Jerome Powell US Fed Chair increased the Fed Funds Rate by 0.75% last week to 3.25% and has signalled that he will do what is required to get the inflation rate down to the 2% target. Policy rates are still negative almost everywhere, the main exceptions being China, Brazil, Hong Kong, and Saudi Arabia. Mexico and Indonesia are almost there, too.
If there is a negative real interest rate, it means that the inflation rate is greater than the nominal interest rate. If the interest rate is 2% and the inflation rate is 10%, then the borrower would gain 8% of every dollar borrowed per year. In the early 1970s, the US and UK both reduced their debt burden by about 30% to 40% of GDP by taking advantage of negative real interest rates.
It is possible to control inflation while keeping real rates well below zero but it is more likely that reducing demand will require raising real rates at least to 0%, and probably a bit higher. Higher interest rates globally are on the horizon as at present they aren’t high enough to significantly reduce inflation pressure in most countries. Central banks have work to do.
No doubt you’ve had plenty of discussions with your classes on economic issues. One of the challenges is to keep students on task and try and get contributions from all students. In order to overcome these issues I have developed a set of playing cards with certain statements on each. Students receive 8 playing cards with different assessment objectives/ skills/ elements of written work in economics – see photo below.
An exam essay question is given to students and then they debate the questions amongst themselves. However students can only speak when they play a card and they must follow what the card says – e.g. Argument, Building on someone’s point etc. This limits each student’s number of responses and makes sure the discussion helps students practice for an assessment, according to the assessment objectives. It also allows for greater contributions from other members of the class. It generally works well although at times you may have to play one of your own cards to keep students on task. I have attached a link to a document with all the statements – below. All you have to do is buy some packs of playing cards and use wide sellotape to attach statements to the cards. Be interested to know how others get on.
Economics has had a huge impact on the world we live in—and understanding the key factors at play in these massive, interconnected systems can give us insight into how to make them better, stabler, and more equitable. Dig into these quick and compelling explainers from TED-Ed and the World Economic Forum for a taste of economics in action.
Below is a short video showing features of the eLearnEconomics site. Since 2008 eLearneconomics has provided a comprehensive and concise insight into understanding a multitude of economic concepts, ranging from the central ideas of demand, supply and markets, to the complexities of microeconomics and macroeconomics. The sites covers Cambridge International Exams A2, AS and IGCSE material, IB as well as the NCEA Level 1, 2 and 3. The site has key notes, flash cards, written answers and multiple-choice questions, all with immediate feedback that provides student-centred learning to improve student’s results and grades.
It has been suggested that China cajoles less developed countries into taking out multiple loans to build expensive infrastructure that they can’t afford to fund themselves. This then leads to fears of possible takeover of assets by China when the borrowing country defaults on its debt. An example of this is the Sri Lankan port of Hambantota. However, a deeper look shows that accusations of so-called debt trap diplomacy turn out to be unfounded.
Sri Lanka – Hambantota.
It was the Canadian International Development Agency—not China—that financed Canada’s leading engineering and construction firm, SNC-Lavalin, to carry out a feasibility study for the port. The initial phase of the project should allow for the transport of non-containerised cargo—oil, cars, grain—to start bringing in revenue, before expanding the port to be able to handle the traffic and storage of traditional containers.
In 2007 after being turned down by the US and Indian companies, China Harbor won the contract to build the port with China Eximbank agreeing to fund it – $307 million,15-year commercial loan with a 6.3% interest rate. There were 2 phase of the build:
Phase 1 – infrastructure to handle non-containerised cargo – oil, grain, cars etc. Phase 2 – transforming Hambantota into a container port.
Instead of waiting for Phase 1 to generate income the government went ahead with Phase 2 and borrowed $757 million from China Eximbank at an interest rate of 2%. By 2015 Hambantota was losing money and the Sri Lankan Port Authoroity (SLPA) signed an agreement with China Harbor and China Merchants Group to have them jointly develop and operate the new port for 35 years.
By this time with a change of government and increases in sovereign bond payments the Sri Lankan fiscal position was desperate. They owed more to Japan, the World Bank and the Asian Development Bank than to China. Only 5% of $4.5bn debt servicing was due to Hambantota.
It is important to note that there was never a default – IMF raised money by leasing out the Hambantota Port to an experienced company. Two bids came from China Merchants and China Harbor; Sri Lanka chose China Merchants, making it the majority shareholder with a 99-year lease, and used the $1.12 billion cash infusion to bolster its foreign reserves, not to pay off China Eximbank.
Africa and Chinese infrastructure projects
The video below from ‘Bloomberg Quicktake Originals’ looks at a similar scenario in Africa to that of Sri Lanka. Over the past two decades, China has built large infrastructure projects in almost every country in Africa, making Western powers uncomfortable amid wider concerns about Beijing’s investments across the continent. However, a deeper look shows that accusations of so-called debt trap diplomacy turn out to be unfounded.
For more on Developing Countries view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
Another of Martin Sandbu’s ‘Free Lunch on Film’ videos from the FT. This one looks at the pros and cons of a wealth tax. A well-designed net wealth tax can raise revenue and tackle inequality but critics say a wealth tax is hard to value, unfair to savers and inefficient. Well worth a look.
For more on Inequality view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
From the PBS NewsHour Paul Solman looks at shrinkflation with some great examples. Shrinkflation is a rise in the general price of goods per unit of weight or volume, brought about by a reduction in the weight or size of the item sold. One of the most famous was in 2016 when the Toblerone reduced a 170g bar to 150g, while the 400g bar shrunk to 360g. This was done by enlarging the gap between the chocolate triangles.
A natural monopoly is when one firm has the ability to supply the entire market at lower prices than two or more firms. A natural monopoly faces downward-sloping average cost (AC) for the entire range for which demand is applicable. The reason for its downward-sloping AC curve is usually that the initial investment in the infrastructure of the firm is large, but once it is in place, the marginal cost (MC) of production is low, for example hydro power. This high establishment cost is a strong barrier to entry and a natural monopoly could undercut any would-be competitor so they could not survive. Natural monopolies often involve some kind of network, for example water, gas,phone, rail.
Equilibrium Output-Natural Monopoly
The rule for maximising profit or minimising a loss (the equlibrium) for a natural monopoly is the same as any other firm. The most profitable output or smallest loss is where marginal revenue (MR) equals marginal cost (MC). Any other position will result in a smaller profit or greater loss. Therefore, the equilibrium output is at a price of Pe and quantity Qe (determined from the intersection of the marginal cost and marginal revenue curves). At the equilibrium output Qe the natural monopoly is making a supernormal profit (of $100m) and produces less than what society or consumers desire. Operating at the equilibrium output position creates a deadweight loss of BFG because consumer surplus and producer surplus are not maximised. The natural monopoly is charging a price in excess of marginal cost (P > MC), this is called mark-up pricing. At the equilibrium output in perfect competition, price and marginal cost are the same. Sellers cannot charge higher prices because they would immediately lose sales to competitors. This is called marginal cost pricing and occurs in perfect competition where at the equilibrium output position price equals marginal cost (P = MC).
A natural monopoly charges more and produces less than would be the case if the firm operated as a perfect competitor. Overpricing and not operating at the allocatively efficient (socially optimum) level means that a natural monopoly can be seen as socially undesirable. However, if consumers are not subject to competitive advertising and marketing, they receive the good or service at cost and the firm carries out R & D (research and development) a natural monopoly can be viewed as socially desirable. A natural monopoly may also be seen as socially desirable because it is wasteful to duplicate the existing infrastructure, so encouraging competition is seen as undesirable. If output is below equilibrium Qe (where MR equals MC), the firm would be missing out on marginal profits because the revenue from producing the last article is greater than its cost of production, implying that the firm could increase output and increase profit. However, increasing output beyond Qe reverses the position. The firm will be making marginal losses because the revenue from one additional article is now less than the cost of its production.
If increased output adds more to cost than to revenue, a firm has obviously passed the point of maximum profit (or minimum loss). Price discrimination may be practised by any monopolist. This is where they segment the market in some way, for example domestic and industrial users may be charged at different rates. A two-part tariff is a system where users are charged a fixed amount for a given time period and per unit charge for use, for example with the phone there is a line rental and a charge for toll calls. Off-peak pricing is a system of charging that results in a higher price at peak time usage than at off-peak times, for example toll calls made after 6 p.m. are at a cheaper rate.
Wage Rate:- The price of labour as determined by market supply and demand. The demand for labour is said to be derived demand: – the demand for labour is dependent on the demand for the goods & services produced. Key factors that affect the quantity of labour supplied:-
age of population
Difficulty in acquiring qualifications – eg. doctors
social attitudes to employment
Change in Demand for labour Change in Supply of labour
Wages A more realistic version of the market model measures the price of labour in real wages rather than in nominal or money wages. The difference is that nominal wages are the actual dollars that are paid for any job while real wages are a measure of the ability of those dollars (earnings) to buy goods and services. Therefore real wages consider the purchasing power of your income.
Sticky Wages Actual wages will rise much more easily than they will fall. Labour markets are extremely rigid when it comes to reducing wage levels. Several factors encourage wages to stick at higher levels and so prevent the market from clearing, as shown in ‘Supply and Demand Applications’ and below.
Equilibrium and Real Wages
Some of these factors occur through the natural operation of the labour market.
Strong trade unions can operate as ‘monopoly suppliers’ of labour. This keeps wages above the equilibrium equilibrium. Fewer workers are hired.
Hiring cheap labour may backfire on employers. This labour may not have the same level of skills as that of the firm’s existing workforce. This will increase costs for the firm if it has to provide too much training. Existing workers therefore hold the balance of power and can demand higher wages.
The idea that a job has a certain worth, an intrinsic value regardless of the action of demand and supply, can keep wages above equilibrium.
The influence of humanity values can be strong. It is easy to pay less for resources other than labour.
Some factors are imposed on the market by the government.
Legislated minimum wages prevent the market from clearing. Although these wages aim to protect the incomes of those in the lower paid jobs, the result is fewer jobs for those same workers.
Welfare benefits can be over-generous and this may discourage the unemployed from seeking jobs.
With mock exams this week here is something on Liquidity Preference – included is a mind map that has been modified from Susan Grant’s CIE revision book.
Demand for money
TRANSACTIONS DEMAND – T – this is money used for the purchase of goods and services. The transactions demand for money is positively related to real incomes and inflation. As an individual’s income rises or as prices in the shops increase, he will have to hold more cash to carry out his everyday transactions. The quantity of nominal money demand is therefore proportional to the price level in the economy. (note: the real demand for money is independent of the price level)
PRECAUTIONARY BALANCES – P – this is money held to cover unexpected items of expenditure. As with the transactions demand for money, it is positively correlated with real incomes and inflation.
SPECULATIVE BALANCES – S – this is money not held for transaction purposes but in place of other financial assets, usually because they are expected to fall in price.
Bond prices and interest rates are inversely related – Interest Rates ↑ = Bond Prices ↓ and Interest Rates ↓ = Bond Prices ↑.
If a bond has a fixed return, e.g. $10 a year. If the price of a bond is $100 this represents a 10% return. If the price of the bond is $50 this represents a 20% return, i.e. the lower the price of the bond, the greater the return.
At high rates of interest, individuals expect interest rates to fall and bond prices to rise. To benefit from the rise in bond prices individuals use their speculative balances to buy bonds. Thus when interest rates are high speculative money balances are low.
At low rates of interest, individuals expect interest rates to rise and bond prices to fall. To avoid the capital loses associated with a fall in the price of bonds individuals will sell their bonds and add to their speculative cash balances. Thus, when interest rates are low speculative money balances will be high.
There is an inverse relationship between the rate of interest and the speculative demand for money.
The total demand for money is obtained by the summation of the transactions, precautionary and speculative demands. Represented graphically, it is sometimes called the liquidity preference curve and is inversely related to the rate of interest.
With the fall of the Berlin Wall in October 1990 there was the predictable euphoria amongst the population in eastern block countries and although you can change a political system overnight, an economic system takes many years. That is why economies in the transition phase usually use this period of happiness amongst the population to implement economic policies which will be very unpopular in the short-term but potentially have long-term benefits for the economy. However were East Germans happier after this freshly regained freedom in 1990?
Research has shown that is took over 25 years after transition for the level of happiness to be higher than in a June 1990 survey taken when East Germany was still a socialist state. Happiness declined sharply from 1990 to 1991 as unification occurred and recovered to about where it was before the transition to capitalism began. The decline in satisfaction was accompanied by a decline in output equating to about one-third of GDP with high levels of unemployment as numerous firms go bankrupt. Unemployment reduces happiness but also impacts those in employment as the threat of losing their job increases. In East Germany the unemployment rate was 14.8% in 1994 and it peak at 18.4 in 2004 – see graph below.
As well as unemployment the social safety net was a factor that influenced the level of happiness in East Germany. Satisfaction with health care, childcare and work were all surveyed from 1990 onwards, and all decline noticeably in the transition to capitalism. Under socialism jobs tended to be assured and employers provided sufficient childcare and financed comprehensive healthcare. With the shift to the capitalist systems a lot of these benefits disappeared. An East German respondent to a survey commented that:
The unification process is costuming me personally DM400 each month. I include in this higher rental and transport costs, as well as social costs. There are problems at all levels: traffic, crime, rent refugees, health care, social security. For me personally it is a vast and serious problem. People have lost old structures and certainties, and don’t know how to cope. I know that we here in the East have to go through a transition process, but it is difficult and for many no longer makes sense.
When asked about their level of happiness people focus on their immediate personal circumstances rather than the political environment. This includes having a job, making a living, caring for their family and ensuring good health. Only around 1 person in 25 members broad systemic issues such as the form of government or political and civil rights.
Many economists assumed that the transition of East Germany to capitalism would make everyone vastly happier. Pre-transition conditions in East Germany show that to increase people’s level of happiness, job security and a strong social welfare system were paramount. Happiness in most Eastern European countries has been on the increase but it is still likely to be short of where it had been prior to transition. However it is not just policies in socialist countries that increase the level of happiness, capitalist countries can achieve similar results.
Source: An Economist’s Lessons on Happiness. Farewell Dismal Science by Richard A. Easterlin (2021)
With mock exams approaching in preparation for the CIE exams in October / November here are some notes on the differing objectives of firms. This could be the second part of an essay question with the first part potentially being about market structures – perfect and imperfect competition.
The standard neo-classical assumption is that a business seeks to maximise profits (MC=MR) from producing and selling an output in a market. However, there are other objectives that firms might decide to pursue and this has implications for price, output and economic welfare. Furthermore, it is sometimes difficult for firms to identify their profit maximising output because they cannot accurately calculate marginal revenue and marginal costs. Any company has various interest groups that have stakes in the company. These include employees, managers, shareholders and customers.
Each of these groups is likely to have different objectives or goals. What the managers want to do is not necessarily what the owners want them to do. Managers may have a lot of freedom to pursue their own objectives rather than those of the shareholders and may try to maximise their own utility rather than the profit levels of the company. Shareholders may not keep themselves well informed and therefore rely on the decision making of the managers of the company.
The dominant group at any moment in time can give greater emphasis to their own objectives, for example, the main price and output decisions may be taken at local level by managers, with shareholders taking only a distant view of the company’s performance and strategy. Below are some other objectives:
Satisficing – with all the interest groups in a company all with their own objectives (higher wages for employees, customer satisfaction, marketing, etc) the overall objectives of a company are the result of discussion, negotiation and bargaining with all these groups. The result of this is likely to be a compromise between parties that does not maximise anything, this is satisficing.
Market share – some firms may be motivated by increasing market share. This is prevalent when firms operate in markets with a few large competitors and try to attract new customers from other competitors.
Survival – some firms look at survival, – especially those new to a highly competitive market. Surival is also prevalent when an economy goes through a downturn and consumer spending falls throughout the economy.
Shareholder value – increase shareholder value means to increase the asset value of the business. Shareholder value is defined as the remaining value of the business once all debts have been paid.
Ethical goals – increasingly, firms are introducing ethical goals such as those associated with the environment and carbon emissions, and with fair trade. This may mean more investment into these goals that leads to a higher cost structure. However, advertising ethical goals to consumers could attract more demand.
Limit pricing – firms may adopt predatory pricing policies by lowering prices to a level that forces any new firms entering the industry to operate at a loss. This allows firms to sustain a monopoly position in a market.
Sales volume maximisation – firm might wish to maximise the number of units sold, in turn maximising its share of the market, although this goal would have to be pursued subject to a profit constraint. The firm could expect to sell a large number of units if it dropped its price far enough, but at some point cutting price any further will involve making a loss. The output and price of a firm that wishes to maximise sales is subject to the constraint of making at least normal profit. Therefore output is set at the level where AR = AC. See graph below.
Sales revenue maximisation – total revenue is maximised when Marginal Revenue = zero (MR = 0), shown on the graph below. The shareholders of a business may introduce a constraint on the price and output decisions of managers, this is known as constrained sales revenue maximisation. Shareholders may introduce a minimum profit constraint designed to underpin the market valuation of their shares and maintain a dividend (a share of the company’s profits).
Interesting set of charts here that I picked up from Mauldin Economics. The left hand chart shows annually from 2019 and 2021 inflation change against the change in government disbursements. Countries with larger stimulus packages tended to experience greater inflation acceleration. Compared to other countries New Zealand had the largest fiscal stimulus with a disbursements gap of approximately 19% indicating that government spending and transfers increased sharply relative to pre-pandemic trends.
The right panel of that graphic plots inflation vs. the change in employment. A positive unemployment gap implies that a country’s labour market has yet to recover from the pandemic recession. Across countries, the size of the inflation acceleration is negatively correlated with the unemployment gap, suggesting that differences in labour market slack account for a significant part of the cross-country variation in inflation acceleration.
Below is an interesting graphic from the FT which shows GDP and Inflation over the last couple of years in New Zealand – you can select other countries as well and it is good to compare different parts of the world. Note that NZ’s inflation and GDP is lower than the global average. You would normally experience stagflation when the stagnant growth is accompanied by high levels of unemployment – NZ has 3.3% unemployment. However the labour markets globally are very tight with just today British Airways cancelling 10,000 flights due to labour shortages.
If you look at Japan you will see very little difference between GDP and Inflation and you could say they may be eventually coming out of a deflationary period.
From the OEC site comes Tradle which operates just like Wordle and is a daily challenge. From the dollar value and composition of a country’s exports you have to try and find which country the data relates to. You have 6 chances to get the correct answer and for each wrong answer they indicate how many kms away the country is from your choice and in which direction. Good lesson starter for the day. You can also go onto the OEC site to look at country profiles – very useful.
In 1939 Paul Sweezy of Harvard University wrote his paper ‘Demand Under Conditions of Oligopoly’ in which he explained conditions around the kinked demand curve. He suggest that rivals in a market react differently according to whether a price change is upward or downward.
If producer A raises his price, his rival producer B will acquire new customers. However if producer A lowers his price, his rival producer B will lose new customers. From the point of view of any particular producer this means simply that if he raises his price he must expect to lose business to his rivals (his demand curve tens to be elastic going up), while if he cuts price he has no means to believe he will succeed in taking business away from his rivals (his demand curve tends to be inelastic going down). In other words, the imagined demand curve has a “corner’ at the current price.
MR curve at 0 output An important point to note with a kinked demand curve is that as revenue falls if the price increases or decreases the MR curve must cut the horizontal axis at this output. Therefore, as well as being where MC=MR profit maximisation output it is also revenue maximisation. If a seller reduces the price of the product below P1, his rivals will also reduce their prices. Though he will increase his sales, his revenue would be less than before. The reason is that the AR portion of the kinked demand curve below P is inelastic and the corresponding part of marginal revenue curve after Q1 is negative. Thus in both the price-raising and price-reducing situations, the seller will be a loser. He would stick to the prevailing market price P1 which remains rigid.
A lot of textbooks draw the second part of the MR above the horizontal axis which indicates that total revenue is still increasing.
For more on the Kinked Demand Curve view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
At the heart of the rise in inflation over the past year has been supply-chain issues as well as the war in the Ukraine. However there are signs that this inflationary pressure is starting to subside with the cost of transportation coming down as well as improved delivery times for produce. The major concern was the COVID lockdown in China and now that restrictions have eased production and the transportation network have returned to some sort of normality. Oil and a number of other commodity prices have declined in recent months due to easing supply-side pressures and expectations of lower global demand, although prices remain elevated.
Useful video from the FT which looks at exporting countries of primary goods and the introducing of greater protectionist measures as global food prices increase. There have been various reasons for these prices – supply chain problems – labour shortages – rising energy cost – drought – and of course the Ukraine War. Ukraine and Russia provide a significant amount of global wheat and plant oils. The VoxEU.org economic policy group stated that export limits imposed during the 2008 financial crisis pushed food prices up by an average of at least 13 per cent. Restrictions on food shipments can also damage the trading reputation of nations that enforce them and rob local farmers of lucrative access to markets when prices are high. Business leaders and policy makers warn that escalating restrictions could lead to a trade war, which will impact the world’s poorest people the most.
Below is a graphic from the IMF showing both developing and developed countries interest rate movements. Obviously during the the COVID pandemic interest rates were lowered to stimulate aggregate demand and reduce the debt burden on consumers and businesses. However with inflation now being well above the 2% threshold that most countries have as their target, interest rates have been on the rise. Central banks need to act resolutely to bring inflation back to their target, avoiding a de-anchoring of inflation expectations that would damage credibility built over the past decades. Although the war in Ukraine and the supply chain disruptions can’t be resolved by central banks, higher interest rates can slow aggregate demand and therefore reduce inflationary pressure.
Just been covering this with my A2 class and as it is a popular topic in the multiple choice paper (P3). Here are some thoughts on the types of questions they could ask on natural monopoly graphs. Remember that the natural monopoly achieves economies of scale at all levels of output therefore the MC curve cuts the AC curve above the AR curve. The following are areas/points on the natural monopoly graph that you should know about. Loss of allocative efficiency is a popular question.