Is Malaysia's Subsidy Rationalisation Program Justified?

The long awaited subsidy-rationalisation programme in Malaysia has finally kicked in on 16th July after several years of empty words. Although painful and of course an unpopular move, it is deemed as necessary since Malaysia has been facing the worst ever fiscal deficit in 22 years. It was standing at 7% of GDP last year. The no-nonsense Datuk Seri Najib, revealed recently in its ambitious plan of reducing the current budget deficit to 5.3% this year, before halving it by 2015

Although this move has began to attract political football, survey shows that most Malaysians welcome such policy with open arms. The announced decision is an increase in price of essential items like sugar by 25 cents (5 pence), petrol and diesel by 5 cents (1 pence) and LPG (liquefied petroleum gas) by 10 cents (2 pence)

It is applauded since the people are insignificantly affected, unlike the previous hike of 50 cents in petrol (10 pence per litre) few years ago. On top of that the Cabinet promises to monitor the prices of all related items

Why subsidy rationalisation is justified?

(1) Improve government finances. Malaysia has one of the largest ratios in the world in terms of subsidies to government spending. This explains why the nation’s balance sheet has deteriorated significantly in recent years. With rising budget deficit (G>T) hence growing national debt, it is of no surprise international rating agency like Fitch Ratings downgraded us from ‘A plus’ to ‘A’. It may affect Malaysia’s ability to raise funds from overseas shall the need arises

(2) Improve development. So far we have been doing fine. Malaysia is classified as a country with high HDI of 0.829. To improve the ranking much more need to be done. We must further improve our education system. More schools need to be built especially in rural areas. Healthcare is equally important too. With the savings of subsidies by an estimated amount of RM750 million (£ 150 million) from now to end of year, number of hospitals in most needed areas in Sabah and Sarawak (East Malaysia) can be doubled. With ease of access to healthcare, gradual increase in life expectancy should materialise. Others like infrastructures, roads and bridges can be constructed to smoothen and increase the efficiency of business transaction by reducing time of travelling. These are the benefits that will last permanently

(3) Low inflation. Most of the research house has predicted a fairly low level of inflation in Malaysia. The CPI forecast for June 2010 is all below 2%, showing that rise in prices of goods and services are within the reasonable range. Although the rise in oil price might cause cost-push inflation (with AS shifting backward) due to higher cost of transportation, it is expected to have a negligible effect onto the growth in third quarter and throughout the year. Furthermore we have registered a robust 10.1% in the first quarter

(4) Not effective in distributing income. By definition, subsidy means reduction in price so that certain quarters can benefit from the low price, in this case the lower income group. In Malaysian context, government intervention to close income gap through such measure has shown an ‘epic failure’. An owner with garage-full of Ferraris gets equal price of petrol as someone who rides a motorcycle. The rich benefit since their expenditure onto petrol as a percentage of total income is so insignificant. This holds true even for some low-profile millionaires or billionaires who drive an average car

(5) Further discourage smuggling. It happens due to large price differential between countries. As such it creates the incentive for profiteers to practice arbitrage. In Thailand, the price of sugar is RM2.60 (52 pence) while in Malaysia RM1.90 (38 pence). In Singapore, price of sugar is RM3.70 (74 pence). As the price of sugar is expected to increase gradually in Malaysia, arguably smuggling activities will reduce since there will be lesser profits. Don’t forget they still have to bribe officers to get their goods through

(6) Reduce chronic disease. It is an established fact that Malaysians craze for sweetness in their daily diet. We normally have everything coated with sugar, from a simple doughnut to ‘teh tarik’ (name for tea in Malaysia). No wonder we have one of the highest diabetes case in the world. The number has doubled ever since 2000. Also sugar leads to other problems like overweight and this may subsequently develop related illnesses like heart attack

(7) Increase efficiency. Bus operators and cabs will have to be more efficient in order to maintain their profits. To bus firms, certain trips may need to be created while some others slashed. Salary to bus drivers and other maintenance charges will also need to be adjusted. To owners of private vehicle, they may need to plan their journey ahead to avoid travelling unnecessarily and caught in congestion which should cost them more

Why Inflation In UK Is Still High Despite Its Weak Economy?

The British economy is currently suffering from a period of high inflation, something which is usually against the norm especially when the economy is still in a dire state, with unemployment at record level of 8% and house prices on average are 10% below the level last seen in summer 2007

The present inflation rate is lingering around 3.1%-3.5%, much higher than both US and Eurozone of 0.9%. Given the high level of spare capacity due to rising unemployment and unutilised machineries, shouldn’t the inflation fall?

Here are some possible explanations:

(a) Weakening currency. The pound has weakened against major currencies like the dollar and euro in the recent few months. Since these two economies are major trading partners of UK, any changes in the direction will therefore have a significant impact towards the level of inflation. A weaker pound means finished and semi-finished goods from Germany and US will be artificially more expensive. To stay profitable and preserve company’s balance sheet during stormy days, inevitably some of these costs will have to be passed on to consumers in the form of higher price, hence inflation

(b) Higher price of energy. Although the Western economies slow down markedly, this isn’t the case for many Asian economies. Malaysian economic growth is vibrant somewhere close to 10%, Singapore’s growth soared to an unprecedented level of 19.3% in second quarter of 2010 (July 14th 2010) and China despite slowing down is still able to retain double digit growth of 10.3%. The rapid growth rate in Asia explains why oil prices remain obstinately high at more than $80 a barrel as it is widely used to fuel economic activities like shipping, more cars and trucks on the road, more business flights etc. Higher oil price coupled by weakening currency explain why petrol price is high in UK. It will feed through the entire chain of production process as businesses trying to protect themselves

(c) VAT (Value Added Tax). This is similar to sales tax. It was raised to 17.5% early this year, and there it has been confirmed that will be further increased to 20% from 4th January 2011. Although it is a painful measure, it is viewed as necessary to pay off the deficits that Labour government ran up. It is estimated that VAT alone will help to raise £13 billion a year under the Coalition’s ambitious plan to eradicate deficit in five years time. This will cause price of cars, flat screen TVs and many other goods to increase in price

(d) Firms shielding themselves. Another possible explanation for the high inflation is that businesses are trying to protect their own profitability. Since the financial institutions are still surrounded by pessimism, many firm still find it difficult to get the needed financing for their operations. With rising excess capacity hence a fall in demand for goods, these firms will have to raise some of their prices to stay profitable as before especially in segment of goods where demand is still inelastic. Therefore prices are still high

Video Lesson by Richard Pettinger on Market Failure: An Introduction

This is Richard Pettinger, a lecturer from Lady Margaret Hall and a former examiner of Edexcel. He is a dedicated writer/ economist and check out more of his postings at

www. economicshelp.org

This video is good for those who are still wondering what Market Failure is all about. Somehow, to those who never experience video learning, this maybe a bit difficult. So try to get used to it from now. It is never too late. Also I find it more effective since it is simulating and interactive. This is how I learn economics- making everything interesting to me, by substituting away from those thick and boring textbooks

Data Response Unit 1: Competitive Markets (Air Pollution)

This post is the continuation of the previous one. The second possible scenario to be tested is air pollution. The extract may have something to do with airports, congestion and rapid industrialisation

Types of question that could be tested are like:
(Bear in mind that the examples given have to be modified accordingly to information provided. Here I’m just assuming it has something to do with flights)

1. By giving examples, explain the potential private costs and external costs due to higher number of flights (expect 6m)

Private costs refer to costs that fall directly onto the producers or consumers when they engage in an economic activity. Examples of private cost due to flights are like wages to pilots and costs of leasing the planes

External costs (negative externalities) refer to costs that fall onto a third party which is not part of an economic transaction. Some of the examples are like air pollution and fall in the value of houses nearby the airport since it may create excessive noise during sleeping hours

2. Using the cost-benefit diagram, illustrate the concept of negative externalities (expect 4m)

In a free market without any government intervention, flights will be demanded until Q1 where MPB = MPC. But from society point of view, the desired level of flights should be at Q2 where MSB = MSC. Over flights by airline companies hence lead to welfare loss

3. Examine any two methods to overcome pollution (expect up to 10m)

First the UK government can propose higher environmental tax such as carbon tax onto airline firms. This is meant to increase the operating costs of airline firms. As such the MPC (or PMC) curve will shift backward towards the social efficiency point. As such the area of welfare loss will shrink. However, there are some problems. Airline firms can easily pass on the increase in costs to passengers in higher fares. Also it is worth to note that it is extremely difficult to quantity pollution. In other word, the tax paid may not reflect the true value of damage inflicted onto the environment

Next, the government could also propose carbon emission permits to airline firms. These are actually market-based solution to negative externalities of production. These permits are issued by government and airline firms are granted the permit to pollute up to certain amount of carbons. More efficient ones can sell excess permits to less efficient airline operators, so that they can pollute more. To government, it does not matter which firms pollute more or less, as long as the targeted overall emissions is not breached. However, such measures will not reduce overall emissions as there will always be inefficient firms that buy these permits from efficient ones. Secondly, it is difficult to set an acceptable level of pollutants. If set too high, pollution will not be reduced. If set too low, it may be harmful to the airline industry since tight restriction on number of flights can cause major loss to certain operators

Last tips:

In tackling data response questions, always look out for the followings:

a. Do I need to make reference from the Extract?
b. Can diagram help?
c. Do I need to define?
d. Do I need to evaluate?

Again, bear in mind that these questions may or may not appear in actual exam. It is to your best interest if you revise everything thoroughly. All the best.

Possible Case Studies and Nature of Data Response Question for Unit 1: Markets: How They Work and Why They Fail? (coming soon)

This post is meant for all those international students who will be sitting for the Edexcel Economics Unit 1: Competitive Markets this coming Friday. Bear in mind that the contents serve as a GUIDE, and again I strictly mean GUIDE rather than leaking out any actual examination questions. There are two reasons for me to put this up. First, is due to the overwhelming request from my fellow students. Secondly, Unit 1 is rather easy and to some extent the examination questions are really predictable

Why do I say so?

(1) MCQs
I have compiled all those MCQs in a booklet according to topics and I found that almost all topics are tested again and again in similar ways. For instance the concept of PPF and rising opportunity costs as well as PPF shifting inward or outward. Others are like diagram of taxation (subsidies) and students are required to identify incidence of tax onto consumers and producers (subsidies enjoyed by producers and consumers) and in many cases, involve calculation. In most cases, a table involving several items will be provided and students have to identify which are normal goods and which is inferior good. This is just a non-exhaustive list

(2) Data response
There are certain ‘fixed questions’ for each type of case studies. For instance, do expect:

Commodities:

(a) Demand and supply diagram, showing an increase/ fall in price + explanations

(b) Whether a good is elastic/ inelastic in demand: Define PED + mention if it’s inelastic and why + evaluations

(c) Whether another good is the substitute/ complementary for the mentioned good in extract: Define XED + mention that it is substitute/ complement + have positive/ negative XED + explain how relationship works + evaluation

(d) Is the good elastic/ inelastic in supply: Define PES + inelastic in short run/ elastic in long run and why + evaluation

(e) Impact of increase in production costs for firms

(f) What happen if the good is subsidise by government: Define subsidies + diagram + explain the diagram and impact onto producers + evaluation

(g) Effectiveness of buffer stock: Define buffer stock + diagram +explanation of diagram + evaluations

(h) Government failure: Negative impact of government interventions + evaluations of why it is not that bad with government intervention

Cigarettes/ Alcohol/ Education/ Healthcare:

(a) Definition of private cost + external cost + examples for each type of cost

(b) Definition of private benefit + external benefit + examples for each type of benefit

(c) Diagram showing existence of external costs/ external benefits

Congestion/ Pollution

(a) Definition of private cost + external cost + examples for each type of cost

(b) Diagram showing that negative externalities exist

(c) Methods to overcome congestion + evaluation of each method

(d) Methods to overcome pollution + evaluation of each method

(3) In real examination, questions are likely to contain both the elements of How They Work and Why They Fail? Depending on nature of case studies, certain case studies like congestion or pollution are likely to carry more questions on Why They Fail. Extracts like rice, rubber, cocoa and oil are likely to carry more questions on How They Work. It is highly unlikely for question like ‘What are the private/ external benefits of consuming cocoa?” or questions like income elasticity on demand to appear in an extract of pollution

(4) The Examination Board will have to think of a case study where questions from both How They Work and Why They Fail can fit into. As such, those ‘weird’ case studies such as Financing BBC (2007), Wind Power Farms and many more are unlikely to be tested

What will probably turn out in this round for Unit 1?

National Health Service (NHS) is in my top list. It is one of the most popular case studies which are yet to be tested thus far. So this round, it has the possibility of 90% to appear in your exam. The nature of the questions maybe somewhat similar to the questions tested in Education (Jan 09)

They are:

(1) How does an increase in government spending onto NHS represent an opportunity cost?
Opportunity cost is defined as the next best alternative foregone. If the UK government does not spend this amount of money onto NHS, the equal amount of money could have been used elsewhere, such as improving the standard of education, betterment of public infrastructures and others

(2) Examine the likely impact on the PPF due to the increase in government investment on NHS. Illustrate your answer with PPF

Production possibility frontier is a curve that shows the combination of two goods than can be produced in an economy if all resources are fully and efficiently utilised

Public expenditure onto NHS will have the impact of increasing the productive capacity of UK’s economy. Healthier workforce on average will have higher productivity and as such higher output per person is expected. This will increase the potential growth as shown by the outward shift of PPF

However the increase in NHS spending is likely to result in austerity measures in other public sectors, for instance education. This is related to the concept of opportunity cost. As such the PPF growth may not be as impressive or it seems. To some extent it could be entirely muted

(3) Explain two other external benefits of higher spending onto NHS (most possibly there will be an external benefit diagram)
External benefits refer to benefits gained by a third party, which is not directly part of an economic transaction

First, healthier workers can contribute productively to an organization. Higher output will result in fall of production costs. Firms can operate more profitably

Secondly, a more productive workforce will be a great attraction to FDI. Foreign firms will be highly interested to set up operations in a country where production costs are low. It will also increase the competitiveness of UK economy. On top of that, government can also collect more tax revenue

(4) Other than external benefits, explain three reasons for state intervention in NHS
UK has an increasing number of old populations just like Italy, Japan and US. As such, demand for healthcare is great

Secondly, healthcare is a normal good. During the period of rising income, increasing number of people will increase their spending onto seeking treatments for instance more regular body check up and other necessary treatments

Merit good like healthcare is often under-consumed due to the presence of asymmetric information. As such government needs to intervene to increase the free market level of consumption to the socially optimal level

Others are like increasing number of new diseases/ rising population

Stay tune for next forecast question: Air pollution

Handy Definitions/ Glossary For Unit 4 (Edexcel Economics): Global Economy

Finally, the long awaited list of definitions for those international students who will be sitting for Edexcel A-Levels Economics, Unit 4: Global Economy in late June 2010

1. Absolute advantage: Is when a country can produce more of a good using similar resource as in another country

2. Balance of payment: An account that summarises the financial transaction between one country and the rest of the world

3. Budget deficit: Where government expenditure exceeds tax revenue

4. Budget surplus: Where government tax revenue exceeds public spending

5. Comparative advantage: Is when a country can produce a good with lesser opportunity costs than the other and hence should specialise in the production of that good

6. Current account: An account that measures the flow of money in and out of a country resulting from the visible and invisible trade

7. Capital account: An account that measures the flow of capital in and out of the country

8. Dumping: An act by manufacturer in one country exporting a good to another country at a price below what it charges in home market or even below production costs

9. EMU (Economics and Monetary Union): Refers to the currency union of EU members who have adopted euro as their sole legal tender

10. EU: Is an economic and political union of 27 member countries located primarily in Europe

11. Eurozone: A collective group of countries which use euro as their common currency

12. Economies of scale: Fall in the long the run average costs associated with an increase in output

13. Fiscal policy: Manipulation of government spending and level of taxation to influence movement of AD and overall economic activities

14. Fixed exchange rate: Is when a currency of a country has a set rate against the currency from another country and there will be no fluctuation

15. Floating exchange rate: Is when the exchange rate of a country against another is determined through the forces of demand and supply

15. FDI (Foreign Direct Investment): Refers to investment of foreign assets into domestic structures, equipments or organizations

16. Golden Rule: A guideline for the operation of fiscal policy set by Chancellor Gordon Brown, which mentions that over the economic cycle, government borrowing is only justified if it is meant for investment and not to fund current spending (payment onto pensions, benefits etc)

17. Globalisation: Refers to the freer movement of human, capital, goods and information

18. Hot money: Extremely volatile short term capital that moves on short notice to any countries that provide better return and is usually associated with investment onto stock market in another country

19. Import quotas: Limit onto the amount of goods that can be brought into a country

20. J-curve: The tendency for the fall in value of currency to worsen the balance of trade before improving it

21. Laffer curve: A curve that shows that for any economy, there will be an optimal income tax rate which will help the government to maximize tax revenue

22. Monetary policy: Manipulation of interest rates to influence the movement of AD and overall level of economic activities

23. National debt: Total amount of money a government owes to private sectors and the purchasers of bonds

24. Progressive taxation: Tax rate that increases as the taxable base amount increases and as such is felt more by the rich

25. Protectionism: Steps taken by government to protect local industry from harmful foreign competition

26. Terms of trade: Refers to the average price of exports to the average price of imports and is a measurement of competitiveness

27. Regressive taxation: Tax burden that falls more heavily onto those people with low income such as sales tax and value added tax (VAT) since it tends to take up a bigger percentage of the budget of a person with low income

28. Sustainable investment rule: A rule which requires debt to be kept at prudent level, which is below 40% of GDP in UK

29. Supply side policy: Policies to influence the movement of AS by increasing the productive capacity of an economy

30. Trade creation: Increased trade between member countries of trading bloc usually resulting from economies of scale due to enlargement of market or common external tariff

31. Trade diversion: Decreased in trade with the more efficient non-member countries which is replaced by the increased in trade with less efficient member due to formation of trading bloc

32. Trading bloc: A regional group of economies cooperating together by liberalising trade between one another

33. Tariffs: Taxes onto goods that are brought into a country

34. WTO: An international agency set up to promote freer trade between member countries, administer global trade agreements and resolving trade dispute if they arise

35. Absolute poverty: A level of poverty where only minimum level of food, clothing and shelter can be met

36. Bilateral aid: Aid given by one country directly to another

37. Debt relief: Refers to the partial or total forgiveness of debt or the slowing down of debt growth

38. Development: The process of improving the quality of life within a country

39. Dependency ratio: A measure which shows the number of dependents (those aged 0-14 and above 65) to the number of economically active people (those who are in working age 15-64)
40. Gini coefficient: A measurement of income inequality ranging from 0 (absolute equality) to 1 (absolute inequality)

41. Growth: A sustained increase in real GDP/ increase in potential GDP

42. HDI (Human Development Index): A measurement of development which include real GDP per capita (PPP), life expectancy at birth and combined gross enrolment ratio in primary, secondary and tertiary education

43. HIPCs (Highly Indebted Poor Countries): Countries with extreme poverty and debt overhang which are eligible for special assistance from IMF and World Bank

44. Import-substitution effect: A policy to replace foreign goods with domestically produced one

45. IMF (International Monetary Fund): An organization set up in 1944 to lower trade barriers between countries, to stabilize currencies by monitoring the foreign exchange systems of member countries and lending money to developing nations

46. LDCs (Less Developed Countries): Countries which exhibit the very low HDI rating of all countries in the world

47. MDCs (More Developed Countries): Countries which exhibit very high HDI rating of all countries in the world and are usually referred to the Western economies

48. Multilateral aid: Aid is given to countries through an intermediary organization such as the World Bank, which pools donations from several countries’ government before distributing to recipients

49. MNC (multinational company): A company which has operations in more than one country

50. NICs (Newly Industrialised Countries): Refer to countries whose economies yet to reach the First World status, but have in macroeconomic sense outpaced many other developing counterparts and is usually referring to countries like Brazil, China, India, Malaysia, Thailand and several others

51. Lorenz curve: A graph showing the difference between the country’s actual income distribution and perfect equality of income distribution

52. Relative poverty: Is when income is less than the average income of a nation by certain percentage

53. SAPs (Structural Adjustment Programs): A series of economic policies designed to promote free market and to reduce government intervention

54. World Bank: An international agency set up to assist countries with the process of development by providing loans, research and advice and was founded in 1940s to initially assist Western economies with capital after World War II

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