Saturday, November 29, 2008

What Determines The Oil Price?

It is not that difficult to understand the commodities market, such as oil. It can be easily & effectively explained using simple demand-supply diagram analysis. The prices of oil will increase if there is strong demand or cutback in supply (or both). Its prices will fall, like now when the demand sets back & there is overproduction in the market

Demand factor

(1) Period. During the winter, demand for oil will increase for heating purposes. The same goes for summer holiday, where most people will be travelling around. These 2 drive the oil price up

(2) Economic growth. Oil price is strongly correlated with level of economic growth. In the period of boom, oil price will normally skyrocket as there is a strong demand for it to fuel the industrial activities. There will be more flights for meetings, more trucks delivering goods, more people doing sales thus more cars on the road & more factories operating. The rise in oil price is also exacerbated by the rapid economic expansion in China & India, which records an average 8-10% of annual economic growth in the last few years

(3) Decision to pile up. The extent of oil price increase will also depends on how much oil those large economies such as US, China & India decide set aside for their reserves. US had long established its own oil reserves, while China has come up with 4 strategic reserves centres at coastal areas of Zhenhai, Zhousan, Dalian & Huangdao. It will start operating this month. Meanwhile India is also in the midst of constructing its storage centre this year, with its first centre in Visakhapatnam. Its 2 upcoming oil reserves will be in Mangalore & Podur.

Countries want to have their own reserves as an insurance against war & other external shocks. In such period they can reduce their reliability on imported oil & release it from their own reserves. Also it may reduce the risk of cost-push inflation onto their economy

(4) Futures traders. The price of oil is actually set in the oil futures market. Futures is a binding contract that gives one the right to purchase oil at a predetermined price & predetermined date in the future. 2 popular traders of futures are speculators & hedgers. Speculators have no intention of buying the product, but merely guessing the direction of the price to profit from it. Unfortunately, these speculators are the major driver of oil prices in the market, driving the oil price to as high as $147 in July. Hedgers are like airline firms buying oil futures to safeguard against any rising prices that may jeopardise their operations

Financial institutions are also on the increasing extent treated oil contracts like investment in shares or currencies. They buy these oil contracts in the hope their value will go up before selling them. Alternatively, if they think that its price will fall, they will sell oil contracts they don’t own (short sell) & buy them later to profit from the difference

(5) Strength US dollar. All commodities such as oil, steel, gold, palladium, aluminium & tin are traded in the value of greenback. Therefore as value of dollar weakens against other currencies, it means relatively cheaper to buy oil. Demand for oil will increase & this will naturally push the oil price higher. Also the dollar may rebound later since there will be greater need for dollar to facilitate the transaction. Its value also depends on many other factors for e.g. level of interest rates in US

Supply factor

(1) OPEC’s role. OPEC (Organisation of Petroleum Exporting Countries) controls 55% of the world oil exports. If the world oil price is on the downward pressure it may jeopardise the revenue for some of its members such as Iran & Nigeria, which economies are less diversified. These 2 are also known as the price-hawk for their aggressive stance in lobbying for higher oil price. Therefore, to safeguard their interest, they have the tendency to cut production. As supply falls back, price will increase

(2) Non-OPEC’s role. Much attention were given to OPEC members, without realising that non-OPEC oil producers such as Russia, Oman, Norway & Mexico have the potential to influence the world oil price. Even if OPEC decided to cut back the supply of oil to raise its price, it will not be successful if on the other hand, these countries raise their production. For instance, in 2001 OPEC’s effort to push up oil price failed when Oman & Russia increased oil production heavily

(3) Weather. Unpredictable weather, such as Tropical Storm Gustav, hurricane Katrina & Rita had the potential of disrupting oil production. For instance it may damage the oil platforms, refining networks, pipelines etc. If it does, there will be a fall of supply in the market, thus driving the price up. As a matter of fact, much of this has to do with “self-fulfilling prophecy”. Oil traders “will want to believe” that this will happen, therefore driving the demand & therefore oil price

(4) Violence against producers. Lots of the world’s oil unfortunately comes from politically unstable countries such as Nigeria & Iraq. For instance, somewhere June this year, some militants had launched an attack at Bonga oil platform where Shell is operating, thus causing it to stop operating temporarily. As supply falls, oil price increased for that day

(5) Level of investment. Depending on the market price for oil. If the oil price is high, oil companies will generate greater supernormal profit which can be then reinvested onto their operations. These include R&D activities, exploration of new oil deposits, setting oil platforms, pipelines etc which actually costs billions of dollars. In the long run, once oil infrastructures were set up, producers will be able to be more responsive to market demand. Any shortage in demand can be met by increasing the supply of oil, thus stabilising the world oil price

The ultimate determinant of oil price will actually be the interaction between the demand & supply curve. Depends on which shifts more. For instance, the current world oil price lingering around $51 is said to be due to demand falling faster than the supply

Thursday, November 27, 2008

Theories Of Development 3: Lewis Dual Sector Model

Proposed by Sir Arthur Lewis in 1954. The theory explains about the transition of labour between 2 sectors, from the agriculture to the industrial

The dual economies

(1) Agriculture. It was assumed that many LDCs (less developed countries) had dual economies, the traditional agriculture sector & modern industrial sector. The traditional farming is characterised by subsistence nature, that is most of the agriculture produce are meant for own consumption rather than traded. Also it is of low productivity, hence low output, low incomes, low savings & high unemployment. Migration of labours to urban is said to have negligible impact on agriculture output as MP = 0. (marginal product of farmer is zero). Think about this. How many farmers can be employed on a fixed number of lands?

Availability of food to remaining people will be higher since the same amount of food will be distributed amongst fewer people

(2) Industrial sector. The modern sectors will absorb surplus of labours from rural. As employment increase, there will be more output hence more income & profits. Additional income will increase demand for domestic goods & services while increase in profits will be reinvested. The rural-urban migration therefore offers self-generating growth


(1) MP = 0 is true in certain times. During the planting & harvesting period, definitely more workers will be needed

Shanty town in India

Shanty town in Mexico

Shanty town in South Africa

(2) Modern sectors may not want to hire more workers. With greater profits, modern sectors may invest in capital-intensive methods of production rather than labour-intensive. As a result, those newly arrived rural migrants which cannot be absorbed into formal economy will join the informal economy & live in shantytowns. (Have you watched Hulk at beginning of the scene in Rio De Janeiro? Those are shantytowns)

(3) Negligence of agriculture sector by government. Realising that it is industrial sector that drives the economy, government may soon neglect primary sector, yet most people live in rural areas where incomes are low. This will cause widening of income inequality

(4) Inability to absorb. The rural-urban migrations in LDCs in reality, has been much larger than the ability of industrial sectors to absorb. Urban unemployment will result & as such we say urban poverty has replaced rural poverty

Theories of Development 2: Harrod Domar Model

Harrod-Domar model is named after Sir Roy Harrod & Evsey Domar, who developed it in 1930s

This model suggests that economy’s growth rate depends on:

(1) Savings. The higher the level of savings, the greater will be the amount of funds available for investment purposes. Investment here include onto fixed capital & human capital

(2) Investment & the productivity of investment. Productivity of investment is also known as capital-output ratio. The lower the ratio the better. To illustrate, say £20 worth of capital equipment produces each £1 of annual output, then a capital-output ratio of 20 to 1 exist. A 10 to 1 capital-output ratio suggest that only £10 of capital is required to produce each £1 of output annually

Economic growth is often associated with amount of labour & capital. In LDCs (less developed countries), it is often the lack of physical capital that hinders economic growth. Meanwhile supply of labour is abundant. When there is economic growth, there will be higher income. As such this allow higher level of savings (cycle repeat itself)


(1) Economic growth vs. economic development. Both are not the same. Economic growth is necessary but not sufficient condition for development

(2) Difficult to enforce savings. In LDCs, incomes are generally low. Therefore it is difficult for people to save. The bulk of earnings will be spent on necessities

(3) Increased in savings, not necessary lead to economic growth. For a start, there must be people who are willing to take the risk to invest. Also it depends on whether they can access the funds at a reasonable interest rates

(4) Borrowing to finance growth. Borrowing from developed foreign countries, international organisations such as IMF & World Bank to finance investment, will only push the recipients to deeper poverty & having problems of debt repayment. This is because most of the aids are conditional & often the borrower will be forced to some austerity measures that will aggravate the cycle of poverty

(5) Law of diminishing return. This suggest that, as investment increases, the productivity of the physical capital will diminish, causing the capital to output ratio to increase. In other word, as more & more labour is being added to a production process, later these workers will get into each other’s way, causing a disruption e.g. waiting for turn to use an equipment. This will cause an increase in production costs

Video Lesson: National Debt By Richard Pettinger

Wednesday, November 26, 2008

Theories of Development 1: Fisher-Clark Theory Of Structural Change

This theory was introduced by 2 economists, Fisher & Clark. They proposed that every economy will go through 3 stages of production

(1) First stage is agriculture. Related to the activities of extracting raw materials through mining, forestry, fishing & agriculture. This is the main economic activity for low-income countries

(2) Second stage is industrial. Related to construction & manufacturing sectors. This is the main economy of middle-income countries. As economies develop, income will rise. Since agriculture goods have low YED, demand for them will increase but at less than proportionate of income. Compared to manufacturing goods, relatively it has higher YED. Therefore as income increases, demand for it will also increase at a higher rate. This will lead to rapid industrialisation, thus the shrinking size of agriculture sector

(3) Third stage is services. Related to provision of services such as education, health, international travel, banking etc. This is the core economic activity of high-income countries. Logically, as people feel even much richer, they will now demand for more services e.g. giving their child good education, greater concern for health & travelling internationally. Tertiary sector has very high YED (could be more than 1)

Argument of Fisher-Clark model:

Misleading theory. There are many LDCs (less developed countries) where its core economic activity is tourism, without actually having a properly developed secondary sector. We can get lots of good examples by referring to African countries such as Kenya

What could happen to these countries?

By specialisation,

(1) Volatile income. Countries such as Kenya & many others which are too dependent on tourism sector are very susceptible to global economic uncertainties. In the period of boom, the demand for tourism will increase tremendously & this will lead to increase in government’s revenue. In the period of economic slowdown such as now, obviously there will be much lesser people who want to travel

(2) Risk of collapse. Tourism has very high YED (more than 1). If the consuming nations such as US & Western Europeans face recession like now, a fall in income will generally lead to a greater than proportionate fall in demand for international travel. This negative spill over effects will spread into countries that rely on tourism sector. As a result, airline firms, hotel industry, local F&B will be affected. Falling profits will force them to cut employment. The negative multiplier effect will then spread into the whole system

(3) Rise in debt. Many of these economies are heavily indebted to IMF, World Bank & developed countries. Economy which is on the brink of collapse will push them to borrow more which is deemed by economists as not favourable. Most of those aids given are conditional or some are tied aid. For instance, World Bank & IMF will impose strict conditions such as cut in public spending to repay loan. But very often, these austerity measures cause the indebted countries to be in much poorer state as less development takes place. For developed foreign countries, they impose condition that the recipient countries must spent it onto the exports of donor country

Monday, November 24, 2008

Justification Of The Recent Fiscal Stimulus Announced By Labour

Chancellor Alistair Darling on Monday 24th Nov, had delivered his annual PBR (Pre Budget Report) speech & described many of the upcoming measures as “extraordinary response to extraordinary times”.

Among highlighted issues:

(a) VAT (Value Added Tax) reduced from 17.5% to 15% starting 1st December to end of 2009

(b) £3 billion worth of capital spending on public works projects brought forward from 2010/2011

(c) Further support £1.3 billion to help those who are unemployed to find work

(d) Tax relief for businesses making losses & deferral of rise in corporation tax rates for small businesses

(e) Tax rate for high income earner will rise from 40% to 45%

(f) Increase in NIC (National Insurance Contributions), something that small businesses claim as tax on jobs will increase 0.5% in 2011

(g) Increase in alcohol & tobacco duty

(h)) A 2p per litre increase in fuel duty

Judging the fiscal stimulus

(1) Preventing economic downturn. The increase in government spending & cut in tax is justified. By channeling £3 billion onto capital spending such as motorway building, council housing, schools & energy efficient projects, the Labour government will be able to create more employment. Also tax cut is an essential way to encourage people to spend into the economy, thereby avoiding a period of deflation. To be honest, deflation seems to be inevitable & yet it is an issue that is not thought off by many. Few months ago, people are worried about stagflation since oil price rose to $147 per barrel in July

(2) To earn more tax revenue. By engaging in ambitious borrowing, the government hopes to see UK economy to recover in a year or two. By then, tax revenue will increase & it can be used to patch the current fiscal deficit. On top of that, government may no longer need to spend so much on unemployment benefits in future. If the government does not start borrowing now, very likely recession will become worse. Unemployment will rise & more will be wasted for unemployment benefits payout. Therefore, government borrowing rise anyway

(3) Inevitable. National debt as % of GDP will rise, but this is expected in the period of recession. The logic is, as economy is slowing down, size of GDP shrinks but the level of debt increase. Do the math & you’ll get it

(4) Effective. Cut in VAT will relatively have a greater impact onto low income earners than those rich ones. As goods become cheaper, it means increase in the purchasing power, especially those poor consumers. Given that low income earners have higher marginal propensity to consume (mpc) & that is higher tendency to spend, this can give a good kickstart to economy. The rich has lower mpc as they have owned most of the goods. Therefore whenever there is an increase in income or purchasing power, they are likely to save huge portion of it

Meanwhile the loss of tax revenue can be recovered by increasing the income tax onto those high earners. For instance, from 2011 onwards those who earn £150, 000 will have to pay extra £3, 000 on tax while those with earnings of £200, 000 will pay extra £ 5,000. This is an increase of 40% to 45%

(5) The past is worse. Current UK’s national debt is just 43% of its GDP. We have seen worse one, 70% of GDP in 1970 & yet the government successfully brought it down


(1) Cutting VAT & other form of taxes may not work. Cutting these taxes may not even encourage people or firms to spend. Most of it could be saved to face future economic uncertainties. Some could be used to pay off debts. Also spending may not take place as the public knew that they will have to pay it back somehow in the future by the way of higher tax

(2) Chancellor Alistair Darling could be too optimistic. He often mentioned about UK economic recovery by end of 2009 or 2010. In my opinion, the economic recovery which may take place in a year or two, could be ‘postponed’. This is because as the economy is about to recover that time, workers & firms will be slammed with burdening tax, increase in NIC by 0.5% by 2011

(3) Worsening current account deficit. Cutting VAT may encourage people to begin spending on imported goods, thus worsening of the existing current account deficit. Also if imports outweigh exports, net exports (X-M) will fall, thus pulling AD down

(4) Fall in tax revenue.
The top rate tax to 45% may actually cut government revenues rather than increasing it. This is because more rich people will have the incentive to evade tax. Although any increase in tax rates on incomes above £150, 000 affects only 1% of earners, this accounted for 25% of all income tax revenue.

So what do they do? For those very rich, they will move offshore & perhaps run their business from a tax haven. That is what many sports stars do

(5) The Japan case. The government has spent £80 billion this year, & yet it fails to lift the British economy out of recession. Therefore what is the justification that the bigger £118 billion next year will be successful? Japan is a good example. The government has tried spending itself out of depression & as a result their National Debt amounts to 194% of their GDP, yet the result is not there

Friday, November 21, 2008

Iran & The Myth Of Price Hawk

Logo of OPEC
All this while Iran is notoriously well known for its aggressive stance to deal with falling world oil price. Iran’s OPEC governor, Mohammad Ali Khatibi recently, has once again urged the other members to cut the production of oil between 1-1.5 million barrels per day & this will be confirmed when they meet in Cairo this 29th November

Last month the production of oil has actually been slashed by the same amount. The central of discussion is why Saudi Arabia & other major oil producers are passive while Iran is so active?

Price elasticity of demand (PED): Measures the responsiveness of quantity demanded for a good (oil) to the change in its price. It can also be written as:

PED = (% if change in quantity demanded) / (% change in price)

Application: To determine whether certain goods are price sensitive or not.

Types of PED

(1) Inelastic PED (PED less than 1). Even when there is a large increase in the price of a good, the quantity demanded will not fall by much. Say, if the price of an item increases by 30%, perhaps its quantity demanded will fall only by 15% (that is less than proportionate). Here its PED is 0.5 (when it comes to interpretation, we are only interested with the magnitude of changes, so the negative sign is abandoned). It works vice-versa. Goods like these are less price sensitive

For goods that are inelastic in demand, producer’s total revenue will increase if the price of that good increase. Examples are like oil, cigarettes, alcohol

(2) Elastic PED (PED > 1). This means even when there is a slight increase in the price of a good, its quantity demanded will suffer a large fall. Here the changes are larger than proportionate. Say price increases by 20%, its quantity demanded fall by 50%. Therefore the PED is 2.5. Such good is very price sensitive

For goods with elastic demand, the only way for producers to increase their total revenue is by reducing its price. Examples are like luxury goods & goods with many substitutes

There are other types of PED such as perfectly elastic demand (PED = ∞), perfectly inelastic demand (PED = 0) & unit elastic of demand (PED = 1), but they are less relevant here

The case for oil & Iran:

There is no close substitute for oil. Even if there is, we might not see them in the near future, such as the development of biofuel. Therefore we classify demand for oil as inelastic. That means even with the increase in world oil price, people will not reduce consumption of oil by much as they still need to travel to work, sending kids to colleges, leisure etc

With the inelastic nature, the best course for OPEC countries would of course be high world oil price as it will lead to higher total revenue (TR). But since its price has slumped from the high of $147 in July to approximately $49 on 20th November, no doubt OPEC members will suffer a huge fall in their TR

But one thing for sure, Iran (possibly Nigeria too) has the largest dependency on the export of oil. As much as 85% of Iran’s government source of revenue comes from oil alone. In other word, Iranian economy is too specialised & if there is fluctuation in oil price, it will largely affect their economy. Saudi Arabia, has began to diversify its economy to services sector such as tourism as a long term plan

Iran needs to negotiate with non-OPEC members

Many books & articles have given too much emphasis on OPEC countries, when the non-OPEC members are quite influential too. They are countries like Russia, Oman, Norway & Mexico

In order for world oil price to remain high, either demand must increase or the supply must be cut or both. In the current situation, definitely there will be no demand. Therefore the only option is to cut supply to boost its price. Therefore Iran needs to pursue talk with these non-OPEC members since they could potentially undermine the ability of OPEC to set high oil prices, by increasing production on their part

Why oil prices still fall despite October cut?

Simple. It does not take a genius to see this. Take a piece of paper & draw out a simple demand-supply curve. What happens when demand curve falls more than the supply curve?

The Rise of Campbell Soup

We have to see this from the point of income elasticity of demand (YED). YED measures the responsiveness of demand for a good to a change in income. It is given by the formula of:

YED = (% of change in quantity demanded) / (% change in income)

We have 3 situations:

(1) YED greater than 1 (luxury good e.g. international holiday, designers’ clothes). As income increases, quantity demanded for a good will increase by greater than proportionate. For instance say rise in income of 10% causes the quantity demanded for that good to increase by 20%. So YED = 2 (it works vice versa)

(2) YED between 0 & 1 (necessity e.g. vegetables, newspaper etc). As income increases, the quantity demanded for that good will increase, but LESS than proportionate. For instance, again rise in income of 10% will only cause the quantity demanded for that good to increase by 7%. Therefore YED = 0.7 (vice versa)

(3) YED is negative (inferior good e.g. bus travel, potato, crush grain). As income increases, there will be a fall in the quantity demanded for such good. Say, income goes up by 10%, the demand for it will fall 25%. Thereby the YED = -2.5 (vice versa)

The case for Campbell:

In US generally there is a decline in households’ income. However, the demand for Campbell Soup as a form of cheap meal in period where more people opt to eat at home surge dramatically. A top analyst in Bloomberg raised the valuation of its share price to $44.50 or 26% higher than the current $35.42

This is a strong evidence to claim Campbell Soup is an inferior good. But of course, its sales will drop in the period of economic recovery.

Should US Government Consider Bailing Out The 'Beg 3'?

The Big 3 has produced too much of those bulky cars with high fuel consumption & yet do not meet environmental standards

Arguments to bail

(1) Prevent worsening unemployment. Jobless rate in US had climbed to 6.5% in October, the highest rate last seen in 1994 (14 years high). In that month itself, total number of people being retrenched hit 240, 000. Overall, for the first 10 month 1.2 million Americans had lost their jobs. Here the ‘Big 3’ considering GM, Chrysler & Ford employ more than half million people.

If US Treasury decides to reject their begging bowl, very likely unemployment will be exacerbated in 2009 to a level of 10%. Don’t forget, there are many industries that are directly related to the auto industries particularly the supplier of car components. People working in that industry will be affected too. Soon the negative multiplier effect will feed into the whole economy

(2) Exacerbating recession. News of unemployment often serves as headlines these days & it creates trauma among working people. Yahoo had just decided to cut 10% of its workforce. HSBC that day had cut 450 employments. Citigroup will slash up to 75, 000 employment worldwide. Today (21st Nov) Rolls Royce just announced about its plan to slash 2000 jobs

As people loss confidence due to job insecurity, they will not be ready to make commitment by purchasing huge items on credit such as cars, properties, plasma TV etc. Also in such period, people expect price to continuously fall (period of deflation), causing them to defer spending. As private consumption falls, recession will be worsened. Great Depression in 1929 & Japan’s Depression in 1990s should be a good example

(3) Stock market panic. As Congress strongly rejects the proposed $25 billion bailout, investors grow panic. This result in heavy selling of shares across Wall Street sending Dow Jones below 8000 points, especially the shares of the Big 3. People no longer interested to hold stocks of companies that are on the verge of bankruptcy. The spillover effect is tremendous as it affects stock market across emerging economies too

(4) Bank tighten loans. With the fear of another credit crisis, now banks have been much frugal in lending. Number of loans approved dropped significantly. They refuse to extend loan even to people who are buying car. This causes the demand for car to fall & therefore a drop in the revenue of automakers. This even hurt more of its balance sheet. Also they refuse to give funds for Big 3 to finance their restructurings

(5) Equity. The US government had previously bailed ‘undeserving’ financial institutions which are largely accountable for all the mess today. So why not just bail the Big 3? Besides, it is not those blue collar workers in Detroit that contribute to the credit crunch

Arguments not to bail

(1) Free market argument. From the point of free market, the Big 3 should be left on their own. There should be no government intervention in whatever way. Furthermore economists argue that the period of difficulty is the best way to distinguish between the performers & the non-performers

(2) Moral hazard. If aid is given easily, very likely these car firms will not struggle to come out with something innovative e.g. competitive models compared to Japanese rivals or fuel efficient cars. Also they may not even have incentive to lower down production costs. Therefore the same problem will persist in near future. This is likely true since costs of production for automakers have been remaining stubbornly high all this while. The possible explanations are superb healthcare benefits given & ridiculous high salary to its workers

(3) Firms, shareholders & unions responsibility. There are many parties that we can put the blame on. The public condemns the poor management ability, for producing models of cars which are inferior compared to rivals, for producing cars which are not fuel efficient (big & bulky SUV) when oil prices are rising & lastly for signing expensive contracts with unions that it cannot afford. Also they have been bashed yesterday (21st Nov) as they flew to Washington with their begging bowl in a flight that costs $ 20, 000 when they can actually take $288 economy flight ticket.

Possibly, $25 billion given could be misused to sustain the lavish lifestyle of those top managements & paying themselves fat bonuses rather than pumping into business. Shareholdersought to be criticised for allowing the management to do so all this while. Unions must share the blame since they have made ridiculous demand for themselves, hence significantly increase the production costs of auto companies

(4) Problems even before bailing out. The car companies have been loss-making most of the time, even in the period of economic boom. For instance, GM’s operation in Europe has not been profitable for 4 years continuously, since 1999. In US, it had made losses amounting up to $12 billion in 2005 & 2006. As such by giving in the $ 25 billion, very likely it will not be sufficient to sustain their large overhead costs. In fact they have been given a $25 billion earlier this year

(5) Where is the line? There must be a limit, to which extent the US government can assist. If it decides to rescue the US auto industry, other industries which are loss making will think that the government is doing charity. As such they will not have the incentive to be more efficient, thereby turning to the government whenever they face difficulty

(6) Let the employment pattern change. It is argued that this transition, although is painful in the short run, but will not hurt the US economy in long run. For instance, UK once employed many people to work in manufacturing sector. But as Britain is losing her competitiveness due to appreciating pound, cheaper goods from emerging economies etc, more & more people leave this sector & join services sector. It does not take a genius to see that UK economy still prosper after that.

Also UK car industry is getting more insignificant nowadays compared to last time, but it does not spell an end to UK economy
(7) Pressure to other governments. While US is still weighing whether to assist the Big 3 or not, auto companies from the developed economies have already begin lobbying & pressuring their government to do the same in whatever way. If the bailout does materialise, these car makers will definitely argue as in why the US government is able to assist, but not their official? For instance, car manufacturers in EU are now lobbying for € 40 billion euros loan. Meanwhile, carmakers in Britain wanted more tax cuts which could potentially lead to worsening fiscal deficit

Thursday, November 20, 2008

Similarities Between PM & A Lecturer

Hi fellow readers, I’m just trying to avoid the conventional postings. Let’s be casual at times. However, I’m neither directly nor indirectly comparing my role to the Prime Minister, not at all. His or her role is far more superior than mine. Interestingly, there could be some similarities

Managing classes is like managing an economy/ a country with different states. Depending on number of classes that I’m responsible for, generally the more classes that I have the greater is my responsibility

(1) PM’s blog vs. my blog. Believe it or not, some leaders do have their own blog to communicate with the people. Malaysia’s former premier, Tun. Dr Mahathir does that. He posts all issues that he disregards with e.g. poor current leadership, world economy, politics etc. I do the same thing too. I write about my opinion on financial issue in America, explaining why pound is falling & yet there is nothing to worry about, whether to bail or not to bail the Big 3 etc. My main intention here is to communicate my ideas to fellow students.

(2) Instill confidence among people vs. students. One of the roles undertaken by a PM is to ensure the existence of consumer confidence. This is utmost important, as it will be a catalyst of economic growth. When people have no confidence, they will not spend into the economy. Same as being a lecturer. I need to ensure my students are well prepared, continuously giving them inspiration (although sometimes pressuring them is more effective), teaching them the skills & techniques to answer papers etc. Without all these, they may not even have confidence to sit for exams. Worse, there are some which choose to skip the exams

(3) Paying tax vs. paying RM 20 for photocopy materials. Government will utilise the tax revenue which comes from income tax, corporation tax, VAT etc to spend into the economy. The same goes for me as well as other lecturers. We will collect RM 20 from each student for the purpose of photocopied materials. In other word the RM 20 is like a kind of ‘tax’. Then we use it for photocopying notes, case studies & exam papers. In real world the government could use that money to build schools, hospitals, upgrade infrastructures & other public works

(4) Mandate given vs. students’ can choose who they want. The public can choose who they want to be the country’s leader through election. The same goes for education industry. In some situation (although limited), students may opt to change lecturers

(5) Election vs. teacher’s evaluation. As there will be term election in the real world, there will be term evaluation for us teacher. If the outcome of the election is bad, we know that the people dislike the current leadership. The same goes for the class. We lecturers can tell if majority of the students like the teacher or not by reading the comments written on the evaluation form. Also the average score for each attribute like clarity in explanation, attitude in class, whether the teacher is helpful or not etc can be use as an indicator

(6) Unemployment vs. weak students. Governments often look into resolving issues regarding unemployment. These are the people that highly need assistance. Also this is to prevent the further widening of income inequality. Equally in class, I’m very concern (although I scold & cynically criticised them a lot) with those who are weak with Economics. I try to extend my help in whatever way I can for instance giving extra lessons, making my phone line available 24 hours a day etc. This is part of my effort to bridge the 'knowledge inequality' among students, especially between the strongest & the weakest

(7) PM late for events vs. me late for classes. I guess I don’t have to further explain on this

(8) PM needs to prepare speech vs. preparing lesson. Some may argue that PM’s speech is prepared by his or her PA (personal assistant). But in many cases, PM has to give speech independently especially in press conference. The speech & answering skills will become better over time. For me, at initial stage I need to prepare extensively for every lesson that I have. But once I’m familiar enough, there is not much preparation needed. Also over the time, I’m more able to address difficult questions asked by my students (although still need to improve). Here, students are like reporters

Is Falling Pound A Curse To British Economy?

Perhaps not,

(1) Fair valuation. IMF estimates that the fair value for pound is $1.50 to £1.The previous $2 to £1 shows that pound was overvalued against the dollar. Therefore the current devaluation is not more than a market correction (just like correction of share prices)

(2) Improve competitiveness. As pound falls against the dollar, Americans will find it cheap to buy more from UK. Export will increase. But for Britons, falling pound indicates falling purchasing power. Therefore they will import less. Depending on how long & how much pound devaluate, this may be able to revive UK manufacturing sector which is in deep recession. Also it may help to absorb some of those previously retrenched workers. Unemployment may be reduced

(3) Economic growth. Falling pound will cause demand for UK goods to increase. Therefore exports will increase. At same time, falling purchasing power means Britons will spend lesser on imported goods. Overall will be an increase in net exports (X-M). This will cause AD to increase, thus lifting the British economy

(4) Other countries are doing badly too. As UK is inevitably running into a recession, Monetary Policy Committee (MPC) will be forced to slash interest rates. People may begin to think that now it is no longer attractive to hold pound. But never forget, UK’s rival such as US is doing much worse. Japan had announced another recession recently. Germany is not spared too. In short all major economies are faring badly. Holding dollar or Euro or yen could be as good as holding pound. Interestingly, among these major economies, UK’s national debt as a % of GDP is among the lowest

Don't believe? Check this out . Although not the latest, but it's value hasn't changed much

Monday, November 17, 2008

What Factors Influence The Level Of Exchange Rate?

What influences exchange rate?

(1) Balance of payments (BOP) deficit. When a country has large BOP deficit, it is likely caused by the huge deficit for trade in goods under current account. This means imports are greater than exports, causing large outflow of home currency. If this is offset by the large inflow in capital account/ financial account, then it should be fine. But for some countries which find difficulty to attract sufficient inflow of hot money, this could be a problem. There will be no balance between the two then

US & UK are two excellent examples. US current account deficit is about 6-7% of its GDP while UK’s 5%. In theory, dollar & pound should have fallen much given the large deficit in their current account. But since their capital account is equally resilient, therefore this had somehow helped to prevent the value from going down much

(2) Strength of other currency. The strength of pound depends much on other factors which are out of control. For instance, UK economy slowdown. When investors realise that prospect of earning good return on assets in UK is getting dim, they will pull out their investment. Many of these foreign investors are from US & other emerging economies. When they fled pound denominated assets, pound will begin to depreciate against many other foreign currencies. Even when US & whole world economy is slowing down, people will still want to hold dollar as US is perceived as the largest yet most stable economy

Other factors like the end of yen-carry trade activities. Yen-carry trade is a term referring to investors (including Japanese) who borrow in yen to invest in other countries that give better returns. This is because borrowing in yen is so cheap. So, investors would like to take advantage of the differential in interest rates. Much of these went to US, Eurozone & UK. Since the developed economies had slashed interest rates that much, investors pulled out their money & return to home country. That also partly explain why several weeks ago, yen appreciated much against dollar

(3) Speculation activities. If investors believe that pound will be a stronger currency in future, they will want to hold pound now to make profit. Therefore the demand for it will increase, causing it to appreciate. Have a look at it, one can tell that this is not more than a ‘self-fulfilling prophecy’. Therefore movements of exchange rate does not necessarily reflect economic fundamental, but rather the herd mentality in the financial market

Source of diagram: BBC

(4) Interest rates. When a country with relatively strong currency begins to offer higher interest rates such as UK, there will be large inflow of hot money. These come from wealthy foreigners, large institutional investors, hedge funds etc. In order to place monies in UK, they will need to supply their home currency in order to buy pound. As demand for pound surge, it will appreciate. These also helps to explain why pound is so strong before the financial crisis, especially when the interest rates was at 5.75% somewhere September last year

(5) Level of inflation. If inflation in UK is lower than elsewhere, generally goods manufactured in UK will be more competitive, since it is relatively cheaper. Therefore demand for UK exported goods will increase, & this means appreciation of pound. On the other hand, Britons may find that foreign goods are not competitive & therefore supplying lesser pound. Therefore pound will appreciate say from $1.90 for £1 to $2.00 for £1

Can Internet Increase Market Contestability?

Definition of contestable market: Market where there is freedom of entry & where cost of exit is low


(1) Lower marketing costs/ lower sunk costs. New firms, usually with financial obligations no longer have to worry over the need to spend excessively on advertisement to market themselves & to create powerful brand. With minimal expenditure, they can easily reach millions of consumers worldwide. Also, since the costs of exit are lower, more will willing to take risk. This increase contestability

(2) Lower start up costs. Internet means some businesses may choose to operate completely online. This significantly helps to reduce large overhead costs such as rental of shops, premises, utilities etc. Dell & Amazon are two good examples

Reduce contestability,

(1) Rise in other form of costs. No doubt marketing costs have been lowered significantly, but there are other costs that rise considerably. For instance continuous expenditure on web maintenance, network security measures, expensive servers & transportation costs when delivering the goods. To some extent it may outweigh marketing expenditure & thus reduce contestability

(2) Practice of limit pricing.
There are many aspects of contestability we have to look at. No doubt firms may now find it easier to get a foothold, but still large established firms can practice limit pricing. They can lower down the price of their goods to a level where new firms may find it unprofitable to join the industry

(3) Not all have access to internet. The intention to use internet as marketing medium to enlarge market share may not be always successful. No doubt costs of entry & exit are lower, but new comers need to consider about targeted market. In developed economy, consumers normally have their preferred brand. Meanwhile, market in emerging economies is slow as not all consumers are internet savvy. Some even have no access to internet

List Of Most Important Definitions For Unit 2: Market & Why They Fail?

Here they are,

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

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

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

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

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

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

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

(8) 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

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

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

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

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

List Of Most Important Definitions For Unit 1: How Market Work?

This can become handy, days before the examination

(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) Absolute advantage. Situation where a country can produce a good using lesser resources than another country

(4) Comparative advantage. Situation where a country can produce a good at lower opportunity costs compared to another country, & therefore should specialise in it

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

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

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

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

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

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

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

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

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

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

(15) Price elasticity of demand (PED). Measures the responsiveness of quantity demanded to a change in price

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

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

(18) Price elasticity of supply (PES). Measures the responsiveness of quantity supplied to a change in price

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

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

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

Will EPF Slash To 8% Helps To Prevent Slowdown In Malaysia?

We have seen something like this in Malaysia earlier. In 2001 & 2003 the cut lasts for 1 year. Now, it’s slightly different. EPF contributors are given an option, to or not to?

Much of the arguments here are pretty much the same like my previous posting. This is because of its similar nature with tax cut


(1) Reviving the real economy. Just like lower tax, the lower EPF contributions by 3% means workers will have higher disposable income at the end of the month. This should encourage more of private consumption into the economy. As C increase, so does AD. Over time, we may witness an increase Malaysian economic growth

(2) Coping with larger commitments. There are many working individuals who have monthly obligations on large items on credit like car & house. Having more money will definitely help them to ease these financial burden


(1) Insufficient to stimulate economy. Malaysia just like other developing & developed nations is not spared from the global economic meltdown. News over unemployment e.g. today Citibank announced that it will be cutting 53, 000 jobs worldwide, more Malaysians are returning to Johore from Singapore etc is good enough to install fears. Consumer confidence begins to deteriorate. Therefore in such period, likely all these cut will not be spent but saved for rainy days. I argue that the RM3.2 billion increased in spending announced by government is little bit too ambitious. As people save, there will be leakage. AD may increase, but not much

(2) Loss of savings. From economic point of view, cut in EPF contributions may have different impact, depending on whether the individual is in low or high income bracket. For high income earners, such a cut will not boost their spending. Rather, most of it will be pocketed. Meanwhile, the poor who has higher marginal propensity to consume (MPC) will likely spend most of it. Therefore within these 2 years, there will be a huge disparity between the savings of the rich against the poor

(3) Is government sure of what it’s doing? There could be a possibility of government ‘experimenting’ a rare way of increasing spending. If this is such a good way to rejuvenate the economy, why don’t we see this option exercise more often? Second, if it is surefire of preventing the local economy from slowing down why still hesitate to make it optional? Why there is no option for us when it comes to tax or interest rates deduction? For e.g. optional scheme to pay lower tax now, but higher in future.

(4) Depends. In theory, it should work accordingly. But in reality, whether people decides to spend or not depends on many other factors. For instance, is there any assurance that the oil price will continue to be at this level, RM 2 per liter? Will economy recover soon? Most important, will there be any increase in income tax these 2 years? Some may argue that in period of economic slowdown/ recovery, this is highly unlikely. But don’t forget, the budget deficit as % of GDP is ballooning (although not as big as in UK & US) as our economy is shrinking & yet government expenditure is ballooning. Do the math & you’ll understand. Government must need finances from somewhere to bring it back to equilibrium

Saturday, November 15, 2008

Will Tax Cut Often Works To Revive Economy?

"Gordon Brown has fuelled talk of possible tax cuts by saying they could help to support consumer spending"

--BBC, 11th November 08—


(1) Demand side effect. In theory, by reducing income tax working individual will have higher disposable income. This will encourage more spending into the economy. By lowering down corporation tax, firms will have greater retained profits. Therefore this may encourage them to conduct R&D & expand their operation. Both lead to increase in AD, through the increase in C & I. Real economy will increase

(2) Supply side effect. With lower tax, individuals will have incentive to work hard or taking up jobs. This is because the more they work the more they get to keep for themselves. For firms, lower corporation tax or tax investment credit will give them incentives to take up R&D activities. They may make more discoveries on methods to increase productivity or lowering down the costs of production. AS shifts rightward. If successfully implemented, there will be lower inflationary pressure & increase in real GDP

Evaluation of tax cut

(1) What if too small?
If the tax cut is too small, it may not be successful to persuade people to start spending into the economy. This is likely true given the current situation of UK economy. In period where consumer confidence is low, most likely those tax cut will not be spent, but rather saved

(2) Tax cut affects who? Depends on who will be affected, the low income or the high income? If the tax cut is on high income earners, large proportion of the money will not be spent but rather saved. But if it’s targeted on the low-income earners, assuming the tax cut is ‘large enough’, it will be successful at increasing spending. The logic is lower income people have more things to own than the rich ones

(3) Tax cut vs. government spending.
It is argued that direct government spending into the economy is more effective to revive the economy, create employment & thus restore confidence among Britons. When government decides to upgrade infrastructures for the upcoming London Olympic 2012, construct new schools, hospitals & other public works has the ability to create tenths of thousands of new jobs, thus ensuring greater overall private consumption into the economy

(4) Crowding out effect
. Tax cut directly means lower revenue for the government. To finance public works, this necessarily means UK government has to raise borrowing by the issuance of government bond. The bond will be normally taken up by private sectors, therefore leaving them with lower funds available to spend & invest. Also as UK government’s debt is mounting, it is increasingly difficult to raise financing. Therefore they may have to increase interest rates to attract lenders. Financial institutions may follow suit, or else they will lose all the depositors. Therefore we say, firms are crowd out by the way of higher interest rates. In nutshell, tax cut to revive economy could be overshadowed by the declining prospects of private sectors

(5) Politicians are forgetful. The problem with cutting tax is that politicians often ‘forget’ to reverse them in the period of economic boom. The truth is they are unwilling to watch the economy crawl then (slowing down). Even if they decide to increase, there will be many industries lobbying not to. This could be one of the reasons why US National Debt has surpassed $ 10 trillion, standing at 70% of its GDP. It is often easy to make tax cut during recession, but no calls being made to increase it to bring it back to equilibrium in good times

Thursday, November 13, 2008

What Jobs Are Considered As Recession Proof?

The safest haven

(1) Teachers & lecturers.
Whether the economy is performing or not, people will still need to attend colleges & universities. In fact it could be argued that in economic downturn, parents are more concerned with their child’s education. This is because once the economy recovers there will be stiff competition for jobs in the market & the only way for young people to market themselves is non-other than having at least a basic degree

However you could argue that lecturers for professional courses such as CFA, ACCA, CPA etc could be out of job. Most who pursue these courses are professional bankers. Since many are out of job as in US case, probably they will stop attending. Furthermore the fee is not cheap

(2) Economists. Strange but true. Demand for economists will always be there & perhaps in current period it will go up. We need economists to explain about the mess in Western financial institution, whether free-market had failed to function, why US dollar appreciates despite its economic woes, why Malaysia is unlikely to fall into recession in 2009 etc

(3) Doctors. Whether good times or bad times, as long as you don’t feel well, you need to go to your doctor

(4) Corner shop restaurants. In recession, people will choose to eat lesser at fine dining outlets. This is based on the argument of YED (income elasticity of demand). For luxury goods, a slight fall in income will cause its demand to fall greater than proportionate (YED more than 1). In fact they may turn to have their meals at corner shops & other cheaper options

High risk of unemployment

(1) Remisiers. Recession & plunge in stock market normally come together, unless it’s just a market correction. This is the period where investors shy away from the financial market. Share prices continue to fall due to loss in confidence, herd mentality of investors, companies making losses & other form of bad news. Remisiers will probably choose to quit, since there will be much lesser people buying shares which translate to lower commissions

However, one can always argue that there are so called value investors, people who think that the best time to invest is non-other than when share prices had reached rock bottom. But these investors are rare breed

(2) Unit trust agents. These are the people who market the trust funds for financial investment companies. In US we have Michigan Interfaith Trust Funds, California Investment Trust Fund Group etc. In Malaysia we have like Public Mutual, MAAKL, Pan Pacific Mutual etc. The prices of unit trust funds are strongly correlated with the performance of underlying stocks. As stock market plunge, so does the price of these funds. Agents will find it extremely difficult to persuade people to invest. More over, who wants their hard earned money to be swipe overnight?

Again you could argue that there are some conscious investors who would jump in & invest at low prices. The process of doing so is called dollar cost averaging, which means lowering down the overall costs of investment by the way of averaging

(3) Real estate agents. Same like the former 2, property market will grow very slowly. There will be much lesser new firms coming up. Also people will be more reluctant to buy property due to job insecurities

(4) Car salesman. In the period of economic uncertainty, demand for cars will fall. People are afraid to take up huge financial commitments, the same argument for buying property. As a result sales will decline drastically resulting in lower commissions. Depending on how severe & how long, those who are unable to remain that way will choose to exit the field. US auto industry is an excellent example. I’m not sure how many have suffered from job losses due to the ‘dying’ GM, Ford & Chrysler alone

(5) Airline industries. Demand for foreign travel is income elastic in demand (having YED more than 1). Now, as people feel poorer, they will demand much lesser of international holidays & perhaps choose to travel domestically. We may witness more retrenchment such as site inspector, maintenance technician, customer services etc

(6) Hoteliers. This is due to the negative spill over effects from poor performing airline industry. Hotel industry which is very labour intensive may begin a large scale retrenchment scheme. However one could always argue that most of the jobs created in hotels are part-time based. Therefore, on-and-off employment is expected especially during summer & after summer holidays. As such employment is not that affected

Wednesday, November 12, 2008

Tips On Writing A Good Economic Essay

Tips To Write Good Essay For Unit 3 (15m)

(1) Knowing the allocation of marks
. The last question in Unit 3: Managing the Economy (Edexcel) is always a short essay of 15m. The allocation of the marks is consistent & is always 3m+6m+6m. The first 3m is always for defining policies (fiscal, monetary or supply side policies), explaining phrases & drawing diagram. The first 6m is always meant for explanation of policies. Students can choose to give only 2 explanations (3+3) or even 3 explanations (2+2+2) if they are not confident enough of expressing & elaborating their ideas. As for the second 6m (evaluations), it works the same. Students can either give 2 or 3

(2) Understand the policies well. To be very frank, the essays are 90% predictable. The only thing they can ask you is non-other than fiscal, monetary & supply side policies & how they affect price level, real output & UK macroeconomic objectives. For those demand management policies, anything that increases consumption (C), investment (I), government spending (G) & net export (X-M) will surely increase AD. Meanwhile for supply side policies, anything that increases productivity, level of employments & competition will increase AS. That’s all

(3) Explanation must be clear. Students must practice or develop their writing skills. They must be able to explain a transmission mechanism (process of an event) CLEARLY for e.g. how with an increase in interest rates affect investment & therefore AD? Sample:

"When interest rates increase, firms may be tempted to cut investment spending. This is because, costs of financing a project or business expansion had increased. Also this may reduce the rate of return on capital & that is reward from investment is now lower. When investment falls, AD will fall"

(4) Good evaluation. There are few traditional techniques I always recommend on evaluation. First, students can always say about lags (delays) in policies such as recognition lags, implementation lags & effect lags. Second, compare between policies. Which is more suitable for e.g. to achieve economic growth between supply side & fiscal and reason for you to say so? Third, comment on what will happen to the price level & real output in an economy near full employment after policies take off. Fourth, costs & benefits for each policy e.g. tax cut may not be effective, privatisation & deregulation fails for British Rail & British Energy, dismantling of national minimum wage creates greater income inequality etc. Fifth, depends on the multiplier effect, the greater is its increase, the heavier will be the pressure onto price level

(5) Read case studies
. This is my priority of all, but unfortunately is not a popular option among students. Sometimes, students didn’t realise that they can’t actually impress the examiners to get those extra marks by showing some level of maturity in writing & also by projecting themselves as a very knowledgeable candidate. Students can always throw in events e.g. relating to incidence that happens during the era of Mrs. Thatcher (coal mine strikes) when they write supply side policies, what happens during era of Nigel Lawson (Lawson Boom), stating that pound has strengthened against dollar all this while (except recently), mentioning about the ambitious spending by Mr. Brown on healthcare & education sectors etc

Explanations given by students tend to be very on the theoretical side without actually relating any real life events to support it

(6) Wise time allocation. Some students tend to spend too long on the earlier part, leaving not much space for them to complete the essay part. Please allocate at least 20-25 minutes for this section for you to think, draft & come out with good evaluations

Video Lesson: Will Interest Rates Cut To 3% Help To Boost UK Economy?

This is what I like about video learning. Don't understand? You can rewind indefinitely, & this guy Richard Pettinger will be so happy to explain to you even 1000 times

Monday, November 10, 2008

Relevant Policies To Increase Output In UK Economy

The most relevant policy that can be undertaken by policy makers is supply side policies, although it can also work through fiscal policy & indirectly through monetary policy. There are 3 areas of supply side policies that we can look at. Supply side policies for product markets, financial market & labor markets

Source: www.

Definition: Supply side policies are policies instituted to influence the movement of AS by increasing the quality & quantity of the inputs of production

(1) Privatisation & deregulation. Privatisation is the transfer of state-owned business to private sector. The intention is to break up large state monopolies & create more competition. Once privatised, firms will have profit motive & this will induce them to adopt the most cost efficient method of production, thus resulting in lower price. Also by adopting efficient methods of production may significantly enhance productivity of workers. More output can be produced. Examples in UK include British Aerospace, British Airways, and British Telecom

Meanwhile, deregulation means allowing more competitors to set up business in an industry previously protected by legal barriers to entry. Competition would then hopefully drive prices down & force firms to be more efficient in production

(2) Education & training. Government must continuously allocate more grants to universities to encourage R&D. Courses taught in universities must also be reviewed from time to time to ensure it is relevant to industrial need. Besides, more courses that teach modern skills must be introduced. Since UK economy is moving away from industries that required manual skills to those that need mental skills, investment in education cannot be underestimated & retraining of those previously manual workers is absolutely vital

It should also be noted that by providing training to those who lose their job in old industry, should be able to increase occupational mobility of workers in UK economy, besides reducing structural unemployment. Having a knowledgeable & well-trained workforce can help to increase real output

(3) Trade union reform. Tough laws can be introduced to curb the power of labour unions to call for strikes, bargain for higher wages & any other actions that can disrupt the operations of a firm. Examples of measures taken are like requiring union members to cast a vote before strike, fining them if they disrupt production process & cause firms to lose revenue. By reforming the union, there will be lesser days lost due to strikes & firms will be more willing to hire. Output can be increased

(4) Reduction of state welfare benefits. When the unemployment benefits have been reduced, those unemployed will find that the opportunity costs of staying idle has increased. This will automatically force them to look for jobs. When there is greater employment in the economy, more output can be produced

(5) Lower tax. By lowering down the personal income tax, may provide an incentive for people to work harder or taking up a new job since they get to keep larger proportion of the money they earned. For firms, introduction of tax relief on R&D & lowering down of corporation tax may encourage them to increase their investment spending, thus coming out with better production techniques. This can lead to higher productivity & lowering down of production costs. There will be more output in the economy.

It also has many other benefits. Ireland & Estonia are 2 good examples of country inside EU that benefited greatly from corporate tax reduction, as its FDI surge dramatically

(6) Healthcare spending. When the government is committed to allocate a huge portion of funds under the annual budget to healthcare sector, it will increase its accessibility. In the near future, UK may have a healthier workforce. There will be lesser days taken off due to sickness, resulting in greater output in the economy

(7) Infrastructure spending. Improvements in the public transport, road conditions & having a world class airport can help to increase business transactions. For instance, having a road that is less congested can help people to reach the workplace earlier. More works could have been done. Also lorries that travel on less congested road may be able to increase its frequency of goods delivering. Overall, there will be more output in UK economy if all modes of transportation is efficient

(8) Reducing or dismantling minimum wage. If there is a minimum wage set above the equilibrium wage rate, then unemployment will be created. Minimum wage prevents some workers who are willing to take on low paid jobs from getting employed. Hence economist argued, by reducing NMW, there will be lower unemployment in the economy. Therefore, more output can be produced, resulting from higher level of employment

(9) Relaxation of immigration rules. Net migration into UK economy can affect both AD & AS. It affects AS in the way of greater number of labours & thus output in economy. It also affect AD by the way of greater spending into the economy & also greater tax collection for government

(10) Encouraging FDI. Increase in the number of foreign firms especially from Japan is good to local economy as they often bring along new technology & better management. Other than creating new jobs, both these can help to improve UK’s productive capacity. Furthermore UK has always been lagging behind its major rival like US, France & Germany in terms of capital spending

(11) Removal of trade barriers. By removing protectionist measures such as tariffs, taxes & import quota, domestic firms will be exposed to greater competition. This will automatically pressurised the local firms to be more cost efficient & adopting the best production techniques in order to survive. As a result, there will be more output in UK economy

(12) Lending support to small businesses. Supply side policies here include loan guarantees for new businesses, advice for new firms etc. Having greater number of small firms is advantageous as not only can it contribute to the increase in AD, but also it creates employment opportunities along the way as it grows. When more people are employed, generally there will be greater level of output in UK economy


(1) Focus on education & training. Most of the firms in UK have undergone privatisation, especially during the era of Mrs. Thatcher. As such there is not much space for further privatisation. Besides, some economists begin to question the wisdom of this policy since some firms like British Rail & British Energy went bankrupt. Also there is a danger of private monopoly exploiting consumers. Meanwhile the power of labour union has been under control & we have not seen strikes as in 1970s. The weakening manufacturing sector means the more insignificant roles play by them. As such the core focus by Labour government should be on improvement in the education system & setting up of more training centres

(2) Achieve UK macroeconomic objectives. The effect of supply side policies is overwhelming. Curbing the power of trade union can help to keep wage inflation low, thus slowing down cost-push inflation. Besides, firms are more willing to offer employment once the labour market is more flexible e.g. easy to hire & fire workers. Also, once UK has achieve higher level of price competitiveness, there will be an increase in export thus narrowing the current account deficit under the Balance of Payment

(3) Failure of supply side policies. Despite concerted efforts by the Labour government to increase productivity of workforce, still UK is lagging behind major rivals like US, France & Germany. Also there is a sharp rise in Balance of Payments deficit, especially in trade in goods. In other word, the problem of losing competitiveness still persists, possibly suggesting the failure of its implementation

(4) Tax reduction will not work. Lower income tax & corporation tax may not even increase the incentive to work harder & produce more, if the tax reduction is minimal. Furthermore, over the years more new taxes have been introduced & this is counter productive. However, one can always argue that lower taxes will benefit government more since people & firms have less incentive to evade taxes

(5) Greater inequality. Definitely weaker labour union is good news for industrial operators, but not all the time for employees. Some large firms may exert their monopsony power over employees by paying low wages, low increment, poor benefits etc. Dismantling or reduction of NMW can be equally a bad idea. Without it, the purchasing power of those with decent wages will be eroded by inflation. Therefore both lead to greater inequality. Also it is argued that jobless people will have even lower incentives to look for jobs

(6) Problems with immigrants. Large inflow of immigrants will depress wages, as supply of labour could be more than demand for labor. Besides they could have problems in communicating English & not all of them are skilled workers. This will then cause structural unemployment. Also even if they are hired, they may not even boost AD through consumption since they are likely to send high % of their earnings back to home country

(7) Comparison with demand management policies. Supply side policies are more effective than fiscal & monetary policy. This is because we can produce more output, thus achieving higher economic growth without actually causing any inflationary pressure onto the economy. Unlike the latter 2, very often economic growth is attained at the expense of higher inflation. Situation will be worse if the economy is near to full employment

Sunday, November 9, 2008

How Good Is GDP As Measurement Of Development?

GDP may be the best single measure to measure the value of output produced in an economy, yet it is not a perfect one.

Problems of using GDP as measurement of development:

(1) Does not take into account income distribution. The GDP of a particular country could be high but that doesn’t mean that everyone is better off. It could be few of the very rich individuals who actually inflate the figures, leaving the rests in deep poverty

(2) Ignoring informal economy. GDP does not take into account any activities that are not traded in the organised markets. These include DIY jobs & underground economy such as smuggling, drugs, and prostitutions. This has always been an ongoing problem for developing countries as large proportion of its economic activities consists of subsistence farming. Here the agriculture output is meant for personal consumption, hence will not be traded in the market. This has undermine the true value of GDP

(3) Depending on inflation. If inflation is underestimated, then the value of real output will be overestimated. This will cause the value of GDP to be unreliable

(4) Different methodologies. Different governments may employ different method of measuring GDP. Some could be more efficient than the others. Also some countries may include illegal activities such as prostitution. As such comparison between countries could be meaningless

(5) Ignoring quality of goods. Over the years, quality of technological goods such as video camera, personal computers etc have improved significantly & yet their prices have gone down a lot. Including these into the calculation of GDP may cause its value to fall & yet many people have benefited from it. Therefore GDP is a quantitative measurement rather than qualitative

(6) Ignoring externalities.
Pollution & other industrial activity actually impose costs onto society & yet these costs are not subtracted from the market value of final goods when GDP is calculated. For instance, a chemical firm produced £3 million worth of output but pollutes the environment & decreases its value by £5 million. Rather than indicating a loss to society, GDP will show an increase of £3 million

(7) Different level of development. 2 countries could have an almost equivalent level of GDP per capita, but one having a higher HDI (Human Development Index) than the other. This means on the average it has higher literacy rates, higher level of education attainment & longer life expectancy

(8) Differing exchange rates. Different countries have different exchange rates, thus there is a need to denominate GDP in a common currency, normally US $. Even after doing, there remains the problem of different purchasing power e.g. $1 in US will not buy the same amount as $1 in Indonesia. This leads to the usage of PPP (purchasing power parity)

Saturday, November 8, 2008

Economic Development vs. Economic Growth

For economic growth there is a generally accepted definition, but not for the case for economic development

Economic growth
Defined as sustain increase in real GDP over time. In layman, it means increase in the amount of goods & services produced with their value adjusted against inflation. If there is no adjustment, the value of GDP will be overstated

Economic development
The traditional measure regard it as a sustain increase in income per capita of 5% to 7% per annum. Some alternative regard it as a country’s ability to expand output at a rate faster that the growth rate of its population. Another measure relates it to the speed of industrialisation. In other word how output & employment in agriculture shrinks over time, BUT output & employment in manufacturing & services sector increase.

The modern view is more comprehensive & multidimensional as it takes into consideration more aspects. In economic development, there must be not only economic growth, but also other aspects such as reduction of income inequality, poverty eradication, greater literacy rates, higher life expectancy, environmental quality & all forms of economic well being.

In reality, many developing nations did reach economic growth targets but at the same time there is widespread of inequality in income distribution, widespread of absolute poverty, low literacy rates etc. A country could have higher income than another (after adjusted for PPP), but somehow having lower level of development to its comparator

Consider Tunisia & China, Saudi Arabia & Uruguay

Lists Of Most Important Definitions For Unit 4

(1) Horizontal integration: When 2 firms in the same industry & at the same stage of production process merge

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

(3) Conglomerate integration: When 2 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 & there is freedom of entry & 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 23% market share

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

(14) Monopolistic competition: A market with many sellers (not as many as in perfect market) & 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/ MC = AR

(20) Price discrimination: A practice of selling the same good but 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

Friday, November 7, 2008

Video Lesson: How The Bailout Package For UK Banks Work?

Challenges For Obama

"Change has come"- Obama, 2008

Interesting facts about Obama:

(a) Became the first ever, African-American to be elected as the President of United States
(b) Represents the Democrat
(c) At 47 years old, he defeated the much more senior candidate from Republican, John McCain at 72 years of age
(d) Graduate from Columbia University & Harvard Law School

Challenges for Obama:

(1) Negotiations with troubled countries. Discussions with Iran could be a tough one. Under the current Iranian leadership, there is no sign that they will halt their uranium development programme anytime in the near future. Meantime Russia is continuously opposing US’ idea to place missile defence system in Poland & the installation of radar in Czech Republic. They argued that this technology could later be manipulated to spy on Russia. Will Obama called that off? Or will he just slow down the process?

Will Obama be able to bridge the gap between Israel & Palestin sealed through an agreement? Lastly, how will Obama rebuild the tie with North Korea which is also due to nuclear warfare issue? No doubt, US has taken N. Korea out from its blacklist but I couldn’t deny the possibility that N. Korea will still be placed under strict controls. It is argued that they still possess the technology & expertise to redevelop those nuclear weapons

(2) Dealing with 2 wars. In his speech, he without fail had mentioned repeatedly that he will withdraw US troops from Iraq within 16 months. But the thing is, will he be able to fulfill his promise? Interestingly, on the other hand he will send more troops into Afghanistan to combat terrorism towering through the borders of Pakistan with or without Pakistan’s consent. Will that provoke Pakistan or even causing more unwanted terrorist threat on US?

(3) Stability in financial system. The chaotic banking panics we last seen in September & October may have been avoided. We no longer hear news regarding large insurance companies at the edge of bankruptcy or any big banks being nationalised. However, if his economic policies fail to lift US out of recession in the nearest period, there will be more people being unemployed. Soon, the repercussion will be magnified by the negative multiplier effect. There will be more defaults. More banks will be at their knees

(4) Possibility of economic collapse. Federal rates had been slashed to one of its lowest level, 1%. Meanwhile, US National Debt is standing at about 70% of its GDP. This proves that there is not much space here for economic maneuver. How low can the interest rates go? How much can the US government borrow? History has proven that if the people have lost confidence with the economy, no matter how large is the interest rate cut; still people will not begin to spend into economy. Japan will be a good example. Meanwhile, National Debt is expected to increase in near future to a level that US may soon default.

There are 4 main arguments here. First, in the period of recession, government will always run a budget deficit. Second, growing costs of Medicare & Medicaid. 3rd is the ability to meet the pension obligations of those baby boomer generations by year 2018. Fourth, more debts will be issued to cover losses in financial institutions

(5) Unstable dollar. Despite the value of dollar has been rising against many other major currencies such as the pound & euro, many economists feel that it is very unstable. First, the ever lasting current account deficit. US has been importing more than it export. The large trade deficit here has been offset by the large inflow of capital from oil-rich countries & also emerging Asian economies. If they lost confidence with US economy, probably they will demand lesser dollar, causing it to depreciate.

Also, ballooning national debt may mean that US will increasingly find it difficult to raise borrowing. This will inevitably pressurise the administration of Obama to increase money supply to deal with this. As supply of dollar increase, its value will fall

(6) Environmental issues. Obama has developed an ambitious plan to reduce US emissions of greenhouse gases to 80% below 1990 levels by 2050. He chose to adopt the market based cap & trade system. Here the pollution credits can be auctioned (remember we learn that in Unit 2, tradable permits?). He also pledged to collaborate with other large oil consuming nations such as Brasil, China, India, Mexico & South Africa to come up with an efficient method of reducing pollution. Also in his speech, he seems to be very interested in the upcoming global crisis & that is water shortage. So, how will he undertake his words? We’ll find out