be significant, at least their standard of living increases

(2) Increase productivity. Everyone reacts to incentive. That is human nature. Workers especially the less-skilled one will be motivated to work harder since now the take-home pay has increased. This will result in lower production costs as total costs are spread over a larger range of output. However, the claim is only true if output increases at a faster rate than increase in wages

(3) Incentive to look for jobs. Again this affects the less-skilled workers. When there is an increase in NMW, the gap between benefits and income from employment widens. It increases the opportunity cost of staying unemployed. As such, more will be pressurised to enter the job market. If this materialise, there will be lesser spare capacity in British economy and UK may produce nearer to PPF

(4) Increase investment. Firms which employ many low-paid workers will now feel greater pinch to their margin. To stay profitable and competitive, they will have to invest for instance in better technology to reduce costs per unit. Also they will find ways to increase labour productivity

(5) Steer economy forward. UK is a consumption driven economy and this component of spending is standing at about 70% of her GDP. It must be acknowledged that poorer people has higher marginal propensity to consume (MPC). In other word, they spend larger proportion of their income to buy things than the rich

(6) Compensate for monopsony power. Normally, it is those multinational firms that have such power. They could be a major employer in an area. It could also be a firm which is one of its own kind that many workers depend their livelihood on. As such they possess strong bargaining power and can easily exert downward pressure on wages. With the mandatory minimum pay, big firms find that it is now more difficult to flex their bargaining muscle

(7) Reduce cost of government. Increase in minimum pay will significantly help to reduce the financial burden of UK government. This is because, the state no longer have to spend so much onto social security programs such as providing cash assistance to the needy or even some other benefits to single mother with a child. The social burden is now corporate responsibility

However, it is not without problems:

(1) Cost-push inflation. Critics argue that the welfare of the lowest paid will not improve. While firms do give in, eventually they factor in the higher wages as part of production costs. Therefore the selling price is now higher. It is associated with the phenomenon of cost-push inflation (Unit 2). Also it is just a matter of time before the lower income people begin to realise that they are being priced out once again. In return, they will bargain for higher salary. The vicious cycle will repeat itself. Soon price level in UK may become too high

(2) No effect on poorest. In theory, increase in minimum wage will raise the standard of living. However, the rise must be high enough to create such impact. I’m highly doubtful how an increase of 7p to £5.80 for those aged 22 and above can do them good. Even in better times, an increase of 15p is highly unlikely to change the welfare of an ordinary worker because the cost of living increases at a faster pace

(3) More young people entering job market. The introduction of minimum pay even to workforce as young as 16-18 years old is said to have enticed more people to abandon their education to adopt a working life at immature age. Supplemented by asymmetric information, youths may not be well aware of the greater private benefits they might get when they obtain a basic degree for themselves. While it is true that they have income while their friends spend time studying, the potential for their friends to earn big income for the rest of their life is much higher

(4) Loss of jobs. With minimum wage, firms will demand lesser workers. At the same time, higher pay attracts more people to supply their labour. The gap created between these two is called unemployment