Thursday, September 30, 2010

Economics of Insurance

Lately, an insurance agent whom I knew through a friend of mine approached me with some ‘awesome’ savings plan offered by his company. Honestly, I couldn’t recall much of the conversation and financial planning tips thrown to me. It is more of his bragging about the potential return and how many people have actually hooked up the product that seized my attention. I was ‘enticed’ while going through the figures he computed.

It wasn’t any medical card or life insurance policy, but an alternative to the conventional savings like fixed deposits in the banks. It offers 4% return for the first 5 years, 5% the next few years and 6% on the following years. The maximum it offers is 6%. My friend, who sat next to me at that time was so eager to sign up considering the 4%-6% offered. I quietly told him to reconsider.

Source: theStar

In Malaysia, CPI (price level) increases on the average of 3% every year. That has been the trend for the last three decades. It is even more important to note that rise in general price level does not reflect the actual situation face by average Malaysians as some will be more affected than the others. For instance middle-income households with large families or those parents who need to travel extensively everyday will be more affected than small families or those who stay within the vicinity say, 20km from their workplace. The CPI is just a weighted average!! It is fair if I say that personal expenses inflation is a better barometer

In that case, I believe that rise in expenditure on food, fuel and transport is definitely surpassing 3% every year. This is because subsidies on fuel, flour, sugar, rice and other necessities have been cut. Let’s not forget that we do not just consume flour, sugar, prawn, fish etc in its raw form but also in value-added items. Food that we consume in fine restaurants or even coffee shops are levied at market price but is not captured by CPI. Transport which carries the weight of 15.9% does not consider the ‘actual price’ of the cars when they are hire-purchased. Prices of construction materials such as cements and clinkers are price controlled, but the prices of house and rental is subjected to market force which is not regulated. Also, surprisingly mobile downloads and phone bills are not included in the communication category although they are integral part of our life

In a nutshell, price level will continue to increase and having a fixed return for a predetermined period is a BIG NO NO from me. If I were given an option, I would rather engage in investment like unit trusts that carry very little risks and yet potentially yield much better return. Let’s invest to beat the inflation

Friday, September 17, 2010

The Tale Of The Rising Yen

The recent Bank of Japan’s massive intervention into money market is one politically bold move which is least expected by many. It creates a surprise, since BoJ has been passive all these years. The last round it intervened was in 2004. Nonetheless, such action is greatly applauded by Japanese exporters, especially those in car (Toyota) and electronics industry (Sony). A weak yen is desired since it gives manufacturing industry a competitive edge. Japanese goods will look artificially cheaper especially to Americans and as such US will hopefully continue to buy from Japan, thus paving way for export-led recovery. It is done by using the yen to buy dollar

Why does yen appreciate?

(1) Profits are coming home. It is reported that Japanese firms will bring back at least 1.5 trillion yen ($16.7 billion) of overseas profits. More repatriation is expected since the government’s announcement of tax breaks last year. It is a measure to boost an economy in conundrum. Lower tax leads to higher retained profits, and hopefully companies will have greater incentive to invest. It could be on the purchase of new capital equipments, new building to accommodate enlarged scale of operations etc, although the effectiveness is subjected to debate. Earnings in dollar and euros will have to be converted back to yen. Therefore yen appreciates due to escalating demand for it

(2) End of carry trade. Before we go into details, it is best to understand what is meant by yen carry trade. It is a practice of borrowing money at low interest rates and lend them out in high interest rates. All these years, interest rates were purposely kept low to revive spending into the economy. As a matter of fact, it is reckoned that Japan has the lowest interest rates at all time in the world, ‘no thanks’ to its slumbering economy. Many people borrow from the Japanese banks and park their money elsewhere, say UK, US or even the Eurozone. In a more technical way it would be, borrow the money from Japan, lend it to the banks in Western economies to do business. In return, those people get higher interest rates gain, and some of it will be paid back to Japanese banks. The reward is the difference between those two interest rates. However, interest rates offered by major Western banks are equally low now. Hence, there is not much gain after all. Furthermore there is always a risk of lending money to a foreign economy that could face the risk of collapsing. Those arbitrageurs now call back their capital to repay their loan to Japanese banks. Again, we use foreign currency to demand for yen, leading to its appreciation

(3) Safe haven. Switzerland is well known as safe haven in the current credit turmoil, and ‘congratulation’ to Japan for joining the rank. The interesting issue here is why investors seem to lose interest with US? Normally, currency investors who seek for stable investment would like to park their money in US given the credibility of the world’s largest economy. Somehow, the dollar has been slumping against many other major currencies in recent weeks as interest rates continue to fall. This makes the dollar as less attractive investment compared to other currencies. Although Japanese debt as a percentage of GDP is twice as large as the US, let’s not forget that most of the debts are owned by domestic investors, given the high-savings ratio in the economy. Therefore Japan is very unlikely to become the victim of capital flight. Secondly, Japan is experiencing deflation. This means although interest rates are low, but real interest rates are high. Put it simple. Even though your money does not grow in terms of amount, things around you are getting cheaper. In short, with the same amount of money you have, you still get to purchase more goods and services. Hence, it creates an ‘illusion’ that Japan’s interest rate is actually higher than the rest of the world

(4) Purchase of government bond. We all know that Chinese monetary officials are the hiding-hands that lead to the steady appreciation of dollar against the yuan. They persistently keep the yuan low by buying US bonds, which subsequently lead to rising dollar. This move has been largely criticised by US lately since it gives the Chinese exporters an unfair advantage. Americans importers are trapped. They have ‘no other options’ but to continuously buy from China since it is artificially cheap. That explains why US is in large deficit and China is in large surplus. No wonder China has the world’s largest dollar reserves (more than 2 trillion dollar). But due to mounting political pressure, China seems to lose appetite for US dollars and begin to diversify into other currencies, including the Japanese yen. This contributes to rising yen against the yuan. However it is argued that the purchase of Japanese bonds is on small scale, and hence is unlikely to have a long lasting effect on yen

In the current credit crisis, rising value of home currency is the last thing all influential economies would like to see. Export-led economies like Japan and China would resist the most since their economic growth largely depends on it. The same goes for US that would like to export itself out of trouble

Tuesday, August 24, 2010

Is Pakistan Economy Ready To Embrace The Worse?

It seems that the flood-nightmare in Pakistan is not over yet. Although the Indus River is already at its 50-year high, it is expected that the water level will continue to rise. With the scale of such calamity, Pakistan is now officially known as the sickest economy in South Asia. Although millions have been contributed by international agencies and governments, still it is insufficient to restore homes, food, buildings and casualties which were washed away by the flood. In some areas, people complain that the aid has not reached them

Potential problems with Pakistan economy:

(1) Militants recruit. There is no perfect atmosphere other than now for jihadists to exploit the situation by spreading seeds of anger and recruiting militants. It is reported that some Islamist charities with suspected links to militant groups have stepped up by providing tents and food for those victims particularly in the northwest, an area dominated by the terror groups. If the Pakistan government does not act fast enough to reduce the scale of the disaster and reach those areas where help is needed the most, I strongly believe that they will have more problems to deal with in the future. Once the number of militant increases, Pakistan and US government will have to spend more money to strengthen the defence

(2) Disruption to economic activities. Pakistan has a broad primary sector where it mainly produces wheat, rice, cotton, sugar and livestock. It contributes to about 22% of her GDP and is the largest employer, hiring 45% of total workforce. Unfortunately, the flood has hit the agriculture heartland very badly. 500 000 tonnes of wheat, 2 million bales of cottons and 200 000 livestock were gone just like that. It affects the livelihood and income of thousands of farmers as well as employment in related sectors such as food processing. Decline in the farming output will probably put Pakistan’s economy to a halt and say ‘goodbye’ to the targeted growth of 4.5%

(3) Reduction in potential capacity. Most of the productive economic resources like land, labour and capital are devastated in just a matter of two weeks. Up to date (27th August), the flood has officially claimed 1600 lives and it is strongly believed that this figure will rise significantly once the water level recede, allowing for other bodies to be counted. It will also further rise due to the slow emergency aid for clean water supply and considering the fact that many are consuming from contaminated water, thus carving path for water-borne diseases. On the other hand, the flood has engulfed huge arable farming pastures. As such, many types of agricultural activities will be ‘forbidden’ in many seasons to come, due to the drastic change in the structure of soil e.g. water-logged. The government’s official assessment estimates that roughly 5000 miles of roads and railways, 7000 schools, 400 health facilities and thousands of agricultural tools like water mills are washed away. This has many implications. Without roads and railways, agricultural output cannot be delivered to designated areas. Factories output will be stranded while waiting to be sent to port. Inability to acquire basic education and healthcare will further reduce the productivity of the people while not having sufficient machineries to work with further reduce Pakistan’s output. It is best illustrated by an inward shifting PPF

(4) Inflation and ballooning deficit. Inflation is defined as a sustained increase in price level. In June, inflation rate was at 12.67% higher than a year earlier, while in July it rose another 12.34%. With such scale of destruction, consensus is now somewhere around 20% in the nearest future. It is largely contributed by escalating food prices and the destruction of food supply distribution network. While it is a great relief to hear that the Pakistani government will gear towards an immediate reconstruction, such news must be treated with great caution. Due to the insufficient foreign assistance, the rise in fiscal expenditure will have to be borrowed from the Central Bank, leading to the increase in money supply thus potentially push the inflation higher. Even the initial forecasted budget deficit for the year 2010/11 is considered as far too optimistic. With the inevitable rise in government spending and fall in tax receipts due destroyed output, it may be at least 6% of GDP now. The deficit reduction was part of the agreement between the government and IMF due to the extension of loan in 2008. Seems that the noble goal has to be brushed aside for a more severe humanity crisis

Sunday, August 15, 2010

US Is A Step Closer To Japanification

To me 2010 is a ‘fascinating’ year. It represents economic threats as well as opportunities for countries around the world that are closely linked to one another via international trade. Heat of debates seem to have moved from topics like ballooning national debt, possibility of hyperinflation through quantitative easing, current account deficit to one where deflation is inevitable

Deflation vs. disinflation
Before I go into the details, it will be interesting to explore the difference between disinflation and deflation. They are not quite the same. The former means prices of goods and services are rising but at a slower rate. Meanwhile deflation is a complete fall in prices of goods and services, hence is a negative inflation rate. If disinflationary period continues until inflation rate is zero, only then the economy is said to have entered into a deflationary period

The Japanese experience
The word deflation is synonymous with the Japanese economy and I mean VERY. Before the so called Long-Lost-Decade which began in early 1990s, Japan had gone through a period of economic miracle until late 1980s. Savings in the banks were at all time high. Since loans and credits were easily available, speculation was imminent particularly in the real estate market and Tokyo Stock Exchange. At the peak of the bubble, Nikkei stock index was over-rated and value of real estates was extremely over-valued fetching up to USD $139, 000 per square foot. It was acknowledged that property prices in Japan were the highest in the world at that time

There are many versions of arguments surrounding the meltdown of Japanese economy. The most popular is that income did not grow fast enough to service the increasing debt load which resulted in growing defaults and delinquencies. People and companies that had borrowed from the banks to invest in real estate were unable to repay the banks when property prices fell. Even banks became insolvent due to credit shortage and lack of liquidity in the entire financial system

Recession to depression and deflation

Recession is generally known as two successive quarters of negative economic growth while depression is viewed as a sustained long term decline in economic activities which is followed by events like shrinking consumption, bankruptcies, large scale unemployment and banks on the run. It is lengthier than recession. Somehow, there is no consensus over how long an economy should be in recession before turning into a depression

Source: economicshelp

It is strongly associated with collapsed of spending into the economy, thus driving AD leftward. This is usually followed by a fall in price level. To be honest, deflation/ disinflation is much more difficult to be tackled than inflation. It is extremely difficult to revive consumer and business confidence once it had totally collapsed. The Great Depression in US and Japan tell all the tales.

Why deflation is disastrous?

(1) Exacerbate depression. When general prices fall, consumers will expect goods and services across the economy will be cheaper somewhere in the near future. As such they choose to defer current consumption. It will not be the case of one or two individuals but the entire nation will think alike. As people defer spending, consumption which is one of the drivers of economic growth falls, further shifting AD to the left. It does not take a genius to see that price level falls. They cycle continues

It is also worth to note that, in such period return from savings is higher. Even when the nominal interest rate is 0% and deflation is say, 3%, the real interest rate is would be 3%. What I’m trying to say is that, although the value of money does not grow (0%), prices of things in the economy become cheaper (-3%). In other words, for every 100 yen, one gets to purchase more goods. Purchasing power has increased. No wonder there is an incentive to save!!!

(2) Increasing the value of debts. During inflation, value of debts will be eroded since the same amount of money that bank receives worth lesser over the time. On the contrary, deflation causes mortgage repayment to be a problem. In depression, wages are falling. Assuming that one owes the same amount of money, the monthly commitment expressed as a percentage of total income will rise

(3) The end of monetary policy. During the period of high inflation, interest rates can be raised indefinitely to slow down spending and investment. However, in deflation, interest rates cannot go lower than 0%. It just does not make sense to have negative nominal interest rates. Therefore this marks the end of the conventional monetary tool and the Central Bank will have to depend on non-conventional method like quantitative easing (print more money). Such new monetary policy action belongs to the realm of experimentation (considering the Fed consulted Japan last year over this) and therefore is prone to error. Policymakers are now left with fiscal tools

Will US turn Japanese this round?

I hate to say this but too bad US is no longer an engine for global economy. Despite still being the world’s largest consumer, it began to lose its steam few years ago. Its dominance is gradually shadowed by the emergence of China and India which easily register an 8% to 10% real GDP growth every year. To make things worse, US economy seems to inherit the Japanese-style meltdown ‘disease’. There are just too many evidence leading to this

(1) Similar origin. Both economies experienced a period of unsustainable economic growth which eventually led to a drastic rise in income. High consumer confidence coupled with liquidity rush in financial institutions largely explain why Americans and the Japanese dare to assume debts beyond their appetite. Rise in income however wasn’t for long but too much debt had already been taken to finance the purchase of residential and commercial properties. One by one began to default in loan repayment. Banks now face cash shortages and hence unable to generate lending. Demand for real estate falls. The property bubble finally burst. Arguably the condition in US is said to be worse due to the introduction of various unsafe loans as well as mutation of debts

(2) Ageing population. Although population is still growing in US, its rate is slowing down markedly, somewhere close to 1%. This is exactly what Japan had experienced in the 1990s. The only difference is that Japan has entered into the era of shrinking population and it may not be too distant in the future before US joins the league. Why is this bad? We first look at the population pyramid. Too many elderly people indicate more trouble for government finances. Bulk of the money will be channelled towards unproductive use like pension payments and the setting up of certain healthcare department to address elderly-related disease. This way of spending will not lead any economy out of trouble. Secondly, where to get the needed finances? Raising the income tax is a big NO-NO from me. Shrinking workforce may mean that working individuals will have to devote 50-60% of their wages to tax so that it can sufficiently cover the expenditure for the retirees. Finally, shrinking population means US will no longer be a consumption driven economy. All these points to frail recovery

(3) Forever rising debt. The current level of US national debt is about USD $ 13 trillion or 89% of her GDP. It is the sum of all the outstanding debt owed by the Federal Government when it runs budget deficit every year (G>T). Two-thirds of the debt is owed to firms, people and foreign governments who bought the bonds issued by US government while the rest is owed to itself via Social Security. Whatever money that has been borrowed will have to be paid back some dates in the future. Right at the moment, there is still no clear solution over the pension payment to Baby Boomers. Number of retirees will increase significantly over the next two decades. Theoretically, taxes must increase. It is just a matter of time before US discovers that foreign government will gradually shy away from all those bonds. Fall in the demand for these securities will cause its price to fall (law of demand) and interest rates to go up (inversely related). This will eventually worsen the state of economy. Furthermore, lessening of demand for bonds will put downward pressure for dollar. Therefore, foreign holders get paid back in currency which worth lesser. Demand for bonds fall further. In a nutshell, ballooning national debt will put a brake to US economic growth

(4) End of traditional monetary policy. Policy makers is US seem to head towards a ‘dead-end’. It faces almost the identical problems experienced by Japanese economy. Like I mentioned earlier, zero interest rate policy does not do any good. Economic activities remain weak partly because some of the banks are still reluctant to pass on the rate cut or while some others just make it more difficult to get credit by imposing various conditions. On the other hand, consumer confidence is at record low. Job losses are on the rise which further undermine borrowing and spending into the economy. Perhaps the Fed will have to keep interest rate low (0% -0.25%) until certain level of inflation is achieved. Although quantitative easing has been aggressively conducted, credit growth and broader money creation still fall. Velocity of circulation for money slows significantly

All these are clear indicators that US economy is ‘ushering’ an era of deflation. It will not happen today, tomorrow or next few months. But for sure, it is underway

Tuesday, July 20, 2010

Is Malaysia's Subsidy Rationalisation Program Justified?

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

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

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

Why subsidy rationalisation is justified?

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

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

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

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

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

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

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

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

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

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

Here are some possible explanations:

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

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

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

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

Tuesday, May 25, 2010

Video Lesson by Richard Pettinger on Market Failure: An Introduction

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


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

Data Response Unit 1: Competitive Markets (Air Pollution)

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

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

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

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

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

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

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

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

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

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

Last tips:

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

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

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

Sunday, May 23, 2010

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

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

Why do I say so?

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

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


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

(b) Whether a good is elastic/ inelastic in demand: Define PED + mention if it’s inelastic and why + evaluations
(c) Whether another good is the substitute/ complementary for the mentioned good in extract: Define XED + mention that it is substitute/ complement + have positive/ negative XED + explain how relationship works + evaluation
(d) Is the good elastic/ inelastic in supply: Define PES + inelastic in short run/ elastic in long run and why + evaluation
(e) Impact of increase in production costs for firms
(f) What happen if the good is subsidise by government: Define subsidies + diagram + explain the diagram and impact onto producers + evaluation
(g) Effectiveness of buffer stock: Define buffer stock + diagram +explanation of diagram + evaluations
(h) Government failure: Negative impact of government interventions + evaluations of why it is not that bad with government intervention

Cigarettes/ Alcohol/ Education/ Healthcare:

(a) Definition of private cost + external cost + examples for each type of cost
(b) Definition of private benefit + external benefit + examples for each type of benefit
(c) Diagram showing existence of external costs/ external benefits

Congestion/ Pollution
(a) Definition of private cost + external cost + examples for each type of cost
(b) Diagram showing that negative externalities exist
(c) Methods to overcome congestion + evaluation of each method
(d) Methods to overcome pollution + evaluation of each method

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

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

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

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

They are:

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

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

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

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

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

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

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

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

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

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

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

Others are like increasing number of new diseases/ rising population

Stay tune for next forecast question: Air pollution

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

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

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

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

3. Budget deficit: Where government expenditure exceeds tax revenue

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Sunday, April 4, 2010

Handy Definitions for Unit 2: Managing the Economy

Here they are:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(18) Inflation: Sustained increase in price level

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

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

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

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

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

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

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

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

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

Video Lesson: UK Budget 2010

Part 1: Budget 2010 in UK

Part 2: Budget 2010 in UK

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

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

(2) Opportunity cost. The next best alternative forgone

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Monday, March 29, 2010

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

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

How Greece end up with such mess?

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

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

Will Greece be able to get the funding needed?


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

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

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

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

May not be able to get sufficient funding:

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

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

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

Friday, March 26, 2010

Does Globalisation Benefit Developing Countries More Than The Developed Ones?

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

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

Why developing countries benefit more?

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

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

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

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

Why rich countries benefit more?

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

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

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

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

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

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

What Expedite Globalisation?

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

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

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

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

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

Sunday, February 7, 2010

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

This is a question being asked by my student recently. Simple. Let's use a little bit of economics and business sense here. Imagine that if there is only one seller in an area or there are just very few available around. This means, it is rather difficult to get hold of that particular item or service. As such it gives the producer some room to adjust the price upward since they are in control of the situation
On the other hand, if a good or service is so widely available that consumers can get hold of it just anywhere, then the producers will not be in advantageous position to manipulate the price upward. This is because, an increase in price will cause the consumers to substitute away from that firm and move towards its competitors. A reduction in price makes more sense in order to get rid of those stocks which may be sitting on the shelves too long. Furthermore there will be new stocks coming in from time to time. If those old stocks are unsold, then there is no place to keep these new ones

Economic Reasons For Price Increase

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

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

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

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

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

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

Saturday, January 2, 2010

Mastering The Art of Evaluation

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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