Free Essay: Discuss the Economic Effects of running out of non renewable raw materials
1. Higher prices of raw materials. As Supply falls price will rise. Demand for many of these goods is inelastic; therefore the price rise could be significant.
2. This would lead to an increase in costs of production, Therefore it would cause the SRAS curve to shift to the left. This would lead to a higher inflation rate and lower economic growth.
However, it is worth bearing in mind that higher raw material prices don't necessarily lead to inflation and lower economic growth. There are many other factors that affect inflation. Cost push inflation from raw materials may be offset by technological advances.
3. Countries who rely on importing raw materials will see an increase in costs. However, they are unlikely to lose competitiveness because it will effect all countries. However, those countries who import the most raw materials will see a deterioration in their current account on the balance of payments.
4. Countries who export these raw materials may see an increase in export revenues. This is because demand is inelastic for these goods. However, there will come a point when they run out of raw materials altogether, negatively effecting their export revenue. This could be very damaging for countries.
5. In the long run, rising prices of scarce commodities will provide incentives for firms and governments to develop alternatives. For example, in recent years there have been developments in finding viable alternatives to petrol. As the price of petrol increases, it becomes more attractive to use hydrogen / solar powered cars. However, markets don't always predict future shortages. Free markets respond to price changes rather than anticipate in advance. Therefore, to develop effective substitutes for some raw materials may lead to market failure. For example, the research starts when it is too late. Therefore, the effect may depend upon whether governments intervene to subsidise the alternatives.
see also: Should we be concerned with running out of oil?
Wednesday, May 30, 2007
Thursday, May 24, 2007
Does GDP measure Economic Development?
- Examine the role of GDP figures as a measure of economic development. (15)
- GDP measures National Output, National Income and National Expenditure.
- GDP per capita gives a rough guide to average income per person in the country.
- GDP is a rough guide to living standards.
- Higher GDP enables more consumption of goods and services.
- Potential for Higher tax revenues, and therefore government spending on public services like health, education and transport.
- Higher GDP may create more employment opportunities.
- Generally countries with much higher GDP OECD countries have more economic development than low GDP
Limitations of GDP in measuring Economic Development
1. Depends on distribution of GDP.
For example, if 90% of GDP is owned by small oligarchy then the majority of economy may have low economic development. This is an issue for several sub saharan African economies, where high % of GDP is owned by small % of those in power.
2. GDP may underestimate economic development.
This is because official GDP statistics do not include black market; this is a significant part of subsistence economies. However, economic development often reduces the size of this "black market" or economic activity which is not recorded.
3. Difficult to Compare Living Standards through GDP.
This is because exchange rates do not reflect local purchasing power of a currency. For example, a Big Mac may cost $5 in Japan, but $1 in India. Therefore, comparisons need to take these into account.
4. Levels of Infrastructure important to economic development.
For example, GDP may not be used to improve infrastructure, communication and transport. These factors are very important for determining development. GDP does not indicate how money is spent. GDP may be used to finance projects that do not help education development.
5. Standards of education important for long term economic development.
6. Some countries may get high GDP from primary products, but struggle to develop and diversify into manufacturing and service sector based economy.
See also:
Wednesday, May 23, 2007
Essay: MRP Theory and determination of wages
Question: " Using marginal productivity theory, examine the view that 'wages are determined not by productivity alone but by the interaction of demand and supply of workers of various skills' "
Marginal Productivity theory states that demand for labour depends upon marginal revenue product (MRP) MRP=MPP * MR.
For example, strawberry pickers will be paid depending upon how many strawberry's they pick. It is easy to measure productivity; the more you produce, the more you will be paid.
However, many other factors determine wages.
Marginal Productivity theory states that demand for labour depends upon marginal revenue product (MRP) MRP=MPP * MR.
- MPP = Marginal Physical Product (productivity of worker)
- MR = Marginal Revenue - revenue gained from selling good
For example, strawberry pickers will be paid depending upon how many strawberry's they pick. It is easy to measure productivity; the more you produce, the more you will be paid.
However, many other factors determine wages.
- Supply (inelastic supply = higher wages)
- Monoposony vs Competitive markets
- Trades unions / min wages
- Difficulty of determining MRP of workers
- Firms non profit maximising
- part time / full time
- service sector / private sector.
- Wage Determination in competitive Markets - the theory of wage determination MRP theory
- Labour Market Imperfections - what else determines wages. Basically this is the evaluation part of this question
Tuesday, May 22, 2007
Globalisation and its effects on developing countries
What are the Advantages of Globalisation for Developing Countries?
1. Inward Investment from foreign Mulitnationals MNCs. This inward investment creates job opportunities and helps to boost economic growth. Critics of MNCs paying low wage ignore the fact other wages in developing countries are generally lower.
2. Greater free Trade Increased free trade creates more export Markets.
For example, improvements in transport have enabled primary products to be sold around the globe. This increases the opportunity to make foreign currency earnings.
3. Improved Technology and information. Globalisation has enabled technology and information to be shared more easily this has helped countries in their development.
4. Positive Impact upon Agriculture
Globalisation has increased the scope for earnings from agriculture
What are Disadvantages of Globalisation for Developing Countries.?
1. Infant Industry Argument.
If developing countries wish to diversify and start new industries, they may find it very difficult to compete against developed countries. This is because they don't have economies of scale or experience.
2. Globalisation can reinforce a state of development.
A developing country may have a comparative advantage in the production of pineapples, globalisation will encourage them to specialise in their production. However, this has drawbacks.
3. Free Movement of Labour
Free movement of labour may cause the highest skilled workers to leave the economy and get better jobs in developed countries.
4. Environmental costs.
Often globalistion has led to the exploitation of natural resources, such as cutting down the Amazon rain forest to increase grazing land.
Related:
1. Inward Investment from foreign Mulitnationals MNCs. This inward investment creates job opportunities and helps to boost economic growth. Critics of MNCs paying low wage ignore the fact other wages in developing countries are generally lower.
2. Greater free Trade Increased free trade creates more export Markets.
For example, improvements in transport have enabled primary products to be sold around the globe. This increases the opportunity to make foreign currency earnings.
3. Improved Technology and information. Globalisation has enabled technology and information to be shared more easily this has helped countries in their development.
4. Positive Impact upon Agriculture
Globalisation has increased the scope for earnings from agriculture
What are Disadvantages of Globalisation for Developing Countries.?
1. Infant Industry Argument.
If developing countries wish to diversify and start new industries, they may find it very difficult to compete against developed countries. This is because they don't have economies of scale or experience.
2. Globalisation can reinforce a state of development.
A developing country may have a comparative advantage in the production of pineapples, globalisation will encourage them to specialise in their production. However, this has drawbacks.
- Limits potential growth (low income elasticity of demand for pineapples.
- Economy unbalanced. - fall in price of pineapples could cause serious problems for economy.
3. Free Movement of Labour
Free movement of labour may cause the highest skilled workers to leave the economy and get better jobs in developed countries.
4. Environmental costs.
Often globalistion has led to the exploitation of natural resources, such as cutting down the Amazon rain forest to increase grazing land.
Related:
Thursday, May 17, 2007
What Causes an Appreciation in the Exchange Rate?
An appreciation means the exchange rate (£) becomes stronger (worth more) against a basket of currencies.
Pound Sterling will become stronger if there is higher demand for Sterling, or lower supply of Sterling.
Reasons for an appreciation in the Exchange Rate
1. Increase in Interest Rates.
Higher interest rates make it more attractive to save in the UK (there is a better rate of return on saving accounts). Therefore, there will be an inflow of hot money (people holding currency in UK saving accounts). This increase in demand for sterling causes the appreciation.
2. Lower Inflation.
If the UK has relatively lower inflation than other countries, this makes UK goods more competitive against foreign goods. Therefore, there will be more demand for British goods and hence sterling. This is a long term factor which will cause an appreciation in the value of the exchange rate.
3. Increased Competitiveness of UK goods.
Increased productivity and greater competitiveness will make British goods more attractive.
4. Expectations
Speculation plays an increasing role in the determination of exchange rates. If investors feel a currency is likely to appreciate in the future they will buy now and actually make it occur. E.g. if people expect interest rates to rise the currency will rise.
5. Surplus on Current Account.
This causes an inflow of foreign exchange into the economy. Typically, a large current account surplus will cause an appreciation in the exchange rate (unless there is a similarly large outflow on financial and capital account)
6. Higher Economic Growth.
Stronger economic growth tends to cause an appreciation in the exchange rate. This is because with higher economic growth, the country is likely to see an increase in interest rates. Also higher economic growth tends to cause greater confidence in the economy. However, it depends on the type of economic growth. If the growth is led by higher consumer spending, this will cause a rise in imports which could lower the exchange rate. If growth is export led, the currency should rise.
7. Buying Domestic Currency
If China sold its US dollar assets and bought Chinese assets, there would be an appreciation in the value of the Yuan
Related
Pound Sterling will become stronger if there is higher demand for Sterling, or lower supply of Sterling.
Reasons for an appreciation in the Exchange Rate
1. Increase in Interest Rates.
Higher interest rates make it more attractive to save in the UK (there is a better rate of return on saving accounts). Therefore, there will be an inflow of hot money (people holding currency in UK saving accounts). This increase in demand for sterling causes the appreciation.
2. Lower Inflation.
If the UK has relatively lower inflation than other countries, this makes UK goods more competitive against foreign goods. Therefore, there will be more demand for British goods and hence sterling. This is a long term factor which will cause an appreciation in the value of the exchange rate.
3. Increased Competitiveness of UK goods.
Increased productivity and greater competitiveness will make British goods more attractive.
4. Expectations
Speculation plays an increasing role in the determination of exchange rates. If investors feel a currency is likely to appreciate in the future they will buy now and actually make it occur. E.g. if people expect interest rates to rise the currency will rise.
5. Surplus on Current Account.
This causes an inflow of foreign exchange into the economy. Typically, a large current account surplus will cause an appreciation in the exchange rate (unless there is a similarly large outflow on financial and capital account)
6. Higher Economic Growth.
Stronger economic growth tends to cause an appreciation in the exchange rate. This is because with higher economic growth, the country is likely to see an increase in interest rates. Also higher economic growth tends to cause greater confidence in the economy. However, it depends on the type of economic growth. If the growth is led by higher consumer spending, this will cause a rise in imports which could lower the exchange rate. If growth is export led, the currency should rise.
7. Buying Domestic Currency
If China sold its US dollar assets and bought Chinese assets, there would be an appreciation in the value of the Yuan
Related
Wednesday, May 16, 2007
Reasons for Unemployment amongst Ethnic Minorities
Unemployment rates amongst different ethnic minorities tends to be higher.
For example, Unemployment statistics for 2001-02 UK Economy:
Source: Official for National Statistics, Annual Local Area Labour Force Survey 28 March 2003
Why Unemployment rates are Higher for Certain Ethnic Minorities Groups
1. Language Skills.
In a service based economy English language speaking, is a high priority. Those workers who have English as a second language are at a disadvantage.
However, many ethnic minorities in the UK are second or third generation and speak English as their first language. Therefore, this argument only applies to first generation immigrants who are now in a minority.
It is also worth noting that unemployment levels tend to be much higher amongst young (first generation immigrants) For example, unemployment amongst Bangladeshi 16-24 year olds rises to 36% compared to 22% for all ages
2. Lower Educational qualifications.
Reports show that Black Carribean student have lower A Level grades and are less likely to go to university. However, educational standards vary significantly amongst ethnic minorities. For example, Chinese and Indian students quite often surpass white students.
E.G. The proportion of black and Pakistani pupils gaining five GCSEs at grades A to C was 29% in 1998.
The proportion of Bangladeshi pupils is 33% while the performance of Indian, Chinese and other Asian pupils continues to outstrip that of white pupils.
% of students gaining Five GCSEs at grades A to C
White Pupils 47%
Chinese Students 61%
Indian pupils 54%
Source for statistics: BBC
See also: Discrimination
3. Discrimination.
The effects of discrimination are hard to quantify. But, it could be a significant factor to explain higher unemployment. In practise racial discrimination is outlawed, but, in practice it can be difficult to enforce.
However, there appears to be a big divergence between Indian unemployment and Bangladeshi unemployment. This suggests education is more significant than discrimination.
Racial discrimination in the workplace
4. Geographical Factors.
Ethnic minorities often live in certain areas of the country and in parts of cities. Some of the areas in these inner city ghettos are associated with higher rates of unemployment. This can lead to a feeling of alienation and hopelessness. Discouraging young ethnic minorities from being able to entering the labour force.
For example, Unemployment statistics for 2001-02 UK Economy:
- White 4%
- Pakistani 16%
- Bangladeshi 22%
- Black Caribbean 12%
- Indian 7%
- Chinese 6%
Source: Official for National Statistics, Annual Local Area Labour Force Survey 28 March 2003
Why Unemployment rates are Higher for Certain Ethnic Minorities Groups
1. Language Skills.
In a service based economy English language speaking, is a high priority. Those workers who have English as a second language are at a disadvantage.
However, many ethnic minorities in the UK are second or third generation and speak English as their first language. Therefore, this argument only applies to first generation immigrants who are now in a minority.
It is also worth noting that unemployment levels tend to be much higher amongst young (first generation immigrants) For example, unemployment amongst Bangladeshi 16-24 year olds rises to 36% compared to 22% for all ages
2. Lower Educational qualifications.
Reports show that Black Carribean student have lower A Level grades and are less likely to go to university. However, educational standards vary significantly amongst ethnic minorities. For example, Chinese and Indian students quite often surpass white students.
E.G. The proportion of black and Pakistani pupils gaining five GCSEs at grades A to C was 29% in 1998.
The proportion of Bangladeshi pupils is 33% while the performance of Indian, Chinese and other Asian pupils continues to outstrip that of white pupils.
% of students gaining Five GCSEs at grades A to C
White Pupils 47%
Chinese Students 61%
Indian pupils 54%
Source for statistics: BBC
See also: Discrimination
3. Discrimination.
The effects of discrimination are hard to quantify. But, it could be a significant factor to explain higher unemployment. In practise racial discrimination is outlawed, but, in practice it can be difficult to enforce.
However, there appears to be a big divergence between Indian unemployment and Bangladeshi unemployment. This suggests education is more significant than discrimination.
Racial discrimination in the workplace
4. Geographical Factors.
Ethnic minorities often live in certain areas of the country and in parts of cities. Some of the areas in these inner city ghettos are associated with higher rates of unemployment. This can lead to a feeling of alienation and hopelessness. Discouraging young ethnic minorities from being able to entering the labour force.
Tuesday, May 15, 2007
2
Tips and advice for Writing Evaluation Essays.
Evaluation is an important component of an advanced essay.
Evaluation is a difficult skill because it requires more than simple analysis and explanation. Evaluation requires the ability to look at facts, arguments and analysis, with a degree of critical distance. To explain the meaning of evaluation it is most helpful to give different examples of what evaluation can involve.
Evaluation is an important component of an advanced essay.
Evaluation is a difficult skill because it requires more than simple analysis and explanation. Evaluation requires the ability to look at facts, arguments and analysis, with a degree of critical distance. To explain the meaning of evaluation it is most helpful to give different examples of what evaluation can involve.
Reasons for Government Spending
Explain Reasons for Increasing Government Spending. (10)
1. Improve Public Services
Higher government spending can lead to improved public services like health, education and transport. These are important for increasing the quality of life and economic well being
2. Increase Productive Capacity of Economy.
Some types of government spending, can help to overcome market failure. For example, education can help increase labour productivity and reduce structural unemployment; if the education spending is well targeted it can help to increase the long run trend rate of growth.
However, not all government spending is guaranteed to actually increase government spending, it may be subject to government failure and inefficiency.
3. Expansionary Fiscal Policy
Increased government Spending without higher taxes is likely to increase AD. It will cause a budget deficit, however, the increased Government spending is an injection of spending to the economy and could help to increase the rate of economic growth. Note, some monetarists argue increased government spending will just cause crowding out, and therefore it will not increase AD.
4. Reduce Inequality.
A significant % of government spending is spent on social security. This includes benefits, such as; unemployment benefit, income support, child benefit and housing benefit. The majority of these benefits are means tested; this means they are targeted to those on low incomes. The aim is to reduce relative poverty and inequality
1. Improve Public Services
Higher government spending can lead to improved public services like health, education and transport. These are important for increasing the quality of life and economic well being
2. Increase Productive Capacity of Economy.
Some types of government spending, can help to overcome market failure. For example, education can help increase labour productivity and reduce structural unemployment; if the education spending is well targeted it can help to increase the long run trend rate of growth.
However, not all government spending is guaranteed to actually increase government spending, it may be subject to government failure and inefficiency.
3. Expansionary Fiscal Policy
Increased government Spending without higher taxes is likely to increase AD. It will cause a budget deficit, however, the increased Government spending is an injection of spending to the economy and could help to increase the rate of economic growth. Note, some monetarists argue increased government spending will just cause crowding out, and therefore it will not increase AD.
4. Reduce Inequality.
A significant % of government spending is spent on social security. This includes benefits, such as; unemployment benefit, income support, child benefit and housing benefit. The majority of these benefits are means tested; this means they are targeted to those on low incomes. The aim is to reduce relative poverty and inequality
Friday, May 11, 2007
Does Globalisation benefit both developed and developing countries?
Globalisation involves the increased integration of national economies. It means a reduction in barriers of trade and investment between different economies.
The benefits of globalisation are related to the benefits of free trade.
1. Consumers will have a wider choice of goods, and prices are likely to be lower. Globalisation has been an important factor in the falling price of manufactured goods.
2.Globalisation gives an opportunity for domestic firms to export a wider market. Export led growth has been an important factor in increasing economic welfare in Asian countries.
3. Globalisation enables increased specialisation of production. This specialisation enables firms to benefit from economies of scale. This leads to lower average costs and increased efficiency.
4. Globalisation causes increased competition between different firms and countries. This puts pressure on firms to be increasingly efficient and offer better products for consumers.
5. Increased Inward Investment. The process of globalisation has encouraged firms to invest in other countries. For example, many firms are relocating call centres to countries like India, where wage costs are lower. This inward investment benefits developing countries because it creates employment, growth and foreign exchange. Some foreign companies are criticised for exploiting cheap labour. But often the wages are higher than otherwise.
Problems of Globalisation
1. Developing Countries May Struggle to compete.
If a developing country wishes to develop a new manufacturing industry, it may face higher costs than advanced industries in the west, who will benefit from years of experience and economies of scale. To develop an industry it may be necessary to have protection from cheap imports; this gives the firm chance to develop and gain economies of scale.
2. Globalisation keeps Developing countries producing primary products. Developing countries may have a comparative advantage in primary products, however, this offers little scope for economic growth. Primary products have a low income elasticity of demand. Therefore, with economic growth demand for products increases only slowly. Primary products often have volatile prices, this can cause the economy to be subject to fluctuations in income
3. Multi national Companies may be able to force out local retailers, leading to less choice for consumers and less cultural diversity.
4. Movement of Labour. globalisation enables workers to move easily around. however, this may cause the highest skilled workers of developing countries to leave for better paid jobs in developed countries.
The benefits of globalisation are related to the benefits of free trade.
1. Consumers will have a wider choice of goods, and prices are likely to be lower. Globalisation has been an important factor in the falling price of manufactured goods.
2.Globalisation gives an opportunity for domestic firms to export a wider market. Export led growth has been an important factor in increasing economic welfare in Asian countries.
3. Globalisation enables increased specialisation of production. This specialisation enables firms to benefit from economies of scale. This leads to lower average costs and increased efficiency.
4. Globalisation causes increased competition between different firms and countries. This puts pressure on firms to be increasingly efficient and offer better products for consumers.
5. Increased Inward Investment. The process of globalisation has encouraged firms to invest in other countries. For example, many firms are relocating call centres to countries like India, where wage costs are lower. This inward investment benefits developing countries because it creates employment, growth and foreign exchange. Some foreign companies are criticised for exploiting cheap labour. But often the wages are higher than otherwise.
Problems of Globalisation
1. Developing Countries May Struggle to compete.
If a developing country wishes to develop a new manufacturing industry, it may face higher costs than advanced industries in the west, who will benefit from years of experience and economies of scale. To develop an industry it may be necessary to have protection from cheap imports; this gives the firm chance to develop and gain economies of scale.
2. Globalisation keeps Developing countries producing primary products. Developing countries may have a comparative advantage in primary products, however, this offers little scope for economic growth. Primary products have a low income elasticity of demand. Therefore, with economic growth demand for products increases only slowly. Primary products often have volatile prices, this can cause the economy to be subject to fluctuations in income
3. Multi national Companies may be able to force out local retailers, leading to less choice for consumers and less cultural diversity.
4. Movement of Labour. globalisation enables workers to move easily around. however, this may cause the highest skilled workers of developing countries to leave for better paid jobs in developed countries.
Thursday, May 10, 2007
Government Intervention in the Macro Economy.
The government intervenes in the macro economy in various ways including demand and supply side policies.
Macro Economics Objectives of the government include:
1. Low Unemployment
2. High but sustainable economic growth.
3. Low Inflation (inflation target in UK CPI = 2%)
4. Equilibrium on Balance of Payments (e.g. minimising current account deficit)
Less important objectives
5. Reduce Government Deficit (in UK Chancellors Golden rule of Borrowing less than 3% of GDP)
6. Stable Exchange rates
Non Economic Objectives
7. Environment - increasingly important
8. Issues of Equality.
Types of Government Intervention
These are government policies which aim to increase productivity and efficiency in the economy. If they are successful, they will shift the LRAS to the right and potentially increase the long run trend rate of growth. An increase in productivity can also help to reduce inflation, especially cost push inflation. Improvements in productivity may make UK exports more competitive and, therefore, should help to improve the current account.
Types of Supply Side policies
Evaluation of Supply Side policies.
Demand Side Policies
Demand side polices to influence the level of AD. It may be to reduce the growth of AD, to prevent inflation. Alternatively, it could be to increase AD in time of a recession.
Types of Demand Side Policies
If there is inflation:
In a recession.
Evaluation
The aim of Demand side policies is to ensure sustainable growth. The aim is to avoid Boom and Bust economic cycles. In practise, this means that growth will be close to the long run trend rate of growth. This enables economic growth, without inflationary pressures.
See also:
Evaluation of MPC in controlling monetary policy
Macro Economics Objectives of the government include:
1. Low Unemployment
2. High but sustainable economic growth.
3. Low Inflation (inflation target in UK CPI = 2%)
4. Equilibrium on Balance of Payments (e.g. minimising current account deficit)
Less important objectives
5. Reduce Government Deficit (in UK Chancellors Golden rule of Borrowing less than 3% of GDP)
6. Stable Exchange rates
Non Economic Objectives
7. Environment - increasingly important
8. Issues of Equality.
Types of Government Intervention
- Supply Side Policies.
These are government policies which aim to increase productivity and efficiency in the economy. If they are successful, they will shift the LRAS to the right and potentially increase the long run trend rate of growth. An increase in productivity can also help to reduce inflation, especially cost push inflation. Improvements in productivity may make UK exports more competitive and, therefore, should help to improve the current account.
Types of Supply Side policies
- Interventionist. Government intervention to overcome market failure. For example, spending on education and training to reduce occupational immobilities.
- Market Oriented supply side polices : This occurs when the government reduces regulations and enables market to work more freely. For example, reducing the power of trades unions and minimum wages can reduce labour market inflexibility's.
Evaluation of Supply Side policies.
- They will take a long time, e.g. increasing education standards.
- May be subject to government failure. e.g. spending on education misplaced.
- Promoting free markets may increase inequality. E.g. removing trades unions may lead to worker exploitation.
Demand Side Policies
Demand side polices to influence the level of AD. It may be to reduce the growth of AD, to prevent inflation. Alternatively, it could be to increase AD in time of a recession.
Types of Demand Side Policies
- Fiscal Policy - changing the level of government spending and taxation in the economy. It will effect the government's budget and fiscal position.
- Monetary Policy - Influencing the supply and demand for money. In the UK monetary policy revolves around changing interest rates, which are set by the MPC (Bank of England).
If there is inflation:
- The government could pursue deflationary fiscal policy. This involves increasing tax rate and / or cutting spending.
- The MPC could increase interest rates. This is known as a tightening of monetary policy. Note, in the UK the government no longer sets monetary policy, the Bof E is independent.
In a recession.
- Government can introduce Expansionary Fiscal Policy. This involves cutting taxes and / or increasing spending, AD should increase.
- The MPC can cut interest rates.
Evaluation
- It is difficult to control predict future economic trends, therefore, it can be difficult to know how much to change tax rates / interest rates.
- Time Lags, Interest rates can take upto 18 months to have an effects.
- Crowding out. Expansionary fiscal policy may increase government spending, but, reduce private sector spending.
- Depends on Confidence. For example, a cut in income tax may not increase AD, if confidence is low.
The aim of Demand side policies is to ensure sustainable growth. The aim is to avoid Boom and Bust economic cycles. In practise, this means that growth will be close to the long run trend rate of growth. This enables economic growth, without inflationary pressures.
See also:
Evaluation of MPC in controlling monetary policy
Wednesday, May 9, 2007
Essay: Discuss the effects of a fall in the Savings ratio?
Essay Question: Discuss the effects of a fall in the Savings ratio?(30)
The savings ratio is the % of income that is saved not spent. A fall in the savings ratio implies that consumer spending is increasing, often this is financed through increased borrowing. For example, in the UK a fall in the savings ratio has been associated with an increase in equity withdrawal.
UK savings ratio is currently 3.7% In 1997 savings ratio was 10%
Effects of Fall in Savings Ratio
1. Higher levels of Consumption.
Therefore, it is expected that AD will increase. (consumption is 66% of AD, therefore it will be quite significant.)
The increase in AD will cause an increase in economic growth and lower unemployment. However, rising AD may cause inflation. Inflation will occur when growth is faster than the long run trend rate. This is now a potential problem in the UK; inflation has recently gone above the government's inflation target of 1-3%. Although other factors, such as; rising taxes and cost push factors have played a role, the increase in consumer spending is pushing up the underlying inflation rate.
2. Boom and Bust
A fall in the savings ratio is usually accompanied by a rise in confidence. It is the rise in confidence which encourages borrowing and consumers to run down savings. Therefore, there is always a danger that a falling savings ratio can be a precursor to a boom and bust situation. For example, the last time the savings ratio fell to this levels was in the late 1980s at the height of the Lawson boom [2], shortly after the economy went into recession. However, things were different in the early 1990s inflation was much higher (10% rather than 3%).
3. Economy more sensitive to interest rates.
With a fall in the savings ratio interest rate changes will have a bigger effect in reducing spending. This is because levels of borrowing are higher and therefore a rise in interest rates has a significant impact on increasing interest repayments. Also, higher rates will not be increasing incomes from savings as much.
Mortgage interest payments account for nearly 20% of homeowners disposable income, for first time buyers it is higher; therefore, any rise in interest rates could reduce spending significantly.
4. Balance of Payments.
With higher levels of consumer spending, there will be an increase in imports.Therefore this will lead to a deterioration in the current account. This has occured in the UK. The UK's current account deficit now accounts for 3.5% of GDP. UK consumers have a high marginal propensity to import; this means as incomes increase, a high % goes on imports. The current account deficit could put downward pressure on the exchange rate in the long term.
Conclusion
A fall in the savings ratio can increase economic growth, at least in the short term. However, the growth may be unsustainable, especially if interest rates rise in the near future. There is also a danger of increased consumption causing inflation. However, at the moment the MPC is looking very carefully at inflationary pressures, and interest rates could rise to reduce spending.
However, some people argue a fall in the savings ratio is not a problem, but, it is just a reflection of strong economy and booming housing market, which increases scope for equity withdrawal.
But if house price were to fall, it could be a real problem as many people would have negative equity.
[1] Savings Ratio Statistics at National Stats
[2] Savings Ratio 1998 Q3 4.%
Related essays:
The savings ratio is the % of income that is saved not spent. A fall in the savings ratio implies that consumer spending is increasing, often this is financed through increased borrowing. For example, in the UK a fall in the savings ratio has been associated with an increase in equity withdrawal.
UK savings ratio is currently 3.7% In 1997 savings ratio was 10%
Effects of Fall in Savings Ratio
1. Higher levels of Consumption.
Therefore, it is expected that AD will increase. (consumption is 66% of AD, therefore it will be quite significant.)
The increase in AD will cause an increase in economic growth and lower unemployment. However, rising AD may cause inflation. Inflation will occur when growth is faster than the long run trend rate. This is now a potential problem in the UK; inflation has recently gone above the government's inflation target of 1-3%. Although other factors, such as; rising taxes and cost push factors have played a role, the increase in consumer spending is pushing up the underlying inflation rate.
2. Boom and Bust
A fall in the savings ratio is usually accompanied by a rise in confidence. It is the rise in confidence which encourages borrowing and consumers to run down savings. Therefore, there is always a danger that a falling savings ratio can be a precursor to a boom and bust situation. For example, the last time the savings ratio fell to this levels was in the late 1980s at the height of the Lawson boom [2], shortly after the economy went into recession. However, things were different in the early 1990s inflation was much higher (10% rather than 3%).
3. Economy more sensitive to interest rates.
With a fall in the savings ratio interest rate changes will have a bigger effect in reducing spending. This is because levels of borrowing are higher and therefore a rise in interest rates has a significant impact on increasing interest repayments. Also, higher rates will not be increasing incomes from savings as much.
Mortgage interest payments account for nearly 20% of homeowners disposable income, for first time buyers it is higher; therefore, any rise in interest rates could reduce spending significantly.
4. Balance of Payments.
With higher levels of consumer spending, there will be an increase in imports.Therefore this will lead to a deterioration in the current account. This has occured in the UK. The UK's current account deficit now accounts for 3.5% of GDP. UK consumers have a high marginal propensity to import; this means as incomes increase, a high % goes on imports. The current account deficit could put downward pressure on the exchange rate in the long term.
Conclusion
A fall in the savings ratio can increase economic growth, at least in the short term. However, the growth may be unsustainable, especially if interest rates rise in the near future. There is also a danger of increased consumption causing inflation. However, at the moment the MPC is looking very carefully at inflationary pressures, and interest rates could rise to reduce spending.
However, some people argue a fall in the savings ratio is not a problem, but, it is just a reflection of strong economy and booming housing market, which increases scope for equity withdrawal.
But if house price were to fall, it could be a real problem as many people would have negative equity.
[1] Savings Ratio Statistics at National Stats
[2] Savings Ratio 1998 Q3 4.%
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Tuesday, May 8, 2007
Effec of higher interest rates on UK Economy
- An increase in the base interest rate will lead to an increase in the general cost of borrowing, throughout the economy.
- Also higher interest rates increase the return on saving money in an interest bearing account.
- Therefore consumers will be less willing to borrow, e.g. on credit cards and personal loans.
- Consumers with variable mortgages will have an increase in monthly payments, therefore, they will have a reduction in disposable income.
- This will cause a significant fall in consumer spending, because, in the UK many home owners have mortgage payments, which account for a high % of their income. (This is as a result of rising house prices)
- Similarly, the increase in borrowing costs will also reduce business investment.
- Therefore with a fall in consumption and investment there is likely to be a fall in Aggregate Demand, or more accurately, AD will increase at a slower rate.
- Therefore higher interest rates tend to reduce the rate of economic growth and inflation.
Evaluation of higher interest rates
However, the effect of a rise in interest rates depends on various factors.1. Effect on savings (income and substitution effect)
Higher interest rates encourage savings and therefore reduce consumption (substitution effect). However, higher interest rates also increase income, for those with high levels of savings(income effect). Therefore, some consumers may actually increase spending. For example, in Japan many firms are currently investing out of savings. Therefore, an increase in interest rates is unlikely to discourage investment. In the UK, levels of debt are high and the savings ratio low, therefore, rising interest rates will be more likely to reduce investment and consumer spending in the UK.
2. The state of the economy
If the economy is growing above the trend rate of economic growth and is close to full capacity, a rise in interest rates will have the effect of moderating growth and reduce inflation. However, it is unlikely to cause a recession because the rest of the economy is buoyant. For example, higher interest rates in the late 1980s didn't cause a downturn initially because the economy was buoyant. Though eventually high interest rates of 1990-92 did cause a recession.
3. Depends on consumer confidence
The effect of a rise in interest rates is sometimes hard to predict. If consumer confidence is high then rising interest rates may not discourage spending; people may just be willing to pay more interest. However, at other times a rise in interest rates may adversely effect confidence; therefore, the effect will be much greater. E.g. In the UK, many are concerned about the booming housing market, they feel the boom could soon turn to bust. A rise in interest rates could be the catalyst to stop house prices rising. If house prices fell it would have a significant impact on reducing consumer spending.
4. Effects on exchange rate
Higher interest rates cause hot money flows, because it is more attractive to save money in the UK. Therefore, this will cause an appreciation in the exchange rate. An appreciation will make exports more expensive and imports cheaper. Assuming demand for exports and imports is relatively elastic, then an appreciation will reduce the growth of AD and help reduce inflation. In the UK, the exchange rate has been strong during the past year. Some experts argue it is fundamentally overvalued. Therefore, a further appreciation in the exchange rate would definitely not be welcomed by the exporting sector.
5. Time lag
It is estimated interest rate changes can take up to 18 months to have its full effect. Therefore, an increase in interest rates now, may reduce growth in the future. However in the UK interest rates have been increased from a low of 3.5% in 2003. Therefore, previous interest rates will begin to have an accumulative effect.
See also:
Monday, May 7, 2007
US Economy of the 1920s
The 1920s was often referred to as the "Roaring Twenties", or the "Jazz age". This related to the booming period of rapid economic expansion, but also changing social attitudes. Society was becoming less regimented and discovering new found freedoms; suddenly people's expectations were changing, and this was fuelled by new technologies and a booming economy. However, hidden behind the optimistic views and a booming economy, there were significant structural problems, which led to the notorious stock market crash of 1929 and the Great Depression of the 1930s.
Reasons for booming Economy:
There was also no system of lender of last resort. This meant that if the banks were short of money, they couldn't borrow from a Central Bank. When the Great Depression struck, people wanted to withdraw their money, but the banks didn't have enough reserves to meet this demand. This caused a fall in confidence in the banking system and many banks went under.
Related
External links
US Economy in the 1920s
- Booming Economy
Reasons for booming Economy:
- Growth in Automobile industry
- High levels of Consumer confidence, increased by new attitudes to consumerism.
- Improvements in technology, partly as a result of WWI
- Improvements in Labour Productivity - e.g. technology and new management techniques
- Scientific Management - Taylorism
- Mass Production - Assembly line e.g. Ford's Car Factory
- Laissez-Faire.
- Anti trust laws were weakened.
- Trade Union membership declined
- Growth in Debt.
- Boom in Stock Market.
- Recession in Agriculture.
- Fragmented nature of banking system
There was also no system of lender of last resort. This meant that if the banks were short of money, they couldn't borrow from a Central Bank. When the Great Depression struck, people wanted to withdraw their money, but the banks didn't have enough reserves to meet this demand. This caused a fall in confidence in the banking system and many banks went under.
Related
External links
- US economy 1920s
- The Jazz Age - Economics of the 1920s
- American Economics in 1920s and 1930s
- US Economy in 1920s - Gene Smiley, Marquette University
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