The main difference between traditional banking and the shadow banking system is that the latter are not subject to the same regulatory requirements that apply to traditional banks. Traditional banks in most countries are regulated by the central bank – RBNZ in New Zealand, Federal Reserve in the USA. The shadow banking sector are not structured or regulated as banks and include: investment management companies, pension funds, hedge funds, money market funds, mutual funds, payday lenders and others. However they still offer the same activities as traditional banks – loans, deposit taking etc. See graphic below from Better Markets.
Because of the fact that there is so little regulation the shadow banking sector has been growing and since the GFC in 2008 their share of global financial assets has grown form 42% to 50% by 2020. Therefore the shadow banking sector should no longer continue to be as unregulated. In the traditional banking system stringent capital and liquidity requirements as well as deposit insurance which makes them less susceptible to panic. However the recent collapse of SVB showed how poorly regulated it was and bank credit contracted $311 billion—or 1.77% in just two weeks The main concern with shadow banking is that because there is little regulation they take on more risk which means greater tendency to have less liquidity in reserve and more exposure to debt. On the flip side, shadow banks can offer a broader range of borrowing options which many industries now rely on for financing.
Source: Better Market – March 24, 2022 The Increasing Dangers of the Unregulated “Shadow Banking” Financial Sector
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The Argentinian central bank has continued its tightening cycle with 300 (3%) basis point increase in interest rates to 78%. Even with such high interest rates inflation has accelerated as basic food items such as grains and meat have increased mainly due to the drought that is affecting the country – CPI 103%. But such high rates are necessary to avoid a big outflow of the currency (Peso) as Argentinians look to the safety of the US dollar and therefore exchange their Pesos for US dollars. This would lead to a collapse of the Peso and a loss of confidence in the Argentinian economy.
The major worry about the inflation is that it has been so prevalent over the last five years that there is strong inflationary expectations. This causes consumers to buy now, rather than later when goods and services are more expensive – AD shifts to the right causing further increases in prices. It is essential for central banks to maintain a stated target for inflation – RBNZ 1-3% – as this leads to greater confidence in the economy and especially in the banking sector. New Zealand was one of the first countries to adopt inflation targeting in1990.
Trust. Ultimately the trust in the central bank meeting their inflation target is important to businesses and households as they plan for future expenses etc. Expectations are anchored around these targets and essential for consumer and producer confidence and ultimately growth. It is imperative that central banks need to be able to build up trust and institutional creditability.
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You might have come across Gillian Tett in the FT and her book Anthro-Vision in which she prescribes thinking like an anthropologist to better understand consumer behaviour, markets, and organisations to tackle issues like climate change, inflation, cost of living crisis etc. Very interesting to see how she progressed her career from a PhD in anthropology based on a study of tajit wedding rituals to become the editor-at-large for the FT in the US.
anthropologists know that there are many ways to look at the world and most of the time people who are different from you look at it very differently and if you don’t think about those differences not only are you robbing yourself of a chance to understand the world in all its glory and get fresh inspiration but you’re also likely to make some terrible mistakes.
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The Croatian government has introduced price caps on basic food items to tackle the cost of living crisis. The foodstuffs that have been capped are sunflower oil, milk, flour, white crystal sugar, whole chicken, pork and minced meat.
Croatia recently adopted the Euro and as with other countries when the transfer from local currency happens consumers argue that businesses use the move to the Euro as an excuse to increase prices. Inflation in the Eurozone is currently 6.9% and in Croatia 10.6% – March 2023. Croatia is one of the poorer members of the Eurozone therefore their population is more vulnerable to price rises.
Croatia – GDP per capita is US$17,685 Euro zone – GDP per capita is US$38,411
The concerns about prices caps is when you remove them and let the market dictate the price of goods. Price caps don’t tackle the fundamental reason for inflation and there can be a lack of incentive for firms to increase supply which can have a lasting impact the longer prices are capped. There is the risk that prices will accelerate with limited supply – it is like water building up on the wall of a dam as the longer you leave it the more damaging it will be when you open the dam wall. Price caps can also lead to an increase in the informal market.
Maximum price theory
If a government set a maximum price control of $350 (see graph) for the market of houses to rest this restricts the rent hat landlords are legally allowed to charge tenant. The maximum price of $350 will cause the price to fall from the market of $450 and an increase in quantity demanded of 3,500 to 4,000 and a decrease in quantity supplied from 3,500 to 2,500. There is now a shortage of 1,500 houses to rent and this could give rise to an informal market where some people are willing to pay a higher price than the legally set price by the government of $350 to rent a house. Elearneconomics
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On my way to work last week there was a very good interview on National Radio (NZ) with Robert MacCulloch an economics professor at the University of Auckland. This ended up to be my lesson plan with my A Level class for the last day of term. MacCulloch argued that the interest rate hike of 50 basis points was too great an increase and could lead to a hard landing and deeper recession that could be avoided. His main arguments were:
Inflation has stabilised as quarterly inflation had dropped from 2.2% to 1.4% therefore no need for a 50 basis point rise.
In other countries (USA) inflation is dropping and those central banks are holding off on interest rate increases.
Stated that the RBNZ wants a hard landing and therefore a recession which can be damaging with higher unemployment.
More gradualist approach should have been adopted.
RBNZ stated that the post-covid inflation was a temporary blip and that stagflation was back in the early 1980’s – we live in a different world today.
Would it be better to go hard early with higher increases and then be able to loosen monetary policy? This may mean recession where you hit mortgage holders and those that become unemployed.
A lot of other central banks adopting a wait and see approach – couldn’t the RBNZ do the same?
Okun’s Law – A slowdown in GDP growth typically coincides with rising unemployment. A hard landing will result in this.
In NZ GDP shrank 2% compared to the UK 11%. NZ grew in 2021 so was there a need to have close to 0% interest rates and print $50bn?
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The Rest is Politics is a great podcast from the UK with Alistair Campbell (Downing Street Director of Communications and Strategy under UK PM Tony Blair) and Rory Stewart (ex UK Conservative Party cabinet minister). In this particular podcast Rory Stewart explains the concerns around the banking system with regard to Silicon Valley Bank, Credit Suisse and the financial instruments that nobody really understands, even the very big banks. There is mention of CDS – credit default swaps which is insurance on the bond. Also a good explanation of the relationship between interest rates and bond prices and how after the 2008 global financial crisis, regulation urged banks to put more of their money into government bonds. Remember that government bonds are seen as very secure and maintain their value. Below is the link to the podcast. The discussion on banks is from the start of the podcast to 6 minutes. Well worth subscribing to this podcast.
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Martin Wolf in the FT wrote an interesting piece in the FT yesterday talking about loose monetary policy and not to wholly blame the central banks for the economic environment today. Below are some of the main points that he makes:
Deregulation of financial markets, free trade and China joining the WTO in 2001 lowered the global inflation rate.
Huge savings were prevalent in the global economy – especially in China and Germany
Balance global demand and supply = big investment in housing driven by financial liberalisation.
COVID – money growth exploded with expansionary monetary and fiscal policy.
Fiscal deficit of G7 countries jumped by 4.6%.
Monetary – quantitative easing and stimulatory level of interest rates
With supply chain issues, China’s lockdown and the Ukraine War, the dramatic increase in demand could not be met by a corresponding increase in supply. See graph
Inflation = higher interest rates = shock to banking system
Loose monetary not the blame for what has gone wrong in the global economy
Mistake to think that there is a simple solution to the failing of the banking systems
Things would not be wonderful if central banks had stood idly by. We cannot abolish democratic politics. Economic policy must be adapted to our world, not to the 19th century. Martin Wolf
Source: IMF
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With the onslaught of COVID one wondered whether the jobs lost during the pandemic would “come back”. Part of the logic was that since robots don’t fall ill, bosses would turn to them instead of to people and COVID would act as a catalyst towards automation.
For a number of years the rhetoric has been that robots will see the end of a lot of jobs and whilst that maybe the case for some occupations the number of people in work has risen to very high levels in developed economies. For instance countries that have the highest presence of robot use e.g. Japan and South Korea also have the lowest unemployment rate. However both those countries do have ageing populations which does make the supply of labour more scarce. A study by Daisuke Adachi of Yale University suggested that between 1978 and 2017 an increase of one robot per 1,000 workers boost firms’ employment by 2.2%. Other research done in Finland concluded that the adoption of advanced technologies led to increases in hiring. According to The Economist there are an estimated 30m unfilled vacancies across the OECD.
“a strong positive association with firm survival, and that greater initial automation was associated with increases in employment”.
Automation and Inequality
However although technology doesn’t necessarily mean a loss of jobs it may have helped to increase the widening gap between incomes. In November 2021 Daron Acemoglu Testified its the US Congress on Automation and Economic Disparity. He identified two types of evidence to show the impact of technology on inequality:
In local labour markets (commuting zones) where there has been faster adoption of industrial robots, we see not just lower employment and wages, but also greater inequality between high-education and low-education workers and a bigger gap between those at the top and bottom of the income distribution.
There is an interesting relationship between two groups of workers – those that had their jobs taken over by automation and those that have not experienced much direct automation. Acemoglu’s research showed that those employed in routine tasks that can automated in industries undergoing rapid automation — have almost uniformly experienced large declines in their real wages. These groups include all demographic categories with less than a college degree. However those workers that have not experienced much direct automation, including those with post-graduate degrees and women with college degrees, have seen their earnings increase rapidly over the last 40 years. The Figure below indicates that more than half, and perhaps as much as three quarters, of the surge in wage inequality in the US is related to automation.
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.
Sources:
Economists are revising their views on robots and jobs. The Economist – January 22nd 2022
Daron Acemoglu – Written Testimony, House Select Committee on Economic Disparity and Fairness in Growth Hearing on Automation and Economic Disparity. November 3, 2021
The principle of economies of scale is fundamental to maritime transportation economics as the larger the ship, the lower the cost per unit transported. This trend has particularly been apparent in bulk and containerised shipping. Since the 1950’s the size and capacity of the containership increased from 500 to 25,000 TEU’s (Twenty-foot equivalent unit) – see table belo
The TEU is referred to as the container which has been the driver of intermodal transportation and its homogeneity means the easy handling of the container between shipping, rail and road. Marc Levinson in his book ‘The Box’ outlined its importance:
‘The value of this utilitarian object lies not in the what it is, but in how it is used. The container is at core of a highly automated system for moving goods from anywhere, to anywhere, with a minimum cost and complication on the way’.
The global containership fleet 2000 – 2021 The trend over the last 20 years is to increase the TEU capacity by building larger ships. The total number of ships in 2000 was 2,606, with the average ship being able to transport 1749 TEU’s. By 2020 the global capacity number of ships increased to 5337 vessels with an average ship being able to transport 4352 TEU’s – see chart. Those containerships that have a capacity of over 2,000 TEU operate in the long-distance trade routes and account for over 89% of the world’s container fleet. Shorter containerships up to 2,000 TEUs made up the other 11% and they operate as feeder services and in short sea shipping.
Of late there has been significant growth in the size of containerships especially the large (ULCS) and mega large containerships (MGX-24) with an overall capacity of between 10,000 – 23,000 TEU. This equates to 573 ships and accounts for 36% of the total capacity of the container fleet – see chart below.
Fleet Capacity Breakdown by TEU size range.
Source: The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger 2nd Edition – (2016). By Marc Levinson
Although the paradox of thrift has been a regular part of the CIE A Level syllabus it is has only become more relevant since the Global Financial Crisis (GFC). It has its origins in the 1714 book entitled ‘The Fable of Bees’ by Bernard Mandeville but it was John Maynard Keynes who really popularized this concept during the Great Depression of the 1930’s. Classical economic theory suggests that greater levels of saving will increase the amount of loanable funds in the banks and therefore reduce the cost of money – interest rates. This allows people to put off consumption to a later date thereby avoiding the risk of taking on debt and thereby give people security if their jobs became threatened during a recessionary period
Keynes’ beliefs
Keynes argues that saving was not a virtue from a macroeconomic view as he believed that negative or pessimistic expectations during the Depression would dissuade firms from investing. Cutting the rate of interest is supposed to be the escape route from economic recession: boosting the money supply, increasing demand and thus reducing unemployment. He also suggested that sometimes cutting the rate of interest, even to zero, would not help. People, banks and firms could become so risk averse that they preferred the liquidity of cash to offering credit or using the credit that is on offer. In such circumstances, the economy would be trapped in recession, despite the best efforts of monetary policy makers. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor.
All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Consequently, monetary policy under these circumstances is futile.
Keynes saw the 1930’s as a time when aggregate demand needed boosting – C+I+G+(X-M) – as the economy was in underemployment equilibrium. With the help of the multiplier, output and employment would increase – GDP. But with increased saving leading to reduced consumption and a fall in aggregate demand, a recession will worsen.
The fact that income must always move to the level where the flows of saving and investment are equal leads to one of the most important paradoxes in economics – the paradox of thrift. Keynes explains how, under certain circumstances, an attempt to increase savings may lead to a fall in total savings. Any attempt to save more which is not matched by an equal willingness to invest more will create a deficiency in demand – leakages (savings) will exceed injections (investment) and income will fall to a new equilibrium. In the graph below, the point of equilibrium is at E where the saving curve SS and investment curve II intersect each other. The level of income at equilibrium is OY and saving and Investment are equal at OH. When the aggregate saving increases, the saving curve shifts upwards from SS to S1S1. The new equilibrium point is E1 with OY1 level of income. Saving and investment are equal at point OT. As the level of saving increases, national income decreased from OY to OY1. Similarly, the volume of saving and investment also declined from OH to OT.
Negative Multiplier
People save more → spend less → another’s reduced income → negative multiplier → reduces demand → unemployment ↑ → incomes ↓ → AD↓ therefore planned increase in savings makes a recession worse.
Paradox of thrift and the GFC
The relevance of the paradox of thrift today is different from that during the Great Depression in the 1930’s. Back then consumers weren’t in as much debt as they are today and the government played a much smaller role in the economy with little or no welfare state to provide automatic stabilizers. Also the financial system wasn’t an interconnected as it is today and the financial engineering that evolved in the 2000’s allowed for the creation of instruments that had no real value to the economy – CDO and CDS. But after the GFC the expectations of consumers became very negative and as workers became fearful of losing their jobs what followed was an increase in savings as they wanted less exposure to debt, which negatively affected consumption.
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Been covering banking and the bond market with my A2 economics class and we talked about the collapse of Silicon Valley Bank. Below is a video from the WSJ on the whole SVB saga and the history behind bank regulation under Obama but deregulation under Trump. What is interesting is the fact that 94% of SVB’s deposits (see graph) were above the $250,000 which is insured by the Federal Deposit Insurance Corporation – government corporation supplying deposit insurance to depositors in US commercial and savings banks. However you do wonder why depositors kept so much money in a bank when you would want to spread your risk. Although you may need cash for day-to-day transactions, money could be put into a market fund and brought back into a bank account when needed.
WSJ talk about bonds and below are some notes on how bond yields work. This is part of the A2 syllabus Unit 9 – interest rate determination: loanable funds theory and Keynesian theory.
How do Bond Yields work? Say market interest rates are 10% and the government issue a bond and agree to pay 10% on a $1000 bond = annual return of $100. 100/1000 = 10% If the central bank increase interest rates to 12% the previous bond is bad value for money as it pays $100 as compared to $120 with the a new bond. The value of the old bond is effectively reduced to $833 as in order to give it annual payment of $100 a year the price would have to be $833 to it a market based return. 100/833 = 12%
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Being St Patrick’s Day I thought it appropriate to look at some humour.
“Why was the Irish economist afraid of swimming? He was conscious of the liquidity trap.”
“How do you confuse an Irishman when trying to maximise his utility when purchasing two products? Put two shovels against the wall and tell him to take his pick.”
“What do you call it when an Irish economist has an idea? Moral Hazard”
“An Irishman said he saw a ghost. The Irish economist said it was just the invisible hand.”
“What’s the difference between Iceland’s economy and Ireland’s? One letter and six months”
“We all know what pareto optimal allocation means… What about Irish optimal allocation — when all persons are equally well off, and one person really gets it bad, worse off, while all the rest are much better off…”
“An Irish economist walks into a pizzeria to order a pizza. When the pizza is done, he goes up to the counter get it. There a clerk asks him: “Should I cut it into six pieces or eight pieces?” The Irish economist replies: “I’m feeling rather hungry right now. You’d better cut it into eight pieces.” (see the “Father Ted” version above)
“Why would Father Jack not make a good economist? There would always be massive inflation as his only policy would be to increase liquidity.”
This year I am trying to get students to develop a deeper understanding of economic issues and to improve their evaluation skills for the written exam. The goal is that students will arrive at a collective meaning, rather than seek a “right” answer. Below is a plan of how you could structure the discussion.
Subject content – Economic schools of thought. Keynes v Hayek – this is part of Unit 9 of the CAIE A2 syllabus.
Content knowledge: Types of economies (left and right wing) covered at CAIE AS Level. The schools of thought are taught in class and questions (MCQ) and short answer are used to test student understanding of the characteristics of each. The two videos below are useful to consolidate knowledge.
Austrian economics and Keynesian economics explained in 1 minute. See below
Music (rap) video ‘Fear the boom and bust’ – Keynes v Hayek. See below
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. Students can only talk when they place a card on the table. Once a student has used up all their cards they can no longer contribute to the discussion. The link below has more detail on this method:
Students read a media extract on the topic. Extract selection is important – not too long and must be easy to relate to core knowledge. I have picked the article by Larry Elliott in the Guardian newspaper as this is media that is different to what students tend to be exposed to.
Number of students in a group is a determining factor – 8 to a group.
Tutorial/discussion over 2 periods
Opening question – essential that this is pitched at the level appropriate to the group as the intention is for the discussion to proceed through student interactions.
The new variant of capitalism should be the dominant policy option for governments.
If this is question doesn’t engage the students you could ask some of the following questions:
Start off with a simple question that is referenced from the text – ‘What aspects of Keynesian economics are evident in the extract?’
Allow each student to answer the opening question – 30 seconds. Other responses can spark conversation once everyone has replied.
Get students to continually reference the text so to keep the conversation relevant
Coaching – there may be the need to encourage deeper and more critical thinking. Need to avoid teaching by offering analysis and possible evaluations. Some questions to encourage critical thinking:
Why was the Keynesian variant relinquished in the 1970’s?
How did the 2008 GFC influence government policy?
Was austerity the answer to the issues caused by the GFC?
How did COVID-19 impact policy for left right and centre governments?
Should allow students to respond from their own perspective but must be related to the extract.
Student reflection – the hope is that students are able to develop a deeper understanding of the complexities of the subject content and read newspaper/magazine articles with a more holistic view of the how an economy works. The level of scaffolding for reflection will vary with each student but there is potential for all students to feel more confident in their knowledge and participation in future discussions.
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Over the last couple of decades property has been a significant driver of Chinese growth. The dependence on real estate is shown below and it is interesting to note that China was more dependent on housing construction than Ireland and Spain prior to the Global Financial Crisis.
Real estate related activities’ share of GDP by country, 1997-2017
Source: Rogoff and Yang
Real estate has impacted consumer spending, employment of workers, investment and demand for raw materials. Investment in property has increased by 5% of GDP in 1995 to 13% in 2019 – 70% of which was residential. As for household consumption 23% is spent on real estate. How do you work out the value of output for residential investment and is there a problem with double counting?
GDP andthe Output Approach
Gross domestic product (GDP) is defined as the value of output produced within the domestic boundaries of a country over a given period of time, usually a year. It includes the output of foreign owned firms that are located in that country, such as the majority of trading banks in the market. It does not include output of firms that are located abroad. There are three ways of calculating the value of GDP all of which should sum to the same amount since by identity:
NATIONAL OUTPUT = NATIONAL INCOME = NATIONAL EXPENDITURE
The output approach is the value of output produced by each of the productive sectors in the economy (primary, secondary and tertiary) using the concept of value added.
Value added is the increase in the value of a product at each successive stage of the production process. For example, if the raw materials and components used to make a car cost $16,000 and the final selling price of the car is $20,000, then the value added from the production process is $4,000. We use this approach to avoid the problems of double-counting the value of intermediate inputs. GDP will, therefore, be equal to the sum of each individual producer’s value added.
The Economist look at a simple example of calculating the output approach using a house. House is built and makes up the whole economy. It is made of steel which is made from iron ore.
House is sold – $1m Steel is sold – $600,000 Iron ore is sold – $500,00
How significant is the construction industry? As the builders add $400,000 to the value – 40% of GDP. But if the whole economy is the house is it 100% as the iron ore is an ingredient of the steel that is bought by the builder.
The Economist mention a paper by Kenneth Rogoff and Yuanchen Yang “Has China’s Housing Production Peaked?” in which they take a different view on calculating the value of property. They use the input-output total requirement matrix with the economy divided into 17 industries – manufacture of machinery, construction, transport etc. The coefficients indicate the production required directly and indirectly in each sector when the final demand for domestic production increases by one unit. By adding up the coefficients corresponding to the construction industry they found that 1 unit of increase in the construction sector requires 2.12 units of inputs from forward (other contractors) and backward (raw materials) industries. In breaking down the construction and installation as part of Chinese real estate, investment is RMB 7,630 bn. Thus 2.12 x 7,630 = RMB 16,176 which is the total value.
Therefore in the original option the Rogoff and Yang model would include the iron ore and not the value of the house or the $400,000 value added by the construction industry. Therefore:
Steel $600,000 + Iron ore $500,00 – $1.1m
There way of removing double counting is unusual as if you add the construction output $1m, steel output $600,000 and iron ore output $500,000 there is a double and triple counting:
x2 = Steel – counted twice – purchase of steel and when house is sold x3 = Iron ore – counted three times – purchased in raw material form, when used to produce steel and when house is sold.
The way that is normally talked about in textbooks is to only count the added value at each stage of production. Iron ore $500,000 + steel $100,000 + $400,000 construction costs – $1m = 100% of GDP in a one-house economy.
Sources: China & World Economy / 1–31, Vol. 29, No. 1, 2021. Has China’s Housing Production Peaked? Kenneth Rogoff, Yuanchen Yang
The Economist: Free Exchange – A universe of worry. November 27th 2021
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By trying to restrict investments in oil and gas ventures, is the ESG movement going to have the effect of reducing supply of oil as global demand increases? With this scenario the price of energy will increase and developing countries will find it even more difficult to provide its citizens with electricity, water etc which requires energy in the form of oil, gas and to some extent coal. Developing countries will need significant financial help from the developed world if they are going to grow in a sustainable and environmentally favourable way. The concern is the reliance on oil and gas and the ever increasing demand – see graph:
Environmental, social, and governance (ESG) investing is used to screen investments based on corporate policies and to encourage companies to act responsibly. There has been a lot of anti ESP feeling as a focus on environmental and social issues conflicts with the corporate duty of maximising the return for shareholders. Banks in particular have indicated that they may withdraw from corporate alliances that have promised to cut carbon emissions across entire industries – see video from the FT below. But as Gillian Tett points out:
The challenges around sustainability and business are not going to disappear. On the contrary, they’re becoming more urgent than ever.
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Below is a useful flow chart for anyone studying monetary policy. Both the NCEA Level 3 and CIE A2 courses cover this topic.
Negative – lower interest rates might depress spending by some retirees who rely on interest income. But these counterproductive channels are small compared to the Positive – lower interest rates = a lower propensity to save and a higher propensity to spend.
The side effects of monetary policy. Falling interest rates = accelerating house prices = social problems and political anxiety. If RBNZ kept interest rates at around 8% as in the 2000s to prevent the house price = New Zealand in deflationary spiral.
The economic and social consequences of deflation would be far worse than the (undeniable) problems with rising house prices. The low inflation / falling interest rate dynamic of the past two decades has been a global phenomenon, ultimately caused by a global change in the balance between savings and investment. The Reserve Bank of New Zealand could not have prevented this global trend from affecting New Zealand interest rates without causing severe damage to the economy. In New Zealand, the most important transmission channels are asset prices and the exchange rate. Falling interest rates tend to push asset prices up, which stimulates consumer spending. Falling interest rates also tend to reduce the exchange rate, which generates inflation via the prices of internationally-traded goods and services.
Source: Westpac Bank
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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
non-wage factors
wages
Difficulty in acquiring qualifications – eg. doctors
social attitudes to employment
discrimination
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
A = Employed B = Involuntary Unemployment C = Voluntary Unemployment
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.
Price discrimination involves charging different prices to different sets of consumers for the same good or service. So when you are on your next flight there are going to be different fares for the same class of seat whether it be in economy, business class or first class. What variables at work to bring about price discrimination in airline routes?
What day of the week you fly – Monday and Friday are usually peak times for business so you should find that fares are expensive. Also because it is usually for business purposes it is assumed that firms will be paying for the flights and therefore are prepared to pay more.
Times of the day – morning and evening tend to be more expensive as this is peak time.
How competitive the route is – if there is a lot of competition fares will be cheaper to the extent that there maybe predatory pricing. There is a good piece in the video showing the fares for flights from Montreal to St Johns Newfoundland. Once low cost carriers entered the market Air Canada dropped their price below cost.
Reputation of each airline – better reputation = higher fare
The video below is a very good especially the fare structure on the New York to Los Angeles route.
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Below is a very good video from the Wall Street Journal on price elasticity of demand (PED). PED is key to understanding how companies price their products. Consumer spending has held up relatively well so far despite inflation, but experts say we’re approaching an inflection point. The WSJ explains the role ‘elasticity’ plays in a company’s decision on whether to raise prices. After the video I’ve included some notes about calculating PED and a mindmap.
Price Elasticity of Demand (PED) This measures the relative amount by which the quantity demanded will change in response to change in the price of a particular good. The equation is:
% change in Quantity ÷ Demanded % change in Price
How is PED calculated?
Consider the following demand schedule for buses in a city centre.
Price (average fare) Quantity of passengers per week 100c 1000 60c 1300 30c 2275
Suppose the current average fare was 100c, what is the PED if fares are cut to 60c?
The percentage change in QD is equal to: • The change in demand 300 (1300-1000) divided by the original level of demand 1000. To obtain a percentage this must be multiplied by 100. The full calculation is (300 ÷ 1000) x 100 = 30%
The percentage change in price is equal to: • The change in price 40c (100c – 60c) divided by the original price 100c. To obtain a percentage this must be multiplied by 100. The full calculation is (40 ÷ 100) x 100 = 40%
These two figures can then be inserted into the formula with 30% ÷ 40% = 0.75 Let us now consider the PED when the average fare is cut from 60c to 30c
The percentage change in QD is equal to: • The change in demand 975 (2275-1300) divided by the original level of demand 1300. To obtain a percentage this must be multiplied by 100. The full calculation is (975 ÷ 1300) x 100 = 75%
The percentage change in price is equal to: • The change in price 30c (60c – 30c) divided by the original price 60c. To obtain a percentage this must be multiplied by 100. The full calculation is (30 ÷ 60) x 100 = 50%
These two figures can then be inserted into the formula with 75% ÷ 50% = 1.5
Please note that the minus sign is often omitted in PED, as the price elasticity is always negative because demand curves slope downwards. The textbook displays figures as: PED = (-) 0.2
What price elasticity of demand figures tell us.
Determinants of Elasticity of Demand
The elasticity of a product is influenced by: • the number of substitutes available • whether it could be described as a luxury or a basic commodity • the proportion of the purchaser’s income it represents • the durability of the product.
Usefulness of Price Elasticity of Demand
The usefulness of price elasticity for producers. Firms can use price elasticity of demand (PED) estimates to predict:
1. The effect of a change in price on the total revenue & expenditure on a product.
The relationship between elasticity and total revenue.
Elastic Inelastic Unitary Price ↑ TR↓ TR↑ No Change Price ↓ TR↑ TR↓ No Change
2. The likely price volatility in a market following unexpected changes in supply.
3. The effect of a change in GST (indirect tax) on price and quantity demanded and also whether the business is able to pass on some or all of the tax onto the consumer.
4. Information on the price elasticity of demand can be used by a business as part of a policy of price discrimination – off-peak and peak travel in major cities. Before 9am – inelastic demand curve – after 9am elastic demand curve.
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Supply chain disruptions and large fiscal deficits have been part of the cause of the inflationary problems that have been prevalent in the global economy. Increased aggregate demand from government spending accompanied by supply constraints have seen prices soar. The IMF blog looked at how we should go back on history and look at how globalisation in the past has offered an antidote to inflationary spirals.
In the 1970’s technology improved global supply chains with the introduction of the shipping container which reduced transport costs of goods. Policymakers like the former US Fed Chairman Alan Greenspan see the relationship between globalisation and innovation a transition to low inflation. This idea has been embraced by current Fed Chairman Jerome Powell who talks of not only technology but demographic factors that bring about sustained disinflation. Trade liberalisation had a part of play here with the role of the General Agreement on Tariffs and Trade (GATT) – now know as the World Trade Organisation (WTO) – providing the rules for much of world trade and presided over periods that saw some of the highest growth rates in international commerce – see graph.
Modern inflation targeting by central banks (1-3% in New Zealand) also brought inflation under control as countries established a process that would allow them to attract capital flows or to globalise further. New technologies will produce better growth and increase the potential capacity of the economy (Production Possibility Curve shifts to the right) but requires a lot of cross-border co-operation. Some countries pursue costly ‘friendshoring’ strategies of steering trade to friendly nations and regimes while attempting to hobble rivals. In particular big economies look to protect strategic vital and strategic resources thereby preventing global economic growth. All of this may seem an easy solution to tame inflation but the reality is there are many variables that influence the inflation figure within countries.
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