Costa Coffee's Acquisition of Coffee Heaven

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Does Current Recession Improve Contestability Of Market?

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

Does the current recession increase contestability of a market?

Yes

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

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

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

No

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

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

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

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

The Food Crisis of India

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

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

Why is this so?

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

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

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

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

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

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

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

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

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

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

9 effective strategies:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How different is it from the past?

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

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

Strategies to do well in Section A :

(1) The 4 principles

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

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

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

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

YED foreign holiday

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

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

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

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

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

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

What popular questions to expect from each topic?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I will blog about Section B later

Video Lesson: Origins of the Global Financial Crisis Simplified

Why Asymmetric Information Exist?

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

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

Consider the following:

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

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

In short asymmetric information can be caused by the followings:

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

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

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

To What Extent E-Bay Resembles A Perfect Market?

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

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

Consider E-bay.

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

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

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

Evaluations:

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

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

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

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

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

Why Minimum Wage Is A Must?

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

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

The latest statistics for minimum wage:

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

Let’s examine the situation

Advantages:

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

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

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

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

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

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

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

However, it is not without problems:

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

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

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

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

Why Is It So Difficult To Avoid A Recession?

Recession generally refers to overall slowdown of economic activity over a period of time or a business cycle contraction. Officially, it is defined as two successive quarters of negative economic growth. During this period, many macroeconomic variables coincide in similar ways. National output (GDP), employment, household spending, investment spending, capacity utilization and corporate profits will all fall

In some circumstance, economists often associate recession to alphabetical shapes. We have ‘V-shaped’ recession, a period where short and sharp contraction is followed by a fast and sustained recovery. ‘U-shaped’ is where the recession is prolonged. If serious it may lead to economic depression. Then we also have ‘W-shaped’, the double-dip recession and ‘L-shaped’ is where a continuous 8-9 quarterly GDP contraction before bottom out.

Which ever type of recession we are talking about, they have something similar in nature and that is INEVITABILITY

Reasons:

(1) Human nature. This is what we are. Even long ago during the Great Depression, Keynes in his masterpiece (The General Theory of Employment, Interest and Money) had warned us about the ‘dark animal spirits’ that each of us have. It is undeniably the mindset and self-soothing believes that all economic prosperity will last ‘forever’. As such, majority of investors jump into the stock market when it is already at its all time high and rush into buying assets in strategic location when the price is fast becoming unsustainable. Bankers on the other side, relaxed certain lending rules to fatten their profit margin at all cause. Regulators became complacent and lazy to run new numbers. Real estate agents only care about their personal commission. AIG and other insurers were blinded by instant profits, hence lazy to really find out what they are actually insuring. By the time they realize, it is too late since the bubble had burst

(2) Lag effect of a policy. One main problem with fiscal policy (especially in US) is that the decision-making process can be long and unpredictable. Once an executive branch proposes a solution, it must go through various stages of debate on the floors of House and Senate. To make things worse, there are often last minute alterations to the President’s original proposal either by economic principal or vested interests. If the legislative branches are in ‘good mood’, the process may be fairly quick. However if there are any conflicts, as it used to have, a simple process which usually takes months may be dragged to years. By the time the policy is put into action, recession may have begun or worsened and the economics antidote could turn into poison

(3) Overdependence. Early 2000s, banks in US were too generous. They lend money to anyone who wished to own a property without checking their creditworthiness. Banks through their creativity bundled the loans into some form of securities which were then sold to many other investment bankers (IB) and financial institutions (FI) in US. With the money raised from selling these securities, banks’ liquidity further increased and the vicious cycle repeated itself. Many of these investment banks who hold the toxic assets at the same time, have investment in other nations through direct investment or share market of the nation. When default in loan repayment started, these IB, FI and many other rich investors who thrown their life savings into these securities began to feel the crunch and withdraw from capital market worldwide. This explained the nose-diving performance of share market in South Korea, Japan, Singapore and many other developing nations. Companies are reporting heavy losses and begin to shed workforce. The larger the exposure, the greater will be the effect. This is one of the disadvantages of globalization in capital market

There is another way of contamination. Some export driven economies such as Singapore is said to be largely dependent on rich Western economies like US. Its economy depends a lot on exports and the manufacturing sector is more than 25% of her GDP. Most of the exports are high-tech capital equipments. It is not difficult to see the logic. A collapse in large economies implies that businesses will slow down markedly and demand for capital equipments will therefore collapse. Germany is not spared from this too. However, the Chinese economy once again exhibit miracle being able to escape the wrath of recession

(4) Banks not learning the lesson. Despite a close shave due to the unthinkable financial blowout, top banks still seem to be hard-headed. With the abysmal performance reported last year, they still pay out billions of dollars in the form of fat bonuses, most which I believe go to the pocket of top executives. The original nine banks that received TARP (Troubled Asset Relief Program) were reported to have paid out bonuses that are nowhere near to their overall yearly performance. Citigroup, for example suffered more than $27 billion losses last year, amazingly able to grant $5.3 billion worth of bonuses in the same period. Some like Goldman Sachs was paying out of their coffer. Despite earning of $2.3 billion, they distributed $4.8 billion worth of bonuses

Why is this so? I believe that the answer is banks are too large to fail. They know that the government will not allow the banks to collapse. It will be a hefty price to pay for seeing the whole financial system melts down just like that. Indirectly, US government is being held ransom. So they take things for granted. Some quarters therefore suggested the ‘‘clawback’’ provisions, which would reclaim pay from employees whose actions may damage the firm’s long term financial health. Personally, I think that these banks are closely regulated just for now. Once recovery takes place, regulators again will become lax. Banks with their creativity will play around with the loopholes in the new system

(5) Inheriting flawed policies from predecessor. These days, everyone seems to want a piece of Greenspan. He is said to be the main culprit behind the asset bubble. During his tenure as the boss of Fed, he implemented a series of expansionary monetary policy and interest rates were set at low level for a considerable period of time. Because the Fed rates stayed at that level longer than necessary, too many people had rushed into the asset craze thereby creating a bubble. Banks in market economy further relax lending policies to harp more profits. The wealth-effect soon spread into the economy. When new boss, Bernanke took over he is trying to cool down the overheating economy. So rates were raised causing some people to default. The bubble burst began. In such case, there is nothing much that can be done to prevent the recession time bomb. Only the aftermath can be minimized

Should UK Reduce Public Spending To Bring Fiscal Deficit Under Control?

To some extent, it does makes sense for the urge by some veteran politicians like David Cameron to end all those ‘unjustified’ spending within the British economy. The ‘unnecessary’ spending that he pledged to end when Tories come into power are like subsidised alcohol and food for ministers, number of MPs in Common House, ministerial pay cut, slashing number of ministerial cars, prices of food and drink in Houses of Parliament will be raised and various forms of allowances for public servants will be axed. If the Conservative walk the talk, £120 million will be saved a year from administration

On top of that, public spending will come to a temporary halt or scrapped at all costs. It is not difficult to understand why such drastic and desperate measures are announced. The critical problem here is the unsustainable fiscal deficit and national debt that UK is currently facing. Like it or not, UK is perhaps now the most indebted nation on earth.

Earlier this year UK’s national debt (includes current and near future obligations) was standing at £1.3 trillion and as a percentage of GDP, the figure is about 105%. Although US was having a debt of $10.6 trillion, as a percentage of GDP is only 69%. This is seriously something to be concerned of

Despite such debt crisis, personally I couldn’t find myself in agreement with David Cameron.

Reasons:

(1) Offsetting the fall in other spending components. UK is a consumption driven economy and before the recession, private spending contributed to about 67% of UK’s GDP. Now with the new era of frugality ‘thanks’ to pessimism in labour market, the spending pattern has changed dramatically. More people are spending time at home rather than outside. Private savings rate are increasing as Britons are expecting the worse to come. The equivalent explanation goes to investment. Firms have cut all forms of spending such as purchase of capital equipments, R&D, expansion etc due to the losses made

Collapse in consumption (C) and investment (I) will contract the economy. Since two biggest component of AD have collapsed, it is therefore vital for public spending (G) to increase by a large momentum to offset the fall in these two, thus reviving the British economy. In short, we can’t save but must spend ourselves out of recession

(2) UK’s debt is not the highest. Earlier, ONS (Office of National Statistics) expects to have to add between £1 to £1.5 trillion to the public sector debt figure, thereby taking it to the unprecedented level of £ 2.2 trillion. This means UK’s debt is standing about 150% of her GDP. However, I have to disagree upon two reasons. First, analysts are most of the time overly pessimistic in their forecasting. They often incorporate many factors which may not materialize, like those with slimmest chance of occurance. Second, this figure is inclusive of all public sector pension liabilities which the government is not spending now. As such there is no need for the borrowing to be made at the present

Also, oppositions like David Cameron normally inflate sensitive figures like potential national debt and tax liable per person above the officially announced rate to persuade Britons to overthrow the Labour government. This happens as national debt and tax are complicated discipline and there are just too many ways to manipulate the figure. I strongly believe that this will be his key pre-election agenda. Stating this doesn’t mean that I’m a great fans of Mr. Brown. It is a norm in all power struggles. It happens in Malaysia too

(3) Recession to depression. Slash in public spending should remind us of the paradox of thrift. When people think that tightening their belt during recession will do them good, it will actually lead to a vicious cycle that eventually reduces their savings. Fall in private spending will cause the economy to shrink. GDP per capita will fall. It also can be explained via negative multiplier effect. When a company makes losses due to fall in demand for their goods and services, it will be forced to slash number of employees

As from the country perspective, fall in public expenditure while can help to resolve debt issue in a very short run, proves to be more detrimental in long run. Contraction of national output will cause fall in tax receipts, putting government in a tighter position. Therefore, desperately it will have to confront another round of spending cut to meet debt obligations. Perhaps, David Cameron is assuming that increase in C and I can help to offset fall in G. However for this to work, government will have to assist companies and the public to stand on their feet

In a nutshell, while bitter to swallow, Britons must be prepared to embrace the worst. It is worth to make a small sacrifice now than to allow the entire future generations to be saddled by debt. The damage has been done. The only way is to look forward and that is spending out of recession.

Why Do I Choose Teaching? Why Economics?

Every term without fail, I receive this popular question from my fellow students. Some even thought that with the knowledge and experience I possess, I should strongly consider exploring corporate field and taking up positions like economist and financial analyst. Besides, these jobs are considered as more financially rewarding.

Here are my answers:

(1) Noble profession. I truly enjoy the feeling of sharing my knowledge with others. Besides there is ‘nothing’ in the world that can defeat the joy and sensation of watching how your disciples are groomed and scored brilliantly in examination

(2) Flexible hour. I’m not that sure about the culture practised in some other colleges in Malaysia, but in my college working hour is so flexible. Everyday on average each lecturer will be required to teach of not more than six hours. Certain days some of us have no lecture or a minimal of two hours lesson. After that we can sign out or even opt to stay back

(3) Break. In between term, there are many breaks. For instance there will be no classes between end of December and the whole month of January. Also strategic months are like May and June. That is because the students are sitting for examination somewhere in between those periods. In August there is another three weeks of term break. For someone who stresses on leisure like me, this should be the first choice of career. However, most of the time I do take the opportunity to conduct several revision or additional classes to prepare my students better. This is a privilege not available to those in the corporate world

(4) Financially rewarding. Although my full time job is lecturing in college, the flexibility provided does allow me and my colleagues to take up a second or even third part time job elsewhere. For instance I’m selling some stuff in e-bay. Other than that, I work as personal assistant (PA) to the kids from a royal family. Some of my colleagues conduct tuition classes outside. Several even earn up to RM 30, 000 (£5,500) a month and that is fat money for an average Malaysian

(5) Meeting new people. Naturally I would like to meet up with new people all the time but I dislike doing sales. Again this job provides the kind of satisfaction I’m looking for. On top of that, each student and class has a unique profile. Lessons must be conducted in a way that suits the atmosphere of that class. I need to create the right ambience which may not be easy but will definitely be an interesting one

(6) Economics is fun. There are so many new things to explore. While the principles and theories hold, it may not work all the way we desire (due to assumption of ceteris paribus earlier). This is where the role of evaluation sets in. Also the subject by nature is very dynamic. There is plenty of news to be digested each day and if possible adopted and assimilated into lessons. As with Math which I previously taught, I find that numbers are static. More or less it deals with our algebraic skills and the ability to manipulate formulas. Questions in examination are highly predictable and same things are taught over and over again which lead to boredom

(7) Do things my way. Being a lecturer, I have full control of how things are done. For instance, I need to ensure that my students love the subject as much as I do (although not all) and therefore employ the proper mechanism to create such interest. I’m in full control in many other aspects such as number of assignments to be given, whether to conduct revision workshop during the holidays or not, how many past year questions to discuss, speed of lesson in each class etc. In corporate one is taking orders from upper management and is highly unlikely I have such vast influence on how things are done. For instance, when I was working in a private bank, there are some standard procedures to process a legal document. Not to forget that all workers have to face ridiculously tight deadlines e.g. turnover of documents in two days and there are so many follow-ups

(8) Recession proof industry. Education is one of the very few industries out there that is constantly facing an upward trend in demand. In developing countries like Malaysia, private education is an integral part of the economy. Increasing number of parents are now aware of the importance of obtaining quality education and therefore ready to pay high sum of money sending their kids to private institution. Upon the completion of pre-U programme such as the A-Levels, many will pursue their tertiary study in top institutions from UK, US, Australia and Singapore. In recession, demand is even greater. Both working and retrenched executives are considering to further their studies to increase their marketability. As such I strongly feel that I landed in the ‘perfect’ job

Why France & Germany Out Of Recession But Not UK?

The recent miracle showed by France and Germany’s economic recovery is highly likely to reignite the debate about just how robust and flexible the UK economy has turned out to be. Successive government was once so flamboyant and claimed that UK can perform much better without staying inside the Eurozone. This is because of so called flexibility where UK will not lose the power in controlling in monetary destiny. It can influence the level of interest rate which will successively determine private spending and investment. Also, it can manipulate sterling to change the fate of the beleaguered manufacturing industry

On top of that, the UK government is not constrained by Stability and Growth Pact, which states that in any fiscal year members of Eurozone should not incur a budget deficit of more than 3% and a national debt must not exceed 60%. As such, in theory UK suppose to be the first European nation to escape from recession since their ‘hands and legs are not tied’. However, the current situation is very disturbing. A-Levels Economics and related references probably will have to be rewritten and to some extent with lower tone, instead of bragging how great the flexibility was

Source: BBC

Why France and Germany escape recession before UK?

(1) Reliance on France and Germany. UK used to a consumption driven economy where private spending once stood at about 65%-70% of its GDP. Unfortunately, the present Great Recession has turned the British economy into a pessimism state. Certain sectors of the economy almost come to a standstill after consumption and investment spending have both collapsed. In such case, the health of the economy is then very much reliant on the other two components of AD which are public spending and exports. Bear in mind that about 55% of UK’s trade is with the rest of Europe especially France, German and Ireland. Therefore, it is not difficult to see that economies of France and Germany need to pick up before UK does

(2) Legacy of debts. It is also worthy to note that UK’s growth was paddled by credit boom in earlier years. Since interest rate was quite low and credit easily obtainable, British people had engaged in a form ‘luxury’ spending. The property market was the biggest beneficiary fuelling an increase in personal wealth at that time. The vicious cycle repeated itself through the process called mortgage equity withdrawal (MEW). Now, with the collapse of both economy and housing market many went into bankruptcies and some saddled by burden of debt in the midst of losing their job.

It is said that most of the income now goes to servicing the debts upon the loan they took out earlier. Meanwhile in France and Germany, their economy is not driven by property market and the percentage of house ownership is significantly lower. Therefore debt is ‘trivial’ and with great level of household savings in Germany, the people can spend themselves out of recession

(3) Less exposure to financial crisis. Although Germany and France experienced similar problems in their financial sector, it was not to the similar extent as in UK. The Labour government is reported to have spent nearly £1.5 trillion in bailing out the financial sector, an amount which is significant as a percentage of GDP and much bigger than total spending by the rest of G20 put altogether. Clearly, UK’s financial sector still has a long and winding road ahead. Banks are still relying on state financing and until now very much reluctant to lend as can be seen from the high deposits required for any form of lending. One need to understand that banks are the main facilitator of economic activities, which without will be major impediment on road towards recovery

(4) Stimulus plan for auto industry. The German’s car-scrappage scheme has been accredited for turning around the fortunes of its automotive industry. At €5 billion, it was on an entirely different scale to the UK’s £300 million scheme. This scheme has been so successful that it has been extended until the end of year after attracting 1.2 million applicants. The initiative actually offers buyers new and more fuel-efficient car in return for their nine years old car

In fact purchasers benefited twice. First, falling demand leads to lower car price and with further € 2500 subsidy, car price looks even much cheaper. It has great domino effect. A revival of auto industry will have multiplier effect onto other car related industries. More jobs will be created. As people begin to spend, they will eventually jump start every sector of the economy. It is unlikely that British half-baked policy could produce such desirable result

(5) Growing demand from outside. Unlike UK, Germany’s economy is export-driven. As such, with the collapse of global commerce, its economy sank by as much as 6.7%, a bigger figure if compared to contraction in UK by 4.9% in the first three months of 2009. However the revivals of Chinese economy and reported stabilization in US have both fuelled demand for Germany’s exports particularly high end manufactured goods, thus pulling it out of recession earlier than expected. The latest statistic shown that German exports had grown at their fastest pace for nearly three years at 7%. This has positive spillover effect onto France economy as German is its major trading partner. UK’s fate is somewhat different since it has grown to become a service based economy

(6) Relaxation of fiscal rule. The Growth and Stability Pact is believed to have permitted certain flexibility onto France and Germany, therefore allowing them to spend more than usual. No doubt, both run huge budget deficit and have enormous national debt, but if we were to stringently follow the book, situations could have turned for the worse. Pro-long recession will inevitably lead to higher unemployment, deflation and increasing difficulty to finance debts. Besides, these two are the largest economies in Eurozone. Their survival will lead to the survival of the rests of Europe. The recent reported contraction in Eurozone was 0.1% and this figure would have been much larger if not due to the green shoots recovery of 0.3% in France and Germany

In the next posting, I will discuss the potential downside risks towards recovery

Impacts Of Low Oil Price On Oil Exporting Nations

Perhaps the glorious days for Middle East are over-at least for the time being. Once, when oil prices were high, the mighty Saudi Arabia generated a billion dollars a day. Now, it has to contend with earnings around $700 million. That’s a collapse of 30% and considering the state of its economy which is not well-diversified, this is big money. Others like Oman and Bahrain felt the pinch more

We will consider the consequences both micro and macro

Impacts:

(1) Falling revenue. Since oil is a form of necessity with no close substitutes, it has inelastic price elasticity of demand (PED). As such, any fall in market price for oil will brutally hit their total revenue

(2) Lower producer surplus. It’s defined as the difference between the market price and the lower price these oil producers are willing to sell at. Since the market price has deteriorated from its high of $150 last year and now lingering around $70 per barrel, that is an enormous fall in producer surplus. However one could also argue that since the OPEC oil cartel can always cut the oil supply which they recently did, they can always manipulate the level of producer surplus from nose diving

(3) Difficult to increase output. Oil producing nations need to invest heavily on oil exploration, oil production facilities and R&D. Unfortunately, most of the funding is derived from oil revenue. With such a drastic collapse in oil prices, I’m uncertain if this will discourage oil companies from continuing the oil exploration process since the operating costs are very high too. If materialise, it is expected that oil supply in the near future may increase but at slower rate than demand. Given the supply of oil is inelastic, any increase in demand will quickly drive the oil price up and could be hazardous in a fragile economy

(4) Job losses. Governments in the region derive 75% to 95% of their income from oil exports. That shows that their economies are too dependent on oil and very thinly diversified at same time. There is no solid manufacturing or even services sector to back them up. As such, falling oil prices will begin to eat into employment and so oil engineers particularly will be the first to feel it. It has devastating effect considering the negative multiplier effect. In the end, an initial collapse in exports will bring private consumption and investment to its knee. More unemployment will result leading to even greater problems

(5) Shrinking economy. Simple AD-AS analysis. Collapse in oil exports, fall in investment rate and private consumption will mean that AD shifts leftward. As this happens, real GDP will shrink and therefore resulting in recession. Also, recession will usually lead to price deflation, a gruesome enemy. We have seen how the mechanics work on Japanese economy. However, one could also argue that this may not happen especially when the governments’ fiscal stimulus is effective enough to prevent the three components of AD from collapsing too much


(6) Fiscal deficit. Happens when government spending is in excess of what it earns from tax. In the current circumstance, fiscal deficit is almost inevitable since tax revenue from all sources like employment, corporate earnings, stamp duties, oil related etc fall. Simultaneously, the ambitious spending by some like Saudi Arabia and Dubai on construction projects and lucrative development projects aggravates. To balance the book, they definitely prefer oil prices to be higher than the current rate. Saudi Arabia and Kuwait while may face the danger of budget deficit, need not worry since these two have the biggest pile of cash reserves. It is those like Oman and Bahrain with smaller cash reserves and lower oil wealth which may face the spending wrath

High Sugar Price

Source:BBC

The price of sugar settled at 22 cents per pound as on Monday, a level which we have not seen since 1981. Again the fundamental cause can be explained via the interaction of demand and supply. As in this case, demand increases as Brazil intensifies its ethanol production which requires sugar

At the same time, supply decreases as one of the world largest producers, India is facing supply disruption due to unfavourable changes in weather. Its had less rain during the monsoon season. Sugar production from India fell 45% on a year-on-year basis from 2008-2009

Why Do People Earn Different Amounts?

Until now, there is no single dominant factor that is capable of explaining the gulf in pay that persists between occupations or even within the same occupation itself. Some of the relevant factors are explained in detail as below. In reality, however it is much more complicated as is often the combination of two or more factors

Reasons:

(1) Compensating differential. A popular economic term that relates wage rate to unpleasantness, risk and other undesirable attributes of a job. Technically, it is defined as an additional income that must be offered to motivate one to take up the undesirable job. A construction worker is most likely to receive a much higher pay than, say a cleaner or a clerk for the risk undertaken. They assume risk like falling off from building, industrial accident when dealing with machineries etc. Some IT officers especially system support, may have to work nights or other unsociable hours. As such they receive higher pay to compensate for this

(2) Education and qualification. Level of education should be a good discriminator of pay scale. If an individual who studies for degree receives a pay equivalent to a cashier having O-Level, there will be very few pursuing tertiary study. The logic is, there is an opportunity cost in terms of income lost when one spends more time studying regardless of full time or part time. So now they are compensated for it

Also, depends on number of years one has to spend. The longer it is, the higher the pay (ceteris paribus). For instance a lecturer with PhD earns more than an ordinary teacher. Similarly, a heart specialist earns much more than an ordinary doctor given the length of time adopted for training. The supply of labour from these highly skilled professionals are low and highly inelastic while the demand for their service is great. That accounts for the vast difference in pay

(3) Marginal revenue. Some people are able to command high salary as every economic transaction they involve in yields high marginal revenue. Consider professional footballers like C. Ronaldo and Beckham. They are central in every game. They influence the number of tickets and merchandise related to MUFC sold, fans base and probably to some extent shape the English premier league. Whenever Beckham advertises for Pepsi, directly or indirectly he influences people to drink Pepsi. As such the company generates unimaginable supernormal profit (MC = MR) and wouldn’t mind paying him millions for one advertisement

(4) Protection by trade union. There is empirical evidence that unionized workers receive better pay than those who are not represented. Although the number of trade unions has declined steadily both in UK and US due to the shift from manufacturing sector to services sector, the effect of their presence is much felt. Probably you have heard of United Auto Workers (UAW), United Steel Workers (USW) etc. The chief aim is to gather more voice and to have more negotiation power, namely collective bargaining

There are many ways to push up the salary. First, they try to increase the demand for the goods produced by union workers. For instance, USW once in early 2000s pressurised the Congress under Bush administration to impose tariffs on imported steel hoping that American industries will turn to ‘cheaper’ locally processed steel. Also they could decrease supply of labour to push up wage rate. Craft unions such as bricklayers and electricians have often adopted restrictive membership policies such as high initiation fees, long apprenticeship programs and limitations on union’s membership. Professional associations such as American Bar Association and American Medical Association also adopted similar practice

(5) Fringe and benefits. To some extent, it is true that some jobs may offer lower wages than others because they got more to offer to employees such as annual holiday, company cars, free life insurance, monthly gathering etc. These jobs are thought by some people to give lots of satisfaction and hence may be prepared to undertake without expecting high salary

(6) Immobility. Some people may be offered a hard-to-resist deal, but is in another area which could be far away from current residence. However, at the same time they value family, relatives and friends more than the pay. As such they reject they job. Also some people may want to move to a better-paid job but not able to do so since they cannot afford housing in new area. Consider receiving a pay which is just extra several hundred £ in City. Accommodation would be disastrous. Nevertheless high labour mobility does help to reduce differences in unemployment and wage rates in different parts of a country

(7) Imperfect information. Some people settle down for a lower pay because they do not know about better-paid jobs elsewhere. Meanwhile, people like fresh graduates although may not be able to demand for high wages, sometimes could end up doing a job which its pay is much lower than market as they were ‘misinformed’ that that is the pay they deserve being freshies. These two situations are called imperfect information

Why Supply Is Highly Inelastic In Short Run?

Source: economicshelp

Price elasticity of supply (PES) measures the responsiveness of supply for a good to a change in price. It is given by the formula of:

PES = (% of change in quantity supplied) / (% of change in price)

It is meant to determine whether the supply of a good is sensitive to price changes or not. The sign obtained from the calculation must always be positive due to the natural relationship between the decision to supply and market price. The higher the price the more will be supplied and the lower the price the lesser will be supplied. However, not all the time producers can be very responsive to market price. In this case the PES < 1. The interpretation is, a large change in price leads to a smaller than proportionate change in quantity supplied. In other word, say even with large increase in market price, producers will be unable to supply much

In real world, there are several items that fall into this. For instance supply of new housing, fresh vegetables and commodities (this may be arguable). Consider a property developer. Even if he receives the information that the area will be booming in nearest time, he will not be able to suddenly increase the quantity of houses and shop lots due to constraint in factors of production. He needs more time to hire necessary workers, obtain planning permission to enlarge the housing area, order raw materials and getting the right number of construction machines

In some extreme cases, PES could be 0 (perfectly inelastic). How is that possible? Yes it is, if we are considering a very immediate time period. Last week when I was in a hobby shop, I planned to get an item called Fallen from Transformers: Revenge of the Fallen and at that time I am willing to offer much higher market price due to its rarity. However I was told by the shop owner that next wave of stocks will arrive the following two weeks. This means, no matter what price I offer he will be unable to supply me that item. So his PES at that time was zero

In short, PES is largely concern with time frame under consideration. The shorter the time, the more inelastic is the supply and the longer the time, the more elastic it will be

Casino And Recession

The ‘Great Recession’ had claimed another casualty-MGM Mirage. It’s a powerful group of 20 casinos operating in Nevada, Michigan, Illinois, Mississippi and China. In the recent report, its quarterly profit ending June took a sharp dip with the lost of $216.2 million. This whooping figure is tantamount to a fall of 69%

Based on this statistic, gaming industry may be regarded as a form of luxury goods but an ‘extreme’ one, perhaps surpassing the income elasticity of demand (YED) in sports car industry, designers’ clothes, expensive handbags and shoes, foreign holiday etc. Even between these goods some can be ‘more luxury’ than others. Recall the formula of YED which is given by:

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

Being a luxury good, YED must be greater than 1. The relationship must be positive. This means, as income falls the quantity demanded for gaming will fall but GREATER THAN PROPORTIONATE. Consider a numerical example of (-28%) / (-10%) = + 2.8 and vice-versa

However, some may argue that a fall of 69% profit may not necessary related to the number of gamers and patrons of its premises. It could be due to other factors yet to be considered such as soaring fuel and food prices which increase its operating costs as well as other cost inefficiencies

How China Accumulate So Much Of Foreign Reserves?

Before 1980s, the Chinese economy was rather insignificant due to the establishment of herself as a ‘self-centered’ economy. In other word being a centrally planned economy where there was very little trading that took place, very few private enterprise and much of the economic activities were in the hand of the government. China conducted minimal trade with outside world by exporting just enough raw materials and simple manufactured goods to cover payments for the import of strategic minerals and other necessities not available back home

How it accumulate so much of foreign reserves then?

(1) Massive trade. The Chinese economy took a turn when Deng Xiaoping, the leader of the Communist Party of China became a reformer who transformed China towards market economics. It took place somewhere in late 1970s. This means unleashing the economy from the central grip by allowing private firms to grow, promoting international trade and encouraging the flow of foreign capital.

As at 1978, its foreign reserves stood at $1.6 billion. However by 1984 the figure whooped up to $17.4 billion. What an amount during that time and considering the accumulation within just 6 years. However by 1985 and 1986 the foreign reserves shrank to around $12 billion. Nevertheless it was a healthy indicator as China was importing capital goods like machineries to finance and expand its production capacity (outward shifting PPF) to meet the growing demand from outside. China’s major export destinations are like US, Hong Kong, Japan, South Korea and Germany. Since then, China’s accumulation of foreign reserves continues to mountain ‘abnormally’ especially with her accession into WTO (World Trade Organisation) in 2001. Countries like US being the world’s largest consumer, continues to buy from China due to factors like low production cost, improving quality and innovation but mainly due to the undervalued yuan. Amazingly China is set to topple Germany as the world’s largest exporter this year due to tumbling European economy.

(2) Inflow of foreign capital. The liberalisation of Chinese economy is one but out of many other reasons as to how it becomes the centre of attention. Large number, cheap and yet educated workforce is often cited as the top reason why increasing number of transnational firms are relocating or even outsourcing part of their production process in China. Of course there are other reasons too, such as tax-friendly policy, ease of obtaining certain natural resources and modern infrastructure. When foreign firms set up subsidiaries, factories or outlets in China the process is called inward investment. They will more often than not, raise capital from home country and bring it into China, especially new firms

In the recent, its foreign reserves had surpassed $2.13 trillion for the first time. However, it is not due to excess of exports over imports. This is as a result of foreign investors perceiving China as the world’s ‘safest’ haven in uncertainties like now. Its economy is estimated to grow by around 8% in the second quarter, indicating that the stimulus package seems to be working well unlike in other major economies. As foreign investors continue to pour money into Chinese stock market as well as property market. The Shanghai Composite Index surged has jumped over 74% alone in this year. There is also a fear that this will create a bubble in an already heating commercial property market. Much of these however are hot money. It refers to money controlled by investors who actively seek short term but high-yielding investment opportunities

As such it can flow out of the country anytime too. Therefore it could be highly unlikely for China to sustain its position of foreign reserves at such high level for long term