So what happens next?

There have been several posts on demand and supply and changes to the market. Below is a link to an article in The Guardian about the effects of the recent weather on honey production.

What side of the market is affected?
What will happen in the market for honey?
How will the market for jam and marmalade be affected by changes in the honey market?
Upon what will the extent of the changes in these markets depend?

Good one for IB micro internal assessment!

The Guardian article is here

Energy prices - a reason to reconsider?

Five of the six big energy companies has announced very high price rises, up to 11%. This is going to have a very large impact on household budgets.

There are two areas I'd like to think about, one fairly obvious and the other more reflective.

1. Fuel Poverty

Fuel Poverty is a relatively new term that refers to a situation where households spend more than 10% of their income on keeping warm. (The definition is vague on gross or disposable income, but only the latter makes sense.)

Clearly an 11% price rise will cause more households to fall into this category. If we taxed energy then people would explain that this was a 'regressive tax'. It would fall more heavily on the poorest households as it takes up a greater proportion of their income.

Therefore we should be worried about these energy price rises on the grounds of equity and income distribution. The Sunday Mirror article below looks at the effect on Fuel Poverty which may now affect one in four households.

2. The privatised energy market

In the 1980's the energy market was privatised. The aim was to introduce competition and force prices down and so making everyone better off.

The effectiveness of this policy should now be reassessed. Has it led to lower prices? Is there actually competition? Was it, in retrospect, a good idea?

Supply side policies take a long time to yield their results. It took two attempts to get the gas market right as well.

Is there really competition in this market? All the big companies are going to raise their prices by about the same amount. This is to be expected as their raw material costs are changing in exactly the same way.

If government still controlled this market then they could moderate the price rises, allow special tariffs to vulnerable groups etc. But the energy companies are private, profit making, firms and they work in the interests of their shareholders.

The Government has proposed forcing all energy companies to make sure customers are on the lowest possible tariff. This implies one tariff per company, probably all pretty identical. A major blow to competition and without any price controls. Politically popular but hardly market economics.

The Daily Mirror article is here

End of recesion or just heading for VW?

People often talk about the shape of a recession. The 'best' is V shaped - a short and sharp drop in GDP with a rapid recovery. U shaped is second best, still a strong recovery. The dreaded L shaped is the one to avoid and the reason why the policy response was so robust in 2008/9.

The UK has now officially reached the end of the W shaped - double dip - recession. Feared for so long and lengthened by the one-off impact of the Jubilee. Officially the UK grew by 1% in the quarter July to September, the fastest growth for five years.

Actually there were special considerations for this growth spurt, mainly the Olympics and the 'catch-up' from the previous quarter, so don't get too excited yet.

The headline figure is, as always, hiding a lot of detail. Look at the BBC economy page for that. It should be noted that the construction sector really is the problem area at present.

Construction continues to shrink and is making a really big impact on the figures. We should be worried about this. Not only does construction employ a lot of people and use lots of locally produced resources, but it is also a 'leading sector' in recoveries. We would expect construction to turn up before we saw a sustained rise in Real GDP.

The other point that might be worth noting is that the economy shrank by 6.4% in the first 'dip' and so far only half of that has been recovered even counting the last quarters growth.

Below is an article by The Guardian's Larry Elliott. You could not find a more miserable and biased economic commentator and he puts the latest recovery in the worst light he can. I'm surprised he wasn't the first to name the next stage as the triple dip or VW shaped recession. Glad I got in first!

Elliott's article is here

The sharp end of international trade and specialisation

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Ford have announced the closure of the Transit van factory in Southampton. The last 500 jobs will be lost from a plant that has produced over two million vans since 1972.

This was not a surprise. A Belgian Ford factory is also to close as the vehicle maker can produce far more cheaply elsewhere.

The closure reflects the continuing decline of Britain’s comparative advantage in basic manufacturing. Turkey will benefit as all production is transferred there.

The move illustrates one of the important effects of specialisation and exchange. We know that specialising allows more goods and services to be produced overall and through trade everyone can consume more and so be better off.

While overall welfare rises somebody bears a cost during the 'adjustment period'. This must occur as an industry grows in one trading partner through specialisation another, somewhere else, must decline. Where an industry declines workers lose their jobs and must seek new ones.

Those who lose their jobs are structurally unemployed. They are in need of retraining and because so many are losing their jobs at the same time it may be difficult to clear the local labour market for some time. The costs will fall particularly heavily on the over 40’s who will find it most difficult to find work.

A point to consider is why BMW (the Mini) and Honda are growing in the UK. Is it because of their product?

The local paper reports this move here

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When adjusting prices does not work

Markets do not always allocate resources efficiently. One such market failure is in the area of demerit goods such as tobacco.

Demerit goods are more accurately described as 'lack of information goods'. Consumers do not fully appreciate the costs and benefits of consumption and so the demand curve for the product is further to the right than it would be to achieve an efficient allocation of resources.

The usual response to this type of market failure is to tax the good. This raises the price and so reduces consumption. However sometimes this does not work to the extent desired. For example with tobacco consumers are addicted and the PED is very inelastic. Educating the population on the dangers is therefore another option and that can include graphic pictures of the harm that tobacco does.

One area of great concern is the diet of the nation. We eat too much overall and or diets include too much fat and salt. This is very concerning because of the health impacts which will shorten life expectancy and impose heavy costs on the NHS.

Taxing fat and salt is difficult, mainly because of the very many products involved. In addition any tax on food would be highly regressive as food takes up a higher proportion of the income of poor households. So far education has not been that effective. Therefore resorting to warning people at the point of sale and trying to get them to more fully consider the information about the product may help.

People know that fat is bad for them in too great a quantity (as are too may calories, salt etc). What they don't know is how much of each is in modern processed food. For some time there has been a call for a uniform method of labelling food to show the content. Each retailer and manufacturer disagreed on the format (some prefer traffic lights others % of daily maximums etc).

Now there is agreement on a uniform system that combines all of the approaches. The move has to be accompanied with education which allows people to understand the dangers of exceeding the recommended daily amounts. But if successful then the demand for high fat and salt goods will shift to the left.

Unfortunately this is only going to be a voluntary scheme so it falls short of 'Regulation'. It is, however, a good example of where adjusting prices is not enough and an example of an alternative policy to reduce market failure. But will it work?

The BBC covers the story here

Fixed exchange rates - pros and cons

Before Hong Kong returned to China it was a small but vibrant trading economy. It dealt primarily with the West and a huge proportion of its activity was traded. 'Made in Hong Kong' was as common a sight as 'Made in China' is today.

Fixed exchange rates were the norm from 1945 to 1971. Hong Kong was too small an economy to maintain its own stable currency and so after the collapse of the world fixed exchange rate system they pegged the HK$ it to the US$.

The Hong Kong economy needed a stable exchange rate so that its firms could trade with certainty, knowing what prices to set and what money would be received. But the maintenance of a fixed exchange rate in turbulent times is difficult and imposes costs as well as benefits on the economy concerned.

Hong Kong's problem is that it chose the US$ to fix to. A perfectly sensible choice at the time, but now the US is pumping money into their economy (Quantitative Easing) this is destabilising the US$.

The BBC article below talks about the recent experience and discusses some of the issues.

The BBC article is here

The complex issue of trade

Japan has seen a fall of over 10% in exports in September compared to a year ago. This is pretty exceptional under any circumstances and threatens the Japanese economy.

The causes are varied and add up to an overall drop. They are:
A boycott of Japanese goods in China
The weakening of European markets
The strong Yen

The unfortunate combination of factors means that japan will see Aggregate Demand falling as net exports (X - M) is a significant influence on the Japanese economy. Japan has run a trade surplus for many years and this has helped raise the rate of growth in Japan. Now a return to recession is a real possibility.

Interdependence of modern economies is a fact of life.

The BBC report the story here

Nobel prize - solutions to market failure

This year the Nobel Prize in Economics has been awarded to two people who have worked on solutions to allocations of resources when prices don't work.

Market failure is common. Scarce resources are then not allocated efficiently and this reduces overall welfare.

Sometimes prices can be adjusted to compensate, perhaps by taxing or subsidising the good or service. When that can't be done other solutions may not be obvious except for some sort of rationing system.

Lloyd Shapely, a mathematician, helped develop early game theory and also produced a paper on matching demand and supply when there are ethical or legal complications. Alvin Roth developed a method to allocate resources from this work, such as organs for transplant.

These two men are unusual winners of the prize, but perhaps appropriately they are applying economics to the real world and it is helping save lives. Given the bad press Economics got thanks to the banks this is good exposure for the discipline.

The prize in Economics is still worth  $1.2 million, and is shared by the two men. Shapely is 89 and could probably have done with the prize a little earlier!

The Guardian reports the prize here

The effectiveness of taxing externalities

Australia introduced a carbon tax of $23 a tonne on July 1st. The aim was to help Australia reduce carbon emissions and meet its 5% reduction target by 2020 (UK target is 50% by 2020 and  80% by 2050 - just saying).

The point of a tax is to raise the price and reduce consumption. By getting people to change the pattern of their expenditure toward the relatively cheaper, lower carbon, goods and services Australian carbon emissions will fall.

By far the biggest contributor to Australian carbon emissions is electricity generation. Australia uses a lot of very dirty coal (especially in Victoria) which has been likened to environmental terrorism. The first data available shows us that there has been a significant change in the use of electricity.

One reason is that there has been quite a take up in solar showers. This reduces an important fraction of daily electricity use, as long as the weather is reasonable of course. So less electricity needs to be generated.

The other effect in the market is the move away from coal by the generators. This is exactly why the carbon tax was introduced.

The Age gives details of the change in power generation.

Employment at a record high

If there is something to celebrate it is that there are more people in work in the UK than ever before. In addition unemployment has fallen from 8.1% to 7.9%, a significantly larger drop than was expected.

This is good news for the economy because more people in work implies higher Real GDP and so an improvement in the standard of living. The Government will be pleased because tax revenues should rise leading to a smaller deficit.

The question of why employment is so high in a recession is one we must visit again. It is almost certainly due in part to a demographic anomaly. The size of the workforce must have risen. Fewer people leaving the workforce (for example not retiring at the previous normal age) and more people gaining jobs would explain this. While a substantial number of people remain unemployed there are more jobs.In other periods unemployment would have fallen substantially already.

There are particular concerns. The young are finding it increasingly difficult to get work and the difference between geographical areas is also widening. Scotland saw a rise in unemployment as did Northern Ireland. Cambridge has the lowest jobless rate overall in the country. Horsham has 1.6% unemployment, Birmingham Ladywood 12.2%. These are big differences showing the costs of unemployment are not evenly distributed.

Good news has to be welcomed. It will help boost confidence in both households and firms, but we really have to start asking about how youth and long term unemployment will be solved over the next few years.

The Telegraph report the figures here with numerous links to related stories.

Inflation falls, but not for long?

The CPI and RPI fell by 0.3% last month. That is good news for the MPC and keeping to the inflation target and is the lowest rate on CPI since November 2009.

The cause of the fall in inflation illustrates that the figure is a moving average. A year ago gas and electricity prices rose significantly, but this year they did not. Of course there were other price rises but not as much as a year ago.

The importance of the September inflation figure is that it many benefits are increased in line with it. So its important for next years Government spending and the fall in inflation is good news for George Osborne.

The BBC covers the story and shows both the influences on the current inflation rate and reviews the benefits that are affected. There is also a section on why lower inflation is good for some people and firms.

The BBC story is here

The debate of EU membership is really coming back

In 1975 the UK held its first ever referendum on whether it should stay in the EU (then the EEC) which it had only joined in 1973. 67.5% of people voted to stay and the Home Secretary of the day, Roy Jenkins, said that it had 'put the uncertainty behind us'.

While there have been people who have called for withdraw, such as UKIP, no mainstream politician has given it serious consideration. Today it appears that the inept and intellectually challenged Education Secretary Michael Gove believes the UK should leave (with support from, among others,  the giant brain of Iain Duncan-Smith).

I have a balanced and tolerant view of Mr Gove, but there is an economic argument for leaving the EU and that debate must now be had. The result will determine nothing less than the economic future of the UK.

The argument for joining the EEC in 1973 was that of trade creation. Barriers to trade would be eliminated between the UK and the other members and the amount of trade and specialisation would increase making everyone better off. This is classic stuff and exactly the sort of thing economists advise countries to do if they want to grow up to be big and strong.

Along with the lowering of trade barriers came political co-operation. This has included a European Parliament and a European Court. EU law supersedes UK law. This is what people like Michael Gove and UKIP object to, it restricts the ability of the UK government to act.

So is there a case for leaving the EU? Well actually yes. The result will depend on the terms of leaving. The ideal solution for the UK would be to get the same deal as Greenland when it left. That put Greenland in the same position as Norway - a part of the single EU market, but not a member.

Norway gets all the benefits of specialisation and trade, but pays nothing towards the running of the EU, has no say in the rules and gets none of the political benefits of a single European voice.

The Greenland option is going to be very hard to stop politically. The question to be decided is 'Do you want Britain to be a simple economic partner of Europe, or a political partner in Europe?'

Under starters orders.  This is going to run longer than the debt crisis!

The Mail (who else?) report Gove's views here

Incomplete analysis can lead to errors

In a time when the Department for Transport have admitted their analysis of Rail Franchise bids is flawed we are reminded that a faulty method can lead to poor decisions.

One of the most difficult decisions to be made is what transport infrastructure to invest in. There are very many factors to consider, such as forecasts of future demand and external costs and benefits. All of these are difficult to value.

The solution is a full Cost-Benefit Analysis that considers all the private and external costs and values them properly. Only then can a judgement be made and even so substantial margins of error must be considered.

So should we give much credibility to a study by MIT that a third runway at Heathrow is a bad idea?

The MIT study says that, compared to a new Thames Estuary airport (Boris Island), a third runway at Heathrow would cause more early deaths due to pollution. So that's it then, decision made.

However when questioned the authors admitted they had not included any of the following issues in their study:

* The cost of construction at either site
* The impact on local transport at either site
* The impact of extra road traffic too and from any new airport
* The external costs and benefits of either airport

Of course their defence was that they were only looking at health impacts of the two options and that is actually quite reasonable. It represents a contribution to the full cost-benefit analysis and a valuable one at that.

The Guardian reports the study here

From market prices to inflation

Markets set the prices for individual goods. Inflation is the continuous rise in the general price level. Of course we are taught that we must not confuse the two. When the price of a particular good rises this is due to either a rise in demand or a supply constraint, not inflation. But surely there is a connection?

The issue of food prices is a good example of where we can link market prices and inflation. Food prices generally are about to rise due to several factors:

1. The wet summer in the UK has led to a lower harvest and it is proving difficult to plant next years crop.
2. There have been droughts in the USA, Russia and southern Europe during the growing season.

This means that cereal prices overall are rising. It's due to a supply shock, relative scarcity has increased.

But this is going to feed through into inflation as it will cause a wider impact on prices.

Clearly the goods which use soya, wheat etc will have to pass on the extra costs. The price of bread for example. But cereal crops are also used to make biofuel and to feed animals. So we can, at the very least, expect the price of meat to rise too.

While these are changes in relative prices of individual goods this will feed through into inflation. Food is a significant item in average household budgets and so has a significant weight in the CPI. The rise in food prices, and goods which use inputs from the agricultural sector, will feed into CPI and cause a rise in the index.

This is, of course, quite reasonable. Average households will find the cost of living is rising

The Guardian covers the story here

The case for Plan A

Yesterday the Conservatives put the argument for continuing their plan to reduce the government budget deficit in the strongest terms for over a year.

Fundamentally there is on two types of news on the economy, bad and absolutely awful. Given that the government might as well take it on the chin and express their beliefs.

George Osbourne, The Chancellor, said he would find more money through benefit cuts. This plays surprisingly well outside of the Conservative Party with the general public. It remains to be seen if it can be done and whether people will accept the reality.

The Prime Minister asserted the cuts will continue, despite the growth forecast for the UK by the IMF being cut. (Well we all knew that!). He pointed out that one million new private sector jobs have been created and this is compensating for public sector cuts.

The government argues that the deficit needs to be reduced to avoid problems in the future. The Opposition says a boost is needed to get the economy growing again.

The IMF says that a short term stimulus might be appropriate, but that the markets will take fright on any large scale and longer term rise in spending that will raise the deficit. So some support for both sides there.

One issue that is clear is that the government has not reduced the deficit as far as they wanted to. This shows just how difficult it is to cut spending. Good luck with the plan George.

The Independent cover the current issues here

"Most people don't understand inflation"

The Office for National Statistics (ONS) are considering changing the way the Retail Price Index (RPI) is calculated.

The RPI and CPI don't provided the same figures for inflation as they have different baskets of good and are calculated in a different way.

This may not seem that important but government benefits, pensions and some investments are linked to one index or the other. When one is constantly higher than the other this means the gap between the various benefits and pensions widen.

Also some may say that the government wants the RPI to be lower so they can save money on those payments based on RPI.

So if the RPI is adjusted it may do some groups harm. Pensioners and pension funds among them.

The ONS are consulting on the need for change, but not many people are likely to respond. According to research very few people understand inflation let alone the complexities of how it is calculated. It may be that people with a lot to lose stay silent.

Rest assured I will be adding my voice to the consultation, but I'd like the use of geometric means in RPI which will cause the reported figure to fall a little.

The article on this raises important points and helps you to better understand how inflation is measured.

The BBC report the issue here

Consumer confidence returning?

Consumption is by far the largest component of Aggregate Demand. Around two-thirds of the total. Therefore rising consumer confidence will be good news for the economy as it struggles out of the double dip of this recession.

Consumers have been shell shocked since 2009. Real income is down due to low wage rises and inflation which is higher than the wage rises (in the public sector and some industries wages have been frozen or even fallen in money terms). Also the uncertainty associated with the recession, the Eurozone crisis and government cuts has led to a higher savings rate.

Currently the economy needs short-run growth desperately. Just using up more of the idle resources of the economy will help a lot. Output and employment will rise and there is then a good chance that a sustainable rate of growth will emerge. Households spending more will allow this to happen.

So the news from Visa that shoppers have spent more in September (around 3%) is great news. One swallow does not make a summer, but it really is a good sign.

The BBC report the figures and speculate on whether the economy has really turned the corner here.

Fuel sales decline 15%

The AA is reporting fuel sales are down 15% in the UK, that's 1.7bn billion litres less compared with three years ago.

The AA blame rising fuel prices. The price of petrol was around £1.05 a litre three years ago and is now £1.37.

Can we infer the Price Elasticity of Demand from this data? Well actually no, ceteris paribus does not apply.

You could calculate the PED but it won't be very accurate. Incomes have changed markedly in the recession, moves to reduce carbon emissions have been ongoing and of course households have had time to adjust to higher prices since the 2008 peak.

Interestingly the same phenomenon has been reported all over the world. All over Europe, in India and North America fuel consumption is down.

The BBC report the drop here

Just because it has not changed does not mean its not significant

Today both the European Central Bank (ECB) and Bank of England decided to leave interest rates unchanged. For the UK it means interest rates have been at an all time low of 0.5% since March 2009.

This lack of change is deceptive. The low interest rates reflect concerns over the very low levels of demand in the economy and the expansionary monetary policy which is trying to stimulate Aggregate Demand. So what is happening is an ongoing active monetary policy.

But rates are pretty much as low as they can go (although there are rumours of a fall to 0.25% next month) and additional help through more Quantitative Easing (printing money) may still be required to help the economy recover.

The decisions to be made about monetary policy are not straightforward. The Bank of England must predict what inflation will be in two years time. As the linked article below shows it is not even clear what the July to September GDP figures will be, so predicting influences on inflation up to two years ahead is far from straightforward.

Monetary policy is a key policy weapon. Balancing the needs of growth (which needs low interest rates) and inflation, which is still above target, is a continuing headache.

The BBC explain some of the difficulties here

Another rail fiasco

The decision to award the West Coast Main Line franchise to First Group in August has already caused a commotion. Virgin had launched a legal challenge claiming 'somebody does not like us at the DfT' (Department for Transport).

Well its not only people in the DfT who find Richard Branson a pain in the arse, but that was not the reason Virgin lost. Officials miscalculated the time value of money and passenger numbers in the 13 year franchise bid. It does make a difference when money flows are received as inflation and interest rates are key elements.

The whole process is now up in the air and will have to be examined again.

For us the process is the issue. How do we assess long term transport projects? Stephen Glaister a former LSE and Imperial professor is a specialist Transport Economist. He looks at the issues in this excellent Guardian article here. (Essential for A2!)

Glaister's article is here

Can government spending really help the recovery

It is the turn of the Labour Party to have their conference this week and opposition parties generally have a free hit at the government.

The Shadow Chancellor, Ed Balls, used his speech to suggest that the government should spend more money (£4 billion) on building new houses and giving a tax break to first time house buyers to try and boost economic activity.

This is standard Keynesian stuff. The government spends more money to boost Aggregate Demand. The multiplier effect then raises national income and employment by even more than that. Balls claims it will 'kick start' the economy.

It's good politics, but not really believable as economic policy. The government is already spending far more than it raises (around £170 billion) to boost Aggregate Demand. Although using government spending on construction keeps a lot of the spending local at first the multiplier is very low (maybe 1.25?) and so it might raise GDP by £5billion if its new money.

The biggest hole in the Balls argument is how it would be funded. According to him Labour would use the money raised from the auction of 4G licences by the mobile phone companies. That money has already been earmarked for use so actually it would be financed by more borrowing.

The argument about how much to stimulate the economy will go on for ever. See what you think of the Balls plan.

The Independent report the policy proposal here